$ELAL: El Al is a wartime monopoly at 2x EBITDA. Is that a trap? | ASB Partners

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0:27all right hello and welcome to yet another value podcast i'm your host andrew walker today we've got a great one we've got adam bukstein from asb partners on the podcast this is the second time on the first time he was on we talked about stride the ticker there is lrn and we're going to actually end this podcast with a 10 or 15 minute discussion on stride but to give you an idea i mean i put out that's right podcast and the number of value investors focus concentrated value investors who at inbounds asking questions, wanting me to connect to Adam on the heels of that podcast was awesome. So I think that just really speaks to the quality of Adam's work and the interesting thought process.

1:00And he's got another one. We're talking about LL Airlines. I hope I said that right. It's the Israeli National Airlines is basically what it is. And he's got a thesis, you know, downside protection, lots of assets, the interesting pricing structure, interesting competitive dynamics, all that type of stuff. He has a full write up on his sub stack, which I will include a link to the in so notes if you want to go kind of check that out. But we're going to get to the full LL pitch in one second. But first, a word from our sponsors. Today's podcast is sponsored by Fiscal.ai. Fiscal.ai is the modern financial data provider for global equities.

1:32Look, that's what they have me tell you. But let me tell you how I've been using Fiscal.ai. And I'll remind you, I'm a customer. I paid with my own money to connect to the Fiscal.ai API. There's two things that I've really found it useful for. Number one, this is something super unique. They've got a huge database of fund letters. And the fund letters are connected by the API. So whenever I'm researching a company, whether it's researching the company because I'm interested in them or looking up an event or prepping for a podcast, the first thing I have my AI do is I say, hey, I'm prepping for a podcast on, what are we, I'm prepping for a podcast on HIMSS.

2:05And the first thing it does is it says, hey, here's all the recent letters on Fiscal.ai of people talking about HIMSS and here's their thesis, here's their bear thesis, all that sort of stuff. So that's the first thing. And that is really unique and that is really fun. And then the second thing I do is I use it for edited financials, right? I've got my model and I say, hey, I'm looking at HIMSS, go build me a model. And it says, sure, I'll build you a model. And every line in that model has a link. So I can see, oh, they're pulling this EBITDA number. They're pulling this segment number. They're pulling this number from three years ago.

2:33I click on it and it takes me right to fiscal.ai and it says, hey, here's these company-specific KPIs. Here's these ratios. And I can see exactly where they're getting and exactly where they're kind of from. So it is a super reliable data provider that can connect to your AI. I found it super helpful. I'm a big fan of the podcast. If you want to try it out, you can use my link at fiscal.ai.yav to get 15 % off their AI connector. That's fiscal.ai.yav, and there'll be a link in the show notes. All right. Hello, and welcome to the Yet Another Value podcast. I'm your host, Andrew Walker. With me today, I'm happy to have on for the second time, Adam Buckstein from ASV Partners.

3:06Adam, how's it going? Good, and yourself? Doing good. As you said, I'm excited for today's podcasts. But as you said, I'm always excited. But we'll get there in one second. Just disclaimer, remind everyone, nothing on this podcast is investing advice. That's always true. Maybe particularly true today because we're going to an international stock. So people should remember there's extra risks, tax consequences, all that. We're not tax advisors. We're not giving any investing advice. So full disclaimer at the end of the podcast and in the show notes. Adam, I think at the end of this podcast, we might do a quick little update on Stride.

3:39The ticker there is LRN, which was the first podcast that we did that people actually, I was getting rave reviews. I got lots of calls from some pretty big funds who were like, hey, this is super interesting. I think I put you in touch with a few of them. But before we get to that, the company we want to talk about today is El Al. This is Israeli Airlines is what I think of them in my head, but I'll stop rambling. I'll turn it over to you and I'll say, what is El Al and why are they so interesting? And you can tell me if I'm saying it wrong as well. El Al, he was good enough. El Al, you know, like it's a little hard to get the exact pronunciation, but you're fine.

4:10So yeah, Elal is the Israeli flag carrier. It was started in 1948 when they founded the country, and then it was privatized in the last 20 years. And, you know, the story to cut to the chase is since October 7th of 2023, there's been this almost continuous disruption in their market. The main airport in Tel Aviv is called Ben-Gurion. And because of multiple wars on multiple fronts, there's an actual missile that hit Ben-Gurion last year. It was like, El Al has found itself in this basically monopoly position on the transatlantic flight. There's been carriers from Europe that have been flying on and off, but you basically have this situation where they've been able to command this leading market share, and they've delevered the balance sheet.

5:18And we're still in the midst of a war, and it trades really cheaply on an absolute relative basis. And I think it's a very high-quality asset type of thing that's going to be around 30 years from now. and the market is, you know, scared out of its mind, but I feel like it's a very asymmetric setup because of the quality of the balance sheet and the, you know, the current setup that we find ourselves in and love to like walk you through the story. Perfect. And before you do that, I should note that you have a really nice write-up. I actually, I thought the best piece of the write-up was the conclusion.

5:53You have just this killer paragraph in the conclusion, which I can quote later, but I'll include a link to the write-up in the show notes so people can go see the full write-up if they don't want to listen to us ramble for an hour. That's a great overview. I've obviously got some push-ups, got some thoughts there, but I guess we can start just, I think you've hit on it, but I do like to start, you know, what are you seeing that the market's missing that makes this a risk-adjusted opportunity? Yeah, so a few things. Number one, I think, just to start with the obvious, it's like this stock is pretty under-followed.

6:25It happens to be that only half of it is publicly traded During the middle of COVID, there was an equity, essentially an equity recap. The Israeli government really did not bail the airline out. They provided some loans, but an investor came in, a U.S. investor, and essentially bought half the, between warrants, stocks and warrants, all the warrants are now fully converted. So we're looking at a fully diluted market cap right now. All the shares outstanding. There's 592 million shares. as we go through the little confusing in terms of the shekel versus the dollar. And I'll walk through that. But it truly is underfollowed and underappreciated.

7:03If you look at the front page, there are basically no U.S. hedge funds. The top holders are all Israeli insurance companies. And so usually I'm skeptical and say like, you know, something that's on the balance sheet, like to say that it's not been appreciated. But like, I really think in this situation, the deleveraging is so unprecedented and it's so significant because they've been able to just have three years of windfall profits that they've totally delevered the balance sheet and now they're like well you know very overcapitalized they're returning capital shareholders and that's you know that's a unique setup like this is a this is a tough business as bob crandall the ex-ceo from American Airlines said, like, this is a rotten, nasty business.

7:47Like, it's very hard. And, you know, we're talking about an airline in the middle of a war with, you know, jet fuel, like, it was spiking, you know, like it was up 86 % last quarter. LL still managed to, like, generate a lot of free cash flow. So that's part of the story here is that they've already proven that they're even profitable with the commodity going against them. So that's number one, like, in terms of the deleveraging and that speaks to the valuation trades at like 2.3 times EV, the EBITDA, you know, generating a lot of free cash flow. So like there's just like an absolute cheapness and a deleveraged balance sheet.

8:23So you don't have to worry about any balance sheet issues. That's number one. Number two is I think the market doesn't appreciate that their, you know, the inbound Ben Gurion is like being completely transformed after three years of war. We're still in the midst of the conflict with Iran. The most important change, which has been permanent, I'm not saying it won't change, there won't be other carriers that will come in, but Turkish Airways and Pegasus, which were top five carriers, they totally left the market. They're not coming back. Even Ryanair, which, you know, Ryanair is your worst nightmare.

8:56Michael Leary has said, like, even when things like, you know, he's kind of like provocative, but he's like, I'm not coming back. Even when like the missiles stopped flying, because they basically took away his slots at terminal one, which is like the cheaper landing rights. He just, he'll probably come back, but you know, he's probably just talking to it. But right now, like, I still think that the market has been permanently transformed and you know, the, so that's number, you know, you have like, that's on the supply side and then on demand side, you know, like Elol has won the trust. They're the only ones that have been able to consistently fly.

9:28There's been this on again, off again, literally for three years, kind of get, I don't want to use the word flywheel. I don't don't overstate it for an airline because it's commodity. They're all flying the same planes. But at the end of the day, there is some lock-in with like the loyalty program and like people that just want surety that they're not going to have their tickets canceled, which has happened. I mean, it's happened to friends, you know, almost happened to me. I was there in May. People are going to want to fly a law. And so that speaks to the pricing power and the, you know, the inelastic demand that they, that they enjoy and, and, and their unique, you know, in their niche.

9:59So that was, I point to those three things. That was fantastic. And look, you really set this up for me as a podcast host, because those things are a lot of the things I wanted to talk about. Let's start with the deleveraging, you know, because I think you mentioned this, and I think this will play into the balance sheet and valuation stuff as well. You know, you mentioned over the past few years that the company has robed kind of wartime profits to really deleverage the balance sheet. They've gone from a net debt position to a huge net cash position. And I guess I have two separate thoughts on that.

10:31Number one, you know, I remember after the Ukraine-Russia war started, a lot of, you know, whether it was energy, steel, a lot of these guys were making just record profits. And even today, you could apply it to the microns of the world and the memory components, though. You know, I think that's a different level of record profits. But I would look at them and say, hey, I think the market's missing how good the balance sheets are, right? These guys have always run with like 2x leverage. Now they're running 1x net cash. And then what ended up happening was, yeah, but they were doing it because of like kind of primetime profits.

11:03And when the profits fell out, they just had these huge cash pools sitting around. But, you know, none of the stocks have really, to my mind, worked that well. Like U.S. Steel got taken out. So that kind of worked for them. But like all the Steel players, Cleveland Cliffs, the one up in Canada, like none of them really worked. So I guess my first thought would be, hey, they kind of delevered through a super normal profits and we come back to profits later. But does that really work? And that would kind of go to the second thing I'd say, where they've got this big net cash position, but a lot of it is from customer float, right?

11:34Customer prepay. And yes, they're not canceling flights, but you mentioned it. The Israeli government didn't bail them out during COVID. And go ask all the airlines how they feel about relying on like a balance sheet made up of customer float when the customers might cancel. And here they might cancel because of a COVID or they might cancel because the war breaks out even further and nobody wants to travel or they can't travel safely. They can't launch flights safely. So I guess I look at this balance sheet and I say, hey, I see two errors that companies or that I've looked at or companies have made in the past that this balance sheet kind of rests on.

12:08Let's not say it's going to go bankrupt, but if we're relying on that for the valuation, could that prove a problem? yeah so let's talk about the balance sheet and so like the way they talk about it they you know there's over two billion dollars in available funds for liquidity about 1.3 billion of that is called air traffic liability which is basically an interest-free loan from their customers because people buy the tickets in advance so even excluding that and assuming that it normalizes and it will someday but you know they've been enjoying this float for the last three years they still have a significant net cash position on their balance sheet.

12:45So that's number one. Number two is it's a real asset. It's just like it's pretty extraordinary. I was looking, you know, they just printed their second quarter. Like they had, I think it was like, if you look at the income statement, there was like that$31 million in like net finance. It was like positive, whereas the Q2 last year was like negative. They have four, that's a$35 million shift just in the financing line. And part of that is they've been able to buy out nine aircrafts over the last, since 2025, they basically bought them off of lease. And that's much better longer term. So like, you know, I would just point to the things that are permanent.

13:23Like, so like, you know, assuming the ATL normalizes fine, they're still going to have cash balance. They're still going to have, they're still going to own 80 % of their fleet. Like two years ago, it was like, it was only 50 % of the fleet. And I feel like that, you know, those two, and the most important thing, though, is I think about this all the time. You're right. Like this screams, this thing is over earning, right? Like, how could you not be concerned that there's going to, it's going to mean revert and the stock's not going to work because it's just going to be very difficult. And I think that I would, I would point back to their last clean year, which was really sandwiched between COVID and the war on October 7th was 2023.

14:00And in 2023, like they were profitable, you know, after CapEx, after leases, after, you know, amortization of loans. So and they to the tune of like 100 to 200 million dollars in free cash flow. So I kind of look at it like that, like worst case scenario. You know, let's say they go back to that, like you're looking at a two billion dollar EV and normalize, you know, at least 150 to 200 million in free cash flow. So I feel like I'm willing to take that bet. But I think that's going to be low because they've added a lot of capacity. It's not clear how much capacity they've added because some of it is wet leases.

14:40So those wet leases are temporary leases that they have, but that's the minority of it. That's the minority of it. The majority of it is just they've added to their fleet. Perfect. Let's turn to evaluation a little bit more. So your write-up, again, the killer line, and people should go read the write-up. it's at the end. But the killer line you have is, hey, are the downside here is supported by they've got the 1.3 billion of net cash that we talked about. They own a lot of their planes and go look at plane prices, like owning planes. All these planes are in the money. You say, hey, they own a billion plus of planes and they've got an external valuation on their branded credit card program and loyalty program that's worth 700 million-ish.

15:19So that's 3.5 billion in kind of hard asset value versus an EV of, depending on how you treat the cash,$2 billion-ish, right? So you're buying it at a substantial discount. I want to talk about that in terms of, you also compare it to a bunch of airlines, JetBlue, United, Delta, all these guys which trade it like five to six times EBITDA, these guys are trading it too. So how do you think about the valuation there? And I'll come back with kind of a pushback on it. Yeah, I think, I mean, look, I'm a general list. I'm not an airline expert. The right way to probably do the valuation is to segment across percentage of the fleet that is owned.

15:59But I think directionally, the more planes you own in this environment, given how expensive leasing is, the higher your multiple should be. And the better the balance sheet. I mean, I just see a lot of things that indicate to me they should at least trade with the rest of the group and not at a discount. Now, obviously, there's a huge geopolitical risk factor. But as crazy as it sounds, they've proven that they can fly under all circumstances and they have an implicit backstop of the government. So when things got really intense, the government stepped in and basically said they would insure the planes when the private insurers would step out.

16:36So I don't want to overthink it, but I think they deserve at least a trade in line with the peers, which would be a really nice return from here. The question is obviously like on what multiple normalized earnings but like you know that's that's the guesswork you know like there's been permanent you know increase in their capacity and i think you know but like you know the big x factor now is like jet fuel you know so like that's kind of masking some of the um you know improvement in underlying earnings power but like i think once things normalize you're just going to see a business that's generating a lot more free cash low and it should it should trade you know in line with peers no and it's interesting because you know airlines one of the questions i have in my head is kind of like hey everybody every value investor you say airlines if you think warren buffett 1990 call 1-800 airlineaholic or whatever right but the interesting thing here is because it's in israeli like there are limited slots and it's got to me and you can correct me i'm wrong but it's got a lot of the new york city uh components to it where in airlines, and I remember this from the Spirit Jet Blue trial, like, yes, airlines are super, super competitive across the domestic board, but there's limited spots in New York City.

17:47And those are really valuable because those spots, because there's plain supply and a lot of demand coming in, those spots are hugely valuable, hugely profitable. I look at Israel and I think you could imagine a lot of the same with the Tel Aviv airport. There's limited spots, a lot of international demand. And guess what? everybody left. So these guys took, I think it's like 50 % of the spots in Tel Aviv. Again, you can correct me if I'm directly wrong, but yes, they're, they put on a lot of supply, but they took out a lot of the best supply and they own it. And there's no way out for anyone else to come unless they like build a new terminal or something.

18:21So you've kind of got a really interesting setup there. You can tell me if I'm misthinking about any piece of that. Yeah. I mean, that's the right way to look at, you know, I forgot the guy, he was the one who deregulated airlines under Carter. And he's like, airlines are like marginal cost with wings so you know when your marginal cost like leaves the market so then like it's obviously much better for pricing so like i i think delta and united like they want to come back like two years ago like they've been it's literally been on again off again for years and they're supposed to and they're supposed to like slowly come back in q4 and they will they will eventually come back like that's how you have to underwrite this that like there's going to be full competition someday, like full stop.

19:03Now, who knows how long this war goes on? Like, you know, who was I listening the other day that like, you know, every war that's been started, like the troops are gonna be home by Christmas. It's like the nature of these things that like they go on longer than people expect. So like we're six months into this Iran conflict, like, who knows, right? So I kind of look at it like, I would be long this, you know, just on normalized earnings, whatever those are, you know, and I think right now the setup is, you have a few more, at least two more quarters of like just gushing windfall profits that further kind of like buy down your enterprise value.

19:38And you're buying like the number one, you know, you're buying, everyone wants to own the number one in the market. Like this is the undisputed number one. It has like this great brand. And, you know, that, that kind of like got me over the hump to own an airline as much as like, you know, it's, I'll contact my buddy Warren and have and get you a membership in the anonymous thing. Maybe he'll be your sponsor, who knows. Let me go to, you mentioned the profits, right? So they're kind of making windfall profits right now because wartime, everybody else leaves, they get the slots. I think people might look at the windfall profits in two ways.

20:13One, they were, the state of Israel obviously has a lot of say here, right? They were kind of required to run. And I believe part of their operating agreement says the state of Israel can require them to run in extreme emergencies and can require them to staff no matter what. So I think there's two sides to that. One, people worry, hey, these guys are going to be required to run uneconomically on the downside. And then the counter is, and you can tell me if I'm wrong, but I was familiar with the golden chair. So I was just kind of Googling around while I was prepping for this podcast. The golden chair is Israel owns a piece of some like kind of state-ish companies that gives them blocking rights over mergers and stuff.

20:51And as I was going around, I saw, hey, they got hit with a competition authority fine for$40 million for excessive and unfair pricing from October, 2023 to May, 2024. And that makes me worry, Hey, are you going to have the worst of both worlds, right? If there's no demand because of war or something, you're going to be required to fly. But if you, there's tons of demands and everybody's coming out and you try to kind of increase your pricing to wartime, wartime pricing, they're going to hit you with, they're going to with fine. So on the downside, you have to have all the capacity operating and on the upside, you get fine for the super normal profit.

21:25So how would you kind of think about the, that's just general state of Israel risk, I suppose, but it's also like regulation risk, all of that type of stuff. Yeah, you have to get comfortable with it. Like, I think first of all, it's kind of, it's scary to like invest in a foreign country. Just, it's just like, you know, there's a different currency and a different government. I think Israel is relatively, you know, capitalistic, insane. And I think that backdrop to go back to COVID, the fact that they did not bail out the airline, like anything's possible because it's the government, but like there is, there is like a recognition and understanding that like they stepped into the lurch and bailed this thing out when they were like losing, you know, tens of millions of dollars on a monthly basis.

22:07Like no one knew this was in the depths of COVID. So I think they, My take on it is they respect the property rights. Yes, of course, Elal is beholden to the government. And that's actually what happened in April this year. They had to fly flights at very reduced capacity because of restrictions from the government just for safety reasons. And of course, Elal did it. But that's like, you know, that's just the nature of the that's the position they're in. One other quirk that I think is important is that one of the things that differentiates, you know, the big question with airlines is like they're all flying the same planes.

22:47Right. They all buy this like what you know, they're all using the same airport. So you're right. Like the slots are important. But even like once, you know, they all assume they already have the same slots. Like how do you actually differentiate yourself? So, of course, there's some things here and there, bells and whistles in the cabin. But Elal has the leading security. There's no one else that does security like Elal does for obvious reasons. And so part of the way the security works is that the government mandates that they have this super security. It's very expensive. They have people in local markets and also in foreign markets that interrogate passengers.

23:24They'll ask you random trivia about the Hebrew Bible. They just try to mess with you to make sure you're not a terrorist. So that costs a lot of money and the government imposes that upon a law. So like this was probably missed, but, you know, last year they renegotiated that cost sharing agreement and the government, you know, like they basically share the cost for that extra security. The point is, it's more collaborative. It's like a partnership, like the government appreciates what they do. And they provide they stepped in and they provided a lot of capacity when everyone left the market. so i'm not concerned about you know that risk that the government's going to try to i mean look you see this there was there was a lawsuit and like it's it's 40 million dollars it's not nothing um but it's not like a kangaroo court thing where like they can't have their day in court it's like a pretty western capitalistic you know where they're you know you're going to be able to defend yourself and um honestly i'm just laughing because i'm having trouble i i went to catholic high school but i'm having trouble imagining like if i got pulled out and they're like hey man tell me about the hebrew bible i'm just uh i i might i might not be able to apply because they might suspend me of terrorism like i don't know man let me go a little bit more on valuation so you know you list uh several peers i think ryanair is kind of your only international peer in your deck in your write-up you've got united delta jet blue i should have put whiz in probably whiz would have been better because like whiz is like a low-cost carrier but like they're kind of like a basket case so like um they're not making money and but that actually was i i left because they do play in the teleview market or they used to well the one the one i was thinking of was uh jet two over in london which is a favorite of a lot of value investors as well right but that trades really cheaply and it does have some of the i mean it's completed it is completely different right they have an airline but that is more known for uh package bookings and that sort of stuff But it gets a lot of float.

25:23And that company, they own a lot of their airplanes. I actually pitched to a friend, we should go activist on them and force them to wrap up the wrap up the whole business and just sell the aircraft because they were trading so far below the value of the aircraft they own. But, you know, that company trades really cheaply. So, you know, you've got this company, you've got them trading at 2x EBITDA versus United Airlines at 6x. And I guess my question would be, hey, is a largely domestic US player, scaled US player that gets a lot of profits from the loyalty program and the credit card points, which I know LL does as well.

25:56But I mean, that pales in comparison to the might of the US consumer. Is that really the right comp? Because if I went to kind of the second tier of airlines, I think you'd find a lot of them are trading kind of around this pricing. Yeah, I mean, I hear that pushback. I think I just go back to like what I said previously that there's just a lot of characteristics in this setup that like speaks to the quality of the asset and the durability, the opportunity, and the niche that they play in. So that's unique to them. um but yeah i don't i haven't studied those other airlines so like i completely okay completely okay and look at some point 2x ebda is 2x ebda but let me focus on the ebda number because i i think this is a more interesting question and this is one that jumped out to me so ebda obviously dna is the back depreciation amortization i've done a lot on aircraft and aircraft lessers and like you know the most important things for aircraft for airlines aircraft lessers everything is getting the plane going right the the less time you can have on the ground the more time you can have up in the air because the plane is your big expense and that depreciation is massive on the plane.

27:08LL follows Jewish holidays, right? So they don't fly on the Sabbath and they don't fly on major holidays. So that's roughly what 12 to 15 % of the year that they're kind of not flying on. If I'm doing one divided by seven plus on holidays, correct in my head. Yeah. I think that applies in two ways, right? When they're buying aircraft and they go and they buy a new Boeing airline. Boeing's going to sell to the high better for the most part. LL is competing against Thai airlines or Jet Tour, who's going to run it 24-7, basically. LL is going to run it kind of in that math, 26 or something. So they're paying 24-7 pricing for something they're going to run 26.

27:51So my first question would be, how can they make that economics work? And then my second question is, if we're valuing it on EBITDA, but 15 % of the time they have an unproductive asset, should we actually be haircutting them for that 15 % of time the assets are on the ground? Yeah, it's a great question. So, and I think this is like interesting. I think this speaks to what's happened that they've, they've, they already had like a large percentage of their planes that were owned. And then like, like I said, since 2025, they've, they've bought back nine planes. So whatever, you know, like they don't share the exact, you know, what they're underwriting to, but like, it seems very clear that leasing is not the optimal, you know, for, it could be for the reasons that you've talked about.

28:35I just think in general, like leasing has gotten much more expensive. Your total cost of ownership when you lease a plane, like you have to return the lead, the plane in a certain condition, right? You have to like, redo the engines and everything. Like you wouldn't do that if you were, you know, you would probably, whatever it is, you know, assuming it's safe, you would push out that scheduled maintenance. So I think that, you know, they're, they're probably responding. That's part of the reality is like why they're like buying their planes off lease. And I think that again, like that's of course true.

29:06You could cut, you could cut the EBITDA by 15%, but then I would just like, let's look at the last normal year. Like they were, they were doing fine. You know, like this, this business has been, you know, six years ago, it seems so long ago, but like let's the post-COVID, it's hard to talk about pre-COVID because it was just a different business. It's new ownership, different balance sheet, everything. But if you take it as it is, I can't envision a scenario where these guys wouldn't be profitable in their market. No. And look, it cuts both ways too, right? Because A, I would guess Israelis pay a premium for their travel because the airlines have to depreciate it over six days instead of seven days effectively.

29:50Right. And that creates, it does create a, a kind of unique moat around the business, especially operating inter inside the country, because if Delta wants to expand, well, all their systems are designed for, Hey, we run this for seven days a week. You know, when we're looking at airplanes, we can put it here for six days a week, or we can go fly it from, you know, Tampa to San Diego seven days a week. So I do think it creates unique, a unique market that might have some moat and some competitive advantage. It is just, you know, the DNA line, I do worry, would I rather$1 of EBITDA from these guys or$1 of EBITDA from Jet2, where the depreciation is kind of going to be 15 % lower at Jet2 just because they run at 7%, 15 % more.

30:35It's an interesting question that kind of jumped out to me. And it's one I haven't really had to think about before because across most businesses I look at, they all operate on the same hours and this doesn't so that's yeah it's a very it's a very unique setup yeah uh let's see let's see if there's anything else i think we've gone through most of my questions on jet on uh ll actually anything else we should be talking about ll or do you want to do a quick update on stride um no that's that's good cool let's talk about stride so we you came on at the beginning of this year and was it the beginning of this year i can't even remember at this point or was it ended last year one of the beginning january yeah but we did it did a really interesting podcast again i got taught it might have been the podcast not the podcast i got the most feedback on there there are some uh fiery ones out there but it was the podcast i got a lot of probably the most professional imbalance from deep concentrated value investors who were interested you know it's company trading at now you guys can't help themselves with 10 times earnings yeah well it's not just 10 times earnings 10 times earnings growing quickly tailwinds modi very capex light like it has session resistant yeah it has a lot of um yeah uh so there has been a lot that's happened over the past seven to eight months since then new ceo earnings a outage uh the stock price is like reasonably flat since then so i'd love to just toss it over to you and just do a quick update on stride if that makes sense to you yeah so the big news that you're you know talking about is the ceo kind of left abruptly um there wasn't a lot of, and then they reported their, you know, they pre-announced their Q4, their fiscal year ends in June because they want Q4 to, excuse me, their Q1 to line up with the school year.

32:21They get their count date, which is their enrollments. So they want that to line up with their fiscal first quarter. And then that basically predicts, it's a very like, you know, they have a lot of, they can see the, basically you can see the revenue for the rest of the year because it's, you The students at the beginning of the school year, they model some attrition and they gain some. So basically what happened is the CEO left right before. His name is James Rue. He'd been the CEO for five or six years. He'd been in the company for 13 years. Under his watch, he had grown EPS from less than a dollar a share to, I think they did over$8 this year.

33:01So pretty fantastic results. And that's obviously there was a huge COVID bump in the middle of that. But like, you know, they've totally grown through the COVID cohorts and kind of proven to the market that, you know, this is sustainable and like this is like the new level for for their market. it so you know so but the stock you know sold out violently um when the ceo left i think the market was concerned that you know he got fired um we don't know really what happened because this upcoming school year is going to be a bust and that you know how could you not think that like it's hard to imagine the guy getting fired if he was like killing it i i think you're understand that i i saw this ak and i was like oh my god i think i told you i mean they fire him on fire change whatever it is july 30th he departed you know like yeah whatever it is july 30th and then the the new ceo who is i think 71 steps in steps in and yes they grew prelim guidance when they uh hired the new ceo but you know earnings were scheduled for august 4th and i was like oh i've seen this movie before you put in the new ceo prelim guidance and then the earnings like three days later, two days, whatever it is, you come out and say, Oh, next year is going to be tough.

34:20It's all, it's all the prior guy though. You know, I'm here to clean things up. Blame the prior guy. I was only a little independent board member here. Yeah. So look, so I would point to a few things. So, you know, like there's always, there's one thing that, you know, I like investors that like, kind of like distill their thesis. There's like, what's the one thing that's really going to move the stock, you know, like what's that fulcrum question. So it's enrollments in the fall. So again, like their first quarter to September quarter, they're going to report enrollments, usually do it three to four weeks, you know, let's talk late October.

34:52So that's going to be the print that's going to like send the stock up 20 points or down 20 points. And the question is like, are they going to be able to grow this year? That's really like all that matters. People, this, you know, when I invested, that was kind of the thesis here is that this is a secular grower and expanding marketplace, generates a lot of cash flow. And like, you know, they're the market leader. And it seems like the penetration, you know, you're talking, you know, I mean, some of your viewers might not, they do virtual public schools. So like, it's really under penetrated, only one to 2 % of students do full time tuition free, you know, stay at home school, you know, it's only in 30 states.

35:33And it just seems like this business could be like much bigger 10 years from now. And so really the question is like, you know, the street is taking down their numbers. I think they have them growing like revenue by like, you know, two and a half percent next year and like, you know, probably barely growing enrollments. And so let's just talk about why, like, you know, questions are going to take the over or the under on enrollment. So like, I'm still very bullish on it. And like, I'm just triangulating around a few data points. And you can tell me, you know, what you think. Number one, I think that the CEO, the whole thing, like, you know, this is all reading tea leaves, but like the last year, in spite of the fact that he had a good multi-year run, the last year was like kind of a disaster.

36:16They implemented a new LMS learning management system, which is like the piece of software that they use for like curriculum and students and parents. It's like brings everyone together. And they upgraded to an off the shelf provider called Canvas, which is like the best LMS in North America. But they told it was a disaster, like most ERP launches are. And so they they they missed their guidance last year. So that was number one. And that was under his watch. Number two, they lost a school in Texas, a 6000 student school, which is like pretty significant on a base of like call it 240 ,000 students.

36:55This is this is Lone Star Academy, and it is the first question on the most recent earnings call for those who are kind of doing. Correct. So like and again, I've been following this company for years and that was an underperforming school. Every year, you know, it's like a portfolio they have, even though they're only in 30 states, they have close to 100 schools. Part of the business model is that like every single state has multiple schools precisely for this reason, because if you lose one school for whatever reason, lose its accreditation. so then you can like you can you know re-enroll those those students in another school so that happened under James's watch so there's like two big kind of like checks against him during the year that would have been plausible for the board to say you know enough is enough um in spite of the fact that like maybe like things weren't falling off a cliff but again we're only going to know when they when they um report so that's number one so number two I think it's important And the one publicly traded competitor, Pearson, came out, you know, the week before they had, you know, they have a division.

37:58This is, you know, they're a holding company that owns a lot of different assets. But like the division that does virtual public schools, like they were just like ebullient, like things are just rocking. You know, demand is very, very strong. You could say maybe they're taking share from Stride, like hard to know. but that's um if i could jump there you know i when i read the q4 earnings call with the new c the it's the new cfo who says it but he says funding environment looks favorable application volumes uh strongest application volumes maybe slightly behind last year but still strong encouraged by conversion rates like it doesn't sound maybe i'm wrong maybe they're lying to me maybe they're putting a great face but it doesn't sound like something that's about to go negative or have the rug pulled out from you or anything.

38:41Yeah, I would agree. There's a lot of breadcrumbs here. And like, then there's like a whole like, just like you have to understand like optically, like mathematically, like, so they basically started the year, they're gonna, the end of the year with less students than they started. And that sounds really bad. And that was a self-inflicted because they were having issues with their LMS. They intentionally throttled back something that's called in-year enrollment. So basically what that means is that when they report next year, they're reporting off a lower base than previously. Usually they add students in the middle of the year.

39:22But that doesn't speak – what matters is the underlying dynamics of the market and are they healthy or not healthy. And so I feel strongly that the market is healthy. Just actually, sorry, to go back to the LSOA, that's the school in Texas that they lost. I'm very, very confident that they're going to be able to enroll a large percentage of those students in the other schools that they have in Texas. That's what happened in New Mexico, right? Correct. Yeah, it happened the previous year. Again, this happens every year. But part of the uncertainty going into the CEO leaving was this was the only school in Texas that had K through two.

40:04It's relatively unique. That's like a smaller niche within the market. And so there was no other K through two school. So they have a private school that they were going to like give to, they were basically going to give those students and those grades free education. They were able to, you know, get a permission from the Texas regulator to open up K-2 in Texas. So I just think that speaks to like my, you know, I think that's more likely than not that they're going to be able to retain those students. But again, there's a lot of smoke here. So I totally understand why the market would be skittish in that context.

40:42If I can follow up on three different points. I mean, the first on the CEO change, I mean, I'm sure you did tons of expert calls. I liked our podcast so much. I did a few expert calls. And a lot of the expert, a lot of the formers I talked to were not big fans of the old CEO to put it something. And I know some people who kind of viewed him as a blocking factor. So, you know, when I saw the change, I was like, oh, I don't, the timing was not great, but I didn't know if it was a, as big a negative as people thought, like I thought it actually might be positive. And just related to that, I will note the new CEO's contract.

41:16I mean, he's a 70 year old stepping into a tech business and his contract is very much like, it spends a lot of time on what happens if this business gets sold. So I thought all of that was very interesting. I'll pause there and add two other things I wanted to say. He's also an impressive guy. If you look at his resume, like he's been on a lot of company boards. It sounds like he understands like, you know, share buyback math. And most importantly, like he did, he did work in the education industry. Like James did not. And like, I feel like in order to take this business to its next level, like you need someone that has like, you know, credibility within it.

41:46And that's, so, I mean, I, it sounds ridiculous, but I could have seen the stock being up on the news, But like, you know, there's just so much uncertainty given the fact pattern going into it that like the market just like forget about this. The feedback on the old CEO, the thing I heard across the board was I believe he was the CFO before he became CEO. Right. Yeah. It was a CFO running a business where relationships and education mattered. And I think the financial results were really impressive. But I think there were a lot of people who worried about the about that combo. But the other thing I want to talk about, we did the podcast in January.

42:21I'll trust your memory. That was right at the start of the real SaaS sell-off, right? From mid-January to mid-March, if you had bought SaaS in mid-January through mid-March, I mean, you were just covered in blood. And Learn is not SaaS per se, but it's not immune. And I think, you know, as the SaaS apocalypse happened, a lot of the, my worries on this and a lot of people are talking to you, their worries were AI, right? And I think there was a pushback, hey, these guys are going to be better than public schools at adopting AI. But I think there was another push that was you don't need to compete with the public schools.

42:54You kind of need to compete with just online and AI spreading in general as lots of competitors start out. I mention this because now we're in July. I think some of those AI fears have maybe subsided. And I would also mention I saw Alpha School came up time and time again. And people were saying, look how great their results are. I think they've had poor results when they've tried to take their private charter school model to public schools. So I threw a lot out there, but I'd love to just get your update on AI as it relates to Stride. Yeah, I mean, there's also like, you know, like this was like, it's this is back in July.

43:29Like Anthropoc came out with like an offering for K through 12 for teachers. It wasn't even like a school, just like a way to kind of like help teachers with their curriculum. Like stock was down like five or ten points on that. so like the market is clearly thinking that way how could it not um but i think that i would just say anyone that's concerned about you know ai like taking over this business like they haven't done enough work in terms of like how like messy and complicated this is like there's just like this is literally like the soup to nuts the entire you know they're basically taking a brick and mortar school.

44:09And the only difference is that it's online. So that means there's teachers, you know, there's, there's actually physical textbooks that, you know, like they're distributing textbooks and, you know, laptops to all the kids. And then there's, you have to be credentialed, right? Like this is taxpayer funded, you know? So like whenever you're, you know, just like go down the list of all the different, and there's like tons of different stakeholders. There's, there's, there's parents, students, teachers unions, you know, like there's just a lot going on. So like, anyone that just comes in and says like you know casually like ai is going to blow this up like there's no way like it more likely is that like you know one of the biggest line items which is is curriculum because like the curriculum has to be like customized based upon the state and even the district and then there's like 12 there's 12 different grades like there's not just like one sku they're selling like tons of and then one of the biggest things people appreciate is like Like, you know, if you're going to take taxpayer money, you have to have – you have to be open to everyone.

45:10So, like, students with disabilities and kids that have, like, individual learning plans because they have some type of learning disability. Like, you have to cater to all their needs and provide for them. So, you know, like, just spend a couple hours, like, you know, going on the chat groups for parents and stuff, and, like, you'll quickly realize that, like, there's no way that, like, someone's going to just let, you know, a piece of, like, AI software come in and, like, run this thing. No, and I can't claim to be the world's foremost expert, but this is, you know, in the few tweets and stuff I saw written, this is what people were saying about AlphaSchool.

45:43And, you know, maybe I feel silly for being worried, but they're like, yes, AlphaSchool, when you're only recruiting and you can screen out for gifted students, so all your students are gifted, and all of their parents can pay$50 ,000 a year for private school, it turns out your results are pretty damn good with AI. But when you're like, you know, and we talked in the first podcast how a lot of these, a lot of students who come to Stride are dealing with much bigger issues. You know, they're coming from public schools. They might have troubled backgrounds. They might be moving around a lot. Like, yeah, the Stride model, the Alpha School model might work great for people who have every advantage of the world.

46:18But public school needs to serve everyone. And Stride is operating in a very difficult environment and putting out pretty, as we discussed, pretty good stats for all that. Cool. Anything else we should be updating on Stride? anything? Yeah, I just think, you know, people think about the investment, you just have to, you know, abstract and think like, you're really being long school choice here. And, you know, it's, we're not getting rid of like compulsory case with 12 education. There's like very substantial economies of scale, like when you are able to, it's like any technology business, you know, like there are, there's a lot of, that's, that's what James was able to do.

46:52That's why the stock, like, you know, it was like up over 10x, like under his watch, which is like really impressive, because they were able to like invest more than a competition and they're also able to like show like some pretty significant operating leverage and you know i think that you know if you look at from on the demand side of it from you know parents and students are just like there's a huge population of people that like they're not not just they like that like the people that use it like they're desperate for this because like they just don't fit into the regular school system so like when you have that dynamic where like people like you know create they really want your product and they need your product they're willing to like go to bat for you especially if there's like you know in a state legislature i think that the political risk has actually been dramatically reduced like post-covid like people's this used to be like a nice have now it's a must-have because like there's another pandemic so like that's kind of like a sea change in and so like i think eventually you know maybe this is going to be a year where who knows what happens you know they were they were conservative on the call why not you know like I would have been conservative coming out of the gate.

47:56Oh, I mean, again, this is one of the reasons they didn't give 20. And you worry, they get the new guy in and he's just going to come and throw everyone under the bus and say, hey, we're slashing everything. We've got no visibility. But I mean, yes, you would have liked if they said revenue is going to be up 30 percent. We're going to enroll to help the students and everything's going to the moon. But they were pretty positive on the call. Things considered. worst case i was just thinking the um so canvas is like their lms and like that was the cause of the big sell-off the stock was down like 60 on the canvas implementation turns out like um canvas is owned by a company called instructure which is owned by kkr so like in the worst worst case like you know like this thing is you know they have a you know a reset year like i can't imagine like they know this asset they probably could figure out like that that was my last question actually would you be surprised if this was a public company in 18 to 24 months i don't know i'm not i'm not playing you know like i i never like try to make that part of i i don't know like i feel like i don't know how to handicap that but i think it is interesting that you know what you know they could insource the cost of the lms and like they probably see what's going on, like, you know, better than anyone else and see that ultimately, like, you know, if the demand is there and they continue growing, this is a great business, you know, and it's going to be around for a long time.

49:19I think this is a, I think this is much more likely than your public, than your average public company to get taken out both just the, the nature of this business and the recent CEO change, but you know, much more likely than your public company. Does that mean 5%, 10%, 75 %? I take the under 75%, but I probably take it over around 5%, but that's a long, long range. This has been great. I enjoyed it. Again, I'm going to include a link to the LL write-up so people can see the full write-up there. And you've got to read through to the conclusion because that conclusion paragraph is just such a banger there.

49:50And we'll have to have you on for a third podcast in the near future. All right. Good stuff, Andrew. Thank you. Bye. A quick disclaimer. Nothing on this podcast should be considered investment advice. Guests or the hosts may have positions in any of the stocks mentioned during this podcast. Please do your own work and consult a financial advisor.

50:35Adam Buckstein: Paid membership with connected payment account required. See Experian.com for details. Thanks.