July 6, 2020- SPAC Landcadia Holdings Announces Merger with Golden Nugget Online Gaming. What Does the Market Think? 

Lululemon to Acquire At-Home Fitness Startup Mirror for $500 Million. What are They Buying it?

Hedge Fund Manager John Paulson, Who Implemented the “Greatest Trade Ever”, Retires. What are his Plans?

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Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by Accelerate Financial Technologies. Accelerate, because performance matters. Find out more at www.Accelerateshares.com.

Transcript:

Julian Klymochko: Welcome podcast listeners to episode 75 of The Absolute Return Podcast. I am Julian Klymochko.

Michael Kesslering: And I’m Mike Kesslering.

Julian Klymochko: Lovely July 3rd, 2020 today. Sun is shining, happy independence day to all our American listeners and for our Canadian listeners, Canada day this week as well. So fairly slow market action. Many market participants on holiday. Certainly, a lot of people taking a long weekend this weekend, so it should be a good one. Nonetheless, there were some notable events. That we wanted to analyse and discuss today.

    • Some action in the SPAC sector. Special purpose Acquisition Company, Landcadia Holdings announced a merger with golden nugget online gaming. What does the market think? That is right. This could be the next DraftKings. Super, super hot stock.
    • Lululemon to acquire at home fitness startup Mirror for 500 million. Why are they buying it? Is this just a continuation of that work-from-home-be-at-home trend that we have seen powering Peloton and others like it?
    • Lastly, we are going to talk about hedge fund manager, John Paulson, who implemented quote, “the greatest trade ever”. He retired. What are his plans now? And why is he returning capital to investors?

SPAC LANDCADIA HOLDING ANNOUNCES MERGER WITH GOLDEN NUGGET ONLINE GAMING

Julian Klymochko: But first, I wanted to chat about this SPAC deal. Blank check company Landcadia Holdings II. It is actually run by gaming magnate, Tilman Fertitta also Jeffries, the investment bank is involved. They struck a deal to combine with Golden Nugget online gaming for $745 million dollars. A bit of a related party transaction because Tilman Fertitta’s company also owns Golden Nugget online gaming but it is a successful private company at this point, Golden Nugget it is profitable. It is a leader in New Jersey burgeoning, online gambling market. It accounts for roughly 34% of New Jersey’ 86 million gross gaming revenue in May. So they are a leader in the online gaming space and this is really just a sector that can have explosive growth going into the future. They are predicting that it could be a $20 billion market opportunity and right now, in terms of Golden Nugget’s estimated 2020 results that are calling for 95 million in revenue, 24 million in adjusted EBITDA. So that’s a proxy for cash flow, so a lot of growth runway is what management is seeing and this company is growing like a weed. Three-year revenue compound annual growth rate of nearly 50%, 50% and especially during the pandemic it has been growing like crazy. Between January and April, this year revenue up 55%. So certainly, management is thinking, this is a tremendous growth opportunity in a market where there’s not a lot of growth and market participants are really paying up for those growth opportunities. And what we like to call story stocks. If you have a good story, a good pitch, especially in the pandemic coronavirus era, you have so called work from home stocks, those stocks and those companies that benefit from people being stuck at home, such as Peloton on the exercise at home fitness trend or Zoom videos, Zoom Communications that capitalizes on work from home.

Certainly Golden Nugget Online gaming is a continuation of that trend of which the market has really, really been rewarding lately. I wanted to compare this to another company DraftKings because Golden Nugget will be only the second publicly traded online gambling company next to DraftKings. And if you look at DraftKings, man, has that been a stock market winner? Their share price has gone bonkers. They actually went public through a SPAC as well earlier this year and the stocks up 209% year to date. And if we look at the valuation metrics on these companies, just on a per revenue basis, because DraftKings at this point is unprofitable. So the markets assigning roughly 15 times revenue, multiple to DraftKings and when it first went public through the SPAC. It was valued at five times, so pretty similar initial revenue valuation, multiple but since then, the stock has gone from 10 to 30. North of 30 bucks on the DraftKings, side. As for now, the market certainly likes this Golden Nugget Online Gaming deal with Landcadia stock, up about 50% on the news to kind of in the $15 dollar range. The deal has not closed yet, it was just announced that they did sign a purchase agreement, which differs from a number of SPAC deals that we have seen announced over the past month. Some of them just signed letter of intent, which are nonbinding. This one is a binding deal. It is a purchase agreement, so it does provide more certainty in closing, which is expected in the third quarter. And once it does go public, it’ll be trading under the symbol, GNOG. GNOG, a bit of disclosure, so we are long, the SPAC Landcadia unit’s shares and warrants, which we always buy these things pre deal. We never go and trying to, we are trying to harvest that upside optionality, which I mean, certainly saw on this one.

It does lend credence to our thesis of getting involved in SPAC, pre deal for that arbitrage; preferably get into the SPAC at a discount. So you are guaranteed that baseline return and on a stock like Landcadia, it just goes to show you there is explosive upside. If they do announce a deal that, the market deems attractive and if you look over the past month. Retail speculators specifically, have been getting really, really hot on these deals. And so that’s another important dynamic to take into account is there’s a bit of a shareholder base turnover that is powering SPAC, share price returns. If you look at SPAC IPO, the guide subscribing to the IPO at 10 bucks a share. These are largely hedge funds and they hold it. Does not really do a lot of pre deal. It slowly takes up as the treasury; the cash accrues interest and the NAV increases.

However, once the deal is announced. If it is a hot deal, if you know, speculators can kind of get involved and then they like the story. They can really sell the story, then there is this turnover where it starts to get bid up by retail speculators. You know, retail traders as ones in Reddit forums, Robinhood traders, et cetera. There is this turnover as hedge funds exit. They earn that profit that they are looking for that upside optionality. And then it gets owned by, these, more retail investors that power the stock higher, as we’ve seen on DraftKings, as we saw on Nicola and other super, super successful stocks year to date, and they all have the same story, high growth opportunity, not profitable yet. Very early stage and you are seeing nothing different here, and so it really has the right formula to be a stock market winner, as we have seen many of these precedent deals do.

So that is something to keep in mind, this shareholder based turnover, which we are now starting to get through the stocks up about 50%, so hedge funds are selling more and more retail investors are buying. And then ironically, after the deal completes and switch the ticker to GNOG, it’s now an independent company, then the ETFs come in. There is that BETZETF. BETZETF, which I am sure, will be a major buyer off, of the retail special speculator. So it’s kind of what I call a circle of life with a SPAC stock. Where it goes from hedge fund, stock goes up to retail speculators, and then they make money selling to the ETF. So it’s a really interesting dynamic there, a circle of life of SPAC and how it can be a kind of the formula to profitability trade these things, a great case study with the SPAC Landcadia Holdings and this Golden Nugget online gaming deal, so I like it. I think it is pretty cool deal. What are your thoughts on this one, Mike?

Michael Kesslering: Yeah, it is an interesting when you bring up the shareholder base turnover is you look at right now, I believe it was two or three days ago. I was seeing on the Robintrack that the amount of Robinhood users were around 16,000 users were holding it in their accounts.

Julian Klymochko: Landcadia, LCA.

Michael Kesslering: Yes, LCA. By today, you are seeing that was of yesterday, I guess since U.S. markets are closed. You are seeing 20,000 users holding it, so there has been a lot of day over day growth as retail digests this deal. And what is interesting, as you look at DraftKings. You look at some of the other story stocks on Robinhood. Is that they have these jumps and they’ll go, you know, jumping from 5,000 share users to 20,000 can take a couple of days and then all of a sudden you go from 20,000 to 60,000 and a 100,000 thousand over the next coming weeks as well, which is very interesting. Now that can cut both ways with story stocks that, you know, investors just get bored of the story or they tire from it. But this seems to be one of the trends and stories that is fairly- retail does have a lot of appetite for it. It is not just retail, investors in general that are looking for ways to play online gambling and that is where I did want to just differentiate a little bit with DraftKings. So, Golden Nugget Online, their focus is casino gambling, so table games and online slot, things of that nature. Whereas DraftKings is a pure play, focus on sports betting. Both of which have a lot of tailwinds in terms of being brought online in the U.S. Now in the U.S. right now, sports gambling there. I believe its 11 or 12 States where it has been legalized. Whereas you look at the overall table games just irregular casino gambling, where there is, I believe only three States that do offer this, that it is legal in where there’s a couple more that should be coming. I believe its four more States have the potential for being added to that list.

Julian Klymochko: Right, but the long-term opportunity will be the entire country is kind of the investment thesis.

Michael Kesslering: Yeah, exactly and so when you are looking. It is just in a bit more of its infancy than sports betting but part of that is a good thing as well. As you had mentioned during the pandemic there is no sports, so anybody investing in DraftKings is really just making a bet on the world, moving back to a pre COVID. The climate to where you do have actual, like, a lot of sports going on. And as well as DraftKings, their focus was a lot of fantasy football, especially in fantasy sports, which was another tailwind to take advantage of in the U.S. but with Golden Nugget there. They are also expanding; they have already kind of announced that they are expanding into Pennsylvania. They had started just in New Jersey, they are expanding into Pennsylvania and Michigan, which are high value States. Targeting 20-21 and that is pending regulatory approval, so once they get, it is illegal in those States, they will be moving into those. As you had mentioned. They are just growing their revenue at a very high clip. They are showing a positive adjusted EBITDA, so they are working towards becoming truly cash positive, which is a positive for them moving forward. And you really just run a lot of credence to the thought that Tilman Fertitta. This was all along kind of a strategy to take this area of the business public, as there’s a couple other options that you could take doing a an IPO. A traditional IPO where you go on a road show and you are marketed to all these institutions, and that is likely a six-month process. You could also look at a direct listing where, it may be in a similar timeframe. Whereas through a SPAC it is really a three-month timeframe is what he’s looking at for this.

So it’s a lot quicker way to go public and depending on how you view it in terms of cash costs, it definitely is cheaper. But you are giving up some of the proforma entity to the SPAC shareholders, so you are paying for that a bit. But this will certainly be one that will be interesting to watch. As of right now, as well, as long as the stock or the SPAC trades through it’s now value. Well then, there really was unlikely to be shareholders or deeming, so whatever is in Landcadia for cash is highly likely to remain with the company and allow the company to use that, to pay down some debt.

Julian Klymochko: Right? Exactly. Because no one is going to redeem their shares for net asset value of $10 dollars and change when the stocks at 15 bucks. One thing I wanted to touch on continue the discussion on shareholder turnover. So LCA Landcadia has roughly 31.6 million shares outstanding and already this week, the deal got announced and over 50 million shares in units have traded. So perhaps a large portion of that shareholder turnover has already occurred, so that is something to keep in mind because if you have a so-called overhang on a stock on a large exiting shareholder, that can always hold it back and once you get through that, overhang can sometimes experience pretty explosive gain. So it’s obviously one that we’re interested in due to the fact that we are long units shares and warrants of this one, and we think it’s cool deal, so we’ll continue to monitor it and as we indicated. Market likes it already, stock up nearly 50% and it is expected to close this quarter, so GNOG you will see public, perhaps by September.

LULULEMON TO ACQUIRE AT-HOME FITNESS STARTUP MIRROR FOR $500 MILLION

Julian Klymochko: Another really interesting deal announced in the market this week perhaps another way to capitalize on the popularity of, you know, being at home during the pandemic. You look at the popularity of Peloton in home fitness. It is this new trend that has absolutely been accelerated due to COVID-19. This whole stay at home dynamic. What happened here at Athlesiure retailer, Lululemon announced their first acquisition ever with the $500 million deal for in-home fitness start up Mirror. Now Mirror, it is really interesting, so you basically put this device on your wall. It is basically like a mirror, but far, far more expensive, about 1500 bucks upfront, plus a 40 bucks per month subscription fee. So it offers live classes through that so-called Mirror, in addition to on demand workouts, personal training and things like that, so basically anything that you can get at a gym, you can now do at home.

Some background on the company-three years old, it had raised roughly 72 million bucks from venture capitalists and other investors, and now it is worth 500 million. So it’s certainly a big win for investors on this one. Big win for Lululemon shareholders as well. The market liked it, their shares rallying 4% on the news. Interesting factor is that Lululemon actually invested in Mirror. A million dollars into the round they did in 2019, so they were familiar with the company. It should not become as a huge surprise, but I always thought Mirror was, you know, pretty potential fad and, you know, really odd but what are your thoughts on it? I know we had some colourful comments when you first heard of it.

Michael Kesslering: Yeah, I mean. I had been served an ad for Mirror. This would have been in at some point in 2019, I think maybe perhaps even around this time in 2019, and it is no doubt. And it was really around the time of the Peloton IPO and for us as Accelerate as a firm looking into new issues and things of that nature. And then as well, doing some, some background reading for our podcast, as we did discuss Peloton, I was served an ad for Mirror and I remember looking at it and I clicked into it and they had very good marketing and whatnot, but I genuinely thought that it was a…

Julian Klymochko: Saturday Night Live commercial.

Michael Kesslering: Yeah, that it was like a parody of Peloton and kind of like the ridiculous. Around that time, there was a lot of Peloton parodies where they would make fun of some their marketing, which I would argue also that their marketing did quite successful because people were talking about it, but I truly did think it was a parody because it’s just a Mirror. That obviously it is expensive. There is a lot of technology in there, but the whole concept of it, just did not really make sense to me and when you do mention, you are looking at similar costs to a Peloton in terms of the all in cost. Where the mirror itself being $1,500 and then $40 a month for your subscription. I just thought, you know, the value add with Peloton to me made a bit more sense. Not that I was, jumping out to buy a Peloton but as well. When I compare the two companies, because I think they are quite comparable, especially with how users have reacted during COVID. Is you’ve seen the app downloads for Mirror as well as Peloton, just go haywire going basically up over a hundred percent month over month, especially during the lockdown, but looking at them and comparing them.

I just saw everything that I would read about Peloton talked about their rabid user base and how they did have a core group of users that were very hooked on the product. That were very vocal about that as well and they had quite a community built up online of this user base. Where I am not really seeing the same thing for Mirror. Now mirror does have a number of celebrity endorsers. I believe Reese Witherspoon being one a few others, but I’m not seeing the kind of grass grassroots level of engagement as you did with Peloton and as well, like looking at the deal right now, admittedly, we aren’t able to go as in depth as Peloton because Peloton went public. They had their S-1 that they had to provide a certain amount of disclosure, whereas Mirror right now they are not very forthcoming with subscriber numbers and things of that nature.

The main quote I have seen for subscriber numbers is in the tens of thousands. So really not giving a lot of detail. They expect a hundred million dollars in revenue this year and expect to break even in 2021. So who knows with that, but I did find it was an interesting deal. I am not going to be jumping to purchase one. And yeah, I don’t think the value prop to customers given the price point, the high fixed costs upfront, as well as you’re still paying $40 a month instead of a gym subscription. Theoretically, I don’t think that that pays off for investors for consumers in this situation, but to each their own.

Julian Klymochko: Dumb question for you, Mike isn’t mirror. Just a sideways TV with the YouTube subscription?

Michael Kesslering: It basically is. Yeah, it is basically a high tech fitness video.

Julian Klymochko: It shows you a what I know, nonetheless, the strategic rationale, basically, as you indicated. We don’t know too much about Mirror. However, we look at Mirror competitor Peloton for their latest quarter. They said revenue surged 66% year over year. Then you look to Lululemon, they revenue fell 17%. So clearly, Lululemon looking to diversify the revenue base capitalizing on the fitness at home trend.

HEDGE FUND JOHN PAULSON, WHO IMPLEMETED THE “GREATEST TRADE EVER”, RETIRES

Julian Klymochko: Last thing I wanted to touch on this week. Legendary hedge fund manager, John Paulson, he is returning external capital, converting his hedge fund into a family office, which we have seen being done by other legendary managers. Such as David Tepper, George Soros, Stan Druckenmiller, Louis Bacon, all these managers who really came to the forefront in the nineties and two thousands and made just a crap ton of money and effectively are retiring after making billions of dollars.

Now is retirement here. It is just a continuation of that passing of the guard as managers who launched 20, 30 years ago; they are just, you know, they don’t really have a reason to keep going. Perhaps returns have come down. They don’t really want to deal with clients anymore because they have billions and millions of dollars and this also allows young and up and coming firms to take their place. So Paulson Investor, if you are looking for a manager? Should check out what Accelerates offering. Definitely can replace that merger arbitrage mandate that he was really known for, but what is super interesting about Paulson’s story is he is most well known for so-called “greatest trade ever” in which his firm purchased credit default insurance, CDS, against billions of dollars of subprime mortgages prior to the market collapse in 2007, in which they banked profits for the fund of $15 billion and he raked in nearly $4 billion personally. So quite the payday of that one investment thesis, super prescient investment pieces he had back 13 years ago.

Some background on his firm. He actually had pretty much no experience on the credit side. He was a merger arbitrageur. He launched his firm in 1994 with $2 million of his own and family and friends’ capital solely doing risk arbitrage. That fund grew to $300 million by 2003, so over nine year’s solid returns, good growth but at its peak, Paulson was one of the largest funds in the world. In 2011, they had about $38 billion dollars in capital and ever since their main strategies, Paulson Advantage, et cetera. They have made heavy bets on pharmaceuticals. A bet after the global financial crisis on U.S. banks and they kind of mistimed those. So given underperformance after their huge win in 2007, 2008, a lot of that client money went out, so assets went from the peak of 38 billion down to less than 9 billion. Most of which is Paulson’s own fortune, so it really does not make sense if you don’t have much client money anyway. The fund or the firm will continue to exist as a family office. And what we have seen is other hedge funds converting to the family office. They tend to complain that, you know, the institutionalized LP base kind of handcuffs them from a volatility perspective. We saw that with BlueCrest and Michael Platt did not mean Mike, where he converted his firm into a family office and then absolutely crushed it once he felt that you could take more risks.

Michael Kesslering: Yeah, absolutely and when you do move to a family office structure, as you had mentioned that the quotes that I had seen this year for what percentage of the assets that his own wealth, John Paulson’s own wealth, made up was 75 to 80% of the firm assets. So you have a lot of effort going into client relationships and you’re thinking about the firm as a business in terms of you’re looking at strategies that can be marketable to outside investors. Yet your own assets make up 75 or 80%, so you are putting in, you know, maybe 40 or 50% of your time. And I think that’s being conservative, is spent on client development. Yet the value you are getting from that is less and less by the day with each redemption. And so it really just comes back to now, he’s able to just focus on investing and making returns rather than having to worry at all about the marketability of what’s going to sell to LPs. He can just focus on making money, and I think that is very interesting. And Julian, there was something that we were talking about offline with regards to style drift and I think you had some interesting comments there.

Julian Klymochko: Yeah, that is a good point. I saw some people saying, “Oh, the reason that he is shutting down or the reason he did so poorly in the sort of back one third of his career leading to the conversion of his firm to a family office was said, “oh, he had style drift.” He was a merger arbitrageur and tried all this other stuff that didn’t work out. But in my opinion, there’s no such thing as “style drift.” In this game, if you are not constantly improving and evolving with the market, then you are dead in the water. You are not going to be successful, so what they call “style drift,” I call progression and being opportunistic. And if you look at Paulson’s career, he was a real example of that because his expertise starting out was in merger arbitrage, and that’s what he was known for and then he was opportunistic and representing a once in a generation opportunity with subprime CDS on the housing market. So we recognize that opportunity in which he really had zero expertise in. A lot of industry experts were talking trash about him saying he didn’t know what he was doing, and he’s going to lose all his money and he sure showed them. So one point is that it is progression, not style drift and you know, if you are not progressing, then you just can’t be successful. You can have a successful career investing. And the other thing is that really interesting dynamic in certain industries, many lose sight, like many experts lose sight of kind of the forest for the trees, such that they’re so tied into the industry. That they can’t recognize, you know, big macro issues and specifically here, Paulson recognized that the mortgage market was overheating and many specialists couldn’t see it because they’re too involved and it’s an interesting example of sector specialists.

It is rare if ever that you see sector specialists be completely bearish and want to short everything in their coverage environment. In fact, I don’t think I’ve ever seen that, so there’s this inherent to bias to belong of sector specialists. That is why I have always been a fan of being a generalist because generalist you has the best opportunities or the best kind of visibility to recognize opportunities. So you can judge the attractiveness and the risk reward dynamics of, you know, merger arbitrage compared to shorting energy bonds, to going long mortgage securities to, you know, whatever it is, distressed debt derivatives.

Michael Kesslering: Julian just to go back to this style drift comment as well. Is to be very clear with his CDS that was a special vehicle set up for that particular opportunity.

Julian Klymochko: It was a new fund. Yeah, he had his policy credit fund.

Michael Kesslering: Yeah, and so he was not just putting it in a merger arb fund. That would be something that we would not agree with if you are invested in a merger arb fund. You are invested in a merger arb fund.

Julian Klymochko: Yeah, you got to stick with a mandate for sure.

Michael Kesslering: Yes, exactly. You stick with your mandate but so what he would have done is gone to his investors say said, Hey, I have this opportunity that I think would be right for you. So he would cross sell to all those investors, but then they wouldn’t be obliged to invest in that new strategy. If he was compelling in his description of the opportunity, then he would garner assets and if not there is no issue there. So that’s one thing that I did want to point out in terms of style drift and as well, when you talk about adapting as an asset manager really that was just a function of him growing Paulson & Co from just a single couple of niche funds into a more wide ranging actual asset manager.

And that’s what every large asset manager does. That is not unique to him. That is just part of you want to offer your clients as many strategies that are in demand from their end. As long as you are able to do the well, and Paulson did show that, he did have some scale in finding opportunities such as this. So I really just think that was part of him building Paulson & Co, as a business, which is what any smart asset manager or entrepreneur would do in that situation. It was a very astute move.

Julian Klymochko: Yeah, the other thing to keep in mind that was he had a similar call on gold, very bullish on gold, which I think was a good call, worked out well for him, but that never really got him the admiration nor the asset flows that the credit trade did. The other thing that investors should keep in mind is that a lot in this business is just driven by performance chasing. Obviously all the money came to him after he made huge gains and assets exploded from, you know, single digit billion to nearly 40 billion. And when he had those flood of assets then performance kind of started decline. So I think on a dollar basis, I’m not sure if he made money long-term for clients, but certainly as IRR were very, very high and just a warning to investors you know, don’t kind of get in and out performance chase.

There is this sort of reversion to the mean that ends up disappointing investors because you see someone who, at the hot hand, very good returns and studies show that those aren’t not only persistent, but tend to reverse. So that is something to keep in mind to not chase the hot hand. Not performance chase, and really just try to stick with a well thought of asset allocation plan that covers all your basis in terms of asset classes, going beyond the traditional 60, 40 such that you do cover these alternative strategies, but don’t just look who has the greatest year to date performance. But that’s about all I got to say, hope you guys enjoyed episode 75 of The Absolute Return Podcast. If you enjoyed it; please check out more  at Absolutereturnpodcast.com would really appreciate it. If you went on, gave us a review, give us a rating, definitely helps the podcast grow. And we’re seeing great growth, which we truly enjoy. We appreciate that you put in a ton of work to this, so if you can tell your family and friends, colleagues, that would be awesome. We are trying to cover everything that investors like to hear. Hedge fund strategies, merger arbitrage, SPAC, et cetera. We really enjoy it too, so with that being said. Wish you all the best in your trading, shorting, speculating, arbitraging this week. Hope you had a great long weekend and we will chat with you next week. Cheers.

Thanks for tuning in to the Absolute Return Podcast. This episode was brought to you by Accelerate Financial Technologies. Accelerate, because performance matters. Find out more at www.AccelerateShares.com. The views expressed in this podcast to the personal views of the participants and do not reflect the views of Accelerate. No aspect of this podcast constitutes investment legal or tax advice. Opinions expressed in this podcast should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information and opinions in this podcast are based on current market conditions and may fluctuate and change in the future. No representation or warranty expressed or implied is made on behalf of Accelerate as to the accuracy or completeness of the information contained in this podcast. Accelerate does not accept any liability for any direct indirect or consequential loss or damage suffered by any person as a result relying on all or any part of this podcast and any liability is expressly disclaimed.

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