Chris DeMuth Jr. shares some stock picks

0:11who funnily enough it's been exactly two years since we've had you on investing experts welcome back to the show it's good to be here thanks for having me again it's great to have you i'm sorry that we've waited so long to have you back for a refresher you run an investing group on seeking alpha called Sifting the World to rave reviews for many years. If you would share with those listeners that may not be familiar with you or your work, what exactly you focus on your kind of lane in the market. Sure. I kind of come from the value tradition. I'm a value investor, but more specifically, I look at special situations and event-driven opportunity, usually with some kind of policy bent.

0:56So my first job was doing government risk analysis in D.C., so some kind of regulatory issue, mostly focused in the U.S. and mostly focused on equity, although that's not a hard mandate. It's just kind of where I spend a lot of my time. As we enter this new year, what would you say you're particularly focused on, if anything, and what you're thinking about these days? I would say that the U.S. equity market is quite fully priced compared to a lot of international markets. So I kind of have residual inventory kind of topics tied to the U.S. And a lot of the things I think about are here. I live in the U.S.

1:40But equities are pretty fully valued, especially kind of mega cap tech. I'm shy about saying that because they looked kind of expensive to me and then more expensive and more expensive and done really, really well through today. But I'm not eager for lots of kind of long U.S. equity exposure. interested internationally where we find opportunities in Latin America, in Asia, and interested in smaller cap that hasn't kind of participated with the kind of especially AI attack boom. Although at least in one case, we have kind of some exposure that is there. And then looking for esoteric opportunities either through kind of litigation or some kind of corporate change where the kind of historical way of looking at a business and a stock might not apply as much in the future.

2:38Well, that dovetails really nicely with what you were saying about the valuation conversation and how hard it is to ascertain the proper valuation. And are we at the end of a bubble? Are we at the beginning of a huge bubble? Like what, where exactly are we? What would you say are the names that you're most interested in and the things that you're thinking about maybe differently that led you to them? Two of the ones that I'm working on literally today, but two positions that I think are the kind of thing that I've written about a little bit in the past. One that I'd mentioned is a Willis lease, ticker is WLFC.

3:15Disclosure, I long have been involved in this one for decades, for a very long period of time. It is an airplane, aerospace leasing company. They mostly lease jet engines. They have a very, very valuable portfolio of engines. They have been run as an almost semi-private company. Their management's not very shareholder-facing. The kind of family that controls it runs it. The Willis family has been founder-led, then founder-son-led since the beginning. It's a very impressive, very good company. I think its market cap's right about a billion dollars. It has been a beneficiary of a really, really tight kind of supply of their engines.

4:03So the business is doing extremely well. The NAV had gotten kind of really, really high, especially kind of corrected for the actual market value of their engines. But the thing that I would point out is a company that was and is very shareholder-facing, well-regarded, and I'd say well-understood by the market is FTAI Aviation. FTAI, no position in it, but I've followed it really carefully. And it has a$24,$25 billion market cap, so much, much bigger than Willis. But I think Willis' model, they're really changing. They've announced a number of JVs in the past month that I don't think the market's realized how much this could transform their business.

4:52It could grow much, much faster and become kind of an asset manager of this airplane, jet engine portfolio. But kind of long-term, I think these partnerships are going to massively increase earnings. And I think their billion-dollar market cap will really converge meaningfully on FTAI's$24-25 billion market cap. but even before the kind of medium or long-term kind of growth story i think they could just buy the engines that the company itself owns in these new partnerships and realize gains that will really make it obvious to the market how valuable these engines are you know we're talking a billion dollar market cap they could end up just monetizing you know 800 million dollars of that billion dollars in transactions from these partnerships and casting a light on how valuable their inventory is.

5:53So Willis is one I've mentioned it and written about in the past. It kind of had a terrible last year. It was down, you know, call it, I mean, just roughly looking at it down kind of high 20s percent this past year might have some tax loss selling going into the end of the year that might, now that we're in January, could allow the stock to pop a little bit. And then just looking at what's very substantively similar business, but I think will become optically clearer this year. FTAI was up, you know, 43, 44, you know, just up massively this past year and then up again this year. So it's just FTAI is properly understood by the market.

6:36And I think Willis is more similar than it's been given credit for. And I think this year, it will reveal itself to be a lot more valuable than it's been given credit for. What would you say are the metrics that you use? And are they sector specific? Are they stock specific? How do you look at the metrics? What do you pay more attention to? And what would you say about the risks present with these stocks? Sure. On my way in, and this is something I've owned for a very long time at this point, I'm very focused on assets. I'm very focused on paying a big, at the time, discount to NAV, especially where it's a plausible business, it's earning okay.

7:19and I'm just looking at an NAV that uses historical appraisals in a market where the market value had raced way ahead. And the market value is really transparent. This isn't something that is just my opinion. I can look at transactions day-to-day for the kinds of engines that they lease. And then whenever there's a backlog, thinking about the economics of a backlog, in new plane production, the kind of midlife planes that they serve, it becomes more and more valuable to keep them online. So the net asset value is hugely important. And then kind of having an idea about the changes in earnings from the, I mean, you can look at historical earnings, but then you say, okay, what is the impact going to be on earnings?

8:17And what's interesting about Willis and their new partnerships is, sure, you're going to have leasing, but you have all the maintenance and all of the other, you're kind of brought into their kind of ecosystem of asset management. And you're going to get paid in like four or five different ways. So, you know, what could look like$25 million of earnings can very quickly become 50 by the time you've done the maintenance work and everything else. So earnings change from new endeavors that are not properly priced in the market, medium to long term, short term, the kind of huge reveal on the asset value, especially if they take the step of buying, of having the partnerships take out the company's inventory, which I think they should and will do.

9:13What other stocks are you looking at? What other names would you add to the list? So I wasn't even thinking that it would be two leasing companies. It's kind of just coincident. California First Leasing, one I've written about a little bit, CFNB. This is a really interesting one to me in that it is a owner of a largely large cap U.S. equity portfolio, a 1940 act company in California. and until recently has been trading at a huge NAV discount. It's kind of a quirky little name. It's one that I think is really interesting. The management has a plan to do a not-for-premium tender, a self-tender, to take out smallholders.

10:04So if you want to hold on to this, it's important to buy at least 100 shares or they could take out smallholders. But they're doing it explicitly because they're trying to do an end run around the 1940 Act kind of compliance in terms of transparency. I don't think this move is particularly shareholder friendly. I think that it's possible that it's defeated simply by, if there are too many shareholders anyways, they're trying to get beneath a threshold so that they don't have to comply anymore. I think that they should simply cash out everybody at NAV, which is currently kind of$33,$34 per share.

10:44It's trading still at a discount to that. It's kind of$27,$28 per share right now. I track the portfolio and the NAV value. It's in a lot of things that I don't think I otherwise would be in. I mean, you can just buy the stocks yourself. There's no skill or edge in the kind of things that they own. But until recently, it was a huge discount, still at some discount. And if this end run around 1940 at compliance fails, that's when I think there could be a real pop of five or six dollars a share to the portfolio value if they simply, if they can't cash people out without a premium, I think they would just pay an AV for a going private.

11:29It's mostly privately insider held. You know, you're talking about a tiny little float outside of what they own, and they presumably like their own management. They presumably like their own asset allocation. They can have it. And if they can't get out of 1940 compliance, I think that the overall burden and expense, I mean, the costs are ludicrous relative to the assets under management that are unaffiliated, right? If you say a$30 million float shouldn't cost all these kind of regulatory compliance costs and others to get it done. And so I think that in terms of things that could happen this year and things that are possibly misunderstood, underfollowed by the market, California first leasing, CFNB, I think has been extremely interesting and is still pretty interesting here.

12:17And is gambling a theme that you like these days? It's certainly a lot to like if you don't not like it, that is. So it's something that I'm very interested in. Something as a father of teenagers I'm kind of wary about, love it as a shareholder, not that excited about it as a human, is the kind of gamification of everything, how much apps are commingling, investing and trading and predicting and gambling. You know, I open up any kind of trading app these days and you almost always have kind of yapping about whatever the game is that night and whether, and because it's all tied to the same balance, you know, you could put immense amount of money on just games, on just the dopamine head of kind of, And so I think you're farther and farther away from thinking about investing as ownership and long-term and businesses.

13:14So that's too bad. But boy, is it popular. We have had a number of, and I always recoil from calling it activists, kind of high engagement situations this past year where we had a strong view, we had a shareholder position. we both bought the stock and unseated the view and when there was a vote tried to get something improved or abandoned that we thought was not in our interest so Core Scientific was one of those in their deal with Core Weave we vocally opposed it we voted against it that deal was voted down we thought there was a chance that there was a good deal to be had in that and we simply didn't reach one but we're very happy with that as a standalone versus the value in that deal more recently the gaming one that requires a vote that we think is very interesting is Golden Entertainment, ticker is GDEN.

14:09We've written about this publicly including our opposition to the deal as structured. It's a complicated one and it's one that they might get away with but shouldn't. They are selling, they're doing a deal with ticker and name, a VICI, a sale leaseback deal for their real estate. in Vegas, and that deal's fine. It's an equity-for-equity deal, a stock-for-stock deal, and I don't have a strong view on it. It's perfectly fine. At the same time, management's slipping the entire operating company to themselves for about one-time's earnings. the derivation of this that a colleague caught and that is going to become just like such a constant check that we do that I thought was kind of amusing and dark was that they deleted on their IR site all their historical presentation materials about how great their operating co was because they want to take it for themselves at an absurdly low price.

15:20Now, how they're getting away with this is they're commingling these two deals, right? So they're saying, like, we have this value, you're going to get this because this other company's paying a premium for real estate. And we're taking off your hands at a tiny price, the actual business. So that is one that I think is very interesting. TBD, whether they get away with it, But I think an arm's length, serious process that was compliant, that lived up their fiduciary duty, that was really shopped in a way designed to get the best highest price would be for the business, for the operating business, a multiple of the price that they're getting.

16:02So if they get away with it, fine. I don't think you really lose much. The current price, just to give you a sense,$27.27 last I saw the market price, and you're getting a little over$28 in value for the deal. So if it goes through, tie, but shareholders should absolutely vote this down over the relatively small operating business. Now, the problem is passive money shareholder proxy advisors aren't going to be that excited by the topic because the mispriced part of it is a relatively small part of it. the larger part, which is also hedgeable, you can short the ICI against it, is kind of neutral, but within it is something that is worth many times what is being paid for it.

16:52So I think that on the activist side, you know, Cora is interesting. I think Golden is interesting. And that's the kind of thing we're looking for, where there's just something anomalous about how the deal was done in the process that leads to a pretty bad mispricing. The weakness of this one was we were quite sure we were going to be able to vote down the core scientific deal. This one's a little bit more of a brainer since the value is decently hidden within the overall transaction. What would you say as an activist investor, what would you say that you've learned along the way? And if anything's changed in your approach or I guess your strategy around that, and then also in terms of the mispricings, what you've learned around that?

17:39Yeah, it's a good question. and I would say quite a lot this past year. I'd say what we've learned is if we need to take a very active position to make an investment work, we should also always have another option, which is just sell the whole position, forget about it, and move on. It's hard. Having control of a board and having control of management day-to-day makes a big difference. If you have a minority shareholder activism as a crude tool, it's kind of a baseball bat, not a scalpel. And if you can use the baseball bat to bludgeon them into just selling to the highest bidder, that's fine.

18:21If it's very subtle, I like and admire the person who did this, but the kind of they need to salt their pasta activism is the kind of thing I'm like, okay, if it's that subtle, I'm going to be cautious about my involvement. If that's needed, maybe I should just also not do it. I would say that one of the things that I've learned is how much smallness is a corporate defense. And smallness is a corporate defense because my expenses as a shareholder don't scale down that well. I mean, I normally get my money back if I win, but the problem or situation is lawyers, advisors, and so forth, there's a kind of unitary cost to that, that if I can make$100 million, isn't that different than if I can make$1 million.

19:17dollars. And so once you get down to make a million dollars, you very quickly are in the hopeless situation. And so smallness, you know, dealing with the kind of quirky micro cap or small cap names that I tend to be really interested in, they can really get away with murder because it's just such an expensive hassle. And I kind of joke with my lawyers on, you know, how small we can make the bills in some tiny situation, but I'm the only one that thinks it's funny. They want to get paid. And the cost associated with fixing tiny companies is really hard. Not just hard in terms of running a campaign, but if there are malefactor individuals, I've had situations where, and this wasn't me, but this is people I've been actively working with, get on the board, fix management, and something was discovered that was a real individual liability from people who were replaced.

20:15And we're like, we're right, they're wrong. We could prove it in court, but there's no point in suing them because they're not that rich. There's not like the dollars involved. There's just no, there's a lot of ways to defend yourself when there's a billion dollar wrong. And it's a lot fewer ways to defend yourself when it's a million dollar wrong because you can't just scale down. And at some point you just like kind of move on. So smallness is a corporate defense. There's a lot of ways the regulators could improve this. If we could do electronic only, I mean, one of the obvious reforms would be for all the people who have electronic only apps, don't have any connection to paper information, one should be able to count it as full disclosure by simply email and not paper mailings.

21:01And also, since I look at a lot of banks and thrifts, the Fed limit on shareholding that makes it pretty difficult, you have to get separate approval to go over 10%. That makes it really hard because it's a$100 million bank. I can only have$10 million. That makes it a lot harder than if I can have 20 or 30. So there's a lot of things regulators could do, but smallest is a defense. And then also, we've been very involved this past year on broken biotech. So one of the areas that primarily a colleague of mine, but my portfolio was involved in too, is looking at biotech companies with failed research and huge discounts to NAV.

21:45So, you know, coming in for 50 cents on the dollar of cash, where it's just blindingly obvious what they should do and it's their duty. I think what we discovered, one, is in at least some cases, people are kind of more awful than your low-end expectations of how much or little they could care about shareholders. and two when we're coming in fresh to a situation where maybe the value of the company's gone from call it 10 billion dollars down to 100 million dollars and the market cap the share price is trading as if it was worth 50 so like this is a super exciting interesting situation to me it's it's what i do it's what i like to do but like i'm the only one who loves the topic so you're talking to the board you're talking to the management you're even talking to other shareholders, especially kind of long only and shareholders in that industry.

22:40And like nobody's that happy about the stock. The board management wish you'd kind of leave them alone. And the shareholders in many cases, especially if you're like a big prominent shareholder, the stock's gotten so eviscerated you can kind of just forget about it if it wasn't for me calling and wanting to get them to liquidate. So it was kind of lucrative, but things that I thought were going to be easy were really hard. Things that I thought were going to be fast were really slow, and lots and lots of friction based on people who got themselves into that situation. And industry specialists whose whole lives are really revolving around that industry, maybe even more than what happens to that one specific company.

23:24So if a project is 99 % doomed. I'm very happy to round that down to 100 % doomed, let's save the remaining money. And they really want to spend every last penny on science experiments because it's kind of what they do. What it's taught me overall is a newfound respect for how little people change, how much human nature from individual to individual. People are mostly one thing and you really need to hire and fire for specific times and places and roles, even if it just seems to be blindingly obvious should be done. People mostly just do whatever it is that they did getting them there, even if it's been a disaster.

24:03Did you get into activist investing because it interested you, because you feel like you're geared towards it, because you felt like that was the most you could get return on your investment? How did you get into it? I would say that we are optimizers. We're always looking for what's the best highest use of capital, of our own capital, of the company's capital. We always invest with a thesis. So it's a fluid category for me. We always invest with a thesis of what should they do. In many cases, they're doing that exact thing. In many cases, we have companies where we see a discount and a difficulty, and I am an active, engaged investor 100 % aligned with how management's handling whatever the difficulty we see that is going to become unwound over time.

25:03So, I guess on the drug side Liquidea and Royvent are two of the kind of both old positions long both and positions I've, you know, companies I've cared a lot about for a very long time. You could say I'm active and engaged, I just like everything the boards and managements are doing. They have complicated, hard litigation roots in both cases. And if they and I disagreed, I would speak up. It just happens to be that they're run by the right people who are doing the right things. Is that activist? I'm just a cheerleader. I have very little to add to what Liquidea has to say, including this next week on how their ETRPA rollout's going.

25:53I have very little say on their, from time to time I actually do have quite a bit to say, but it'll be kind of aligned and cheerful thoughts on the litigation and regulatory process and how to deal with, in the case of liquidia, an incumbent that has just done everything possible to prevent them from getting to the market. And now we'll do everything possible to pull them off of the market. And so if I put my money in something, I act like I own a place because I do and they can agree or they can disagree. The process of kind of going through an actual battle is usually something that I'd love if there were other shareholders involved leading the charge on like I'm just not big enough and concentrated enough to want to pick fights that I have to win individually.

26:39but something like core scientific we had a strong view we had boats we had chairs we had been involved um at for us a significant scale but we also had a case that was pretty easy to make to other shareholders so there's a lot of leverage if you can be uh persuasive and there's leverage on seeking alpha i made my case on seeking alpha amongst other places and so um you can kind of get uh situations where you can punch above your weight by uh saying things that you think are true at a time you think they're strategic to say them to other people who have self-interested reasons to be persuaded by the ways to unlock value.

27:19You can buy a CFNB for$28 and I think you'll get $33 or$34 in short order as long as enough people, you know, it's kind of a self-fulfilling aspect of, you know, these things always require something. Sometimes they require a successful go-shop period. Not that frequently, go-shop periods don't normally work. Sometimes they require a second bidder. Sometimes they require tough negotiating with the buyer, but sometimes they require shareholders to nudge them. And so I think we're kind of part of that, or we're part of the conversation. And we're part of the conversation in a way that's intuitive to me because I'm always thinking about, like, what should this company do?

27:58What's the plan for unlocking whatever part of the value I see as mispriced or hidden or discounted, and maybe discounted for the completely benign way. If you're not going to spend all your time thinking about this, the second best bet might be spending none of your time thinking about this. So if there's some big merger or spinoff or contingent value rate, they're all reasonable things to not want to have to do. But you just don't want to kind of stumble around, overpay for them, or take on some huge risk you didn't know about. And so I'm thinking about all these issues anyways, And if it simply takes me speaking up, I'll speak up.

28:37Do you think parenting teenagers is a lot like being an activist investor? Parenting teenagers can be. I'm in the doubly humiliating situations that they crush my returns to their brokerage accounts just being kind of levered long mega cap US tech. It's only six companies they've ever heard of. And they, you know, kind of have a multi-bagger year after year. and they're like, why is my dad focused on these obscure... Yeah, you make it look so hard and it's so easy.

29:11The model I have for what I'm trying to do is I'm very interested and there has to be some kind of aesthetic interest and philosophical interest. I'm very curious in the markets and outside the markets and situations where something is at first glance superficially ugly or unremarkable, but beneath the surface, if you really understood it, there's something beautiful and amazing and valuable there, or something that is superficially really impressive, but actually once you understand it, you're like, no, that's terrible. That's the story of everything I've ever cared about in fiction, nonfiction, in literature, in art, in markets, and so forth.

29:53Now, recently, of all the countries you could be in my country, of all the centuries you could be in this century, and all the things you could know easily, conveniently about, have done unbelievably well. Maybe I'd be the last one to discover hidden in plain view, mega cap American equities, the most well-known things they've done. Now, partly this was free trades and retail mania. And partly, you could go back 100 years and there's always some sector that gets to be this huge percentage of the market. And it's been one of the clearest, easiest mean reversion opportunities anywhere. You know, something becomes 30 % of the overall market cap, it then goes back to 10.

30:45And what is it, 30 %? There's always somebody who's going to explain to you why it should be 30 % or 40 % or 50 % and why it'll be like that forever. And then like clockwork at mean reverts. We've never had market leaders that were this big, either in terms of their market cap and percentage of the market cap, and then exacerbated by the feedback reaction of more and more money that's passive and market cap weighted. but they're also really good businesses like i'm slow and tepid to be convinced by this but i wonder if it at the time every other market leader justification rationale right before it mean reverted felt as convincing as this one but these really are the best businesses and i you can go back a century and i don't think there was anything like uh the most superficial first level thinking, trite lines you could say about network effects and economies of scale on businesses where there's almost no marginal cost of growing some of these businesses.

31:56It's actually until big asterisk until AI, where there's actually some very high costs associated with it. But until recently, it was so trite, but it was so true and correct and right and lucrative to just know that one thing. And so I'm always kind of waiting to not be contrarian for the sake of contrarian, but kind of debunk the kind of obvious thing in the press and the price. But the stuff in the press and the price on huge American equities have been pretty dang right for the century so far. You mentioned the broken biotechs. I'm curious, you know, hosting the Cannabis Investing Podcast, if any of those involve, and you mentioned copious amounts of research, if any of those were psychedelic companies?