Charlie Munger (Trades, Portfolio) has often said that the best way to find a solution to a problem is to invert it. Rather than asking what could go right, ask what could go wrong.
So, what happens if we invert the Daily Journal (DJCO, Financial) as an investment idea? To put it another way, what are the risks of investing in this business that investors should be aware of?
Inverting the Daily Journal
When we strip out the company's investment portfolio, the Journal is actually a pretty bad business.
The company's print business has been in decline for many years, and efforts to reinvigorate the enterprise by investing in digital technologies are not going particularly well.
For the fiscal year ended Sept. 30, 2018, the Journal reported consolidated revenues of $40.7 million, down from $41.4 million in the prior year. Pre-tax income out of the traditional business, which includes print journals, hit $237,000 from a prior-year loss of $360,000.
Meanwhile, the pre-tax loss at the technology business increased by $2.3 million to $14.4 million. Tax benefits of $19.5 million helped push the company into a consolidated net income position of $8.2 million for the financial year.
At the end of September 2018, the company held marketable securities valued at $212 million, including net unrealized gains of $158.4 million.
So, if you were to take the operating business by itself, the Journal wouldn't be a particularly attractive investment. When you add in the investment portfolio, it looks a lot better. But Munger isn't getting any younger, and he has been entirely responsible for getting the company's investment portfolio to where it is today.
The question is, when Munger eventually steps down from his position of the helm of the company, does the rest of the management have the investment skill to be able to carry on managing such a vast equity portfolio when the rest of the business is struggling?
Breakup value
There is no definitive answer to the above question at this point in time. It is one of those unknown quantities that we always have to take into account when conducting security analysis. It may be the case that when Munger eventually leaves his position at the helm of the company, the rest of the management decide the best course of action is to liquidate a business.
It in this case, Journal stock would be worth substantially less than it is today. According to its fiscal 2018 earnings release, its security portfolio had accrued a liability of $42,151,000 for estimated income taxes due only upon the sales of the net appreciated securities. When you factor in these taxes, the liquidation value of the portfolio falls to $170 million. The market cap of the business right now is $296 million, which puts the value of the rest of the Journal business at $126 million, roughly three times 2018 sales.
This seems to be an unusually high valuation for a loss-making newspaper business with a struggling digital division. On that basis, it is apparent that the market is placing a high value on Munger as an investment manager, which won't apply when he is no longer around.
Conclusion
This is not meant to be an accurate valuation of what the Journal is worth today. It is just a back of the envelope analysis of what the company might be worth in the worst-case scenario, the death of Munger and liquidation of the business.
The figures do reveal that the company seems to be overvalued at current levels based on a worst-case scenario analysis, but this is just a rough estimate. Because we don't know when Munger will pass, or what course of action the rest of the board of directors will take after his passing, I cannot say with any certainty that this outcome will be realized. It is just some food for thought.
Disclosure: The author owns no share mentioned.
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