FRMO Corp. (FRMO, Financial) is a holding company controlled by Murray Stahl (Trades, Portfolio) and Steven Bregman. It holds equity as well as a royalty interest in the private asset management firm Horizon Kinetics where the duo are also executives and head the investment team. FRMO Corp. also invests quite a bit of cash into Horizon Kinetics funds and partnerships as well as various private ventures.
I’ve been a shareholder for years. Listening to their earnings calls or reading their essays on various subjects from Bitcoin to the move towards indexation has been more valuable than any dividend I’ve ever received. The FRMO September earnings call talked extensively about their crypto investments. I want to take the opportunity of the large drop in values across the cryptocurrency markets, with Bitcoin down almost 50% from its high, to highlight some of the most original thinking I’ve encountered in U.S. asset management.
Bill Miller is the guru who famously put a great deal of Bitcoin in a hedge fund he runs, but there are no other value gurus who have announced creating Bitcoin exposure through their mutual funds like the Horizon Kinetics Internet Fund and the Kinetics Market Opportunities Fund. Horizon Kinetics has been running a value strategy for years and years quite succesfully. Besides Miller and Horizon Kinetics, it is rare for value investors to have ventured into Bitcoin. The bitcoin funds didn’t start this year out great but obliterated their categories in 2017.
In this particular earnings call Stahl talked extensively about Bitcoin. He’s actually talking and publishing quite a bit about Bitcoin, presumably for three reasons: It is controversial, customer education around the subject is limited and it is good marketing.
Stahl’s tactical advice about investing in cryptocurrencies can be summed up as (emphasis mine):
"I didn’t know if cryptocurrency would be a reasonable asset class or not, and there’s a fair chance of failure—we still don’t know. I have a little bit more confidence today than I had when we began to invest in it, because it’s grown so much. The idea was to invest a small enough amount of money so that if the whole sum were lost, we could go on to fight another day. Reasonable minds may differ about what that sum should be. Even in failure mode, maybe—probably not—but maybe I would have enough insight and foresight to sell it before it would reach zero, so maybe I wouldn’t lose the whole sum, as modest as that might have been. I’d just lose a goodly piece of the whole sum. That’s possible."
In addition to buying Bitcoin either straight up or through the Grayscale Bitcoin Investment Trust (GBTC), the firm also engaged in Bitcoin mining:
"As I wrote in the annual report, we raised $5 million for this mining business, with no fees. I just wanted to show people we could pay a robust dividend and keep the unit value constant, or as constant as one has a reasonable right to expect. In the next iteration, there will be fees. So, it’s like we gave a free sample, to show that our merchandise is really good."
Likely Horizon Kinetics is designing some kind of product around this concept. Until they do, your best shot to try this at home is through bitcoin cloud mining services.
Index disruption
Even if you are not interested in Bitcoin at all, it is still a good idea to be mindful of what’s happening in this industry. In the earnings call Stahl outlined how the technology can function and ultimately cut out some of the middle men we’ve gotten used to. No wonder Jamie Dimon and Dick Kovacevich, CEOs at JPMorgan (JPM, Financial) and formerly Wells Fargo (WFC, Financial), cried fraud and pyramid scheme. Dimon did later take that qualification back though. As Stahl puts it:
"It’s pretty easy to see that it would create a big problem for the 14.3% of the S&P 500 that is in the financial sector—largely banks. It’s not just a problem for banks, because currency trading, which is another big profit maker, could be eliminated. You could eliminate trading in general, because those who want to buy and sell securities could be matched up on the blockchain. It could eliminate the middleman. There’s tremendous potential for disintermediation within that 14.3% of the S&P 500. Even if I had no interest in ever buying bitcoin or other cryptocurrencies, I ignore them at my peril...
...Assuming that blockchains and cryptocurrencies are successful, major portions of the index are about to be disrupted…"
One of the problems with the current index is how changes in the economy are not captured within it. Just think about how Silicon Valley’s greatest successes like Uber and AirBnB are remaining private forever. Even as venture capital exits, enormous private equity-like investors like SoftBank Group buy up chunks of them. It is no longer a given that innovation will be represented within indexes.
"A stock index means you’re just buying stocks. But what if there is major economic activity happening but it’s not happening in a stock? How will you maintain proper diversification, especially if that segment of the economy that’s growing presents an existential challenge to a part that’s being displaced?"
FRMO is pursuing this sort of diversification by participating with small amounts of capital-at-risk in cryptocurrency and cryptocurrency ventures. I copy their approach by holding some cryptocurrencies but also by investing in blockchain related companies like Overstock (OSTK, Financial) and Seagate Technologies (STX, Financial) and of course FRMO Corp. itself.
What I like about these companies is that they are sound businesses and if Bitcoin/blockchain fails, there is still a large amount of free cash flow being generated. This translates into a position where I capture some of the upside but also retain protection on the downside. Overstock did have a tremendous run over the last six months, so it could be a bit rich. Guru George Soros (Trades, Portfolio) did recently add to his holdings, however. The most obvious value play is Seagate which trades at just 6.2x FCF.
Disclosure: Author is long FRMO, STX, OSTK and Bitcoin.
