Idea Brunch with Harris (“Kuppy”) Kupperman
Kuppy shares his inflection investing strategy, why he loves newspapers, and his top six investment ideas
Welcome to Sunday’s Idea Brunch, a weekly interview series with underfollowed investors and emerging managers. We are very excited to interview Harris (“Kuppy”) Kupperman!
Kuppy is the Founder and Chief Investment Officer of Praetorian Capital, a concentrated inflection and event-driven hedge fund he launched in 2019. In addition, Kuppy has serves as the chairman and CEO of Mongolia Growth Group Ltd (TSXV: YAK – CAD$43 million), a real estate and financial services conglomerate. Praetorian Capital was reportedly up 127%, net of fees, in 2020 and up another 128%, net of fees, for the first 11 months of 2021. Additionally, Kuppy founded Kuppy’s Event Driven Monitor (KEDM), which tracks over two-dozen Event-Driven strategies. You can find Kuppy’s commentary on the markets on his blog and Praetorian Capital also publishes all its quarterly letters here.
Kuppy, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch Praetorian Capital?
Happy to join you. I’ve been investing in the markets for almost 25 years now. For a decade, I ran a successful fund, but closed it when I started focusing more of my time on Mongolia Growth Group (MGG). In 2018, I got into a situation at a company named Aimia where management was paying friends to take profitable divisions off their hands. It was the worst corporate governance in the history of finance, but there was incredible value there if someone could stop them from looting the thing. I came to realize that as a private individual, I just didn’t have the scale to sue them for malfeasance or to credibly challenge them in a proxy fight. I’m not an activist, but I also don’t want to get stolen from as a shareholder. The situation made me realize how valuable a larger pool of capital could be as it would give me the flexibility to impact the outcome of events. I never set out to build a large fund, I want to stay small and nimble, but I want to have enough scale so that I can impact outcomes when necessary. It also helps to have the budget to pay for a talented team to help research companies and identify value and naturally the incentive allocation is a nice way to leverage my skills. My fund is just shy of $100 million today, and I think we still have plenty of headroom in terms of capacity while staying nimble in small-cap opportunities. In the end, my focus is on dramatic outperformance, not marketing and asset gathering. I think the performance shows that, both in terms of where results have been, and how the capital base hasn’t gotten unwieldy.
Can you describe a bit about your inflection investing strategy?
I try and identify themes that have been ignored, sectors that are hated, companies that are misunderstood. I wait until I can see a change in trend, a reason why things will get better, and I get involved right at the moment of inflection—before it’s yet reflected in the public numbers. I only focus on situations where I can make at least 3-times my money and preferably 5-times. That’s my return threshold. Too many people find a stock trading at $20 and figure out why it should be at $25. That makes no sense to me. You’re taking all this risk and not getting compensated. I find a dollar and try to figure out why it will be worth 5 and why it could overshoot to 10. The key is in identifying the reason why things will get better and being disciplined if it isn’t panning out. I make my capital work hard for me and want to be concentrated in only the best trends. When the trend slows down or reverses, I get out fast.
I run a very concentrated portfolio. As a result, I’m also completely fixated on the downside. I focus on companies trading for low single-digit cash flow multiples or at huge discounts to replacement cost. I am laser-focused on balance sheets. Often, things don’t inflect. If I get it wrong, I don’t want to lose much. I don’t want something unforeseen to cost me dearly. Given my concentration, I don’t have the luxury of taking losses. In summary, I find something at an inflection, I play it big right from the moment of inflection and I try not to get it wrong. Even when I get it wrong, I usually make money, or maybe lose a few percent.
One special situation you have talked about recently are local newspapers, which many investors view as cash-burning dinosaurs. Can you tell readers why you see so much potential in local newspapers?
Newspapers are the original subscription business. They’re unbelievably sticky businesses with negligible churn. You start reading and you never cancel unless you move or die. People inherently want to know what’s going on around them. The problem is that newspapers were slow to adapt to a digital world. They literally gave the product away for free on the website and then tried to charge people for the print product. It was asinine. As a result, subscriber numbers comped negative, leading to less advertising revenue, leading to lower overall revenue. As revenue declined, the newspapers cut journalist staffing, which lead to a worse product as content suffered. It was a vicious cycle that has played out for three decades now.
What people have missed is that over the past few years, the newspapers have finally reinvented themselves in a digital world. They’ve perfected the app technology so that the content is no longer browser-based. They’ve embedded video and started cross-linking to other interesting reporting. Digital news is a much better, real-time product than print and a digital subscription costs a fraction of what a physical newspaper costs, yet comes at a high 90’s contribution margin. Digital is simply a much better business because it’s cheaper for the consumer and the product is better, so it stays stickier. Investors have totally missed this transition.
I could have told you this a few years ago, but back then, digital revenue was a small fraction of total revenue at these papers—it didn’t matter to the bottom line, even if it was growing at a crazy rate. Fast forward a few years and digital growth is accelerating and it’s now an increasingly large percentage of the business. Let’s look at Lee Enterprises (NASDAQ: LEE — $203 million) where we’re the second largest shareholder. Digital is now 34% of revenue, it’s likely around half of total EBITDA as digital margins are higher than print margins. Digital subscribers grew 65% YoY in the most recent year. Total subscriber revenue was roughly unchanged YoY as print subscribers continued to slowly decline and a print subscriber pays a few times what a digital one does. Everyone sees these newspapers as shrinking businesses, but 2021 was the year that subscription revenue at LEE stopped shrinking. I think 2022 will actually show subscriber revenue growth. Lee trades at about 1.5 times EBITDA and three times FCF. That seems like the wrong multiple for a subscription business that is growing fast. Why isn’t this worth 15 times EBITDA? Or more?? I mean, many SAAS companies trade at more than 20 times revenue, many of them lose money too. Why shouldn’t a digital subscription business trade at a better multiple if it’s a better business? What if they can figure out how to improve their advertising? Right now, they have all this data on readers. They know what you’re reading. They know your interests. Why can’t they do better ad targeting?? This reminds me of Facebook back when they had all the eyeballs, but didn’t know how to monetize them. I think it will take some time, newspapers aren’t known to be tech-forward, but they’ll figure it out eventually.
You asked why I launched my fund. It was because I saw an opportunity to use more capital to influence the outcome of things. In November, LEE received an unsolicited takeover offer at a silly price. The board didn’t immediately reject the offer for being stupid, so we filed a 13D explaining why the price was simply wrong and adding that we would not tender our shares at that price. The next day, LEE rejected the offer. I don’t see myself as an activist and hopefully, I never have to engage in activism again in my career. At the same time, I’m not going to sell a growing business at slightly more than 1 times EBITDA. I believe that my activism has had a positive outcome for all shareholders and the shares are now trading at almost a 50% premium to the offer price, validating our thinking.
In addition to running a very successful hedge fund, you have built a loyal 37,000+ following on Twitter, a popular blog, a newsletter for professional investors that tracks event-driven situations, and are chairman and CEO of a financial services company. Has being in the trenches building businesses and sharing content online changed your approach to investing?
Absolutely!! Buffett once said that the best way to learn about investing is to run a public company. It’s just amazing what I’ve learned. I know you’d ask, “what could I possibly learn as CEO that I wouldn’t learn as an investor?” I’d answer that it’s stunning how little you understand about the state of affairs at many companies when looking in from the outside. About how press releases and the financials are driven by legal considerations, driven by what the auditor will think, or if the exchange will care. What’s the materiality of a decision and how it gets reported into the financials is one of those unique questions that you don’t know how to answer until you’re running a public company. It makes me a better investor because I now know when something is written by management, or the legal team, or the auditors. If it doesn’t quite make grammatical sense, you know it’s that way on purpose. Sometimes, you can almost tell what the next press release will be, based on the way the last one was written or who wrote it and what they’re trying to say. It’s understanding the nuance of how things are disclosed and displayed that I think has made me a better investor. There’s a unique process to public company disclosure and I like to think we’re one of the most transparent companies out there. We try and do everything with the best ethical standards. Good news, bad news, basic quarterly reporting, we always deliver it as fast as we can with as much disclosure as possible—even then, there’s always debate about what’s too much or too little information and how to improve our disclosure without giving away trade secrets or violating non-disclosure agreements. Imagine how things work when management is trying to hide something nasty or do something criminal? I think I just have a much better eye for this stuff now.
In terms of my public profile, I wouldn’t be public if it didn’t have advantages. It’s amazing how people, people I’ve never met or engaged with, will read something I’ve written and reach out to correct me. Or they reach out because they have the same position or view and want to share notes. Even when speaking about a smaller company, I’m bound to find other shareholders or employees or competitors by just being visible. I frequently find someone who’s short and can explain why they disagree with me. My public profile is just an incredible tool in the markets. It takes an amazing amount of my time, but the returns on that time are exponential. Every time I add a follower, I add to my ability to process complex information and make better decisions.
Kuppy, what are a few interesting ideas on your radar now?
I run a super-concentrated portfolio that focuses on inflections in various companies and sectors. I have four core themes right now. We already spoke about newspapers, so let’s talk about the other three (oil, uranium, and US housing).
Oil is the easiest. It’s a global commodity. Demand grows almost every year. Six billion people are just entering the steepening phase of the S-Curve and they intend to use the same amount of per capita energy as a billion of us use in the Western world. I see demand accelerating from 1-2 million bbl/d of annual growth to some higher number. Meanwhile, supply has plateaued as capital spending has been in decline for many years. US shale bridged some of this, but they’ve now drilled a lot of the Tier 1 inventory. ESG along with increased regulations will make it harder to keep growing shale. The same goes for most of the world. Western governments and acronyms have declared war on carbon and made it more difficult to grow production. Meanwhile, demand keeps growing. This will get solved by much higher prices. People keep saying, “so what, oil goes to $100.” I think they’re off by a multiple. Why can’t it overshoot to $500 in a true energy crisis? We just saw European power prices go to a crazy place. Why can’t oil go there too? I’m playing this in two ways, long-dated oil futures, call options and call option spreads. I’m also playing this through Valaris (NYSE: VAL — $2.70 billion) which is the world’s largest owner of offshore drilling equipment. I believe that offshore drilling will recover as oil prices increase, especially as most of the new oil discoveries have been offshore discoveries, in places that are more friendly to increased production. I think that a lot of future oil production growth will come from offshore and that will naturally increase utilization and vessel pricing. I bought VAL right after it emerged from bankruptcy at about a dime on the replacement cost of the equipment. During prior bull markets, these offshore drilling companies have traded for two to three times replacement cost. That’s a lot of upside and the risk is negligible as they have a net cash balance sheet and the company has positive FCF today. Utilization is already increasing dramatically since I bought it. Next will come pricing.
Uranium is another theme. There’s been a relentless uranium bear market for over a decade and with the price below the cost of production, mines have shut down. The world uses about 180 million lbs a year and production is about 125 million. There’s another 25 million lbs of secondary supply. Therefore, there’s a 30 million lb. production deficit currently. That number will expand in future years as dozens of reactors are being built. Uranium is the obvious solution to carbon-free baseload power. Demand will only grow from here. Eventually, the above-ground stockpiles will be used up and the price will overshoot. That’s simply the nature of commodities. They overshoot to the upside and the downside. A nuclear reactor is a paperweight if it cannot secure uranium. There’s going to be a panic to secure uranium at some point, just like there was in the late 2000s. I’m playing uranium through Sprott Physical Uranium Trust (TSX: U — CAD$1.77 billion) and Kazatomprom (LON: KAP — GBP6.82 billion). Sprott is an entity that buys physical uranium. It’s the least risky way to play this trend. I simply own the physical and I wait for the price to recover. I bought when uranium was roughly $31/lb. Today it’s $43/lb. The trade is working nicely. KAP is a bit riskier, but it’s the lowest cost producer, the Kazakh government owns 75%. There’s massive cash flow and they pay much of it out in dividends. I worry a bit about corporate governance and geopolitics with KAP, but it is what it is, and I’ve weighted it smaller than my U.
My final trend is US Housing. The US used to produce more than 1 million homes a year. For over a decade, we’ve produced less than a million. We’re now back above 1 million and there’s a 5 - 10 million home backlog of catch-up demand, after taking account of population growth. There is also a massive demographic migration in play. People are moving from high-tax, overregulated states and they are moving to the south, particularly Florida. St. Joe (NYSE: JOE — $3.06 billion) is one of the largest landowners in the state of Florida. They’re selling lots, building communities, and keeping the commercial real estate. The shares trade for about a quarter of NAV. NAV grows about 20% a year. By paying a quarter of NAV, you’re making about 80% a year on your money and you’re doing it at a company with negligible financial leverage and massive accelerating cash flow. I think the shares should trade at a premium to NAV, given how strong this demographic trend is, instead the shares trade at a huge discount to NAV. It just makes no sense. The gap will close.
The other way I’m playing this is a company named Cornerstone Brands (NYSE: CNR — $2.20 billion). They’re one of the largest players in vinyl windows, siding, stone facades, gutters, etc. None are sexy businesses, but given recent industry consolidations, they have surprisingly strong returns on tangible capital. I think this business can produce ROAs above 30% a year and do it with a few turns of debt. This means you’re making over 100% a year on your capital. The shares trade for a low single-digit cashflow multiple. This seems wrong. People are convinced that the demand for housing will fizzle out. I don’t see how that’s possible. The US population keeps growing and the government keeps subsidizing homeownership. Where will the people go? The country needs more homes. I think both of these companies could be multi-baggers this decade.
What are some of the first things you do when researching a company? What does that first hour of research look like for you? Do you do anything that few others do?
I have to admit, I don’t dive too deep into companies. A superficial understanding is sufficient. I focus on the inflecting trend and why the trend has real strength. Most of what I need to know about a company is contained in the balance sheet and the cash flow statement. If I get the trend right, I’ll probably get my company right. If the trend is wrong, who cares how cheap it is. In terms of analysis, I have friends with these massive spreadsheets. It seems so silly to me. Either it’s painfully obvious or it isn’t. Newspapers are inflecting because digital is growing parabolic. Do I have to know which mastheads are growing faster than others? Does it matter if it’s 1.2 or 1.5 times EBITDA? Who cares?? Either digital keeps growing or it doesn’t. It’s that simple. Either the price of oil and uranium go up to incentivize production or the world runs out. It’s simple. If a few hundred thousand people a year move to Florida, real estate values will increase and most of JOE’s land is in two of the fastest-growing counties in Florida. It’s one of the prettiest places in Florida, of course it will keep growing fast. Keep it simple, make sure it’s mind-numbingly cheap, make sure management doesn’t blatantly steal from you or do anything toxically idiotic and don’t overthink it beyond that.
I focus on getting the trend right and put my energy into finding the right way to express that trend. I own oil futures and options instead of producers because extraction businesses are terrible, capital intensive, shitty businesses. Even the experts get it wrong. What hope do I have? Part of why oil is going higher is because governments will tax these guys and make it painful to extract oil. Why do I want to be exposed to that? I want to bet on oil going higher, not well economics. I focus on how to play the trend and that’s it. I own JOE because they sell the lots and keep the high-return commercial real estate. Homebuilding is a terrible business, they let someone else do that. Every time they build on an acre, every acre next to it goes up in value. The network effects are massive. I want that, not the brain damage of a homebuilder. Keep it simple, focus on returns on capital and stay in high-quality assets. That’s my research process.
Honestly, with an inflection, your best case, worst case, base case outcomes are so wide in terms of valuations that the process is pointless. Get the trend right, avoid landmines and you make money.
What would you like Praetorian Capital to look like 10 years from now?
I want to have the best numbers. That’s it. I want to build a team to help identify more trends, to stress-test more trends, to do deeper dives into what’s driving these trends, and to always find ways to get an edge.
Last year, we created KEDM as an internal project to identify Event-Driven opportunities. I thought we were missing maybe 10% of the stuff out there, instead, we weren’t even identifying 10% of the stuff out there. There’s so much opportunity around corporate events. Spin-offs, Privatizations, CEO Change, Bankruptcy Emergence, Demutualizations, etc. These are all inflection events. Something is changing dramatically at the business. The same goes for IPOs or SPACs or Secondary offerings. Capital structure is changing. A growing business now has more capital to grow faster. These are all things to watch, they’re all inflections in a trend, yet we were missing them because we didn’t have a systematic way to track them. I’d look at something after a triple and say, “Crap!! I 100% would have played it. How did I miss this??” Now I don’t miss stuff. I knew we had something special when friends started asking me to forward the spreadsheet. We had 200 people on a weekly email within 2 months. It was crazy. I also knew that we needed to hire people and scale up to track more stuff, so we turned it into a business. Readers can go to our website and take a trial. Two years ago, I never thought I’d be publishing anything. I wasn’t looking to start a new business. So who knows where this adventure brings me. I just want to create Alpha every step of the way and have the best numbers in the business. (Publishers note: I use KEDM and think it is an awesome product.)
Kuppy, thank you for the great interview! What is the best way for readers to follow or connect with you?
Thank you Edwin for having me on! Readers can follow my blog here or follow me @HKuppy on Twitter.
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