Updated thoughts

Following another Berkshire annual meeting I want to summarize my current thoughts on portfolio positioning with some macro thoughts juxtaposed to micro ideas.

I thought the most telling moment in Buffet’s Q&A came when he talked about the unsustainability of the US deficit:

Those are Buffet’s quotes and the potential for a sovereign debt crisis has been a black swan event I have worried about for a long time. It is the boiling frog effect and one that Buffett notes that there is little appetite to tackle. I have thought about how to protect my assets from the potential debasement of the currency which would be preceded by a bond market collapse.

US Debt Unsustainability

All investors are aware that in 2024 the US spent close to $6.75 trillion a year and brought in just under $5T in revenue. This deficit level as a percentage of GDP as Buffett noted is close to 7% and historically a 3% level is sustainable. As Buffett noted the US as the dominant global economic and military power has not yet faced any consequences to runaway deficits. The fiscal profligacy of the Biden administration was staggering. Similarly, Trump’s deficits during his first term were equally as staggering and the situation was not much better under Obama or GW Bush. As a result, the country has now run up nearly $37T in debt. The cost to service that debt is rising by the day as the amount of low coupon debt issued during the zero-interest rate policy during 2020-22 rolls over. The interest on the debt is now $1T and rising. It is higher than military spending and is now nearly 20% of revenues. Normally these numbers should be ringing alarm bells in Washington and the bond market (the latter is starting to show signs of the bell tolling). However, Trump’s new budget shows a similar sized deficit as his ~$165B in proposed cuts is offset by ~$100B increase in military spending. Meanwhile, DOGE has been a big bust. Musk, holding true to his reputation, made ridiculous claims he would cut $2T, then ratcheted down to $1T and the actual numbers may turn out to be less than $100B, a drop in the bucket vs the near $7T in expenditures. The vast majority of the spending is on entitlements which neither party is willing to touch. Entitlements are going to grow inexorably due to demographics and inflation linked increases. As Buffett said, how many years will it take until investors realize that the US government will eventually have to monetize the debt or force an onerous debt exchange on Treasury bond holders? 2 years, 20 years? No idea. How does one hedge themselves from the risk of currency debasement and eventual runaway inflation? Other countries, where the rule of law is respected, face similar challenges making the Euro, Yen, GBP similarly treacherous. Emerging markets are difficult as foreign investors risk various forms of asset confiscation as the rule is not respected.

GOLD and BITCOIN

Gold and Bitcoin have both done well and I am uncomfortable holding as I have no idea how to think of what the appropriate price is for either one of them — I mean I don’t even have a BALLPARK idea. So, I sadly have avoided them and won’t jump in now. (Besides in a MAJOR crisis I am not sure both can’t/won’t be confiscated)

This leads me to buying hard commodities which should provide a shield from monetary inflation. Oil and gas, copper, and other minerals all fit the bill. Unfortunately, before we get to a sovereign debt crisis, we may first endure a cyclical downturn which could pummel demand for these commodities while supply adjusts much more slowly. It seems like Oil prices are now in this situation. I purchased Frontera and AMPY last year which has turned out to be quite poor timing. Frontera is down 35% from my cost and AMPY has been a disaster down 60%. AMPY has had a number of own goals from an ill-advised and poorly timed merger to operational problems in Q4. Both stocks trade at lower valuations than they did during COVID despite much improved balance sheets and significant hedges. Oil prices seem destined for a prolonged stay in the $50-$60 range which likely means both stocks will be lower in the short term. I fully expect this cyclical downturn to set up a significant bull market in time as OPEC brings all its production back and more expensive crude like Shale pares back and shrinks by a similar amount. Meanwhile, a price in the $50s with a weak dollar means very low prices for the rest of the world and, as such, demand could remain quite resilient. Clearly my 20% portfolio weight in these two stocks has been painful and may get worse. However, in time I expect a strong recovery and eventually a decent IRR (much more so in Frontera vs. AMPY as the latter has a $5.50 cost basis).

NMM

I decided to sell my NMM in the low 30s taking an ugly 30% loss. My fear is globalization is clearly in retreat and shipping will eventually see an ugly downturn. Tankers may actually do well but the container exposure at NMM scared me out and this will likely be a bad decision, but I did use the money to buy TEVA and VTRS which I believe have similar upside without the huge downside.

RMTI

RMTI has been another major disappointment as the company was blindsided by one large customer risk. While I was aware of this risk, I considered it highly remote and so did RMTI. However, it happened and now RMTI is in a position where the market dynamics have changed from a duopoly to a 3-player market where it is a minnow with two whales swimming about. The CEO here is a shrewd operator and I have confidence he will engineer a positive outcome. Japan based Nipro’s entrance in the market where they don’t have any distribution is a perfect fit with RMTI which has distribution and touch points with a huge customer list that Nipro can cross sell higher margin products into. It makes all the business sense in the world for these two to get together although clearly RMTI is not in a strong negotiating position having lost the DVA business to Nipro. Nonetheless, RMTI in private hands is a $7M operating profit business ($3M in operating earnings plus $4m in public company costs that go away in private hands). RMTI has $13M in net cash and $23M in net working capital. I believe it is worth 10x operating earnings plus net NWC which equates to ~$105M or $90M for the equity. This would equate to $2.75 a share but they probably settle for less at $2.25- $2.50. Given my cost of $1.50, this could eventually turn out to be a decent IRR and it does have the benefit of having no cyclicality. So I wait, but clearly this has been a major disappointment for me and one I failed to see coming.

IMMR

IMMR remains my largest position and is basically a defensive bet with what I believe to be significant upside vs. the risk we are assuming. The company has $6 in cash and securities, a profitable patent troll business, and its 11.2M share stake in BNED. The 1-year anniversary of the BNED transaction is in June after which I think the chances of some sort of monetization increase dramatically. Simply distributing the shares means for each IMMR share we would receive ~0.35 of BNED. At ~$10 BNED vs. current $10.50 this is worth $3.50 per IMMR share. I do believe BNED shares are cheap and could be worth much more, especially if they are able to engineer a deal with one of their two major competitors. Any such deal would have huge synergies but, at this point, this is a hope/dream so let’s just assume $3.50.

The patent business has a significant lawsuit against Valve Software which I believe will be settled soon for $25-$50M. This would bring in $1 per share and a small new royalty stream. It highlights the value of the patent business which I conservatively value at only $3 a share.

This brings the total value here to $12.50 a share. Assume a 20% discount of 20% which is excessive in my view given the company is buying back shares down here and I believe the stock should be trading closer to $10. This is significant upside with plenty of optionality at BNED for a company with very little downside.

Smaller Positions

I continue to hold smaller positions in TWMIF, SCOR, TORO, HRBR, NRDE, ARVN, (a basket of other biotechs) and LMNR. Most of these have thus far been ugly losers although I do believe they all have significant value. None of them should be public companies anymore. The threshold where it makes sense to be a public company IMO is now well above $500M. The structure of the market now is one where index funds dominate flows and now own 50% of the equity market. Given index funds are highly skewed to S&P 500 and large caps in general, small caps get very little money flowing to them from the 800 lb gorilla so to speak. Active players in the HF space have also abandoned the space as the liquidity has dried up and the risk/reward have become unfavorable. Small caps tend to be lower quality and prone to negative surprises. If you are compensated when you are correct and can make 2-3x your money, the expected value is positive even when your mistakes lead to 50% losses. However, given the lack of attention and money flows when you are correct, you tend to get paid less for the upside and when you are wrong, you lose much more as liquidity makes it difficult to exit. Historically playing in this less efficient space has been fruitful for me but given the new market dynamic, in hindsight, I should have skewed my own bets towards reasonably priced larger cap names. My performance has been horrendous over the past 6 months. Most of the underperformance has been due to poor stock picking. The lack of interest/liquidity has exacerbated the declines and likely has impaired the upside for some of these companies because upside is likely to come from takeovers vs. appreciation in public markets.

I will end the rambling here and write up a post on LMNR which I am unsure on how to size…