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Asset Based Investing vs Business Based Investing


Gregmal
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OK so with the election over and focus here moving back to investing shortly, I thought it might be a neat exercise to kick around the above subject matter. At the crux of the Berkshire vs something like a Brookfield, the main difference, IMO is not the contrast in leverage utilization vs cash hoard, but the focus on assets vs businesses. I have long looked at Berkshire and admired their businesses. They are powerful and almost run themselves. Great brand value, which is an asset to a certain degree, but nonetheless the majority of their holdings are "operations". Whereas on the other end, you have Brookfield which buys assets as the primary driver of their strategy. Infrastructure stuff is kind of a hybrid, both an asset but also an operation. Its probably where BRK and BAM have the most in common.

 

Generally speaking though, what are the opinions on preference for the two? An asset, like an office building or a pipeline requires rather minimal attention, is hard to impair or mismanage, and regularly spits off cashflow. A subsurface royalty or a ground lease you are basically just letting somebody else use your space for a recurring, high margin fee. Whereas a Costco, an Apple, a chemical company, or a homebuilder, needs to consistently be on top of their game. They have consistently evolving variables, employees, regulatory expectations....however just anecdotally, I've found that businesses can compound with great velocity and you can much easier hit a real home run getting into a business at the right time, whereas an asset just kind of goes slow and steady.

 

Where do folks stand? Is it different in terms of public vs private? Theres obviously a great advantage to not having to worry about evolving and operating a business if its a privately held asset. Its also much harder to destroy value and make bad decisions with an asset...which is not to say it cant be done, but an asset that simply appreciates due to existing, is much harder to impair than one where you regularly have to make judgment calls or face operational risk. Its funny but folks often associate classic value investor aphorisms like "margin of safety" with Berkshire, but on a fundamental level, that seems more appropriate to ascribe to the Brookfield strategy....of course the debate around the utilization of leverage not withstanding.

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it's an interesting question. essentially financial assets vs real assets.  if the economy is good I will take the former. and if not, the latter

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I see no difference between the two. Frankly I try to avoid using the term "asset".

 

Marty Whitman goes on-and-on about how investors are misguided by the income statement and forget the balance sheet.

 

Well they're the same damn thing (mostly), at least in my mind.

 

"Assets" are just things which produce "earnings".

 

The only thing that matters is how much earnings and for how long.

 

And your description of "Asset" is also odd. Take canary wharf - incredibly valuable, but how much is it worth in the middle of mississippi or at the bottom of the atlantic?

 

Using labels just promotes lazy work. "Durable" assets like real estate - how "durable" were they during COVID? Meanwhile tech/software did great because those "less durable" assets were actually...more durable?

 

Screw the labels and just try to estimate the earnings streams

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Thats a reasonable take, but how durable is the cashflow from a painting? The NY Mets? A bar of gold? You could probably chuck some single family residences into the category as well. Vintage cars too. Supply and demand can exist outside of the presence of earnings.

 

Also with regard to covid, it sure has created short term, temporary headwinds and tailwinds for many businesses. Its also accelerated already in place trends. Most of these where already occurring prior. But looking at it from an exception to the rule scenario often just leads to excuses not to invest. How durable was tech during the dot.com bubble? Depends when you bought it. How durable was housing 10 years ago? Generally speaking though, there are trends and strategies that work well when properly implemented, most of the time. Its what is fascinating with BRK vs BAM. BRK takes a more risky approach IMO, buying operating business. They are just 1) very good at it, and 2) very conservative. BAM takes a very conservative strategy...hard assets that often produce income streams, and puts it on steroids. Taking something exciting and making it boring vs taking something boring and making it exciting. Both results are hard to argue with.

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I dont think it is a lazy distinction at all.  if you can build a durable brand that generates business profits, that is the nuts.  but IP and goodwill like brand equity is hard to build and hard to maintain. an enviable asset, in terms of location/scarcity etc is also the nuts and probably longer lasting, but probably not as lucrative in terms of generating return. 

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You’ve slightly muddied the water because a team like the Mets generate earnings every year. A painting you is different as you only generate earnings upon sale. But still, all these generate cash flows albeit at different times (and therefore the discounting is different).

 

How much would you pay for a gold bar which could Never Be Sold Again - ie guaranteed zero future cash flow.

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I think what LC is talking about is that earnings get generated by assets whether they are listed on the balance sheet or not. Some may be tangible and easier to identify some may be intangible but nonetheless very valuable.

 

But I think what we're talking about here is tangible asset heavy businesses vs tangible asset light businesses. The type of business will dictate whether it's heavy or light. A utility or a REIT will naturally be asset heavy whereas a software company will naturally be asset light. Honestly I don't think there's anything wrong with either. They're just different beasts. The asset heavy business will tend to be safer because there's only so much you can do to screw up the asset but that comes at the expense of growth. You'll get better operators and worse operators but there's a limit to how much you can squeeze out of an asset.

 

On the other side are the "asset light businesses" - really intangible asset heavy companies. The can be much more profitable for the investor because you can really grow and expand those intangible assets which will turn out to be very profitable for the investor. That is balanced larger risk as those intangible assets can drastically loose value if mismanaged. Sure you can say that Apple has some great intangible assets, but it had them once before and theirs' and IBM's too went poof with commoditization. That can happen once again. Blackberry went from a 100B+ market cap to a 4B market cap in just a few years. There's also the version where the value of your intangible assets change because their potential growth profile changes. KHC I think is a great example here. It's clear that it has some great intangibles. You can see it in the ROA. But the growth profile of those intangibles changed drastically and so did their value.

 

Because a lot of this intangibles are a lot more difficult to value. If Greg and I were to sit down an value a rate regulated, monopoly high voltage network I don't think that we'd come out with wildly different values but we probably will if we try to value SAP. Buffett loves intangible asset heavy companies because of the optionality of growth that these bring. But while he's loved Coke's and Gillette's intangibles he didn't love Silicon Valley's intangibles. My guess is that he felt he could value the former's intangibles better than most and he felt that most could value Silicon Valley's intangibles better than he or that they are not valuable.

 

In the end it doesn't really matter. Your overperformance/underperformance will come from valuation error. The reason why people did so well with Google, Apple, Amazon, etc is because their intangibles were either undervalued in the past or over valued now. But then that also happens with boring hard assets too. Remember the high voltage network above above? Why did I do so well on Hydro One?

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Thats a reasonable take, but how durable is the cashflow from a painting? The NY Mets? A bar of gold? You could probably chuck some single family residences into the category as well. Vintage cars too. Supply and demand can exist outside of the presence of earnings.

 

 

I think there is a difference between collectibles and assets or business that generate cash flow. I don’t think accumulating collectibles is really investing.

 

For other things that generate cash flow, it is more about semantics. A business is harder to value than a real estate asset that is rented out and where you have a pretty good idea about future cash flow and comps.

 

The problem with investing in hard assets like real estate assets is that we don’t have direct control of the asset (the cash flow and when it can be liquidated) and there is an layer of G&A expense that is never going away unless an entity is liquidated, which rarely happens. So those Reits etc. in my opinion should trade at a discount to NAV, the question is how much.

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Thats a reasonable take, but how durable is the cashflow from a painting? The NY Mets? A bar of gold? You could probably chuck some single family residences into the category as well. Vintage cars too. Supply and demand can exist outside of the presence of earnings.

 

 

I think there is a difference between collectibles and assets or business that generate cash flow. I don’t think accumulating collectibles is really investing.

 

For other things that generate cash flow, it is more about semantics. A business is harder to value than a real estate asset that is rented out and where you have a pretty good idea about future cash flow and comps.

 

The problem with investing in hard assets like real estate assets is that we don’t have direct control of the asset (the cash flow and when it can be liquidated) and there is an layer of G&A expense that is never going away unless an entity is liquidated, which rarely happens. So those Reits etc. in my opinion should trade at a discount to NAV, the question is how much.

I know we're taking this in a different direction but I kinda disagree with you on REITS. The G&A is obviously there but it should be a small amount kinda like the G&A at Berkshire HQ. that is unless their crooks but then why would you invest with crooks. There is an offset to the G&A in the form of better financing options as you and I can't go out there and get a syndicated loan and such things for our asset.

 

Then there's the tax aspect of REITS. Depreciation recapture in a progressive tax system is one nasty bitch. But REITS you can hold in tax free accounts. That in a huge advantage for REITS vs physical asset.

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G&A also likely gets scrapped in any sort of M&A, or at least a good chunk. For smaller scale and high cost of capital REITS, yea, a discount to NAV is always warranted IMO. But generally speaking there isn't, and shouldn't be, because you have the large guys trading at premiums and its almost too easy to acquire when you can issue shares the way most of them do. If you are a specifically focused REIT, you very much have a reason to roll up smaller guys as NN and NNN leases require little overhead. The management teams dont have any say it whether they sell unless there is concentrated ownership. This of course assuming nothing crazy happens like with CWH.

 

Regardless of focus on REIT, the Brookfield strategy of taking these stable income producers and pulling as much capital out as possible, and then levering that capital has squeezed significant amount of value into the complex. Of course, its sometimes compared to an elaborate house of cards, but I think there is merit to the strategy. Metaphorically, I like the reliability of collecting $20 every time a car shoots over the GWB much more than I'd like having to run Costco, even though there are few businesses better than Costco.

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G&A also likely gets scrapped in any sort of M&A, or at least a good chunk. For smaller scale and high cost of capital REITS, yea, a discount to NAV is always warranted IMO. But generally speaking there isn't, and shouldn't be, because you have the large guys trading at premiums and its almost too easy to acquire when you can issue shares the way most of them do. If you are a specifically focused REIT, you very much have a reason to roll up smaller guys as NN and NNN leases require little overhead. The management teams dont have any say it whether they sell unless there is concentrated ownership. This of course assuming nothing crazy happens like with CWH.

 

Regardless of focus on REIT, the Brookfield strategy of taking these stable income producers and pulling as much capital out as possible, and then levering that capital has squeezed significant amount of value into the complex. Of course, its sometimes compared to an elaborate house of cards, but I think there is merit to the strategy. Metaphorically, I like the reliability of collecting $20 every time a car shoots over the GWB much more than I'd like having to run Costco, even though there are few businesses better than Costco.

 

But, to use your example, you're paying for that reliability of the GWB right? Because a lot of others enjoy that reliability right? Brookfield does too. I guess they try to compensate for that with their house of cards in a black box routine. But that introduces risk and thus hurts that reliability wouldn't you say?

 

There are also limitations. Only so many cars can shoot over the GWB and there's nothing you can do about that. You can compensate for that with pricing but there's a limit there too. On the other hand if you take a company like Coke, they can generate an insane amount of value if they smartly manage their intangibles and increase their customer base. The Eastern Europe takeover by Coke was nothing short of genius and it created many, many, many GWBs out of thin air!

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Yea, basically. I guess in a nutshell, when done right, you are absolutely better off owning a great business. But overall, the reliability of the asset is the safer choice. I suppose anecdotally that's why you see a lot of normal people get rich via real estate, or at least more so than you see normal people getting rich owning and growing a business.

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between sorting through real asset-based businesses and brand/IP/marketing-based businesses generating returns, there is also one other player...you, the investor.  your objectives are suited differently by each.  and one business could morph into another. ATT used to be a dominant asset-based wireline/cable, now it's morphing into digital entertainment. far are likely that the 99 year lease of the Polo flagship on Mad/72 (@6%) will satisfy the German pension fund's objectives than a similar holding period of ATT (to take an example)

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