It has been a good year so far for our investments. We will spend this letter talking about a few
of our holdings that have news this year that we think matters. We will also mention a couple
of thoughts on inflation.
We will start with Newmark Group, a nationwide real-estate services company. Newmark is a
spin-off from BGC partners. In the spin-off, Newmark was granted around 6.2 million shares of
Nasdaq stock that BGC received in 2013 for selling Espeed to Nasdaq corporation (BGC
originally got around 15 million shares in the deal). Each year they were allowed to sell around
a million shares of the stock but no more. This meant that Newmark still had to wait six years
before they were totally out of this investment unless there was a corporate event at Nasdaq.
Guess what, there was one. Nasdaq decided to get out of their Espeed investment and sell it to
Tradeweb. This event (assuming it passes regulatory approval later this year) triggered the
automatic vesting of Newmark’s remaining 6.2 million shares of Nasdaq stock. At the time of
the announcement the value of Newmark’s Nasdaq stock holdings was $868 million. The total
market cap of Newmark at the time of the announcement was ONLY $2.2 billion. This meant
that should the deal go through (we think it will), Newmark’s cash position from the sale of this
stock was going to represent 40% of the total value of Newmark’s market valuation. We
thought that was great news for the company and we bought more stock for clients at $8.
Today it is trading at $12.50, which is up 56% from when the news was announced. A happy
side note to this deal is that the value of the Nasdaq stock Newmark owns has gone up another
$248 million since February (it’s now worth $1.16 billion to Newmark shareholders). Newmark
will have a lot of cash to work with soon and we are expecting a big stock buyback from them.
We still believe Newmark’s stock is very undervalued at $12.50.
BGC Partners also had some good news this quarter. Over the last three years BGC has invested
(our estimate) around $200 million in developing a new insurance brokerage business inside
BGC Partners. The up-front expense of doing this new venture has hurt earnings, which has in
return hurt the price of BGC’s stock. This quarter they announced they are going to sell this
investment for $500 million. In the last quarter this division lost 400 thousand dollars. The sale
of this investment will improve earnings. We think they got a good price. It is the company’s
guess that the internal rate of return on that 200 million investment is around 25 to 30% per
year. BGC’s reward for this good investment was a stock that is trading lower than it was in
2018. The 500 million dollars they will receive works out to about 15% of the market value of
BGC’s stock at today’s prices ($5.7). We think they will take that money and buy back their
stock with it. The company’s main business of electronic brokerage continues to do EXTREMELY
well. We think a fair value for BGC is over 10 bucks a share.
Lumen’s stock price is still very undervalued. At the beginning of the year the stock was trading
at $9.75 a share. At that price, the investment was trading for a little over three times free cash
flow ($3 a share in free cash flow). This means that in three years, assuming no change in our
free cash flow estimate, you will receive all your money back either in dividends or the
company paying down its debt. This is a fantastic return in a world at zero interest rates. This
quarter the company “hinted” that they are considering buying back their stock instead of
paying down debt. We think this is highly likely to occur. We think they will continue to pay out
a dollar a share in dividends (a 7% yield at today’s prices) while we wait. The logic in buying
back stock is simple math. They are borrowing at a 4% to 5% interest rates. Their stock is
yielding 7%. You can increase your free cash flow by keeping their existing debt at these low
rates and buying back your stock, which is yielding a higher rate. We think this logic makes
sense until the stock is well above $20. Our best guess is they will announce a billion-dollar
share buyback this year. With the stock currently valued at $14 billion this will be well received.
We expect revenue comparisons to improve significantly starting in q3 this year. Let’s hope
they buy back the stock before then.
Berkshire Hathaway continues to roll along. The stock made new all-time highs this quarter. We
think the stock continues to trade at a discount to what its worth because of the ages of
Warren Buffett (91) and Charlie Munger (97). Last quarter Berkshire bought back around $7
billion of their stock. They have around $150 billion in cash sitting on their balance sheet.
Should one of the two founders pass away, the company has ample liquidity to buy back their
stock should they wish to do so. We think they will buy it back. We hope they live to see the
next decade. They are still very sharp when you hear them talk. That said, we think the discount
this stock trades at versus the market is not warranted. We think it should trade well over $300
dollars a share (it is $275 today).
For about four years now we have been talking about how inflation will be coming back with a
vengeance. Well, it’s here. Have you tried to buy a house lately? How about a car? How about a
“number one” at your local fast-food restaurant? If you have, you will notice that prices are up
a lot. The CPI index is up 5% year over year. PCE index is up over 3.6%. Meanwhile treasury bills
are trading at basically zero. This makes no sense to us. The money supply was up over 25%
year over year. This is the highest reading we have ever seen in the United States. The Federal
Reserve continues to say this inflation scare is transitory. We don’t think so. As we have written
before, the trade wars are going to continue to push prices higher. You will not be able to
outsource manufacturing from the US to the rest of the world as easily as you could the last 30
years. Free trade and capital flows are going the wrong way if you are betting on deflation. Our
governmental leaders have zero respect for budget deficits. We have record retail demand, but
we don’t have record employment to satisfy this demand. These are relatively new or
accelerating problems that will only get worse with time. We have invested money in value
stocks, gold, steel, oil and Latin American stocks to profit from inflation. We do not think this
mess will be solved easily. Until the dollar goes to new four-year lows or oil hits a $100 a barrel,
the Fed can continue to say this is transitory. Once those two things occur (we have bet they
will), life will be more difficult for all of us financially. We have planned to profit from inflation
and so far, we have. The markets will be more difficult once (some say if) the Fed decides this
inflation scare is not temporary. We hope to adjust to what the markets serve up.
Sincerely
Mark Brueggemann IAR Kelly Smith IAR Brandon Robinson IAR