Learning investing from Ben Graham and Warren Buffett means you probably know a thing or two about cigar butts. These days cigar butts are few and far between. A cigar butt is defined most widely as a company whose market cap is less than its cash and liquid accounts receivables less any outstanding liabilities. In short, the company is worth more dead than alive. The problem that Buffett realized early on is that there is a strong institutional imperative to never shut the company down, but exhaust all available resources until it is the company is no longer worth anything, dead or alive (this is starting to sound like a Bon Jovi song).
At times I am attracted to what I call “cash flow cigar butts.” These companies have cash flows that are worth more in a matter of one or two years than their market cap. Typically, these cash flows are sticky in the near term and therefore provide a certain level of comfort for not losing money on the investment. However, there is a similar problem with these companies. Luckily, I have learned this lesson theoretically and not through experience.
Intersections (INTX) is a company that is best known in the consumer market for identity theft protection called Identity Guard. However, their bread and butter business is not selling this product direct to consumers, but as an add-on product through other marketing channels, mostly financial institutions (i.e. Bank of America, Capital One, Chase). The economics work out for Intersections much better as an add-on product because customer acquisition costs in the direct market are so high that is makes it tough to price the product for profitability.
However, in recent years, a variety of federal agencies have not taken to kindly to these add-on products. I won’t discuss the particulars of these actions, but suffice it to say the financial institution marketing channel is dead. There is no new marketing to financial institutional customers, but there is a portfolio of consumers that are in run-off mode. These customers provide a steady stream of cash flow for Intersections.
Last year, Intersections might have been able to effectively shut down the ongoing business and run it off in a way that would have created the most value for shareholders. Instead, they choose to do two things. First, go full speed ahead into the direct to consumer market, which has historically not been their bread and butter. This has dramatically increased customer acquisition costs and these customers, for whatever reasons, are more prone to churn, thus limiting the profitability of new customers. In other words, the customers are canceling before Intersections can profit from the marketing spent on acquiring them.
Second, and this is the most interesting and key aspect of this post (talk about burying the lead): Intersections embarked on an entirely new product line, and by new product, I mean: electronic dog collars. To say this is grossly outside their area of expertise would be somewhat of an understatement. Over the past 1.5 years, Intersections has spent approximately $11m internally developing this product that has yet to launch. $11m is not small amount for a company that is currently worth only approximately $80m Additionally, the manufacturing of this product is not even included in those numbers, so I would anticipate the costs to continue to increase. Voyce, the name of the dog collar, could be a multi-billion dollar product, who knows.
My key takeaway is that reinvestment of future cash flow is at management’s discretion. They will not always do what is rational from a shareholder standpoint.