Journal For Week Ending 10/12/2019: Bought SMIT, Passed on UBER (and Others)

In the past 2 weeks, I continued to accumulate the Trade Desk (TTD) (thesis as stated in my last write up here). I also jumped on Schmitt Industries (SMIT). There's not much to say about this company. It’s a simple cigar-butt play as summarized in my tweet here:

wow. $SMIT just sold its main biz.

Waiting to see use of proceeds.

market cap <$12mm. What's left of the company?

Measurement segment, 3 buildings in Portland (40.5k sqft), big NOLs, ~$12mm of cash (including sales proceeds), and a CEO who really knows how to invest https://t.co/0PKB2tTBVA

— mspacey (@mspacey4415) October 10, 2019

So basically I’m buying a $12mm market company with $12mm in cash. I essentially get a bunch of stuff for free: buildings, NOLs, and measurement business. It's not that hard to imagine the whole thing could be worth more than $20mm, or ~$5 per share (Stock is trading around $3 at the time of this writing).

I also took smallish positions in TWTR and ROKU.

Twitter is something I personally find incredibly useful for learning and research. The stock is not cheap but the company has been making user interface improvements that I believe can increase user base as well as engagement levels. Twitter has a irreplaceable position in our culture and that should command a higher floor multiple than usual.

Roku is more of an opportunistic trade. I have been researching the whole connected TV space (along with Trade Desk) and thought ROKU was a good company, but held off from buying because it’s expensive. So when the stock price came down and filled some technical gap I took a gamble on it.


Some Stocks that I Passed On

I passed on a bunch of stuff the past 2 weeks. The most prominent ones are Uber, Chewy, and Spotify. They are all tempting buys as they are entrenched businesses with strong brands. All these stocks looked to be bottoming too.

Here I will comment on why I passed on Uber. Perhaps in a later write up I’ll share the same about Chewy and Spotify as well.

Uber

I am mostly concerned about the sensitivity of margins to prices (that consumers pay).

In 2Q19, management mentioned loss of $100mm for Ride Share. We can back out the fixed cost and see that this implies 20% contribution margin for core Ride Share business.

The thing is, this 20% is off their 20% take rate (as in Uber gets 20% of what riders pay). As a percentage of consumer spend it’s really 4% contribution margin.

Yes you can make up for low margins with volumes and still have great profit dollars. That’s not the problem. The problem is sensitivities - any change in pricing (or take rate) could wipe out the economics.

So far I’m talking about current data, but the real question is this: What does fully ramped economics look like?

We know this 20% contribution margin in Ride is a mix between a) fully ramped, very profitable cities like San Francisco, and b) not yet ramped loss making cities. What can we infer about fully ramped margins? Let’s plug in some numbers for illustration purposes.

• Let’s say 60% of tickets come from fully ramped big cities that are profitable; assume loss making cities have negative 20% contribution margin.
• So you do 60% x + 40% (-0.2) = 0.2
• Doing the math, this would work out to about 35% contribution for fully ramped cities.

Again, this 35% is off Uber’s 20% take rate, so expressed as a percentage of what customers pay, you’re talking about maybe 7% contribution margin, even when fully ramped.

After deducting fixed cost, you probably have EBITDA margin in the low single digits. Again, a little drop in customer pricing or take rate would wipe out the economics.

When I started my research I imagined Uber to be this high margin money making machine with software economics. That’s just not the case.