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Circle of Competence Issue #104


"There are old pilots and bold pilots, but no old, bold pilots." - E. Hamilton Lee, 1949


Skin in The Game

This week I watched Nassim Taleb's talk at BlockCon where he explored the concept of having 'skin in the game' and how asymmetric risk sharing pervades our everyday lives.

The example of asymetric risk and reward that Taleb loves to showcase is the 2008 great financial crisis, where the large bank CEO's received millions in severance pay while tax payers were left holding the tab to bail out the banks.

But how should we think about the thousands of businesses and millions of citizens who have been given lifelines by the government in the form of a $2 trillion stimulus package to combat the economic fallout from COVID-19? Most of these businesses were prepared for normal circumstances, and even an economic downturn. But most weren't prepared for the equivalent of an economic heart attack with demand down 50-70% month over month.

If we lived in a 100% capitalistic, red-in-tooth-and-claw society with little to no social safety net (i.e. an economic equivalent of the pre-historic jungles), all of these businesses from the corner coffee shop to Delta airlines would be toast. But that's not the reality we live in - thank goodness.

But since reality isn't black and white, the real questions lay in the grey area.

Does the small business owner who socks away cash, pays his employees a living wage, and yet still has to close down for months on end - does she deserve a bailout any less than a large corporation that spent nearly all of its profits buying its minority partners out over a period of years in the form of buybacks? Who deserves assistance more? What about the employee that diligently contributed to their 401K, borrowed to go through school part time, only to find their jobs eliminated? These are all difficult questions and there are no shortages of opinions.

As Morgan Housel has pointed out, this virus will cause people to question the wisdom of over-optimizing for efficiency and maximizing opportunity cost, and encourage a shift towards survival and security.

In my opinion, this isn't such a bad idea.

To tie together Taleb, COVID-19, and Housel's points, if you play like you have more skin in the game (i.e. you have a more symetrical risk vs. reward curve), you play for survival, and the upside will take care of itself over time. If you don’t (looking at you public company CEO's), your incentives to play the long game for survival simply aren't present. As Munger says, you get what you incentivize.

These are uncharted territories, economically and medically speaking, for everyone. But we have had pandemics before and there are lessons to be (re-)learned from history.

I think the lesson to be learned here is to optimize for survival first, and growth second. It may look sub-optimal 80% of the time, but it will keep you in the game longer. There are old pilots and bold pilots, but no old, bold pilots.

When times are good, the emphasis is on the upside, on growth. The next focus is on being prepared for threats on the horizon. The last thing on your mind is survival. But if you play the long game, these rules are reversed. Survival first, then growth.

The viral outbreak has reminded us all of this historic lesson - survival is the foundation, not an afterthought.

Update on Texas Pacific Landtrust (TPL)

Disclaimer: I am not your financial advisor, and this is not financial advice. Do your own research.

Speaking of skin in the game, on February 15th, I wrote a case study on Texas Pacific Landtrust. At that point, it was trading at roughly $770 per share. I was long, and remain long, and have continued to purchase shares as they have declined to current levels at $379 per share. At current prices, the company is trading at around 9x trailing earnings (which will most likely be impacted by the precipitous decline in oil prices).

The shares of TPL have been absolutely hammered with the rest of the energy sector as demand has dried up for oil and the rest of the oil-producing oil has refused to cut production. I probably couldn't have timed this piece any better.

This is always the risk of publishing pieces on companies that you own and like. But, if you like a business at a certain price, as long as the thesis doesn't fundamentally change, you should like the business even more at lower prices.

So what was my thesis and did it fundamentally change?

Texas Pacific Landtrust owns roughly 900,000 acres in and around the Permian Basin in West Texas. It derives substantially all of its revenues from land leases, oil and gas royalties, and water services and rights that are all based on the use of its wholly owned acreage. The thesis was (and remains) that this business will continue to be a capital-light, high return avenue to access one of the most productive oil and gas fields in the world.

Questions, asked and answered:

1) Will oil and gas demand pick up eventually once the virus outbreak is contained and people begin to travel/move about?

- I believe it may take a few quarters if we enter into a fairly big recession, but yes, demand will pick back up.

2) Where is the most prolific oil production region in the USA?

- The Permian Basin, with over 11 billion barrels of proven reserves.

3) Will this company survive an economic downturn?

- Even as oil/gas demand dries up, their land leases will continue to generate revenues, albeit reduced due to defaults, and oil and gas producers will eventually return to production, generating oil and gas royalties for the trust. Their balance sheet includes no debt and their net income margins are extremely high. They will certainly be impacted by the steep decline in oil prices, but again, they have other sources of revenue, their balance sheet is a fortress, and they have over $300MM in cash. If your time horizon is 5+ years, this, in my opinion, may be a great opportunity to own shares in a company that possesses some of the best oil and gas land in the world.

4) Anything else worth knowing?

- Horizon Kinetics owns 22.5% of the company, has been buying shares all the way down, and has pushed to convert the company from a trust structure to a Corporation structure in a similar manner to how the private equity giants converted to Corporation structures from Limited Partnerships in 2018 and 2019.

Notable Fintwit

- Apparently, Dicks' Sporting Goods store is selling... wait for it... its private jet.

- The historical nature of last week's unemployement claims is staggering when compared to previous economic downturns.



Berkshire Hathaway and the coronavirus crash (Rational Walk)

The oil glut is filling up the world's tankers fast (Bloomberg)

Woulds heal, scars last - essay on the effects of coronavirus (Morgan Housel)

Wolfe Research guide to reading a 10K (Wolfe Research)

Seth Klarman's Baupost Group seeks capital (Yahoo! Finance)

Blizzard, Winter, or Ice Age? (O'Shaughnessy Asset Management)

Weekly update, Howard Marks' latest memo (Oaktree)

What industries and geographies have the most debt (Aswath Damodaran)


A spur to the biotech century ahead (Wall Street Journal)

Fireside Chat: Nassim Nicholas Taleb & Naval Ravikant (BlockCon)

Artificial Intelligence Current Trends (Exponential View)

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