Boston Omaha - Shareholder Letters - Alex Rozek and Adam Peterson

Boston Omaha - Rozek Peterson - Shareholder Letters

Learning from Peterson and Rozek

I’ve been following the annual shareholder letters of Adam Peterson and Alex Rozek, Co-Chairmen of Boston Omaha (NASDAQ: BOMN) for some time now. I like their letters for their candour and value-oriented approach to investment selection and capital allocation. Most interesting of all is their large stake in billboard businesses. I don’t know about you, but I’ve never thought about the economics of billboards. So, it was interesting to learn about Rozek and Peterson’s views, not only about the billboard industry, but on their other ventures too.

This post will summarise some of the lessons that I took from their writings. We’ll start with Boston Omaha’s investment philosophy, before looking at their take on the billboard, insurance, and fibre-optics industry.

Boston Omaha (NASDAQ: BOMN) stock chart

The Boston Omaha way

“Boston Omaha’s focused objective is growing intrinsic value per share at an attractive rate, while seeking to maintain an uncompromising financial position.”
Rozek and Peterson, Boston Omaha Shareholder Letters

Like any value-oriented investor, Rozek and Peterson’s goal of course is to grow long-term intrinsic value per share of Boston Omaha, and to ensure that it’s always in a position to navigate unexpected calamities and opportunities. That said, the company doesn’t have a fixed plan or acquisition strategy. They’ll purchase durable businesses with sustainable cash flows as opportunities come about.

The framework

There are several elements to Rozek and Peterson’s approach to investing and business:

Firstly, they believe in decentralisation, incentives (alignment) and partnership. Decentralisation is about finding great managers, and giving them the autonomy to operate. But for decentralised systems to work, companies must get their incentive schemes right. So Peterson and Rozek focus on the alignment of interests towards shared and desired goals. They also view their shareholders as partners. Peterson and Rozek invest alongside shareholders and eat their own cooking.

Secondly, they believe in long-term thinking and a focus on cash. Boston Omaha’s holding period is forever. They seek businesses that can produce cash sustainably, whether as free cash flow, float and so on, for the parent company to redeploy. Likewise, Peterson and Rozek prefer companies that can adapt to the twists of industry, innovation, and economy. And so their acquisition criteria are threefold: (1) consistent earning power, (2) durable competitive position and (3) an attractive pre-tax return on equity capital.

Investment horizon

“One of our biggest strengths at Boston Omaha is our long term horizon… If we don’t see a reason for Boston Omaha to own it for the life of the asset, then we likely don’t see a reason to own it at all.”
Rozek and Peterson, Boston Omaha Shareholder Letters

The long-term horizon is important to Boston Omaha in several respects. Firstly, it allows business partners, owners and sellers to work with a buyer (Boston Omaha) that will honor their deal or agreement. Secondly, it allows Boston Omaha to acquire businesses based on their estimate of the company’s earnings power relative to the purchase price. They don’t have to worry about what others might pay for the business or assets down the track. Thirdly, long-termism imposes its own form of discipline and patience into their decision-making. They’re able to avoid “an itchy trigger finger” when the market is devoid of promising opportunities.

Diversification

Not much for me to summarise here, except for a snippet from the two CEOs on their approach to diversification:

“Diversification is a potential result from a series of what we hope will be successful decisions over a long period of time, rather than a strategy at the outset.”
Rozek and Peterson, Boston Omaha Shareholder Letters

Leverage

Peterson and Rozek aren’t averse to the use of debt if the consistency, durability, and economics of the business are sound. But they don’t believe that the use of debt itself is “some sort of managerial accomplishment”. For this reason, they report both the unleveraged and leveraged results of their billboard operations to hold themselves “accountable to being good managers of the assets”.

Performance, incentives & costs

Rozek and Peterson believe that book value per share is an approximate measure of Boston Omaha’s management performance. If they’re performing well, then shareholders should see the company’s book value per share grow at an attractive rate relative to other investment opportunities. Peterson and Rozek hopes that their shareholders focus less on short-term stock-ticker, and more so on the company’s long-term growth in book value per share and earnings power.

Note that book value per share is distinct from but related to intrinsic value. The latter is what Peterson and Rozek used to make company decisions. Intrinsic value is sensitive to beliefs, assumptions, and judgements. If you’re right (or wrong) about the company’s intrinsic value, then you should see results reflected in their cash flows, earnings power and growth in book value per share over time.

Book value per share = (Company’s assets – Liabilities) / Shares outstanding

Intrinsic value = Present value of future free cash flows

Incentives

The Co-CEOs at Boston Omaha have two primary responsibilities: (1) allocate capital to existing or new opportunities; and (2) set the incentives of their management teams. It’s also reminiscent of the decentralised model that Berkshire Hathaway has used for decades.

Executives at Boston Omaha’s parent company are eligible for their Management Incentive Bonus Program. The program is worth up to 20 percent of adjusted stockholder’s equity that exceeds 6 percent growth year-on-year. Note that adjusted stockholder’s equity focuses on book value growth from retained earnings and excludes the sales or purchases of Boston Omaha stock.

This distinction is important. For example, Boston Omaha has on several occasions issued shares at a premium to reported book value. Misaligned managers would be tempted to count that towards their remuneration scheme. Rozek and Peterson’s goal rather is to incentivise the company’s focus on business generated returns, and growth in book value per share via retained earnings. This helps to align management with long-term shareholders.

Cost-conscious

Their attitude towards partnership, long-termism and the right incentives has also contributed to their cost-conscious culture. For example, it’s interesting to note that both Peterson and Rozek paid themselves the minimum wage until Boston-Omaha reached a reasonable scale. They also like to keep office costs and overheads to a minimum, with their headquarters out in Omaha. Rozek himself, as noted in his 2019 letter, is working from his mother’s apartment!

“Since one of us was in Boston and the other was in Omaha, the [company] name just made sense. It also appealed to our mutual thrift to save some money on high priced branding consultants. (The truth is we don’t know any).”
Rozek and Peterson, Boston Omaha Shareholder Letters

Billboards, insurance and fibre optics

There’s a lot for shareholders and business students to learn from the way Peterson and Rozek think about the economics of their investments. Below are some of the notes that I took on their recent investments in billboards, insurance, and fibre optics.

Billboards

Boston Omaha describes their investment rationale in billboard businesses across south-eastern United States in their 2015 letter to shareholders. Billboards in their view have been a relatively stable, durable, high margin business, with favourable economic characteristics. These characteristics include the industry’s supply limitations due to regulation; rising demand as a low-cost advertising channel; low capital and lease intensity; fewer substitutes; a fragmented customer and supplier base; and flexible reinvestment opportunities.

Its attractiveness also meant that the opportunity was available only to Boston Omaha at a “fair price”. They also point out that increased competition for the economics of billboard businesses is likely. But Peterson and Rozek believe that a “well-managed and well-located billboard plant will continue to earn its economic keep”. They also pursued bolt-on acquisitions to consolidate the market for the existing and acquired assets.

Their acquisition criteria for billboards are worth noting too: (1) day-one cash yield relative to the purchase price; (2) cost efficiencies from proximity to existing boards; (3) desirable location from an economic and regulatory standpoint; (4) favourable land lease and/or easement conditions; and (5) occupancy and pricing rates, relative to the competition and history.

And to track business performance, they recommend looking at “land cost trends over time, scaling of overhead expense” and “free cash flow generated relative to both our tangible PP&E investment [and] total investment”.

Insurance

In insurance, they seek agencies that operate with a large margin of safety. That is, a sizeable difference between their premiums charged and anticipated losses. They prefer insurance in commercial segments (as opposed to personal) with shorter tail-risk and policy durations (a year or less). The focus is on higher policy counts, lower loss limits and underwriting discipline.

The reasoning above helps to explain their investment in surety and fidelity insurance through General Indemnity. Firstly, the ten-year average loss ratio for surety and fidelity insurance is less than half that of the industry (e.g., personal auto, homeowner insurance, and so on). Secondly, the net premiums written in surety and fidelity ($6B in 2015) is small relative to other segments (e.g., personal auto was at $200B in 2015), which is unattractive to the large insurers (potential competitors).

Thirdly, the loss ratios are likely to remain low due to high distribution costs. Many of the surety bonds are of small value ($100), and costly for insurance agents to earn a commission on at scale. This creates a niche that General Indemnity can focus on: “being the low-cost producer in this high-cost distribution business.” Rozek and Peterson sum it up neatly:

“If we are going to hunt for opportunity, in general, we prefer to go where the crowds aren’t”.
Rozek and Peterson, Boston Omaha Shareholder Letters

In tracking their performance in insurance, they recommend looking at the growth in premiums and underwriting profit relative to the capital employed. This put results in context of the capital, acquisition, and retention costs that is needed to generate said premiums. But as Markel Corporation wrote in their letters to shareholders, it’s also important to consider the underlying riskiness of what’s underwritten, which can change materially over time. For the outside investor, this isn’t easy to discern.

Fibre operations

In 2019, Boston Omaha reported their investment in AireBeam, a broadband internet service provider in southern Arizona. Peterson and Rozek describe their interest in AireBeam’s fibre operations for several reasons: (1) durable revenues; (2) tax-advantaged cash flows; (3) continued growth in demand; and (4) low life-time costs to network maintenance. The pair also plan to reinvest excess cash flows to “grow [their] fibre footprint in a disciplined manner”.

Amongst essential utilities and resources (i.e., water, electricity, gas, sewage, and so on), data is likely to experience the highest growth in demand. In Boston Omaha’s view, glass in fibre optic cables can service this demand without significant capital needs after the initial pipe. The result as well is a superior product and network for customers in regions where data capacity remains a problem (i.e., AireBeam’s market selection).

If one is to monitor progress in the fibre optics business, Rozek and Peterson recommend several metrics, including: “homes passed”, subscriber volumes, average revenue per users and capital expenditures over time.

Boston Omaha shareholder letters – Rozek and Peterson on value investing and billboard businesses