Expert Investor: Yaron Naymark – Deep Dive on an Unconventional Stock

HOSTS Alec Renehan & Bryce Leske|11 June, 2020

Meet your hosts

  • Alec Renehan

    Alec developed an interest in investing after realising he was spending all that he was earning. Investing became his form of 'forced saving'. While his first investment, Slater and Gordon (SGH), was a resounding failure, he learnt a lot from that experience. He hopes to share those lessons amongst others through the podcast and help people realise that if he can make money investing, anyone can.
  • Bryce Leske

    Bryce has had an interest in the stock market since his parents encouraged him to save 50c a fortnight from the age of 5. Once he had saved $500 he bought his first stock - BKI - a Listed Investment Company (LIC), and since then hasn't stopped. He hopes that Equity Mates can help make investing understandable and accessible. He loves the Essendon Football Club, and lives in Sydney.

In this episode we speak to US-based expert investor Yaron Naymark. Yaron is the portfolio manager at 1 Main Capital, a long-focused fund investing in high-quality, attractively valued, growing businesses. Yaron has over 10 years experience in finance and before 1 Main, worked at CitiBank, H.I.G. Capital, Altalis Capital and Glenhill Capital. 

In this interview we discuss Yaron’s investment philosophy – finding companies with long runways and an ability to compound their earnings at high rates of return. We then get stuck into a specific company that Yaron is looking at, and suffice to say it is an interesting one. RCI Hospitality (NASDAQ: RICK) is an operator of strip clubs, nightclubs, gentlemen’s clubs and US-military themed restaurants. Yaron explains his process to research RCI and his investment thesis for the company.


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Bryce: [00:00:56] Welcome to another episode of Equity Mates, a podcast where we help you learn to invest in 45 minutes or less. We break down the world of investing from beginning to dividend so that you can hopefully make some returns. My name is Bryce and as always, I'm joined by my equity buddy Ren. How's it going, Bro? [00:01:11][14.7]

Alec: [00:01:11] I'm very good. Bryce very excited for this interview. We are recording on Friday the 13th of March, Australian time and we're saying chaos in the markets overseas and to talk about his investing journey. But I think we're going to get into what's happening these days as well. We have an American fund manager joining us. [00:01:31][19.9]

Bryce: [00:01:32] Yes, we have Yaron Naymark from one main capital over in the U.S., your own. Thanks for your time. [00:01:38][6.1]

Yaron: [00:01:39] Thank you for the distraction on a bloody read day, [00:01:41][2.5]

Bryce: [00:01:43] Friday 13th Covid. Markets not open in Australia at the moment, but if it's anything to go by, what's going on over in the U.S. and Europe overnight? We're in for an absolute bloodbath again today. I think the Dow Jones is officially in a bear market as of yesterday or the day before. So, yeah, looking forward to this conversation. [00:01:59][16.8]

Yaron: [00:02:00] And the S&P 500 is in a bear market as of today. [00:02:03][2.4]

Bryce: [00:02:03] They go, say, over [00:02:05][1.5]

Alec: [00:02:06] the ASX, likely to follow this morning. [00:02:08][2.5]

Yaron: [00:02:09] Yeah, exactly. [00:02:10][0.9]

Bryce: [00:02:11] So your own is a portfolio manager at one main capital, a US based asset manager. He has over ten years of experience in markets and finance before working at one main. Your own worked at Citibank, H.I.G. Capital and Glen Hill Capital as well. So a lot of experience and we're looking forward to delving into that a little bit. But before we do, flip it over to Ren for a bit of a game. [00:02:33][22.8]

Alec: [00:02:34] Yeah, so your own we always like to start these interviews with a game, a game of overrated or underrated or overvalued, undervalued, just to get a sense of the person who was speaking to and what they're thinking about some indexes and some investing themes that a sort of big today. If you're up for it, we'll get stuck. Yeah. [00:02:52][17.9]

Yaron: [00:02:52] Yeah, definitely. [00:02:52][0.3]

Alec: [00:02:53] As you can hear from our accents and Australian podcast and look, fair enough if you don't have an answer on this one because you're not so close to it. But we'll start with it. Overrated or underrated? The ASX 200 index, which is the benchmark Australian index. [00:03:07][14.2]

Yaron: [00:03:08] Yeah, I'll go with overrated. I think if you invested in any of the major non US indices over the last ten years, you're probably flat on your investment with a lot of volatility along the way. So I tend to think of most of them is overrated. [00:03:24][15.3]

Bryce: [00:03:25] So then overrated or underrated? The S&P 500 [00:03:27][2.3]

Yaron: [00:03:28] I will go with overrated again. I mean, that's one of the that industries that has performed well over the last ten, fifteen years. But that was driven by a large degree to the time and fang stocks, which I guess that they've become such a big part of the index point. And I mean, given the large numbers, it's really tough to imagine that you can assume forward returns will equal parts returns. And on top of that, I mean everyone's long aspects. And it's not the only way it's going to. And that's kind of boring to be along with everyone else as well. And so I could operate on that one as well. [00:04:05][36.6]

Alec: [00:04:05] Fair enough. So as we said, we're having this conversation in a sea of red and a lot of that has been driven by coronavirus concerns. So putting aside the impact on financial markets, which we're seeing play out in front of us, overrated or underrated coronaviruses impact on the economy? [00:04:22][16.8]

Yaron: [00:04:23] Yeah, I would say I mean, it's it's kind of tough to disconnect what the markets are saying from what the economic impact is because the markets are trying to discount the economic impact. I would say that a few weeks ago, the economic impact definitely underrated today, frankly. And then probably and I get a lot of criticism for people from people I know for saying this because everyone thinks it's the end of the world. But I think it's a bit overrated at this point. I mean, it doesn't mean that the stock market can't go lower. People, you know, even not looking at the stock market can't freak out any more than they're already freaking out. They probably well, the market may go lower, but I think that there's lots of situations out there where people are buying, you know, eight months worth of toilet paper to leave at home, for example. And I just don't think it's going to be that bad. I mean, I've been getting text friends all over the country telling me to go to the ATM. I'm in New York City, but they're telling me to go to the ATM and take out cash and go to the supermarket and buy six months worth of canned beans. And I just maybe maybe I'm an optimist, but I just don't think it's going to get that bad. You know, it's unfortunate for the elderly and whoever gets it, that has a bunch of risk factors that makes it risky for them. But for the average person, it's not going to be as bad as as the tax I'm getting and why. [00:05:37][74.1]

Bryce: [00:05:38] It's almost as if Christmas has come for the doomsday preppers that we saw on to, you know, that TV show over in the States years ago. [00:05:44][6.5]

Yaron: [00:05:45] Yeah, I mean, even even a broken clock is right twice a day. Right. So if you're calling for the end of the world. Every year, every month or every week, you're eventually going to get it right. I'm not saying this is the end of the world, but, you know, anyone who has been calling for the end of the world for weeks and months and years definitely did not see this one coming. So they can't even get credit for that. [00:06:06][21.5]

Bryce: [00:06:07] So overrated or underrated index investing. [00:06:10][2.6]

Yaron: [00:06:11] I'm going to be boring because I'm going to say overrated for everything. I mean, I think an index investing is overrated. I mean, I touched on it when you asked about the ASX, but I mean, if you had bought and held almost any major index except for the NASDAQ, the S&P 500 over the last five years, you probably pretty disappointed and and your results and you were able to find some of the winning stocks even within those bad indices that had disappointing results. You could have done incredibly well. So I'll go with overrated for index investing. [00:06:41][30.3]

Alec: [00:06:42] Yeah, nice one. Now, the last one to close us out, overrated or underrated US Treasuries, definitely overrated. [00:06:50][8.1]

Yaron: [00:06:51] I mean, the target inflation rate in the US is two percent and long term treasuries yield one percent. And so if you buy long term treasuries, you're betting against government achieving a target that it's very clearly laying out for you and it's totally within the government's control. I mean, they could print money whenever they want to. So, I mean, they may not achieve their inflation target today or tomorrow, but if you're buying a 30 year bond, I can almost assure you they're going to achieve a two percent inflation target over 30 years. And so you're basically guaranteed to lose money in real terms. So I think anyone who's buying bonds today, whether they're euro bonds or US bonds, I think they either have to own them or they're playing a greater fool game. And they think that, you know, someone else is they're buying it at a one percent yield. And I think someone else is going to buy it from them at a half a percent yield in three months because Carone is going to get so bad. I don't think anyone actually, you know, any anyone who doesn't not for selling it. If you're a bank or something, you might be forced to own it. But any investor that's not a bank that's forced to own it. If you're buying a two percent treasuries that are one percent Treasury today, I don't think you're happy making one percent for 30 years. I think you think it's going to go up by 20 percent in the next six months because Carone is going to get really bad and then you could sell it to someone else, 20. And so it's a graters pool game. And I don't know, mean it's not not the way I like to make money. [00:08:17][86.2]

Bryce: [00:08:18] So you run before we get into one main capital. We always like to take a step back and understand a bit about your background. And we're really interested in understanding the story behind your first investment. So you to take us back to when that was and perhaps if there are any major lessons from that first investment that you've carried through to today. [00:08:38][20.1]

Yaron: [00:08:39] Yeah. So I guess background and then and then the first investment I grew up in the States to immigrant parents, they ran a very small business, but they had a lot of friends that had larger businesses. And I grew up, you know, surrounded by business people who had all kinds of conversations about the problems of the day or their growing pains. And so I was exposed to it at a very young age. I've always been passionate about business and then later on investing that a lot of reading in my high school and college days about investing grades and which I always found it very intriguing. So that's kind of how I got into investing. And in terms of my first investment, I'm not going to say the name of it, but I'll give you the story just in case my family friend listens. But it was in during the dotcom bubble. I was pretty young and had a family friend who at the dinner table with a bunch of my parents' friends, was talking about a stock where they knew someone who knew someone who was the CEO of this company. And they said it's a screaming buy in stocks going higher. And that and I told my dad we'd open an investment account and put a few hundred bucks in it because the stock was going to go to the moon. And my dad agreed to let me do it. And we bought a few hundred bucks worth of the stock and it proceeded to go down like ninety percent. And our family friend kept kept talking about it for months and kept doubling down and losing a lot of money on it. But I guess the lesson I took away from that was you have to know what you own and you can't borrow someone else's conviction. You know, even if someone is pounding the table telling you something to buy, they're going to forget to call and let you know the second they sell it, if they change their mind and if they don't change their mind and they're doubling down all the way down to zero, I mean, you're not going to know if they're wrong if you don't have your own conviction. So that's the takeaway. [00:10:28][108.3]

Bryce: [00:10:28] Sounds similar to Alec's first investment. He lost, I think, lost. Ninety nine percent. He's lost so much on his first investment four years ago that he can't even cover the brokerage. [00:10:38][9.8]

Yaron: [00:10:39] So you know what it's kind of like? I think it's probably a blessing to lose money on your first investment because then you realise it's it's not supposed to be easy and you need to do a lot of hard work and you need to know why you own some. Thing is, I would say it's kind of like going to the casino if you make money the first time you play blackjack, you just think investing is easy or gambling is easy and it's just easy to take money from the casino and that that that's starts you off with some pretty bad habits. So I think it's pretty humbling to lose money in your first investment. So congrats. [00:11:11][32.2]

Bryce: [00:11:12] Yeah, completely agree. Your own. There's obviously a lot of members in our community who have started their investing journey quite recently towards the sort of peak of the most recent market and are now probably feeling quite disheartened about the whole thing, watching some hard earned cash fall away pretty quickly. And to your point about losing money and you first try it, it's not the be all and end all. What sort of, I guess, small piece of advice would you have to these people who are watching their first investments fade away pretty quickly? [00:11:41][29.2]

Yaron: [00:11:42] Yeah, I mean, I would say I touched on it a second ago, would say it's not supposed to be easy. It was easy. You know, then everyone would do it and everyone would be rich and then it wouldn't mean anything to be rich. And I think that investing is just it's a lot more than picking the right stock. If you're actually trying to manage a portfolio, you need to put a lot of thought into the portfolio construction, you know, what industries you're exposed to, what types of economic Bryce you're exposed to. And just think about portfolio construction and risk management in addition to the individual stocks you're picking. And then I guess a lot of people who I speak to about investment who are kind of new to it, they kind of come at it from the ends of the spectrum. From what I've noticed. I mean, some people come at it purely from a narrative perspective. You know, they hear the story about this company that's going to change the world and they're not really paying attention to the valuation or the price of that story. And other people are purely focussed on valuation and and pay a lot less attention to the little the little details that that really matter. And I would say to everyone, but by combining the two is is very, very important. And then I guess tangential to that, I'm in the game of asset management is just it's a game of constant refinement. You know, the more you play, the better you get. And it's only after you've looked at thousands of investments and you've made a lot of errors of omission or errors of commission that you start to pick up on small nuances that you might have missed, you might have missed earlier on and your investing career. That can be really big deals when you're trying to differentiate between different opportunities. You're looking at whether it's, you know, the quality of the management team, the durability of the growth of the business, the returns on invested capital industry structures, there's there's so many nuances within each of those buckets that are very meaningful that I think the more reps you can get and the more names you could look at, the better you're going to be over time. [00:13:43][120.4]

Alec: [00:13:43] I like that. I like that. It's the sort of ten thousand hours rule applied to investing. You just have to put the time into the work. I guess looking at your background, you have done the work. You've worked a number of asset managers and you've, you know, as Bryce said in the introduction over ten years in the finance game. So for speaking to two people who aren't in finance and who have never worked in finance, can you tell us some of the things that retail investors like Bryce and I misunderstand about the world of professional asset management? [00:14:17][33.5]

Yaron: [00:14:18] Yeah, I mean, a lot of the things I touched on, I mean, it's it's not supposed to be easy. If it was easy, everyone would be doing it and then it would be meaningless for it to be for you to do better than the averages. And it requires a lot of time and a lot of reps, like I said. I mean, it's just a game of constant, constant refinement of your strategy. And no two people are alike. No two people have the same exact strategy and two people have the same exact risk tolerance. And sometimes something might be in your sweet spot that's not in someone else's sweet spot. And you just need to learn where your sweet spots are and how you're comfortable making money. And there are some very important kind of high level, important things that every great investor has in common. And a lot of them have to do with risk management and understanding what makes stocks go up or down. But I would say just continue to continue to spend time studying the qualities that work for you and invest in investments. And you're going to continue to get better over time. [00:15:16][58.2]

Alec: [00:15:16] Say, yeah, I like that. I like that. So moving to your work, one main capital, if we start broad, can you tell us what your investing philosophy is? At one main [00:15:28][11.2]

Yaron: [00:16:52] Yeah, so one man is so long biased investment fund. I found that about two years ago and makes investments in a combination of long term quality and then shorter term special situations. I lean towards the compounders all as equals, that there's an abundance of opportunities to look at it and to look at the longer term compounders. First, the fund is fairly concentrated and because it's fairly concentrated, I look for strong downside protection and any investment I make, whether it's in the form of a reasonable valuation and strong, the ability of the business, high current cash generation and where I have a high confidence in the growth outlook of the business. And so in terms of I like compounders, I mean the I guess the way the way I think about it is there are basically two ways you can make money as an investor. And and the first is capital appreciation, which means the stock goes up and the other is the cash of the business and the form of dividends in companies. They're rarely priced. And they were using that a high dividend yield without something that's pretty obviously broken about the business. So I tend to throw those out just for the sake of simplicity. And if you throw those out and make good returns based on the stock price developed for capital appreciation, stocks go up for one reason. Either a company's earnings goes up or the multiple that the market subscribes to, those earnings goes up and accessed. When multiples are at extreme weather, they're very low or very high. It's kind of hard to predict a change in multiples. So and typically, I guess if they are too extreme, so if it's multiples are very, very low or multiples are very, very high, I guess you can bet on the change in the multiple because extremes tend to mean revert. And so if you buy something with a low multiple, you have the optionality for that multiple to go up, which is enticing to a lot of value investors, but typically for buying something with a low multiple, like how the optionality of the multiple going up. It's typically at that low multiple because the quality of the earnings or the growth trajectory of their earnings or the balance sheet, there's some issue with them. So similar to the high dividend stocks, if you just you kind of tend to, you know, except for the special situations where typically I have a nuanced view on why I think they're priced the way they are. I think that could change. I tend to from the long term compounder perspective, I tend to talk about the extremes. And so I tend to look at companies that are right in the middle of the pack in terms of valuation. And for those opportunities, they tend to be high quality businesses that have very predictable growth and their earnings profile or earnings per share profile. And when you find those, they're great because, you know, you could you could underwrite a multiple that you're comfortable with owning the business at. And then if they could grow its earnings per share at fifteen or twenty or twenty five percent clip over over an extended period of time, you're basically put in a multiple expansion of compassion aside, which like I said, it's very tough to predict. I mean, typically long term compounders hold there multiple and then you can kind of grow your capital with capital appreciation, with the earnings per share growth. So the beauty of buying those types of businesses is that you get to know the business very well. They tend to be higher quality. You don't need to replace them as soon as they work. I mean, if you buy a special situation for a dollar and then it doubles six months later to Dollars and you sell it, you need to find something new to replace it with. And that that new thing you find, you're not as familiar with it. It might be a lower quality business. You might not even be able to find anything at all. And there's a lot of mistakes you could make. The more action you take investing, the more you expose yourself to mistakes that you could potentially make. So it's much easier and safer, in my opinion, if you buy something at twenty times earnings that you think can grow. Earnings per share a 20 percent a year for 10 years, then to buy something at 10 times earnings, that you can go to 20, but it could go to eight and the earnings might actually go down instead of up. That's why it's selling for 10. And, you know, the other market participants tend to be pretty smart. The markets aren't efficient always, but over the long term they tend to be. And so if something is selling for 10 times earnings, a lot of other market participants have probably picked over it and tried figuring out whether 10 times was too cheap. And if they left it at 10 times, then a lot of times there's a reason. So I think with special situations, you need to have a much more nuanced view on why it's going to work. Whereas for compounder and, you know, you get up to speed more quickly, you're exposing yourself more risk. And with compounders, you get another business for longer and you don't need to make your investments as frequent. So that's why I tend to lean towards those in all situations. I tend to look for a reasonable value entry valuation, strong management team, strong balance sheets and a business that can withstand the test of time. So that's kind of what the strategy is. [00:21:56][304.3]

Bryce: [00:21:57] So at the time of research, your biggest holding was USSI one hospitality teka R.K. Correct us if that has changed since, but it would be great to use that as an example as to why you sort of chose that stock and how it sort of fits what you've just explained. How are you able to talk us through sort of the process and reason companies, if effectively you biggest holding? [00:22:22][24.8]

Yaron: [00:22:22] Yeah, of course. So it's RCI Hospitality and I see one. Oh, sorry, it's fine. It was my biggest holding by far as we entered the year. It's been hit pretty hard with this Korona sell off and so it organically declined to become a smaller than my top position. It's still up there. It's probably a top three or four still, but it's no longer my top position, unfortunately. But I'm happy to use that as an example. I mean, I think it's I think it's a great example of a business that when I bought it, I entered a very attractive entry valuation and it had a lot of the qualities I look for in compounders. So it's a great case study. I still think it's very interesting, even with this current sell off. And so it's basically a business that owns gentlemen's clubs in the US, owns about three dozen of them across the states, and it also owns restaurant sports bar like military themed sports bar concept called Bombshell's, which is a much smaller part of the business. And so the stock sells for a pretty cheap valuation today. But even before the current sell off, it was selling for a very low multiple on its maintenance free cash flow. And just to give you context that the maintenance free cash flow, the business is about mid 30s, millions of dollars today. So probably call it thirty five million dollars of maintenance, free cash flow. That's that's cash flow from operations, less maintenance capex and the market cap of the company. When I my my my cost basis in the company is probably the market cap of under two hundred million dollars. So I was able to get a two hundred million dollar market cap to buy a stream of over thirty million dollars of free cash flow. So that's a very that's a very attractive entry valuation. And so when you hear a valuation like that, you typically think, OK, that's probably a low quality business. Like why else are you able to buy this for a single digit cash flow, free cash flow, multiple. And so when you when you peel back the onion, it's actually not a low quality business. I mean, there nightclub segment is a very protected business. They tend to have their licences, their liquor licences, them and their licences to operate. These gentlemen's clubs are grandfathered into place. And the places where they own these clubs, they tend to be either at the top club or the only club and those cities. And it's impossible to get new licences. I mean, no new city want to approve new gentlemen's clubs in those cities. So there's really no new competition. They could pop up. They have great reputations, great brands. And the nightclubs just just meant cash flow from quality of business standpoint, high quality of business. From a management standpoint, the CEO of the company is great. He's built the company over several decades. He started with one location and kind of gradually built it up to over three dozen. Today, he has a vast majority of his net worth invested in stock. He really cares about shareholders and the stock price. And so management team check. And then in terms of can they compound their capital at attractive rates over a long period of time, the answer to that is, is a resounding yes. I mean, he is able to take that. Thirty million dollars. Thirty five million dollars of free cash flow that the business generates. And he reinvest it in acquisitions of other nightclubs. And those acquisitions, he tends to buy clubs that, I don't know, three, four or five times even with that and a lot of times they're one hundred percent financed by banks and seller notes. And so the returns on equity of those investments are extremely high. I'm in third. 20, 30, 40 percent on equity sometimes, and the most recent acquisition, did the CEO of the company reach an agreement to buy a nightclub in the northeast corridor of the US? I have narrowed it down a bit. I think it's I think it's a Boston club. I'm not a hundred percent certain, but I think it is. And and then they announced that they were buying this club for 50 million dollars and they were able to get financing for the whole 15 million. So the company is actually putting up none of its own equity and that club is going to contribute a couple of million dollars of free cash flow. So they're putting up no, I mean, that's an infinite return on equity rights. And so but for the most part, they're able to take their thirty five million dollars of free cash flow. They reinvest it back into these nightclubs at very attractive entry valuations, as well as their Bombshell's restaurant concept, which also has a very attractive return profile. And I'll touch on that for a second. The bombshell segments, like I said, it's a military themed sports bar concept and they basically their cost to build those locations is probably four million bucks. They tend to buy the underlying real estate in their nightclub segment, as well as the restaurant segment. And so they're able to get a mortgage on the property and then the equipment that goes into the restaurant, they're able to get capital leases on. And so the actual equity that the company needs to put up to open one of these locations could be like one or two million bucks tops. And those locations generate five, six, seven million dollars of revenue and 20 percent operating margin. So call it a million, two million, five of of operating profit on a one to two million dollar investment from the company. So, again, very high returns on equity. So if you roll this picture forward, three, four or five years where it takes us 30 million dollars of free cash flow that generates every year, reinvest it into nightclub acquisitions and Bombshell's development, it's very easy to see how free cash flow per share is going to grow at very high rates over the next three, four or five years. And the beauty is when you buy in at a low entry valuation, you have the optionality of the multiple going up. I don't think from a fundamentals perspective, you have much downside in terms of the multiple going down. Obviously, the multiple got hit over the last few weeks because everyone's worried that coronavirus is going to shut down the clubs and restaurants. But hopefully that's a very short term issue for the business. And putting that aside, I think that there's a lot more upside to the multiple than there was. I mean, if Crohn hadn't come, I didn't think there was any downside to the multiple. Obviously, the multiple went lower because of Corona, but without and I don't think there was much downside to the multiple. And I could see a lot of upside as the market starts to appreciate the company's ability to reinvest these attractive returns. The other question is, this is such a high quality business with a good management team and the ability to reinvest at these higher rates of return. Why does it sell for such a low entry valuation? That and I guess a lot of times that's you know, that's the biggest question I ask, because sometimes most of them do something is too good to be true. It probably is. And so you have to really understand why that opportunity is being offered to buy the market. And the conclusion I've come to, which I've spent three years following the company now, and I'm pretty confident in my conclusion is that there's a few reasons. One is I think a lot of institutional investors are hesitant or can't own a company that operates gentlemen's clubs. I think that if you're taking money from pensions or foreign governments or whatever, it's just hard to go and tell your employees that you own this kind of true. And it's a pretty small and illiquid stock as well. So the universe of managers who can even look at it from a liquidity perspective is pretty small. And then the other the other thing is that the company has had a history. You know, the CEO, while I think he's a very good capital allocator now, this company has been public for a very long time. And the CEO wasn't always a good capital allocator. You know, he built this from the ground up from one location or two locations, the five locations, 10 locations. And when he first became a public company CEO, he was getting told a lot of different things on what he needed to do to get a stock price from a lot of different people. And I don't think he really had a great handle on what the right answer was. I think he thought that needed to grow the top line of the business just for the sake of growth. And they didn't really spend a lot of time focussing on free cash flow per share growth of the business. So he issued a lot of equity to do acquisitions when the equity was cheap and acquisitions he was doing were less cheap. He invested in these pet projects that had the potential to accelerate revenue growth but didn't have a good record profile. And so he did a lot of things for a longer time that kind of put the company on a path to not grow free cash flow per share at very attractive rates. That changed about four years ago when a big shareholder of the company came and presented to the board on what they needed to do to get the stock price up. And it resonates with me because when he told me a story, I was like, wow, this guy really gets it now because shareholder can. The board with a presentation titled Do Nothing. That was the title of the presentation and they were like, look, you traded this absurdly low valuation on free cash flow and you're doing all these things trying to get your stock up like, you know, just do nothing if you do nothing. Stop making stop what you're making. Back then, it wasn't 30 million bucks. Maybe it was 15 or 20 million bucks of free cash flow. You're taking that and burning it on dumb pet projects that aren't good good investments. Right. Then they're not generating good returns on that. And those investments, you're not going to be growing your free cash flow and investors aren't going to ascribe a high multiple to the free cash flow because you're just burning it on dumb things. So just do nothing and your valuations go up and on top of doing nothing. If you find opportunities where you can invest at these attractive returns, like buying clubs at X valuation or buying your stock back, if it trades at Y valuation, then that's when it makes sense. They told they told the management team also to read this book called Outsiders, which is a book about capital allocation. And when you talk to the management team now about how they think about deploying capital, I mean, it's night and day from the transcript you read Pray Twenty Sixteen when they implemented this capital allocation strategy. And so if you look back at the stock price over 15 years, you might be like, well, it hasn't done that. Well, like, why hasn't it done that? Well, and you can you can very easily dismiss it as a stock that just historically hasn't done that well. And and it's always not going to do that well. And so I think you need to pick up on on that change that happened in twenty sixteen. And then when they implemented that strategy in twenty sixteen, it actually started to work. I mean the stock went from ten bucks to thirty five bucks and like 18 months the stock went up three and a half. The CEO who has most of his net worth tied up in the company, didn't sell any stock during that period. And so it shows you, he believes that the value creation opportunity was real, even if. Thirty five bucks. And then in mid twenty eighteen, the company started getting attacked by this anonymous short seller on Seeking Alpha, who actually brought up some valid criticisms of the company, but also just said a lot of things that were just frankly untrue and inaccurate. But the valid criticism that they said about the company or that the company had a bunch of related party transactions that it wasn't disclosing to investors. And so that led to the SEC opening up a formal investigation into those related party transactions. Then when the company announced that the auditor also basically resigned at the end of that internal review that the company had to do and to look into those allegations. And so you had a situation where the S.E.C. opens an investigation and resigns and all that just looks really bad to investors who are already having a hard time justifying ownership of this to their peers. And so the stock sold off from thirty five down to like 14, 15 bucks on that. Since that point in time, I scaled into the position. I mean, it was a position for me, a decent size position, but I made it really big in the teens after that happened. And the reason I was comfortable to scale it to such a large position was the company actually hired an international law firm to lead an internal review into all of the allegations made by the short sellers and that international law firm. The attorney in charge of it was a former US attorney who had the authority to look into anything and everything that he found relative to to those allegations. He was able to look into text messages, emails and and he after several I think it was like a six month review. He came out, he allowed the company to come out with an AK describing his findings and then those findings. It basically said that, yes, they had some related party transactions that they didn't disclose that should have been disclosed. For example, the CEO's brother was selling furniture to the Bombshell's restaurant. And another example is the president of the nightclub division was the brother of a board member of the company that wasn't disclosed also. And so you had all these I would call them minor things. I mean, that weren't if I knew about them, if they were properly disclosed, I wouldn't have thought twice about them. But because they weren't disclosed, they looked bad. And I understand why the has yet to open an investigation with the company. But importantly, none of those things had an impact on the company's income statement or cash flow statement or balance sheet that they had previously filed with the S.E.C.. So like the cash that they said they generated, they actually generated the earnings they said they generated actually generated. They just didn't disclose that. You know, the president of the nightclub division was the brother of a board member. And so once those disclosures were made, I got comfortable that, you know, the earnings were real. And now it's just a matter of time between now and when the S.E.C. investigation formally concludes and the stock could potentially start to get its mojo back. And in the meantime, the company is growing its free cash flow per share. This incredibly attractive rates because it's able to reinvest and these nightclub acquisitions at low multiples and these restaurants have very high returns on invested capital. And so that was the thesis now with this current. Virus throwing around the things I mean, so it just kind of round out that the initial part of the thesis, I mean, this year the company was finally starting to get back on track. It filed its 10K. It wasn't able to file its 10K on time. Why all this drama was going on and they were finally able to file their 10K. And when they filed their 10k, the stock started and went from 18 bucks a share. That got up to twenty six, twenty seven bucks a share by mid-February. So it was up a lot to date. And then this current affair started dominating the headlines and the stock came back from twenty five, twenty six bucks down to like 11. But right now and that's why it's not my biggest position anymore. I think the babies kind of been thrown out with the bathwater, in my opinion. And I understand why restaurant and leisure stocks have sold off the way they have. If you look at most of them, a lot of them don't own a lot of their real estate or any of their real estate. So they have these big lease liabilities. And if traffic is down in their restaurant, they still need to make the lease payments. And some of them have debt and they don't have a lot of cash on their balance sheet. And so we can get really scary really quickly from a liquidity perspective. And all of a sudden, people are worried about the solvency of the businesses and and doesn't really, really doesn't have a solvency issue. The biggest question mark is how big is the impact going to be near-term and how long will it last for? But the company owns 80 percent of its of the real estate underlying its clubs. It's Ren expense for the lease locations is very low. Its interest expense on its debt comes out to less than 10 million bucks a year. And so the company has enough cash on the balance sheet right now to probably last over a year if they had to shut down all of their locations for a full 12 months. And even if they had to shut down all their locations for longer than 12 months, they own so much of the real estate that they could probably do sale leasebacks or take additional mortgages on their real estate. And on top of that, like their locations are geographically diversified. So they have their big markets are Texas, Florida and New York. So you would have to think that Texas, Florida, New York all have to shut down for eighteen, twenty four months for this company to be insolvent or deferred to the equity to be impaired in some way. So I think it's unfortunate the stock is sold off, but I think it's an incredibly interesting opportunity right here. If anyone likes to look at it, I'm happy to answer any questions anyone has. Feel free to email me. My email address is on the website. But right now, I think that there's a path to them generating close to 40 million bucks of free cash flow next year, just what they own. Assuming, you know, if Corona's confined to twenty 20 issue that in twenty twenty one with just their current restaurant and nightclub dates, I think they're doing close to 40 million of annual free cash flow. They'll probably have eight million shares outstanding. So you're looking at about five bucks a share of of free cash flow per share next year and the stock's at eleven bucks. So it's like two and two times free cash flow right now, which is very, very cheap for a company with high insider ownership and the ability to reinvest at nice rates of return. So I think that's a pretty good example of the types of investments I look at ones that could come. I think it's one that if it went from 11 back to twenty six and from twenty six to forty five, I wouldn't necessarily look to sell it and try to recycle the capital into other opportunities, because I think even at forty five bucks they can grow their free cash flow per share at 20 percent a year for the foreseeable future. And so I'm happy even if the multiple goes up from two times or what it was before six times the 12 or 13 times, I'm happy to own it at 13 times because I think it can hold that multiple and I think it can grow. It's free. It's free cash flow per share. Twenty percent. So hopefully that was a good summary. But if you have any questions, I'm happy to follow up. [00:39:38][1036.1]

Alec: [00:39:39] Yeah, very comprehensive summary. It's fascinating just how much detail we can go into for one stock that runs gentlemen's clubs with one hundred million dollar market cap. And it just makes you think that every stock, you know, all five thousand publicly traded in the US all have such deep stories like that. And so I guess the question that comes to my mind is, when you're dealing with this universe of five thousand stocks, what's your stock discovery process like? How are you deciding that I'm going to focus my time on pretty small nightclub operator? You know, that's the sort of in this marketplace that not many people think of. Like, how do you even get to doing such deep research on that company? [00:40:18][39.3]

Yaron: [00:40:19] Yeah, I mean, I'm genuinely curious person about a business which makes it easy. So when I see a product or service being sold or provided, I naturally think, you know, what's the business model for that? Who are their competitors? Is this a good business or a bad business? That just comes naturally to me. But in terms of filtering through investments, potential investments that actually want to spend time on, I have a wide funnel. It could be anywhere from the stock screen on Bloomberg or a lot of friends who work at different funds that I talk to on a regular basis that. Then what they're looking at could be a Wall Street Journal article about something that might be piqued my interest. I'm a member of a members only forum called the Micro-Cap Club, where people discuss micro-cap opportunities. So the funnel is very wide. And then my filters tends to be very quick. And I think that if you've been doing it for long enough, you can very quickly figure out if something is worth spending more time on or not. And I think it's important to have a filter to be able to filter things quickly, because I give this example to lots of people. But, you know, when I first started as an analyst at a hedge fund, my PMS would say, hey, I heard about this opportunity from a friend and why don't you take a look at it? Let me know if you think it's interesting. And the first thing I would do is I would I would be like, all right, I really want to understand, like the financial models, I would open up Excel and I would open up the 10K and I would start modelling it and try to understand what happened to the financials over the last five to 10 years. And how cyclical is this business and what's the operating leverage on on revenue growth or revenue declines? And then I would I would sit down and I would be ready to talk about it with my friends. And they would be like, oh, like it says in the 10K that they have a customer that's forty seven percent of their sales, like, would we even look at this? And I would be like, oh man, why did I just spend half a day modelling this business? And so those, those types of filters, you learn to look very quickly through the things that could be potential deal breakers, because the the quick the more quickly you can say no to something, the more time you have left over to do research on the ones that fall in the Yes. Pile. And so, I mean, that's just kind of it's a lot of no's. And then eventually something falls in the pile and it falls into the pile. I start digging in and spending a lot of time through Google searches or talking to my friends at other funds who may have looked at it and trying to read industry reports. And the second it becomes and a lot of times, you know, midway through or three quarters of the way through, then it turns into a.. Know, based on something I learnt in my research process. And that goes into the no pile. And I move on to something else. But I think filtering quickly through the the things that are obvious and and having a broad network and just being genuinely curious are kind of the things I would I would point out. [00:43:03][163.9]

Bryce: [00:43:03] Nice. We've reached our time, unfortunately, but we always like to wrap up with three final questions that we always ask our guests at the end of the show. So the first one is, do you have any must read books that our audience should get around investing or otherwise? [00:43:20][16.6]

Yaron: [00:43:21] Yeah, I really like behavioural psychology, but I think they're great for investing. So I would say books like Predictably Irrational Thinking Fast and Slow are great. And from an investing standpoint, I don't know. I mean, I think when I first started a book called The Little Book That Beats the market actually helped me a lot. I know it sounds kind of dumb, but I thought it was awesome. [00:43:41][20.4]

Bryce: [00:43:42] So we read that as well. Great. Great little book. Yeah, that's good. Where do you go for your investing information? [00:43:50][8.3]

Yaron: [00:43:51] I'm a Bloomberg subscriber. I go out there every day. I talk to friends all the time. I go to the micro-cap club, which is an awesome resource for anyone looking at small cap names. I highly recommend it. Yeah, I just read the newspaper, I, I anytime I go into a store, go to a restaurant that I like or see a new product that I like, I kind of Google it to see if it's a public company and if it's a public company. I kind of want to know what its financials are like. If I hear a company going public, I pull up this one. So I would say I just I mean, Google is an amazing resource and that's a good place to start for any company. [00:44:23][31.3]

Bryce: [00:44:23] Now, it's good using your surroundings as a source of information and inspiration, certainly something that we try to instil on the show. And finally, thinking back to your to your time when you put some money into the tech stock, any advice for your younger self? [00:44:40][17.1]

Yaron: [00:44:41] Yeah, I mean, I think I mentioned that earlier, but you can borrow someone else's conviction because they're not going to tell you when they sold. And if they're wrong, they're not they might not recognise something that you might recognise. So I think you need to have your own conviction, anything you own. I think you need to study as many of the investing greats as possible, because like I said earlier, there's there's so many ways to skin the cat. And each person has kind of their own style, their own nuances of it. So the more you read about different styles, the more you could kind of figure out how this works for them. That resonates with me. This might work for me. It's all about trial and error, repetition, like I said. I mean, the more mistakes and the more wins you make, the better you'll come up with time. [00:45:22][41.4]

Alec: [00:45:23] That's great advice. Now, Yaron, thanks for taking the time. We really appreciate it. We could have gone deep on a lot more stocks, but unfortunately that's all the time we have. But if people do want to hear more about you or read more of your work and you say you going deep on other stocks and other industries, are there any places that I should be going, you know, Twitter or your website or anything like that? [00:45:45][21.7]

Yaron: [00:45:45] Yeah, I mean, you could reach out to me on Twitter. I've opened the EMS. It's the Twitter handles one main capital, and that's. Number one, the word main, and they are in capital and my website as well, it's always that one main capital dot com and my email address was there. So feel free to reach out by email or through Twitter. [00:46:03][18.0]

Alec: [00:46:04] Nice one. Well, thanks for taking the time. As we said at the top of the show, it's seems to be chaos in the markets there. So we appreciate you taking the time off, watching the sale of Red to talk to us and hopefully we can do this again sometime soon. [00:46:17][13.1]

Yaron: [00:46:18] Yeah. Thanks for the time, guys. Stay safe out there. [00:46:20][2.1]

Bryce: [00:46:21] You try. Thanks, Kiran. [00:46:24][2.8]

Speaker 5: [00:46:25] Thanks for listening to Equity Mates investing podcast production of Equity Mates Media. Please remember that everything you hear in Equity Mates investment podcast is general advice on link. The content has been prepared without knowing the personal objectives, specific financial circumstances or goals. The host of Equity Mates investment podcast may maintain positions in the companies discussed before considering any investment. Please read the product disclosure statement and consider speaking to a licenced financial professional. [00:46:25][0.0]


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