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Welcome to the 12th episode of the AMM Dividend Growth podcast. If this is your first time listening, I’m Glenn Busch a portfolio at American Money Management and the lead portfolio manager for our dividend growth strategy.
I thought this episode was going to be about our investment in United Technologies but a bunch of things happened this week so this is a portfolio update episode.
We’ve got the corona virus and how were managing our portfolio to talk about.
We’ve got Bob Iger out at Disney.
And we have Intuit’s 7 billion dollar purchase of Credit Karma.
But first, the disclaimer.
[disclaimer]
Originally this portfolio update episode was just going to cover Disney and Intuit. But given recent market action and the amount of calls we’ve received from clients. I felt I should talk about our portfolio and how we’re managing it as it relates to the corona virus.
A truism about the market is investors pay up for certainty and comfortability. But when times are uncertain and the market seems riskier, investors want more return for their risk before they get back into the market. So stocks reprice lower.
A common question we get is why not sell now, get out of the way of the uncertainty, and then buy back in when things are back to normal?
This is a market timing call.
They’re asking us to sell now knowing that the market is going lower from here and then to buy back when we know that the market is going to go back up.
We can’t do that.
I don’t know if anyone can reliably do this. Sure some people make a good call every now and then but can they do it consistently?
We don’t know if the market will continue going down from here and we sure don’t know when it will stop and start going back up.
What usually happens when we sell into a market decline and into uncertainty is we’re selling low and then when things calm down and things feel better the market has already moved higher and we’re buying at higher prices. We’re selling low and buying high. That’s a recipe for permanent impairment of capital.
What we do is focus on the things we can control. We control how we value a company. And we control our portfolio rules and systems.
In episode 10 we talked about our systems and how it was forcing us to trim our positions in Apple, Visa, and MasterCard plus a few other positions that got too big. Right now those systematic trades are looking really good. But I’ll always be the first to say that was absolute luck. We had no special insight. Just rules.
The other thing is heading into this correction our newer accounts, accounts opened within the last year, still had a lot cash. We weren’t going to add positions to their account if we couldn’t buy them at a good price.
Now after this quick sell-off we’re relying on our valuation work and systems again to direct our trading. We have several positions that are trading at prices we would like to buy them at. As I record this, we’ve picked up three positions so far. Including Visa which we sold earlier. The selloff brought it back down to a price we’re willing to pay and a good amount of new accounts did not have a position in Visa yet.
The corona virus is a perfect reason for this quick sell off. It’s an open ended risk. Our imagination can run wild with all sorts of doomsday scenarios. And the news is always there to help us with our imaginations.
It doesn’t help that our cognitive biases tend to push us to overweight the probability of a doomsday scenarios at times like this.
I do think it’s helpful to talk about the spectrum of outcomes.
The first is it really is the zombie apocalypse virus. People lock themselves in their homes. The global supply chain shuts down for a long time. Businesses suffer and they start to go bankrupt. People lose their jobs. Real estate drops off as people can’t pay rent or afford they homes. Credit spreads blowout and you get a large long recession and a global one at that.
The second is what I would say is the base case. The virus runs it cross over the next quarter. China’s efforts to slow infections and deliver quality medical care work.
China was ill-prepared for this and there is evidence they tried to cover up the news that a new virus was spreading before the Chinese New Year. Where the virus broke out, Wuhan province, they were lacking adequate healthcare and medical supplies to handle the initial outbreak. China’s efforts to ignore the threat in the hope it would go away blew up in their face. Which is why China has responded with this massive containment operation.
There is also some circumstantial evidence that the virus isn’t as infectious in warmer climates so as China and other places warm up the infection rates drop.
Because of the virus and containment operations China experiences a slowdown, its PMI just came out in the 30s, and it should show at least a contraction for a quarter or two which would label it a recession. It takes time to get factories back up and running. People are slow to get back to work and global supply chains are disrupted. Inventories around the world get depleted. This would probably give way to global recession.
But it would be more of a transitory recession like we saw in the early 1990s especially in the U.S. Unemployment rates don’t spike that much so there is still demand for consumer products but that demand gets shifted a couple quarters.
During this time governments around the world add stimulus through official channels, like rate cuts, and through unofficial channels, like China reducing the down payment necessary to buy an apartment or house.
Then the global supply chain comes back online, there is extra stimulus in the markets, inventories get rebuilt, and consumer purchases pick up again. You could see a strong recovery out of a transitory recession.
The best case scenario is like the base case but the virus gets under control quicker and China gets back to work within the next month. And even though the virus spreads around the world, governments and their medical systems are prepared, keeping infection rates down and death rates down. We see a short contraction but not a recession. Companies dependent on travel like airlines will bear the brunt of the contraction.
These aren’t the only scenarios and they help us set the range of possible outcomes.
And it doesn’t tell us what the stock market will do. The stock market usually acts in anticipation. So if things start to look like the base case or better, then the stock market would probably react positively ahead of the official numbers.
And we do see some good news. Infections are slowing down in China that is if you trust China’s numbers. Now that there are infections in other countries with more we’ll get a better picture at infection rates, mortality rates, and time till recovery.
Countries and businesses around the world are taking steps to slow down transmissions and break the chain of infections. Some stuff may seem like an overreaction but it is necessary for health organizations to catch up with the virus and get the right systems and practices up and running. And for businesses to prevent further disruptions to their operations.
The other good news is mortality rates, infection rates, and recovery rates are much better in countries with better healthcare and better access to healthcare for its citizens.
But back to what we’re doing. Our job is to invest during times of uncertainty. We have to weigh the probabilities of the different scenarios. Our highest weight would be the base case so that is how we’ll manage our portfolio going forward that is until the facts change.
We’re moving forward but cautiously.
We’re staying focused on our valuations and buying high quality companies where the price makes economic sense.
And right as corona virus the sell-off was gathering steam, Bob Iger had to announce that he is stepping down as CEO of Disney immediately. Not the best time for a company whose business depends on mass amounts of people congregating together and touching the same things as a thousand other people.
Matthew Ball whose essays over the years helped influence our thinking on Disney summed up Iger’s sudden step down best.
This is the 14th month of Bob’s 36 month extension. Which is a little soon.
Disney had a great earnings report a few weeks ago. Why not announce at the end of the call? The news of him stepping down would’ve been blunted by the good news.
This is happening right in the middle of the Coronavirus outbreak. This will be a crisis situation for a company who generates a lot of revenue and profit from theme parks where mass amounts of people congregate and who will likely to avoid during all this.
Bob Iger just wrapped up his press/book tour. You think he would’ve stepped down before the tour to really hype his book and his achievements as a guy who was a weatherman that rose up to become the CEO Disney and reshaped the company and positioned it well for the coming future.
Matthew listed three possible explanations for the random Tuesday step down.
1. A scandal
2. Health issues
3. Running for president
I don’t think it’s a scandal.
If it’s a MeToo type of scandal I think this would’ve come out already. Now it could’ve just happened but I still think it would have come to the surface relatively quickly. Plus, Bob is remaining the Chairman of Disney and overseeing its creative endeavors. Why would Disney keep such a close relationship with someone caught up in a Scandal that tarnishes Disney’s family brand?
Bob also mentioned way back when that he would like to run for President but it is too late for this election. And Bob doesn’t have Bloomberg’s money to start this late and spend his way to national prominence.
Also, Bob is a good long-term strategic thinker. I think after seeing what happened to Howard Schultz, Tom Steyer, and the backlash against Bloomberg that Bob may wait for a better opportunity to get into politics. If at all.
Sadly, I think the most likely of the three would be health issues. Again, nothing has leaked so hopefully that is the case.
A 4th idea and the most bland one was maybe Bob and the board were waiting to finalize Chapek as the new CEO. Iger was going to retire years ago but without a suitable replacement he stayed on. Which was a good thing because the company needed him for a couple more years to finish putting all the pieces into place the future and his ultimate successor.
Now with Chapek in position and the company set up for success, Bob was ready to step down. And the timing, though random, was just when everything was in place and Disney was ready to name the successor. A late Friday news drop would’ve been way more suspicious.
And Bob is not going away. He will be helping Chapek over the next year with the transition and Bob will focus on an area he loves, the creative side, and he gets to continue to oversee his major acquisitions.
Of course the market reacts negatively to a strong leader stepping down. But again, Disney is really in a strong position. Chapek just has to manage it effectively for the next few years while he works on and steers through Disney’s near and mid-term strategic projects. And he gets to shape and plan Disney’s long-term strategic initiatives. Like Tim Cook did when Steve jobs died.
I do agree with Matthew about Bob’s run as CEO. It was an amazing run. He has successfully positioned Disney to grow into the future of media without destroying its current cash cow, its cable affiliate fees. And what its Parks business has done during Iger’s tenure is just phenomenal too.
Bob came to Disney through ABC. He started there as a weatherman dreaming of becoming a news anchor. He quickly changed career paths and went the corporate route. Then ABC was bought by Capital Cities and Bob stayed with the company. Then he was in a position to help Capital Cities/ABC when it was bought buy Disney.
Bob became CEO of Disney in 2005. His first acquisition was Pixar ahead of the boom in digital animation. And Bob bought the best digital animation studio. I’m 40 and I don’t have kids yet but I still watch every Pixar movie.
Then in 2009 he bought marvel. Which a lot of people thought was a terrible deal because the rights to its most bankable properties, X-Men and Spiderman, were held at other studios. But given the string of 21 successful marvel movies, the 22 billion in box office revenue they brought in, and Avengers: Endgame bringing in 2.8 billion alone makes the 4 billion for Marvel look like a steal.
Then there’s LucasFilms for $4 billion. Which had the opposite reaction. Everyone thought that was a steal. I thought so too. I still do even with some of the missteps they took with recent movies. I think they rushed new saga movies out too quickly without having the overarching story arc in place or even stopping to think should we even continue the Skywalker saga or should we start something else?
Rogue One was great because it expanded the universe and it answered a lingering questions from a New Hope. How did they get the plans to the first Death Star and why did it have this fundamental weakness?
Star Wars Rebels the first property put out after Disney bought Lucas Films is a masterpiece.
And it looks like the Star Wars universe is finding a great new home with Disney+.
The Lucas Films division is learning from its mistakes.
Bob invested in and then acquired the rest of Bamtech. It’s the most unheralded acquisition of his but I think it is one of the more crucial ones. Bamtech was needed to build the infrastructure for its OTT dreams. Disney+ and ESPN+ don’t work without the Bamtech acquisition.
Then there is his last and transformative acquisition of Fox. Disney already had a tremendous library but with Fox it is now unparalleled. It catapulted Disney right to top with Netflix.
Disney still makes the bulk of their profits and cash flow from cable affiliate fees and that was the concern with their business model that cord cutting would really hurt Disney. It did and is but Bob has positioned the company during the midst of this secular trend to be a leader in streaming and by owning the customer relationship Disney can monetize the relationship through so many different channels.
A random Tuesday afternoon is weird but Bob Iger has positioned Disney well for the immediate future and they just need a steady hand to see it through and hopefully they found that in Bob Chapek.
Lastly, we have Intuit’s purchase of Credit Karma. I was loosely aware of Credit Karma before this acquisition. I used it a long time ago when it first came out to get my free credit score. I didn’t know its current business model so when I saw Intuit paid 7 billion for it my initial reaction was a slight shock.
But then I looked into it a little further and I think they got a good deal.
Credit Karma has about 100 million users with a wide range of engaged activity on the site. And they’ve linked a lot of financial accounts to monitor their financial lives. Credit Karma has something like 2,600+ data points per member.
Cerdit Karma is essentially a lead generator for banks and insurance providers. These companies pay Credit Karma to have their insurance and financial products be shown to Credit Karma’s users whenever they request info about credit cards, loans, bank accounts, and insurances. The users are high quality leads and the financial product providers will pay up for them.
And with all the data points Credit Karma has it can offer it’s the users the best products per the personal info.
Credit Karma’s margins are not known but this is a similar purchase to Mint.com that Intuit made years ago. And right now Mint has operating margins around 44%. Both Credit Karma and Mint have low operating expenses and as information providers their cost of goods is predominantly the costs to acquire new customers. I think we can assume Credit Karma has a similar margin profile as Mint and it could improve under Intuit.
Intuit is paying about $71 per user. Users that are highly engaged with their financial life. These users are very profitable leads to financial product suppliers and to Intuit. Intuit can cross sell its Mint.com platform, its Turbo Tax platform, and QuickBooks Online.
Each successful cross sell increases the lifetime value of the client by a significant amount.
Intuit is expanding its core products globally and Credit Karma’s business is easy to easy to expand into new markets.
It’s cliché time.
Data is the new oil.
Intuit wants to own the financial data of the best financial consumers, both individuals and small businesses. The Credit Karma acquisition helps Intuit in this goal.
That’s it for this portfolio update episode. The next one should be about our position in United Technologies. If you enjoyed this episode and you want to catch our next one on United Tech, then please hit subscribe. And if you have a second, please leave a rating in your favorite podcast player to help other discover this podcast.
Until next time.
