Mindset Value Fund 2020 Annual Letter
The Fund finished up 51.5% after fees despite two costly mistakes
Disclaimer: The below post is my 2020 Annual Letter that I sent to investors in the Mindset Value Fund. This post is NOT a solicitation. I talk about stocks that I own and my view of the future. It is imperative that you do your own due diligence and not rely on anything written below. I’m posting this in order to show how my writing this past year translates to actual performance. With that, I hope you enjoy and gain insights.
I’m pleased to report that the Mindset Value Fund was up 22.4% net of fees for the fourth quarter and finished the year up 51.5% net of fees.
Two Errors of Omission Cost the Fund
While I’m pleased with the results for the year, to be honest, we should have been up much more. I missed two stock opportunities that I knew and researched well. The first and most glaring omission from our portfolio is a company called Terrascend (Canada: TER, OTC: TRSSF). What attracted me to Terrascend were great sponsors, a strong Chairman of the company and a new CEO from online grocery shopping who was brought in to professionalize the cannabis company. And more importantly, the company was starting to turn the corner (cash flow positive) and the market wasn’t fully appreciating it.
After working on the stock in May and June, I ended up not buying it. Did I really want more exposure to cannabis besides my position in AYR Strategies (Canada: AYR, OTC: AYRWF)? My hesitation led me to watch as the stock rose and rose and rose higher. Then I convinced myself that I shouldn’t chase the stock. Terrascend has gone up over 500% from June’s price.
BioSpecifics is another whiff of mine. In February, I wrote up a bullish report on the company before COVID hit. But when COVID struck, I decided to sell the stock as I was worried that a lost year or possibly two years of sales would materially affect the company’s value, especially as their patent expires in 2028.
In the end, it didn’t matter as their marketing partner Endo Pharmaceuticals (NASDAQ: ENDP) acquired the company for $88.50 per share, a 50% increase from my sale price. Ouch.
What We Got Right and The Future Looks Bright
Thankfully, despite those two big misses in 2020, we still had a strong year. Our largest positions powered our performance across the board. These positions include Nelnet (NYSE: NNI), Nintendo (Japan: 7974, OTC: NTDOY), La Francaise des Jeux (France: FDJ), Twitter (NASDAQ: TWTR) and HireQuest (NASDAQ: HQI).
But enough of the past, what does the future hold for our portfolio and our largest positions? In short, the future is very bright, especially because I believe our portfolio is still materially undervalued.
Nelnet is on track to have a phenomenal 2021. I expect Nelnet to produce over half a billion dollars of pre-tax cash flow from operations and the continued drawdown of their student loan portfolio. That is over $13 per share of pre-tax cash flow on a stock trading at $70 per share. When you peel the onion back, an investor sees layer and layer of value in its technology divisions and investments, and one realizes this quiet technology compounder is easily worth more than $100 per share. Even better is that now that they only own 45% of the fiber network division Allo, those fiber network losses will not run through the income statement anymore, making Nelnet a cleaner and simpler story to understand.
Despite rising almost 60% last year, Nintendo still sells for only 12.6 times fiscal March 2021 annual earnings, excluding cash and investments. I expect the video game company to come out with new bestselling games including a new Legend of Zelda and possibly a Donkey Kong game. Also, the company is rumored to be planning a more powerful version of the Switch, dubbed the Switch Pro. Finally, Super Nintendo World, a new theme park will be opening next month in Osaka, Japan. The company and its strategy continue to be fundamentally misunderstood and under appreciated.
I still can’t get over the fact that I get to invest in and own a true gambling monopoly and national lottery in La Francaise des Jeux. Trading at a 5% unlevered free cash flow yield, when French government bonds are trading at negative interest rates seems absurd. I expect the company to expand via acquisitions this year, and when you can borrow at 1% almost everything is accretive. FDJ is one of the most resilient businesses I have ever invested in and has become more profitable thanks to digital adoption and costs wrung out of the business during COVID.
While last year was a volatile year for Twitter especially politically, the company’s social network is as powerful or arguably more powerful than ever. The problem is that it is under-monetized on an astonishing level. Without the distractions of the former President, there is an opportunity for Twitter to offer subscription services and other opportunities in order to monetize the power of its network. I expect the stock to re-rate multiples higher, especially if the company can get more aggressive in their strategic direction and execution.
And as the economy re-opens, the housing market soars and the government lobs fiscal stimulus after fiscal stimulus, I’m really excited for HireQuest’s 2021. The franchise staffing company was on track to earn $1 per share before COVID hit. That means the stock trades at 10 times earnings (8.5 times ex-cash!), despite its eye popping near 60% operating margins and resilient franchise model. If this company can not only regain its past earnings power in a stronger post-COVID economy, but also acquire companies and convert them to their franchise model, I think the stock could more than triple. It’s illiquid, but this is one of the most compelling stocks we own.
The Biggest Thing We Got Right: Cannabis is the New SaaS
Last but most definitely not least, there is our star performer for the year and the fourth quarter: AYR Strategies. While we missed on Terrascend, we did not miss on AYR. The stock rose from mid-single digits to $24 per share and has continued its strong performance into January thanks in part to the Georgia senate election results that seem to indicate a more favorable regulatory environment.
We don’t even need legalization, but regulatory and legal shielding to banks and exchanges to protect them from legal liability. This is surely coming. I believe in the next 12 to 24 months US cannabis companies will be trading on the NYSE and NASDAQ. And when that happens, I could see AYR trading to potentially $200 per share. If you thought the electric vehicle stocks were a bubble, wait until speculators get their hands on a truly profitable fast-growing sector like cannabis.
But here is the best part of AYR. I think the company is on its way to producing $500 million in cash flow in the next 3 years through organic growth and acquisitions. Assuming some stock dilution due to acquisitions, I think the stock is easily worth north of US$50 per share now just to trade in line with comparable cannabis valuations. This says nothing of the valuation if it traded on the NASDAQ.
In this environment, I think it is a financial crime to sell leading US cannabis stocks before they list on US exchanges. And for this reason, I think cannabis provides a truly asymmetric opportunity. That is why over 40% of the portfolio is now invested in cannabis related investments. We own a lot of AYR, but also other names that no one really knows exist. But they will, oh they will.
Summary
I’m almost overwhelmed by the opportunities offered to us right now. It feels weird to proclaim this at all-time highs in the market with multiple sectors of the market seeing frothy and very speculative behavior. The opportunity lies outside those heated spaces and stocks. I keep telling people that once you look outside of the top 200 or 300 companies that everyone keeps yelling about, there are very compelling businesses that sell at quite attractive valuations. These opportunities are primarily international, in small caps or in cannabis (for regulatory reasons).
While I’m sure there is volatility ahead, I’m very optimistic about our portfolio for this year.
Sincerely,
Aaron M. Edelheit