Tag Archive for: Warren Buffett

Mauna Loa

Mauna Loa is Earth’s largest active volcano. The Hawaiian mountain is also the world’s tallest. Mauna Loa rises 30,085 feet from base to summit which is higher than Mount Everest measured from sea level to peak (29,029 feet). To say that much lies below the surface is an understatement. The weight of millions of years of volcanic eruptions has actually caused the Earth’s crust to sink by five miles. Therefore, the total height of Mauna Loa from the start of its eruptive history is an astounding 56,000 feet.

The 45,000 residents of Hilo, Hawaii, while living among some of the most beautiful surroundings in America, also face the possibility of extinction. Mauna Loa last erupted in 2022, but lava flows were minimal. Eruptions damaged small villages in 1926 and 1950. The most recent serious threat occurred in 1984, when massive rivers of molten rock stopped just a short distance from Hilo Bay. The threat to Hilo is not an apocalypse of Pompeian proportions. No, the real danger is a slow and painful demise. If Hilo Bay fills with lava, cargo ships can’t dock. The Big Island would cease to be habitable.

Now if you think I’m about to use my newfound knowledge of volcanic peril as some kind of metaphor for the current state of financial markets, you would be absolutely correct. It’s coming down Fifth Avenue. About as subtle as Captain Kirk wearing a Bill Cosby sweater.

In my metaphor, Warren Buffett is the Pacific Ocean near Hawaii. Vast, deep, and refreshingly cool with about $325 billion of cash on hand after selling more Apple stock, according to Saturday’s 3rd quarter report. Yes, he’s got some risk from storms but mostly it’s smooth sailing. Mauna Loa is the AI bubble. As lava keeps building up, the peak gets higher. It’s thrilling… and dangerous.

Technology companies will spend $200 billion this year on capital improvements related to artificial intelligence. This technology will require the addition of 14 gigawatts of additional power by 2030. To put that in perspective, Berkshire Hathaway Energy’s coal plant in Council Bluffs produces 1,600 megawatts of electricity.

Do you think nuclear is the solution? Well, Georgia just opened our country’s latest nuclear facility. The Alvin W. Vogtle Electrical Generating Plant sits along the Savannah River in Waynesboro. This marvel took 15 years to build and cost a mere $35 billion. Its generating capacity is 4,500 megawatts.

Technology has a history of delivering miracles, but it also bears witness to a poor track record of capital allocation. Look no further than Lumen Technologies (LUMN), the offspring of the fiber optic cable bubble of 1999-2001. Lumen holds the fiber assets of CenturyLink, Qwest and Level 3. If those names sound familiar, there was nothing like the Level 3 bubble for Omahans of a certain vintage who rode the Kiewit spinoff to dizzying heights and painful lows. And we all remember the Qwest Center. Despite a debt restructuring earlier this year, LUMN remains safely in junk territory and will be fortunate to stave off bankruptcy.

You didn’t come here for macro-economic observations or a mini-course in geography. There’s investment ideas to be had.

Welltower

My contention that Welltower remains 40% overpriced relative to the underlying value of its assets took a step back after the company raised annual per share FFO guidance to $4.33 from $4.20. In my estimation, this upgraded forecast is worth $1.3 billion of additional net asset value and raises the total to $50 billion. A nice boost, indeed. Shares rose accordingly.

Despite the improved performance, my bearish outlook for Welltower remains firmly intact. If you’re scoring at home, you’ve got a REIT with a market cap of $80 billion yielding less than 2% and trading at 30 times FFO. The company also announced a $5 billion equity offering. REITs like Welltower that invest capital at modest yields are forced to turn to equity for growth when the debt gets too expensive. They become dilution machines.

CK Hutchison

There are times when value traps are like a Siren’s song. It’s like watching Lethal Weapon when nothing else is on. You know that there is no plausible reason why Gary Busey’s henchmen can’t kill Danny Glover in the middle of the desert, but you’re damn well going to watch anyway because you need proof that this cinematic muddle was deserving of three sequels. But thank God they kept going! Lethal Weapon 2 has that fantastic moment when Joe Pesci brings Danny Glover to the South African consulate and tells them he wants to emigrate to the land of Apartheid.

Anyway, CK Hutchison is the descendant of the Hutchison Whampoa conglomerate built over decades by Li Ka-Shing in Hong Kong. I wish there was an updated biography of Li who is now in his mid-nineties and has passed the reigns to his son. He certainly belongs in the business hall of fame. CK Hutchison has a market capitalization of about $20 billion and holds some of the world’s largest port infrastructure assets and telecom businesses. The stock trades at 29% of book value and offers a dividend yield of about 6%.

I ran a few back of the envelope numbers, and CK Hutchison pencils to roughly $60 billion of value. Yet, the stock has been “cheap” for many years. Why decide to invest now? It seems like the second generation of Li’s family (now in their 60’s) has figured out that something needs to be done for long-suffering investors. The company listed its infrastructure assets on the London exchange in August as “CK Infrastructure”. They have also contributed their European mobile networks to a joint venture with Vodafone.

The appeal of CK Hutchison is that its port infrastructure is irreplaceable. Unlike auto manufacturers and steel companies which deservedly trade below book value due to brutal competition, ports are generally impervious to competition. Nature only created so many locations around the globe where massive cargoes can dock. Globalization may be taking a step back, but it’s not stopping. I’m going to dig more deeply into CK Hutchison.

Until next time.

DISCLAIMER

The information provided in this article is based on the opinions of the author after reviewing publicly available press reports and SEC filings. The author makes no representations or warranties as to accuracy of the content provided. This is not investment advice. You should perform your own due diligence before making any investments.

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Strange

In 1990, Jeremy Irons won an Oscar for his portrayal of the mercurial and debonair Claus Von Bülow in Reversal of Fortune. Von Bülow captured tabloid headlines for the attempted murder of his Newport socialite wife, Sunny (Glenn Close). The case seemed hopeless. Only Claus had access to the insulin that left Sunny in a diabetic coma. Evidence was only part of the problem. Claus was not exactly a warm and fuzzy guy. With his angular chin and vaguely European accent, the ascot-wearing Von Bülow was aloof and arrogant. Against the odds, the young professor Alan Dershowitz (Ron Silver) and his earnest team of Harvard Law students delivered a stunning acquittal. 

At the end of the movie, Claus sits in the back of his chauffeur-driven Jaguar as Dershowitz bids him farewell, saying: “You know, it’s very hard to trust someone you don’t understand. You’re a very strange man.” As the door closes, Von Bülow deadpans, “You have no idea.” 

“Strange” is subjective, of course, and context matters. Claus was probably a normal guy if your scene was 1970s ski chalets in Gstaad. To a working class jury in 1980s Rhode Island, he was eccentric. 

If you’re on the artificial intelligence bandwagon, everything might seem pretty normal right now. Short term interest rates are coming down and we may be on the cusp of a new information technology miracle. In this exuberant era where the NASDAQ sets new records nearly every day, Omaha’s Warren Von Büffett seems strange. After all, he’s sitting on $240 billion of T-bills. Imagine selling all that Apple stock right when this AI thing is just starting to take off!

What’s strange? What’s normal? I like Jodi Picoult’s thoughts on the matter: “I personally subscribe to the belief that normal is just a setting on the dryer.” Ms. Picoult usually digs deep into matters of the heart, but she could just as easily be opining on the current state of financial markets.

The value of corporate equities as a percentage of GDP has only been this high two other times. While most of us mortals must pay our debts by forking over cold hard cash to the lender, huge numbers of heavily indebted firms are paying their interest bills by issuing IOUs. You need to squint to see the spreads on corporate bond yields. It turns out that nearly losing one presidential candidate to assassination, and the other to dementia doesn’t have much of an effect on markets. Did I mention there are two wars with nuclear implications going on? How about the collapse of the world’s second largest housing market? Nope, hold my beer because the QQQs keep ripping higher. 

I remember the Three Mile Island meltdown. It was not an auspicious moment in American history. We had kind of a Jimmy Carter-malaise thing going down, and our status on the world stage was being put out to pasture by Ayatollah Khomeini. We couldn’t even manage nuclear power plants very well. When they said we’re re-starting Three Mile Island again because we need so much power to run these AI chips, my bullshit detector issued an alert. 🚩

Welltower (WELL) is a company that Claus Von Bülow might prefer: Very strange, indeed.  Welltower stock behaves like it belongs among the exalted world of artificial intelligence  – surging ahead by 45% over the past six months alone. Given the levitating stock price, it probably shouldn’t come as a surprise that Welltower’s CEO quoted Jensen Huang in his last shareholder letter. The excitement fades pretty fast when you realize that Welltower operates in the staid world of housing elderly folks.

While other senior living companies trade within a justifiable range of the value of the underlying assets, Welltower seems divorced from reality. By my reckoning, the company trades at a premium of over 40% to its underlying bricks and mortar. Welltower is a Toledo-based owner of senior living facilities that trades at a market capitalization of over $80 billion, or $132 per share. However, a reasonable valuation of the real estate indicates that the stock should trade closer to a level of $50 billion. That computes to a share price near $80.

As a real estate investment trust (REIT), Welltower is required to pay out most of its earnings as shareholder distributions. Yet the yield on offer is a paltry 2%. Growth can only be achieved by adding external capital, and Welltower has issued billions of dollars in new stock since the debt markets became less hospitable. In December 2022, the company also gained the dubious distinction of a write-up by Hindenburg, the famed short-seller, for questionable dealings with the mysterious Integra Health Properties.

Moreover, Welltower is not a simple business. WELL has a complex collection of disparate facilities throughout the country operated by a diverse set of managers. Many facilities are net-leased to other operators leaving Welltower the simple role of cashing rent checks as a landlord. Many others are operated hands-on by the company. Looking after the elderly is a tough business. You need skilled medical staff to run these properties in addition to a legion of cleaners and minders. The government is constantly looking over your shoulder (especially after the whole Covid fiasco), and Medicare money comes with strings attached.

Welltower also acts as sort of a bank for senior housing developers, with over $1.7 billion of notes receivable on the books. To complicate matters further, WELL also owns a collection of outpatient medical clinics.

There are certainly many reasons to praise Welltower. The company disposed of $5 billion of struggling assets during the dark times of Covid, and rebounded with a $10 billion acquisition frenzy over the past three years. Welltower added another $2 billion of development during that time. In 2023, operating income (including depreciation) increased by over 30%. 

Hindenburg’s questions aside, I don’t see anything nefarious about Welltower. It is just really expensive. Welltower is a business which earns returns on capital around 6% and returns on equity around 7-8%. This won’t set your nanna’s pulse racing. Through 6 months of 2024 reporting, operating income has only risen 5%. Meanwhile, notes receivable from operators have doubled since 2022. Who’s borrowing from Welltower at 10% interest rates? Probably not the most seaworthy. The firm racked up $36 million of impairments in 2023 and $68 million for the TTM period to June 2024. These aren’t horrible figures, but they show that not everything comes up smelling like roses in the senior living business. 

Management recently guided for $4.20 per share in funds from operations (FFO) for 2024. This preferred metric for real estate investment trusts adds back depreciation and other non-cash items. I reverse-engineered the guidance for FFO to arrive at a pro forma net operating income (NOI) for 2024 of $3.3 billion. This NOI calculation takes FFO a step further by removing debt service costs and the administrative costs of running the company to arrive at an unleveraged, asset-level value for the business. 

In fairness to Welltower, the increase in NOI is substantial compared with the $2.7 billion generated in 2023. The company has certainly improved operations, pruned underperforming assets, and had much stronger occupancy levels as the post-Covid senior market has recovered. A 22% increase in NOI is impressive for any business, especially a real estate company with slow-moving assets. 

How does $3.3 billion of net operating income translate into asset values? I capitalized the income using 5.97% to arrive at a gross asset value of $55 billion. 

The 5.97% “cap rate” was derived using the following logic: I simply applied the spread for Welltower’s Standard & Poor’s BBB credit rating to the “risk-free” 10-Year Treasury yield of 4.07% to arrive at a current debt cost of 5.15%. I assumed that the company earns an equity yield just 1% higher than this cost of debt (6.15%) and weighted the equity percentage at 85%. One could argue that this 5.97% cap rate is slightly high. Perhaps I could impute a bigger weighting to the less-expensive cost of debt. After all, Welltower has been able to raise debt at much lower rates in the past.

My counter-argument would be that a lower cap rate would be too aggressive for a business that has a mixture of assets, ongoing charge-offs for underperforming notes receivable, and a collection of diverse and unpredictable operators assigned to the facilities. Finally, I am not making any allowances for capital improvements at existing properties. These assets require nearly $600 million per year in upkeep that is not reflected in NOI. They are, however, certainly an ongoing cash obligation for Welltower. I am being very generous by excluding them in the value computation.

To arrive at a net asset value, I added cash of $2.6 billion as well as construction in progress at book value, and unconsolidated equity interests at 1.5x book value. After subtracting debt of $14 billion, Welltower’s net asset value pencils slightly above $48 billion.

You may say that I’m not appropriately valuing the future. There’s more upside at Welltower, says you. Yes, there is more upside. Unfortunately, as a REIT which is required to distribute its earnings to shareholders, incremental growth can only come from external capital: Sell more stock or raise more debt. When you’re earning returns on capital in the 6% range and you’re borrowing at 5%, you don’t have tremendous opportunities for upside. 

I am short Welltower. It’s a $132 stock that should be priced to yield in the mid 3% range around $80-85. 

I could leave you with some Jim Morrison lyrics. Instead I will give you something special by Wire. Or you may prefer REM’s 1987 cover version:

“There’s something strange going on tonight.

There’s something going on that’s not quite right

Joey’s nervous and the lights are bright

There’s something going on that’s not quite right.”

Until next time.

Disclaimer:

The information provided in this article is based on the opinions of the author after reviewing publicly available press reports and SEC filings. The author makes no representations or warranties as to accuracy of the content provided. This is not investment advice. You should perform your own due diligence before making any investments.

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No country for old men

At the risk of sounding like Jimmy Carter, I felt a sense of malaise at this year’s commercial real estate summit. Last week, the Omaha conference reached its 35-year milestone under the guidance and creativity of the indefatigable attorney and developer, Jerry Slusky. Maybe it was the panel discussion that devolved into career counseling for young brokers by a grizzled veteran. Perhaps it was the lack of statistics on rental trends and square footage absorption, leading a developer to wanly muse about seeking out markets where “demand exceeds supply.” This revelation produced solemn nods and much chin-stroking from the pilgrims.

Lenders assured me that none of their loan books had the faintest whiff of distress, yet a panel on the subject implied otherwise. One general contractor told me that many of his clients in the southwestern portion of the US are going ahead with apartment projects “even though the numbers don’t work” because they know they are locking in today’s cost basis for the future. I had no response to this business plan. Using such logic, one could have made this justification to move forward on a real estate development at virtually any moment in the past 75 years.

It was the irascible Creighton economist Ernie Goss who brought out the wet blanket. I love an economist who is one-handed. There aren’t many. Dr. Goss gamely mixed John Maynard Keynes with Warren Zevon, befitting a professor who could pass for Bob Dylan’s cousin. Goss talked about the agricultural sector in gloomy tones. Corn at $4 a bushel is no bueno for Nebraska. His most sobering reminder was the chart showing that interest on the national debt now exceeds spending on national defense. No empires have survived this inflection point. All that Aztec bullion filled Spain’s coffers for two centuries before an overextended domain began to unravel in the late 1800’s. France sold its New World colonies to pay for Napoleon’s conquests. Lest one thinks such fate can’t befall the holder of the world’s reserve currency, it was Britain with her once-invincible pound sterling that was hobbled by two world wars and went cap-in-hand for an IMF bailout in 1976. George Soros heaped further ignominy on the beleaguered pound in 1992.

I can be prone to cynicism. It’s a blind spot, and an especially poor trait in a real estate developer where one’s raison d’etre is the rosy future. But I can’t help but feel there is a bit of the “end-of-the-Roman-Empire” feeling around. There’s bacchanalia galore with stock indexes hitting all time highs, private jets whisking families on vacation, the return of the Hummer, liquor lockers at private clubs, multiple country club memberships, CNBC masquerading as due diligence, billions of dollars in NIL money for college athletes, the de-facto legalization of THC and sports gambling, and Nebraska finally going all-in on it’s own casino gambling. Meanwhile, the low end of the income spectrum faces insurmountable home-ownership costs and pain in the grocery aisle. There are two wars being waged on the doorstep of NATO, a former president was nearly assassinated, and the current president all-but-admitted he was too senile to serve another term. And yet! And yet. What’s the VIX at? 100? Nope, try a benign 15.79. Credit continues to flow. Jerome Powell just declared victory. Game on.

You’re starting to ramble. Are you turning into an old man? Well, I don’t think of myself that way, but in actuarial terms the answer is unfortunately, “yes”. But there’s a place for old men. I’m not talking about ending up like Sheldon Levene in Glengarry Glen Ross. I’m envisioning Clint Eastwood here. Cigar and a Smith & Wesson. Let’s take another wise old Omaha guy I like – Warren Buffett. Berkshire Hathaway owns $235 billion of Treasury bills after significantly reducing holdings of Apple. Buffett may be old, but he’s not cynical. I can’t recall an annual meeting where the words “America’s best days lie ahead” weren’t uttered. However, in this instance, I prefer to watch what the man does, not what he says.

Dude, this is bumming me out, and your Hollywood references are beta. Let’s move along to that book you’re reading.

Ok. I’m about halfway through Nate Silver’s On the Edge: The Art of Risking Everything. It’s a fun read, but I think Silver could have used a better editor (pot, meet kettle). We follow his poker exploits, head down his sports betting rabbit-hole, take a tour of the venture capital industry, and then make an off-road excursion into the bizarre downfall of Sam Bankman-Fried. These are members of “The River,” Silver’s term for those who think in terms of probabilities and make wagers using their best estimates of positive expected value (EV). Yet, so much of what passes for rigorous evaluation of odds based on massive amounts of data often coalesces into little more than well-informed gut instincts. Silver seems to recognize this despite his continued attempts to explain most decisions in probabilistic terms. Take bluffing, for instance. Poker players smoke out a weak hand with a massive bet. Brute intimidation can often work better than the best statistical calculator. Venture capitalists are guilty of herd mentality and they have been conned by the likes of Adam Naumann and Elizabeth Holmes more often than they care to admit.

I am not a mathematician, and my knowledge of statistics is only good enough to read a Nassim Taleb book without a thesaurus. Nor am I a gambler. However, one character seems to be missing from Silver’s book – the 18th century Swiss mathematician Daniel Bernoulli. Silver relegates him to the footnotes. It was Bernoulli who first started to ask why people didn’t take certain bets, even though the probability might yield a positive expected value. Bernoulli figured out that the value of a bet was in direct proportion to the utility of the additional wealth to be gained. A rich man probably wouldn’t take long odds if it meant a major loss of capital, but a poor man has little to lose on a longshot. If you want a great discussion of Bernoulli and his role in finance, pick up The Missing Billionaires by Victor Haghani and James White.

Silver brushes right past Bernoulli’s revolutionary discovery. In a parenthetical aside, he writes “If you had a net worth of $1 million, would you gamble it all on a one-in-50 chance of winning $200 million and a 98 percent chance of having to start over from scratch? The EV of the bet is $3 million, but I probably wouldn’t.” Probably wouldn’t?!?! How about “no way”! Unless you are very young and have immense confidence that you can re-earn your million-dollar nest-egg, you’re not going to take that bet.

The marginal utility of wealth is critical to understanding the business wagers called “investments.” A venture capitalist on Sand Hill Road with $200 billion of assets under management will not agonize over staking $20 million on an AI-powered start-up that automates logistics in warehouses if it has a chance for asymmetrical upside returns. A solo investor with a net worth of $20 million would never take on such a venture alone, despite his or her immense personal wealth. Kahnemann and Tversky famously uncovered the psychology behind such thinking. Humans are risk averse. Most of the time expected pain of loss is greater than the appeal of a gain.

All of this talk of Bernoulli and wagering based on one’s wealth rather than simply the expected value of a bet reminds me of another Warren Buffett gem: When discussing the failure of Long-Term Capital Management which was headed by Nobel laureates and nearly brought markets to a standstill in 1998, Buffett remarked:

But to make money they didn’t have and didn’t need, they risked what they did have and did need. That is foolish. That is just plain foolish. It doesn’t make any difference what your IQ is. If you risk something that is important to you for something that is unimportant to you it just does not make any sense. I don’t care whether the odds are 100 to 1 that you succeed or 1000 to 1 that you succeed. If you hand me a gun with a million chambers in it, and there’s one bullet in a chamber and you said, “Put it up to your temple. How much do want to be paid to pull it once,” I’m not going to pull it. You can name any sum you want, but it doesn’t do anything for me on the upside and I think the downside is fairly clear. So I’m not interested in that kind of a game. Yet people do it financially without thinking about it very much.

I think we’ll leave it here for now. Coming soon… I have crunched some more numbers on Peakstone Realty Trust (PKST), and I think it trades at a 30% discount to it’s net asset value. You also get a 6% dividend while you wait. Elsewhere, Iron Mountain (IRM) seems to be infected with the same kind of data center hype that is artificially buoying the legacy data center stocks Digital Realty Trust (DLR) and Equinix (EQX) – companies that inflate their earnings by minimizing their depreciation and distorting operating cash flow by attributing far too much weight of capital expenditures to “growth” vs “maintenance”. Finally, I ran some numbers on Carnival Cruises (CCL) with the thesis that it would make a good short. It’s leveraged to the hilt. There were no COVID bailouts for cruise operators who are domiciled in tax-havens. Sorry, you can’t have it both ways. It seems I am wrong about CCL. Barring a major consumer slowdown (not entirely out of the question), the stock seems fairly valued. Until next time.

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The secret life of the gas station

I’ve read a lot of business books and I have to say that The Secret Life of Groceries now ranks in my top four. It’s right up there with Power Failure: The Rise and Fall of General Electric, Shoe Dog, and the Enron book by Bethany McLean, Smartest Guys in the Room. Benjamin Lorr spent over four years working alongside the army of the invisible who feed us every day. Lorr introduces readers to the groundbreaking approach of Trader Joe, but quickly descends into the harrowing world of industrial fishing where human slavery still exists. The indentured servitude faced by many long-haul truck drivers is only slightly more uplifting. You can learn about the battle for shelf space by following the journey of the unheralded condiment known as “Slawsa”, but your stomach will get queasy reading about everything from industrial chicken plants to the seafood counter at Whole Foods. The writing is masterful.

It’s probably time for a similar book on the convenience store industry. The growth of commercial roadside stores seems to encapsulate all that is right and wrong in our post-industrial society. The bright lights, shiny logos, ice-cold refrigerators, and elaborate coffee kiosks say much about our need for instant gratification, instant calories, and lack of time. Gleaming canopies with antiseptic white LEDs beckon drivers in need of gas for the automobile, but hydrocarbons are merely an appetizer. Fat margins are earned from products that mostly make you fat. What’s your addiction? The gas station can give you a quick fix. Candy, soft-drinks, alcohol, cigarettes, lottery tickets, caffeine and even pizza and brisket can be found in the widening world of convenience. Low-wage employees are surprisingly friendly. Or are those nervous smiles? Anyone heading through the door could turn out to be packing heat and looking for cash, or a strung out junkie searching for a place to sleep.

There’s a reason why Buffett fought hard for the Pilot truck stop empire with the Haslam family. The profits are staggering. (Note: a recent article in the Knoxville, Tennessee paper has a wonderful story on the Omaha son who reached the highest levels of business and now runs Pilot.) Have you seen the returns on capital for Casey’s? My, oh, my they are something to behold. When Casey’s bought Buchanan Energy and the associated Bucky’s chain for $580 million in 2020, I thought they were crazy. That’s an amazing amount of coin for 94 retail stores and 79 dealer locations. Guess what? Casey’s barely broke a sweat. Adding pizza to the stores was sheer genius. More margins. Pile ‘em on. My favorite convenience store owner? Alimentation Couche-Tard, the Quebec giant owner of Circle K and Couche-Tard. I just like saying the name. Buying your Zyns from a French depanneur seems tres exotique.

The chart on Casey’s looks like they sell graphics chips. Au contraire. Just potato chips.   

Casey’s is a $13 billion market cap company trading at nearly 28 times earnings. The stock is not cheap. CASY is the third biggest chain now with over 2,500 stores in 16 states. Adding $5 billion of market cap to a convenience store business in eight months seems a little excessive to me, but hey, when the stock market trades on vibes… you get Fireballs. Casey’s is based in the Des Moines suburb of Ankeny. Iowa is also home to the headquarters of Kum & Go (another store name that people love to say for some reason).

Not all parts of the automobile service world are going up and to the right like French pole-vaulter Anthony Ammirati. Take car washes. Somehow Omaha managed to go for thirty years with a bunch of sad little spinning brush machines at the back of gas stations. These soapy muppet tunnels were augmented by about three full-service “touchless” emporiums that faced varying degrees of near-insolvency. The VIP at 90th and Center wasn’t just a lounge back then, kids.

Now in 2024, there are car washes everywhere! Apparently, we’ve had it wrong for 30 years. Our cars have been in desperate need of more washing! Or at least that’s what the guys in private equity thought. Sign people up for a subscription model to get a car wash whenever they want in a gleaming new facility and your total addressable market is every car owner in existence. If I see one dirty car in Omaha from now on, well that’s just a damn shame. There’s no excuse. You want a car wash? The choices are endless.

I’m going to go out on a limb here with this prediction. There will be a lot of car washes for sale in about three years. Oh sure, some will be fabulous businesses. Dropping by Menards? Get a car wash. Stuck on Dodge St? Get a car wash. Huge amounts of fixed capital investments, low labor costs, a subscription model. Ka-ching. In fairness, the average age of a car is 12.6 years, so there is something to be said for people wishing to preserve their principal mode of transportation.

Well, if there’s one thing private equity is good at it’s finding a business model and beating the absolute sh*t out of it. Yes, there’s that competition problem: a lot of people with infinite amounts of cheap capital had the same idea. At the same time. Plus, did I mention huge fixed capital costs? That operating leverage cuts both ways. When volumes aren’t there, the losses pile up quickly – especially when there’s a lot of debt (and debt masquerading as leases). Oh, and the nice equipment requires expensive chemicals, expensive water, and breaks down eventually. So, you can see the risks. The only publicly traded car wash company, courtesy of an escape act from Leonard Green & Partners, is Mister Car Wash.

Despite the stock collapsing from an IPO debut of $20 per share in 2021, MCW still trades at a market capitalization of $2.43 billion. The company has $1.8 billion of debt and operating leases. Sales grew at a lackluster 5.77% in 2023 at the Tucson-based company, and operating income for the first six months of 2024 is basically flat compared with 2023, at $97.5 million.

The problem with Mister Car Wash is very apparent: It simply is not improving returns on capital and economies of scale. More locations in a saturated market are not a recipe for shareholder value creation. Should a car wash chain be selling at more than fifteen times EBITDA? Probably not.

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Old dollars

Rocco Schiavone is a chain-smoking police investigator who has been banished to the Valle D’aosta in the Italian Alps in the humorous and dark cop drama that bears his name. Early in the series, Rocco introduces us to his version of Dante’s hell. Murder is a “level 10 pain-in-the-ass”. Dealing with magistrates is at level 8. A closed tobacco shop is level 9. If Rocco owned apartment buildings, he’d probably list capital improvements on old buildings as a level 7.

We own and operate a collection of older buildings that were constructed in the late 1960’s and early 1970’s. Let me tell you something. They eat money. Sh*t breaks all the time. Literally. Air conditioners, pavement, carpets, decks, windows, appliances. Depreciation is real, my friends. Yes, it’s a lovely tax-deductible non-cash expense in the early days when a property is new. But as the depreciation wanes, you find yourself replacing capital items at a cost well in excess of the tax benefits.

This is the problem of old dollars. It’s even worse in an inflationary environment. If you have a parking lot that was built in 1990 for $20,000, you’ve got zero depreciation benefits today. It’s over. Now you need to replace the pavement. Guess what? It costs $35,000. The greatest inflation in 40 years in the pandemic boom made this problem so much worse. About $10,000 of that parking lot cost increase occurred in the span of four years. Four years! Maybe Rocco would elevate this to a 9.

Buffett lamented the pain of inflation when discussing Berkshire Hathaway’s BNSF railroad. He figured it would cost $500 billion to replicate the railroad today. Depreciation and amortization amounted to $2.5 billion in 2023. In 2024, the railroad announced a $3.9 billion improvement plan. Old dollars vs new dollars. Inflation destroys old dollars. Level 9 agony.

Therefore, a capital-intensive business that is not expending asset replacement dollars at levels significantly ABOVE current depreciation is probably under-investing in the year of our Lord, twenty twenty-four. Take Verizon (VZ). There are only three major wireless carriers in the US. The word “oligopoly” comes to mind. The dividend yield is so tempting at 6.6%. You might think that it’s the sort of holding widows and orphans should cling to for the quarterly stipend. Yet, you would be sorely mistaken.

Verizon doesn’t earn enough to cover it’s dividend when you take into account the immense investment needed to maintain a robust wireless network. Verizon is making capital expenditures that are roughly equivalent to depreciation charges. Four years ago, you might think this was a satisfactory situation. Today? They are behind the curve.

Verizon revenues have been flat for three years at $133 billion. Depreciation on a $307 billion asset base runs to roughly $17 billion per year. The market capitalization for VZ is $168.8 billion and the company has net debt of $148 billion. I think debt-holders will do just fine, but the equity holders will continue a slow grind into obscurity. The company can’t afford it’s hefty dividend of $11 billion per year, and if you account for investments in wireless licenses, the business is cashflow negative.

Defenders may argue that Verizon has been on a costly multi-year 5G network investment path that is about to wind down. I suspect not. If there’s one thing we know about bigger, stronger, faster technology demands, there will be a 6th, 7th and 8th generation waiting in the wings. I’m not even considering the ball-and-chains legacy land line business, pension fund requirements, and the whiff of litigation from aging lead-encased wires from the NYNEX days.

Capital expenditures amounted to $18.8 billion in 2023, so they are running about 7% higher than depreciation. What about inflation? If construction costs are 40% higher in four years and BNSF is spending 40% more, shouldn’t Verizon? The stock’s 30% decline since 2021 reflects a dwindling return on capital. Returns have declined from a healthy 12% in 2021 to just about 7.8% today. Let’s file Verizon in the value trap category. Avoid the siren song of that big dividend.

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