by Travis Johnson, Stock Gumshoe | February 22, 2019 12:13 pm
I don’t want to give you too much to read, since probably the most interesting reading this weekend will be Warren Buffett’s annual letter to shareholders (which should be posted here as part of Berkshire’s Annual Report, around 8am EST tomorrow), but I do have a quick teaser answer to share with you… and a couple earnings-related updates on some Real Money Portfolio stocks…
First, as I was lolling on vacation for a few days this week I got buckets of questions about Marin Katusa’s latest “Forever Royalties” pitch for his Katusa’s Resource Opportunities newsletter ($2,500, no refunds), so I should get you a quick answer… and as you might not be surprised to hear, it’s the same answer as I provided the last time Katusa pitched a royalty story.
Back in June, Marin was promoting the idea of “Independence Day Royalties” with a tease that was very light on clues. I guessed back then that he was hinting at Lucara Diamond, the best match I could identify, and I think that’s still the company he’s teasing today.
Why so? He doesn’t drop a lot of clues, but these are the ones I gleaned from his latest ad, which he calls “Forever Royalties” and says will be “my single biggest investment ever”:
“A disruptive new development—similar to a ‘toll-road’ crossing three continents—will completely turn a secretive $80 billion resource industry upside down….
“I call this opportunity ‘Forever Royalties,’ for two reasons:
“One, because this rare resource can truly last a lifetime…
“And two, because never before in history have royalties on this valuable commodity been available to anyone outside the industry—until now.”
He goes so far as to compare this to having a royalty on email, or on fracking… which is a pretty effervescent level of hype… but he does also drop a few more specific clues:
“It’s publicly traded… but it’s not a conventional royalty stock.
“If you ran a stock screen for ‘royalty companies,’ you’d never find it.
“Basically, it’s a ‘backdoor’ way to collect royalty checks from this $80 billion industry.”
And it’s well-established enough to have the backing of some big names…
“The investment and management team behind this secret ‘toll-road’ opportunity – all of whom I know and have personally worked with – are the 1-percenters of natural resource companies.”
So what does this company do?
“The company itself owns and runs one of the highest-margin and most valuable operations in the world.
On the surface, it looks just like a boring, well-run, profitable company.”
But, we’re told, the secret sauce hiding underneath the boring, well-run company is their new “toll road” business that will shake up the industry:
“In the current market, because this resource is so valuable, it always gets to where it’s going, from the mine to the end-user…
“But the ‘road’ it travels to get there is long, fractured, inefficient, and not at all transparent.
More on this idea of a “toll road:”
“This newly developed technology will turn it into a modern super-highway with toll ‘checkpoints’ that will take just seconds, used by every single company in the sector.
“That’s why I refer to it as a ‘toll road’…
“Because by buying shares of this company, you’ll receive a little piece of every single ‘checkpoint’ transaction – a toll – in this entire industry… for as long as you want.”
That’s all pretty similar to the clues that were being dropped last June… so why am I more certain now that Lucara is the correct solution? Well, it still matches all the clues, but Katusa also drops a couple new clues:
“This isn’t some pipe-dream technology that may or may not happen in the future… or is still in the testing phase, with years before it’s a reality.
“This ‘toll-road’ is online right now—and it just completed its first run.
“Seven major companies took part. And the royalty checks will be sent out in March of this year.”
So yes, that’s still a reference to the Clara diamond-trading platform that Lucara bought last year, and which, yes, did have its first test run recently — seven major diamond buyers participated in that run, which is described in a press release here.
Clara is basically an electronic selling platform for diamonds that’s designed to get better prices for producers (like Lucara, which owns it and is so far the only producer participating) by doing stone-by-stone pricing that’s made more efficient by electronic matching, though they also (arguably) get a little gimmicky by using blockchain and a diamond “fingerprint” to ensure traceability and security. So far, it’s just Lucara selling its own diamonds in this way instead of by bulk tender offers as has been traditional in the industry for eons, and they’re hoping to bring other miners onboard as well and say there is already some interest — the value of Clara, they hope, is not just that it’s a way to sell their own stones at slightly better prices, but that it’s a scalable platform that could generate some high-margin revenue for them if they can convince other miners to also sell their stones through Clara.
So far, though, Clara is a tiny part of the business and has little impact on financials — whether it takes off over the coming years and provides a meaningful new source of revenue for Lucara is an open question, and not one where I have any insight in handicapping the answer.
The core business for Lucara, their actual Karowe diamond mine, is a bit more challenging — 2018 was a much worse year for them than 2017 was, partly because of higher operating costs and a shift to a new mining contractor, and partly because they sold one massive diamond in 2017 that swayed the results (that was the 1,109 carat Lesedi La Rona, which sold for more than $50 million and accounted for almost 25% of revenue that year). That’s been the story with Lucara for a while, though not to that dramatic extent — their performance varies a lot based on the number of “specials” they find and sell (“specials” are the crazy-large diamonds — 10+ carats, including a few dozen most years that are larger than 100 carats).
And that mine, in Botswana, is also in a bit of a transition phase — they are expecting to release a feasibility study sometime in the next few months for building an underground mine to extend the mine life (from 2026 to “at least 2036”), so we’ll know more about the potential economics of that later this year. It is a profitable and pretty high margin mine at this point, but that might change if the underground operations are a lot more expensive.
And yes, you do sort of collect “royalties,” along with the insiders — that’s because Lucara pays a substantial dividend, currently 10 cents (Canadian) per year (2.5 cents/quarter). That dividend is based on the mining operation which generates essentially all of their revenue, not on the “maybe someday” revenue stream of the Clara platform, but it is real money… and it is generally a low-cost and profitable mine. And yes, the ex-dividend date is March 22, so it’s sort of reasonable to say that “royalty checks” are being mailed in March (though the dividend isn’t based on Clara at all, and is unchanged from last year… and won’t actually hit your account until April 11).
So yes, even though the ad hints at yours truly (“This is one secret we don’t want spilling out to the general public by our favorite stock sleuth,”) and it’s still less than a 100% certainty, I’m more sure now than I was in June that Katusa’s new “royalty” company is Lucara Diamond (LUC.TO, LUCRF OTC in the US). Which just released its latest quarterly (and full year) results and, if we’re going to be informed by the falling share price, failed to inspire investors with said results (the stock is down another 5% as I’m typing).
And my opinion hasn’t changed — the stock is down by 20-25% since Katusa was pitching them last summer, but going by the financials it’s still a decent miner with established (if uneven) profitability and a meaningful dividend (almost 6% now, thanks to the falling stock price), so if you want to own a small single-mine diamond miner you could do worse. Just keep in mind that you’re also carrying the risk of a business that’s based entirely on one mine, so the operations and expansion capacity of that mine, along with wholesale diamond prices and the presence or absence of more mega-diamonds in their ore, will do more to determine whether any particular year delights or disappoints Lucara investors than will their new Clara diamond-selling platform.
Marin Katusa seems to believe that Clara will dominate the industry and begin to take a little slice of every diamond sale on earth, which might be possible, I don’t know, but it’s not necessarily an industry that changes quickly or embraces technology… and it’s certainly not a given that other miners or traders will decide to just throw their log in with Lucara instead of developing their own platforms, so I’d guess that you’ll need to have a lot of patience on that part of the business. If you want to be conservative, probably just hoping that it will improve Lucara’s selling prices for their own stones by 5-10% by cutting out some of the middlemen in the supply chain is a more realistic goal… and if you think about it like that, it might help you to sharpen your focus on the actual mining operation which generates all of their revenue.
So there’s one for you… what else is going in the portfolio this week?
The Trade Desk (TTD) wowed investors again this quarter, beating estimates handily on both revenue and earnings and, again, publishing very optimistic comments from CEO Jeff Green, who usually sounds like he can’t believe how lucky he is to have built such a fast-growing company.
Things seem to have been fantastic all around for TTD, which essentially sells access to a software/analytics platform, with access to inventory from lots of different publishers, that lets advertisers choose their ad placements automatically, driven by data. By far the fastest growing segment of their business is in “connected TV,” which is largely services like Hulu that provide an ad-supported video stream, but that’s still a fairly small business and they are growing fast in mobile advertising as well, including video ads, and expanding internationally.
This is still a very small chunk of the ad world — their advertisers spent about $2.5 billion on The Trade Desk’s platform last year, which is impressive and enough to drive great revenue growth for TTD… but it’s also less than one half of one percent of the global advertising market. There will be a ceiling on how big programmatic advertising can be, and on what portions of the global ad market can be automated and directly data-driven, but we’re not likely to be anywhere close to that ceiling. The bigger fear is competition, and there isn’t a lot of high-profile competition right now that worries me. Add on that TTD benefits from scrutiny of Facebook and Alphabet, since it’s largely positioned as a way to access the rest of the media/advertising world that’s not stuck in FB and GOOG’s “walled gardens,” and there’s no real reason for optimism about the “story” of Trade Desk shares to slow down.
Google’s decision to close off advertiser access to some of its data (the DoubleClick ID) provided a nice boon to The Trade Desk in the second half of last year, just when it was releasing powerful new software tools and pushing its “Open ID” capability that can help provide similar kinds of data (though without the personally identifiable connections Google has), and the current YouTube worries are only increasing the relative value of professional and controlled content platforms (some advertisers are very publicly “pausing” their Youtube spending just this week because of the latest wave of “inappropriate content” running alongside ads — in this case, pedophiles lurking in the comments sections, though every few months its something different… “user generated” and “automatic” mean huge profit from scale and without content creation costs, but also huge challenges when it comes to policing content).
So pretty much everything is going The Trade Desk’s way, yet again. And in addition to beating estimates handily they also boosted their forecast for 2019 — this year is not likely to be as fantastic as last year was, they had some surprise boosts to their business in 2018 that they couldn’t have forecasted (like Google canceling access to DoubleClick ID), so they think they’re likely to be more accurate with their forecast this year. It’s certainly a stock I want to hold, but is it buyable at these prices (after that report, it opened up at new all-time highs today)?
Well, part of the reason that I started reporting my Real Money Portfolio to the Irregulars a few years ago was that just sharing my sentiment about a stock wasn’t terribly helpful… it’s easy to say you like something or don’t like it, and to change that opinion a dozen times in a month, the sentiment that really counts is the one that’s backed by portfolio moves and allocations. The flip side of that, though, is that my opinion is very much colored by my position and by my position size… so I really can’t buy more TTD here, which makes it a hold. I do like the company a lot, and think everything is going very well for them, but I’m also cognizant of the fact that it’s very volatile and hasn’t ever tended to move straight up — if you don’t own shares I wouldn’t try to talk you out of taking a small position in a growth darling that still has huge long-term growth potential, but I would wait for the almost-inevitable dips and disappointments to make any larger buys… and personally, with TTD closing in on a 4% position in my portfolio, I’ll continue to hold with a small smile on my face.
That’s usually my default position with stocks in rapid-growth companies… it’s OK to buy a little at nosebleed valuations if the potential growth is compelling, particularly because that sharpens the mind and forces you to focus on the stock and understand what you think their future looks like, but don’t commit a lot. Huge expectations and lopsided sentiment cause volatile share prices… and volatile share prices present opportunities for investors who are already comfortable with the company and ready to think long term. You just have to walk the thin line for companies that you really think are compelling long-term opportunities — buying a few shares so you don’t suffer from “fear of missing out” if it shoots 500% higher and never looks back, as is possible but unlikely, but not buying with so much optimism that you’re destroyed the next time the stock falls 25%. Momentum growth stocks can be hard to handle psychologically, even if you think the underlying company has dramatic real potential — not many companies can justify trading at 20X sales without scaring people out every now and then.
I originally bought TTD shares when it was in a little bubble of optimism in the $60s in 2017, but didn’t make it a substantial position until it had a nasty several months and dropped almost 30%. That was still a tough decision, buying more shares, and is wise and easy only in retrospect — the stock did almost hit a stop loss trigger back then, and buying stocks that have fallen sharply is frightening, which is why they sometimes keep falling for a while. If things go as I expect for TTD, the stock will show great gains even from this point five years from now… but I would be shocked if there aren’t some big 20-30% dips along the way. I don’t know if I’ll ever buy more, we’ll have to see what my portfolio composition is like at the time and I’ll likely always be uncomfortable with a stock that’s this volatile being more than 3-5% of my portfolio, but I will also keep adding more cash to my portfolio over time, and one never knows what the future holds.
The latest YouTube scandal, by the way, does little to dissuade me from liking Alphabet (GOOG), which has been one of my largest positions for years. Yes, it’s awful that user-generated content surfaces the ugliness of human beings, from racists to pedophiles to whatever other ugliness you can imagine, but it’s also true that it builds community and democratizes creativity. I suspect we will forever be debating where the balance should be, but user-generated content isn’t going away and Facebook and Alphabet are so large and entrenched (and so cash-rich) that they will be uniquely positioned to continue to dominate — every solution to these kinds of problems requires throwing money and people at the issue, and no one can throw as much money as Google at a problem. Any purchases I make in GOOG from this point would likely be in the “nibble” category, since it’s already 6% of my portfolio, but I still think it’s a pretty easy buy below $1,050 or so.
And iQiyi (IQ) reported this week, too — another phenomenal growth story, as they now close in on 100 million paying subscribers subscribers (87 million at the end of the year, up from 50 million at the end of 2017)… and, like Netflix before them, another phenomenal “damn the torpedoes, full speed ahead” spending story (spending accelerated in the fourth quarter as they invested even more heavily in content, so in the quarter they essentially spent $1.5 billion to get $1 billion in revenue). This is a stock where I think it makes sense to speculate with a relatively small position, mostly because of the potential that this spending and their ability to develop hit content (they’re doing well at that so far) could let them build a Netflix-like business over the next few years, but the heavy spending makes this a bit of a high-wire act.
If they were the only big company building a consumer video streaming service and trying to be the “next Netflix” in China, I’d invest more… but since they’re competing against Tencent and Alibaba, which have insanely deep pockets, I keep the position small. Nothing in this quarter changes that, it just gives me some increasing confidence that they’re following that Netflix script and pushing the kind of content that their customers want, so as long as the subscriber numbers keep climbing they’re on the right track. We won’t know for a few years whether their heavy spending was worthwhile, if video streaming in China ends up being a price-competition business it probably won’t work, but if they outlast or “outhit” Tencent Video and Youku Tudou (from Alibaba) and the other competitors, and are able to continue growing their paying subscriber base without slashing prices, the future could be phenomenal. My position is unchanged, I still think it’s worth speculating anywhere in the $15-25 neighborhood… I may nibble more, as I did a couple months ago, but I’m unlikely to place a big bet on this stock. This is one that will be driven by big-picture concerns about China in the short term, and by sentiment about whether or not they’re going to “win” the China streaming wars, not by the revenue number in any given quarter. I think it’s going well so far, but stocks built on sentiment can fall very fast and keeping the position size small gives me the freedom to let it ride.
So that’s your brain dump for this week, dear friends — enjoy your weekend, and we’ll be back with more teaser solutions and blatheration for you in a couple days!
Disclosure: I own shares of The Trade Desk, Alphabet, Facebook, and iQiyi among the stocks mentioned above. I will not trade in any covered stock for at least three days, per Stock Gumshoe’s trading rules.
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