Interview With Toby Carlisle of Greenbackd

Includes: DIA, HAWKQ, QQQ, SPY
by: Mariusz Skonieczny

Toby Carlisle is the author of Greenbackd, a blog dedicated to undervalued asset situations with a catalyst. He recently founded an investment firm, Eyquem Fund Management, and raised a modest amount of external seed capital for his maiden fund, Eyquem Global Value. The fund pursues a systematic deep value investment strategy with a focus on capital preservation, which means that the fund is predominantly invested in special situations like liquidations, turnarounds and activist and private equity targets. Enjoy the interview.

Mariusz Skonieczny, Classic Value Investors: You are the editor of The Greenbackd Blog, can you tell us what “Greenbackd” represents and why you decided to start your blog?

Toby Carlisle, Greenbackd: Greenbackd seeks to identify undervalued asset situations where a catalyst exists likely to reduce or remove the discount to value. My favorite stocks are those trading at a discount to net cash, or in other words, backed by Greenbacks, hence Greenbackd.

I started Greenbackd for two reasons. First, I believe it’s a good exercise to record the rationale for each investment in writing. Investing notes help me to avoid the false post hoc explanation for why I opened a position, which is especially important if I want to revisit them much later, say in five to ten years. Second, I made those notes public to keep me honest in my analyses and to meet like-minded investors.

Mariusz Skonieczny, Classic Value Investors: How did you first get involved in investing?

Toby Carlisle, Greenbackd: I got interested in the stock market near the end of my undergraduate degree, in about 1999, when I read Barbarians at the Gate. A friend pointed me to Buffett’s Berkshire Hathaway (NYSE:BRK.A) letters. On his advice I read Buffett’s letters and then the Roger Lowenstein book, 'Buffett: The Making of an American Capitalist.' I struggled through the 1951 Edition of Security Analysis not really understanding much of it. It took me a while to buy my first stock, primarily because I had no money and student loans that dwarfed my income. I was working as a corporate advisory and securities lawyer before I bought anything.

Mariusz Skonieczny, Classic Value Investors: The interesting thing about you is that you started by studying Buffett’s letters to shareholders, but then you switched to focus solely on Benjamin Graham’s philosophy. Why did you decide to do that?

Toby Carlisle, Greenbackd: I used Buffett’s letters to reverse engineer his valuation methodology, which I found to be excellent at identifying companies whose earnings were about to fall off a cliff, thereby justifying the previous, seemingly cheap, stock price. It didn’t often translate into good stock picks and I got plenty of bad surprises using it.

The transition to deep value started when I started working as a lawyer in 2002. My first big matter was a defense against two semi-famous investors from the ‘80s who had a blocking stake in a going private management buy-out. They bought their stake late in the game at close to the buy-out price and sought another $1 from the purchaser, which pushed the price from around $5 to around $6 per share.

About the same time I noticed there were investors taking positions in busted dot coms and making money. These were all companies with horrendous cash burn problems and no business plans. They weren’t comprehensible in a Buffett context, and it made me realize that there was more to investing than the methodology discernable from Buffett’s letters. As a result I revisited the 1934 edition of Security Analysis, found the chapter on liquidations and I started there. The progression from liquidations to other special situations was a reasonably short one.

Mariusz Skonieczny, Classic Value Investors: In the most basic terms, can you describe how your style is different from that of Buffett’s?

Toby Carlisle, Greenbackd: In one very important respect it’s the same: I try to buy at a big discount to a conservative estimate of value. Where we differ is in the source of value. Modern Buffett-style investors desire a “wonderful business at a fair price.” To me, that’s only half the story. I think of the company as a creature separate from its business. My estimate of value is generally not based on the performance of the business, but on the assets owned by the company that owns the business. I may very well attribute nil or negative value to the business, but consider the company to have substantial value in its assets. So the primary difference is that modern Buffett-style investors look for business value and I look for asset value. I like hidden assets.

I should point out that I only differ from modern, Munger-and-Fisher-influenced Buffett. Proto-Buffett was a Grahamite investor.

Mariusz Skonieczny, Classic Value Investors: Buffett said, “Time is the friend of the wonderful business, the enemy of the mediocre.” If you purchase mediocre businesses, how do you protect yourself from the underlying company getting worse and worse as time passes?

Toby Carlisle, Greenbackd: The short answer is this: I try to buy very cheaply. In my world, cheapness trumps “goodness” every time. One of my strategies is to try to buy the business for nothing. If it’s a mediocre business, as most are, then “free” is a price that will, for the most part, ensure that I’m buying below value. Of course, some businesses are worth less than nothing, so sometimes nothing is too much to pay.

Nothing regresses to the mean like return on incremental capital, which is the basis upon which post-Munger-and-Fisher Buffett-style stocks are valued. It is difficult to identify businesses with genuine moats because there are simply so few around, and it’s exceptionally difficult to purchase them at a sensible price because everyone knows which ones they are. Generally the only opportunity to purchase these stocks is when they are in crisis, or when the market is having a periodic sell-off. I’ve got a list of great businesses that I’d like to own at a price, and I’ll buy them if they ever see that price.

Mariusz Skonieczny, Classic Value Investors: How long do you usually hold your positions?

Toby Carlisle, Greenbackd: I don’t know. I’ve never calculated it. I buy expecting to hold for a long period of time, by which I mean two to five years or more, but it’s a function of price and value. In the last eighteen months I initiated a large number of positions, and I’ve sold out of almost all of them, so my average holding period will have come down substantially. I think that’s a pretty rare sequence of events over a full career.

Mariusz Skonieczny, Classic Value Investors: I think that many investors struggle with the decision of which investment style to follow. What kind of investors is your strategy most suitable for?

Toby Carlisle, Greenbackd: My high school biology teacher taught us that “ontogeny recapitulates phylogeny,” which is the notion that the development of the embryo in the womb parallels evolution. While the theory is discredited in biology, I think it’s interesting to consider in a value investment context. The analogy would be that an investor in her or his development starts out as a Grahamite net net investor and grows into a Buffett-style franchise investor. I regard Grahamite net net investing as crawling and Buffett-style investing as sprinting. Even Buffett crawled before he ran. Of course, if you redefine “net net” as Seth Klarman and Marty Whitman have, there’s really no need to ever leave the net net space.

Mariusz Skonieczny, Classic Value Investors: If someone wants to learn more about your strategy, what books or resources would you recommend?

Toby Carlisle, Greenbackd: Read the 1934 edition of 'Security Analysis,' Seth Klarman’s 'Margin of Safety,' and Joel Greenblatt’s 'You Can Be a Stock Market Genius' for the theory. Then read an ocean of SEC filings, particularly liquidation proxy filings and 13D notice filings where the investors annex a letter spelling out their theses. It can be an odd corner of the market. I used to say, “Read some Dostoyevsky, Chekhov or Solzhenitsyn to get into the mood,” but it’s more tragicomic than futile, so anything from the Theatre of the Absurd is more appropriate. Sometimes the authors of SEC filings flick the switch to Vaudeville all by themselves, so you have to be prepared to start out reading a filing and find yourself midway through reading Waiting for Godot. In investing, you don’t want to be Estragon or Vladimir deciding to hang yourself if Godot doesn’t show up tomorrow.

Mariusz Skonieczny, Classic Value Investors: What advice would you give to beginning to intermediate investors?

Toby Carlisle, Greenbackd: The best advice I can give is this: Do your own research. Read primary source documents. Read original SEC filings. Read the footnotes. Don’t rely on screens or secondary source documents. It’s amazing how often I’ve found assets hidden in the footnotes of filings.

Mariusz Skonieczny, Classic Value Investors: Would you share a recent investment and why you chose it?

Toby Carlisle, Greenbackd: One stock that I believe is cheap right now is Seahawk Drilling (NASDAQ: HAWK). The stock is still trading around my entry price. HAWK is a $140M market capitalization company listed on the NASDAQ Global Select Market. It owns the second largest fleet of “jackup rigs” providing shallow water drilling services in the United States Gulf of Mexico and offshore Mexico.

(From the company’s 10Q: “Jackup rigs are mobile, self-elevating drilling platforms equipped with legs that can be lowered to the ocean floor until a foundation is established to support the drilling platform. Once a foundation is established, the drilling platform is jacked further up the legs so that the platform is above the highest expected waves.”)

It was a wholly-owned subsidiary of Pride International, Inc. (NYSE:PDE) until August 24, 2009, when PDE distributed 100% of HAWK’s outstanding common stock to PDE stockholders. Selling pressure from exiting PDE stockholders, and reduced fleet utilization and day-rates in the United States Gulf of Mexico as a result of low natural gas prices and the credit crisis pushed HAWK’s stock price down well below its spin-off price. Just as it seemed that demand for HAWK’s rigs was improving, the significant oil spill from the sinking of the BP / Transocean (NYSE:RIG) deepwater drilling rig off the coast of Louisiana in April 20, 2010, and resulting regulatory uncertainty surrounding oil and gas exploration in US waters, pushed the stock down further still to around one-third of its $430 million in tangible book value, at which time I acquired my holding.

The company’s tangible assets consist of $140 million in working capital and its fleet of twenty jackup rigs, carried at $460 million, against $170 million in liabilities, including $6.5 million in debt. Cash burn is around $10 million per quarter at present rates. HAWK’s CEO worked with regulators in Washington to help them to make a distinction between shallow and deepwater drilling, and to have the moratorium lifted on shallow water drilling. That has now occurred, so I think HAWK’s position is improving. It is not without hairs, however, including a significant dispute with Mexican tax authorities, which HAWK expects will be resolved, and increased competition for rigs in the Gulf of Mexico.

I believe that a recovery in natural gas prices and further regulatory certainty for shallow water drillers in the Gulf of Mexico should see HAWK trade at or above its tangible book value.