Capital Structure: Discussion centers on optimal leverage for micro caps, emphasizing Ben Graham’s view that net cash increases value while net debt reduces it.
Intelligent Use of Debt: Examples include Nathan’s Famous (NATH) special dividends and buybacks, and John Malone-style media recapitalizations when structured prudently.
Credit Risk Pricing: Markets often ignore small net cash/debt but react sharply at extremes (e.g., ~5x EBITDA), making credit quality a key equity pricing driver.
Deleveraging vs. Adding Debt: Prefers companies that can add prudent leverage for high-ROI investments over deleveraging stories, except when valuations are extremely distressed or maturities loom.
Sector Nuance & Management: Energy vs. entertainment leverage decisions hinge as much on management’s capital allocation discipline as on industry cycles and predictability.
Case Study – WW International (WW): Highlights how high operational and financial leverage created extreme volatility; positive cash from operations but weak recurring revenue and churn, with added pressure from weight-loss drugs.
Micro-Cap Red Flags: Cautions on promoter behavior, at-the-market offerings, and dilution; notes few micro caps have strong recurring revenue or financially savvy leadership.
Portfolio Approach: Suggests investors seeking volatility could use portfolio leverage/options rather than rely on risky corporate leverage for returns.
Transcript
welcome welcome welcome how's everybody doing hope you are doing well my name is Andrew with Focus compounding on air live with Jeff genon Jeff how's it going today it's going very well Andrew how's it going with you it's going great we hope it's going great with everybody else as well this is the first time you're tuning in with us thank you so much for joining us be sure to check out all of our content that we push out into the investing Universe the best way to do that is to follow me on X Focus compound go to focus compound.com to get access to investment writeups from Jeff going all the way back to 2005 and of course if you're interested in learning about our Money Management Services you can reach out to me at andreid Focus compounding tocom so in the last podcast that we recorded uh we briefly discussed um this question that somebody had sent in but I thought it would be good to dedicate an actual fullon podcast to it since we spoke a lot about movies and uh the movie industry in the previous podcast uh if you want to send in a question send it in email me andreid Focus compound.com we'll pull them put them on the screen just like right here and we'll talk about them on the podcast uh somebody asked could Jeff discuss how he thinks about optimal capital structure specifically for micro cap names that may or may not have access to investment grade Credit in addition how would he think about debt deleveraging stories that offer more upside via leverage when compared to some in quote higher quality names within the same industry how much credit in valuation does he give or not give when something is highly leveraged and he likes it verse unleveraged and he doesn't like it but it might not change in everything in between feel free to take that in any direction okay um All About leverage yeah so this is a very complicated subject because I think when I talk on the podcast people think that I'm really against debt um and there's a few parts to that one and Ben Graham I think said this in um uh the interpretation of financial statements I think but basically any company that has net cash has to be worth more than it would be if it had net debt and any company with net debt has to be worth less than it would be if it you know had had net cash right so in other words whether we always talk about in terms of Enterprise Value instead of market cap or something what he was saying is we can apply some sort of idea that if they're piling up cash that might they might never get good use you should not ding a company to say the fact that they have a lot of net cash and haven't done anything with it it means that they're stupid and so I'm going to apply that they deserve like a lower PE or something on the other side sometimes people say oh look how smart they are that they're using leverage I'm going to think that it should be even higher um uh my uh feelings about management and kind of the multiples I should put on it so so I think the um in terms of absent anything else about what our our feelings are about it it is better to have cash than to have debt just in terms of the valuation and you need to incorporate that into it having said that having debt and doing smart things with it like say um I think Nathan's which is was maybe micro cap at the time borrowed and paid out a special dividend um I think that there have been ones that have borrowed and bought back a lot of stock so that can make a lot of sense Nathan's you know outside of covid was a very very predictable sort of business now my guess on that actually is that some and I could be totally wrong about this there were was someone associated with Nathan on the board and everything that had a history with other companies that had used a lot of Leverage and which it's more traditional to use leverage in those things that are bigger companies so my guess is that that may have kind of influenced things you see this more often with like private Equity firms that maintain some stake in a company that's been public for a while sometimes they kind of recapitalize them instead of having some other exit right instead of selling the whole company so I think that's what trickles down into that is the thinking from other parts of the uh how they work with other portfolio companies um the the uh we talked about The Outsiders John Malone has a chapter there and you can look at John Malone influence companies today that would be an example I'm not saying that I like every John Malone company in what they do but if you were looking for what I think is an intelligent use of debt I think you're more likely to find that among those kinds of companies and I don't think that non-investment grade um credit necessarily means that you shouldn't be using it um but I do think that things need to be used in an intelligent way for creating value and that they need to be Str structured the right way many companies have debt because they need it in some form or or more accurately they felt they needed it to grow a lot of it is very shortterm and um a lot of it is also uh the companies are not highly liquid in terms of what things they have on their balance sheet off setting that so their current position is is sometimes quite weak and everything so I I do worry about that I also always say to investors who say they like the leverage like you know like Hostess was a public company remember and people would say oh I like the leverage on and stuff I'd be like look there if you want you can leverage safe low beta stocks yourself if that's really what you're into if you like that this thing bounces around a lot you could always apply leverage to something in your portfolio I'm not recommending it but it you know sometimes it seems like people like um they want to own the Johnson Johnson's of the world but they want them to move a bit more and what that really means is you want to own them on margin or something is what they're really saying um and but when the company does it it's fine but I would never do it myself it's not as dramatically different as you might think the same thing if you used like leaps or things like that so sometimes I think people like the idea of owning good companies but they like the whatever we want to call it the more exciting gambling whatever aspect of it that leverage provides so I worry about that a lot um but for companies where it makes sense I I I like it and usually that is super rare in micro caps because you need some sort of like financially oriented person maybe they're a second career maybe you know something else like that you don't see it naturally occur I would say that often in in things like micro caps um I I see a lot of you know I mentioned the John Malone thing because there's very very few examples I can think of companies especially very small companies where them doing a lot of extraordinary events a lot of um issuing stock buying back stock putting on debt paying special dividends whatever is being done and it's smart the more transactions you see like of that usually the worse the company is and you're seeing a lot of at the market offerings or or whatever things a lot of delu of things they're they're they may be telling you that it's really good stuff that they're doing that's their spin on it but when you look at the numbers I I don't see it so uh you just see more of a promoter type aspect to it than a long-term owner um having said that if you look at the history of Berkshire hathway it was a tiny you know not by today's standards it wouldn't be a micro c cap if youjust for inflation stuff but it was highly liquid and not on things that people would have found easy to trade and it was doing all sorts of things it did it borrowing at 8% and doing this and that in the first few years buying things and everything and it was all very smart right and we talked about John Malone and TCI and all that that was obviously very junk credit um the other side of it too which I've mentioned before is there's all these Factor things that include like the beta people talk about low volatility things um I've always thought that that you could replace that to a significant extent if you had an ability to understand the credit risk of a company I do think that companies that are perceived to have very low credit risk the stock stocks do trade higher than stocks that are perceived to have very high credit risk the way that works with the market though tends to be pretty fast the market gets worried about it seems to focus on that when there's so high uh there's so um great credits that they're like AAA type stuff and they realize this and readjust and that they're things that are on the verge of being ready to be headed for a real liquidity crunch they don't seem to worry about small amounts so I do notice that there the market I don't think gives enough credit to a company that has one times evid do in net cash and doesn't punish a company enough for having one times uh um iida in in debt you know at what it starts to worry about is when it's up there at five times or something when there's a big pile of cash it doesn't notice 5% of the market caps in cash it notice is 25% it doesn't notice one times uh de B but it gets real worried at five and so it happens quickly that way um and I would separate the quality of the business from the quality of the the credit quality right so stocks often people write about them as if they're junky and because they are in the possibility of danger of bankruptcy uh delution whatever because they have a lot of debt and companies that have beautiful balance sheets they write about as if they're great but the business and the corporation are kind of two separate things um you can have a really high quality business that's choking on too much debt and you can have a really low quality business that because of its past is really well capitalized has no danger of ever heading towards bankruptcy or anything what are your thoughts on debt deleveraging stories uh generally don't like them as much just because I feel the returns that you get from them are usually pretty low in terms of the use of paying down the debth MH but there could be ones that are exciting if the price is really low right um personally I you know if I was picking a part of the cycle to be in I would rather be in the stock that can have debt and doesn't yet and it adds the debt while I'm invested in it than the company that has a lot of debt and now says it's going to pay it down now that might change in the future but debt has been quite cheap and so I've not been investing in companies where I think the returns inside the business or from buying back the stock would be worse than the return than um the returns that you could get from paying down debt right because you have to consider when you pay down debt there's a there's an tax aspect to it and other things but even today it even if is pretty expensive debt if you have like an better than about 8% after tax in cash uh investment opportunity it probably makes more sense to do that than to pay down the debt now it may make total sense to pay down the debt for safety purposes especially if there's a chunk of it coming due sometime soon what I'm saying is almost more if you imagine like a very long-term Term Loan and so there's no uh a bigger um maturity upcoming or something like that you know equalizing it as if it's perpetual debt we're thinking about it versus like Perpetual projects that you could invest in but it's hard to come up with answers that paying down debt actually makes more sense than like buying back stock in a really good business or certainly what companies claim they get in terms of eida payback periods and all of that but that might be changing you know um it it could change like on the very short term it looks like it but still we're talking about longer term things if you look at the uh yield curve and stuff that aren't unusually high so um I don't like them as much usually but sometimes they can work out because the they're so cheap right if if people thought this thing was going to go to zero or something in the common then sometimes it can take a while for them to recover from that and so people can just see this much debt and not be happy about it but in general I would prefer the opposite um I would prefer that there not be debt but they're telling me that they're willing to put debt on that would be much more exciting to me than than there is debt and we're going to pay it down would you think about debt on like an energy company differently than you would think about debt on like a entertainment business right we just spoke about movie theaters do you think those are two separate things entirely it a little bit but it depends more than I would have guessed about the people running it and their thinking you would think that you know I've invested now somewhat in energy things um oil and natural gas and other things um and it has been a bigger Factor what the capital allocation attitudes of the people running it are than what the cycle of prices are it has been bigger that way than I would have thought and you could have predicted that ahead of time in terms of their behavior and how they talk so I'm not saying that it's 100% but it might be more like 50/50 who is is managing um Capital allocation and what industry they're in rather than 100% what industry they're in so it's true that a more predictable say entertainment thing um is probably some place you feel safer in terms of them being able to make predictions right Tom Murphy would not have had the returns that he did or probably jum Malone if they hadn't been in industries that were more predictable that way owning Media stuff it's a lot easier to know how much debt to put on something how quickly you can pay down and everything than if you're having to say well in this projection is oil going to be $90 a barrel or 40 in year three yeah you can't pay down debt if that happens right um whereas he doesn't need to know that much what uh the advertising Market is going to be to know that he can pay this debt down when he acquires a station within three or four years or whatever so yes but I'd say it's at most 50/50 I still think that who is making the decisions is as important as the industry is what I've learned mhm mhm what's the most leveraged company you've ever invested in off the top of your head is there anything you could think of I've invested in financial services things so in theory depending on how you count the leverage they're by far the most leveraged ever um they would otherwise would be we Watchers okay which was controlled by private Equity thing basically yeah and the stock almost went to zero and could have gone into bankruptcy if it had been a um different kind of time in terms of Financial Market stuff now it went from probably $35 to $4 to $100 back down to like four or something but so you traded it way right you short it on the way down rebot it on the way up yeah got it yeah so you you also could have made uh in there are some people I'm sure who I mean I know people who made 10 times their money in it uh buying after I did and and selling after I did and there you could have lost everything in it basically um because I do know people who who had that experience um that was a that's a combination there though so what happened was that was a highly highly um operationally leveraged company but very very predictable so historically it had been very predictable but it had these very high operating margins sort of like a if you want to think about it like um a daily newspaper or something right say you had a lot of Leverage on that and then something changes that's exactly what happen so um uh it's not even called Weight Watchers anymore the companies now goes by WW International and you also would have to go so far back in terms of uh years to see what I'm talking about you can't see the good years anymore but if you look it had probably I guess you could see a little bit 2014 2015 that's when it's having the problems is then already but you can see that the what was the um well you can go to the cash flow statement that might help so if we look back what was Cash Flow in let's say 2014 or 2015 232 million was 2015 was 55 million 2016 119 million yeah yeah now one thing you can see right is that if this company had never so basically a private Equity type fund took it over it was kind of a the original thing I guess it was a sort of carve out spin out whatever from Hines or something it had a corporate owner at one point and then and um it was basically almost half owned by a fund and um they paid made payouts several times of like uh they buyback stock I don't know if they kept their proportional interest which would be like a dividend to them if they did but um they would like put on a lot of Leverage and buy back stock there's a few issues that I had with it one because they came from a private equ typ background they were they were very um indiscriminate about the stock price so they saw it as leveraging up and buying back the stock is just to add leverage to it to improve the capital structure in terms of optimizing it not worrying about whether you're paying $80 a share or $40 a share right you just do it because um it you want to add leverage and then the other thing is it is true we can see what debt does to a company truthfully so you want to look at the stock if you look here you can see where I'm talking about where it went from yeah so what is it years that uh so it had a high previous high of 2011 and then it looks like the low was 2015 yeah okay but then after that it went to an all-time new high right yeah it went from about four bucks to yeah $100 so if you want to be in really leverag things here's the thing it was both operationally leveraged and fin financially leveraged yeah so it is true though that this company would not as much as people are say oh things change and now of course you have weight loss drugs and that's why people expect it to be out of business but um it actually would you know as a stock without applying high amounts to debt to it it would never go broke because even if you just look at the business the business really doesn't tie up capital and it and it has good cash Generations such that cash flow from operations is virtually always positive as a rule you don't I would say and I know everyone uses eida but I would say uh you want to be much more careful putting debt on any company that ever has negative cash flow from operations than you do a company that even in the worst years has positive cash flow from operations generating cash flow from operations is really the most important thing for being able to um uh make payments on debt and everything and then also there's the structure of it and all of that but um this stock was always extremely volatile that way mhm it also doesn't really have recurring Revenue exactly which is a bit of a problem so it would spend very high on marketing to bring people in but they don't they churn fast now they churn slower on Weight Watchers than they did with any other thing but all diet things all weight loss things churn at very high rates so and all Fitness things too people don't actually keep gym memberships for long so they churn no matter what it's not you know you're better off in a business where you're selling junk food and cigarettes and booze and stuff cuz people don't churn on that stuff they keep using those things whereas if you have uh gyms and weight loss things they they turn off of those you know if there's a recession or something people quit the gym and take up smoking again and and um so they don't reverse that right so there's always a problem that people churn too fast so they might go for nine months or something on this program and then quit um and so that means you have to spend a lot of money to bring them in next time so that was part of the problem too um obviously it could work out very well if you had um if it had improved back to the state that it was before and had a lot of Leverage and then it gets worse if it if it um didn't and I would say the of those things the most important one was the lack of recurring Revenue that you were investing in something that is very hard to sell that people generally I think it's good to be in a product that people use even if they don't necessarily have High um good feelings about it and stuff rather than a product where people is more aspirational where people say they use it and they don't you know and so uh so lack of recurring Revenue I think is a huge Factor there mhm are there any other things or anything that you think uh as it relates to micro caps people should be aware of or think about as it comes to leverage on those businesses well recurring Revenue like I said it's very very important and there's very few micro caps that have high amounts of recurring Revenue now something like Nathan's which you mentioned does but most don't so that's one of the biggest problems and then um the other problem is that you you it's kind of mixed you often have owners who are like either the people who took the company public in some cases but often someone who's like a owner operator and sometimes that means that their operation stuff is focused on the uh business that they came from which may not have that much of a financial aspect to it that they're focused on and so they're less likely to run them in a in a way like that I think it is companies that were at one time owned by private Equity or something like that that are more likely to have that kind of behavior so someone who was in the company that was involved in a small transaction that was financial and is still public or then went public again or something is much more likely the thing um that you would see this kind of thing in then like a family business that does this because what they'll do is they'll just it's not they won't put leverage on it but they'll put leverage on it buying you out and they can stay on as management you know there be a management buyout it's not that small companies don't put on Leverage they just don't put on Leverage as like tiny companies that stay public and do smart things they'll just do it for themselves you know got it cool well I want to thank everybody so much for tuning in with you both of us if you have a question uh that we can pull for the podcast uh just like did for this episode email it to me at Andre focused compound.com be sure to hit that subscribe button wherever you are listening or watching us here today and of course if you're interested in learning about our Money Management Services reach out to me at Android Focus compound.com I don't think everybody so much for the support and we will see you in the next podcast take care
Analyzing Debt: Optimal Capital Structures
Summary
Transcript
welcome welcome welcome how's everybody doing hope you are doing well my name is Andrew with Focus compounding on air live with Jeff genon Jeff how's it going today it's going very well Andrew how's it going with you it's going great we hope it's going great with everybody else as well this is the first time you're tuning in with us thank you so much for joining us be sure to check out all of our content that we push out into the investing Universe the best way to do that is to follow me on X Focus compound go to focus compound.com to get access to investment writeups from Jeff going all the way back to 2005 and of course if you're interested in learning about our Money Management Services you can reach out to me at andreid Focus compounding tocom so in the last podcast that we recorded uh we briefly discussed um this question that somebody had sent in but I thought it would be good to dedicate an actual fullon podcast to it since we spoke a lot about movies and uh the movie industry in the previous podcast uh if you want to send in a question send it in email me andreid Focus compound.com we'll pull them put them on the screen just like right here and we'll talk about them on the podcast uh somebody asked could Jeff discuss how he thinks about optimal capital structure specifically for micro cap names that may or may not have access to investment grade Credit in addition how would he think about debt deleveraging stories that offer more upside via leverage when compared to some in quote higher quality names within the same industry how much credit in valuation does he give or not give when something is highly leveraged and he likes it verse unleveraged and he doesn't like it but it might not change in everything in between feel free to take that in any direction okay um All About leverage yeah so this is a very complicated subject because I think when I talk on the podcast people think that I'm really against debt um and there's a few parts to that one and Ben Graham I think said this in um uh the interpretation of financial statements I think but basically any company that has net cash has to be worth more than it would be if it had net debt and any company with net debt has to be worth less than it would be if it you know had had net cash right so in other words whether we always talk about in terms of Enterprise Value instead of market cap or something what he was saying is we can apply some sort of idea that if they're piling up cash that might they might never get good use you should not ding a company to say the fact that they have a lot of net cash and haven't done anything with it it means that they're stupid and so I'm going to apply that they deserve like a lower PE or something on the other side sometimes people say oh look how smart they are that they're using leverage I'm going to think that it should be even higher um uh my uh feelings about management and kind of the multiples I should put on it so so I think the um in terms of absent anything else about what our our feelings are about it it is better to have cash than to have debt just in terms of the valuation and you need to incorporate that into it having said that having debt and doing smart things with it like say um I think Nathan's which is was maybe micro cap at the time borrowed and paid out a special dividend um I think that there have been ones that have borrowed and bought back a lot of stock so that can make a lot of sense Nathan's you know outside of covid was a very very predictable sort of business now my guess on that actually is that some and I could be totally wrong about this there were was someone associated with Nathan on the board and everything that had a history with other companies that had used a lot of Leverage and which it's more traditional to use leverage in those things that are bigger companies so my guess is that that may have kind of influenced things you see this more often with like private Equity firms that maintain some stake in a company that's been public for a while sometimes they kind of recapitalize them instead of having some other exit right instead of selling the whole company so I think that's what trickles down into that is the thinking from other parts of the uh how they work with other portfolio companies um the the uh we talked about The Outsiders John Malone has a chapter there and you can look at John Malone influence companies today that would be an example I'm not saying that I like every John Malone company in what they do but if you were looking for what I think is an intelligent use of debt I think you're more likely to find that among those kinds of companies and I don't think that non-investment grade um credit necessarily means that you shouldn't be using it um but I do think that things need to be used in an intelligent way for creating value and that they need to be Str structured the right way many companies have debt because they need it in some form or or more accurately they felt they needed it to grow a lot of it is very shortterm and um a lot of it is also uh the companies are not highly liquid in terms of what things they have on their balance sheet off setting that so their current position is is sometimes quite weak and everything so I I do worry about that I also always say to investors who say they like the leverage like you know like Hostess was a public company remember and people would say oh I like the leverage on and stuff I'd be like look there if you want you can leverage safe low beta stocks yourself if that's really what you're into if you like that this thing bounces around a lot you could always apply leverage to something in your portfolio I'm not recommending it but it you know sometimes it seems like people like um they want to own the Johnson Johnson's of the world but they want them to move a bit more and what that really means is you want to own them on margin or something is what they're really saying um and but when the company does it it's fine but I would never do it myself it's not as dramatically different as you might think the same thing if you used like leaps or things like that so sometimes I think people like the idea of owning good companies but they like the whatever we want to call it the more exciting gambling whatever aspect of it that leverage provides so I worry about that a lot um but for companies where it makes sense I I I like it and usually that is super rare in micro caps because you need some sort of like financially oriented person maybe they're a second career maybe you know something else like that you don't see it naturally occur I would say that often in in things like micro caps um I I see a lot of you know I mentioned the John Malone thing because there's very very few examples I can think of companies especially very small companies where them doing a lot of extraordinary events a lot of um issuing stock buying back stock putting on debt paying special dividends whatever is being done and it's smart the more transactions you see like of that usually the worse the company is and you're seeing a lot of at the market offerings or or whatever things a lot of delu of things they're they're they may be telling you that it's really good stuff that they're doing that's their spin on it but when you look at the numbers I I don't see it so uh you just see more of a promoter type aspect to it than a long-term owner um having said that if you look at the history of Berkshire hathway it was a tiny you know not by today's standards it wouldn't be a micro c cap if youjust for inflation stuff but it was highly liquid and not on things that people would have found easy to trade and it was doing all sorts of things it did it borrowing at 8% and doing this and that in the first few years buying things and everything and it was all very smart right and we talked about John Malone and TCI and all that that was obviously very junk credit um the other side of it too which I've mentioned before is there's all these Factor things that include like the beta people talk about low volatility things um I've always thought that that you could replace that to a significant extent if you had an ability to understand the credit risk of a company I do think that companies that are perceived to have very low credit risk the stock stocks do trade higher than stocks that are perceived to have very high credit risk the way that works with the market though tends to be pretty fast the market gets worried about it seems to focus on that when there's so high uh there's so um great credits that they're like AAA type stuff and they realize this and readjust and that they're things that are on the verge of being ready to be headed for a real liquidity crunch they don't seem to worry about small amounts so I do notice that there the market I don't think gives enough credit to a company that has one times evid do in net cash and doesn't punish a company enough for having one times uh um iida in in debt you know at what it starts to worry about is when it's up there at five times or something when there's a big pile of cash it doesn't notice 5% of the market caps in cash it notice is 25% it doesn't notice one times uh de B but it gets real worried at five and so it happens quickly that way um and I would separate the quality of the business from the quality of the the credit quality right so stocks often people write about them as if they're junky and because they are in the possibility of danger of bankruptcy uh delution whatever because they have a lot of debt and companies that have beautiful balance sheets they write about as if they're great but the business and the corporation are kind of two separate things um you can have a really high quality business that's choking on too much debt and you can have a really low quality business that because of its past is really well capitalized has no danger of ever heading towards bankruptcy or anything what are your thoughts on debt deleveraging stories uh generally don't like them as much just because I feel the returns that you get from them are usually pretty low in terms of the use of paying down the debth MH but there could be ones that are exciting if the price is really low right um personally I you know if I was picking a part of the cycle to be in I would rather be in the stock that can have debt and doesn't yet and it adds the debt while I'm invested in it than the company that has a lot of debt and now says it's going to pay it down now that might change in the future but debt has been quite cheap and so I've not been investing in companies where I think the returns inside the business or from buying back the stock would be worse than the return than um the returns that you could get from paying down debt right because you have to consider when you pay down debt there's a there's an tax aspect to it and other things but even today it even if is pretty expensive debt if you have like an better than about 8% after tax in cash uh investment opportunity it probably makes more sense to do that than to pay down the debt now it may make total sense to pay down the debt for safety purposes especially if there's a chunk of it coming due sometime soon what I'm saying is almost more if you imagine like a very long-term Term Loan and so there's no uh a bigger um maturity upcoming or something like that you know equalizing it as if it's perpetual debt we're thinking about it versus like Perpetual projects that you could invest in but it's hard to come up with answers that paying down debt actually makes more sense than like buying back stock in a really good business or certainly what companies claim they get in terms of eida payback periods and all of that but that might be changing you know um it it could change like on the very short term it looks like it but still we're talking about longer term things if you look at the uh yield curve and stuff that aren't unusually high so um I don't like them as much usually but sometimes they can work out because the they're so cheap right if if people thought this thing was going to go to zero or something in the common then sometimes it can take a while for them to recover from that and so people can just see this much debt and not be happy about it but in general I would prefer the opposite um I would prefer that there not be debt but they're telling me that they're willing to put debt on that would be much more exciting to me than than there is debt and we're going to pay it down would you think about debt on like an energy company differently than you would think about debt on like a entertainment business right we just spoke about movie theaters do you think those are two separate things entirely it a little bit but it depends more than I would have guessed about the people running it and their thinking you would think that you know I've invested now somewhat in energy things um oil and natural gas and other things um and it has been a bigger Factor what the capital allocation attitudes of the people running it are than what the cycle of prices are it has been bigger that way than I would have thought and you could have predicted that ahead of time in terms of their behavior and how they talk so I'm not saying that it's 100% but it might be more like 50/50 who is is managing um Capital allocation and what industry they're in rather than 100% what industry they're in so it's true that a more predictable say entertainment thing um is probably some place you feel safer in terms of them being able to make predictions right Tom Murphy would not have had the returns that he did or probably jum Malone if they hadn't been in industries that were more predictable that way owning Media stuff it's a lot easier to know how much debt to put on something how quickly you can pay down and everything than if you're having to say well in this projection is oil going to be $90 a barrel or 40 in year three yeah you can't pay down debt if that happens right um whereas he doesn't need to know that much what uh the advertising Market is going to be to know that he can pay this debt down when he acquires a station within three or four years or whatever so yes but I'd say it's at most 50/50 I still think that who is making the decisions is as important as the industry is what I've learned mhm mhm what's the most leveraged company you've ever invested in off the top of your head is there anything you could think of I've invested in financial services things so in theory depending on how you count the leverage they're by far the most leveraged ever um they would otherwise would be we Watchers okay which was controlled by private Equity thing basically yeah and the stock almost went to zero and could have gone into bankruptcy if it had been a um different kind of time in terms of Financial Market stuff now it went from probably $35 to $4 to $100 back down to like four or something but so you traded it way right you short it on the way down rebot it on the way up yeah got it yeah so you you also could have made uh in there are some people I'm sure who I mean I know people who made 10 times their money in it uh buying after I did and and selling after I did and there you could have lost everything in it basically um because I do know people who who had that experience um that was a that's a combination there though so what happened was that was a highly highly um operationally leveraged company but very very predictable so historically it had been very predictable but it had these very high operating margins sort of like a if you want to think about it like um a daily newspaper or something right say you had a lot of Leverage on that and then something changes that's exactly what happen so um uh it's not even called Weight Watchers anymore the companies now goes by WW International and you also would have to go so far back in terms of uh years to see what I'm talking about you can't see the good years anymore but if you look it had probably I guess you could see a little bit 2014 2015 that's when it's having the problems is then already but you can see that the what was the um well you can go to the cash flow statement that might help so if we look back what was Cash Flow in let's say 2014 or 2015 232 million was 2015 was 55 million 2016 119 million yeah yeah now one thing you can see right is that if this company had never so basically a private Equity type fund took it over it was kind of a the original thing I guess it was a sort of carve out spin out whatever from Hines or something it had a corporate owner at one point and then and um it was basically almost half owned by a fund and um they paid made payouts several times of like uh they buyback stock I don't know if they kept their proportional interest which would be like a dividend to them if they did but um they would like put on a lot of Leverage and buy back stock there's a few issues that I had with it one because they came from a private equ typ background they were they were very um indiscriminate about the stock price so they saw it as leveraging up and buying back the stock is just to add leverage to it to improve the capital structure in terms of optimizing it not worrying about whether you're paying $80 a share or $40 a share right you just do it because um it you want to add leverage and then the other thing is it is true we can see what debt does to a company truthfully so you want to look at the stock if you look here you can see where I'm talking about where it went from yeah so what is it years that uh so it had a high previous high of 2011 and then it looks like the low was 2015 yeah okay but then after that it went to an all-time new high right yeah it went from about four bucks to yeah $100 so if you want to be in really leverag things here's the thing it was both operationally leveraged and fin financially leveraged yeah so it is true though that this company would not as much as people are say oh things change and now of course you have weight loss drugs and that's why people expect it to be out of business but um it actually would you know as a stock without applying high amounts to debt to it it would never go broke because even if you just look at the business the business really doesn't tie up capital and it and it has good cash Generations such that cash flow from operations is virtually always positive as a rule you don't I would say and I know everyone uses eida but I would say uh you want to be much more careful putting debt on any company that ever has negative cash flow from operations than you do a company that even in the worst years has positive cash flow from operations generating cash flow from operations is really the most important thing for being able to um uh make payments on debt and everything and then also there's the structure of it and all of that but um this stock was always extremely volatile that way mhm it also doesn't really have recurring Revenue exactly which is a bit of a problem so it would spend very high on marketing to bring people in but they don't they churn fast now they churn slower on Weight Watchers than they did with any other thing but all diet things all weight loss things churn at very high rates so and all Fitness things too people don't actually keep gym memberships for long so they churn no matter what it's not you know you're better off in a business where you're selling junk food and cigarettes and booze and stuff cuz people don't churn on that stuff they keep using those things whereas if you have uh gyms and weight loss things they they turn off of those you know if there's a recession or something people quit the gym and take up smoking again and and um so they don't reverse that right so there's always a problem that people churn too fast so they might go for nine months or something on this program and then quit um and so that means you have to spend a lot of money to bring them in next time so that was part of the problem too um obviously it could work out very well if you had um if it had improved back to the state that it was before and had a lot of Leverage and then it gets worse if it if it um didn't and I would say the of those things the most important one was the lack of recurring Revenue that you were investing in something that is very hard to sell that people generally I think it's good to be in a product that people use even if they don't necessarily have High um good feelings about it and stuff rather than a product where people is more aspirational where people say they use it and they don't you know and so uh so lack of recurring Revenue I think is a huge Factor there mhm are there any other things or anything that you think uh as it relates to micro caps people should be aware of or think about as it comes to leverage on those businesses well recurring Revenue like I said it's very very important and there's very few micro caps that have high amounts of recurring Revenue now something like Nathan's which you mentioned does but most don't so that's one of the biggest problems and then um the other problem is that you you it's kind of mixed you often have owners who are like either the people who took the company public in some cases but often someone who's like a owner operator and sometimes that means that their operation stuff is focused on the uh business that they came from which may not have that much of a financial aspect to it that they're focused on and so they're less likely to run them in a in a way like that I think it is companies that were at one time owned by private Equity or something like that that are more likely to have that kind of behavior so someone who was in the company that was involved in a small transaction that was financial and is still public or then went public again or something is much more likely the thing um that you would see this kind of thing in then like a family business that does this because what they'll do is they'll just it's not they won't put leverage on it but they'll put leverage on it buying you out and they can stay on as management you know there be a management buyout it's not that small companies don't put on Leverage they just don't put on Leverage as like tiny companies that stay public and do smart things they'll just do it for themselves you know got it cool well I want to thank everybody so much for tuning in with you both of us if you have a question uh that we can pull for the podcast uh just like did for this episode email it to me at Andre focused compound.com be sure to hit that subscribe button wherever you are listening or watching us here today and of course if you're interested in learning about our Money Management Services reach out to me at Android Focus compound.com I don't think everybody so much for the support and we will see you in the next podcast take care