Quarterly Letter — Q1 2022
Dear Owner Partner —
It is incredible that Antarctic explorer Sir Earnest Shackleton's ship, the Endurance, was found 107 years after it sank. This astonishing achievement by the Falklands Maritime Heritage Trust will probably go down as the world's most challenging shipwreck search, given the brutal conditions of the search zone. Named after Shackleton's family motto, Fortitudine Vincimus ("by endurance, we conquer"), the ship got stuck in the polar pack ice wasteland of the Wendell Sea north of Antarctica and eventually sank on October 27, 1915.
But what is even more impressive is Shackleton and his 27 crew members survived the whole ordeal.
Over the course of ten months after the ship sank, the crew moved across the shifting ice floe, left the ice in the three remaining lifeboats to voyage to the remote and uninhabited Elephant Island, and ultimately found safety after sailing 800 miles across the Southern Ocean to South Georgia Island. Alfred Lansing's 1959 must-read book about the voyage, Endurance: Shackleton's Incredible Voyage, is sourced from the crew members' diaries and a tour de force showing how Shackleton's spirit of adventure, genuine leadership, and mental toughness on display led to the crew's survival.
Reading about Shackleton's exploits teaches so many lessons. It provides many examples of what great leaders do, whether concentrating one's attention on the matter at hand, perceiving the situation, planning, and taking action – or moving quickly from suffering to disappointment to reflection to find clarity, conviction and, ultimately, purpose. In his case, his purpose was survival. Say nothing about remaining calm, staying cool, and rapidly adapting to a challenging and changing environment.
Around here, we think of the business of business and investing as nothing more than making decisions and then executing those decisions. Shackleton can be a guide here as well. He made decisions quickly. For him, the worst decision was to make no decision and wallow in uncertainty. He worried about what he could control and not about the many things he did not. His decision-making logic was simple: a less-than-ideal action, swiftly executed, stands a chance of success, whereas no action stands no chance.
We are business analysts making capital allocation decisions all the time. We focus on finding outstanding essential service private and public companies at sensible prices - not mediocre companies at bargain prices. We work hard to understand them deeply from the bottom up and allocate capital accordingly in an effort to maximize our returns. Our decision-making logic gets executed through our capital allocation algorithm. It is straightforward and works from the inside out. First, because we do not take a salary or management fees from the holding company, we distribute a small amount of capital to fund our modest lifestyle and keep the wolves from the door. Next, we invest in the maintenance and growth initiatives at our existing private operating companies. Once those initiatives are funded, we make sure we have an adequate cash reserve to protect us from anything wicked that comes our way. Once the reserve is built, we look to buy new private operating companies and then public companies that pass our investment checklist. Finally, if we still have excess capital, we distribute it to you.
In all cases, our decision-making algorithm focuses on the things we can control and not stuff out of our control like macroeconomics or geopolitical showdowns. The future outcomes of those things are important but unknowable. We are not macroeconomists or geopolitical strategists, or tacticians. We don’t make decisions on the direction of inflation or interest rates, supply-chains machinations, or warfare winners. Those pursuits are a waste of our time.
Taking that a step further, we do not have a master strategic plan nor a need to proceed in some preordained or conventional fashion. By remaining flexible and keeping our business and investment options open, we make decisions based on what makes long-term business and investment sense for you, given our core values, a set of operating principles honed through experience, and a practical and tight circle of competence.
Shackleton's purpose and the path forward were survival. Our purpose and path forward are acquiring attractively priced, well-run small private and public essential service companies that can deliver free cash flow growth for a long, long time. There is no fundamental difference between owning an exceptional private operating company and owning the common stock of an outstanding public company. We protect, enhance, and deploy our hard-earned and sacred permanent capital in a durable, concentrated, and differentiated collection of superior companies. These companies are run by able and honorable entrepreneurs and possess important and unique long-term competitive advantages so that free cash flow earnings are very likely to be materially higher many years from now.
HOLDING COMPANY UPDATE
After good results in 2021, the first quarter holding company's financial performance was satisfactory on the two most important metrics you should focus on. First, we achieved solid growth in equity book value per unit (the increase in NBH’s equity value, which is assets minus liabilities, divided by the number of outstanding NBH membership units), and second, return on invested capital (NBH’s earnings adjusted for interest expense divided by the total value of equity and debt capital used in the business). As a frame of reference, NBH's 6% growth in equity book value per unit during the quarter and 31% growth in 2021 could be compared to the S&P 500 Index's -5% and 29% growth in value during the first quarter and 2021, respectively. Similarly, our 22% return on invested capital compares favorably to the S&P 500 Index aggregate return on invested capital of 10%. On the one hand, this comparison is somewhat forced: our asset collection is primarily small private companies with a small allocation to public companies vs. the S&P 500 Index of large public companies. On the other hand, you choose how to allocate your capital, and the S&P 500 Index, as an investment option, could be considered your most practical and best alternative. We believe that we will prove to be a better option over the long term. By the way, Warren Buffett directed Berkshire Hathaway shareholders to evaluate performance over time by measuring growth in equity book value per share, which is essentially the same thing as what we are doing here.
PRIVATE OPERATING COMPANY INVESTMENT UPDATE
Our collection of private companies continued the momentum coming out of 2021 and executed well in the first quarter. As a result, aggregate revenue and free cash for the quarter grew year-over-year. Our operating profit margins improved. Most importantly, our outstanding employees continued to deliver excellent service to our customers despite the daily volatility of life these days. We are grateful for their dedication and amazed at their ability to do what they do.
ACN Solutions
Spencer Wirick, ACN's President (and our Director of Public Investments) produced a monster quarter and shattered records on many fronts: record quarterly revenue, a record number of new filing agent service clients added, record free cash flow generation, and record free cash flow per filing (the most important financial metric we track for ACN). Clearly, his investments in marketing in the second half of 2021 continue to pay off.
Brahler's Cleaning & Restoration
The first quarter was one of intense internal evaluation and change, given the difficulties we continue to experience at Brahler's. Our Director of Private Investments and operational excellence champion, Dillon Thompson, was embedded part-time here to get the company back on track. He and the team made several intelligent decisions to right-size the company. This included shutting down the unprofitable Reconstruction & Remodeling division to focus all energy on our very profitable Disaster Mitigation and Cleaning divisions. We have increased our investment in digital marketing, and it has already delivered a positive return in the first quarter. We continue to strive to get the right people on the bus and in the right seats, which meant reshuffling company leadership yet again with focused reinvestment in and around our operations expert, Stacy Ignacio. Given a very volatile weather quarter, the quarter's Disaster Mitigation results were fantastic and company-wide costs continued to come-down.
Hart's Ambulette
Once again, Kristy Summers, Hart's President, increased customer trip count, revenue, and free cash flow during the quarter despite the "omicron" pandemic and nasty weather headwinds early on that resulted in temporary nursing home closures and medical appointment cancellations. Despite raging fuel costs (the second largest cost input behind driver wages), Kristy delivered record gross and operating margins, which is noteworthy. In addition, her marketing efforts continue to pay off by adding new nursing home facilities to our customer list.
S&S Filter
After crushing it in 2021, Dan Debellis, S&S's President, continued to deliver in the first quarter with solid revenue and free cash flow growth and a strong business activity pipeline, including adding three new customers. The only thing holding the company back is its inability to add more employees. As a result, Dan and the team have streamlined the hiring process over the last quarter; we look forward to the results.
New Private Company Pipeline
When Dillon Thompson is not working expertly to improve our operating companies' operational profitability, he is working hard to find new enduringly profitable service companies for us to acquire. Today, his pipeline focuses on managed information technology and mobile drug testing service spaces. While still too early to get more specific here, we remain excited to learn from these incredibly talented entrepreneurs. They built unique businesses and are now looking for the proper transition plans and the right homes for their companies. We hope to help them.
PUBLIC COMPANY INVESTMENT UPDATE
While our public company collection total return performance since inception has been solid relative to standard benchmarks (see above), it has been underwhelming lately:
We don't pay much attention to market indices over shorter periods. We are deliberately constructing a collection of publicly-held companies that are very different than the aggregate make-up of popular stock market indices. The companies in our collection have the following attributes not easily found together in the average company in an index: (1) broad insider ownership where the management teams we partner with are aligned with us on a very long-term basis; (2) impeccable balance sheets for maximum financial flexibility; (3) high and stable returns on invested capital; (4) long-term revenue growth runways; and (5) most importantly, the trade-off between durable competitive advantages and the price paid for our shares skewed materially in our favor. As a result, there is no reason to expect our results to move in tune with the popular crowd's indices and delusionary short-term madness. We fully believe that we will outperform over long periods.
Most of our public companies reported full-year (2021) financial results during the past three months. Our core positions, which represent 81% of the collection (more "opportunistic" companies make up the rest), grew revenue by 18% year over year (2021 vs. 2020) on a collection weighted average basis; free cash flow increased 61% on the same basis. Compared to 2019 (the full year before the COVID-19 pandemic plagued 2020 results), revenue grew 3%, and free cash flow increased 12%, again on the same basis. It is good to see our collection, in aggregate, return to growth. We expect more normal growth trajectories in the years ahead. Other than our positions in AmerisourceBergen Corp, Berkshire Hathaway Inc., Criteo S.A., and Graham Holdings Company, we will continue to refrain from publicly identifying the other nine companies in our collection since we are still building our positions. In most cases, these are illiquid, "trade-by-appointment" situations in very small public companies.
We remain relatively unexcited with the aggregate public company investment opportunity set because market valuations are too high. Our previous sentiment bears repeating here. We don't have to buy the whole market (i.e., stock index investing) and are not forced to put capital to work. By remaining flexible and keeping our investment options open, we decide what makes long-term investment sense given a practical and tight circle of competence.
…
Dillon, Spencer, and I are focused on creating a best-in-class investment holding company for our owner partners. We will push hard on our investment strategy's self-sustaining flywheel, which is simply owning enduringly profitable companies that generate free cash flow that we will use to own more and more enduringly profitable companies that generate more and more free cash flow. Channeling Shackleton, this is our purpose and what we can control all day, every day.
As always, thank you for your continued interest in North Beach Holdings.
Best regards,
Russell P. Moenich
President/Chief Investment Officer
Disclaimer:
The views expressed represent the opinion of RPM Capital LLC (RPM) and North Beach Holdings LLC (NBH). The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment.
Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While RPM and NBH believe the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and RPM's or NBH's view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance, or events may differ materially from those expressed or implied in such statements.
Forward-Looking Statements:
Certain statements in this communication constitute "forward-looking statements" within the meaning of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the "Acts"). Any statements contained herein that are not statements of historical fact are deemed to be forward-looking statements. The forward-looking statements in this presentation are based on current beliefs, estimates, and assumptions concerning the operations, future results, and prospects of RPM, NBH and its operating companies. As actual operations and results may materially differ from those assumed in forward-looking statements, there is no assurance that forward-looking statements will prove to be accurate. Forward-looking statements are subject to the safe harbors created in the Acts.
There are a number of important factors that could cause our results to differ materially from those indicated by such forward-looking statements, including, among other factors, risks inherent in private equity investments, competitive markets for investment opportunities, no assurance of profit or distributions, illiquidity of investments, economic and market risk, inflation and interest rate risk,lack of liquidity, lack of diversification, and conflicts of interest.
RPM and NBH undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information or future events.
Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. Past performance is not an indication of future results.
This letter does not contain all the information that is material to a prospective investor.
Not an Offer – The information set forth in this letter is being made available to generally describe our investment outlook and process. The letter does not constitute an offer, solicitation, or recommendation to sell or an offer to buy any securities, investment products, or investment advisory services. Offers are made only to accredited investors by a confidential offering memorandum and related offering materials, which will contain important disclosures regarding the terms and risks of investment, and in accordance with the terms of all applicable securities and other laws. To obtain further information, including a confidential offering memorandum, you must complete our investor questionnaire and meet the suitability standards required by law. The information published and the opinions expressed herein are provided for informational purposes only.
Not Advice – Nothing contained herein constitutes financial, legal, tax, or other advice. RPM makes no representation that the information and opinions expressed herein are accurate, complete, or current. The information contained herein is current as of the date hereof but may become outdated or change.
Risks – An investment in NBH is speculative due to a variety of risks and considerations as detailed in the Confidential Private Placement Memorandum dated April 2022, and this letter is qualified in its entirety by the more complete information contained therein and in the related subscription materials.
No Recommendation – The mention of or reference to specific companies, strategies, or instruments in this letter should not be interpreted as a recommendation or opinion that you should make any purchase or sale or participate in any transaction.