Description

Daily Journal Co. (DJCO) should be a name that most Charlie Munger acolytes are at least be familiar with. DJCO is most known for its annual shareholders meeting in Pasadena, CA with Charlie Munger and other legendary Graham & Doddsville-type value investors such as Gerry Salzman (CEO of Daily Journal) and Peter Kaufman. While most investors think of Daily Journal as a dying public notice daily paper, the business carries a few material hidden assets and an impressive high-growth operating business. Additionally, the true value economic value of these assets is completely overlooked by investors given its small size (~$490M market cap) and absurdly conservative accounting.

History: Charlie Munger and Rick Guerin initially bought what is today Daily Journal back in 1977 for $2M (similar to Buffett newspaper purchases). Daily Journal became a collection of local newspapers that provide information on the legal industry, real estate, and general business. Over the years, these papers have spun off significant amounts of free cash flow, which DJCO used in 2009 to buy depressed shares of Wells Fargo, Bank of America, and reportedly a few South Korean industrial conglomerates. In 2012/13, DJCO began its next stage by taking out a $30M margin loan against these public equity holdings to acquire nascent government SaaS players New Dawn and ISD. In classic Munger fashion, DJCO chose to forgo paying capital gains by selling shares and instead took out a ~20% LTV loan at Fed Funds + 50bps. This loan is non-callable and is likely never going to be repaid, but for the sake of conservatism I’m going to count it as a liability.

Business Segments:

Cash/Real Estate: DJCO has $27M of unrestricted cash on the balance sheet and $17M of commercial real estate in downtown Los Angeles and Utah. The Los Angeles headquarters was constructed in 1990 with an expansion completed in the late 1990s. Since these assets are held at book value, I expect that the replacement cost is far higher than carrying value but will error on side of conservatism here and hold at book value.

Public Equity Positions: DJCO’s public equity positions were marked at $179M as of Sep. 30. While the company doesn’t report directly what securities are held, 13-Fs suggest that most of the reported value is BAC/WFC. The remaining public equity value is likely composed of Korean industrial conglomerates such as BYDDF, PKX, and HYMTF, but it is unclear exactly what is owned given differences in foreign holdings reporting. Since the Sep. 30 filing, all of these stocks are up 20%+ individually and the sum-of-the parts below uses 35% which is a fair estimated using an informed weighted average.

While the value of these stakes should be theoretically reduced by the large deferred capital gain (likely a ~6x MoM), it is unlikely that DJCO will ever sell and will instead continue margin loan issuance if liquidity is ever needed. To be conservative in the sum-of-the-parts to follow, I’m assuming a 20% tax rate on the capital gain.

Newspaper Business: DJCO operates 10 newspapers across California and Arizona (e.g. Los Angeles Daily Journal). As a paper of public record, these newspapers are strongly counter-cyclical and experience peak earnings when foreclosure announcements accelerate ($8M net income in 2009). While these businesses produce a normalized ~$500K in net income annually, I choose to value this segment at $0. While partly driven by conservatism, DJCO management has also made some comments that make me think they see this reporting as a public service duty and may burn some cash supporting this endeavor.

Journal Technologies: DJCO’s niche government SaaS operation provides software for trial & appellate courts / agencies related to court systems, including prosecutorial agencies, public defenders, probation departments and pre-trial offices. For example, attorneys are able to file court motions electronically vs. standing in line at the court house, and legal fees / parking tickets are paid using this software. Journal Tech is reportedly differentiated by a browser-based case management system that is highly configurable for various document filing needs, but competes against larger players such as Tyler Technologies.

Government software, and court software in particular, has an incredibly sticky customer base given the mission criticality of these operations and price insensitivity of the purchaser (~10 year contracts). Government departments all have special requirements and long RFP processes so growth will be steady for a long time as they penetrate the large and significantly underpenetrated TAM. However, DJCO has demonstrated the benefits of a land-and-expand strategy by parlaying large contract wins in Los Angeles and Australia into many other court systems in the region or state. There is also a large upsell/cross-sell opportunity in certain court systems that have different courts for probate, civil, family law etc. that use different reporting systems and tangential government services like schools. Growth is therefore a function of price escalators (~3-5% annually) + new licenses + new contract wins.

Journal Technologies Revenue Recognition:

Now this is where things get very interesting. The disclosures on this business are next to nothing, making it impossible for investors to value the business off the 10-K. For example, DJCO’s accounting is absurdly conservative particularly on revenue, which they don’t recognize until the system has gone live and the customer is satisfied. Per the 10-K, “In most cases, installation fees are not due until the customer has indicated its satisfaction with the installed system, and it has “gone live”. Accordingly, we do not recognize revenues for installation services or for most other consulting services until after the services have been performed and accepted.” Additionally, software R&D costs have been 100% expensed vs. capitalized, dragging down historical margins. As Charlie Munger said at the 2017 shareholder meeting speaking about Journal Technologies, “You can’t look at our financial statements and make very good judgements about us.”

Compounding the issue related to revenue recognition is the fact that Journal Tech has chosen to differentiate itself in the RFP process by choosing to not collect upfront cash from the client for the first 3-7 years post-implementation. The government client must accept the system in writing once all systems are operational and all employees are fully-onboarded. For example, read the language in the Austin, Texas contract. The contract was signed in 2017, but DJCO does not receive its $1M implementation fee and $280K annual SaaS fee until at least mid-2020 as the implementation has not gone live. There are many examples here, but to provide a sense of scale for the backlog, in late 2019 DJCO inked a ~$68M contract in Victoria, Australia while at the same time only booking $1.7M of total non-U.S. revenue in FY 2020.

Since these contracts are public domain for most states/municipalities, it is possible to comb search public information for contractual terms. DJCO reports that they are currently licensed to 500+ organizations and while it is nearly impossible to identify all existing contracts researching outside-in, we have uncovered ~100 contracts in public records for ~$50M of run-rate subscription revenue, the majority of which is contracted but yet to begin paying Daily Journal anything. Similarly, Matt Peterson discussed the idea at the VALUEx 2019 Conference and identified run-rate billings from existing implementations of $100-150M. Note that this is purely recurring SaaS revenue which should be 80%+ flow-through margin as implementation costs have already been expensed.

It should be apparent that the combination of 1) conservative revenue recognition and 2) unusual contracts drives very uninspiring GAAP and cashflow results while masking very attractive underlying economics. 

Valuation

Given the above SOTP logic, the below is the implied standalone valuation of Journal Technologies.

With a run-rate revenue range of $75-150M, Journal Tech trades at only ~2-4x run-rate revenue vs. Tyler Technologies at 14x forward. With a similar steady-state margin profile to Tyler Technologies, Journal Tech is only trading at ~6-15x EBITDA. Journal Technologies should quite clearly be priced like a SaaS growth company with recurring revenues, but the implied price is currently well-below intrinsic value. 

Catalyst

DJCO begins recognizing Journal Technologies revenue, Delayed client cash payments hit CF statement as deferred revenue