Episode #295: Jacob Rubin, Philosophy Capital Management, “I’ve Learned In This Business, You Want To Be Successful And Justify Charging A Fee, You Swing The Bat”
Guest: Jacob Rubin is the Founder and Managing Member at Philosophy Capital Management LLC, launched April 1, 2020. Prior to Philosophy, Jacob was a Managing Director at Lonestar Capital and spent time at Goldman Sachs, JPMorgan, and Macquarie. Jacob earned a BA in Economics-Philosophy from Columbia, an MBA from Stanford, and an M.Phil in Economics from Cambridge.
Date Recorded: 2/26/2021
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Summary: In episode 295, we welcome our guest, Jacob Rubin, founder and Managing Member at Philosophy Capital Management, which focuses on value and distressed credit.
In today’s episode, we start by discussing Jacob’s windy road to end up where he is today, including a stint under Jerome Simon at Lonestar Capital Management. Then we dive into his investment philosophy, which can be described as old school value in a new school world. He shares how he uses pattern recognition to his advantage, how credit and equity investing help one another, and the thesis for some of his top holdings.
As we wind down, Jacob explains how he thinks about the short-side of the portfolio and tells the story of why watching a TikTok video led him to immediately cover a short.
All this and more in episode 295 with Philosophy Capital Management’s Jacob Rubin.
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Transcript of Episode 295:
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Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: What’s up, everybody? Another banger of a show for you today. Our guest is the founder of Philosophy Capital Management, a value and distressed credit shop up on Sandhill Road. Today’s episode, we start by discussing our guest’s windy road to end up where he is today, including a stint under Jerome Simon at Lonestar Capital Management. Then we dive into his philosophy, which best can be described as old-school value in a new school world. He shares how he uses pattern recognition to his advantage, how credit equity investing help one another, and walks us through case studies of some of his top holdings. As we wind down, our guest explains how he thinks about the short side of the portfolio and tells the story of why watching a TikTok video led him to immediately cover a short position. Please enjoy this episode with the Philosophy Capital Management‘s Jacob Rubin. Jacob, welcome to the show.
Jacob: All right. Thanks for having me, Meb.
Meb: Where do we find you right now?
Jacob: I am coming to you live from just by Stanford University out in Menlo Park, California.
Meb: It’s a Friday afternoon. I have my redneck Red Bull, but I like to call my diet Mountain Dew. I hear you’re a bit of a trail runner. You ever done the Leadville? What does a trail runner mean for you? Is that the long-distance or is it what?
Jacob: I actually live on a ridge right near here. It’s a little town in the woods called Portola Valley with skyline ridge up above us. Basically, my life is real simple. It’s family. I think I mentioned to you earlier, but I got three little ones all under five. So complete craziness on the home front. Then started this fund and then totally obsessed with investing. We’ll get to that. And then three, if I’m not changing a diaper or doing some diligence, I’m on the trail. And so I haven’t done Leadville. I’d love to. I have done this thing called Black Canyon 100K, done a bunch of other that’s out in Arizona, just north of Scottsdale, and signed up for a race, the Siskiyou out and back up in Oregon that’s 100K, doing that in July. I was trying to do this Me Walk one up on Mount Tam in the Headlands in Marin County, and it got cancelled last year, and again this year. Thank you, COVID. I’m sure we’ll talk about how being a contrarian and being an ultra runner is kind of the same thing.
Meb: I can claim that I’ve done Leadville. I just haven’t done the race. I was the alpha architect crew, West Gray and other, some other podcasts alumni. Did it last summer. No, two summers ago. I guess it would have been last summer. And I just went to support them and drinks and beer and hang out. But, my God, that is quite a commitment and impressive, anyone who does those. When I say trail running, I ended up doing like three miles. That’s about trail running for me. The Oregon one sounds cool. Where is that?
Jacob: So it’s just over the border. It’s sort of near Ashland. And it actually covered some of the PCT and it just looks absolutely epic. I actually don’t even want to talk it up too much because I would love it to stay sort of hidden so I could keep going to it.
Meb: Oh, so you’ve done it before?
Jacob: Actually I was… So I saw Me Walk was in trouble and I really want to keep my Western qualifiers going for Western States 100. This one’s also a qualifier. So I signed up and then the more research I did, the more I said, “Wait, this shouldn’t be a backup. This should be the real deal. This one looks amazing.” So we’ll find out in July how it is.
Meb: I needed adventure to get on the books and look forward to one of my favorites in Oregon back in the day with my brother was there’s a fishing trip you can do down the Rogue River where you camp each night at a different lodge and you’re fishing for steelhead and whatnot. And my favorite story from that trip is we signed up, we get the boats in, we’re getting ready to go down, and the guy in charge of trip says, “Just let you know, I got some bad news. There’s going to be another boat going down kind of when you guys are going.” And as fishermen, you kind of want to be alone, don’t want a bunch of other people around. And we were kind of bummed. And then we turned around. It turns out it was a bachelorette party going down the river at the same time. And so couldn’t come up with a bigger juxtaposition than these gristly fishermen going down the river and this inflatable boat of girls who had hand-cranked margarita machines at, like, 9:00 in the morning just going down the river. So we weren’t worried too much about them burning all the fishing spots.
Jacob: That sounds hilarious. The other thing about all this running stuff, I remember a couple of our early letters, I was drawing parallels from ultra running and what it takes to being a contrarian value event distress-type investor, a really great veteran of the business emailed me saying, “After the first two pages, you wrote a good letter.” He’s just like, he doesn’t care at all about this fluff and all this running, but it’s kind of interesting how you’re wired. And I mean, it’s basically my one big passion outside of investing.
Meb: You got a few you all crazies, Vineer Bhansali, one of my favorite podcasts guests, big options guy, he’s a big trail runner too. Listeners, those are some of my favorite episodes, talking about tail risk and bonds and everything. All right. Let’s get chatted. All right. So you’re up in North Cal, you are buds with another alumni, Mr. Rasmussen, where’d you meet him? Columbia, Stanford, whereabouts?
Jacob: Big shout out to Dan Rasmussen and for Dodd, he did an episode with you, and I listened to it and thought it was fantastic. I noticed it was one of your top 10 most popular or something like that. So good job, Dan. And I don’t know how to displace it. I’m going to have to just have crazy stories and try and get up there. But, Dan, we met because we both went to Stanford Business School and I was out here working for another GSB alum, but from a couple of decades earlier named Jerome Simon, Lonestar Capital, who was a pretty well-known guy in certain circles, a legend, really, and Dan was starting for Dodd and came around and we found that our Venn diagrams overlap in a really interesting way where…we’ll get into it, we’re way more niche-y to a lot more sort of roll up your sleeves and really dig in type of stuff. But some things he screens for with his more quantitative approach are interesting to us as well. And so what we’ve found over the years is if ever he loves something and I go do my process and I love it too, that’s a good bet. And I’ve got a few folks in the event world, the art world, different worlds where if that happens and we do our independent work the way we do it and someone has a different style but we overlap a little bit and we have a double hit…not that I run always in other circles or anything, but then actually it even led to something else, our analyst, Chris, who’s an all-star intern with Dan. Small world.
Meb: That’s funny about the Venn diagram. I say the same thing, but based on the factor side, is like with value and momentum is love, and it supplies both of market’s top-down as well as bottom-up love when those two are saying the same thing. They often don’t, but the rare times they do are a good time to get really excited. Can we talk a little bit about Lonestar? Because I think I’m familiar. Many of the listeners may not have heard of it before. Tell us a little bit about your time there, what’d you learn, and how has the experience, all that good stuff?
Jacob: Well, first of all, let me just throw out two things. One, as I get into the investing stuff, if I throw out names, just disclaimers, it’s not advice. I might make mistakes. I’m going to do my best to talk names. Hopefully, you got that thing at the beginning. And then also if I go personal and go off the rails a little, I actually think it’s really not about me, it’s about what we do in our strategy and the opportunity we attack. The personal stuff, the stuff about Jerome and Lonestar and me and philosophy, what we do takes a certain wiring and the opportunities are perpetual and evergreen. They’re not dependent on factors or cycles because that wiring is rare. And so if I go off the rails and I’m telling stories, I actually think it’s substantively relevant to the strategy and why it makes sense at a base logic. So you talked about Lonestar, you really should go a little bit earlier, not to go way too far, but in my story, I was a down the beaten path, non-risk taker for a long time. My mom is a CPA. My dad was a lawyer, the State of California. These are not risk-taking folks. They grew up with nothing.
Meb: I was going to say, talk about the Venn diagram, there you go.
Jacob: This is not a family where you’re going to go off and start something, start a fund and take a chance and invest all your money and risk it all. No way. This is a, “Oh, you’re good at math, you’re going to mathletes and math camp, and you’re going to go to a good school and you’re going to ride that pony till you win.” Like it’s going to be math, which was sort of my thing. And I went off to Columbia, like you said, I dove right into the econ program. My first width of thinking for myself was instead of just majoring in econ, throwing in a joint major with philosophy, my parents were sort of like, “What are you doing?” That was an actual, genuine moment of these models are rigid, they assume rationality, they assume consistency. That’s not what I see in life, that just chafes. Let me go study decision theory, Amos Tversky, Kahneman, Isaac Levi, all these guys. And so then I got back on the path. I didn’t go too far. And I worked at a bank, JP Morgan. I went off to business school at Stanford. Everyone was nice and happy.
Meb: I’d like to give a shout out to GSB who I owe an enormous deal of gratitude because as a young, poor person, I had no access to all the software databases that most financial funds do. My work around was to get access to the GSB library databases through some friends that were at Stanford that formed the basis for my first academic paper ever. So Stanford, shout out. I’ll return the favor someday. Really appreciate it. Continue on the story.
Jacob: I say it’s just the beaten path, like it’s so boring. It was eye-opening. And that’s an amazing place, but it was still just on the plan. And I think what’s relevant for our fund and what we do now is, I had to get to a place where I think for myself the way Jerome and Lonestar did it. And so working my way there, coming out of business school, actually, my father passed. Tough moment there. We’ve all…you know, a lot of us have experienced loss and sometimes that can be the thing that changes it up. And so coming out, I took a job at Goldman. So still just doing that thing that, you know, my CPA mom, shout out, mom, thought was great. But then I met a woman who became my wife. Now we have these three little kids and I had a couple of critical talks.
One, a friend of mine, we used to race bikes together. We grew up together and he had gone off the beaten trail earlier. He randomly went to Cambridge in England. So he sat me down and he was like, “Dude, everything you’re doing is fine, but don’t you have a little more perspective now? Maybe you should try something like…” When I went to Cambridge, I started rowing. He’s like, “You’d love it.” We race bikes. Like, “You should go row there.” He’s like, “Have you ever heard of this thing called bumps?” Like, “What the hell is bumps?” And he’s like, “You get in the boat on a river, 19 boats lined up, a couple of boat links apart, and they literally fire a cannon and you just start rowing for your life and you got to bump the boat you’re chasing before you get bumped and then the next day you change places on the river and all this stuff.”
All of a sudden, I just thought, “I kind of want to do that. I really want to do that.” But then I was worried, “So how does this fit in my plan?” And then I talked to this mentor in my life on the finance and business side who was an original Montgomery securities guy, one of the only businesspeople I really knew. He runs a fund now. And he said, “You’re about 30 now. When you’re 65, you have a 35-year career, a 34-year career, plus you went to Cambridge in England. What sounds better to you?” And it was no-brainer. And then the final nail in the coffin, and I tell that girl I was only dating, “I got into this school in Cambridge,” and she said, “Let’s go.” And she went to the business school, off we went. I do an MPhil in economics in Cambridge, I row for my college. It was everything and more. And I came back and just determined to not follow the trail, but rather follow a combination of what I find interesting and what I’m good at. It’s kind of fun to do something you’re good at. And I wasn’t the best banker in the world by any stretch. And I’m a terrible salesperson. And just… I needed to find the thing where being quick at math, thinking like with game theory naturally, being very strategic, and not being shy. If all of that stuff could help you achieve good outcomes, then that’d be a good job for me. And I found someone else named Bruce Gregory, he had worked at a number of funds. He had run his own fund called Aslan. He had been a partner at Fortress, working with Pete Breger deep in the distress world. He was doing like Icelandics and really weigh out their stuff and trade claims, dating back to Lehman and all of that.
Meb: What’s an Icelandic?
Jacob: The banks, the liquidation.
Meb: I thought that was you say the Texas hedge or something. I thought it was a nickname for a particular type of trade, but, okay.
Jacob: The lingo and everything here, by the way, as we get into the investing side, it gets so crazy. Look how long I’m going just to get back to Jerome and Lonestar, but that’s like this Stuckey thing back here. We have a whole jargon around the road to Stuckey’s. That’s a Lonestar. I’ll just touch on it now since I’m talking about it.
Meb: What is Stuckey’s?
Jacob: It’s like a roadside diner chain, I guess, throughout the South. I’ve actually never been to one in real life. For me, it’s more mythical and fantastic. But the idea is you go down the freeway 50 miles to Stuckey’s, 10 miles to Stuckey’s, next exit, Stuckey’s. And we come up with these roadmaps with quantifiable, measurable mile markers to know if our thesis is tracking, and it helps with risk management and position sizing. And that’s how you know when you’re wrong, and when we get it wrong, we sell. And so we see something unexpected like today’s Vista news or whatever, tomorrow’s scandalous headline, you could just pick anything and you say, “Well, was that part of the plan?” And if not, what does it mean? What calls do you need to make? What do you do to your position? Are you out? Are you adding because it’s actually immaterial?” etc., etc. So we keep this as this guiding principle. We have like RTS thrown around all the time, which means nothing to anybody except us. Sorry to digress. So to getting to Lonestar, basically I found Bruce. We were going to get into business together. I finally had a seat on the buy-side and we were going to relaunch his old fund, but we ended up joining Lonestar. So Lonestar had been around a couple of decades, not the big Texas PE real estate.
This is a different…this was a hedge fund doing event, distress long-short equity credit with a very heavy value bias. So your basic, get the numbers right, what’s capex? Is it maintenance versus growth? What’s cash interest? What’s cash tax? What’s free cash flow? What’s our yield? What’s the credit pricing in? Is anything mispriced? That kind of basics. But it went a lot further than that. Jerome is just wired differently. And so what I found back to this original thought around being a contrarian versus being on the path, when I went to Cambridge, ever since then, I just felt like, “F it. I’m just going to think for myself.” I don’t know if it was the loss of my dad or what, or finding a supportive spouse, who knows? But somewhere along the line, it was, “I’m just going to go for it.” And I walked into Lonestar and that just hit me like a ton of bricks. We just did it a different way. That came into unformatted spreadsheets, conditional formatting, fancy. You could put a company logo in the upper corner of an Excel spreadsheet. I got laughed out of the room. Then I learned that the whole office was whiteboards on the wall. And I went up to the wall and I spread three financial statements, five years, three years back, two years your forward, laughed out of the room. That’s not how we do it. We get to what matters. What … matters is in every single number on all the financial statements. Let’s understand them, read them, process them, and get to the stuff that counts.
Ultimately, where I’m going to take all this is what counts is having the academic chops, the understanding of the macro and the micro, but then it’s just the pattern recognition and the wiring. And that’s it. Because if you can recognize the patterns, but you’re not wired to get into the burning building, and most people aren’t, then the pattern won’t help. And you might have all the guts in the world, but if you don’t have repeatable patterns that have followed predictable evolutions, then you’ll just be hit or miss. You’ll have a really bad batting average. Part of the story here is I had all these classmates out of GSB who ran off and founded companies and got way richer than I am. And they’re superstars. GSB has changed the world. They went off and changed the world. I did a totally different thing. I just shoe cobbler, apprenticeship, take everything I thought it was and park it and just watch this guy do what he did. And I remember I once went to an Irish Zone. I met some guys, another fund out here at Park West.
And I’m talking to these guys and the reverence for this mythical Jerome Simon was palpable. I remember someone said, “He pitched one time at Zone. What he pitched was surf at NAFTA gas. Knowing what I know and working with them for six-plus years, shoulder to shoulder, I could see why he did that. Because you go and you hear a long workday pitch or a long this or a long that, and it’s just like, “Okay. Smart, fine, got it.” You hear someone pitched her for NAFTA to gas and you’re going to remember it. And, you know, that it’s trading at a negative EV, but on the other hand, it’s a bunch of Russian crooks. How do you weigh those two things? What’s the up-down? And it’s just so badass and so different. I was fascinated from the jump.
Meb: That’s a little point to me, too. And you are going to be active managers, are going to be allocating, is the hedge fund hotel names are the ones where everyone owns. It seems to me in a world of tens of thousands of securities, why is everyone focused just on the ones that CNBC is talking about? And it seems a lot more interesting to be..see a monger “fishing” where there’s no competition. Makes so much more sense. So you were there for how long?
Jacob: Six years. And then basically last year spun out and launched my own. You know, we still co-locate, cross-pollinate, and talk a lot. He helped sort of seed us and get us going, but we’re our own show now.
Meb: What was the final push, the inspiration? And you said, “Look, I’m going to do this.” Cannonball in the pool?
Jacob: The do launch a fund when you’ve got a good spot, I had built up a good relationship with the whole team. We actually share CFO now. It’s very kumbaya, very close. I looked at it in a few different ways. One is I’m 37. And so you think, “Okay. What’s the right age?” You will want to be hungry and have a 20-year runway and be ready to kill it. I also recently wrote in our last letter about how I got some signal, some real signal out of a TikTok video. And I shared that anecdote with some other long-term value guys who are like, “Holy shit. I would have never found a TikTok video. Like what is TikTok?”
Meb: And to be clear, you were uploading a video of you dancing while you found this other signal. Correct?
Jacob: Yes, exactly. We have a company channel in TikTok. It’s just me dancing to cat videos. No. Being young has its benefits, but you’ve got to pay your dues. You have to see enough. You have to have your face ripped off enough times. That has happened. I’ve been dead wrong. I’ve gotten it wrong on substance, I’ve gotten it wrong on bad luck, and I’ve just felt what it feels like when your stomach hits the floor. And whenever we’d have LP meetings, Yeti, our CFO, his biggest chime in, it would be like, “Guys, we’ve gotten it wrong. We don’t give up.” I think it’s because this kid goes and does this long running. I don’t get it, but it pays off for this strategy and you have to be able to do that in this strategy. Because you don’t bat 1,000.
Meb: What is the sort of framework, Philosophy Capital Management, a value fund in a world of venture capitalists. How do you guys think about the world?
Jacob: I guess I set the groundwork thinking contrarian off the run. It’s clichéd. A lot of people will say that. The good news is as we talk our names, we find that no one else owns them. So I think it’s valid and true. But at the end of the day, the way I would really position it is, yes, we are long-short equity and credit, we have a wide mandate, value, event-driven. We’ll do distress debt, get into bankruptcy. That’s what we do. But really what we’re hunting is market inefficiencies, broken markets. Because our view is, “Okay, you’ve got this world out there. Everything is going passive. Everything’s going transparency, information at your fingertips. And it’s hyper-competitive, so lower and lower fees, all these different bespoke products, how are you going to justify your existence and your fees in a marketplace that’s this evolved?” And the answer is you are going to find cracks, crevices, parts of the market where the market just doesn’t work. It doesn’t work. And that’s how I’m going to extract value and outsize return and generate alpha. And the way that’s going to end playing out is I have to know what areas of the market to look in and get a return on my time.
And markets break down in predictable places. Okay. So, one, technical inefficiencies. Guys at mandate can only own so much triple C paper, and a certain CLO can’t own it if it gets delisted, can’t own it if the dividend goes away, can’t own it if they don’t have timely financials, can’t own it sub a billion equity cap. Then you have emotion, scary, a big class action. You know, mass tort type liability. Don’t want to touch it. Anything around opioids, too scary. Can’t analyze it. Don’t want to touch it. Can’t be bothered. Long, nasty history. Don’t want to go there. Guard, bad memory, scar tissue, or the whole world cares about narrative in the future and everything that’s ESG and sexy and they don’t want to know about that boring, free cash flow machine. So all of these things add up to opportunity for us. And I’ve sort of put it out there in our networks. If you see something that no one’s looking at, maybe it’s on fire. Do I care about a good business? Absolutely. But in a sense, our portfolio ultimately diversifies even across business quality, like we have 18 B-team, C-team managements because ultimately we’re comparing price to what we’re getting and we’re trying to find major mispricings with huge asymmetric potential. And that’s not always going to be great quality like, yeah, in March of 2020, you could buy Schwab and it was awesome with a great sort of embedded option on one-day rates will pick up. Like, that was genius, and great, and high quality, but that’s rare. I think that’s part of what we’re doing here, is we are hunting market inefficiencies and breakdowns.
The other thing too, just to highlight, is we’re sitting here on Sandhill. I’m literally leasing this office from a Bitcoin fund and our neighbors are all venture capitalists. And it’s all about Tam, Tam, Tam, the future. And it just goes back to that wiring, like we swim up the current. I think it’s the coolest thing ever. And it just fires me up to kind of be behind enemy lines where I care about modeling and assumptions and cash. But being here, you need to know the other side of your trade. And that’s not a problem here because people here don’t care about your value trap story. And so if you want to answer the question, how will this value ever be realized by other market participants, like, if you’re a value guy, you kind of want to sit here. You don’t want to go sit where all the wise guys are.
Meb: That’s interesting. There are a couple of comments on some of your points. The first is like, you know, I put a lot of this under this category of, you know, whether it’s unloved or just too hard. As you were describing some of these in the beginning, it’s just like the stuff with Harry Worth’s on it, that people are just like, “I don’t even want to deal with that. That’s too complicated for me,” which would 100% be the things that I’d be like, “Ah, it’s too much work.” It reminds me of the old Greenblatt book from the ’90s, “You Can Be a Stock Market Genius” where he was talking about spinoffs and it creates a structural, at least back then. It’s probably more efficient now, but maybe not totally.
Jacob: Look at Arconic. Arconic came out of seven bucks and was like, “What are you doing?” But there are no numbers anywhere.
Meb: But you have, like, the quant funds like mine where it’ll spin something off, it’s no longer in the model and you just sweep it aside. And that’s a fascinating world to me because, like you mentioned, it’s harder to dig in. And I was also smiling when you were talking about some of the trends, whether it’s ESG or Ben Johnson and Morningstar had a great tweet today where he said, “There’s something like 34 funds have filed to launch or have launched in the past 3 years with innovation or disruption in their name.” It’s like, you should have launched these 5 years ago or 10 years ago, but the industry has this way of chasing the hot hand or whatever’s exciting.
Jacob: But here’s what’s fun. Like when I think about ESG, I’m taking it like a realist. First of all, do I care about the planet getting better? A hundred percent. But I’m also cognizant of fund flows and just how powerful it is. And every LP I talk to is getting more and more money specifically earmarked for that. Well, that matters. It matters to valuation, price discovery. So I factored in. It kept me away from energy all the way until basically November of last year and then we made a big energy bet because when you can buy Emergent two times EBITDA with no leverage, you just do it. But the bar was so much higher. And then like recently, for a long time I was in this plastics company, Berry Global, because it was just too cheap and it worked. Over years, it compounded, but it’s plastic. And I learned acutely that plastic’s a problem. And it was always going to be a headwind. It will never close the valuation gap fully. And then a spat comes along, Live Oak became Danimer, and they had a recyclable plastic solution. They partnered with big customers like Pepsi. And I did some checks, but I knew from Berry for years and years, I went to Berry. I said, “Do you know these guys?” And they said, “Yeah, they’re legit.” I’m like, “Really? Interesting.” And that just meant to me unlimited demand forever. And I knew it from six years of working with the non-ESG friendly option. Right? And so it’s, like, then you can get behind ESG in certain cases and in some cases like the energy, it just makes the bar higher but at a certain threshold you go in. And so for us, it’s a factor in the equation. It’s not some willy-nilly theme for us.
Meb: All right. Well, let’s talk about some of the themes for you guys. We’ve had a little bit of the color on what you guys think about. So hard to uncover and fine, but maybe walk us through whether it’s case studies, frameworks, whatever you want. Madlibs is open to you, where you go with that question.
Jacob: So hopefully it comes across with all this windup that we’re contrarian-oriented and we care about sort of mispricings and where the market breaks down. So what has happened really for us is we’ve found a certain number of patterns that just work. And I believe completely that this business is phenomenally difficult. And if I have certain things that rinse and repeat and work, I’m always open. If you show me something new and it makes sense to me on a deep level, maybe over time it’ll become a new pattern. But swim in your lane, rinse and repeat, know what you’re good at, I subscribe. And so one pattern, for example, would be something like a cheap value story, somewhat misunderstood, mispriced, cheap to comps, great free cash flow, bit of debt, de-leveraging, maybe darn it, for God likes it. Fair price. Okay?
But there’s an option, a free option that nobody is seeing, ignoring, it’s completely invisible. And that option is something that gets it…escape velocity out of a value trap. That option is something you dream of, you think about. So a great example here was our biggest position has been this thing, Loral. So, Loral, you want to talk about hair and difficulty. There was this guy, Rachesky, MHR, they’re a controlling shareholder of hold co, which is Loral. Loral is essentially one of two shareholders with a Canadian pension PSP that owns a Canadian private geostationary satellite company, and you said ad-libs or mad libs or whatever, called Telesat. So very hairy. Telesat’s private, Loral’s a hold co. There’s this guy with a major reputation who’s involved in a hold co and oh, by the way, for five years, essentially PSP and Rachesky were at odds and threatening to sue each other.
So it’s hairy, underfollowed, the numbers are hard to find. We do the digging and we find that the time run 20 bucks, we find that it’s like 17%, 18% free cash flow yield, debt trades over par. We did a DCF of the geostationary business, which was not a sexy business at all. It’s being disrupted. But we made the most brutal assumptions you could make. We assume the backlog just goes away. We run off the existing business to 0, punitive discount rate, but they were getting FCC proceeds, 344 million from the U.S. government for clearing some C-band down here. So we gave them that. Loral had some cash on the balance sheet at the time. They subsequently dividended it. Ultimately, we got to like 20 bucks. That was the price we were paying. And then as we dug in, that’s where it got interesting. We found that they have an unbelievable amount of spectrum up in Canada, prime spectrum.
If you followed spectrum auctions in the U.S., they have gone twice where anyone thought they would go, we’re talking tens and tens of billions of dollars, approaching $100 billion. And up there, they’re doing the same process. They’re behind, they’re doing it right now. They’re trying to play catch up because there is an argument that they should do their clearing activity coincident with when we do ours, because there are no borders in space on their right there. So they are playing catch up. And these guys own a ton of it. Like it could be billions of dollars’ worth. So then we go digging like, “Well, how’s that going to go?” Well, the Canadian government is giving these guys money for a new project, a lot of money, 600 million. They’re lobbying records showing that they’re meeting all the time, 15 times a month. They are a Canadian company for decades. They are based there. They are hiring people there. This could be a strategic thing for the government. It wouldn’t make sense, if you put some game theory on this, for them to smash them on a spectrum process. That would be utterly illogical. I don’t know if it will hit, I don’t know how it will play out, but I see the math. I run sort of megahertz pop numbers from here up on Canada and it’s ridiculous. It could triple the market cap from when we got in. I put that in my pocket.
Then I start studying this LEO, right? They have a low earth orbit. You’ve heard about Starlink, what SpaceX is doing, Typer from Amazon. You got one web emerging from bankruptcy. So there are all these LEOs, four of them. But these guys, I actually learned about this laser company, Minor Act, whatever I learned about that, which helped me learn about this. These guys have a really interesting design. MIT says it’s the best one out there. They’re in the process of securing partners in financing. And we ran the math. We did a very deep dive on if this thing could work. We think it can work and we think it could be huge. Literally, when we add this to the equation, the whole thing can go to $300. Now it’s like 45 bucks. But when we found it, the pattern was, we literally… I mean, sell-side has a game, right? Sell-side can’t put out a $300, $20 stock. I mean, they’ll be laughed out of the room. It never would pass muster. We can say whatever we want. We just do the math. And we put out base case down, case up, down case was $18. The up was 300, and it was at 20. It’s just remarkable.
And then we start asking around and nobody had a clue. I know spectrum experts who at the time weren’t aware of how much these guys had in Canada. The LEO guys, we’ve talked to X1 web people. Like, we learn the state of the industry. Like, nobody was really on top of what they were doing. So it was ignored, misunderstood. And then the … grow, it’s, like, the company was doing all this work under the surface, but it was very arduous, hard work, getting all these parties, the pension system, Rachesky, the Canadian government, Loral shareholders. They’re trying to get everybody herd these cats. And they’re making progress, but you don’t see it. It gives you time to build a position, to due diligence, to build conviction, to size up. And now the reason it’s 45 is they started having really good announcements, and so now it’s not like a free option anymore. You’re paying something for it today. You’re not paying very much.
Meb: How does the value get realized? I mean, other than coming on the “Med Faber Show,” is this something that it’s just time, you know, and big funds start to appreciate it? Is it news flow from the company?
Jacob: First of all, not that we want to go out and pump anything up or do it that way, but you can help. If you’re an investor, I try and be like a suggestivist and give advice and be very vocal. I’m never going to go public about it or tell anybody else what I told the team, but have suggestions and be vocal. And you can tell people about it, factual, just… And always with the disclaimer, “Hey, I’m talking my book. If you don’t want to hear it, that’s fine. But assuming it’s okay, I’ll tell you some facts.” Getting the message out in some of these cases is half the battle. Then the government is going to come out with spectrum results. Thoughts on spectrum in Canada, anytime, the process, essentially the comment period, comment on the comments, that’s all done. So we’ll see what they say. They’re going to do a dual listing this summer and do a roadshow. They’ll hire banks. They’ll get sell-side coverage. They’ll tell everybody the story. They’ll raise money. There are a lot of catalysts here to essentially start crystallizing what we see on paper.
Meb: It’s funny because as you talk about this company, it definitely rings some bells. My old man was a Lockheed Martin guy and they had definitely sold a portion of their business to Lockheed in the ’90s, the defense side. I would have been interning there, I think, maybe at the time doing a whole lot of nothing other than drinking diet cherry vanilla, Dr. Peppers, which I’m forever grateful for because I would wander around the hallways, be done with my job at 9:00 a.m. There’s only so much you can do at a rocket company when you’re a freshman in college. But spent the entire summer learning about the stock market. So thanks, Lockheed and Loral.
Jacob: There’s this thing Flex, right? Flex is this old boring business, whatever, industrial electronic manufacturer distributor. They’ve made big changes, management changes. They’re changing their business around, doing more sort of sketch to scale, actual more value add. The cool thing is you add it up. You do the math. That’s what we do. We do the math. It was a pretty cheap price, fair price to buy the business. And late last year, I couldn’t believe this. They announced publicly they 100% own a subsidiary, 100% own, called Nextracker. You talk about ESG. Nextracker is a raise and related software for solar panels, large scale. Nobody, even their shareholders, longtime shareholders, nobody knew they owned it. I couldn’t believe it. I know a top shareholder. I hit him up. I’m like, “Is it true? Did you not know they own this thing?” He’s like, “Yeah. They never said a word to anybody.”
And what’s relevant now is the direct comp, this is a world leader. The direct comp goes public, array, and it’s trading like six times sales. This is an industrial business trading on, you know, a cheap EBITDA or free cash flow basis. I don’t think it takes a rocket scientist to say, “Why don’t you spec that sub?” It goes back to sub and there we go. And so, sure enough, every call since then, they talk about monetization. All the questions are about monetization. And it’s one of those things where it’s just this hidden asset. And so we keep looking for those. Like that’s one pattern, like find a good business that’s cheap, it’s a fair value, but I’ve got this upside. And then one day it hits and the stock goes up 50%. And then we sit down as a team and we reevaluate, “All right. So it’s not the free option anymore. What do we do?”
Meb: These are notoriously hard to uncover, otherwise everyone would be doing it. It’s particularly hard, I imagine, to screen for uncovered gems. What’s the process to find these? Is it just networking and digging and doing a little latticework? I mean, how do you uncover hidden gems, the hidden assets with the call option?
Jacob: So part of it is multifaceted. Okay. Boring answer. So the biggest one, we always called it hip bone, thigh bone. So more of our fancy scientific jargon. But hip bone, thigh bone is, basically, you’re working on Berry and it educates you and then you’re in the plastic world and one day you learn about Danimer. You’re working on Cascades. I’m not involved in this anymore, or the one I’m about to talk about, I was in this Canadian packager, Cascades, and you learn that they own, I think, it was like 58% of this thing in Italy called Reno De Medici. And then you go look at Reno De Medici, it’s publicly listed trading at like three times EBITDA. Just cleaned up their debt, big free cash flow yield. You go buy Reno De Medici. Nobody knows about it because nobody…hardly anybody knew about Cascades and you could just have to have your eyes open.
And so I would say hip bone, thigh bone, and building up that comprehensive database. Like one thing that Jerome…it was so impressive about him that I’ve come to appreciate is the recall. He’ll be like, “Oh, this telco thing is like Hellenic telecom, you know, all these years ago. Oh, this one’s like that. Like this one’s like that.” There’s a pattern recognition, total recall. So most of these gems come from just poking around and connecting to things you were already working on. If there’s a pie chart, that’s the biggest slug. And the cool thing, the fun thing is I didn’t have that in the beginning. Thank God I got it now. And that’s like how I don’t get disrupted. You can’t disrupt that because it’s not screenable. An upstart, the new generation out of Stanford, like they got to pay their dues. Like they won’t find it because they haven’t built that. So that’s kind of fun.
The other way is a network. I think there’s this balance. I’ve had conversations, you know, prospective LPs who are concerned, to your point, about getting caught up in the fast money crowd. And you saw what happened to some funds in January, and if you’re going to be off the run, you better not have gotten caught up in that January problem. That’s the bad side of a network. There is a lot of good to it. If people know what you look for and they see it, they hit you up. And if you are feeding people great thoughts, great ideas or tidbits, or you know that they’re into something and you see something relevant and you forward it to them and you just sort of make it your job, full time, to throw out usefulness into the world, over time, it just comes in.
And a lot of these ideas are just sometimes it’s someone who might not even be in it that like, “I think you might want to look at that thing and then I love it.” Distress, though, like here’s another pattern. Like distress, that’s a mandate. There aren’t that many people looking at it. That’s a roll up your sleeves. The arbitrage there is will you roll up your sleeves? And, you know, will you call advisors, and lawyers, and everyone you need to call to understand who’s getting stabbed in the back and who’s in the cool kid club and all that stuff? So that’s another one, but related would be…. So here’s another pattern. This is from our mandate. It spits out a pattern. And the pattern is solvable credit is good for equity. So go look at like Tupperware. They had a big debt problem, going current debt, it’s going to become going concern, whatever. You do some work, you understand the players, the bankers, like who’s involved. Like nothing non-public. I mean, I’m talking, not getting free stag, public guy, never even go near the line, but you start getting familiar with how these things work and you’d gain confidence they’ll fix the credit problem. That’s a multi-bagger equity waiting to happen. We call it like an existential debt. So that was one. Party City, they did a big wise guy deal. They had all these…it was very complicated. But at the end of the day, there was an equity sitting there and they fixed the credit. Hovnanian, homebuilder, right? They fixed the credit or the credit gets resolved, equity goes nuts. And so one of the great ones that we did, I kept being in the distressed and the bonds were working. And I was… In the beginning, honestly, I was a little afraid.
Meb: Those cases you buy in the equity, you buy in the debt, or both?
Jacob: I started out buying the distressed bonds or term loans, anywhere I saw the optimal risk-reward. And I started noticing every time through my whole career, every time that credit worked, the equity worked the best. And it made sense. And here’s how. We got into Bombardier bond debt late last year. The idea was they were closing a big sale of the trains business to Alstom. And I could see that it would clean up some pension liabilities, it would clean up some minority interest case that would go over to Alstom, and it was a big minority interest over 2 billion and they’d get a ton of cash. And the cash meant buying out all the near-term maturities. So the debt was a no-brainer. That was money good, because this deal was going to close. Like I was on the webcast of Alstom overnight when they voted yes on the deal. And then the next morning I was rushing to buy Bombardier, like stock did nothing because nobody cared.
But the equity, we started realizing that if you take out the front-end, you just bought yourself three years of optionality, right? And I did a Black Scholes and I just actually priced the equity like an at the money option and I just changed…essentially just tried to capture theta just three years, and it was like over half the equity price on the screen just by getting three more years. So it was trading at 28 cents Canadian and we priced that difference in call option from, like, if it had 5 months versus 3 years and 5 months, was it 15 cents of value? And I knew it was happening from the refi, and I knew from Party City and Hovnanian and Tupperware and all the others that this was a no-brainer, you know, not to mention it’s a reopening play. And then there you go. That’s just a pattern. It’s really fun too.
Meb: You got a few more themes, don’t you?
Meb: Let’s hear some more.
Jacob: Another one that we encounter is just like unloved tech.
Meb: That’s such a thing in 2021. I don’t think there’s anything unloved about tech. You’ve managed to find some unloved tech? Are we talking about compact computer or what? Commodore 64?
Jacob: Some of the IRR guys I’ve joked like if I’m calling you, like something didn’t go right. Because if you’re trading on, like, some multiple sales basis, I’m not going to call. But there are cases where companies break the rule of 40. They’re not going to grow enough, they won’t have enough of a margin. People lose confidence that you’ll survive the Goliaths of the industry, but actually, you have some very, very powerful recurring revenue customer base, like a real reason to live. And I’ll do some checks. And it might screen like 8, 9 times EBITDA, 12%, 13% free cash flow yield, which is not a screamer by normally, but it’s tech and it’s recurring. It’s a melting ice cube. And often what we found is those are particularly ripe for M&A, either rumor or an actual takeout. The first couple of forays into this fact pattern was like Symantec or LogMeIn. A couple of those. Like there was no love there. They both ended up with M&A.
Meb: I’m smiling as you said LogMeIn because I did our kind of, like, annual credit card. I’m like, “Wait, why are we still paying for LogMeIn? How long have we been paying for this?” Because I don’t think anyone’s used this in three years.
Jacob: It’s funny. So I’m no longer involved. And I don’t want to speak too ill of them, but suffice it to say that as part of the research project, I got us signed up and now we use them. So sorry, guys. A recent one could be something like Dropbox. They have this big pivot and they basically gave up on chasing the growth dream and said, “You know what? We’re going to start making free cash flow and we’re going to optimize profitability. We’re going to take our, whatever, 600 million users and find a way to monetize them. We have a place in this world. We’re going to get really sticky with a lot of customers.” And it’s interesting and there’s some things maybe I don’t really want to dive into in terms of their infrastructure and some of the wrinkles there. But bottom line is, people are not thrilled with that company.
And then I go in and it’s like some of the metrics are pretty interesting, they have a monster base of users who like the product. They have no problem with it. We just have to find out how to get them to pay more and we have a very aligned head of the company. If you’ve looked at his comp, he came out with a new comp plan and the options run all the way up to…or the strike prices are on all the way up to 90 bucks for a $20 stock pick into mid-30s. So he wants the stock to work. The funny thing is the IR guy’s now that…he was the IR guy at LogMeIn. Literally, the same guy, shout out to Rob. This isn’t a huge position for us, but we are exploring it. It’s more in the starter category. I really want to figure out a couple of wrinkles to their business that, I think, are misunderstood. So I’m not ready to totally go out there, advertising all these nuanced views, but I think there are a couple of wrinkles that could be really interesting and nobody’s caring because it’s like, “Well, why should Dropbox exist when you can get all these other options for storage for free?” That’s just like the wave your hands, you know?
Meb: And plus the stock really hasn’t gone anywhere for a few years, so people start to give up on it. How many names do you guys own in the portfolio? How do you kind of put it all together?
Jacob: So we’ve got about 35 longs and about 35 shorts. One of the things I hear most frequently is that’s a lot for a thin team. But ultimately, a lot of the names are related. For example, we were in this thing, Danaos, DAC, a Greek shipper that was trading at like less than one times PE and hundred something percent free cash flow yield. That’s when we found it. That’s because it was a Greek shipper. People are, like, they don’t want to look at Greek shipping, right? But we understood a few things about containers in part because we had been in this AAWW and ATSGs, which is container by air. And we had looked at container by sea and we found Danaos, and then Danaos has a 10% stake in a Israeli shipping company, Zim, Z-I-M. So now we have a little Danaos, little Zim, both. Zim just IPOed. They IPOed right into the end of January hedge funds getting crushed, degrossing. And so it got completely mispriced. It was supposed to be at like 18, priced at what, 15, traded to 11, and we just load it up. And that’s related to Danaos, right? So I say 35 longs. It’s like we got both of those. They’re very much connected. I mean, I’m just like staring at my book. And I would say there are maybe almost 10 different situations where they’re kind of connected.
Meb: Danaos is interesting. I mean, Greece, in general, is interesting because, I mean, that was a story that was so much in the news for quite a while post-crisis, and so if you pull up a chart of Danaos, I think I have the right chart as DAC ticker. You have the 2008 implosion where the stock used to trade at, I don’t know, over $500 and then for the decade-plus has been just like a long line. But over the past year, you’ve really seen an uptick in interest, at least it seems, almost a billion-dollar market cap at this point now that everyone’s forgotten and abandoned Greece. How’d you come across that one? You’re vacationing over in Mykonos or what?
Jacob: There’s someone involved who we respect a lot. And it’s a public filing. I don’t really want to say who, but they’re involved and I saw it. And then that’s interesting. How did I even see it? God, I mean, it was really cheap.
Meb: I mean, that’s the thing with the 13Fs, though, that I used to love just digging through them and almost never was I interested in the names that I had heard of. Almost always just like, I’ve never heard of that stock. Why is Seth Klarman or someone buying it? To me, you know, it was such a fun treasure hunt. And in some cases, it often is not interesting, but it’s such a great way to find some interesting screen.
Jacob: It’s a feature of this market that you all people got to show their hands. It’s amazing. And so, yeah, we call it 13F season and we’ll take a look at pretty much all the guys we think are really smart. It’s got to fit what we do. You know, it’s funny too that a situation right now, a somewhat controversial name that we’re long, we’re going into right now, it fits a lot of the fact patterns, it’s called ErosSTX, ESGC, super hairy. It was a big short write-up on the aero side for years. It’s been under-followed, ignored, abandoned, everything on Bloomberg’s wrong. All the numbers are wrong. Management team’s wrong, it’s all wrong. Complete opaque black box. Plus the business gets hit because they have a movie studio and movies during COVID. So for all those reasons, nobody’s looking. TPG is essentially a liquidating seller.
Meb: This is the Indian-American media company?
Jacob: Yeah. It’s like an Indian thing and then a Hollywood movie studio. And I don’t want to give the whole pitch here, but what I’ll say is this is a fun wrinkle since we talked about 13Fs and filings and knowing who’s in it. TBG is selling, and there’s a whole backstory of why I’m comfortable with it. They’re selling a lot. They’ve been filing a lot of 13Ds. They’ve been in the market every day this year, but one, selling in size for a small company. And I just keep wondering who’s buying. I have a feeling, I feel like there’s some cookie crumbs out there that could give you some good bets. I’m not willing to come out here and make that bet, but offline I’ll just tell you. And you could bank that as my completely, whatever, wild ass guess. But I think I know who. Maybe I’m dead wrong. I don’t know. But it’s fun to play. I can’t wait till the filings come out.
Meb: It’s definitely one that I’ve never heard of. I don’t know if I’ve heard of vast majority of your stocks, which is something I like. Talk to me a little bit about the short side. Shorts are, I feel like, almost extinct to this point, at least a short mandate fund, but you still have the craziest like you that included as part of your book. How do you go about that? Is it a mirror image of what you do on the long side? Or is it a totally different animal?
Jacob: Completely different animal. It is not an inverse at all. I would say early on it was all about many ways to win, to try to level the playing field because you can get screwed in so many ways. The guys on the other side, the management teams of the companies you want to short, they know more than you and they control a lot of the flow of information. I’ve seen this so many times. Early in the year, they’ll put out guidance and you’ll say, “That’s completely bullshit.” You are never going to do what you just said. Well, who’s going to stop them? It’s to free country. They say what they want. Stock goes up. After the next quarter, they come out and they say, “Back half waited. Everything’s fine.” And then, God, how does it go? Third-quarter would be something like timing issue. They’ll have some excuse. They’ll adjust it out. Won’t even show up in the numbers. And then fourth quarter, everything’s adjusted under the rug. It’s all about guidance for next year. It’s like it never even matters. That’s just one way they screw you. Then they can screw you buy outright lying. And we’ve seen guys who go to jail for it. And we’ve seen plenty of guys who outright lie and don’t go to jail, many of which we all know who they are. So I got to deal with reality. I’m not some moral-less police. Like if they’re going to lie, I got it factored into the equation. So, many ways to win just to level the playing field. These guys can cheat, and lie, or even just embellish. They could hide the puck, whatever you want to call it.
So that’s one thing, not to mention, you know, squeeze-ability and that’s short interest is visible and there are all sorts of algorithms targeting it that makes life hell. So there are technical ways to get screwed. There’s sort of ethical ways. There are legal ways. And then there are always the risks. There’s some other dumb guy who buys the story and buys the company. Your short starts working, it goes down 15% and they get taken out at 25% premium. So all of the above has happened to me. I have scars everywhere and it’s been miserable. I remember one day, at my five-year wedding anniversary, I never take vacation. I took four days and we went back to Europe. We were going to revisit some of the places we’ve been to pre-marriage. The day I get there, this scummy pharmaceutical company guy… It’s a long story. Someone should end up in jail. There are a lot of lawsuits. There’s a guy who can’t go in the United States involved. And it was so ridiculous, and they made it all up and stock went up like 30%. And I’m just sitting there and trying to…you know, my wife’s like, “What are you doing?” And I was miserable in some beautiful part of Switzerland, and then she was miserable.
Meb: Let that be a lesson to you, not to take your phone and computer on vacation. Thirty percent up, that’s nothing. That’s like an hour and game stop time. Did you end up holding it? Did you have to cover?
Jacob: Covered, no. We have stop losses. And we just… I’ve heard other people talk about stop losses and say it doesn’t work, but no, we have stop losses. And we don’t believe… Honestly, I think even shorting frauds, but one of our partners said in XPM, he said, you know, that shorting frauds is the worst return on time you’ll ever have. Even if you get it right, the pain, the stress, the distraction from your long book or your other shorts, the fact that your risk management will get blown to smithereens. So oftentimes we will just ignore the frauds. It’s just too much and it’s a bad use of energy and time. So what we do is we will have some secular themes, some structural themes, and maybe we’ll have a basket playing that theme and we’ll have moments of inspiration, but we start with what we won’t do.
So if it’s too squeezable, if it’s too popular, if it’s too crowded, we just stay away. We try and be really dynamic. There are times when you want low octane sort of…we call it like mundane and expensive. Some COVID beneficiary, that’s a generally sleepy business that all of a sudden trading 50 times earnings and spend 20 times earnings for its whole life. It’s been around decades. It’s a perfectly fine business. They just had the best operating climate they will ever have in history and they’re trading at 50X that. I’ll short that. And then I’ll do some more work and I’ll try and analyze it. And I try not to be one dimensional or just about valuation, but in a certain climate, you want to pivot towards a lower octane and you don’t want to go into the controversial stuff when the GameStops and the AMCs are happening.
And, in fact, coming into that, there were a couple of shorts we had that when I started catching wind of what was happening, we immediately ran a screen on our own book and we covered proactively any controversial short we had. We covered all of them. Because our thinking was, even if they’re all right, if any one or two becomes like a GameStop or an AMC, or…I mean, go down the list, Macy’s, or Dillard’s, or this one, that one. I mean, we had all the list of the highest shorted stocks. I mean, then it hits “Wall Street Journal,” then it hits here and there. If any one of them goes nuts, it’s a disaster for the whole book. And so take your medicine. And that’s, honestly, shout out to Jerome Simon. He is the best I’ve ever seen at this. No emotion, no ego. Your ego gets tied up and it’s all the work you did, that you have a sunk cost in the work, advocacy bias and wanting to think you’re right. You get pissed off at the cheaters and how stupid the market is. Get rid of all of it. Cover, move on. Your job’s to make money. None of that other stuff matters. And I sat at his elbow just trying to osmosis, to just get that. And I remember if you were in a room with him saying, “Where’s Jacob? What was his fault? You know, where was he bad?” He would say, “In the beginning, I was stubborn on the short side.” You learn in a hurry or you get out of the business.
Meb: You mentioned you have scars like all of us do. Do you have any sort of guidelines, guardrails for position sizing? You mentioned kind of like stop-loss concepts. How do you think about the shorts as part of the entire book?
Jacob: So shorts are a size smaller unilaterally across the board. They’re just smaller. It used to be that I would do short up to 5%, no longer. In this day and age right now at this part of this bubble or whatever you want to call it, I mean, no short over 250 bips. The long side, we’ll go up to 10%. At cost, we’ll allow it on occasion to appreciate like a Loral situation or something, if it’s just going nuts, like I’m not going to going to just jump at it. But at 15% we automatically start trimming. Some people make their money on concentration. That’s obviously a way to outperform, just simple math. We don’t do that. Our way of outperforming is our things are so mispriced… If it’s not 100% upside, we don’t look at it. And we’re not even excited about a double. It’s not a hokey-dokey. It’s like the real math, like realistic multi-baggers. That’s how we make our outperformance, not size.
Meb: The fund got started, what? What year with Vintage?
Jacob: The existing fund, Philosophy Capital, was April 1, 2020.
Meb: So who starts to fund on April 1st?
Jacob: Yeah. The guy who runs into burning buildings and goes on the hills.
Meb: And so I was going to say what’s the longest positions you’ve held, but I assume a lot of these have the potential to be multi-year holdings. Is that accurate or not?
Jacob: Yeah. So what I’ve said sort of on this front is, I think, these 10-year models are bullshit. How can you anticipate all the black swan events, the tail risks, or even the technological disruption? Now, I’m on Sandhill Road, like these people predict the future. They’re really good at it. God bless. I can’t do it. Okay. So from the beginning, it’s like our time horizon is shorter because my confidence level, sort of my confidence interval on all the assumptions we do, all the predictions we make, after two, three years, I’m like, “The whole management team could be turned over. The whole industry could be upside down. The world could be at war.” Like, I don’t know. So most investments for us start with, call it, a 12 to 24-month time horizon. We use this road to Stuckey’s. We might have 12 to 18 months of predicted mile markers, both in magnitude and time.
But what’s happened is, in that period of time, you get to know it intimately. They start trusting you, and knowing you, and you have a great rapport and dialogue with the team, you might even be able to influence the outcome, their actual operations, because they listen to you. And ultimately, 18 months becomes 5 years because it evolves, it changes. You know, I’ve been involved with Will Scott now, this other company, WSC, 2018 early, maybe before then. I got to go check, for my old firm. And what happened is the world changed. I mean, the world changed. They did transformative deal after transformative deal. My conviction in the team went higher. My conviction in understanding the sponsor went higher. I know them pretty well. And ultimately, my roadmap for them starting here today goes out two years and I love it. And I’ve been in it for years. So that has all sorts of benefits, the tax benefits for those of us who care. Not everybody in our fund cares about taxes, but if you could be tax-smart, that’s great.
Meb: How far down the market cap spectrum will you go?
Jacob: That’s just another factor you have to diversify on. We put out our stats in our monthly that show that our average market cap’s around 3 billion, but we’ll go to just a few 100 million. We’ve got a whole bunch of names. I mean, we already talked about Danaos. When we got in that, it was super tiny, about as low as we go. But it’s all about liquidity. And if I’m going to something that low and liquidity is stretched, because ideally, you know, we’re 100 and something million now, we’re going to cap it at a billion. I do want everything we do to be scalable up to our max size. And so I’m looking at liquidity, is this scalable? Is this something we can get out of when we want to? And if it’s not, it’s going to be sized appropriately, and there are a finite number of those in the book. And typically a key component of the thesis is that that’s going to change. It’s illiquid now. It will be liquid when we care. And then as it gets more liquid, we can make it bigger. Although, hopefully, it gets bigger by itself.
Meb: So as we kind of start 2021 here, anything in particular on your brain you’re excited about, scratching your head about? Any thoughts about the way the world’s moving? Anything else we haven’t covered that you’re spending time thinking about when you’re on your 10-hour runs?
Jacob: Yeah. I wish this were easy and obvious. It’s very much not. One thing I skipped upfront is this notion of value. And we pitched at a Goldman Sachs emerging manager thing last summer and had a whole bunch of slides. Chris, with his quant shops, helped us do a bunch of proprietary analysis, looking at small-cap value to big cap growth, and going back to, I think, 1968. And basically what we said was as of the middle of last summer, the under-performance on a trailing basis was about minus 50%. It was about as low as it’s ever been. Every other time it got down under minus 40, the next 24 months, it reversed in a huge way. And so we were making this go value, go value pitch, which is nice. But like we think we’re evergreen and we think we’ll survive even when it’s a headwind as it’s been.
So that’s reversed. It’s reversed back to about even. Every time that reversal has happened the way it just did, it doesn’t stop at getting to even. Value then goes forward. And then you layer that with what’s happening on the long end of the curve, you know, in terms of the possibility of inflation. Now the front end’s picking up, you think about money printing on and on, you listen to “Singers Podcasts” with Grant Williams recently, you check out what Michael Burry saying about inflation and you start thinking that there is a reason to care about value. All these people in growth, it’s like you’ve made a lot in growth. It might be time… I don’t know if you’re overweight or not, but it might be time to move some chips to value. I think the setup is there for something more. The last few years we’d have these two, three days, oh, my God, value is back. And then no, it’s not. Something deeper is happening right now. The macro backdrop’s different. A reopening play combined with money printing, I think you want free cash flow.
Meb: I agree with you. I think we’ve actually seen the resume shift happen. There was a stat. Someone had posted, I have it on Twitter, where it looked at the French-Fama value factor back to the 1920s, long, short, and previously 1999 was the worst year ever for that factor, and the best year was 2000, until last year, 2020 was then the worst year ever for the factor. So 2021, we’ll see. We’ll check back in at yearend. But to me it seems like after the bottom and then certainly maybe interest rates later, and then the election, you can pick any of those waypoints, but they all seem to have been material shift in about seven different macro factors, but who knows? I’m a quant, I’m just saying. Seems like that’s the case.
Jacob: It is a funny thing too. So you start thinking about inflation and what it means for value and then you think about the short side. And we got short, long-duration corporates that were trading like 90 to 100 bips wide at treasuries, and treasuries were like at nothing. And it’s like super boring. These bonds don’t move that much, but shorting at 2.9% yield to worst out to 2050 in this environment of infinite money printing. Like, that’s a good trade. And so we put those on. They’ve worked a little bit, but if it works, it’s going to work. Here’s what’s tricky. I said it was tricky. It’s not obvious. Reopening, vaccine, fiscal support, you know, the government coming to the rescue, bullish, bullish, bullish, bullish. If this inflation thing gets going and they get it to the 2.5%, 3%, back in econ when I was at Cambridge, in all the equations, they have inflation expectation as a key variable.
It’s the expectation. We have never encountered a situation where we try and bump up inflation and then stop it in a world of viral social media. And I’m just like when all the pontificators get on Twitter, the way you can stoke fear now is inflation corrallable by the people who are in charge of stopping it. And the risk there is, if it runs away, I don’t know that there’s anything good. And so what I want to do is be really focused, nimble, and have a mandate where I can take down my net fast. That’s my solution, but, God, it’s going to be hard to predict. Like, you want to make money when the sun is shining, but when this thing turns, it could happen fast. So it’s a conundrum.
Meb: It’s a philosophical question for Philosophy Capital. That’s the question. As we start to wind down here, what’s been the most memorable investment So far?
Jacob: This Loral thing is the most memorable. And the reason being is… And I hate that I might’ve done this today. This pitching your winners is so effing annoying. I hate people who pitch winners and talk about winners. If I could go back and redo it, I’ll talk about losers.
Meb: Let’s hear both. You can tell two. There’s no reason you can’t say two.
Jacob: I’ll tell you two. I mean, I mentioned the Switzerland short blow up in my face. I could mention another. Remains huge because the spectrum, the magnitude of it, the alignment of incentives between the people who decide the outcome of spectrum and this company, it’s lined up. They just got more fundraising from the government of Quebec and permitted all these jobs. They’re tying into French import-export financing and a French manufacturer because France and Canada are tight. It’s all lining up.
Meb: This is a scenario where you had to say, “Look, here’s my approach. I have price targets. When it hits 100, 200, 400, this is where it’d be out”? Or do you say, “It’s like a continual reevaluation where, as new news flows comes in, you know, we kind of take a look at it?” How do you think about it?
Jacob: So I’ve done very scientific work on what the EBITDA is going out pretty far, discounting it back, probability, risk-weighting that against other outcomes, doing classic event-driven and coming to a net present value, probability-weighted assessment target of $141. That’s what I got. If it heads there as it’s been doing, I’m going to trim for risk management purposes because that’s just how our strategy is. The key variable will be incremental information. If things happen and they screw up our whole thesis, you got to factor it in and dynamically adjust. Oh, boss, Jerome, nothing would piss him off more than static analysis. So we’re going to be adjusting that number every single time stuff comes out. The reason I call it out again for being a memorable investment in my career is you go launch a fund, little bit nerve-wracking. You write a letter, it goes out to all these people. First time in the spotlight a little bit, not just under the shadow of a big PM. That is the first name where I pitched it hard when it wasn’t working. We started buying 23, kept buying to 16. Wasn’t working, wasn’t popular. People pointed out how bad it was. I thought a short could write it up. People just… The things they said about geosats, about Rachesky, about this history, like it was a graveyard. It was so unpopular. I went home feed about that. Like you’re thinking about business risk, but I’m just going with my process and the math. And at some point I’ve learned in this business, you want to be successful and justify charging a fee, swinging the bat. And so that was when I did that, the fact that our predictions come true feels good.
Meb: It’s interesting, too, because I think it’s actually, in many cases, when a stock goes against you or sideways, it actually causes you to redouble your efforts. You know, I feel like it’s easy to get lulled in when something is going up to get warm and cozy as it kind of goes up and feel less pressure.
Jacob: I get more stressed. Things go up, my stress level goes up because it gets hard. Like, what are you doing? Like, do I sell? Are we adding on up? Because cost average’s up.
Meb: How big of a position can you let them go?
Jacob: I might’ve mentioned earlier, 50% hard cap. That’s it. After that, it’s not our strategy.
Meb: All right. So let’s hear about the bad one. Did you have one in mind?
Jacob: I screwed up going in every direction. I screwed up owning it when it went down, I screwed up the sell. I screwed up not getting back in. This is embarrassingly bad. Atlas Air, I alluded to AAWW. So this is a cargo air, became popular recently as people realize that passenger planes out of the sky means limited supply for cargo space, and these guys are on fire. But it was really cheap and really levered, and coming into August of 2019, August 1st, because this led to a bad month for me because the squeeze I was talking about was the end of the month. The last day of the month, and this is the first day of the month, that month sucked. They came out with results and it was on the heels of some, I want to say, geopolitical tensions, and they have some transpacific routes and they got smoked. Stock went down and kept going down. I think it ultimately went down 40% or so. What happened was I try and be disciplined. I didn’t need your Excel. I thought maybe this was a buy, but I wasn’t pleased with the result. I got on the phone. I talked to this company for four years running. I knew them really well. Many of the people I talked to that day not long after retired. I got on the phone and I said, “Guys, first of all, you told me two things. You told me, number one, you’re not that exposed to transpacific and you have fixed contractual business.” And lesson learned, contractual business often doesn’t mean contractual at this level.
That was the lesson learned. They might have a contractual minimum, and that might be 30% lower. Also, lesson two, depending on your counterparty, they could say, “Redo our contractual business. Or if you don’t, we’ll see this contract through and then never work with you again. What do you want to do?” So contractual business, not that valuable. I at the time didn’t realize that. So I said, “Guys, you’re supposed to never have a 30%,” whatever miss they had. Like I thought you’re contracted. And they sort of said, “Yeah. Well, only this much, and everything else went to zero and this went to our minimums.” And so it was a big miss and I had screwed up understanding what contracted business means.
The other problem I had was they said they would de-lever by paying down a certain amount of debt every single quarter. They had told me. The market, not just me. They said, “Every single quarter, we’re going to pay…” God, what was it? Sixty million bucks of debt, something like that. They didn’t de-lever all that quarter because there’s supposed to be a capex cliff, no more spend. So I called them on the phone. I said, “Guys, you said you de-lever every single quarter as of whatever last quarter, there’s no de-levering.” And they said, “No, we did. We did.” “What do you mean you did?” And they said, “Yeah. We paid down this debt over here.” “Walk me through it. I’m looking at your net debt figures. There’s no change.” They said, “Well, we pulled on the revolver.” “What? Your pay down debt in your mind when you told me that involves pulling on a different piece of debt? Like no, no, no. This was explicitly clear. You have consistent, free cash flow generation to de-lever every quarter on an absolute basis and your net debt would go down.” So this eroded all trust that I had in the company, it also told me I didn’t understand what I was doing. I had it wrong. I didn’t understand. I didn’t think they could do a quarter like that. So I sold. Oh, and they had labor problems. Their unions were just consistently a pain and worse than I ever thought it would be. Lo and behold, though, COVID happens and this is where I screwed up and I’m mad at myself. I should have known they would be a major beneficiary. I should have been the first one buying that stock.
Meb: Settling old score, “I’m not going to buy that again.” But it’s almost like a reasonable, I feel like in some cases like it’s like one-strike you betray the trust or even something’s like a little fishy. I don’t know. Anyway, what happened?
Jacob: I think Greenlight wrote it up, a few people wrote it up, and I’m seeing what they write and it’s everything I thought back in the day and I’m like, “Uh.” And I’m not there and everyone else is making money. The stock doubled back. But it’s fine. These things happen. I don’t get everyone right, I’ll admit it.
Meb: What happened to it afterward? Just the rocket to the moon or what?
Jacob: Yeah. Totally. Well, my old boss has one habit. I hope he doesn’t mind me sharing, is he’ll send me screenshots of the chart with some, like, little pithy comment. And I’m like, “I don’t need a reminder. I see it every day.”
Meb: Jacob, this has been a blast. Other than watching you dance on TikTok or seeing you out on the trail, where do people find what you’re up to? Where’s the best place to fall along?
Jacob: Philosophycap.com. We got an email there if anyone wants to talk or whatever. We are trying to grow, we’ve got a business. I shouldn’t shy away from that. But, otherwise, we’re definitely inclined to stay a little quieter.
Meb: And more importantly, they come knock on your door and they can go next door and talk about crypto, too. Two for one deal.
Jacob: You know, these guys know what they’re doing. They’re very good. And they made more money than I will ever make, so good for them.
Meb: It’s been a blast, man. Thanks so much for joining us today.
Jacob: All right. Thanks for having me.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at email@example.com. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.
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