A recent addition to my portfolio was the Daily Journal (DJCO). My friend and hedge fund manager, Matthew Peterson, presented the idea at VALUEx 2019. He is not only a great guy but an out of the box thinker who is always a pleasure to speak to. If you read the description of DJCO or look at the recent accounts and valuation ratios you are likely to quickly dismiss the stock. What’s so interesting about a loss-making $300m market cap company, in a declining industry with an illiquid stock?
In summary, 3 words: Charlie Munger Technology. Huh? Well, Charlie Munger, the legendary partner of Warren Buffett, is the chairman of the company and a major shareholder. Rick Guerin is vice chairman. For those of you who don’t know Guerin, from 1965 to 1983 the partnership he managed rose 33% versus 8% for the S&P 500. He is mentioned in Buffett’s “Superinvestors of Graham and Doddsville”. Peter Kaufman who is a director, runs Glenair and was also on the board of Wesco when it was acquired by Berkshire. CEO Gerald Salzman has worked with Munger for many years while he has been involved in a variety of roles at DJCO for over 30 years. So essentially, this is a solid board with a value creation mentality inspired by one of the greatest investors ever. So imagine what the characters of the rest of the managerial staff? Munger has owned this company for 40 years so I assume that the people involved have been hand-picked and ready to carry the torch.
The company itself has 2 business: the traditional newspaper (and related online publications) and Journal Technologies. I consider the newspaper business to be worth zero. In my discussion with Matthew, he believes it generates around $1m pre-tax and in a recession around $5m. This counter-cyclicality is because during recessions there are more foreclosures. By law foreclosures have to be made public. This is done via newspapers and as the Daily Journal is the cheapest (charging ~$40 per ad versus ~$100 by competitors) it gets a lot of business.
Journal Technologies provides software to courts, justice agencies, government agencies and bar associations. Their court management system is licensed to over 500 organizations. This is the hidden asset and where shareholders will make their money. Currently, organizations are updating their very old technology, and Journal Technologies is working with its clients on this transition. The genius of this business is that DJCO is not getting paid during the implementation phase. Once everything is up and running (and this could take 2-4 years usually) then DJCO gets paid along with a yearly reoccurring license fee. Politicians don’t like paying for things they won’t get any credit for, so this arrangement suits them nicely. Several contracts have ~5% or inflation embedded fee increases for a 10 year period followed by a jump/gap (double digit) to a new fee for another 10 year period. Tech support employees working at the clients love the software. Some have actually increased their number of licenses following implemented as they were so happy with the software (another source of growth). This is a highly valued service and once in place will have high switching costs as employees are unlikely to commit to learning new software (remember these are government employees). The company’s main competitor is Tyler Technologies, a $9 billion company which is unlikely to even consider DJCO existence. Munger has mentioned in passing that once this is a success they could move into other areas (eg. schools). This has remained a hidden asset as the company has said very little about it. The last annual general meeting was on Valentine’s Day and despite my wife’s complaints, I had dinner while watching Munger speak (it was broadcast live online). The meeting had similarities to Berkshire with many random questions thrown at Charlie (eg. how to raise their kids, success in life, etc). A couple of people did ask questions about the technology division but despite some hints of success, there was very little meaningful info given. Munger did say that their little company counts the Government of Australia as clients!
Matthew dug up a lot of contracts and following his lead I also spent some time and found several myself. According to Peterson’s extensive research, Journal Technologies could have $50m in revenues in 1-2 year and $150m in 10. Once the implementation phase is over, margins will improve significantly. (Note that now, DJCO is incurring the cost without getting paid and thus earnings are understated). At that point we can expect the company to be re-rated and considered a SAAS (software as a service) growth company with recurring revenue. Obviously, SAAS companies have much higher valuations and more so if they generate 25% in margin (which is likely with this type of business).
It’s important to mention the company’s investments. Post the financial crisis, Munger decided to put the firm’s extra cash to work. He purchased a portfolio of equities which is mostly Bank of America (BAC) and Wells Fargo (WFC). This portfolio rose significantly, and on the 10-K, we see $212m in marketable securities. Cash is $9m while the company holds real-estate worth around $16m. On the liability side there is a $30m non-maturing margin loan (that was used in 2012 to buy the SAAS business) with a very low interest that is covered by dividends and a $40m deferred capital gains tax liability due to the stock which would only get paid on sale of the investment portfolio.
Based on the 10-K numbers, if we take investments + cash + real estate we get ~$238m (9+212+16), and if we deduct $70m liabilities we get ~$167m value. $320 market cap minus $167 leaves $157 for the valuation of Journal Technologies. Considering the growth runway that’s cheap. Here is another way to think about it: Even if everything is worth ZERO (unlikely) and the stock portfolio appreciates by around ~4% per year then in 10 years, the stock portfolio alone would be worth the entire market cap! There is a lot to like here in my opinion. Of course this isn’t an appropriate investment for many people or funds. Like I mentioned the stock is illiquid and the company is small but personally I like the simplicity of the idea. And if you’re wondering, then the answer is yes, you need to have some belief in the people behind the company for this to make sense as an investment. Personally, I’m comfortable with the people at the helm.
On the upside, if they get to $150m in revenue and a 25% margin then with a 20x multiple that’s $700m. If the investment portfolio rises by 5% annually then that’s another ~$350m so essentially the stock could be worth 3x its current value. Munger turned $2m in 1977 to $300m in 2019 (~13% per year) and I expect that sort of return to continue. But I don’t think I’ll have to wait so long because once the market starts to realize the potential then the stock will move a lot quicker than people think. So I happy to initiate a position in DJCO. Long from $220.
