Trillions of dollars in Index Funds are distorting the S&P 500

Trillions of dollars in Index Funds are distorting the S&P 500

Investors who poured trillions of dollars into index funds on the conviction that no one can beat the market may actually be making it easier to do just that.

All that dumb money could be offering wily stock pickers a chance to buy smaller companies on the cheap, according to new research.

Academics have shown that passive flows into the S&P 500 over the last two decades disproportionately pumped up prices of its largest members -- paving the way for small companies in the benchmark to eventually outperform.

That may seem like a wild idea to anyone on Wall Street who witnessed the relentless rise of the megacaps in recent years. But the argument is that passive flows ultimately make the S&P 500’s small members too cheap relative to the big.

“Flows into funds tracking the S&P 500 index raise disproportionately the prices of large-capitalization stocks in the index relative to the prices of the index’s small stocks,” authors Hao Jiang, Dimitri Vayanos and Lu Zheng wrote in the paper. “The flows predict a high future return of the small-minus-large index portfolio.”

The research will prove timely to critics of the passive boom who say a bubble in the biggest tech names is about to burst, while small caps start 2021 in fighting form.

‘Distortions’

The team from Michigan State University, the London School of Economics and University of California Irvine analyzed data from 2000 to 2019.

They found that so-called noise traders tend to push up the price of fashionably big companies as they enter the S&P 500. As a result, those companies arrive with higher index weights which in turn trigger more buying from capitalization-weighted funds tracking the gauge.

A similar effect occurs when the funds get inflows -- the new cash is more likely to go toward stocks seeing high noise trader demand.

“When prices are distorted, weights of value-weighted indices are biased, and flows into index funds exacerbate the distortions,” the academics wrote.

It all paves the way for the outperformance of smaller S&P 500 companies when the price gap eventually normalizes.

Market moves over the past 10 years offer some support to one side of the story. The big have got bigger, with tech stocks such as Apple Inc. and Amazon.com Inc. accounting for an ever-increasing share of the index, while smaller companies in global indexes underperform.

But the longevity of that trend has killed confidence in the so-called size factor, a well-known quantitative strategy based on the notion that small-caps outperform large-caps over the long run.

The new research suggests that the size effect lives on -- just within the S&P 500, rather than across the entire stock market as the old academic studies once stated.

A “small-minus-large” portfolio of stocks in the index -- which takes a long position in the smallest shares and shorts the biggest -- earns an average 10 per cent per year, the research found. But an equivalent portfolio using shares outside the S&P 500 delivers an insignificant return, indicating the mountain of cash indexed to the benchmark may be creating the distortion.

Index Fears

Wall Street has long fretted the side effects of the indexing boom, with researchers warning about everything from the co-movement of shares to the threat to standards of corporate governance.

The biggest question hanging over the latest research is if and how smaller companies can ever catch up.

Megacap defenders point to fundamental justifications for their lofty valuations, such as Big Tech’s ability to capitalize on technological shifts and grow profits. There is evidence that passive investment has made S&P 500 prices more informative on aggregate, if not always on an individual basis.

Yet if the distortions keep growing, they may sow the seeds of their own reversal. A working paper last year from the Board of Governors of the Federal Reserve System suggested that ultimately a “feedback effect” may disrupt the active-to-passive shift itself.

“If index-related price distortions become more significant over time, they may boost the profitability of active investing strategies that exploit these distortions and ultimately slow the shift to passive investing,” the authors wrote.

Source

https://www.bnnbloomberg.ca/trillions-of-dollars-in-index-funds-are-distorting-the-s-p-500-1.1548051

Some Interesting Canadian Reits

Some Interesting Canadian Reits

TRICON CAPITAL (TCN TSX)

Tricon is a residential real estate firm largely focused on rental housing, primarily in the U.S. Sunbelt and Toronto and segmented into three verticals: Single-family rental (SFR) homes, multi-family rentals and for-sale housing. The company’s principal strategy is to offer affordable upscale rentals in high-population growth markets to middle-market consumers who have historically offered landlords longer-tenure and therefore more stable cash flows than other segments of the rental market. The SFR sector is one of the few real estate asset classes to experience net demand growth amid COVID. The pandemic has caused households to begin leaving city centers, shifting demand towards suburban single-family homes. In addition, work-from-home is expected to further drive deurbanization and create demand for larger living spaces. As a result, Tricon has been able to increase occupancy to record highs approaching 98 per cent and achieve blended rental rate growth of 5.1 per cent in May. Despite record demand and accelerating fundamentals, shares of Tricon trade at a 21 per cent discount to consensus net asset value, which offers a compelling entry point for investors as U.S. peers are currently trading at an 8 per cent discount to their net asset values.

EUROPEAN RESIDENTIAL REIT (ERE/U TSXV)

European Residential REIT is the world’s only REIT focusing on multi-family apartments in the Netherlands, the third-most densely populated country in the world. The REIT currently owns and operates 5,632 residential suites across 131 properties in the country. It emerged in its current form when Canadian Apartment REIT sold a portfolio of 41 multi-residential properties located in the Netherlands and ERE took over its management and control. ERE offers unitholders first-mover advantage in consolidating the apartment sector in the Netherlands, where fundamentals are robust and no other institutional operator of size exists. CAPREIT identified this opportunity and decided it would be rewarding to sponsor ERE as a standalone vehicle with its own cost of capital and independently-focused investor base. Despite COVID-19, fundamentals in the REIT’s core markets remain largely unchanged, with ERES able to collect 100 per cent of rent, increase occupancy by 120 basis points as of April 30 and successfully send out renewal increases of 2.4 per cent. This compares to North American peers who have predominantly lost occupancy, collected below-historical average rents and have achieved flat net effective rent growth. Notwithstanding robust fundamentals, units of ERES remain a compelling investment, trading at a 14 per cent discount to their IFRS net asset value.

GRANITE REIT (GRT/U TSX)

Granite, the largest industrial REIT listed in Canada by market capitalization, owns a diverse portfolio of industrial properties across Canada, the U.S. and Europe. The REIT’s CEO, Kevan Gorrie, is an accomplished industrial real estate executive. Positive fundamental performance across Granite’s markets is expected to reaccelerate due to a rise in ecommerce, tenants increasing their inventory levels to meet demand, and slowing development starts, which limits the amount of new supply. In addition to benefitting from a fortress balance sheet, the REIT has been incredibly successful in significantly reducing exposure to its largest tenant over the past two and a half years. This improved Granite’s credit profile and contributed to further unit price appreciation. The REIT’s units are attractively valued, trading at a slight discount to NAV whereas its U.S. peers trade at a 9 per cent premium on average.

Source

Andrew Moffs, Senior Vice-President and Portfolio Manager at Vision Capital,

BNN-Bloomberg, June 25, 2020

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BSR REIT (HOM-U TSX)

BSR is a unique Canadian-listed REIT that invests in U.S. multi-family apartments within the U.S. Sunbelt states of Texas, Oklahoma, and Arkansas. The REIT’s principal strategy is to own and operate affordably-priced apartments within these strong population and job growth markets and selectively deploy value-add renovations that achieve high returns. Not only has management of BSR perfected this strategy over the last 20 years, but management also has a significant ownership stake in the REIT, resulting in BSR having one of the most aligned and experienced management teams within the Canadian-listed apartment sector.

Tricon Residential REIT (TCN TSX)

Tricon Residential Inc. is the only Canadian-listed company that operates and manages high-quality residential real estate across North America with a focus on single-family, and multi-family rental buildings in both the U.S. Sun Belt and Toronto. The Company’s principal strategy is to offer affordable upscale rentals in high-population growth markets to middle market consumers, who have historically offered landlords longer-tenure and therefore more stable cash flows than other segments of the rental market.

Canadian Apartment Properties REIT (CAR-U TSX)

Canada’s largest publicly-traded rental residential enterprise, it owns 59,000 residential rental suites and manufactured housing community sites. It also owns controlling stakes in two publicly-traded European apartment REITs focused on Ireland and the Netherlands, respectively. Notwithstanding the uncertainties generated by the pandemic, CAPREIT’s units are a compelling investment for several reasons. First, it possesses a strong balance sheet with $372 million of liquidity, a debt to gross book value of only 36 per cent, access to over a $770 million unencumbered asset pool and minimal near-term maturities. Second, it owns a defensive portfolio of apartment units with in-place rental rates that are 7 per cent below market and are affordable relative to other housing options. Third, recent transactions suggest that apartment valuations have increased during COVID-19.

Source

Andrew Moffs, Senior Vice-President and Portfolio Manager at Vision Capital,

BNN-Bloomberg, November 10, 2020

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CAPREIT (CAR-U TSX)

CAPREIT is the largest apartment landlord in Canada and its shares have suffered due to a rent freeze implemented by the Ontario government and concerns over demand from foreign students and occupancy. Nonetheless, CAPREIT's apartments remain one of the most affordable housing options in Toronto and Vancouver with rent controls placing CAPREIT's realized rents significantly below market. Even with the rent freeze, CAPREIT should still be able to realize double-digit rent increases on turnover. We believe that the secular immigration tailwind for Canada will continue after COVID is over and that CAPREIT's stock is a good long-term buy with a 2.75 per cent yield and trading below book value.

Source

David Baskin, President at Baskin Wealth Management,

BNN-Bloomberg, December 10, 2020

Disciplined Growth Investors

Disciplined Growth Investors

There are various approaches to investing in the stock market. Marty Whitman's philosophy is one approach. This post features another...Growth stock investing as practiced by the firm, Disciplined Growth Investors...Founded by Frederick K. Martin, the CEO of the company. His firm  has an excellent long-term track record of investment performance...

Investment Philosophy

There are three tenets that, together, drive Disciplined Growth Investors’ philosophy.

The Power of Big Ideas – “Big ideas” are investments in companies that have a realistic probability of generating outsized returns for shareholders. Think appreciation of 10, 20 or even 50 times an initial investment. These companies often share certain key traits – a clarity of mission, huge addressable markets, management teams that balance the interests of all stakeholders and, most importantly, a sustainable competitive advantage. These businesses are admittedly rare, but the potential rewards are substantial.

Disciplined Buyers – Finding a great business is only half the battle. Having the discipline to only purchase these companies at a price below their intrinsic value increases the likelihood of an attractive future return. And to be perfectly honest, we simply hate paying too much for a stock.

Patience – We think in terms of years and decades, not months and days. Outsized financial returns do not happen overnight. Success is typically a tortuous path, one that requires ample patience. We are willing to look foolish in the eyes of the market in the short-term, as long as the fundamentals of a company are sound. Experience has taught us that value creation will inevitably be rewarded.

Investment Process

A sound investment philosophy requires a rigorous process to be successful.

Idea Generation – There are no “magic” screens or filters that neatly isolate promising investment candidates. It requires looking under a great many rocks. Successful idea generation is the ability to recognize a great growth company when you see one. The knowledge gained from long holding periods, as well as a systematic examination of our winners, losers, misses and near misses has sharpened, and will continue to sharpen our ability to identify raw potential.

Value Assessment – Our research process concentrates on one critical question, “What is this company really worth?” To answer it, we must first develop a comprehensive understanding of the business. We use that understanding to build a detailed financial model and to estimate normalized earnings today, as well as seven years in the future. Next we apply a time-tested valuation methodology, one derived from the teachings of Benjamin Graham, to make our assessment of intrinsic value.

Portfolio Construction – When it comes to constructing portfolios, stock price volatility is the gift that keeps on giving. We exploit price volatility to purchase great businesses when they are temporarily “on sale” for reasons that we believe will have a minimal impact on the long-term value creating potential of the business.

Risk Management

Our risk management process is designed to mitigate the risk most devastating to investors – a large, permanent loss of capital.

Know What You Own – The Golden Rule of risk management is to know what you own. If we cannot develop a comprehensive understanding of the business and the industry in which it operates, we have no basis for owning that company. Period.

Margin of Safety – We look to build a margin of safety into our purchase price. We start by using a reasonable set of assumptions in our financial projections. Then we bolster that margin of safety by employing a challenging hurdle rate—a relatively high expected return over time. A challenging hurdle rate reduces the initial purchase price, which hopefully results in an acceptable return, even if our growth assumptions prove faulty.

Intelligent Allocation of Capital – The first two elements of our risk management process help to limit the number of mistakes that make their way into the portfolio. The intelligent allocation of capital is designed to avoid compounding potential mistakes. By allocating incremental capital toward positions that meet expectations and away from those that don’t, we essentially starve mistakes out of the portfolio.

There are more detailed discussions about our investment philosophy and process in the “Insight” section of the website, as well as in our book, “Benjamin Graham and the Power of Growth Stocks.”

Website

https://www.dginv.com/view

The Investing Style of Marty Whitman

The Investing Style of Marty Whitman

Third Avenue Management Founder Marty Whitman died Monday at the age of 93.

Many Third Avenue investors will probably remember Whitman as much for his insightful and witty letters to shareholders as for his successful stock-picking approach. Whitman has authored The Aggressive Conservative Investor and Value Investing: A Balanced Approach. Both of these books shed light on his approach. But Whitman's record speaks for itself: He won Morningstar's Fund Manager of the Year Award in 1990 for his work running Third Avenue Value.

A vulture of a value investor, Whitman would often rummage through the rubble of distressed stocks--those of beaten-down companies, some on the brink of insolvency. But many of Whitman's depressed stock plays eventually turned around for the better.

The key to Whitman's stock-picking success was buying companies that were cheap and safe, and holding onto them.

Whitman was a value investor after Benjamin Graham's own heart. Like Graham, Whitman would look for stocks that were dirt cheap, but instead of using a company's price/book ratio (Graham's preferred valuation measure) Whitman would focus on a company's takeover value, or how much he believed a buyer would pay for the whole company.

A shrewd analyst of business accounting, Whitman would comb through a company's financial statements to figure out what he thought the business was worth. He then would determine whether the company’s balance sheet had remained strong in spite of setbacks in the business. He would generally pay no more than 50% of what he thought a buyer would pay to acquire the whole firm.

In addition to a having a very cheap share price, Whitman also favoured firms that met the following three criteria:

1...Companies with very little debt on the books.

Whitman looked for debt on the balance sheet and in the footnotes of the company's financial statements; he had seen companies downplay hefty liabilities by burying items in notes. Because he often invested in troubled companies, Whitman didn't like firms overburdened by debt: Debt can make a company’s troubles even worse.

2...Companies with high-quality assets.

Whitman defined high-quality assets as cash or real estate. He looked for assets with value.

3...Companies that don't require a huge overhead to generate cash.

Whitman liked companies that could make money without spending a lot of money. A money-management firm, for example, can conduct its business online, via telephone, or in a face-to-face meeting, which doesn't cost a lot.

An analyst in Morningstar Chicago interpreted the safe and cheap framework.

- The first step in the safe and cheap approach is to theorize what you could lose.

If there isn't a safety net--a high-quality asset, in most cases--to keep the shares from going to zero, then there is absolutely no reason to waste time hypothesizing about the upside potential. The safe and cheap investor tends to focus on companies that own rock-solid assets: The balance sheet takes precedence over the income statement.

- Savvy management.

The safe and cheap approach also holds in high regard management teams dedicated to creating wealth in the most tax-efficient manner, as well as management that takes advantage of inefficiencies in the capital markets. A savvy management team is important and typically includes a group of insiders who own a sizable equity stake in the company.

- Well-capitalized business.

It must be well capitalized, possess solid long-term prospects, provide excellent financial disclosure, and be available for purchase at a discount to its fair value. The "safe" component is satisfied by the first four attributes, while the "cheap" component is fulfilled by the last.

Well-capitalized businesses with solid long-term prospects tend to fall into three buckets under this approach.

1. The first bucket is a strong operating company enjoying an economic moat and a balance sheet with no significant burdens.

2. The second bucket includes companies that also lack significant liabilities, but own tremendous underutilized resources. These assets can be put to use in more efficient ways to create wealth over time.

3. The third bucket consists of companies that own well-positioned assets that throw off solid cash flows and are partially secured with non-recourse debt. This type of debt, which only allows lenders to rely upon the asset for repayment (as opposed to the parent company), lowers the risk profile while enhancing cash returns on equity and providing tax-efficient ways to realize appreciation.

- Excellent disclosures.

The safe and cheap approach also favors companies that provide excellent disclosure. This disclosure typically supplements required filings and provides non-GAAP measures, and is often critical in assessing the true health of a business and its balance sheet. Such disclosure is also especially important since the safe and cheap investor may be taking advantage of depressed stock prices created by short-term concerns to acquire stakes in blue-chip companies.

- Buy at a meaningful discount to fair value.

Whitman seems to have rules of thumb for buying in different business lines. He favors buying financial-services companies below book value, real estate companies below private market value, asset managers below book value plus 2%-3% of assets under management, and operating companies below 10 times peak earnings. All of these measures revert to the company's fair value, or what Whitman terms "net asset value." While we prefer to value a company and its moat by estimating the present value of future cash flows, we couldn't agree more with Whitman's stipulation that buy orders only be placed at discounts to intrinsic value.

The above information was taken from Remembering famed investor Marty Whitman and Marty Whitman's 'Safe and Cheap' approach

Stock Idea...Atrion Corp...ATRI on the Nasdaq

Stock Idea...Atrion Corp...ATRI on the Nasdaq

Recent results have been weak due to the Covid-19 Pandemic presenting an opportunity to buy a good stock cheap.

Business Description

Atrion Corp develops and manufactures products for medical applications. Its fluid-delivery products contribute the largest proportion of revenue and include valves that can hold and release controlled amounts of fluids or gases and are often used in anesthesia and oncology applications. Atrion's cardiovascular products include the MPS2 Myocardial Protection System, which delivers fluids and medications, mixes drugs, and controls temperature and pressure during open-heart surgery. The cardiovascular business also sells cardiac-surgery vacuum relief valves, inflation devices, and other products used in heart surgery. The firm's ophthalmic products include medical devices that disinfect contact lenses. Atrion generates the majority of revenue in the United States.

Atrion Corporation (Atrion) is engaged in developing and manufacturing products, primarily for medical applications. The Company's medical products range from fluid delivery devices to ophthalmic and cardiovascular products. Its fluid delivery products include valves that promote infection control and needle safety. It has developed a range of valves designed to fill, hold and release controlled amounts of fluids or gasses on demand for use in various intubation, intravenous, catheter and other applications in areas, such as anesthesia and oncology. Its cardiovascular product, MPS2 Myocardial Protection System (MPS2), is the system used in open-heart surgery that delivers fluids and medications, mixes critical drugs and controls temperature, pressure and other variables. The Company manufactures specialized medical devices that disinfect contact lenses. Its other medical and non-medical product lines consist of instrumentation and associated disposables.

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From the company's website...

Highlights:

Atrion’s ability to generate strong cash flows is a key strength that enables the company to deliver consistent growth and profitability and to support ongoing R&D and capital improvements in technology, facilities and equipment. Over the past several years, these investments included new manufacturing machinery and equipment that enhance our ability to meet customer needs with even greater quality, flexibility and efficiency. Our consistent generation of cash flow also enables us to invest in value-creating initiatives such as stock repurchases and dividend payments.

Despite fluctuations in markets, product demand, and the economy, the company has continued to return value to stockholders through consistent, strong earnings growth. Over the past twenty-one years, Atrion attained annual compounded rates of growth of 6% in sales, 17% in operating income, and 20% in EPS—all of which we achieved organically rather than through acquisitions. During this same time period, the company’s stock price increased from $8.00 per share to over $700 per share.

Our return on equity has also steadily increased from five percent in 1999 to 16 percent in 2019. From 1999 to 2019, we repurchased over two million shares of our stock and consistently executed the timely repayment of debt associated with these buybacks. The Company has no outstanding debt as of December 31, 2019. At December 31, 2019 our cash and investments totaled $100.6 million.

Summary:

Although Atrion is a relatively small company in the medical products arena, a number of our products hold leading market positions in their respective niches, creating a stable and diversified revenue base.

Atrion's presence in the healthcare and medical products industry is based on providing devices and components to niche markets that offer significant opportunity for product development, market penetration and revenues growth. We work to enhance our position in the markets we serve by:

- Focusing on customer needs

- Expanding existing product lines and developing new products

- Maintaining a culture of controlling cost

- Preserving and fostering a collaborative, entrepreneurial management structure

As a result of this strategy, a number of our most successful products hold the leading market positions in their respective niches, demonstrating that small markets can produce attractive returns. For example, Atrion is a leading U.S. manufacturer of soft contact lens disinfection cases, clamps for IV sets, cardiac surgery vacuum relief valves, minimally invasive surgical tapes, check valves and balloon catheters for the treatment of tear duct blockages. Atrion is also the leading manufacturer of valves and inflation devices used in marine and aviation safety products.

To respond to new market opportunities, we make research and development a continuing priority. During the past five years, we invested $73 million in manufacturing and quality assurance equipment to further bolster our position for the long run.

Supporting a successful and diversified product line is a commitment to financial flexibility and strength. Atrion maintains a steady and consistent focus on managing assets wisely, making products that meet specific market needs, and improving productivity and profitability. As a result, we have delivered consistent growth in earnings per share from continuing operations, while funding the needs of the business and investing in the resources, technology and assets to ensure operating efficiency and fuel future growth.

Atrion has approximately 400,000 square feet of manufacturing, research and development capacity in three facilities in Alabama, Florida and Texas. We continually upgrade the manufacturing technology in our plants - automating processes where possible to maximize efficiency and quality control. The result is a seamless development and production system that can respond to new and increasing customer demand.

Atrion is committed to creating continuing value for stockholders. In recent years, the company has completed several stock repurchase programs, aimed at enhancing stockholder value. Since 2003, when we initiated the payment of quarterly dividends on our common stock, we have increased the dividend sixteen times. In August 2019, we boosted the quarterly dividend from $1.35 per share to $1.55 per share.

The development of new products to meet market needs is an ongoing strategy of the company's. Atrion has developed a line of swabable valve products that minimizes the risk of needle-sticks for medical personnel, and the MPS2®, the second generation of our Myocardial Protection System. The MPS2 is a proprietary technology that delivers essential fluids and medications to the heart during open-heart surgery providing increased flexibility to the surgeon and enhanced safety to the patient.

Our company's goal is to continue to build its presence in the medical products industry by leveraging our leadership position in niche markets and by developing new products to meet increasing customer demand for effectiveness, safety and cost. Atrion is committed to building value for the company and its stockholders through continued growth in earnings per share.

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ATRION 2019 Letter to Stockholders

It is my great pleasure to report to you on the progress we made in 2019, and to speak to strides we are focused on making in 2020.

Performance

In 2019, our earnings per share grew 7% to $19.73. We increased our dividend by 15%, the sixteenth consecutive year of double-digit increases. Our operating margin was an enviable 26%, reflecting the focus on operating efficiently and effectively. Sales were up slightly—just 2%, in part impacted by a nationwide shortage of contract sterilization capacity. Our cash and short- and long-term investments increased over 12% to $100.6 million at the end of the year, and we remained debt-free.

Discovery

Whether developing products to combat illness or to increase survivability in marine and aviation emergencies, exploration of new ideas, materials, and manufacturing techniques underlies our work.

The third generation of our Quest Myocardial Protection System (MPS 3) received regulatory clearance in Canada at the end of 2018, and a limited market release was conducted there in 2019. This console and its related disposables represent the most complex new product program in our history. This successful effort—ranging from writing millions of lines of software code to seamlessly integrating electrical and mechanical systems—has greatly expanded the capabilities of this uniquely powerful platform. We anticipate our MPS 3 receiving FDA clearance, and being introduced in the U.S., later this year. This introduction will further advance our status as the market leader in this clinical niche. 

Central to this effort and the many others we undertake each and every year is an extremely talented team of experts in the sciences, engineering, manufacturing, and quality assurance, as well as support services and an incredible production team.

Acceleration

Our approach to growth is rooted in continuously investing in our people, products and new manufacturing technologies. Over the past year, the pace of new product development and launches increased—a trend that we expect to continue in the years ahead. We currently have over two dozen products in various stages of development. As they come to market, they will help us expand our market share. We also invested record amounts of capital in manufacturing technologies in both 2018 and 2019 to ensure the highest levels of quality and efficiency.

In 2019, we increased our focus on talent discovery, development, and management to shape our next generation of leadership, and we are continuing to focus on those aspects of our business this year.

These investments in people and products are aggressive, and they are key to solidifying the foundation of our work. However, at the same time we continue to manage the Company in the fiscally conservative manner that has guided our approach for years.

Appreciation

At the time of this writing, we are greatly concerned about the COVID-19 pandemic. To protect the health and safety of our employees, we are closely monitoring the guidance provided by the Centers for Disease Control and Prevention, and, at the same time, we are mindful of our special responsibility to supply hospitals with critical products that will be needed for various illnesses. Any breaks in the supply chain to hospitals will have profound implications for the critically ill. I do not know what tomorrow will bring, but I am extremely grateful for the courage and grace of my co-workers who are working with great dedication. 

When we released our earnings for 2019, we predicted 2020 would bring high single-digit top line growth and low double-digit operating income growth. Whether the COVID-19 contagion will affect this outlook or the timing of regulatory approvals for new products is unclear at this time. Regardless of whether our results are impacted, at Atrion we focus on sustainable growth and responsible management. Our priority is to ensure the Company’s growth over the long term, not just on achieving certain results for a specific calendar year.

I am grateful to you, our stockholders, for your continued support,

David A. Battat, President and CEO

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Comments from BNN-Bloomberg Contributors

Atrion Corp. (ATRI NASD) - Last purchased on August 10, 2020 at US$663...Aug 25, 2020, David Driscoll

Atrion is a leading supplier of medical devices and components to niche markets. Atrion’s proprietary products, ranging from cardiovascular and ophthalmology products to fluid delivery devices, are sold to end-users and distributors worldwide. The stock has traded at its current price level since mid-2017 as revenues have temporarily flattened. However, the company has new products to introduce in 2021 and it just raised its dividend 13 per cent to US$7 a share on higher expectations.

ATRION (ATRI.O)...July 29 2019...Brett Girard

This Texas-based small-cap medical device company offers niche products in the fluid delivery, cardiac and ophthalmic categories. Management is keenly focused on free cash flow, with a healthy allocation to both R&D and dividends (it has a five-year dividend growth of 80 per cent and a 10-year dividend growth of 300 per cent). Relative to pharma patents on products don’t expire, making R&D and the reinvestment cycle more predictable and steadier. In 2018, when the small-cap Russell 2000 Index declined 12 per cent, Atrion was up 18 per cent. It’s traded lower in 2019 as investors take profits, but with no sell-side analyst coverage, this is an under-the-radar cash flow machine for years to come.

Company's Website

https://www.atrioncorp.com/about/

Brookfield bids to take Brookfield Property Partners Private

Brookfield bids to take Brookfield Property Partners Private

Brookfield Asset Management Inc. and a group of investors have offered to acquire the stake in Brookfield Property Partners that they don’t already own, in a US$5.9 billion deal to take the real estate company private.

The Canadian alternative-asset manager said it has made a proposal to acquire the outstanding units for US$16.50 each, or about a 14 per cent premium to Thursday’s closing price in New York. Brookfield Asset Management already owns about 60 per cent of Brookfield Property Partners, which had a market value of US$13.8 billion as of Thursday’s close.

Units of Brookfield Property Partners jumped as much as 15 per cent to as high as US$16.71 apiece in early trading in New York on Monday, after an earlier Bloomberg News report.

Privatizing Brookfield’s real estate subsidiary is appealing because it has consistently traded at a discount to the underlying value of its assets, Nick Goodman, Brookfield Asset Management’s chief financial officer, said in an interview.

“We believe that it has been consistently discounted for more than just the past year,” Goodman said. “We believed it would be a premium offering to the market given it has a unique global portfolio and some of the highest quality real estate in the world. But it has consistently struggled to trade at its net asset value.”

While Brookfield Property Partners’s units traded at all-time lows in March, near the beginning of the Covid-19 pandemic, Brookfield waited until the unit price had stabilized to push ahead with the privatization effort, Goodman said.

The stock also trades at a discount because a lot of the company’s value has been created through the development of long-term projects like New York’s Manhattan West, Goodman added. Such projects can take years to start generating returns for investors.

“We’ve just built more conviction over time that the right form for this is in the private markets,” he said.

Cash or Stock

Under the proposal, investors in Brookfield Property Partners can either elect to take the US$16.50 per unit in cash, or instead choose 0.4 of Brookfield Asset Management’s stock, or 0.66 of Brookfield Property’s preferred units. Holders of Class A stock in Brookfield’s other publicly-traded real estate entity, Brookfield Property REIT Inc., can participate once they exchange their shares for Brookfield Property Partners units.

Brookfield Asset Management has presented its proposal to the board of Brookfield Property Partners, and asked members to form a special committee to evaluate the offer. Any transaction would be subject to a vote requiring approval from the majority of minority holders, Goodman said.

Brookfield Property Partners owns, operates and develops one of the largest portfolios of real estate in the world. At the end of September it had about US$88 billion in total assets, including developments like London’s Canary Wharf and Brookfield Place in New York. In 2018, Brookfield acquired GGP Inc., the second-largest mall operator in the U.S., for about US$15 billion.

The pandemic has taken its toll on the company as widespread stay-at-home orders keep workers away from offices and shoppers away from malls. Brookfield Property Partners shares have fallen more than 20 per cent over the past year, though they’ve bounced back to double from their March lows.

Brian Kingston, chief executive officer of Brookfield’s real estate group, said in a letter to unit holders in November that he believed the worst of the crisis is now behind the company, and that he continued to see signs of the recovery from the economic shutdown.

Sources

BNN-Blommberg

https://www.bnnbloomberg.ca/brookfield-bids-to-take-brookfield-property-partners-private-1.1543521

Constellation Software Spin-off of Topicus.com

Constellation Software Spin-off of Topicus.com (TOI on the TSX)

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Historically, the benefits for Constellation to stay as one company have included better access to capital for larger deals and enhancement of operations within acquired companies through sharing of best practices. As Constellation and the operating groups get larger, these become less important and factors such as employee focus and incentives become more important. Constellation has always operated in a decentralized manner but has continued to push autonomy down to the operating groups, most notably shifting the capital allocation down to the operating groups. Constellation today is often described not as one company, but six mini-Constellation Software’s under one umbrella.

In May 2020, Constellation’s subsidiary TSS acquired Netherlands-based Topicus.com BV (I’ll call the pre-merger Old Topicus) with a plan to seek a separate listing of the combined companies which would be named Topicus.com. Constellation had originally planned to complete the spin-off by November 2020, but for undisclosed reasons has delayed it to a future date. The stock will be dual-listed in the Netherlands and on the TSX Venture exchange. The total purchase price is valued at EUR 217.4m with TSS paying EUR 133.6m and IJssel (the seller) buying 9% of TSS for EUR 83.8m. IJssel will also commit an additional EUR 27.6m loan to TSS. The debt required to finance the deal will be funded entirely at the TSS-level without recourse to Constellation Software.

TSS was acquired by Constellation in 2013 and is the only operating group that solely operates in Continental Europe (mostly in the Netherlands and Central Europe). The Topicus.com prospectus tells us that TSS has 85 software businesses which, in the future, will be organized into three TSS operating groups: TSS Public for the public and healthcare sector, TSS Blue for the private markets, and Old Topicus upon completion of the merger. Maintenance organic growth at TSS has grown faster than Constellation as a whole.

Old Topicus focuses exclusively in the Netherlands, and is a dominant provider of software for education, healthcare, and finance markets.  Growth has not come from acquisitions, but from a cultivated culture that hires smart people (average IQ of 130+) and gives them space to explore new ideas. Employees are grouped into cells of 7 to 10 who have responsibility for a product and, if an employee has a new idea for a business, Old Topicus will help explore and incubate the idea to create “in-house start-ups” where the employee retains equity interest in their idea. This process has resulted in successful products such as the ParnasSys pupil tracking system which has an 85% share in primary education, the FinDesk platform which has an 75% share in mortgage advisor software, and practice management software which has an 85% share in GPs.

Impressively, Old Topicus did not use any outside shareholder funding in its growth and as a condition of merging with TSS, insisted on maintaining its identity; hence the listing:

“The plan to create a publicly listed operating group made up of Topicus and TSS was a key part of our discussions with the Topicus founders. They didn’t want their legacy disappearing into the craw of an omnivorous conglomerate.  While they knew that Topicus would have autonomy within Constellation, they also wanted identity. The public listing is expected to afford our Netherlands-based businesses a platform from which to celebrate their culture and achievements.”

– Constellation press release – May 20, 2020

The combined TSS + Old Topicus will be more focused on organic growth and internal product development than Constellation has historically been. With Old Topicus CEO Dan Dijkhuizen being the CEO of the combined post-spin company (TSS CEO Robin van Poelje will be Chairman), it will be very interesting to see how the company approaches capital allocation and acquisitions given its historic focus on internal growth. As with the rest of Constellation Software, bonuses will be paid based on return on invested capital and revenue growth and managers must invest a portion of their bonus into the stock. I’m not sure if the programmers at Old Topicus will have the same bonus and compensation scheme, though I’m sure the internal start-up concept is something that Topicus.com will want to maintain.

The entire spin-off has been designed in a way to set incentives and give autonomy for the new company while ensuring that Constellation retains control and retains cash flow to invest. Constellation will have a share that gives it majority voting (50.1%), and control of the board. Constellation and Joday/IJssel (the former owner of Old Topicus) will also own preferred shares that pay a 5% dividend of about EUR 61.8m per year. Detailed financial information on Old Topicus has not been disclosed, but TSS + Old Topicus earned EUR 518m in revenue in 2019 and likely low-mid EUR 100 million in EBITA (proxy for pre-tax cash flow), so the preferred share dividends will initially use up a large chunk of annual cash flow. With a relatively stable invested capital base, management is therefore incentivized to focus on organic growth rather than face pressure to deploy a growing capital base. The preferred shares are convertible into common stock at some point in the future based on a variety of conditions, so Topicus will slowly get access to its cash flow over time. Constellation itself would also be retaining a decent chunk of TSS cash flow that can be used for its own purposes and since most of the initial cash flows are flowing back to the owners of the preferred shares, employees and shareholders investing in the stock of Topicus.com will truly only participate in the growth and value-creation of the entity going forward.

Possible spin-off of Volaris

Another Constellation Software Operating Group, Volaris, has also quietly reorganized itself and created two new companies, each with its own CEO and branding: “Modaxo” to focus on people transportation, and “Lumine” to focus on communications and media. Long-term followers of Constellation Software may remember that Volaris used to be called Trapeze, which focused on public transit software, so Trapeze has gone full circle in separating itself as a new vertical. Since Volaris is one of the larger operating groups and even has its own “Volaris University” in training up capital deployers so perhaps CEO Mark Miller wants more autonomy. We will see what happens.

To sum it all up, the Topicus.com spin and the reorganization of Volaris are simply next steps in the evolution of Constellation Software into a mature organization and it will be fascinating to see how many tricks Mark Leonard has up his sleeve as Constellation Software continues to grow.

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Sources

Earnest Wong,

Baskin Wealth Management

https://baskinwealth.com/an-ernest-opinion/constellation-software-spin-off-of-topicus-com/