Tag: equity

Re-examining Big Lots Stock – Case for Optimism? $BIG

Reading Time: 4 minutes

It’s a start of the new year, and the end of a year where the S&P500 was down nearly 20%. Some may focus on what worked, I’ll look at an idea that did not go well. Big Lots stock, down 68% in 2022, it’s market cap is just ~$425MM.

I think there’s still room for optimism (even if its just a “dogs of the Dow” type of viewpoint). This bagholder just won’t quit. Mainly because I think the stock is trading at ~3x FY’24 EBITDA, 8% dividend yield, with some upside if they continue to sell some assets.

Don’t get me wrong. Don’t take this as “Big Lots stock is my largest position.” Far, far from it. Could we go into a recession? Sure. Am I happy that FCF may be mediocre despite the low EBITDA multiple? Of course not. That’s why position sizing is important.

That said, from here the stock looks interesting (even if that means when I first wrote it up was much too high). This could be one to add to the radar at the very least. I’m also looking out to 2024. So if you’re someone who is looking for something that will definitely do well this year, not sure this is the place. Especially because if under this new lens it just looks “interesting”, then it probably has a bit more downside before the upside arrives (just my experience).


I think my biggest mistakes in 2022 were buying low-quality business that seemed like they had tailwinds. Things can quickly change, tailwinds can evaporate, and you’re left with a low-quality business! It worked for awhile and then it really did not work…

Retail is a tough business. That’s apparent right now where many are caught with too much inventory (in the face of destocking), mark downs are evaporating profits and working capital has eaten liquidity. Freight and labor have also been challenging.

What makes this a particularly bad pick for me is I’ve been calling for the bull whip to play out for some time now and this is a clear example (here and here).

But I really liked what Big Lots was doing – pivoting store formats, bought brands with staying power (Broyhill), improving cost structure and growing stores to help absorb fixed cost leverage. I still think all of those are true. But as I’ll show below, they really got hit with freight, promotional activity, and labor costs.

Theoretically, the challenges mentioned above should be “one time” in nature, or at least cyclical problems, not secular. And they are all known now, at least I think they are…

I built a waterfall chart from 2019 to show the pressures Big Lots has seen. But just to rehash in FY2022 (which will end Jan’23, so Q4 is still an estimate).

  • Sales will have declined ~11%
  • GMs down >400bps
  • Opex up as a % of sales >350bps

Big Lots ended 2019 with ~6.5% EBITDA margins, so no surprise it is now negative.

But when you break down the reasons, Big Lots has called out freight being 400-500bps of operating margin pressure via GM and Opex. And they said that has peaked at this point. Promotional activity has peaked, too.

Looking forward, Big Lots has already faced destocking as mentioned. If we assume modest sales growth to 2024 and some of these headwinds abating, I could see Big Lots easily getting back to $255MM of EBITDA in FY’24 with some reasonable assumptions.

Bridging Big Lot’s EBITDA from 2019 to the current year to my expectation a couple years from now

With a ~$425MM market cap and ~$825MM Enterprise Value, that means Big Lots stock is trading at 3.2x EBITDA!

Is it the cheapest retailer I have ever seen? No. But I think that multiple could look even lower given more asset sales are on the come:

I have no idea what these assets could sell for. Back in 2020, they did a sale leaseback of 4 distribution centers for a gross amount of $725MM (net proceeds was more like $575mm after taxes and such). That’s not really a comp, but was interesting how low book value was compared to the actual proceeds (recorded a $463MM gain on sale).

I did find several listings of Big Lots stores that ranged anywhere from $2.5-$4.5MM (honestly averages in the middle). If it could sell 25 stores for $2MM a piece, that is $50MM gross. There’d probably be $3.5MM of incremental rent expense as a result, but that’d still be a win in my book given where the market cap is.

Big Lots has nearly $720MM of PP&E on its balance sheet. Selling assets at better than a 10% cap rate is accretive given Big Lots stock is trading at such a low multiple. It helps liquidity and can help pay down debt. I’ll take it.

While dangerous to anchor on, let’s not forget book value is $27/share.

As I mentioned at the top, a big concern here is $255MM of EBITDA may not generate much FCF. They’ll probably spend $170MM on capex per year (albeit to grow stores). I think with interest the stock is probably trading at a 10% FCF yield at best.

So one to watch. I still think this business and brand are underappreciated long-term. But alas, buying low-quality businesses even at cheap prices can be a dangerous game.

Expectations Reset for Vimeo, Risk/Reward Attractive $VMEO

Reading Time: 13 minutes

Vimeo stock collapsed following the spin from IAC. That caught my attention, I read some of their calls, but I never really dug in. Then, in early January, I tweeted there was an interesting cash-covered put trade you could do at $12.50 strike. As Vimeo stock has fallen more, I decided to do some “napkin” math on the stock.

Say Vimeo grows half the rate of management’s target, FCF margins end at 20%, and priced at 20x FCF. Discount that back at 10% and you get a market cap that isn’t too far off from today. These are all “finger in the air” numbers, but it showed me I should do more work.

If I had one takeaway from reviewing the company is that each Vimeo subscriber is not created equally! And when you break down the math, the targets become much more believable. If you want to cut to the chase, I’d suggest reading the “All Customers are Not Created Equal” section below as well as the model cut outs I have.

Is there risk? Of course. But I think many are likely saying, “eh, I’ll just wait” right now and that’s big time group think.

But first, I’ll go through a quick background, why the stock has gotten pummeled, and what you need to believe to make money from here. I’ve included a few screen shots of two of my models to emphasize this point.

Background:

Vimeo was spun out of IAC in May 2021. The spin followed strong 2020 results as Vimeo enabled many businesses to operate during the pandemic. No doubt, Barry Diller & Joey Levin at IAC recognized tech / SaaS multiples were high and a partial sale + spin would be best for shareholders.

Indeed, IAC sold a partial stake in Vimeo for $150MM which valued the company at $2.75BN in November 2020. Then in January 2021, another $300MM of equity was sold valuing Vimeo between $5.2BN – $5.7BN. In the first case, the valuation was a touch under 10x ’20 sales and then quickly moved to about 20x sales.

Today, we’re looking at Vimeo with a market cap of $2.3BN, or 6x ’21 sales (5x if you exclude cash, as Vimeo is FCF+, albeit from SBC & deferred revenue). Spun out at $57, the stock can now be purchased for under $14.

Ok with that background of “why Vimeo is even public” out of the way, we can explore why the stock is getting hammered, and then we can address why it’s a reasonable buy.

Why did Vimeo stock get pummeled?

Vimeo’s stock has gotten smoked for a variety of reasons.

  • Pandemic-enabled companies are coming home to roost (Peloton, Zoom, Docusign, Moderna are all down >50%)
  • Joey Levin straight up said it was expensive!
  • Growth is decelerating
  • Lost credibility: Vimeo will likely miss targets in its first year following an investor day that promised 30% growth for next 5 years
  • They are changing price strategy starting in ’22. A foundational change can lead to volatility
  • Spin dynamics, possibly
  • Investors are less enamored with tech / SaaS

I won’t go into all of these, but I think the first few are worth going through.

Pandemic-enabled and “a bit rich” at the spin:

In IAC’s Q3’20 letter, Levin stated that Vimeo was “a business that benefited meaningfully from the pandemic.” They also said, “we can’t be certain that the magnitude of the positive lift to Vimeo will persist when the virus’ effect on our lives becomes less pronounced…

They went on to say, “Vimeo’s access to capital inside of IAC will be much more expensive than access to capital outside of IAC.” They decided to test the market by selling some shares (Nov ’20) and then some more (Jan ’21). They noted how the investors were willing to pay on a P/S multiple, almost besmirching the reputation of the buyers!

Read between the lines. They were saying others are willing to pay much more for Vimeo than we are.

Growth deceleration + Lost credibility

In that same IAC letter, they called out acceleration during the pandemic which was obvious.

Prior to the pandemic, we were steadily proving Vimeo’s fit in the market. Organic bookings growth consistently accelerated last year from 11% in Q1’19 to 27% in Q4’19 as we began to expand from our filmmaker roots to a broader audience of small businesses and large enterprises. Then the pandemic hit, and that acceleration exploded to 41% in Q1, 79% in Q2, and 56% in the most recent quarter.

If we look at the latest monthly metrics, we can see Vimeo is growing strongly, but at a slower pace. They actually face the worst comps in Q1’22 so it is likely this decelerates even more.

Vimeo Monthly Metrics are decelerating

Total revenue is coming down from high-50s to 60% to 40s, high-twenties and now around 23% in December. Look at Q1’21 figures and we can probably conclude comps will be tough. Perhaps the company grows “just” high-teens / low twenties.

This is problematic as management set out much more lofty 5 year goals at their investor day in March 2021. A few quarters in and it looks like we will be under the goal.

Vimeo hasn’t reported Q4 yet, but investors can look at the reported monthly metrics as a guide. Even before they reported December metrics, they were guiding investors down at conferences:

[Regarding Q4]. What we have said is that revenue growth to be about 25% year-over-year. And if you think about that, we are lapping a very strong growth rate in the fourth quarter of last year, which was about 54%. So on a 2-year stack basis, we are significantly higher even compared to Q3 of this year. We haven’t talked specifically about 2022 and what the growth rates would be there. We are still in the planning process and for all the reasons that you talked about, the visibility being harder. We’ll provide more guidance as we get through this year and into early next year.

But what we have said is that the 30% growth rate is unlikely next year. And we also believe the first half of next year and the growth rates will be muted for the same comp reasons that we talked about earlier, and we expect the growth rate to be accelerated in the second half of the year. So if you think about our growth rates coming down in the second half of this year, that would continue through the first half and then we expect it to reaccelerate sometime in the second half of the year.

My emphasis added.

But let me say one heuristic I have learned over time. Anytime a company says that “we’ll make it up in the second half”, it is a SHORT for me.

But Dilly D – if that is the case, how can you possibly buy the stock now?

I think a lot is priced in at this point (also dangerous words as making it up in the second half). But after studying the business model, strategy, and thinking about the TAM, I do think this business can continue to grow at high rates.

Ok enough depressing talk, let’s talk about why Vimeo now looks cheap!

Why Does Vimeo Stock Look Cheap?

  • Vimeo is a more focused company, post-spin. They are free to operate the way they want & invest where they want. Focus on a singular goal is important.
  • End of the day, Vimeo is a good business
    • Classic “freemium” model converts users to paid in highly efficient manner. That said, enterprise customers (where decent amount of S&M is dedicated) are worth way more than typical “Pro” subscriber.
      • Enterprise 1% of subscribers, but 25% of revenue.
      • 50% of paid customers started off with the free plan (i.e. freemium model)
    • Vimeo is an alternative to YouTube for business
  • Pandemic likely pulled forward sales, but also accelerated market growth and adoption.
    • Decent amount of growth is “locked in”
    • I’d gamble some things from the pandemic will stay (e.g. virtual “town halls” for companies, more video options for live events, etc.)
  • Brand value is worth something (I won’t dive in here, but something to think about)
  • The “What do I need to believe?” case seems reasonable

More Focused

First, I think a focused, small company can really do wonders. Investors worry big tech will squash the “little guy.” See online dating, industrial distribution, media content, marketplaces, among many others. But Vimeo lives and dies by this “niche.” They come into the office everyday thinking about this one thing.

Steve Jobs said with “focus and simplicity you can move mountains.” To me: stand alone company = more focus, though maybe Vimeo requires more investment short-term.

I think we started the year with about 75 quota-carrying sales headcount, and we would end the year at about 150, so almost doubling. We have opened offices, at least in 4 or 5 new geographies that we didn’t have at the beginning of this year, so significant expansion

Seems like they are investing for growth.

End of Day, Vimeo is a good business

On the Self-Serve segment of our revenue (meaning, a customer begins to pay Vimeo without having spoken to a salesperson), we’re seeing about $5 in profit for every $1 we spend in marketing. That ratio has continued to steadily improve and we haven’t yet found the limit on our ability to spend on marketing with those returns

IAC Letter

IAC also mentioned during the pandemic that Vimeo “accidentally” went EBITDA positive as the growth resulted in a lot of operating leverage.

Go back to the 2020 summary results with long-term goals below. Look at that operating leverage on the gross margin line and EBITDA. Pretty impeccable. This has been true over time when you spread the financials as well and look back to 2018 and 2019. I do think a SaaS company like Vimeo should be able to reach 20%+ EBITDA margins, which we can get into in the model later.

All Customers are Not Created Equal

As mentioned, Enterprise is just 1% of subscribers, but 25% of revenue. This checks out with their other disclosures:

As of December 31, 2020, we had over 3,800 enterprise customers, who, as of the quarter ended December 31, 2020, pay us over $22,000 per year, on average. We define “enterprise customers” as those who purchase plans through contact with our sales force. Our enterprise customers grew 87% year-over-year for the quarter ended December 31, 2020, and these customers now represent nearly 25% of our total revenue for the same period.

The goal is to increase Enterprise exposure. In fact, as of Q3’21, it was 30% of revenue.

I created a hypothetical scenario where Vimeo had 100 paid customers, 99 on a “Plus, Pro, or Premium” contract and 1 enterprise customer. Let’s assume nothing changes other than their ability to gain one more enterprise customers. Note, I somewhat made up numbers to back into an ARPU roughly around today’s levels.

The other subs can be flat, ARPU can be flat, but the mix effect can drive significant results.

And assuming ARPU is flat is pretty conservative. They stated in their S-1 that Net Revenue Retention was 110% and in Q3’21 they stated:

Our enterprise net revenue retention remains healthy with our sixth consecutive quarter of NRR above 100%.”

Pricing Strategy Change

Let me also say they are changing their pricing strategy. As I said, foundational changes can cause a lot of turmoil. Currently, this is in “beta” but they are moving from a storage-based model to a “per seat” model. In other words, they are going to try to base payment tiers off of customer success. You host a webinar, Vimeo will charge off of registrants. If you have an internal library of content, it will be based off of admin seats.

This may turn off some people. But Vimeo is doing it now because they feel they’ve expanded the product platform enough to make it enticing. Plus, aligned payoffs makes a lot of sense. Think about Facebook ads where the company buying the ad only pays when someone clicks – that is high ROI and easy to tie which increases lock in.

This is no doubt a big project and scary, but they have been talking about it for at least a year. If it works, they’ll move customers up in pricing tiers (e.g. from the self-serve model to a higher tier). For what it is worth, most SaaS companies are on a per seat model.

Here is Vimeo talking about converting customers and retaining them, as well as bringing up per-seat pricing. This is from March-21, but they also spoke about this in 2020.

In terms of the conversion and upgrade mechanisms, so I think of it in two ways. One of the biggest features that we see help unlock our free users to convert in the first place is being able to create content. The creation of content is a big barrier. So things like our Create app or Vimeo Create app, being able to record your screen and send a video message, those actions are really the things that we found activate a free user to get them to be paid.

From there, the way we tend to move our users and subscribers up tiers is unlocking more advanced functionality. Some examples would be livestreaming, advanced marketing tools, the ability to capture e-mails within a player, put your customization and branding, add calls to action, privately and securely share content or create a video portal, those are all the mechanisms today. Tomorrow, we see even more mechanisms. You’ll see us do things as we expand our product suite. You’ll see us look at per-seat pricing, for example, so that we can actually use the number of seats or the size of your team as a way to move people up tiers. But even what we have today, we see, I think, about 25% of our self-serve subscribers move up tiers from those other features I just mentioned.

Vimeo has >200 million free users today and they have a good history of converting them to paid. I think about Dropbox: it is much easier said than done converting free users, but when you are actually able to bring them up the chain, it is a beautiful thing.

If you go back to the S-1, it seems like this isn’t a “new” change, but something thought about for awhile now:

Over 65% of our new enterprise contracts came from customers who were existing free users or self-serve subscribers first

We seek to employ a “land and expand” strategy where we inspire our existing subscribers to increase video adoption and usage and upgrade to higher-priced plans over time. For enterprise customers, we seek to expand the number of employees, teams and departments using our platform and increase contract value organization-wide.


What about YouTube?

All of this can be a disconnect for people who quickly think of YouTube as a competitor. I’d say a lot of YouTube is B2C, ad-driven revenue.

Most people today probably still think of us as the sort of indie smaller version of YouTube. And for most of our history, that’s what we were. We were a viewing destination and a place to watch a video, like YouTube.

And 3 years ago, we pivoted away from that strategy to really being a B2B video SaaS company…today, we enable any business of any size to connect with their customers and their employees with video…we do this by providing a very simple, high-quality, end-to-end solution for those businesses and professionals. So SMBs and marketers will use us to make social media videos, post them all over the web and drive traffic back to their business or store. Fitness studios and churches will use us to live stream their classes and their sermons. And yes, we have Fortune 500 companies using us to host virtual town halls and conferences and events

Anjali Sud at a GS conference in 2020

Video is a big market and there are a lot of different use cases (read: niches). To head off the “YouTube vs. Vimeo” argument, let me pause and offer a few reasons why someone would choose Vimeo.

  • YouTube is quantity over quality: Vimeo can offer higher quality videos with more customization
  • No ads: there is a component of control here, such as no control over what ad plays in front of your video. Plus, an ad is inherently trying to drive traffic away from the site. That is NOT what a Vimeo customer wants.
  • Make money with pay per view: Back to that fitness class example, a small business can set up a “pay per view” using Vimeo
  • Password / privacy protection: Can create company specific vids or those for customers without sharing with the world

It’s reasons like these that the NYSE does live stream of opening and closing bell on Vimeo, or why Starbucks does workforce training on the platform. From a quality perspective, a lot of music videos are now on Vimeo as well as short-films where the filmmakers care about their videos not being compressed.

Anyway, it is a difficult question for many of the 800lbs gorilla squashing Vimeo’s niche, but I go back to how big the video market is. To me, the analogy is similar to an Etsy vs. Amazon – both can exist.

I think this conversation on Vimeo will not die down. It will likely continue to “dog” the company for some time, especially when reports of other video players adding new features (like Zoom) emerge. Unfortunately, I can’t “prove” Vimeo will win in every case. That’s the bet.

Summary Model Scenarios

For the first model summary, I wanted to show a “management case” and have ’22 at subs and ARPU growing 9-10%, for 20% revenue growth, followed by re-acceleration. I assume some modest leverage on COGS, but they are already at their goal, and some fixed cost leverage (mostly coming from G&A – where I assume ~70% of G&A is fixed).

Yes, I do assume SBC is added back to EBITDA for Adj. EBITDA.

I assume, because they’ll be generating so much cash and already have a lot of cash on hand, that they start buybacks in 2023 = FCF. They likely do acquisitions instead, such as the two at the end of 2021, but those assumptions are too hard. Buybacks start at $20/share and stock price increases 15% p.a.

Bottom line: If you think this is reasonable and want to buy the mgmt case, then we are buying the business for 3.7x 2026 EBITDA and the company will be generating a lot of the current market cap in FCF.

In this case, the company will be doing $4.35/share in FCF in 2026 (remember, stock today is <$14). 20x that figure gets you an $87 stock price.

What about the scenario where they were *just* a COVID winner?

I think that’s interesting. The truth might be somewhere in between.

Let’s say subs slow to just 3% a year but ARPU decelerates meaningfully. NOTE: This is in full contrast to the Enterprise customer math we did above! In reality “what I think will happen” is subs could slow, but ARPU accelerates.

But anyway, you can see the results here:

Given I still assume buybacks (at the same prices in the first case) I have Vimeo doing $1.20 in FCF/share by 2026. If you put 20x on that, that’s a $24 stock. That may not seem like much, but that’s 60% over 5 years and foots to a 10% CAGR.

If the truth is somewhere in between, the risk / reward looks pretty attractive now.

I tweeted this in the beginning of the year, because I saw it as an interesting way to play Vimeo and wait for a better price:

Full disclosure, I did do that trade. At the time of writing you can get $2.25 for this contract! That’s an 18% unannualized “yield!” And I also have done that. Worst case, I am buying Vimeo stock at $10.25, or $1.7BN. I am comfortable owning there, too!

Selling cash-covered puts is more conservative than buying the stock. BUT it has less long-term upside. Sentiment seems pretty low, and definitely can get worse, but there is risk you miss out owning a great, little business with a long runway ahead.

Hear Me Out: Lots to Like about Big Lots Stock $BIG

Reading Time: 6 minutes

What if I told you there was a company with an average ROE > 22% over the past 10 years… It also earns a double-digit ROIC… What if I told you that this company was a beneficiary of COVID, and the cash flow greatly increased its future optionality for years to come? What if I told you this company also has been a consumer of its own shares – especially in market volatility (i.e. when you want it to be buying shares). The title gives it away, but I am talking about Big Lots stock.

Yes, I’m sorry readers. This is a value stock (vs. some SaaS-y growth stock). Brick and mortar retail, no less. 

The stock is now down ~14% after posting Q3’20 results.  While the company posted 17.8% SSS comp (a record), they noted some deceleration (perhaps too much pull forward of Holiday shopping into Black Friday + they closed early on Thanksgiving).  Even so, the deceleration meant Q4 was looking like a +Double-digit Q, and their gross margin guidance seemed conservative, so I thought I’d take a deeper look. 

There are several reasons why I think there is significant upside to the stock with reasonable downside protection — including some things to assuage the B&M concerns.  


The quick and dirty background on Big Lots is its a discount retailer with its foundation in the south and south west, mainly opening up in strip malls (typically an “anchor” tenant). They have ~1,400 locations today, but if you haven’t heard of them it’s because you aren’t in a location they target (more suburban and rural and where the ~30% discounts to other retail they offer are appealing to the price conscious).   


There’s a debate over whether companies that have strongly benefitted from COVID will give back all of the gains they’ve seen this year. In some cases, like in SaaS, investors see a sticky business with low attrition. So it appears investors are saying SaaS will give no sales back  post-COVID. In fact, the street is saying they’ll continue to grow. I’m not saying that is wrong, but for retailers, they are saying the opposite.

For example, people are stuck at home. They aren’t traveling, not going to restaurants, so they’re spending on making the home better. Dollars have shifted from some sectors and into other sectors. As COVID ends, people travel more and go to restaurants, there will be less dollars to go around and they’ll cut back on the beneficiary-of-COVID sectors.

I agree with this generally. Clearly Big Lots is making more sales than ever. These comps it is posting are unsustainable and it will likely post sales declines comps next year.

However, this also didn’t come for free. On BIG’s Q1 call, they noted they canceled their annual Friends &  Family event, gave their employees Easter off (which is typically a big sales event), gave a temporary $2-hr wage increase, provided an additional 30% employee discount, and additional bonus pay. So looking forward, its not just so easy to say the sales comps will reverse. 


I really like the option value of Big Lots. The boost from COVID has done 3 things. And if the term wasn’t overused, I’d say it’s a flywheel – each of the factors reinforces the others:

  1. Improved comps, therefore operating leverage, allowing them to generate a ton of cash flow
    • Big lots YTD has produced about 3x as much FCF as it did last year ($267MM vs. $80MM PY). It also did a sale & leaseback transaction in Q2 to generate $587MM of cash.
    • Q3 is a working capital investment Q ahead of the holidays, but I could see them ending the year with >$700MM of cash
    • Big Lots is also coming off of a capex spend, so future cash flow should also look better
  2. Accelerated competitiveness of Big Lots and its strategic plan
    • Without COVID, I wonder if Big Lots would have accelerated as quickly with Buy Online, Pickup in Store… or E-Commerce (which is probably small, but up 50% in the Q)
    • They also now have >20MM people on their rewards database
    • Sure, a lot of retailers have had to adapt, but there could be something to the theory that struggling retailers (both big and small) will close some locations and post-COVID, the playing field may be altered
  3. Introduced new buyers to the concept
    • With COIVD impacting so many businesses, and a lot of them shutting down, there’s no question that Big Lots benefitted from increased traffic. The question is – can they convert some of those new buyers into repeat buyers?
    • As of right now, the market doesn’t appear to be giving Big Lots much credit for this. In fact, it seems to be getting the least credit out of the few comps I looked at
    • However, as I noted, Big Lots actually does have really good deals. And they are focusing on a market with tailwinds (furniture, home decor, which I speak about later). Couple this will more rewards customers and I think its unfair to say they can’t retain much business

These are intertwined. But the issue with Big Lots, and why its multiple has been halved over the past few years, is that people view the company as being in secular decline

The WHOLE POINT of this post is to say, I think that may be too pessimistic

But take a look at what mgmt is saying it is investing in and able to do right now. I ask myself, “is this company getting better or worse in the future?” and “is my downside well protected?”

In fact, I can’t think of a better strategy to adopt pre-COVID – mgmt’s strategy has been focused on increased home furnishings. Mgmt is probably thinking “I’d rather be lucky than good” — targeting the home was a good idea.


For more background, Big Lots had basically grown nominally the past 12 years. They got a new CEO in 2018 which helped oversee a refresh of the stores, put the best categories up front, and accelerated online investments.

Furniture is a high margin category and they purchased Broyhill, which allows them to offer indoor and outdoor discount furniture (note: Broyhill is on track to do $400MM of sales this year – this is an asset they acquired at the end of 2018 for $15.8MM). Food is fiercely competitive, so they are deprioritizing that. 

The issue with this original plan is how they will inform buyers they offer / are expanding in core categories – it is clear traffic was up this year, so perhaps that will help going forward.

The other factor is that we clearly had a major recession. Big Lots is a discount retailer, typically trying to offer goods at a sizeable discount. These sort of end markets tend to have tailwinds after a recession (see my AZO post), albeit this recession may be brief. 


If you’re thinking, “ok this is good. I just hate the legacy brick and mortar exposure.”

The good news is 684 leases expire through 2022. That is almost half of their locations. In my view, BIG is in a much stronger negotiating position since the strip malls they tend to sit in may have been hit hard (i.e. anchor tenant leverage).

Second, if they need to “right size” their footprint, BIG can walk away, liquidate inventory, and invest elsewhere…. Including locations it thinks may be more profitable.


I don’t think Big Lots is in a bad position and I think the stock is cheap. There are upside to my numbers here below, yet the stock trades at just 5.8x 2022 EPS. For context, Dollar General trades at 22x, AZO trades at 13x, Home Depot at 20x, Ross Stores at 22x. Maybe the best comp is Bed, Bath and Beyond trading at 10x ’22 EPS and they’ve had much worse performance than BIG… the list goes on.

Ok – so some of those comps have performed better and earn a higher ROIC than Big Lots. But BIG also has the lowest expectations priced against the lowest multiple. And I view the downside risk as pretty limited.

For example, based on my estimates, the company trades at just 5.8x EPS. If it were to trade at 10x EPS, you’d have a $78 stock, or ~65% upside from today’s levels. 

You can also tell the company gobbles up its shares and I expect that to continue. The company repurchased $100MM of stock and has $400MM of remaining authorization (that’s around 25% of its market cap – which it could do given the cash). That eventually will grind EPS back up to the peak we may have seen this year, especially if the stock price doesn’t react.

Secret SAAS Businesses

Reading Time: 4 minutesSAAS stocks are all the rage. While the S&P500 is up ~12.5% at the time of writing, the Tech-Software ETF is up 41%. Over the past 4 years, the gap is +215% for Software and +88% for the S&P.

It makes some sense. These are companies that have long runways of growth, are FCF generative (if you count stock-based comp as an addback, but point is they tend to be people-heavy, but asset lite), and a good portion of them are really sticky businesses through the subscription model.

A sticky business is important. Imagine you’re a business owner trying to prepare shifts for your employees. You don’t know if a customer will come into your store or if you’ll be bombarded that day. If you are bombarded, you might lose sales because you don’t have enough staff. Recurring revenue companies can plan much more effectively and align costs with revenues appropriately.

I’ve outlined this before, but the subscription models also tend to spend a lot of money on just acquiring the customer. So the first year, the business isn’t that profitable, but on renewal it is highly profitable.

Also think about this dynamic in COVID-19 impacted world. Economies were literally locking down. I was running scenarios on companies that I’ve never had to do before – “how would these businesses look with ZERO revenue for the next 3 months.” If you’re in a business where you are mission critical to the customer and get paid a small monthly fee for that service, then you weren’t sweating it as much.


Therefore, I think there was a changing of the guard this year. Well, maybe it actually happened in the 2015/2016 recession scare. (The latter would make more sense because that’s when we saw the atmospheric launch of FANG and SAAS.)

Investors had long been valuing recession proof businesses at much higher multiples than more cyclical peers. Think Utilities, Consumer Staples, large Healthcare companies. I think following the great financial crisis (the GFC), it had a big psychological impact on investors – “try not to own things that can get crushed like that again.” And therefore, the discount rate on these cash flows went lower (due to perceived lower risk).

SAAS combines those attractive characteristics with ultra growth. But the subscription really made it easy to count on what was going to be in the bank account. So low discount rate + hypergrowth = highly valued.


Secret Subscription Models

Something I’ve been thinking about the past few years is “secret SAAS” or really, “secret subscription” businesses. These have very similar characteristics to SAAS, but aren’t in software.

Some of these companies have highly recurring revenue, but may not have a monthly subscription. Some of these names are also dominant and will own their category, but it might be niche and many people just don’t know about them.

The only thing missing from my list is the hypergrowth. But you also aren’t paying 10-100x sales for any of them…

Perhaps I’ll do a post on each of these, but please feel free to reach out, comment below and comment on Twitter (@DollarDiligent) names you think should be added to the list.

Secret Subscription Business Models (no particular order):

  • Flavor and Fragrance Names such as Sensient Technologies and International Flavor & Fragrances
    • I really like names that are critical to an end product’s use, but are a very low cost input. This typically translates into limited switching and little pushback from some price increases
    • Flavors & Fragrance names provide the products that impart taste, texture, or smell to consumer end products.
    • These are mission critical. They also are sold into pretty recurring end market – food and fragrance.
  • WR GraceAre you a refiner that wants to upgrade that barrel of oil into higher value products like gasoline or jet fuel? Well – you need a catalyst. The catalyst creates a chemical reaction to start the process. This is also true in creating plastics.
    • Unfortunately for you, refiner, you can only get this catalyst from 3-4 companies. But they are very high touch, high R&D businesses and the cost of the catalyst is very little compared to the cost of a refinery.
  • Beacon Roofing and Carlisle Roofing segmentThere is a large installed base of roofs. And many were put in place 15+ years ago. As they age, the roof needs to be replaced.
    • No matter what the economy looks like, if the roof is leaking, it needs to be replaced ASAP.
    • This leads to very high recurring revenue (albeit storms can make some years lumpy)
  • Moody’s / S&P Global / MSCINeed to refi your bond? S&P and Moody’s are the gatekeepers. Need to access the ratings? If you want to access detailed reports, investors need to pay a fee. In a large market, this adds up to highly recurring revenue (in addition to other platform services the companies offer, such as Platts and Cap IQ)
    • For MSCI and S&P – Having managers benchmark to your indices provides a highly recurring fee each year. Changing your benchmark tends to be a “no no” and the more recognized the benchmark company, the more circuitous it is
  • Apollo and Blackstone and other asset managers.
    • Earn management fees on a large, mostly locked up capital. Sure, there are incentive fees that may not be highly recurring, but the bulk is actually just management fees
  • Franchisors – many come to mind like Domino’s, Planet Fitness, McDonald’s etc. These names take little capital to run themselves and earn recurring royalty fees from the franchisees

MasterCard Stock – Opportunity to Add a “CARP”: Compounder at a Reasonable Price $MA

Reading Time: 5 minutesMastercard reported earnings this past week and the stock got hammered as it missed expectations. Take this as an opportunity to buy Mastercard stock.

MA Chart

MA data by YCharts

A lot of people know Visa and Mastercard, but they don’t know how the business actually works. Simply put: card networks act as the toll booth connecting the “issuing bank” with the “acquiring bank” and they take a fee as the transaction goes across. The “issuing bank” is the bank that issued the credit card. The acquiring bank is the bank of the merchant. Ryan Reeves has great commentary on this network, which I found in a tweet of his. He also has a blog post on it where he explains it well:

The company where you put your money, called a bank, gives you a piece of plastic, called a credit card, that signals you will pay for something later. When you buy coffee from Starbucks using your piece of plastic, your bank sends the $4 to Starbucks, instead of you paying. But before Starbucks gets the money, two things need to happen.

Your bank has already made a promise with another company called a card network whose job it is to act like a toll booth between two banks. The most popular card networks are Visa and Mastercard.  These card networks make promises with other banks called merchant banks, who hold money for the stores where we buy stuff. So the money from your bank first goes to through the card network and then to the merchant bank and finally to Starbucks, each company taking a little bit of money along the way for their services. And then the final piece, at the end of every month, you pay back your bank for the money they sent to Starbucks. And that’s how credit works!

Here’s a diagram from Plaid as well as their explanation:

Card networks—for simplicity in this explanation, let’s say Visa—receive fees from the issuing and acquiring financial institutions. Visa makes money by collecting a small percentage (0.13 percent as of early 2015) of total transaction volume, rather than by charging a fee on each transaction. But it also sets and doles out the rest of the fee paid by the merchant to the other players. While this percentage may seem nominal, billions of transactions processed each year (with minimal overhead) add up to a very profitable industry.

What’s more, a network like Visa’s entrenched partnerships and critical technologies create high barriers to entry for new players. Established card networks also have low marginal costs to continue operating, making them attractive business models.

So Plaid touches on a few things here: High barriers to entry, toll booth business, low marginal costs. This translates to really high margins and super high FCF. And since payment transactions are growing quickly (ex-COVID), the company is able to leverage those costs and expand margins. For example, look at both revenue growth and margin expansion. Most companies I follow don’t even have 50% gross margins

People often look at the current market structure and think, “This will clearly be disrupted. It is too complicated.”  Card networks work because they have high degrees of trust and a large network, which makes their usage more attractive. Take American Express on the other hand which actually has a different model. Have you seen many merchants say they don’t accept American Express? Amex “consolidate functions of the merchant bank, card issuer, and card network by personally extending credit and cards, and minimizing parties involved.” However, their fees are too high for the merchant and AmEx gives a lot back to the consumer.

Square also differs somewhat, too. Instead, they aggregate the merchant transactions and pass of the processing to Chase.  You will always hear about one of these names (Square, Stripe, Apple Pay, etc) are “disrupting payments.” In reality, they are all still passing through the card network monopoly.


As I discussed in a post where I broke down the core driver for long-term shareholder returns, Mastercard has compounded FCF at ~20% rate for almost 14 years. And its stock has compounded at an even higher rate as people realize this.

So why is there an opportunity now? Well, COVID-19 has caused investors to reset the bar lower this year. Sales were down 14% in Q3’20, but Op Income down 20% (due to fixed costs). You can’t have a dramatic recession and expect spending to be up. That obviously will have a direct impact on Mastercard. But that makes Mastercard interesting because its a very strong business, but also a recovery play. Indeed, there may even be higher tailwinds on the way out – think of less use of physical cash.

And the long-term growth story is still intact. Look at how much in transaction volume is still down via cash and check.

Is Mastercard Cheap? I think so. But you say – Mastercard trades at 45x 2020 EPS?? And 34x ’21. That is not cheap.

First of all, is Mastercard an above-average business? Yes. Is its long-term growth rate above the market? Yes. It should trade at a premium.

Second, Mastercard trades at ~3% FCF yield, but also it can grow FCF/share at a 10%+ CAGR for the next 10 years. This would be half the rate of the past 14 years. I think growth will continue from continued market gains (remember, pre-COVID, the company was growing top-line in the high teens and bottom line even faster due to operating leverage. This will continue at a high rate in a post-COVID world). That points to at least a low double-digit IRR for the stock. I would also point you to my post on how Growth can help pay for a lot of sins

I’m not going to publish my whole model here, but I encourage you to check your models for this. This is the beginning FCF yield + what I expect FCF to compound out. It is interesting how it almost matches up perfectly with the IRR of the investment:

There are still capital structure benefits that could come. As I talked about in my MSCI post, MSCI is leveraging its cash flow and returning significant cash to shareholders. Mastercard is roughly net debt zero. If they had 2.0x of leverage, that would be an incremental $18-$20 billion available for shareholders, which would obviously boost returns. I also think they’d be comfortably investment grade at that level as well.