The problem is I never bought. I kept waiting and waiting for a “cheap enough” valuation that never arrives. A few years later the stock has tripled, while that long awaited recession never came either. (Yes it’s beyond frustrating.)

Here I would recommend accumulating BFAM on the next 10–15% pull back.

Summary Upside

• Sustained high single digit/low double digits top line growth.
• Margin boosts from operating and financial leverage.
• Ability to roll up small operators using high price stocks = “equity leverage” / reflexivity.
• Option to open up centers to unsponsored families.
• Possibility of franchising /capital light model in the future.
• Stability from solid free cash flows.

Summary Downside

• Corporate sponsored model would be hit in a recession
• Trend toward smaller companies and work from home could hurt BFAM

Bright Horizons operates almost 1,100 child care centers, about 70%/30% split between North America and Europe. North American centers have an average capacity of 126 children per location. European centers can cater to 81 children per location.

Instead of going direct to consumer, the company finds employers who want to subsidize childcare for employees. Typically the employer builds the center, while BFAM manages the operation.

The employer based model allows BFAM to attract parents/kids in bulk, so the company enjoys efficient sales and marketing costs. But it exposes BFAM to the job market as well as trends in corporate market.

• Anecdotally, there is political will to rein in, or even break up big corporations, the type that’s most likely to provide these childcare benefits.
• In general there is a trend toward smaller companies or startups — these are less likely to be BFAM clients.
• The trend is also for more working from home / remotely. Both would decrease the need for child care centers near office sites
• M&A among clients can lead to consolidation of work force or child centers. This can lead to closures for BFAM.

BFAM has two operating models for real estate. In the employer sponsored model (that’s most centers), an employer sponsor funds the development and ongoing maintenance of the center, and BFAM has an operating contract to manage the center. In the lease/consortium model, BFAM leases the property itself.

Next, let’s take a look at valuation and analyze if BFAM can grow into the valuation.

After several years of unsuccessful waiting, I’m starting to think BFAM’s valuation is not so bad.

A nice chunk of capex is growth capex. If you deduct only maintenance capex, management says they expect ~$250mm-$275mm of free cash flows for 2019.

So at ~$130.5/share or $7.6bn market cap, this is about 29x FCF. That’s actually not too bad in today’s environment, if growth can continue for the next few years.

Remember, this is the sort of consumer facing stock that never gets cheap. If fundamental performance holds up, floor multiple is probably around 20x FCF. If that FCF grows ~15% a year (which it does right now), then in 3–4 years this grows into floor valuation — i.e. you get your principal back and the rest is upside.

An expensive stock actually juices earning growth for BFAM, as it allows management to pay for acquisitions accretively (e.g. buying a center that has earning yield of 10% and pay with stocks that yield 3% will grow your EPS). It’s also a competitive advantage whether BFAM is trying to enter a new market or further build out its presence in existing markets and go for local density.

Despite fairly frequent acquisitions, management did a great job the past few years keeping debt controlled while using buybacks to decrease share count.

Originally published at https://greytabinvest.blogspot.com.

The reasons I’m holding remain the same: 1) intermediate term defensiveness, 2) long term upside, and 3) Stewart acquisition synergies. For the next year or so it’s a value/dividend play: number one player in oligopoly; strong cash flow generation at solid valuation; great balance sheet; 3%+ dividend yield. In the longer term FNF has upside from demographic tailwind (millennial reaching prime home buying age). FNF is also in the process of acquiring the industry’s number three player, Stewart, and will benefit from acquisition synergies.

Quarterly earnings will fluctuate and are not my focus. The main things I look for in earning calls are: 1) Stewart acquisition progress, 2) financial health, and 3) any disruptive threats in the horizon. Here are the latest.

1) STC acquisition. Not much update on this front. The deal is still stuck on NY regulators and it may come down to divestitures.

2) Financials. Balance sheet remains very strong. FNF debt outstanding was $837mm (compared to investment portfolio of more than 4.6bn). Debt to total capital ratio was 14%.

3) Disruptive Threats. One of the biggest trends in real estate is the emergence of iBuyers. The risks for FNF are 1) they have relationships with real estate agents who recommend FNF’s services, but iBuyers seek to place themselves at the center of transaction, resulting in channel disruption for FNF. 2) Also iBuyers will have better bargaining leverage compared to regular home owners since they hold large portfolios.

This exchange from 1Q19 transcript shows that FNF may have not grasped the full significance of iBuyer. It’s hard to tell, maybe management is simply being careful about what they say to maintain relationship with real estate agents. That said, it’s still early innings in the iBuyer game and a group with strong tech track record like FNF will likely get on top of it.

Mike Nolan
“…I think what we see at least today is that the real estate agent is still at the center of the transaction. And so while there’s disruption potentially in brokerage, I don’t know that that’s disrupted the agent yet. Now that could change of course. But we’re really focused on real estate agents, because that’s who gives us the transactions and that’s why we’ve made investments in real estate technology and lead gen and things like that because that’s where we’re going to continue to focus.

Jason Deleeuw
Got it. And what about the iBuyers and — I mean, how are you relating to them? It seems like it’s going to continue to be a growing segment of the market. Is there a change in how you’re doing that? Or you’re reaching out to them or you’re already working with some of them? How is that working?

Mike Nolan
Really both. We’re reaching out and working with some of them. They’re a customer just like anyone else.

They have transactional volume that they can control. And we’d like to perform that title and closing works. So, we’re calling on them. We’re working with them. In some cases they might be working with our agents. So by extension we’re working with them. But they’re really just another type of customer from our perspective.

Overall, title insurance is a sleep industry and the latest quarter was business as usual. I continue to hold a 4%-5% position, and would hold even in the unlikely scenario that Stewart acquisition does not come through.

Checking In on Fidelity National Financial (FNF) was originally published in Money Notes on Medium, where people are continuing the conversation by highlighting and responding to this story.

The Long Game

As a reminder, we’re playing a very long game here. What matters strategically is being closer to end customers and the transaction itself. Achieving that would flip the power dynamics of the industry in Zillow’s favor.

Here’s a tweet storm I put out a while back on how Zillow has to change its role in the transaction flow.

1/x. Everything Zillow $Z $ZG does (inc. iBuyer and lending) should be judged on how it helps them get closer to consumer and transaction. This goes hand in hand with how data flows through the value chain.

— mspacey (@mspacey4415) April 3, 2019

As a clarification, Zillow Offers will help generate listings instead of “stealing” them from agents (as the accusations go). Here’s how.

Prospective sellers can check out binding offers from Zillow before awarding that listing to an agent. At that point two things can happen: a) if they sell to Zillow, then Zillow obviously controls the seller listing for that property; b) even if they don’t sell to Zillow, Zillow would have came across this clear intention to sell before the agents — a “pre-seller listing” if you will. This is incredibly valuable information in the industry.

In short, by beating agents to listing generation, iBuyers change the entire power dynamics of real estate value chain.

This shift in leverage toward the platforms is why even Keller Williams is getting into iBuying, as seen in this article:

“I feel like I have no choice now,” CEO Gary Keller said during a presentation in January. “I can’t allow Opendoor or Zillow to go out and be the only player in the iBuyer space and then begin to dictate terms and build brand around ‘they buy houses.’”

The key words are “dictate terms”. Once you win the game and control the listings, there are many options for monetizing. For now investors are still worrying about Premier Agents, but in a few years what matters won’t be Premier Agent, but “Premier Listings” or whatevers Zillow choose to call their product.

How to Track Progress; Status from 1Q19 Earning

In judging Zillow’s strategic progress, I’m looking for a few things. First, I want to see the iBuyer market taking off. Second, I want to see ZG mitigate the pressure to sell inventories at inopportune times (most likely by addressing holding cost via renting). At some point down the line, I also want to see proof that iBuyer proliferation is giving Zillow greater leverage over the value chain.

Regarding the 2nd point, here’s another tweet storm (sometimes I find the condensed format of Twitter explains things better).

1/x. Today’s Barclays report on $Z $ZG has a good point — if you try to flip homes but it’s on market too long, then selling price & iBuyer margins are going to take hits.

— mspacey (@mspacey4415) March 15, 2019

So how are we doing? The latest quarterly earnings from Zillow and Redfin showed clear signs of market demand for iBuying. Zillow Offers revenue ramping from zero to ~$130mm to $240mm for the coming quarter is no small feat. More importantly, inbound seller requests are impressive:

“In Q1, we received more than 35,000 seller request and that demand is rapidly accelerating. We now receive one request every two minutes, which is nearly $200 million in potential transaction value per day.”

Redfin’s program, although on a smaller scale, also shows strong market demand.

“From the first quarter of 2018 to the first quarter of 2019, RedfinNow quadrupled the number of homes we sold. This was still less than 50 sales in a quarter, so we are far from the scale of competitors… Demand in Dallas and Denver, the markets we opened in December and March, has been stronger than we anticipated.”

That’s enough for me to conclude that iBuyers are gaining traction, and that the game is changing in Zillow’s favor. So I added to my position.

What I have not seen so far is the second progress criteria — mitigate pressure to sell by controlling holding cost. On the other hand, this could actually be an upside opportunity for the stock. The day Zillow announces some single-family-for-rent REIT is the day that bear thesis of “Zillow is getting into capital intensive home flipping game” goes away.

Remaining Questions

There are some remaining questions I’m still considering. The biggest one is how the game works in a multi-polar iBuyer world.

The iBuying game is on, and obviously Zillow can’t buy all the homes for itself. So this will not be some winner-take-all, monopolistic market. In that world do you really have power over agents? Yes, iBuyers will control a good chunk of listings, so agents have to go to them. But won’t agents pit one iBuyer against another?

The answer is to be determined, but I would say in any case Zillow will still have better power vis-à-vis the agents, and thus profit potential, compared to now.

A Follow up on Zillow: Tracking Strategic Progress was originally published in Money Notes on Medium, where people are continuing the conversation by highlighting and responding to this story.

In my original post below, I talked about the concept that fraud is cyclical. It turns out there are words for it — the “bezzle” and “net psychic wealth” — coined by John Kenneth Galbraith. He explains it much more elegantly than I can:

“Weeks, months or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in — or more precisely not in — the country’s business and banks. This inventory — it should perhaps be called the bezzle — amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.”

- John Kenneth Galbraith

So the “fraud is cyclical” thing is certainly not any unique insight of mine. In my post, I further distinguish between frauds perpetrated by management, frauds unknown to management, and unintentionally inflated results from murky data.

Original Post (1/19/2019)

I recently read Howard Mark’s “Mastering the Market Cycle”. It was particularly interesting to see how he reconciles common value investing believes like “can’t time the market”, “ignore the macro”, and so on with more acceptable topics like “where are we in the cycle”. I had always thought the differences are little more than semantics, but Howard Mark pointed out some subtle differences that I had not thought of.

Reading the book also had me thinking through cycles some more. Here are just some thoughts that I will elaborate in this post.

• Why credit cycles do die of old age, and how lack of new borrowings alone would lead to recession.
• Instead of looking at asset prices and judge whether they are rich or cheap, look at capital provider’s behaviors. Are deals getting done at ridiculous terms?
• Thoughts on inflated earnings. While most investors are well aware of natural cyclicality, what’s less well understood are various degrees of fraud and “pushing the envelope” behaviors.

Why Cycles Do Die of Old Age

Bull markets die with the end of credit cycles, which die of old age.

Over the past 30 years debt to GDP ratio throughout the world has ballooned, meaning new borrowings drive an ever bigger share of spending.

Whenever someone take out a mortgage to build a new home — that stimulates the economy. You take out an auto loan to buy a new car, that stimulate the economy.

But how many mortgages and auto loans can I take on? How many houses and cars can you buy? TVs? If you just bought a new house this year, chances are you’re not about to buy another one next year. Not when you’re up to your neck in debt.

As time goes on we approach some natural limit on indebtedness, and new borrowing activity decreases. Instead of borrowing, we have to pay down debt. That means less spending in the economy, and less spending means less jobs are needed.

This may not be obvious to some — less borrowing and/or paying down debt may be prudent, but it causes the economy to contract.

So thus credit cycles do die of old age, and with that, spending and the associated bull markets die of old age.

Look at What Investors Do, Not What They Say. Oversupply of capital

Here’s maybe the most useful thing I learned from Mark’s book — in judging where we are in the cycle, it’s much better to judge investor behavior rather than asset valuation, or even investor sentiment as expressed through media.

Asset valuation is inevitably subjective (7x PE looks cheap but is that peak earning or not? Depends on if you think if a recession is coming soon right?).

Investor sentiment and news flow can also be misleading. News headlines and Twitter can be flooded with panicky takes, but if VC deals are still getting done at 20x revenue then it’s hard to say the market is in capitulation mode.

Much more reliable are investor actions, as expressed through lending terms, M&A terms, IPO terms.

What does this all mean for us now (December 2018)? The U.S. stock market has taken a beating; news flows are undoubtedly bearish (trade wars! Government shut downs!) And we have cyclicals like Goldman Sachs trading at 7x PE. Are we near bottom of the cycle? I would say hardly.

Masayoshi/Softbank’s Vision Fund is buying anything and everything with Saudi money. Companies are still doing large buybacks. Consumer staples are getting into marijuana space at high valuations. Amazon is still expanding into new industries everyday. These are not signs of capitulation.

Intuitively, ease of financing also implies lowers barriers to entry, excess capacity, and crowded competition in the underlying industries. This “creative destruction” is not good for investors.

Frauds (and false profits) are Also Cyclical

I think frauds are important triggers of financial crisis because the “you think you have money, but suddenly you don’t” effect triggers panics and sudden liquidity demands.

It’s no coincidence that scandals like Enron and Madoff get uncovered at end of the cycle. For one, eroding asset values force investors to take a cold hard look at their portfolio, and there frauds are uncovered. Second, the unveiling of fraud alert the market to huge losses, which leads to a more skeptical market and even more unveiling of frauds.

Frauds are cyclical. They may be discovered only after the fact, but some portion of an economy’s output will always be from questionable behaviors. More at top of cycle, less at bottom of cycle; less frequently discovered at the top, more uncovered near the bottom.

Frauds may have nothing to do with management’s integrity. Frauds can take place while senior managers are blissfully unaware, or even explicitly forbids it. The Wells Fargo scandal from a few years back — where low level branch employees create fake client accounts to meet aggressive sales goals — is an example.

As the economy expands and firms fight for market share, the pressure to improve performance naturally incentivizes all sorts of fraudulent or “push the envelope” behavior that inflates revenues.

Nor does inflated revenue and data need to come from intentional fraud. Ellen Pao’s “it’s all fake” tweet has an interesting discussion here.

It’s all true: Everything is fake. Also mobile user counts are fake. No one has figured out how to count logged-out mobile users, as I learned at reddit. Every time someone switches cell towers, it looks like another user and inflates company user metrics https://t.co/tk1PKuvLL6

— Ellen K. Pao (@ekp) December 27, 2018

Unlogged in devices can create confusion and inflate data. I personally have the experience of inflating advertising metrics recently. I played this videogame where I constantly have to play to level up my avatars. So I quickly learned the common practice of building a macro or bot to “auto-farm”. This game is free to play and depends on advertising revenue. So the company is likely selling overstated user metrics when pitching to advertisers (albeit unknowingly).

Nowadays entire business models are based on advertising revenue, which are based on unreliable user metrics. This inflated revenues and earnings will drop when the cycle ends — and not in a controlled, linear fashion that analysts tend to forecast in their models.