July 1, 2024

Hulking Cash Hoards

Authored by Louis Stevens

I may have mentioned it, though I'm not positive that I did, but I am currently re-reading Peter Lynch's acclaimed book "One Up On Wall Street." I know that I've discussed the book, and the value thereof, with you in the past, and I do believe every investor should read it, especially those that will choose to spend their time with L.A. Stevens in the years and decades ahead.

As a somewhat unrelated aside, one interesting aspect of the book is simply the ability to review Mr. Lynch's thinking regarding the many different securities he shared as case studies or examples in the book.

In investing, we all invariably get investment ideas wrong. It's the nature of the game, and, in One Up On Wall Street, you'll find at least a handful of instances in which Mr. Lynch's viewpoint on the world proved to be misguided, which I say with genuinely every ounce of respect for him. He authored the book in 1989, then provided an update to it around 2000; so we've had about 25-35 years now to witness how his predictions or views of the world have played out as the world around us has evolved. One of the most notable evolutions has obviously been the emergence of the digital industrialization of earth, which has brought with it entirely new paradigms for investing; namely, the emergence of durable and high quality digital businesses, such as Salesforce, Amazon's AWS, or Apple's hulking software business, purchased by the foremost technophobe, Mr. Buffett (which should be a signal to all that times have, indeed, changed).

But, while times change, the central constant has been and will always be that good investing entails buying quality businesses at reasonable to discounted valuations, then holding them for the long term. Money is a game of energy dynamics, governed by the law of physics. While risk/return makes the future inherently uncertain, basic mathematical principles govern the pricing of stocks over the long run (short term is anyone's guess and a game of fear and greed usually).

And, to this end, we will briefly (remember this our "Briefs" series) discuss one element of buying quality businesses at reasonable to discounted valuations: The Cash Element.

Hulking Cash Hoards

While reading through One Up On Wall Street, I happened upon this excerpt that detailed Mr. Lynch's approach to accounting for a company's cash balance, and, as importantly, its debt balance.

In discussing businesses with you, I use the metric "Enterprise Value" (which = Market capitalization less net cash).

This implicitly communicates the ideas shared in Mr. Lynch's writings, and, were he not writing for specifically a retail audience, he likely would have used the phrase enterprise value as well.

I use enterprise value to account for cash, or the lack thereof, in the same way Mr. Lynch accounted for cash in his assessment of Ford.

For instance, I've been noting that Sea Ltd. has $8.6B in cash/investments against $2.35B in convertible debt. This represents a net cash hoard of $6.25B. With 570M shares outstanding, this represents $11 in net cash per share that we get when we buy the stock at $71/share, and this is worth noting. I've also been parsing the value of each line of the Sea Ltd. business in the same way Mr. Lynch parsed the value of each line of Ford's business. For instance, I've noted that Garena generates ~$1.2B in cash/year, and it will grow 10%+ this year, possibly 20%+ if Free Fire India relaunches. As a standalone company, this would likely trade at $30B in market capitalization, which equates to $52/share (Sea has 570M shares outstanding). So we're already at $63/share, and we've not even begun to consider the value of SeaMoney, Sea's logistics arm (Fulfillment by Shopee), Sea's digital ads business, or Shopee, which has earth-leading market share relative to its peers globally, ex CN/RU where I have no idea what the market shares are). And it's worth noting that Sea Ltd. has returned to what I would consider hypergrowth at its scale, i.e., 23% year over year growth, as something of an aside here.

Every single business I discuss with you has a hulking cash hoard that, in some instances, is preposterously large.

In the case of Grab, it has $5B in cash and $750M in long term debt on its balance sheet. At just $14B in total market capitalization (share price * shares outstanding), this implies that over 33% of Grab's market cap is in cash.

When we buy Grab, we pay $3.50/share, and we get $1.06/share in cash. (The co. is also growing 20%+.)

Snowflake has $4.75B in cash and $0 in debt. (The co. is growing 30%+.)

Monday has $1.3B in cash and $0 in debt. (The co. is growing 30%+.)

And the list goes on and on. The businesses I discuss with you have preposterous amounts of cash and little to no debt.

Importantly, were the inverse true, we'd develop a greater appreciation for accounting for cash in this way.

For instance, if the company had $6B of long term debt and $1B of cash, enterprise value would account for that by expanding, instead of contracting. Here's an example:

For instance, if Sea Ltd. had $6.25B of negative net cash ($2.35B cash; $8.6B long term debt), or $6.25B of net debt, its enterprise value equation would result in an enterprise value that was higher than in the net cash example provided above.

So instead of, for example, 20x EV/fcf, Sea's debt-ladened balance sheet would lead it to being valued at 25x EV/fcf (random example).

This horrible balance sheet position would be communicated by the higher enterprise value, and by extension, more expensive stock. The higher enterprise value, and by extension, more expensive stock would communicate to investors that this is a less attractive value proposition, and the inverse would be true in a net cash scenario, hence this is the value of using enterprise value instead of just market cap.

That's all I have for you today. Thank you for reading.


L.A. Stevens has rated Sea Ltd., Grab, and Monday "buy."

L.A. Stevens has not rated Snowflake.

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