Quarterly Letter - Q4 2023
Dear Owner Partner -
First - I know you are wondering if I cried when Charlie Munger, Berkshire Hathaway’s Vice Chairman and Warren Buffett’s right-hand man, died this past December.
Yes, I did.
He was an absolute legend and had a massive impact on my approach to both investing (North Beach is loosely based on Buffungerian principles and practices) and life (“I think a life properly lived is just learn, learn, learn all the time”). No one has been quoted more than him in these letters; I am sure we will quote him even more in the future. Like my other legendary mentors (e.g., Grant, Vanderbilt, MacKaye, and Blender), it is weird to think about how someone I never met could have such an enormous impact on my life.
And, of course, it is not just me - he had and will continue to significantly impact many of my friends, colleagues, and the broader investment world. His timeless wisdom, rationality, and mental model approach to thinking (collected in the excellent book Poor Charlie’s Almanac and required reading for everyone I know) will persist well into the future, similar to Marcus Aurelius, David Hume, and Ben Franklin.
Charlie Munger is dead (at age 99). Long live Warren Buffett (at age 93)!
…
Last month, I read a book about the making of an absolutely legendary album by an absolutely legendary musician (whom I also have never met!): Deliver Me from Nowhere: The Making of Bruce Springsteen’s Nebraska by Warren Zanes. While most Springsteen fans focus on Born in the USA and his popular early albums, only the fanatics focus on the importance of Nebraska. And the fanatics know the 1982 album was a massive departure from anything Springsteen did before or after.
Coming between the rousing E Street Band-backed albums, The River and Born in the USA, Nebraska is just Springsteen, recorded on a rudimentary TEAC Model 144 Portastudio (i.e., not professional recording gear) alone in a bedroom of a rented house in Colts Neck, NJ with the stripped-down sounds of a Gibson acoustic guitar, another 12-string guitar, a mandolin, a harmonica, and a glockenspiel. The record’s hauntingly distinctive “echo” effect resulted from everything running through a Gibson Echoplex. Zanes points out that this effect conjures “the dissociative sound of distance and the past.” Showcasing only his raw but epic singer-songwriter talent and not the entire E Street Band sound, Springsteen was actively trying to put some distance between his “rock god” responsibility, massive popularity, and some inner artistic and personal conflict he was dealing with at the time. Though Springsteen did not know he was making an album when he put down the songs, Zanes succinctly describes Springsteen chasing “the sound of one man.”
While not as emotive, jarring, or ground-breaking as Springsteen’s Nebraska, North Beach is evolving from our original investment approach a bit as we start the new year.
KEY INVESTMENT “WAVES” STILL IN PLACE
As we mentioned in past letters to you and as a point of review as we start the new year, our investment process attempts to ride three huge waves into the future.
Compounding Value Wave
The most powerful (and unending) wave we want to ride is what Albert Einstein reputedly called “the 8th wonder of the world” - the power of compounding our value. Another Munger quote: “The elementary mathematics of compound interest is one of the most important models on earth.” However, the human brain has difficulty comprehending compound growth, also known as exponential growth. A simple exercise: if you invest $1 at 10% for five years, you will end up with $1.61. If you invest $1 at 10% for ten times as long (50 years), you do not end up with $16; you end up with $117.40!
As part of our investment process flywheel, we want to continually reinvest as much of the value we receive from our investment holdings as possible to grow equity book value per unit and our culture and compound our value for decades to come:
Private Company “Supply-Side Shock” Wave
The next wave focuses on what the U.S. Small Business Administration calls the most significant intergenerational transfer of private companies in history. Many of these transferable private companies are valued at less than $5 million and owned by folks over 55.
Some of these baby boomer owners are “distressed” sellers. No, they are not bankrupt or going in that direction. It is quite the opposite. These folks own very financially viable businesses. However, they must sell due to forced retirement (by their spouse who wants them to relax or move to Florida or both!) or health reasons and not having a succession plan. Their children do not want their business, and/or there is no employee or group of employees with the financial wherewithal to buy the company. Sophisticated professional buyers (e.g., private equity firms) are primarily interested in private companies valued at $5 million or more. There are not enough qualified individual buyers for companies valued at less than $5 million. That is where we believe we can offer an alternative solution to these business owners.
As a result of lower demand, these small companies are being sold at very compelling valuations compared to the broader U.S. stock market measured using free cash flow yields (the higher, the better):
Private Company “Supply-Side Shock” Wave
The next wave focuses on what the U.S. Small Business Administration calls the most significant intergenerational transfer of private companies in history. Many of these transferable private companies are valued at less than $5 million and owned by folks over 55.
Some of these baby boomer owners are “distressed” sellers. No, they are not bankrupt or going in that direction. It is quite the opposite. These folks own very financially viable businesses. However, they must sell due to forced retirement (by their spouse who wants them to relax or move to Florida or both!) or health reasons and not having a succession plan. Their children do not want their business, and/or there is no employee or group of employees with the financial wherewithal to buy the company. Sophisticated professional buyers (e.g., private equity firms) are primarily interested in private companies valued at $5 million or more. There are not enough qualified individual buyers for companies valued at less than $5 million. That is where we believe we can offer an alternative solution to these business owners.
As a result of lower demand, these small companies are being sold at very compelling valuations compared to the broader U.S. stock market measured using free cash flow yields (the higher, the better):
Micro-caps outperform when the line moves up; large-caps underperform, and vice versa. Like a lot of trends, the ratio exhibits a “reversion to the mean” tendency and has shown three distinct phases since the mid-1980s: (1) after peaking in July 1983, micro-caps underperformed large-caps until February 1999 during the Dotcom Internet Bubble; (2) micro-caps then outperformed large-caps through March of 2006; (3) since then, micro-caps have underperformed. We may enter a new phase someday, and micro-caps may outperform large-caps. We want to acquire high-quality small public companies at attractive values now so that we can ride this wave up to what we believe will be enhanced values in the future.
HOLDING COMPANY UPDATE
Our fourth quarter financial performance was satisfactory on the most important metric we track: we grew 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) by 2% driven by positive performance from both our private operating company and our public company collections. ACN Solutions, once again, had stellar revenue and free cash growth, while both Hart’s Ambulette and BioVac Industrial Service grew free cash flow modestly. The public company collection grew 12% in the quarter, driven by solid performance from our undisclosed positions in a fleet telematics company and a financial technology and communications company.
More importantly, since inception (January 1st, 2021), our equity book value per unit grew 72% (20% compounded annual growth). Our long-term performance compares favorably to the S&P 500 Index’s 33% total growth (10% compounded annually) since inception; our short-term performance not so much. We don’t pay much attention to our performance over short periods. Given how our “mark-to-market” valuation accounting policy and procedure works, our overall performance can and will be weird and volatile. Nevertheless, we fully believe we will add material value and outperform over long periods.
Alternatively, a more straightforward way (using cash-on-cash results!) to characterize our performance since inception: our holding company received cash dividends from the private operating and public companies, equating to 88% of our aggregate purchase cost of those companies.
As a reminder, the above comparisons to the S&P 500 Index are somewhat forced: our asset collection is primarily small private companies with a small allocation to public companies vs. the S&P 500 Index comprised of large public companies. But, 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 continue to believe we will be the better option over the long term.
As part of a regular review cadence of our investment process, we assess our capital allocation options, i.e., what we can do with our excess cash. Our ten possibilities include:
Existing operating company internal reinvestment
Existing public company reinvestment
Existing operating company external investment (“add-on” acquisition)
New operating company investment
New public company investment
New risk-free short-term Treasury bill investment
NBH Owner Partner unit buyback
New outside investment manager vehicle investment
Hold cash
Pay out a liquidating cash distribution
As a result of our quarterly review, we remain more positive on small public company investments and will add more capital to this bucket when available. Rest assured, we continue to believe that the best use of capital remains investing in our existing and new operating companies, which we continue to evaluate even as we are working on acquiring the landfill and RNG service provider company mentioned above.
…
Despite our triumphs and challenges this quarter, we plan to keep working on: (1) improving our investment and operating processes; (2) improving our culture: and (3) growing the equity book value per unit of North Beach. We intend to do this all day, every day, in any way possible. 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. This effort is our purpose and our indomitable will.
As always, thank you for your continued ownership of North Beach Holdings.
Best regards,
Russell P. Moenich
Investment Analyst & Executive Chairman, North Beach Holdings
President & Chief Investment Officer, RPM Capital LLC (North Beach Holdings LLC’s Managing Member)
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 undertake 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.