March 2018 Commentary
Our unconditional duty, and the only one we abide by, is to grow investment capital at an above average rate while avoiding any permanent loss. We measure ourselves against S&P 500, as it represents a wider range of companies including the manufacturing, retail and service sector companies than Nasdaq index.
In this month’s newsletter, I like to talk about a company that I have purchased long time ago in my personal portfolio. I like to bring up this topic, as this company has one unique characteristic that makes it similar to bitcoin. This company is Texas Pacific Land Trust (Ticker: TPL). As of today, its Market cap is 4.1 Billion dollars and market price is $525. This company is followed by 0 analysts from the market, even though it is very profitable. In contrast, Microsoft has 35 Analysts from major Wall Street banks. How does this company perform against major companies with huge advantages in Research & Development, Marketing, huge revenues? We can look at the Morningstar for the stock performance results. It compounded annually at a rate of 30.92% for the last 15 years and better than Berkshire Hathaway!
For an investor what matters is the total returns on his original investment. Warren Buffett is known as one of best investors of our time with the longest track record. Berkshire Hathaway gets over $114 Billion dollars of float from insurance operations of GEICO and National Indemnity Corporation. All the premiums they receive from policy holders is an interest-free loan without any time limits to Mr. Buffett to invest in stocks and bonds. This float gives a huge advantage to Mr. Buffett in producing great returns for the investors. Berkshire also owns $170 billion worth of marketable stocks, which continuously provide dividends and kick them into the hands of Warren to invest. Berkshire Hathaway has 377,291 employees, where as Texas Pacific Land and trust has 32 employees! Still it outperformed one of the best investors of our time over a 15-year period. How is this possible?
Let us compare this company to Microsoft. It outperformed Microsoft by a huge margin. Microsoft has huge monopoly on IT departments everywhere with their Windows Operating system and Office suite. Marginal cost of production for Microsoft is very low.Once they made one copy of the Office software,they can reproduce the same copy of the software millions of times and generate enormous revenue. They manufacture PC Hardware with surface laptops, Xbox systems andWindows phones. They operate in search business similar to Google and provide cloud computing services with Azure. They have some enormous advantages over a tiny company with just 32 employees. They have free access to capital markets and can raise huge amount of capital for their business at near zero interest rates. Still, Microsoft underperformed this company over a 15-year period.
The same can be said about Exxon Mobil. It has close to 25,000 producing oil wells. They control close to 21.2 billion barrels of oil and has 69,600 employees. They control huge number of oil fields in every continent and closely analysed by 23 analysts. It brings in an annual revenue of $237 billion. It has access to capital markets and due to their superior credit-rating able to borrow for the long term at rates as low as 3%. Despite all these advantages it was out-performed by Texas Pacific Land Trust over a 15-year period, where Exxon only provided 7.77% to 30.92% from TPL.
This brings up the question, what is so unique for this little-known company to produce such great returns beating all those established high-performers with massive advantages? We need understand about the history of this company. This company was a formed as a trust in 1888 with the bankruptcy of the Texas Pacific Railway Company. The railroad had previously sold bonds to finance construction of western line to connect with Southern Pacific way out in West Texas. The railroad secured the bonds with land. When the Railway company went bankrupt, the bond-holders of the railroad were given land that was originally titled to the railroad company. As a result of this transaction, the company started as a Trust which held 3 million acres of land in 1888. When the trust was formed, the bondholders exchanged their bonds for shares in the trust and those shares have been trading on New York Stock Exchange ever since. This company had a simple mandate. That simplicity in itself is its strength. The company’s mandate is to dispose off the land and pass the benefits to the shareholders by repurchasing shares in the open market. It does not need to get into debt. It does not need to acquire other companies. It does not need to perform any marketing for its products. It does not even need to find new drugs to bring to market. They don’t need to perform any research or development. All Texas Pacific Land Trust does is use the company’s cashflow and buyback shares. It does nothing more, that is why it functions fine with 32 employees.
How does the company generate cash-flow from this land? It currently owns around 887,698 acres of land after trying to slowly self-liquidate. It produces cash by granting mineral rights to oil companies. If there is no oil in some patches of land, it is mostly used for grazing cattle. Occasionally they sell a few acres, but not very frequently. Notice that this company had 1.1 million acres in 1932but still has 887,698 acres on the books in 2017. They pay a small dividend and whatever money that is left out is used to buy back stock. They have been doing this since 1932. In 1932, there were 500 million shares outstanding. This process of buying back has brought current shares outstanding to 7.85 million shares. Once you extract oil, you cannot do anything other than shipping the oil via a pipeline. If this pipeline goes over the land where cattle is grazing oil companies still need to pay rent for providing access across the land owned by Texas Pacific. This helps them in generating more rental revenues.
Their revenues are inflationary. It has no associated cost, because they are not building oil rigs; they are not renting rigs. The Trust is merely signing a document that gives an exploration and production company permission to operate on its land-it’s an easement, essentially. It gives them permission to operate for a limited time period on their land. So, the incremental revenue is really incremental profits. But what is much more important is that they use this money to buy their shares. Eventually, if they kept buying in shares at the current rate, I estimate that somewhere between 20 to 25 years there will be one share left. That 1 share will be very valuable, because you will be owning close to 800,000 acres of land with the potential of royalty income. This can be seen in a real-life example. It was reported in a local newspaper that a particular individual has lost their share certificate of Texas Pacific Land Trust. This certificate was worth approximately $350 in 1907. This share Certificate #390 was later found in a Wells Fargo bank vault in 1979, was restored to an heir of the original owner and liquidated in 1986 for an amount in excess of $5,700,000. It is a CAGR (Compound Annual Growth Rate) of 12.89% over the 80 years. This stock brought this amazing return by doing so little. I am pretty sure that S&P 500 has not returned that much in the same period.
At Ikkurty Capital, we focus on Blockchain assets and we don’t spend any time on stocks. There is an interesting lesson to be learnt from understanding why Texas Pacific Land Trust stock has performed so well. This company achieved this by continuously buying back shares, reducing its outstanding shares from 500 million to 7.85 million. Since outstanding shares are reducing, every time they buy back a share, the next share purchase is a greater proportion of the remaining shares. They built a compounding machine. The supply of shares is shrinking; therefore, the price has to just keep going up. This is similar to bitcoin in many ways. Bitcoin’s total supply is 21 million which is supposed to be released by 2140. Bitcoin’s current circulating supply is close to 17 million. But we do know for a fact that every year large number of people are losing their passwords and losing access to their wallets. Based on a study, nearly 3.78 million bitcoins are lost forever. This is exactly like the shares being retired in case of TPL. Every year vast number of people are going to lose the coins, due to many human errors. All those lost bitcoins are a gift to all the people who are still holding their bitcoins, causingthe value of remaining coins to go up. In case of bitcoin, when you lose the private key you lost your money permanently. It is exactly like retiring stock by buying back shares in the open market. Stock market is a mechanism to transfer wealth from impatient holders of capital to patient holders of capital. All those patient investors of bitcoin will be well-rewarded from the money lost from the impatient holders, who do not understand the mathematics behind bitcoin.