The Pastor

This post has nothing to do with investing. While I have been quite busy with my investing recently, I haven’t found anything useful to write about it. Instead I find myself opining on the jobs market and practicing my writing with random pieces like this one:

Once upon a time, I lived in a part of the world you’ve never been to. Plenty of people visit this country each year, but I guarantee you’ve never been to this particular location. It was a dingy boxing gym down a side-alley in a third-world back-street, and I wondered every day if I’d be raped or bashed walking down the alley to get my workout. Actually it was one of the safer neighbourhoods in town, a locus for promising young men who preferred to spend their time in disciplined striving, as well as a safe space for women to exercise in a culture where men literally get away with murder – but I digress.

One day I was at a kickboxing lesson there, and I met a US citizen we’ll call The Pastor, although his real name was Alex. The Pastor was utterly unremarkable, about 170cm, precisely average height, and I guess about 35 years old and 85 kilograms. His physique was average, if you didn’t look too closely. He had a totally ordinary face, a slight paunch, and routinely wore a red t-shirt that was two sizes too big. He was handsome in an unremarkable way, mostly due to the broad face, smooth cheekbones, easygoing manner, and the glow of obvious good health that radiated from his every pore.

The first thing I noticed about him were his hands when we shook; they were like dinner plates. This sounds like hyperbole when you read it in the stories, but truly his hands dwarfed mine. I was a weight lifter at the time and I had also never seen an ordinary man with forearms this beefy, especially since his physique did not appear overly large. He did not have a ‘V’ shaped torso, nor was he bulky or slim, just strong. As we shook – he did not squeeze hard – I saw rigid steel cables bulging under the skin where his forearm muscles should have been.  That’s curious….

We partnered up for training and went through the usual indignities. I kicked him in the stomach and it told me of a high carbohydrate and low-protein diet not unlike what the locals ate. When I tried to throw him down – futilely, the underdog pride of a young man who knows he is outmatched – I caught a glimpse of his leg muscles. His calves were monstrous. Taut steel cables ridged his legs where I heretofore thought only muscle grew.

He let me go and I kicked him again. My foot hooked in his loose shirt, stretching it out, and for the first time I saw the logo against the red material. It read ‘NSW’ and there was a US flag next to it.  Bizarre. Why does New South Wales have a US flag next to it? Curious… The answer hit me like a thunderbolt, and I stopped mid-step. He seized me in a bear hug and jammed his knee into my solar plexus; the air whooshed out of my lungs.  I pressed my elbows into his collarbone, creating space between us as he let me go.

‘That’s a Navy Special Warfare t-shirt, isn’t it?’

“No, no I have a buddy at Coronado, he gave it to me. I’m not with…” he trailed off.  That’s not what I asked…

For the uninitiated, NSW in the US military stands for Navy Special Warfare and it is the acronym for the command that (among other things) trains US Navy SEALs at Coronado beach. In my insignificant little corner of the world, I was pretty sure I’d just stumbled across a bona fide Navy SEAL. These are not dissimilar to our own SAS. (If you’re interested in physical or mental fitness in any way, let me recommend a book called The Warrior Elite about SEAL training, truly remarkable.)

“I see. So you work at the embassy here then?”

‘No man, no, no…. thank you though, no, I’m a pastor.’

He said he’d been in the country for 5 years. At that point I pegged his physical fitness as a side effect of his activity with the locals, probably digging ditches and building houses and that kind of thing. I have seen a couple of people with a similar build in the construction industry and once when I worked at the scrapyard I also saw my body grow in a similar way as his, though not to the same extent – not even close. (In my experience, physical labour seems to affect your forearms, your calves, and your thumb muscles most noticeably.)

Thinking about it in hindsight though, he definitely is or was in the navy. His musculature was a dead giveaway, because the taut muscles were those of someone who does extraordinary amounts of sustained exercise without necessarily lifting heavy weights. You do not get muscles that firm in construction because the work is not hard enough (even though it might be very hard). Equally, you cannot get muscles that powerful by lifting big weights while still maintaining a physique of ordinary size. The only way to get muscles like that, and I say this as a connoisseur of these things, is by doing hundreds of repetitive, light weight-bearing motions, like doing pushups or hiking long miles with a heavy pack. Even the kickboxing instructor at the gym, an active semi-pro in Thailand (a well-fed and fierce Westerner, not a skinny Thai), did not have this kind of musculature.

The other dead giveaway was The Pastor’s physical toughness. He’d only been kickboxing for a week and already he was hard enough to trade full-contact blows with the instructors or advanced students. This is 100x more remarkable than it sounds on paper, and if you’ve ever played a contact sport like rugby or boxing, you know what I’m talking about. (Advanced students can connect with enough force to break bone, and it is not uncommon to take dozens of these strikes in a three-minute practice bout. The only way to avoid injury is conditioning…unless you’re The Pastor.)

Physicality aside, probably the most remarkable thing about The Pastor was his total self confidence. He was an incredibly nice guy, at home in any situation, and would regularly give genuine praise or ask insightful questions that drew people out of their shells. To this day, I cherish his kind words about the power in my round-kicks. With these skills he could definitely have been a pastor, although I never once heard him mention God, church, religion, or anything related.

He never fessed up to his prior career, but I have known many fit men of varying professions and hobbies, and none came close to fitting his mould, either physically or mentally. I choose to believe that he was previously a Navy SEAL, and became a pastor afterwards but did not abandon his physical fitness regime. When I get a chance I hope to go back and find him, because I think men like him are exceedingly rare, and I wonder what I could learn from his experience and his worldview.

Is there a point to this story?  Not really, I just wanted to tell you about a remarkable man I knew.

A post-mortem for Thorn Group Ltd

I previously bought and sold Thorn Group Ltd (ASX: TGA) shares for the 10foot portfolio. I lost about 8% of the investment or about 0.4% of capital on the transaction, but I avoided the blow up that came following the recent market announcement.

I believe that the Thorn purchase was a mistake as I was too vague and had poor thought process. The sale decision however was correct, because the risks outweighed the rewards, and this was true even before the subsequent downgrade + collapse in the share price. I thought it would be useful, if uncomfortable, to revisit several of the implicit assumptions I made in my Thorn thesis.

For reference, a combination of increased competition and these posts from Dawney & Co about Thorn led to my selling my shares in the company. I will tackle a few of the comments made variously by Dawney, management, and myself regarding Thorn, and how my thinking has evolved today:

  • Thorn will hit the limit on its warehouse facility and will be unable to secure additional finance

I thought this was unlikely as NAB has been really keen to grow its business lending volumes recently and I thought it was highly likely that the warehouse facility could be sold off + replaced, or the cap increased. However, it was announced that the corporate cap was kept flat and will actually be stepped down in coming years, which means I was wrong about NAB’s appetite for Thorn.

To be honest, if I had not spotted the additional competition, I likely would have held Thorn and been stung by the finance issue instead:

However, the total of both facility limits has remained capped at $355m and the corporate facility rollover includes progressive step-downs.”

  • Competition would decrease due to the caps making smaller competitors unviable

Possibly this would happen but it will happen over a period of years, not instantly. This means that a Thorn investment was being driven by the company’s access to credit, not the consolidation and cost advantage I highlighted in my investment thesis. This is another good example of a ‘factor mis-match’ which I wrote about here. Unfortunately while I was able to identify one in RNY Property Trust, I missed it in Thorn by prioritising several factors (industry consolidation, continued originations, roll-off of regulatory penalty) over a shorter-term, more important factor (access to finance). And since I was wrong about access to finance, I could have potentially wrecked the whole investment.

Also, consolidation missed the point that perhaps smaller competitors like Rent The Roo would seize the opportunity to launch a big push for market share, which they appear to have done.

  • Competition

I mis-read Thorn’s competitive position. I thought that as one of the larger rental providers in Aus, and one that was already priced close to the newly imposed leasing caps, Thorn would suffer the least. I expected other competitors to struggle to reprice their leases, leaving Thorn (with a cost advantage) in the lead. Fortunately this is an area that I kept an eye on and increasing competition led to me selling.

  • Afterpay?

I couldn’t say for sure if Afterpay Touch Group Ltd (ASX: APT) had any impact as it is not intentionally a direct competitor. However it’s necessary to consider the niche that this business occupies in the market. For no cost, Afterpay allows customers to repay purchases over a 2mth (?) period with 4 fortnightly payments. This effectively makes Thorn’s value proposition at the cheaper end of the market obsolete.

Depending on the product, an $800 fridge becomes 4 x $200 fortnightly, instead of $15/wk for 3-4 years (~3-4x the price of an outright purchase) or whatever it is with Thorn. I don’t know for sure the precise point at which Afterpay becomes viable for Centrelink/poorer customers, but there is clearly a price below which Thorn is totally obsolete – if the product is available via an Afterpay retailer. Larger purchases, say above $1000, are probably still unviable to most Thorn customers via Afterpay.

**Edit**: I haven’t seen Afterpay disclose its limits on its transactions. Probably an $800 fridge is beyond the limit. However some cheaper items like a Dyson vacuum (~$300) would probably be more viable with Afterpay compared to Thorn.

  • Franchises

Fairly or unfairly I thought a recent boom in leasing to franchises was a blossoming risk, and it was a key element in my decision to sell. I get the appeal of a lease because it allows a business to match lease payments to cash flow instead of taking a big capital expenditure hit – especially difficult in low-profit businesses like franchises. I think this is definitely a growth market. However, the sheer scale of the growth Thorn reported and the fact that it was attributed to franchisees made me uncomfortable. (With the benefit of hindsight – was Thorn aiming to pivot away from a weakening lease market?)

Tangentially in my looks at other businesses I saw what I thought were programs encouraging people to buy franchises irresponsibly, e.g. by helping fund the start-up costs via loans, and so on, and franchising is a business model that – while I quite like its economics as an investor – I don’t have a lot of confidence in.

Find The Moat has done a considerable amount of work on this where he points out that Domino’s is predominantly in the business of selling franchises, not pizza. Overall I couldn’t get comfortable with the booming leases to franchisees and I felt that at least this part of the decision was well-reasoned, although again it is probably a longer-term concern.

  • Switch from 3-year to 4-year leases lowered origination volumes

I didn’t really think this was a problem, even though Thorn’s finance lease origination is important for profit. The 4-year lease in reality should be more valuable because you’re getting another year’s worth of cashflow out of the leased item. However, this definitely could impact headline profit, and in my buy thesis I was focused on profit as the driver of value. So this is another example of a mis-match I fell for – I focused on the overall ‘value’ of the 4-year lease, even though Thorn’s originations + profit – the thing that was key to the thesis – could have been lower under the 4-year lease arrangement.

While the financing was the biggest single mistake of the original thesis, I’ve uncovered several of these factor mismatches in my post-mortem of my decision-making, and the investment was clearly poorly thought out.

As a side note, if it was that obvious that the switch to 4-year leases would lead to a year of lower originations (mgmt keeps pointing it out), Thorn should have guided for this years ago instead of letting the share price run up to $3. I wasn’t interested in Thorn then so that is no skin off my nose, but I thought – and still think – that this is an excuse for competitive threats.

With the cap in the financing facilities, limited corporate cash and high corporate debt, it’s hard to see Thorn maintaining even the current pace of originations, so I could see profits and dividends falling further.

Is it an opportunity yet?

I wrote when I sold that I’d want a fatter pitch for Thorn in the future, something like if it was trading below NTA at the bottom of the cycle. Thorn shares are now below their NTA. First, I’m definitely once-(almost)-bitten, twice-shy on this one so it’s pretty hard to see 10foot heading back into Thorn in the future.

However, because of what I wrote above about the financing and competition, it’s also hard to see profits recovering in the near future, and they may decline further. I will likely be much more cautious, looking to get a price that basically ascribes no value to the business or the NTA. As a result I’ll be watching from the sideline for now.

The bottom line

In summary, one mistaken premise – a belief in the accessibility of finance – lead to a mistaken Thorn purchase. One probably correct premise – fears over increased competition – lead to a correct Thorn sale.

It’s important to note that this post is for my own accountability, to see what I could learn from my mistakes. Given how Thorn turned out, I would suggest you don’t use my writings to inform your own thinking on the company.

I have no financial interest in any of the companies mentioned in this article. This is a disclosure and not a recommendation. I formerly owned shares of RNY Property Trust and Thorn Group, but sold them all.

Purchase #10: (Undisclosed)

I have made the 10th purchase for the 10foot portfolio. I will not be writing about this one for a while, possibly a year or longer, as I consider I have an extensive edge in this small company. I think that a limited percentage of investors understand the business as well as I do, and even fewer are willing or able to invest here.

That’s not to say that only I understand the opportunity – I know at least one skilled investor is looking – but I would prefer not to tip off the crowd before I am ready.

I have a clear path laid out where, if a couple of near-term events happen (50/50 chance), I could see myself deploying up to 20% of the portfolio here. I think the conceivable upside is a maximum of between 2x and 4x over the next 5 years with relatively low risk, and the downside if things don’t go as planned in the near term is perhaps 30%.

This company is reasonably similar in investment style to the rest of my merry band of misfits. If the near-term events occur, I will buy a stack more shares and the investment will require a 3-5 year timeframe from then. I’ll disclose the thesis at that point. If milestones are not met, I expect there will be an exit in the next 6-12mths, likely without loss, in which case you will also read about it then.

Fear not, I’m not going to suddenly turn up with a miracle 5-bagger in some ridiculous no-revenue penny stock.

On 5 October 2017 I bought x shares for $550.45 after brokerage.

I have subsequently disclosed the position here, it is Tower Limited (ASX:TWR). Here is my purchase theses. Info on all my purchases and average cost are contained in the first link:

Purchase #10: Tower Limited

A lengthy screed on Tower Limited

I apologise as I know it is frustrating to see a post about a purchase only to get no detail (hellooo clickbait) but I thought it was necessary for my accountability.

I own shares in Tower Limited. This is a disclosure and not a recommendation.