A Double Play of "Desert Island Stocks"
We profile the Substack of new friend "Six Bravo," their strategies and their stocks ...
[Editor’s Note: As part of our mid-year review, SPC’s Bill Patalon interviewed the Six Bravo Team about their popular Special Situation Investing Substack. Bill asked Six Bravo about their beginnings, the fine art of special-situation investing, and favorite strategies. But he also invited Six Bravo to take part in our “Desert Island Stocks Challenge.” Here’s a transcript of their talk.]
WPIII (Q): Okay, gents … as a onetime reporter, I love stories. Especially “origin stories.” What’s yours?
What was the inspiration for launching the Special Situation Investing on Substack … and Six Bravo?
What got you guys started?
SB (A): Thanks for the opportunity, Bill. Glad to be here.
The idea behind the Special Situation Investing podcast and the Substack was to journal my own research and offer it to others in real time. There are loads of podcasts and blogs that interview investors or analyze past investment triumphs. But far fewer of those ventures put themselves out there in real time. So I started offering short write-ups back in January 2022 and putting them out in podcast form.
My co-host and I have discussed investing and investments since we met in 2017. He joined me in creating write-ups a couple months after I started the podcast, and at that time we added our content on Substack, since that was a platform he was already familiar with.
So, for about two and a half years now, we’ve steadily just put our thoughts out there to document and share in real time. The hope is that the process and vulnerability helps us – and our readers and listeners – to become better investors.
As far as Six Bravo goes, it’s obviously a pseudonym and is really just a nickname from back in my military aviation days. During the first few podcasts, I was still on active duty and I wanted to maintain anonymity. But now that I’m out, it’s no longer as important, just something that’s there because the podcast started out that way.
WPIII (Q): Who were your inspirations? Any special investors you’ve gleaned from?
SB (A): You can tell from our writing that we’re big fans of the great value investors, with Warren Buffett and Charlie Munger being high on the list. What’s interesting is that going all the way back to Ben Graham, there is this generous legacy among value investors. Graham, Buffett, Munger and so many of their modern counterparts each put loads of intellectual property in the public domain. And that’s just wonderful. The Buffett partnership letters alone are an incredible business education if you just read the material and take the time required to absorb it.
Murray Stahl has been especially helpful to us, ever since he came to our attention back in 2020. One of the many things that I’ve learned from him is how important creativity is in investing. At some point, I realized that whatever information he’s exposed to, he just turns it around and around in his head until something new jumps out that required a different perspective. I saw that trait first in Stahl. But now I see it in the other investing greats, too. It’s not their brilliance alone that makes them so much money, although they’re clearly very intelligent, but it’s their creativity, and to some extent their temperament, that set them apart.
Here’s an example of sheer creativity, this time from Buffett. He was clearly aware of the risks building up in residential mortgages during the run-up to the Great Financial Crisis, yet he still invested in, and did quite well, buying Clayton Homes—a producer of manufactured homes. This is how he thought about it: Clayton was primarily lending to a lower-income demographic and, because of that, had put safeguards in place to ensure that their loans would be repaid. Shorter financing terms, larger down payments and more-resilient earnings from borrowers meant that the “E” in Clayton’s P/E ratio was much more robust than the same earnings in, say, Fannie Mae or Freddie Mac’s P/E.
That’s just one small example of how creative these guys are. You can be a brilliant accountant and understand where every penny goes in a specific company. But that’s not what delivers great returns. It’s the ability to see beyond the numbers and understand why the same earnings from one company are ultimately worth so much more than the earnings of another company – even if their financial statements don’t look that much different from each other.
WPIII (Q): Having laid the groundwork, what’s your ultimate objective for your Substack?
SB (A): Personally, we don’t have a grand vision for the podcast/Substack. We still view it as a vehicle to track our investment ideas and to put our own eclectic thoughts out into the world. And as I said earlier, hopefully we and others will benefit from our time and effort. Also, if my kids happen to read it when I’m gone – and glean some wisdom from it – that would be a success in my book.
As to overall goals, I really just want to be a learning machine. For me, investing is a great excuse to justify my curiosity. Somebody asks you why you're reading a book about the East India Trading Co., well, it’s investment research. A book about geology … investing research. Geography, politics, history … all investing research. Without investing, I’m just a guy who reads too much. And since I enjoy the reading, I might as well do the investing work, too.
WPIII (Q): Just as artists can work in multiple outlets, I know “special-situation investing” isn’t the only strategy you work with. But it was your name – and a superbly executed report on buybacks and dividends – that first caught my attention. And I’m a devotee of special situations myself. So, in this talk, let’s stick with that.
What (in your view) is special-situation investing? I’m intentionally oversimplifying this … and there’s some crossover between these. But … you’ve got:
What the Street and the corporate-governance crowd likes to call “financial engineering” – buybacks and dividends.
Spinoffs and other types of breakups.
Turnarounds and restructurings.
And assorted buyouts (the LBO craze of the 1980s was the flavor du jour when I started out as a business reporter … and Barbarians at the Gate was one of the must-read books).
Do those types of investments fit in your definition? Or others? What are your favorites?
What’s the allure of special-situation plays? The advantage to investors? Especially retail investors. For individual/retail investors … what’s the best way to fly? Key tips?
SB (A): I like the investment category framework described in the book Warren Buffet’s Ground Rules.
One of our earliest write-ups was on this book. The author, Jeremy C. Miller, does a great job organizing Buffet’s partnership letters topically – instead of chronologically. Miller explains how there were three categories—generals, controls and workouts—that Buffett shifted between to achieve superior results under differing market conditions.
WPIII (Q): Give folks a rundown on each of the three …
SB (A): Sure, Bill.
Generals are essentially great buy-and-hold companies at a good price. Think 100 baggers or coffee can investments or anything that fits into a similar framework.
Controls are businesses that you own outright or have a controlling stake in. Returns from this category come from your ability to improve operations, streamline the actual business, or sell off parts of the business. It can be a great strategy for those who have the capital to execute it.
Special situations fall into the “workout” category and include investments with a specific catalyst or timeline. Spin-offs, acquisitions, mergers and those type of investments all have a set catalyst, or timeframe, that drive the thesis and the returns.
Financial engineering, as you put it, is another great way to describe special-situation investing. Basically, your investment return is derived from a catalyst and not simply buying and holding a great company.
The special situations I like best are spin-offs.
WPIII (Q): Yeah, I’m a big fan, too. I covered a number of them as a reporter — the Eastman Chemical Co. EMN 0.00%↑ spin-off from Eastman Kodak Co. KODK 0.00%↑ being one I especially remember — and I’ve chronicled some really good ones in the newsletters I’ve run. Invested in some good ones personally.
SB (A): I don’t invest in many of them. But when the setup is right, they are an easy way to add to your returns. They lend themselves to small investors, too, because they generally work with less capital, can move quickly, and don’t have the institutional checks and balances in place that might otherwise slow a professional investor down.
The Raytheon merger with United Technologies back in April of 2020 was a great example of how a spin-off can work.
WPIII (Q): I know that company well … my Dad, a defense-engineer, started his career with United Technologies units Hamilton Standard and Pratt & Whitney. I followed the “trail” of that company ever since. He’s a big reason for my longtime interest in the defense sector,
SB (A): Well, Bill, because of COVID-19, everything was falling apart … and, in fact, Raytheon was trading so low that it showed up on Joel Greenblatt’s Magic Formula screening tool.
In any case, the SEC’s merger approval was conditioned on United Technologies divesting Otis Elevator and Carrier Global before the merger’s completion.
The SEC documents that United Technologies filed leading up to the merger were fantastic; they essentially told you what everything would be worth and how many shares of each company you would get if you owned United Technologies from 19 March 2020, the record date, through 3 April 2020, the distribution date.
Anyone who read the filings could see that they were going to double their money within a month but given the macro environment and the odd nature of the transaction I’m sure that a lot of institutions didn’t invest in the spin-off.
For the individual investor, however, it was a layup with United Technologies trading at panic levels and the merger timeline set in stone nearly a year in advance. In that case, the small investor was handed a great opportunity and there are other situations like it if you just keep looking long enough.
WPIII (Q): I love that story, guys. So let’s spin it forward … What are some of the top themes you all are looking at right now? Where does it take you? What are some of the companies you’re looking at?
SB (A): If you study history, you begin to see themes that offer outperformance opportunities for set periods of time. Net-nets in the Graham years, consumer-branded monopolies in the Buffett years, M&A during Greenblatt’s era — and on and on it goes.
The common theme is things that are hated — or not understood — is where the opportunity exists. M&A, junk bonds and all the rest in the 1980s weren’t widely understood. So you had outsized returns available if you were willing to do the work and learn about the financial engineering that dominated that decade.
As to where we see opportunity today, my cohost and I both agree with Murray Stahl’s perspective that monetary debasement (i.e. inflation) is going to be a dominant theme for the foreseeable future and that passive investing is becoming the crowded trade.
Anything on the ESG hit list is also fertile hunting ground for quality at a great price.
If those three themes are correct, then a whole swath of poorly understood and hated companies will offer outsized returns going forward. Companies with very low capital expenditure requirements and built-in inflation-adjustment mechanisms, that aren’t included in the indexes, and that are required to maintain our way of life but (let’s just say) don’t have high ESG rankings, all these have great potential.
What are those investments specifically? Well to circle back to the point of our particular Substack: We write about these companies in real time and don’t keep any secrets. We like exchanges, royalties, brokers and crypto – along with traditional special situations, whenever good ones come around.
In terms of investment categories, all of those fit into the poorly understood category and several of them also fall into the hated category. And that means that, if nothing else, at least we’re digging for treasure in the right places.
WPIII (Q): That’s incredibly eloquent … one of the most-clear descriptors of opportunities that I’ve heard in a long time. And I mean that.
While we’re on a roll here … let’s run down a couple of the companies and stocks you’re looking at?
SB (A): Currently we’re buying Natural Resource Partners, ticker NRP 0.00%↑.
It’s a coal royalty company that also holds a large stake in a soda ash mine and some miscellaneous oil, gas, and aggregate royalties. The business model isn’t well-understood and the industry is hated, so again, it’s a good place to invest. It has already performed quite well from when we first started buying it back at three times cash flow (CF).
There is a special-situation element to it, as well: The royalties are largely valued-based on their dividend yield and NRP’s yield is about to increase significantly. The company is in the final stages of a nine-year-long journey to eliminate its debt and clean up its capital structure. Once the debt is gone, management has been quite clear that the free cash flow (FCF) will be available for unit holders.
WPIII (Q): A very nicely stated investment case. And I like that one of my other colleagues — Matt Warder — talked about NRP earlier in this series. Good stuff.
What else?
SB (A): We’re also still buying Bitcoin. We like the fact that it’s outside the mainstream U.S. large cap investment complex and that it’s still poorly understood – even by some of the people who own it. Our list of investments is always changing though, so anyone who’s interested will have to stay tuned as we learn more and discover new opportunities.
WPIII (Q): Very nice.
You know … it’s kind of interesting … this interview isn’t merely about “special situations.” This story … this interview with you folks … is actually a special situation, itself. We’ve been publishing the “SPC Mid-Year Review” series — with our “Desert Island Stocks Challenge” — for our readers the last two weeks. And you’ve been kind enough to participate.
But this is also an introductory interview – it’s the first time the SPC team has had the chance to speak with you. So this is a full profile/interview, as well as the update.
That makes it special …
So let’s shift gears here … and consider the midyear.
What has surprised you about 2024? Any predictions for the rest of the year?
SB (A): Neither my cohost or I spend much time trying to predict specific events, or really predicting anything at all. One can’t predict a specific hurricane, its arrival time, or its intensity; but one can identify a structure that is vulnerable to hurricanes and then take precautions in advance.
I see economics and investing the same way.
You can tell that debt globally is at extremely high levels. And you can see that, at the nation-state level, debasement or outright defaults are the only way out from under the load. But you don’t know exactly how that is going to play out. I can better spend my time preparing for what lies ahead – instead of trying to predict it – and so that’s where I spend my time.
So I guess I have just about zero predictions for the remainder of 2024, or any other timeframe.
WPIII (Q): That’s okay … that’s where I come down, too … which is why I’m a long-term “storylines” guy.
But I do like your “forewarned is forearmed” analogy. I mean, if you think about it, if predictions are one side of the coin, preparedness is the other. Very nice … I like that.
SB (A): Thanks, Bill.
WPIII (Q): That brings us to our “Desert Island Stock Challenge,” where I’ve been asking our experts: If you knew you’d be marooned on a desert island for a few years – meaning you’d be holding whatever you owned – what (specifically) would that be?
SB (A): That’s an interesting question, Bill …
I think it was in The Snowball by Alice Schroeder that a similar discussion was raised by Buffett, at a meeting of the Buffett Group. Warren answered the question saying that his desert island stock would be the Dow Jones. Curiously, Buffett didn’t own any of the stock at the time – leading you to believe that, while the question is useful, it doesn’t always result in a person owning the stock that they cite when presenting their answer.
To answer your question directly, though, I would keep my Texas Pacific Land TPL 0.00%↑ stock and my Natural Resource Partners NRP 0.00%↑, along with the Bitcoin.
Assuming I had someone to manage the position in my absence, I’d continue shorting path-dependent ETFs as well, but only if somebody was watching it. Those positions require options to cover and some management of the position-sizing, too, so it’s not a set-it-and-forget-it type of thing.
Those are those are the positions I’d maintain because they’re very unlikely to go to zero and at the same time stand a solid chance of outperforming any benchmark I might use for comparison.
WPIII (Q): Thanks, guys. This was terrific. Let’s talk again …
For folks who want to follow up on some of these ideas, check out our recent stories about Natural Resource Partners, courtesy of Matt Warder, and this report on Bitcoin, thanks to my friend Dave Zeiler.
Our Six Bravo/Special-Situtaion friends and Substack neighbors published this superb report on NRP … and this super-thorough “update” on Texas Pacific Land.
In fact, if Six Bravo’s insights about these two have peaked your interest … I urge you to invest the time and peruse both those reports. Totally worth it.
SB (A): Thanks, Bill … thanks for that.
WPIII (Q): Absolutely … I thoroughly enjoyed this.
And for all you folks reading this … I’ll see you back here next time.
Great conversation; Six Bravo -- what did you fly?
Love your show, great short content!!!!
Should you have an interest in interviewing Murray Stahl please feel free to reach out. Mschumacher@horizonkinetics.com