This is truly remarkable in light of the following:
There is no goodwill on the balance sheet.
Unlike Berkshire, Fairfax and Loews, DJCO avoids insurance risk.
Shares trade on the NASDAQ at a 30% discount to a pessimistic estimate of fair value.
I) THE RECORD
Never a down year
NAV doubles every 2.5 years for an IRR > 30%
Forget about Vito Maida, Michael Burry, Bruce Berkowitz or David Winters. Munger is the investor of the decade. The other guys are not just being nice when they say Munger is brilliant.
Munger did it by loading up on treasuries in the first half of the decade and selling them in 2009 to buy WFC, USB and some other securities. Painfully simple.
II) BUSINESS and HISTORY
DJCO has been publicly traded since 1986. That year, the fund run by Charles Munger and his close friend Rick Guerin was liquidated. One of the holdings, DJCO, was IPOed. The stock was distributed to the fund's investors. Guerin and Munger ended up holding about 80% of DJCO (40% each).
Today, Munger and Guerin still sit on the board. With them at the helm, the company simply adds a zero to NAV each decade like they did with their New America fund in the '70s and '80s.
The company has about 200 employees including 30 at Sustain for software development and consulting.
III) OPERATIONS and COMPETITIVE ADVANTAGES
1) Newspapers and Information services
Charlie Munger is a lawyer from California. The newspapers published by DJCO seek to be of special utility to Californian lawyers and judges.
One thing lawyers have in common is that they are acutely aware of the relationship between time and money. Lawyers will spend X hours at the office and bill clients 3X. I have done business with a number of law firms. At all of them, lawyers monitored their personal “multiplier” on a weekly basis. 4x was something to brag about; 2x wasn’t.
Basically, in the mind of a $500-an-hour lawyer, anything that helps rack up another five minutes of billable time each day is worth $1000 dollars a month!
Lawfirms pay DJCO a few hundred dollars (up to $1500) per annum. For that, they get a daily paper, a monthly booklet and access to DJCO's online resources.
The Daily Journals provide case summaries of all opinions certified for publication by all California Courts and the U.S. Supreme Court.
The Daily Journals also include a monthly booklet listing all judges in California courts as well as courtroom assignments, phone numbers and courthouse addresses, judicial appointments, elevations, confirmations, resignations, retirements and deaths.
The Court Rules service reproduces court rules for certain state and federal courts in California. The company updates Court Rules on a monthly basis. The volumes are normally updated or replaced whenever there are substantial rule changes.
The Judicial Profiles services contain information about all active and retired judges in California. Most of the profiles have previously appeared in The Daily Journals as part of a regular feature. The Judicial Profiles include biographical data and financial disclosure statements on judges and information supplied by each judge regarding the judge's policies and views on various trial and appellate procedures and the manner in which appearances are conducted in his or her courtroom.
Foreclosure information primarily provides distressed property information, some of which also appears in some of the company's newspapers, as well as expanded features.
The California Lawyer magazine is distributed on a monthly basis to about 150,000 attorneys.
I guess it’s fair to say DJCO is to California lawyers what Google is to you and me. Unsurprisingly, margins are obscene. Like Google, most of the money DJCO makes is from advertising.
The business may not be growing but it certainly has competitive advantages. The incumbent can spend more time and money to gather high-quality information and can charge more for advertising.
There is a broker hiding in the 10-K. A division of DJCO (CNSB) is a commission-earning selling agent specialized in public notice advertising. Public notice advertising consists of legal notices required by law to be published in an adjudicated newspaper. The major types of public notice advertisers are real estate-related businesses, governmental agencies, attorneys and businesses. CNSB places notices and other forms of advertising with adjudicated newspapers, many of which are not owned by DJCO.
Sustain develops software that enables court systems and other justice agencies to automate their operations. Such systems are referred to as eCourt software. The term “eCourt” is in fact a trademark of Sustain software.
The California Administrative Office of the Courts (AOC) has during the past several years installed Sustain Justice Edition in 13 of the State Superior Courts. The contract was worth about $20 million.
The AOC installation integrates Sustain with the California Department of Motor Vehicles, California Department of Justice, police department (traffic citations), district attorney, jail, etc.
Sustain software is licensed in 12 U.S. states and Canada. The two largest courts in North America (Los Angeles Superior Court and Toronto) use Sustain, along with more than 100 courts in Georgia alone.
Sustains is based on the Java2 Enterprise Environment (J2EE) platform, an industry standard for developing enterprise applications. Users only need a web browser.
Sustain competes with Infocom Systems Services Inc., Justice Systems Inc. and Tyler Technologies (Odyssey).
IV) BALANCE SHEET and PROFITABILITY
Balance sheet: There’s no debt and about $15 million of cash plus treasuries.
Cash flow statement: DJCO spent $10 million in 12 months buying marketable securities (common stock of two foreign companies) without drawing down their cash (+treasuries) balance or taking on debt.
In other words, the owner of DJCO earned $10 million in 2011. Under GAAP, the company earned about $5 million on average over ten years.
Book value is $65million, for a decent ROE of 15%.
Back out $70 million of excess cash and investments to get a not-so-decent triple digit unlevered ROE. A triple-digit ROE means a dollar retained becomes worth two dollars within two years.
Remember, these numbers include the Sustain software business. At present, that division is a net user of cash.
Gerald Salzman serves as CEO and CFO. He has been at the company for as long as anyone cares to remember. Per annum, the board pays him $250,000, a bonus and a claim on 0.5% of earnings over the next ten years.
It adds up. The way this works is that the claim on “0.5% of profits” he got in 2002 expires by 2012. Assuming he’s still employed, he gets another claim for 0.5% until 2022.
Salzman currently takes home about 8% of profits. 8% is the accumulation of the claims he was granted in 2002, 2003, 2004, etc. DJCO has accrued a $5 million liability on the balance sheet for the outstanding grants.
This scheme has some interesting effects:
In a bad year, DJCO’s expenses are automatically lowered.
CEO pay is tied to performance.
A new CEO can step in with the same scheme without shareholders taking a hit.
I can see why Salzman doesn’t employ a CFO but would if it made sense.
Salzman probably has some clear ideas about succession.
Charlie Munger is chairman of the board and manages the investment portfolio. He gets paid nothing. He buys some of the newspapers though. If you want to brag to people about how Charlie Munger pays you to manage your money, buy DJCO.
Peter Kaufmann is a member of the board. He runs Glenair and is the author Poor Charlie’s Almanack.
There's a superinvestor hiding in the 14A. Mr. Guerin has been a director of the Company since 1977. Along with Walter Schloss, Bill Ruane and of course Munger, Guerin is one of the "Superinvestors of Graham-and-Doddsville". Of that group, Guerin has the best record. Guerin too is a close friend of Buffett.
I can see why Charlie sits on the board for free. I know I would if I got to talk stocks with Rick Guerin.
This board has the best capital allocators I have come across. Bar none. You get the services of two superinvestors for free.
Again…. WOW !
As always, there is something to worry about. Management has an impeccable record spanning many decades. Succession is an issue. It does create some uncertainty with shareholders but there are many reasons why these men wouldn’t disclose their plans.
There is a fair chance that at some point Li Lu replaces Munger on the board. Li Lu manages some of Munger’s money and sits on the board of Knovel. Like DJCO, Knovel makes web-based software.
Alternatively, Guerin and Munger could simply call it a day, declare victory and liquidate the business in a tax-efficient manner. They’ve done it before. History doesn’t repeat but it does often rhyme — sell the Daily Journals to Gannett, the Washington post, the Buffallo evening news or Dolan (Daily Journal of Commerce), distribute the portfolio of investments to shareholders and IPO Sustain.
VI) VALUE and PRICE
There are 1.38 million stocks outstanding. At $69 the company sells for $95 million.
Ok, we are creating DJCO form scratch…. right. We need:
1) The investments and the treasuries => $70 million
2) Buildings, equipment and land (gross). => $20 million
Remember, DJCO specializes in advertisements concerning foreclosures in California. The book value of the land probably understates current fair market value.
3) Sustain software and current contracts with Courts => $20 million
AOC spent billions (yes, that’s a “b”) building case management software for Californian courts. For some reason, the courts continue to use Sustain. I’m being pessimistic here so I’ll just use the amount AOC paid DJCO ($18 million) for a license and ignore the sunk costs plus the value of the contracts in Canada, Oregon and Georgia.
Yes, I believe AOC would buy Sustain outright, in an instant, for $20 million. There’s a clear business case in that deal.
4) Brands and licenses (eCourt and adjudicated newspapers) => ?
Let’s call it $120m => $93 per share.
Munger says invert. Assuming someone were willing to lend you $120 million at 0% but you MUST spend it to create a company that will put DJCO out of business. Would you be willing to borrow the money ?
7 x owner earnings of $10 million, plus
treasuries and securities worth $70 million => $100 per share.
The newspaper alone, with $10m of pretax earnings could easily service $70 million of debt at 8% interest.
I’m not an LBO artist but I would pay $120 million for DJCO in an instant. Now in control, I’d have DJCO borrow $70 million and use that money to buy more stock. I’d subsequently split off the investments, now worth $140 million. => $100 per share
I’d give Salzman 20% of the stock of the now levered DJCO, distribute the remainder among the employees and go fishing.
In other words, under my control, DJCO would be instantly worth a 35% premium over current prices. The company is not under my control though. You decide if DJCO deserves to trade at such a discount because Munger has control and I don’t.
1) At some point, the uncertainty surrounding the issue of succession will be cleared up.
2) In recent months, Munger has deployed another $10 million into the common stock of two foreign manufacturing companies. Given time, the investing community will figure out BYD was one of the stocks. In typical Munger style, he bought at the bottom.
As was the case in 2009, the market value of the investments will eventually be reflected in the stock price.
3) One of the securities is referred to as “certain bonds”. Those bonds are yielding about 8% today and 10% on cost (2009). I think it is unlikely Munger in March of 2009 was buying straight bonds at 10%. Even if he was, the 10-K wouldn’t refer to them as “certain bonds”. As any fan of Leucadia will tell you, bonds can be worth many multiples of their nominal (book) value.
For now, the yield on these bonds is consistent with the convertibles of Goldman Sachs. Munger is a fan of Goldman. At some point, we will know for sure
VIII) SPECIFIC RISK
There are some risks worth mentioning.
1) Revenue loss. About half of current profit comes from public notice advertising. This has been at an elevated level due to the large number of foreclosures in California. If the housing market returns to pre-2007 levels, DJCO’s profits could be cut in half.
I believe this particular risk may be balanced out by a positive effect on the market value of the portfolio of marketable securities.
2) Availability of the services of Munger. One problem with great management is that you need good replacements when their services are no longer available to the company.
I believe there is a fair chance Li Lu eventually replaces Munger on the board and Salzman Jr. replaces Salzman Sr. The company has not announced any plans though.
3) New legislation. Public notice advertising is required by law. The law may change.
4) AOC has spent billions since 2000 developing their own software for the courts. In the meantime, they have been installing incremental versions of Sustain as an ”interim solution.” Should AOC succeed in developing a viable alternative, Sustain would lose an important client.
Munger says invert. What are the odds of an unlevered newspaper, a software company plus a portfolio of five Buffett/Munger stocks ending up worth nothing?
IX) WHY IS THIS CHEAP?
1) DJCO trades by appointment only. The bid/ask spread can be meaningful.
2) This company was covered in the book "Damn Right!". In that book, DJCO is described as a "media project" that Munger is not really doing for the money. This perception was supported by the fact that, until 2009, DJCO simply piled up heaps of cash. The recent deployment of that mountain of cash supports the case that management is capable of and willing to create value for shareholders, just like they were doing when they were running a fund. Munger and Guerin are just a bit more patient than most.
3) The newspaper is regarded as profitable but declining while the software business (Sustain) is “too hard” because there are no GAAP earnings. Spend an hour researching Sustain and you’ll find it’s a business with high barriers to entry that is growing like a weed.
This is not a recommendation to buy or sell anything. I own shares of the Daily Journal Corporation. I have no position in any of the other stocks mentioned.
Any and all questions welcome as usual.
Ben Comston's excellent analysis of DJCO's investments.
Audit of AOC attempting to create an alternative to Sustain's eCourt software.
Recent Proxy statement with Salzman's compensation scheme. It mentions Salzman Jr. Munger gets 0.
How a bond with a book value of 100m can be worth billions (Fortescue and Leucadia).