|Shares Out. (in M):||1||P/E||8.4x||n/a|
|Market Cap (in $M):||65||P/FCF||8.0x||n/a|
|Net Debt (in $M):||0||EBIT||12||12|
During the first quarter of 2009, Charlie Munger, Chairman of Daily Journal Corp. (DJCO), made a significant redeployment of the company’s excess cash into an investment in common equities. Based on circumstantial evidence, we believe (but cannot be 100% certain since the Company has not disclosed what its invested in) that Munger purchased shares of Wells Fargo and/or possibly US Bancorp at their recent early-March lows.
As such, DJCO now contains a hidden asset that may not be fully reflected in its current share price. We believe DJCO’s core business is worth $20 per common share (excluding the value of investments on its balance sheet). Further, each DJCO share also could represent ownership of 1.23 common shares of WFC or 1.23 shares of USB less deferred capital gains taxes plus $10.5 million of short-term T-bills. This provides a total valuation of DJCO of $47-$51 per share (if full capital gains taxes are applied to current prices for USB/WFC). If deferred capital gains taxes are ignored (since Munger is typically a long-term investor who views deferred taxes as a form of equity), then DJCO is worth $52-$58 per share at current USB/WFC prices.
Regardless of what stock(s) were bought, we believe that the long-delayed deployment into common stocks of patiently gathered excess cash by a renowned investor/capital allocator like Charlie Munger is bound to add value to DJCO over the long-term.
DESCRIPTION/VALUATION OF DJCO CORE BUSINESS:
Daily Journal Corp. publishes several legal newspapers/websites in California as well as Colorado and Arizona. It also has a software business that supplies case management software to Courts and Justice Agencies. Of course, what makes it well-known for a small cap company is that it is Charlie Munger's other, other company (after Wesco Financial and Berkshire Hathaway).
On a statistical basis DJCO appears cheap, with trailing-twelve month earnings of $7.6 million, EPS of $5.42 and a PE-ratio of 8.8x. And being a Charlie Munger company, the quality of earnings are high, without stock option dilution, senior executive retirement plans, deferred compensation plans, etc.
DJCO’s earnings history shows little revenue growth but lots of EPS growth. The current earnings are probably too high to use in valuing the company since the core business is somewhat counter-cyclical. Revenues typically increase during recessions due to increases in legal notice advertising (think bankruptcies/foreclosures in CA/AZ). The core legal newspaper business has actually been pretty stable with average cyclical EBITDA margins of 22% (though lately in the midst of this recession, margins are much higher and may not be repeatable). The software business has stabilized after losing money and we’ll assume it will breakeven in the future. The table below helps illustrate the earnings trends and detail. In the long-term column, we estimate average annual long-term earning power and free cash flow (ex interest income). We believe the core business is worth $20 per share conservatively valued (ex investments).
|DJCO Earnings Analysis||2002||2003||2004||2005||2006||2007||2008||Long-Term|
|Traditional Business Revenue||31,814||30,250||29,200||29,039||29,245||31,193||35,828||30,000||Estimate|
|Software Business Revenue||2,491||3,979||4,662||4,233||3,128||3,920||4,777||4,500||Estimate|
|Traditional Business EBITDA||6,606||6,160||5,498||5,504||6,426||7,550||11,743||6,600||22% Margin|
|Software Business EBITDA||(3,196)||(1,351)||( 201)||( 167)||(1,542)||( 493)||112||0||Estimate|
|Depreciation||(2,544) ||(2,356) ||(1,340) ||(821) ||(899) ||(990) ||(990) ||(900) ||Estimate |
|Interest Income||63 ||100 ||74 ||361 ||611 ||897 ||852 ||0 |
|Interest Expense||(157) ||(150) ||(190) ||(380) ||(358) ||(363) ||(129) ||0 |
|Reversal of Software Liability||0 ||0 ||0 ||0 ||0 ||2,975 ||0 ||0 |
|Income Tax (Expense)/Benefit||0 ||0 ||(110) ||(210) ||(1,800) ||(4,260) ||(4,475) ||(2,280) ||40% Tax Rate |
|NET INCOME||772 ||2,403 ||3,731 ||4,287 ||2,438 ||5,316 ||7,113 ||3,420 |
|Capex ||1,438 ||3,281 ||2,850 ||642 ||943 ||394 ||377 ||300 ||Estimate |
|Traditional Business EBITDA Margin||21%||20%||19%||19%||22%||24%||33%||22%|
|Free Cash Flow||4,020|
|Value @ 8X Free Cash Flow ||28,140 |
|Common Shares Outstanding||1,409|
|DJCO Core Business Value Per Share ||$19.98 |
DJCO has no debt and will occasionally buy back its stock. From looking at its repurchase history, DJCO will only come in and buy its own stock at $36 or lower. After being largely dormant since 2004, the Company has re-initiated its stock buybacks in the latest 2 Qs -- buying $1.6mm worth of stock at an average price of $36. Assuming Munger is an astute and shareholder-friendly repurchaser of company shares, the $36 repurchase price values the core business at $20 if cash/T-bill investments on the balance sheet at the time worth $16 per share are ignored. This repurchase price helps to validate our core business estimated value.
RECENT COMMON STOCK INVESTMENT:
Since DJCO generates cash in excess of any reinvestment needs, it typically builds up cash on the balance sheet which for all of its history it invested in short-term T-bills. These investments reached a level of $23.6 million of cash/T-bills at the end of 2008. But that changed dramatically during the first calendar Q of 2009 (actually Q2 for DJCO).
Here's the before and after from each of the balance sheets:
Dec. 31, 2008 Cash and T-bills $23.6 million Mar. 31, 2009 Cash and T-bills $10.5 million Common Stock $24,7 million
The 10-Q for the quarter ended March 31, 2009 describes the situation thusly:
”Cash and cash equivalents and U.S Treasury Notes and Bills were used primarily for the purchase of marketable securities of $15,501,000…. All the marketable securities are common stocks, and almost all of the unrealized appreciation was in common stocks.”
Since the quarter-end mark-to-market balance for equities was $24.7mm and DJCO started the quarter with zero equities, that means that Munger achieved an unrealized gain of $9.2mm -- or a 60% gain within the quarter for his common stock buys.
WHAT DID MUNGER BUY?:
The 10-Q doesn't say -- so we're into the realm of speculation.
We know that Munger often says about investing that the key is to "bet very seldom...but when you do bet big in a concentrated way on high quality companies when the odds are massively in your favor". Based on Munger’s m.o., we believe that the investment was probably a very concentrated investment in only one or two common stocks. The idea that it was a concentrated bet is also reinforced by looking at Wesco Financial's (WSC) equity portfolio, which Munger also manages. One can find this portfolio via Berkshire Hathaway's 13Fs which encompass WSC's portfolio since BRK is an 80% owner of WSC via its Blue Chip Stamps subsidiary. The following table lists Wesco's holdings in common stock at year-end 2008 (which did not change at Q1, 2009) as well as the theoretical maximum gain possible for Q1 low price to Q1 ending price.
Dec. 31, 2008 Per BRK 13F-HR Per WSC Jan-Mar '09 Jan-Mar '09 Intra-Quarter STOCK FAIR VALUE 10-K FAIR VALUE Low Price Qtr-End Price Gain From Low AXP 36,045 $9.71 $13.63 40% KO 326,198 326,198 $37.44 $43.95 17% JNJ 19,463 $46.25 $52.60 14% KFT 268,500 268,500 $20.81 $22.29 7% PG 385,756 385,757 $43.93 $47.09 7% USB 250,100 250,100 $8.06 $14.61 81% WFC 372,722 372,722 $7.80 $14.24 83% GS 10% cum prfd 205,000 GS warrants 4,508 Other 265,016 TOTAL 1,868,292 1,868,293
One can see that WSC's portfolio proves that Munger likes concentrated portfolios. So our guess is that the DJCO equity purchase was also a very concentrated bet on one, possibly two, stock(s). The S&P was only up 20% from early March bottom to March quarter-end. BRK-A and BRK-B (Berkshire Hathaway) was up around 24%. It looks like Munger’s selection could have been Wells Fargo (WFC) and/or possibly US Bancorp (USB).
Here are four reasons why:
1) The math works. DJCO's intra-quarter gain on equities was 60%. As seen in the table above, purchases of WFC and/or USB during the early March 2009 lows can support possible 60% gains.
2) Both USB and WFC are large positions for WSC, thus, clearly Munger is very comfortable with both of these banks. While WSC did not purchase any shares of WFC or USB during Q1, 2009, it has been a big purchaser of both banks' common stock in 2007 and 2008.
3) Munger (and Warren Buffett) have spoken favorably about WFC/USB. Buffett in a CNBC interview from the BRK AGM in Omaha in May particularly singled out WFC for praise. He stated that when Wells shares fell below $9 earlier in the year (March 2009), he would have put all of his net worth in one stock, if he could have.
4) There don’t appear to be any other good large-cap candidates that fit the 60% intra-quarter gain requirement. We ran a stock screen to identify candidates that might've shown a possible closing quarterly price vs quarterly low price of 60% or more and at least $1 billion of market cap during the quarter. Most of the big banks (stress-test 19) plus GE, HOG and Torchmark make the list of 88 stocks that made the cut – but the only ones that appear to meet Charlie’s company quality criteria would appear to be WFC and USB.
PUTTING IT TOGETHER:
Based on circumstantial evidence, it appears possible that Munger plunked $15.5mm of DJCO cash to buy WFC (or USB or both). If this speculation on DJCO's equity purchase(s) is correct, then that $15.5 million investment which rose to $24.7mm at the end of March would now be up to $33-42 million at today's prices for USB/WFC. Thus in summary, DJCO looks cheap at a market cap of $64.5 million -- if mid-cycle net earnings are around $4 million (EPS = $3) and cash + investments has ballooned to $55 million (not including deferred capital gains taxes). Even without knowing what DJCO/Munger invested in, we believe there is good value in DJCO based on the strength of Munger's legendary capital allocation skills.
- long-term appreciation of common stock investment(s).
- eventual disclosure of holdings.
- market begins to value DJCO on the basis of "sum-of-the-parts"