Why this time won’t be so different

From its record high of 29,551 on February 12, 2020 to the March 16^th, 2020 low, the Dow Jones Industrial Average lost 9,632 points, or 31.7%. This precipitous decline, according to CNBC, was 7x faster than any previous bear market decline.  The last decade of relative tranquility in the stock market has made this sudden shock seem even more severe. Thankfully market declines of this magnitude are highly unusual.  However, market corrections, which are defined as a 10% drop in value from the previous high, have occurred 37 times since the beginning of 1950, according to the Motley Fool. This works out to a correction approximately every 1.89 years, making downward moves in the marketplace a bit more commonplace than you might have imagined.

It is important to remember that each one of these corrections (37 out of 37) have been eliminated by a new bull market. Sometimes it takes just weeks to put a market correction in the rear-view mirror, whereas it can take multiple years for steeper corrections. Regardless of the time frame, the story has always been the same: the U.S. stock market has increased in value over the long-term.  While past performance is no guarantee of future success, we see no reason why this time will be any different.

Nobody likes bear markets; however, they are an integral part of the investment process as they give you the opportunity to purchase great businesses at bargain basement prices enabling you to experience future outsized returns. Each time you experience a bear market it feels like “things will never improve” and “this is the worst one ever,” and the one we are currently experiencing is certainly no exception.  The current situation has been particularly painful as we are contending not only with significant economic pain but unspeakable human tragedy as well.

Despite the scary headlines, we have reason for optimism (provided you are patient). As value investors we are always on the lookout for bargains.  Currently many of the companies we follow are selling significantly below what an acquirer would pay for the entire company.  According to JP Morgan, small cap value shares currently sell at an average P/E ratio of 11.3x versus their 20-year average of 16.3x. This is in stark contrast to small cap growth shares which are selling for 38.7x earnings versus their historical average of 29.6x. Mid cap value and large cap value shares are also selling significantly below their 20-year average valuation. The current bear market has given you the opportunity to buy great companies, with both solid balance sheets and growth prospects at bargain basement prices.

Corporate insiders are buying stock in their own companies at a pace not seen in years, a sign they are betting on a rebound after a Coronavirus-induced rout. More than 2,800 executives have purchased $1.19 billion in company stock since the beginning of March. That’s the third highest level on both an individual and dollar basis since 1988, according to the Washington Service, which provides data analytics about trading activity by insiders. Corporate insiders can sell stock in their company for many reasons (to diversify their holdings, to make a major purchase such as a new home, or they simply believe their stock is overvalued). However, there is only one reason why they will purchase their own stock personally: they think it is undervalued. Corporate insiders by the nature of their jobs have access to more information than outside investors regarding the prospects for their company, so the fact that they are purchasing shares personally is quite bullish.

We are seeing opportunities to buy the proverbial dollar for fifty cents in many of the companies we follow. Below I highlight the investment thesis for some stocks we find to be particularly attractive.

Liberty Braves Group (ticker: BATR K/A)

• The Liberty Braves Group is a tracking stock that represents Liberty’s ownership of the Atlanta Braves Major League Baseball franchise and a real estate development business surrounding the team’s ballpark in Atlanta, Georgia.
• The Braves are the epitome of a trophy asset that is extremely difficult to replicate. There is a finite supply of major league baseball franchises (just 30)
• Owners of professional sports franchises get to participate in the robust market for sports media rights. As an MLB team, the Braves share in the economics (with the 29 other owners) of the national media rights contracts that MLB negotiates with media companies. The Braves also hold local media rights for the broadcast of the team games, which it monetizes through local media platforms such as regional sports networks and radio stations.
• At current levels, investors can acquire an interest in the Braves at a 50% discount to our estimate of the private market value of the team.

The Madison Square Garden Company (ticker: MSG)

• The Madison Square Garden Company is the owner of two first-rate sports teams including the NY Knicks of the NBA and the NY Rangers of the NHL. As a testament to the value of these assets, The Knicks ($4.6 billion) and Rangers ($1.65 billion) continue to be ranked as the most valuable NBA and NHL franchises, respectively according to Forbes.  Notably, Forbes values have historically understated the private market value of sports franchises.
• As with the Braves, there are a finite supply of NBA and NHL teams and the Knicks and Rangers are among the most coveted franchises. The Knicks in Rangers both serve a passionate fan base in the nation’s largest media market.
• Although the two teams are among MSG’s most valuable assets, they are not the only ones. MSG also owns prime NYC real estate including valuable development residing above the team’s arena in NYC, which itself sits atop the busiest transportation hub in the nation.
• Shares of Dolan-controlled entities have historically been accorded a “Dolan Discount,” given the perception that the Dolan Family is not shareholder friendly. On the contrary, we note that the Dolans have implemented a number of shareholder friendly initiatives over the years including spinoffs, dividends/special dividends, and the sale a business (Cablevision) at a very favorable valuation. More recently, MSG has recently agreed to sell the LA Forum for $400 million, well above the ~$125 million it acquired/renovated the asset for in 2012.  In our view, the upcoming separation of MSG’s entertainment assets from its sports assets is another initiative that should go a long way toward unlocking shareholder value.

At current levels, MSG trades at an ~20% discount to the value Forbes recently ascribed to just the NY Knicks. Accordingly, with an investment in MSG, one is being paid to hold the Knicks and is receiving a number of its marquee assets for free and which represent significant value including the NY Rangers, valuable real estate in NYC, Radio City Music Hall, among many others.

Starbucks is an example of a high-quality business that has gone on sale. Starbucks has faced a temporary demand shock to its cafes across the world. However, over 90% of Starbucks stores have now re-opened in China, and management can bring the experience gained from the Chinese market to the rest of the world, as the lagged effects of the CoronaVirus impact operations in other regions.

Looking at the broader picture, ample market opportunity remains in China for store count expansion, especially now that its primary rival (Luckin Coffee) faces regulatory issues stemming from its fraudulent activity. Furthermore, the CoronaVirus disruption does not tarnish Starbucks stellar store level economics (30-40% store EBITDA margins; <1.5 year payback on investment), and the company’s strong balance sheet enables it to weather the near-term shutdown in operations without instituting mass layoffs.

Given the characterization of the current situation as a temporary demand shock (versus a permanent erosion of value) we believe shares are attractive at today’s levels relative to our intrinsic value estimate of $86/share. The dividend yield of 2.5% and expected share repurchases of ~$3 billion in 2020 help provide a floor in the valuation.

In conclusion, we are certainly not calling a market bottom. We cannot say with any degree of certainty whether the stock market will be higher one week, one month, or one year from now, but we do believe that the businesses we own in our portfolio are selling at a significant discount to what they are worth. It is our belief that investors who hold these businesses for the long-term will be handsomely rewarded for their patience.