Tuesday, April 24, 2018

$FRPH - Value in Action

tl;dr: Bought FRPH at $39/share in July 2016. Currently, the stock is at $58/share, driven mainly by value enhancing steps taken by owner-operators, the Baker family. This article reviews how FRPH put Value in Action.

FRPH recently announced the sale of their industrial warehouse assets (41 properties) to Blackstone for $359M. The management announced that this was good time to sell given lower taxes and low cap rates. I thought this transaction provided a good opportunity to write about FRPH as "Value in Action" investment. The management doesn't promote the stock much - just look at their bare bones Investor relations website, but they have been long term owner-operators and have created significant value.

FRP Holdings ($FRPH) was formed in 1986 from spin off of real estate and transportation businesses from Florida Rock Industries. I first learned about FRPH from a stock pitch by Bill Chen of Rhizome Capital Partners. The original Florida Rock was run by the Baker family. The Bakers sold Florida Rock, a constructions materials company (aggregate mining and cement and concrete products), to Vulcan Materials for $4.6B in 2007. In 2015, FRP spun off its transportation segment into Patriot Transportation Holdings. Based on their long term record (1994 - now), the Bakers have been long term oriented and patient capital allocators, and they own 32% of FRP Holdings. They have extracted value from the original Florida Rock via spin offs, resource conversions, sale of businesses, and tax efficient and sale.

Here's how the market cap has increased in the last 20 years:
Florida Rock Industries         1994:  $260M,             2007 (sold): $4.6B
FRP                                        1998:  $111M,             2018 (FRPH + Patriot): $642M

Martin Whitman said that resource conversion is a more common source of wealth than earnings growth. An example of resource conversion by FRPH is the transformation of concrete plant on the side of Anacostia river to Dock 79 which offers apartments and high end restaurants. Part of this conversion was possible due to construction of the Nationals baseball stadium in that area and accompanying transformation from industrial to residential / mixed used area in DC's Capitol Riverfront area.

Dock 79

Before 2011: Dock 79 site was a concrete batch plant (Source: JDLand.com)

2016: Dock 79 from the same angle as the concrete plant picture above (source: JDLand)

FRPH plans to develop Dock 79's adjoining land parcel into another apartment building (Phase 2) below - 71 Potomac - where they are starting construction in Q218. This will be followed by 2 more phases (yet undetermined) following the construction of new Frederick Douglass bridge in 2021.

The Hampstead Trade Center offers another example of value enhancing play from the Bakers. FRPH bought it as part of 1031 exchange. 1031 exchanges are standard way that FRPH reinvests proceeds from sale of real estate, and lowers tax burden. They have now re-zoned this land from commercial business part to residential use and are looking to sell it.

Table 1 below shows the valuation estimates from both 2016 and now for FRPH. I've adjusted the estimates up as FRPH has executed on enhancing value. Though the valuation estimate is $69/share, I think its possible that the Bakers can find additional ways to enhance the value, especially in the Land Development segment.

Table 1: Sum of the parts valuation for FRPH

Note 1: Proceeds from Industrial Warehouse sale to Blackstone (all numbers in $K). I didn't include cash tax from this table in the valuation because the Bakers have successfully used 1031 transactions to avoid paying taxes. I do think that they'll end up paying some taxes, but don't know what number from $0 to $50M to put on it.

Note 2: Valuation for Land Development Segment

Many of the developments in Note 2 are long term projects and so putting value on these is hard. But the location of some of these land lots makes it an attractive investment. The Phase II of Riverfront has broken ground and construction will start soon. But Phase III and IV will proceed only after construction of the new Frederick Douglass bridge which is scheduled to complete construction by 2021.

For 2nd life of mines, Ft Myers second life will start in 8-10 years after mining has ended.

Buzzard point (square 664E) site is along the Anacostia river close to the new DC United Soccer stadium which opens in July 2018. This has the potential to a valuable site similar to Dock 79 (close to Nationals baseball stadium).

What are the future possibilities?

1. Spin off of mining segment
2. 1031 exchange for the Industrial warehouse sale
3. Continued development of Riverfront Phases II - IV
4. Massive growth in Buzzard Point area, similar to Capitol Riverfront / Navy Yard area
5. Sale of Hampstead residential lots with horizontal development

Sunday, April 22, 2018

Book Review (and short snippets): The Great Depression - a diary

This book  is based on diary written by Benjamin Roth, a mid 30s lawyer in Youngstown, OH and is focused mainly on 1931 to 1941 period. The unique aspect of the book is that he captures the investment environment, opinions of "experts", stock prices, and outcomes of investments from 1930s to 1960s. There are interesting case studies involving several people making investment errors and ignoring risks during the boom of 1920s. One example below shows $180K initial investment reduced to $10K.

While statistics such as "market fell down 90% during Great Depression" are thrown often around on Twitter, reading of Roth's diary makes the impact feel more "real". It moves slowly through the market crash days and shows that it wasn't a linear drop, but many mini-busts and mini-booms and many false starts. Before reading the book, I didn't know of 1937 business slow down and stock market drop.

Youngstown was one of the boom towns of the 1920s with rapid growth in steel industry, followed by steep drop in steel factory utilization and unemployment in the 1930s. This provides Roth with unique insight into the bust phase of a previously booming town. An example below about two brothers shows how people got caught into the boom of 1920s and recycled money into speculative priced assets is shown below (with disastrous results). Margin (leverage) made the results worse!

In addition to stocks, real estate investments got big losses in the Great Depressions. Examples below on houses, vacant residential lots and commercial real estate also show decades of underperformance following the crash. For houses, prices didn't rise above 1929 highs for another 25 years. Also landlords struggled with recouping their carrying costs due to depressed rents. Same for vacant lots - most didn't recoup the carrying costs. Downtown commercial real estate suffered due to flight from cities to suburbs following the WW II, GI bill and building of freeways.

Roth captures well-reasoned forecasts from various economy and market experts, only to show time and again that those forecasts were just wrong. In the end, he concludes that its best to make safe investments where price is lower than intrinsic value. And to keep cash (liquid capital) and courage to take advantage of recessions and bear markets. Roth cites example of Floyd Odlum as someone who had cash and the courage to put it to great use to buy undervalued stocks during the crisis and became one of top 10 richest tycoons in the US. This reminds me of Seth Klarman's comment that "cash is dry gunpowder" and makes me more comfortable holding higher % of assets in cash to take advantages of downturns.

This book provokes lot of thought around the central question on risk in investments: How does one protect capital? And it shows how things can go horribly wrong when risk is ignored. Sometimes, it is hard to remember this in midst of a long running bull market like today. While a crash like Great Depression might not happen again, its still useful to remember that big crashes are a possibility. And risk doesn't disappear just because its not obvious.

Additional suggested reading:

1. Howard Marks: The Most Important Thing
2. John Kenneth Galbraith: A Brief history of Financial Euphoria

Monday, April 2, 2018

How Reddit post got me thinking on speculative pricing of assets

I recently came across this reddit post --  someone with $310K income asking about whether they should try to buy $800K condo with 1 bed, 1 bath in San Francisco. Now $800K is the asking price which probably means that people will bid it up another 10%-20% because that's the "norm".

Two things caught my eye in this post:
1. The carrying costs of this condo (interest, property taxes, HOA fees) will be ~$4K / month, which is higher than renting an equivalent apartment ($3.2K - $3.6K) in the same SOMA area in San Francisco. Clearly its cheaper to rent vs buy, but probably the fear of being priced out in the future is driving this person's actions.
2. This person has close to 14% of their net worth in cryptocurrency!

Could this Reddit posting person be recycling capital from the good ($310K combined salary, presumably from tech) into the speculative ($800K for 1 bed / 1 bath condo, $45K in cyptocurrency)? Probably they're trying to get "fast appreciation of assets" to buy that 1000 sq ft $2.5M Palo Alto home 10 years down the road.

Could this be a speculative episode justified by housing shortage, tech riches (currently), and fear of missing out if not acted immediately?

What are the conditions for a speculative high pricing of assets?

I turned to John Kenneth Galbraith's A Short History of Financial Euphoria for some answers. Galbraith says that speculative episodes are caused by  people either thinking this time is different (due to new technology or new opportunity), or they think that they are smart enough to get out before the speculation dies (they won't be the last fool holding the asset).Another theme in Galbraith's book is that progress in finance is cyclical - there is no permanent high plateau. And the gap between the cycles is ~20 years because the memories of the old bubble are lost in that period.

Based on Galbraith's description, these might be potential candidates for speculative pricing :

1. Technology ETFs

I hear these two things a lot here in Silicon Valley -

a. This is a new dawn, tech will do great as investment regardless of valuation (insert some buzzword here like AI, or machine learning, or self driving)
b. ETFs are the way to go, and there's almost universal consensus that human investors underperform the market. Even better if there's an app to invest one's money ("automate, why do the hard work yourself?")

There's lot of conversation around FAANGs that sounds similar to Nifty Fifty from 1970s. Nifty fifty were fast growing companies (McDonald's, IBM, Texas Instruments, Digital Equipment Corp, Coca-Cola, etc)  that were considered a buy at any pricing (price being 42 times earning at the peak), before losing 2/3rd of their price in the crash from 1972 to 1975.  Here's a good article on Nifty Fifty.

FAANGs are no doubt great companies  (i.e. have great products), but are the valuations too rich?

2. Bitcoin / cryptocurrency

It has all the ingredients for a bubble : Shady operators, unregulated markets, product without intrinsic value, your cousin telling you why you ought to buy it.

See the chart below and here's the accompanying writeup on why Bitcoin might be a bubble.


3. Housing cost in big cities

The SF condo post from Reddit highlights how renting is cheaper than buying. But SF is hardly the only city that has speculative pricing for houses. A recent FT article showed how house prices in all major cities in the world rose rapidly and in unison after the 2008 crash. Global low interest rates were cited as the cause, along with flight to safety for foreign (read Chinese) capital into real estate in "global cities".  As James Grant says, low interest rates lead to mispricing of capital and credit, and thereby mispricing of risk.

The most interesting case in terms of real estate speculation seems to be Toronto. Toronto Star archives paint a scary picture of the 1990s Toronto housing bubble - some examples being a penthouse sold for $299,000 in 1991 when a couple of years ago it would have reaped $450,000 to $495,000. There was also story of elderly man buying 3 condos with his $300K retirement and losing it. Sounds like people stretched too much to buy house that they could not afford.

And now in 2018, some similar things are repeating in Toronto - buyers are walking away from signed deals, and some are selling houses at steep losses within an year, see the tweet example below (h/t @ExtraGuac4Me). Another example was when @catosletters heard a CIBC bank teller telling him that she bought a second condo and rented it back to previous owner!  Even back in 2015, Mr Money Mustache showed how renting in Toronto was way cheaper than buying. Could this be a repeat of 1990s since 20 years have passed and the memories of the previous crash have faded?

Scheid Vineyards (SVIN) - substantial upside potential

I first found about Scheid in a  writeup  from Aaron Edelheit. Scheid is the 33rd largest winery in the United States when measured by num...