Investing in Horizon Kinetics through the back door with FRMO

Most investors who travel through the pink sheets have stumbled upon FRMO Corp (FRMO) at some point.  The response is always the same, first disbelief that a company could grow book value at 76% a year for almost a decade, and secondly the thought "what the heck do they even do?"  To understand FRMO we need to understand Horizon Kinetics first.

Horizon Kinetics is a boutique investment firm that runs a number of mutual funds, aptly named the Kinetics Funds.  They provide institutional strategies, investment advisory, and boutique research.  Many value investors will be familiar with the Horizon Kinetics quarterly market commentary.  Two of the firms founders are Murray Stahl, and Steven Bregman.  Horizon Kinetics is a relatively recent combination with the company being formed in 2011.  The company is a merger of the prior companies: Horizon Asset Management, Kinetics Advisors, and Kinetics Asset Management.  Lastly Horizon Kinetics has approximately $7b in assets under management.

So what does Horizon Kinetics have to do with FRMO?  FRMO is also run by Murray Stahl, and Steven Bregman, and FRMO owns a portion of Horizon Kinetics.  In essence an ownership stake in FRMO gives an investor an ownership stake in Horizon Kinetics too.  And currently this is the only way to own a piece of the investment boutique.  If the story were that simple I probably wouldn't have done a post, there's a lot more to FRMO then a simple ownership stake in Horizon Kinetics.

FRMO started off as a strange structure, the company was a shell that owned intellectual property rights to funds and strategies that Horizon Kinetics employed at the advisory and in the funds.  As the funds and strategies did well FRMO received royalty income streams.  The Horizon Kinetics products were very successful, and FRMO's share of the revenue streams grew increasingly valuable.  At the end of 2002 FRMO had $185,745 in shareholders equity.  As of the most recent filing the company's shareholder equity is $55,938,847.  Just sit and think about that for a few minutes, in the last decade shareholder equity grew from less than $200k to almost $56m.  This clearly shows how valuable the ideas that Stahl and Bregman sold to Horizon Kinetics were.

FRMO isn't a net-net, or a deep value asset/earnings discount stock, it isn't really like much else actually.  Even without a deep value label FRMO is clearly an oddball stock.  The company is nothing more than a pile of assets, and a lot of raw brain power.  The company has no liabilities outside token amounts of accounts and taxes payable.  They employ no one, pay no salaries, and don't operate like any standard business.  Yet without employees the company continues to grow, which is a great example of how easily capital scales and grows once it reaches a critical mass.

The first question I had, and by extension a few readers will have, is if they've grown at such an incredible pace why are they trading on the pink sheets, and completely unknown?  The company ran into some problems a few years back with their unconsolidated holding.  The SEC wouldn't let them file without presenting audited statements for the holding because the holding size was above a certain ownership threshold.  The problem for FRMO was that they didn't have access to those statements, and as a result couldn't satisfy the SEC's requirements.  With the inability to file timely statements with the SEC they were forced off the exchange and into the pink sheets.   After the merger that resulted in Horizon Kinetics the FRMO shrunk as it became a holding in a much bigger company.  The holding size is now below the threshold that requires audited statements for unconsolidated holdings.  The company is working on getting a clean bill of audited financials for a few years so they can re-list.

I want to pause here and say that if you get nothing out of this post I hope you will at least head over to the FRMO website and read the annual shareholder letters, as well as spend some time in the research section.  Murray Stahl has published a lot of papers explaining some of his investment ideas, and his investment strategy.  One thing I share in common with Stahl is my preference for owner-operator companies.  Out of the 50 or so holdings I have 22 are owner-operator companies.  The research and shareholder letters contain some truly unique investment thinking, something rare in the markets these days.

Based on the description above FRMO might seem like a complicated story stock.  The type where if you don't read three hours of message board history you'll never quite "get it".  Or the type of stock that has a book written about it (JG Boswell).  FRMO isn't a story stock, they have a small amount of history, but they're very easy to understand.  Beyond that their valuation is actually very simple and straightforward.

The company has a $55.9m book value against a market value of $76.32m.  The company's assets consist entirely of cash and marketable securities.  From these securities, and from the residual revenue streams the company generated $3.2m in net income last year, and $1.05m this latest quarter.  The company derives roughly 25% of their revenue from consultancy and advisory fees, 50% from dividends and interest, and another 25% from investment partnerships.  The company's expenses are artificially high because they are required to accrue salary expenses even though there are no salaries paid out.

If we take the market value and subtract out the liquid assets we're left with $14.42m as the value the market is assigning to Stahl and Bregman's brain power, and investment acumen. It might seem like there's no way to value this brain power, but I would suggest there is.  These two men grew FRMO from under $200k to $55m, and Horizon Kinetics from a firm with zero AUM to $7b AUM.  The way I view this is that the two men running FRMO have been extremely successful twice in the past, and their plans for the future are similar to what they've done in the past.

One objection a lot of investors have with cash boxes, which FRMO roughly qualifies is that management might do something stupid with the cash.  For most net-nets and lower quality businesses this is certainly true.  The opposite is true in FRMO's case, the cash and securities are entrusted to two capable investment managers.  You can get an understanding of Stahl and Bregman's investment philosophy through the Horizon Kinetics quarterly letters, and the FRMO research page.  After reading through both of these, I'm happy to essentially let Stahl and Bregman manage a small portion of my portfolio.

One last thing I want to touch on is what FRMO might have in their future.  This was probably the murkiest topic for investors, the company gave little to no visibility into the founder's plans.  This has changed recently, FRMO held their first public annual meeting, and has started to hold quarterly phone calls.  I can attest that they'll even take questions from individual investors, I had a chance to ask a question on the last call.  There were two things mentioned on the call that I found very fascinating, the first was the mention that FRMO would consider an acquisition if it met strict criteria.  Given Stahl and Bregman's track records I don't have much concern they'd overpay.  The second item mentioned is that FRMO has been exchanging their revenue streams with Horizon Kinetics for shares in Horizon Kinetics.  There was even a brief mention of the possibility that at some point FRMO and Horizon Kinetics could merge somehow, although there are some legal and tax complications to that.

FRMO isn't an asset investment, or an earnings investment, or maybe even a value investment, it's a bet on the jockey investment.  At current prices it seems the market, is underpricing Murray Stahl and Steven Bregman's ability to turn pennies into Franklins (for non-US investors $100 bills).  Be forewarned, there are not many sellers of this stock, most people buying want to hold for the long term, so getting shares can be difficult.

Talk to Nate about FRMO

Disclosure: Long FRMO

30 comments:

  1. Quick question, how come it isnt net-net? Balance sheet full of securities and cash and only minor liabilities (5M)

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    1. A net-net is a stock where the marketcap is greater than the value of current assets minus all liabilities. FRMO's marketcap is greater than NCAV, and book value.

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  2. Is the revenue coming from the entities that are recorded as investments on the balance sheet? i.e. if they liquidated their investments, would there be any revenue left? (just making sure we're not double counting by including the investments AND a multiple on the rev/earnings).

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    1. Partially, I mention the breakdown above, some of the earnings are from investment income, some are from intellectual property licensing.

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  3. How much are revenues going to get hit from the swap of payments (not sure which payments) for a greater share in Horizon Kinetics?

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    1. This is the big question mark, we don't really know. The revenues were set to expire so in theory this is a good swap, but doubtful its a one for one.

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  4. Hi Nate, I have been enjoying your blog for a couple of months now. Keep up the good work.

    What happened in 2008 that sent it's stock price plummeting down from $16/share to < $1/share? The SEC filings skip that period and so do the shareholder letters. Do you have any information on that? Do you have confidence that it will not happen again?

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    1. I don't really know what caused the runup, or the plumet, investor mentality or psychology or something. I don't have any special insight into the future, but if this suddenly ran up to $16 I can confidently say I'd be a seller. That would be about a nine-bagger from my puchase price, I'd be happy with that for sure.

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  5. Dang it - I guess the secret is out.

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    1. I think someone has the same thought for most stocks I post about.

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  6. Appreciate the blog and your perspective.

    Could be something but if book value has compounded at such a quick pace, why is that not reflected in the stock price? What is your rough estimate of book value?

    This is a fascinating idea and thanks again for bringing it to the attention of your readers.

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    1. Good question, if you look this traded at an absurd multiple to book value a few years ago, that value has contracted. I guess you could say investors overpaid back then, and maybe being burned now feel like it's not worth as much.

      Book value is $1.43 a share or so, it's $58m (shareholder equity) divided by 39m shares outstanding. I say rough because I rounded heavily.

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    2. Thanks Nate. Much appreciated.

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  7. FMRO paid $3 a share to the shareholders that got cashed out in the reverse split (about a year ago). That would seem to indicate that $2.00 is a pretty attractive price right now.

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    1. I think the $3 says a little bit about where Murray and Steven think this should be as well. Shareholders have asked a few times what they think FRMO is worth, and they're very coy, but they have indicated they are not selling, and think this is attractive here.

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  8. Any concerns re managers not being able to provide audited financial statement back when they were applying for listing. We re they trying to save cost? We re they just not able to get it completed for some technical reason? Were they trying to hide something(I don t think you think this, but possible?)?

    Interesting idea. Thanks for posting

    Plan on reading shareholder letters.

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    1. This is covered in the shareholder letters. In short a new accounting rule came out that required holdings over a certain percentage publish up audited financials. The interest in Kinetics Advisors at the time was above the threshold, and they were a private company whose accounting was on a cash basis not GAAP, so they couldn't provide the financials. The SEC required them to delist. The merger with Kinetics and Horizon solves this problem, the holding is below a threshold now, and they're working on getting relisted. So yes, a technical reason.

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  9. Do you know how much exactly FRMO owns kinetics?

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    1. It was .86%, but as of the last quarter I believe it's closer to 1% now.

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  10. Thanks Nate.

    Other thing that I was wondering about was why this company exists? i.e why is it not private?

    The only thing I can think of is that Stahl & Bregman would like a public record of their work.

    Having read the shareholder letters, and some other articles I like the way these guys think.

    Regarding valuation, tell me if I am on the right track:

    Valuation= net assets of ~ $55.9 million + 10 x pre tax net income (advisory fees, partnership investment) or (10 x 50% x $4.6 million)

    =~$78 million for ~ 39 million shares
    =~ $2 per share

    A fair price for excellent business /run by excellent managers who own 1/3 of the company

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    1. I can agree with that for sure. This isn't a slam dunk bargain, but for excellent managers I think paying this price is fair for sure.

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  11. Anyone who'd like to read about indexation and FRMO's ideas about that, read the Annual meeting of shareholders transcript from research center

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  12. There is also a great deal of information about what FRMO does, what are its goals and interests etc. all that is majorly covered in transcript

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  13. How do you find the recent gain and announcements, stock purchases and, have you considered selling ?

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    1. I have thought about selling, I haven't yet. The gain has been substantial, I'm up 70+% since my initial purchase a year ago.

      I'm encouraged by the announcements, I think FRMO is slowly becoming Horizon Kinetics. I also think they're looking to re-list which would be positive for the stock. For now I'm just being patient.

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  14. Same here. share purchases etc have been interesting and I have tought why they arent listed?

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    1. They had an issue with the SEC. They owned a portion of a fund that couldn't disclosure their financials on a basis that the SEC wanted. The SEC forced them to delist. They intend to re-list, there is a period, three years I believe from the time of delisting before a company is eligible for re-listing. Once the company received a clean audit they changed their fiscal year so re-listing would happen quicker.

      If you read the old shareholder letters on their site Stahl and Bregman explain the issue in detail. It's really a semantics issue that forced them onto the pinks.

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  15. Do you still own FRMO ?

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    1. would you purchase at current prices. growth record notwithstanding, it seems pretty expensive.

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