TIP275: Mastermind Discussion 4Q 2019 (Business Podcast)

Episode Summary

Executive Summary: The episode centers on a quarterly mastermind stock-picking debate featuring short and long ideas, with a strong emphasis on valuation discipline, liquidity, cyclicality, and risk management. Toby shorts i3 Verticals as a highly levered, volatile, expensive payment processor; Preston and others counter with concerns about timing and growth durability. The group largely supports Biogen and Allstate as value ideas, while Hari’s GrafTech pitch draws the most debate due to lumpy financials but also strong contracts and asymmetric upside.

Main Topics: Short thesis on i3 Verticals: Toby argues i3 Verticals is expensive, highly levered, and vulnerable to a near-term liquidity squeeze despite rapid revenue growth and market enthusiasm for SaaS-like businesses. Biogen as a high-margin value pick: Preston pitches Biogen as a cash-rich, high-margin biotech with attractive IRR, strong acquisition discipline, and potential upside from an Alzheimer’s drug launch. Allstate amid macro and rate concerns: Stig presents Allstate as a stable compounder with strong free cash flow and buybacks, while the group debates how low interest rates and insurance-cycle risk affect upside and downside versus Berkshire. GrafTech’s asymmetric but volatile setup: Hari describes GrafTech as a low-multiple industrial with contracted revenue, pricing power, and Brookfield support, while others worry about lumpy financials, cyclicality, and China-related competition. Portfolio construction and position sizing: The group repeatedly stresses small position sizes, concentration limits, rebalancing, and using momentum/volatility tools to manage downside rather than making heroic forecasts. How to estimate future growth: In the audience Q&A, Preston and Stig explain that growth forecasts are best estimates built from management guidance, industry research, business-unit analysis, and conservative scenario planning.

Key Arguments: i3 Verticals looks fundamentally expensive with extreme valuation multiples and high leverage, but its short-term price path is volatile enough that timing risk is high for shorts. Biogen is attractive because it generates high-margin cash flow, has little leverage, and has strategic acquisition history; the Alzheimer’s catalyst could re-rate the stock. Allstate benefits from strong free cash flow, buybacks, and low capital intensity, but insurance earnings are sensitive to interest-rate regimes and auto-cycle conditions. GrafTech’s current low valuation is supported by take-or-pay contracts, stable needle-coke supply, and Brookfield ownership, creating asymmetric upside if demand holds. The group favors small, diversified positions because even good ideas can be bumpy, especially in biotech, insurers, and cyclicals. Insurance company valuation must account for underwriting cycles and investment income; low rates can pressure returns on float but can also force better underwriting discipline. Growth forecasts should not be mechanical; they should be grounded in product stability, competitive position, and historical cash-flow behavior. Momentum and volatility thresholds are useful risk controls, especially for positions that remain in favor for long periods but can break down suddenly.

Data Points: i3 Verticals market cap: $780 million - Toby cited this as the company’s approximate size. i3 Verticals enterprise value: ~$1 billion - He noted net debt pushes EV above market cap. i3 Verticals net debt: ~$200 million - Debt load contributing to short thesis. i3 Verticals EV/EBIT: 153x - Presented as an extreme valuation multiple. i3 Verticals debt/EBITDA: 5.5x - Highlighted as leveraged for the business profile. i3 Verticals 71-day share move: +50% - Toby noted the stock had surged sharply despite fundamentals. i3 Verticals prior 70-day move: -40% - Illustrates extreme volatility. Biogen annual revenue: $13.4 billion - 2018 top-line figure used in the pitch. Biogen bottom line: $4.4 billion - 2018 after-tax profit cited as evidence of margin strength. Biogen IRR estimate: ~10% - Preston’s intrinsic value output. Biogen prior drug revenue concentration: 42% from Tecfidera - A point of concern because patent challenges could pressure results. Allstate revenue: $40 billion - Used to frame it as a large, stable insurer. Allstate tip multiple / EBIT-to-EV: 10.1x - Stig’s valuation screen metric. Allstate share price range: $68-69 to ~$110 - Described as appreciation over five years near 52-week highs. Allstate dividend yield: ~2% - A contributor to expected return. Allstate buyback yield: 6.7% - Supportive of shareholder returns. Allstate investment portfolio: $81 billion - Used to explain sensitivity to low interest rates. Allstate portfolio return: 0.8% - Example of weak investment income in a low-yield environment. Allstate equity allocation: 9% of total assets under management - Used to compare with more equity-heavy allocators like Markel. GrafTech revenue (2015 acquisition): $530 million - Before Brookfield’s operational restructuring. GrafTech EBITDA (2015 acquisition): $45 million - Pre-restructuring profitability baseline. GrafTech revenue (2018): $1.9 billion - After restructuring and prior to/at IPO period. GrafTech EBITDA (2018): $1.2 billion - Shows dramatic operational improvement. GrafTech graphite electrode price range: $1,500-$2,000/ton to $13,000-$15,000/ton - Demonstrates pricing volatility. GrafTech revenue under contract: 65% through 2022 - Take-or-pay agreements stabilize cash flows. GrafTech fixed contract price: ~$9,700 per metric ton - Contracted output price mentioned in the discussion. GrafTech dividend yield: 2.7% - Adds to the stock’s return profile. GrafTech annual volatility: 60% - Used to explain difficulty in applying standard valuation. GrafTech position size in Preston’s portfolio: 8% - Preston disclosed a large personal position. Toby fund structure: 30 long / 30 short positions - Reveals portfolio construction approach. Long/short size ratio: 4.3x - Longs are about 4.3 times the size of shorts. Short position inception size: 1% - Typical short sizing in Toby’s fund. Preston’s Allstate momentum volatility: 17% annual volatility - Used to suggest a stop around $93 at a $110 share price. Projected 2025 needle coke demand: ~2x current level - Hari’s bullish thesis for GrafTech tied to EV growth.

Pivotal Quotes: "Things don't get cheap without a reason." — Toby: On Biogen and other apparently cheap stocks, acknowledging that value often comes with real business risks. "There is a big difference between uncertainty and risk." — Stig: On GrafTech, distinguishing temporary uncertainty from permanent capital loss risk. "It's more art than science." — Preston: On forecasting growth rates in the audience Q&A.

Implications: The episode reinforces disciplined value investing: demand conservative assumptions, manage position size, and separate temporary volatility from true business risk. It also shows how contracts, catalysts, and balance-sheet strength can create asymmetric opportunities in cyclicals and healthcare.