DISCLAIMER & DISCLOSURE: The author holds a position in Kingsway Corporation at the date of publication but that may change. The views expressed are those of the author and may change without notice. The author has no duty or obligation to update this information. Some content is sourced from third parties believed to be reliable, but accuracy is not guaranteed. Forward-looking statements involve assumptions, risks, and uncertainties, meaning actual outcomes may differ from those envisaged in this analysis. Past performance is not indicative of future results. All investments carry risk, including financial loss. This analysis is for educational purposes only and does not constitute investment advice or recommendations of any kind. Conduct your own research and seek professional advice before investing. This podcast/video interview focuses on a company that almost nobody understands correctly, which is exactly why it’s so interesting. This is not a stock that currently screens well. It’s misunderstood and financial metrics are misleading. So don’t get lost in the numbers. This is a qualitative investment thesis. The business piqued my interest because I am particulalry focused on companies with an opportunity to reinvest capital at high accretive rates of return over the long-term, and which have first class management teams. This one ticked both of those boxes. Here’s what you really need to understand: * ‘Search Funds’ are a niche “entrepreneurship through acquisition” (ETA) model. * Stanford professor Irv Grousbeck (not merely an academic, but successful entrepreneur with a net worth of a couple of billion dollars, and co-owner of NBA Boston Celtics) and Will Thorndike (author of ‘The Outsiders’ book and seasoned investor himself) helped popularise the ETA model. * ETA involves backing talented early-career CEOs (often MBAs) to find, acquire and manage an acquired business. * Acquisitions are private mom-and-pop type lifestyle businesses which are capital light, enjoy recurring revenues and have no customer concentration risk, but which have been operated as lifestyle businesses and starved of growth capital. Without succession plans in place, founders ultimately look to cash out. This generally means that they are available to buy at low single digit multiples. * Investments are typically too small for traditional PE firms, but too complex for individual investors. * In 1994, Thorndike founded Housatonic Partners, a fund focused on the ETA model and he enjoyed enormous success. He has quietly been one of the most significant investors in this model for decades. * Thorndike is on the Advisory Board for the International Search Fund Center at IESE Business School and frequently lectures at Stanford and Harvard. * The Center for Entrepreneurial Studies at Stanford Graduate School of Business conducts biennial studies of all core search funds. Its findings reveal that, since 1984, the ETA model has generated steady IRRs ~35% through various economic cycles. Now that I have your attention, please be aware that until now there have been a few issues with search funds: * The ETA model has, until now, been the preserve of wealthy private investors. Retail and other public market investors had no way to access search funds. * Each search fund focused on the acquisition of one company and so there was a high level of concentration risk. * Without the liquidity of a public market, private investments in search funds require an expiry date so that investors know when to expect a return on their money. This forces short-term thinking and exit decisions at inopportune moments. * Thorndike has conducted his own analysis that many of these search fund businesses have been sold too early and go on to achieve outsized returns over the medium to longer term, meaning too much vaue has been given away historically. The answer to all of these challenges is to create a publicly listed permanent capital vehicle focused on deploying the search fund model, building a diverse portfolio of search fund businesses, owning them for extended periods (maybe even forever) and enabling public market investors access to this asset class for the first time. Kingsway Corporation is the only such business. It is run by CEO JT Fitzgerald, himself a search fund veteran. Will Thorndike is both an investor and a member of the advisory board. And if that hasn’t captured your imagination, so too is Tom Joyce, previously CEO at Danaher and the architect of the acclaimed Danaher Business System (DBS), a version of which Kingsway is deploying itself. In this interview with JT Fizgerald (CEO of Kingsway), we breaking down how Kingsway is using that playbook to build a programmatic acquisition engine, why accounting quirks are actively hiding the real economics and how a shifting business mix could make the financials suddenly “snap into focus.” This is a story about misunderstood numbers, hidden compounding, no analyst coverage, a wonderful business flying completely under the radar and valuation multiples that don’t reflect what’s actually being built. At the moment it is merely a micro-cap, capitalized at ~$400 million, but it has an enormous growth runway ahead. Oh, and one more thing. It has over $600 million of NOLs on its balance sheet from legacy operations when this company used to operate as an insurer prior to the GFC. It has entirely reinvented itself, with a completely new model and management team and so while the legacy issues are in the distant past, all earnings and capital gains over the next 5+ years will be entirely tax free. Ignore this opportunity at your peril. For further reading: Receive more like this direct to your inbox: Highlights from the Interview *Not a verbatim transcript, so please do listen to the recording The Evolution: From Insurance Co. to Public Vehicle for Search Funds James Emanuel: I’m James Emanuel, and joining me today is JT Fitzgerald, CEO of the U.S.-listed business Kingsway Financial Services (KFS) [Now Kingsway Corporation (KWY)]. This may be one of the most exciting companies that most people have never heard of. It has a market capitalization of just shy of $400 million and a very interesting story. It is a new company and an old company at the same time. Founded in 1989 as a niche insurance business, Kingsway thrived for nearly two decades. However, the Great Financial Crisis hit the company hard, leading to large losses that became an existential threat. These net operating losses (NOLs) became an attractive asset because they can be used to shield future returns from tax. At that point, Joseph Stilwell, an activist banking investor, stepped in to exploit those NOLs and turn Kingsway into a merchant bank. Insurance operations were shut down, but the merchant bank struggled as a public vehicle. In 2016, JT Fitzgerald entered the stage to explore the introduction of warranty operations, with very attractive commercial attributes, within the business. However, JT had experienced success with search funds, having launched his own company, Argo Management Group. He had the idea to transform Kingsway into a publicly listed search fund business. It took time to convince the board to dispose of legacy assets and restructure, but ultimately, JT became the CEO. He has proven that this model works and is an effective way to exploit those net operating losses. The first search fund launched within Kingsway delivered a 10-times cash return on investment in just over four years. Since then, the company has gone from strength to strength. JT, welcome. JT Fitzgerald: Thank you, James. Happy to be here. James Emanuel: For those unfamiliar with search funds, would you explain the model? JT Fitzgerald: In essence, the search fund model is an investment and acquisition strategy where a group of investors partner with a talented, early-career entrepreneur to search for and acquire small operating businesses. After the acquisition, the entrepreneur transitions into the day-to-day management of the company, typically tran… Get full access to Rock & Turner Investment Analysis at rockandturner.substack.com/subscribe
