If there is one inexorable rule of investing, it is that over time, governments will do everything and anything needed to increase their tax revenues—even if it means sacrificing the moral high ground that they previously defended during election time. Nowhere has this appeared more obvious to me than when it relates to internet gambling. When its election time, the politicos all claim to find internet gambling immoral—fast forward a few months and budget deficits change moods—regulate it and tax it suddenly seems viable. Therefore, it comes as no surprise to me that last week Chris Christie passed a law to legalize internet gambling in New Jersey. Now that there’s a crack in the dam, every other state will race ahead to grab a piece of the pie—remember, principles tend to get prostituted between elections.
This brings me around to an old position of mine, Bingo.com Ltd (BNGOF:OTCBB). I’ll start by stating the obvious, this stock is a good deal smaller than my normal sandbox—calling it a pico-cap is generous. That said, at one time, my fund owned over 20% of the company’s shares. Why would we own so much of such a small company? I’m a sucker for a management team with a lot of skin in the game—especially when they keep anteing up more money to buy shares—even when things aren’t going well. The other factor was that I intuitively knew that internet gambling would eventually be legalized. Even in the nebulous gray world of internet gambling, people somehow found this business and funded their wagers. Just imagine how it would do if they could actually market and legally take deposits? Why would someone pay money to play Bingo online? I have no idea, but the results spoke for themselves.
The tale starts with one of our analysts doing the usual search for rapid revenue growth combined with insider buying. Over the years, I’ve learned that explosive revenue growth tends to be a good place to search for future profit growth—especially in a high margin business. When it comes to insider buying—well, that’s just obvious. If the insiders believe, it’s definitely worth looking closer. The business was small, very small, but it was growing revenues at over 10% sequentially a month (from a very low base) now that new management had taken over. The company had a fixed cost structure with very low overhead. It wasn’t hard to see how half of the money would go into marketing and half would go to shareholders (who were increasingly the managers due to the aggressive insider buying).
At the time, internet gambling was something of a gray area. Some companies were aggressive at marketing to Americans and some companies pretended to shun US gamblers. Bingo.com was one of those that was patiently waiting for the laws to change. They took what money flowed to them, but they weren’t aggressive about marketing in the US. Still, revenues were ramping up—and fast—they were just on the cusp of profitability. Things don’t always ramp up linearly, but at just $10 million in revenues, why couldn’t you get to a market cap that was five to ten times what I was paying? Then one day, it all changed. In a true sense of Congressional irony, the SAFE Port Act (to regulate our nation’s ports) contained a provision that banning financial institutions from helping to transmit money to gambling businesses. If you can see the correlations between the industries, you are qualified for congress.
The stock cratered and we waited. The thing about good management teams is that they’re smart and they move fast. They slashed costs to the bone and decided to hunker down and wait for the law’s inevitable change. It was at this moment that a rather small position became larger. Management was going to participate in a financing that would give the company the staying capital to wait for the US laws to change—in addition, they were going to try their luck in Europe. Why not—if management is buying shares, I’ll take a few more shares also.
Let’s just say that their European business was a bit slow to take off. They didn’t lose a lot of money, but the money slowly trickled away and we ended up participating in a few other management led financings as the share price slowly declined. In the end, my fund became the second largest owner outside of management—which isn’t hard to do when you consider that the market cap dropped to only a few million dollars. The whole time, I knew that the laws would change, that their European initiatives would eventually take off—which they now sort of have.
2010 was a very good year for our fund and I was looking at our potential tax bills—something that I take pretty seriously as the largest investor in the fund. At the time, our unrealized loss in Bingo.com was a few times the size of the entire position, so I liquidated it at year end. Do I have regrets—not at all. I knew the laws would turn, but I didn’t know when. In the interim, I had plenty of better uses for our capital. More importantly, I could save a whole lot of our capital from disappearing into some government program in the form of taxes. The math said to sell the shares—which I did.
Why am I telling you this whole story? It comes back to the number one underlying thesis of this whole site, watch the macro and watch it closely—it’s the only thing that matters. Secondly, just because an asset is cheap, that doesn’t mean that you need to invest. There are a whole lot of cheap assets in the world—some even come with great management teams. None of that matters if the macro doesn’t line up for you. When I bought my first BNGOF shares, I thought the macro was going in my direction. When it changed, I should have just taken the loss and moved on. I certainly should not have doubled down if the medium-term macro was going against me. Today, six years later, you can buy the shares for the same price as where I bought my first big batch in the management led financing. That’s a whole lot of time to sit around and wait for a position to work for you. It’s all about the macro and will always be. It doesn’t matter if it’s cheap or unique, watch what’s happening in the overall trends and adapt to those trends.
In the scheme of things, it was a small position and I didn’t lose that badly, but I learned a great lesson. Watch the macro and watch it closely.