Quarterly Letter - Q4 2024
Dear Friends of North Beach -
…And then there were three…
No, this is not a bit about the ninth studio album of the same title from the prog-rocker-turned-commercially-uninteresting band Genesis. While I am not a fan (at all) of the band's music, I know that the 1978 album marked the end of their true cutting-edge artistic era and started a much more boring sound for the band. This transition was destined to happen after Peter Gabriel's departure and Phil Collins' songwriting promotion a few albums prior. But I digress…
"And then there were three" refers to the number of North Beach Owner Partners after our reorganization in June (please see our Q2 2024 letter for further information). Interestingly, the three remaining Owner Partners are now all internal team members. North Beach successfully returned all capital (along with an excellent return on that capital!) to "outside" Owner Partners in exchange for their choice of a cash payment or a stake in LFG Service Partners, our industrial landfill service provider platform that we created in June last year.
To cap the year off, our full-year 2024 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 28% (including a 39% return from our public company collection). More importantly, since inception (January 1st, 2021), our equity book value per unit grew 119% (22% compounded annual growth) compared to the (simple but not totally applicable benchmark) S&P 500 Index’s 66% total growth (14% compounded annually) since inception.
EXISTENTIAL REVIEW
Our quarterly letter is dead (long live whatever comes next?!). Not having outside Owner Partners creates a bit of an existential problem for this publication in the future: Who will I write to and why?
After some careful thought (you may recall we did not publish a third-quarter letter last year), my intention (subject to change!) will be to keep you, a valued and interested friend of North Beach, appraised of what the team and I are working on and what we are thinking about as we work. While I am not sure what this will exactly look like right now (and I am very open to suggestions!), we will do our best to add value and provide differentiated insight to you.
That said, our reorganization forced an examination and subsequent revolution of our investment approach and process and how we will move forward. A few highlights: (1) We now have an even more intentional focus on micro-cap public company allocation given our current opportunity set; (2) Our private company service industry group filter is tightening up, i.e., the industry groups we now find interesting and are within our circle of competence has been dramatically condensed; (3) We are actively seeking out very capable and aligned (via capital or otherwise) operators we can partner with on private company ownership.
Micro-Cap Focus
Regarding our micro-cap focus, the orange line in the chart below shows the price ratio between the Wilshire U.S. Micro-Cap Index (a collection of the 2,500 smallest public companies in the U.S.) and the Wilshire U.S. Large-Cap Index (a group of the 750 largest public companies in the U.S.):
When the line is moving up, micro-caps are outperforming/large-caps are underperforming, 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 generally underperformed, and the ratio is currently close to its all-time low. We may enter a new phase someday, and micro-caps may outperform large-caps. We want to own high-quality micro-cap companies and ride the wave.
Industry Filter Focus
Over the years, we have learned a lot, including what industries align with our skillset, experience, and tight circle of competency for potential private company ownership (we are much more open in our public company search). We used to look at and were open to owning any service-related company. We did not care much about barriers to entry or what shirt-collar color the employees wore. Oh, you have an asset-heavy company with tons of aging rolling stock? Bring it on!
This is not the case today.
We want super-niche companies that are asset-lite and employ light-blue-to-white-collar employees. Examples of industries we are investigating include regulatory compliance, test & measurement, quality assurance, certification & accreditation, non-accounting auditing, environmental monitoring, and specialized maintenance.
Owner-Operator Partnerships
Warren Buffett has counseled that “when a management team with a reputation for brilliance joins a business with poor fundamental economics, it is the reputation of the business that remains intact.” He implies that he would rather bet on the horse than the jockey. While I believe this is good counsel, someone on a podcast I listened to recently pointed out (I don’t recall who, unfortunately), that the importance of the management team is inversely crucial to the size of the company, i.e., the smaller the company, the more important the quality of the management team. Given our experience, this makes excellent sense.
Knowing that, we want to partner with high-quality, capable, experienced operators to buy private operating companies as either a minority or majority owner partner. We bring capital, experience, and defined skills before a deal closes, including sourcing, structuring, win-win negotiation, and due diligence review. After the acquisition, we excel at active board-level operational oversight and capital allocation prowess.
We are stepping up our networking efforts with anyone remotely interested in the “entrepreneurship through acquisition”(ETA) and “searcher” movements. If you are interested or know of someone who is, please let us know! We would love to discuss partnering in a truly “win-win” fashion.
Positioning
Maybe the most important conclusion from our examination and revolution is that we like our positioning. We don't have to do anything at all unless it is extremely compelling and offers massive asymmetric upside vs. very limited downside. We own two stellar free-cash-flow-generating private operating companies (ACN Solutions and LFG; note Hart's Ambulette was recently sold), ten public (mostly very small/micro-cap) companies, and surplus cash reserves. Channeling King Menelaus’s relaxed and sufficient vibe after the Spartans won the Trojan War, our company collection keeps the wolves in the hills and the women in our beds.
Shane Parrish, the founder of Farnam Street, an expert mental modeler, and author of the incredible book Clear Thinking: Turning Ordinary Moments Into Extraordinary Results, advocates that:
“A good position allows you to think clearly rather than be forced by circumstances into a decision…You don’t need to be smarter than others to outperform them if you can out-position them. Anyone looks like a genius when they’re in a good position, and even the smartest person looks like an idiot when they’re in a bad one…What a lot of people miss is that ordinary moments determine your position, and your position determines your options. Clear thinking is the key to proper positioning, which is what allows you to master your circumstances rather than be mastered by them.”
Today our positioning gives us time to think, read, research, and wait for the right pitch (knowing there are no called strikes in the game we are playing!).
A CURRENT THOUGHT
And with the usual full disclaimer that we are not macroeconomists or political pundits (we are business owners and analysts), one of the things we are thinking about, given the season (post-election), is a variant of "reflexivity." Reflexivity here is less the epistemological kind and more the Sorosian (or maybe Sorosical?) kind, that is, a theory that positive feedback loops between business expectations and business fundamentals can cause market price trends to substantially and persistently deviate from “equilibrium” (whatever that is) prices. Given the newly elected Republican "full boat" government, the deviation in question could be materially positive if the 2016-2020 lower taxes and lower regulation playbook is run back. This, in turn, could instill broad confidence across the economy and create a positive feedback loop.
We talk to other private and public business owners regularly, and while it is still early and there is a non-zero probability that the Republicans may not work together for the greater good, there seems to be a collective sigh of relief related to avoiding a higher tax regime and regulatory burden. Given a more confident and friendly business environment, many (including us) already feel more excited about reinvesting in their business, knowing they may get a higher return than under a different political outcome.
On the other hand (we hate it when there is another hand!), we are incrementally a bit more worried about the companies we own that benefit from regulatory compliance. ACN provides services to help our investment manager clients who must conform to the Securities and Exchange Commission (SEC) laws. LFG performs compliance services for landfill owners under Environmental Protection Agency (EPA) laws. Long-time friends may recall that back in 2020, there was a potential threat to ACN’s largest revenue source when the SEC proposed changing a reg. Thankfully, the proposal was not passed.
As I repeatedly write in almost every letter, for us, it is more beneficial to try and understand what is happening now in the areas we can control and, as the Buddhists say, have radical acceptance of all things we cannot control. Come what may from the new administration, we know we cannot control the broader economy, the governmental makeup and its intentions, or the broad market valuation level. We are business analysts and owners and stay within our tight circle of competence. We focus on owning outstanding small private and public service companies. We work hard to understand these companies deeply from the bottom up and allocate capital accordingly. We then strive to help guide the operation of our private companies well and be excellent partners to the managers of our public companies.
…
Even though it is just the three of us now, our path forward endures after a rewarding internal examination and revolution: acquire, operate, and partner with attractively priced, well-run small private and public service companies that can deliver free cash flow growth for a long, long time. We plan to keep working on improving our investment positioning and processes and growing North Beach's equity book value per unit. We intend to do this all day, every day, in any way possible. We will push hard to compound value for our future generations through honorable value-add action and enduring ownership.
As always, thank you for your continued interest in 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 opinions 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.