Texas Pacific Land Revisited (TPL)

Is Texas Pacific Land, a Spawner?

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Welcome to Episode 30.

Famed investor, Mohnish Phabrai, popularized the idea of investing in “Spawner Companies” several years ago in a talk with Peking University, Guangua School of Management students. In the discussion he contrasts investments in “growing-pies” with investing in “discounted-pies” pointing out that investing in discounted-pies yields a lower, 2-3x, return per investment when compared to growing-pies which can yield 10-100x per investment if properly identified and allowed to compound. Discounted-pies have their place as they often appreciate in a declining market and are easier to identify than are true growing-pies but a growing-pie once identified is a thing of beauty.

As Pabrai’s talk progresses, one of the growing-pies that he focuses on is the Spawner. Spawning companies are those which constantly spawn related and unrelated businesses. Examples include Alphabet, Amazon, Alibaba, Tencent, and Baidu. Mohnish breaks Spawners down further into four sub categories which include adjacent, embryonic spawners, cloner spawners, and non-adjacent spawners. Apex spawners, according to Pabrai, are those which display all four sub category traits in a single business.

As highlighted by Mr Pabrai, spawners offer investors several distinct advantages. For starters both the business and the investor gain a tax benefit. Earnings from normal business operations can be directed into incubation of new business and thus reflect an expense to the company rather than being taxed as income giving the business a sort of free loan from the government. The investor is tax advantaged by holding a business for years or even decades without the high turnover and resulting taxes that result from trading discounted pies.

Spawners are further advantaged by an extended business life. Like any living thing, a business goes through distinct stages from birth, to rapid growth, to maturity, old age, and eventual death. Barnes and Noble stuck with a single business model and is now in the mature to declining stage of its bookseller life whereas Amazon, which started in the same business, is still in a growth mode decades after its inception. Amazon continues to spawn new businesses, some of which, eventually mature and take the place of dying or outdated business models. Amazons cloud storage business was once a small side project but it now dwarfs the revenue generation of Amazons founding bookseller business.

Texas Pacific Land Corporation, which we’ve covered previously on this podcast is advantaged in several ways. It carries no debt, has almost no operating expenses, employees barely more than 100 people, and gets high ESG marks despite it’s connection to the oil and gas industry. What I realized recently is that TPL’s business model also qualifies it as a spawner.

Specifically, TPL fits into Mr Pabrai’s adjacent-spawner category. Adjacent spawners are those which continually create new businesses that are similar or adjacent to the companies existing business model. This trait is a double advantage for TPL. TPL is first advantaged as a royalty company in that it derives profits from the price of the commodity sold but doesn’t suffer from increased operating expenses that compress the margins of any normal business. Said another way, TPL shares are a perpetual call option on the price of oil.

TPLs second advantage comes from its adjacent spawner business model. I consider the company an adjacent spawner because of the businesses it already created and those that it continues to create. Contrast TPL with other oil and gas royalties and you’ll discover that it alone is adding new business to its core oil and gas business. Whereas a typical royalty company has a set charter to distribute x percent of it’s income through the end of it’s asset life or an arbitrary date in the future TPL is continually “inventing” new business lines.

In a sense its primary line of business was spawned, oil and gas, began generating profits decades after TPLs land was set in a trust in the late 1800’s. From the mid-1900’s on TPL generated increasing revenue through it’s oil and gas business and only in the last two decades added the water business to its list of income streams. The water business now contributes substantially to TPLs overall revenue.

Demonstrating the companies ongoing spawner DNA, TPL added and continues to expand its renewable energy segment by incorporating wind and solar energy production to its portfolio. Both wind and solar will outlast the oil and gas business and serve to extent TPLs compounding runway decades into the future.

Within the last quarter, TPL announced the addition of bitcoin mining and carbon sequestration to its business portfolio. Both businesses are in the very early stages but represent, once again, that TPL is a spawner at its core.

Before wrapping up it’s worth touching on the synergy that exists between TPLs two previously covered advantages. Because TPL applies a royalty model to the businesses it spawns its exposed to all of the upside and little to no downside of each new endeavor. Take for example the bitcoin mining announcement. The capital and infrastructure are to be financed by two separate operating companies with TPL securing a small revenue stream in exchange for use of their fully owned acreage. TPLs contribution comes in the form of remote land, beneficial for noise abatement, and its collocation with existing energy production but not in the form of cash or the diversion of it’s limited employee focus.

If the newly spawned bitcoin mining project takes off it could represent a substantial income stream in the future and if it fails it will have cost shareholders nothing. The positive convexity built into the royalty and spawning DNA of the company again acts like a perpetually dated call option on all future business lines that TPL will generate.

Long into the future TPLs land business could evolve again and income streams may shift. If residential development springs up in the Permian basin as it did in Midland Texas following its oil boom TPL could own valuable underlying land key to the development of shopping centers and subdivisions. How likely is this to occur is anyone's guess but once again it represents a free option lying in wait for a proven spawner to capitalize on.