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DISCLAIMER & DISCLOSURE: The author holds a position in Kingsway Financial Services 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 Financial Services 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 recordingThe Evolution: From Insurance Co. to Public Vehicle for Search FundsJames Emanuel: I’m James Emanuel, and joining me today is JT Fitzgerald, CEO of the U.S.-listed business Kingsway Financial Services (KFS). 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 transitioning out the retiring founder.James Emanuel: This model was spawned out of U.S. business schools where MBA students were anxious to embark on a career, and private equity investors provided the funding. They find a “mom-and-pop” shop with great potential where the founder has no succession plan. The search fund buys out the owners, and the MBA student steps in as the new CEO to scale the business. Is that fair?JT Fitzgerald: That’s right, with one distinction: the model existed long before it was formally called a search fund. The term started to come into existence roughly 30 years ago, spawned out of Stanford and Harvard. One distinction is that the equity supporters generally have gone down this path themselves. It’s not private equity in the traditional sense. I view it as “craft investing” in the artisan-apprentice sense. The folks backing today’s searchers typically have been operators themselves.The Thesis of Permanent CapitalJames Emanuel: In the past, these search funds were the remit of private investors. You saw an opportunity to launch this model within a listed entity to give you access to a permanent capital vehicle. This allows you to grow a diverse portfolio while providing investors the liquidity of the public market with no lock-in periods. Was that your perspective when you joined in 2016?JT Fitzgerald: When I came to Kingsway, the thesis was the attractiveness of the platform as a permanent capital vehicle. Research shows that search fund return profiles have been very good. However, if you look at the returns to the people who acquired those businesses when the searcher exited, the next seven-to-ten-year returns have been just as good. This means that, historically, searchers and their investors have been exiting too soon.The idea of a platform where you could own those businesses for a longer period and continue to compound capital was very attractive. In a private investment context, there’s often a hard-wired requirement to generate liquidity. Finding a vehicle that eliminates those requirements was compelling.James Emanuel: Could you provide a brief background of your career prior to Kingsway?JT Fitzgerald: Prior to business school, I was a floor trader on the Chicago Board of Trade, trading fixed-income futures and options. That world was changing abruptly with electronification. I used that disruption to go to business school. A mentor encouraged me to pivot into an operating role. He had done something out of Harvard in the late sixties that looked very much like a search fund.In business school, I studied a case on one of the original search funds. It was a lightning-bolt moment; I learned you could find investors to support an inexperienced person to buy and run a business. I raised capital and formed my own search fund in 2002. My partner and I acquired a manufacturing business in Lexington, Kentucky, from a retiring founder with no succession plan. We ran it for several years, and I eventually elevated to a board role before we exited in 2016. Along the way, I also became an investor in other search funds. I’ve been both an operator and an investor for over 20 years.Sourcing the “Silver Tsunami”James Emanuel: You find MBA students to be owner-operators, and then you launch a search fund. Over 99 percent of businesses are small privately owned enterprises. How do you filter through hundreds of thousands of targets?JT Fitzgerald: We focus on what we call the “silver tsunami”—a demographic reality where a huge number of privately owned businesses in North America are run by people reaching retirement age. The search fund model is a uniquely shaped key to solve the succession problem for owners who want to monetize their primary asset.We take an industry-first approach. We underwrite industries that are large, growing, and contain good business models. Once we narrow that down, our “operators-in-residence” spend roughly 80 percent of their time on proprietary sourcing. We use private company databases, reach out to owners directly, and describe our transition model. The remaining 20 percent of our time is spent with brokers and intermediaries. Roughly half of our deals have come through the broker channel. We often win deals not by being the highest bidder, but because of our focus on succession and our long-term holding period.James Emanuel: Which is more difficult: finding the right business or finding the right operator?JT Fitzgerald: Both are hard for different reasons. The search is a numbers game. Factors like revenue quality, margins, and customer concentration are quantifiable. Finding businesses with those qualities takes discipline.Entrepreneur operators are harder to screen for because their attributes are largely qualitative. We look for high-attribute people—smart, curious, driven, humble, and tenacious. There is no score for that. We have a lot of interest, and our job is to filter for the folks who possess traits indicative of success as a leader.The Search Fund vs. Traditional Programmatic AcquirersJames Emanuel: I distinguish between serial acquirers, like Brad Jacobs, and programmatic acquirers, like Constellation Software or Berkshire Hathaway. Those companies prefer continuity and a hands-off approach. They facilitate a change in ownership, but not management. Your model changes both. You are essentially speculating that the business is good and the person you insert will succeed. How do you view that risk?JT Fitzgerald: That is a fair characterization. Our model is different than “buy it and keep the team.” However, in businesses with $1.5 to $4 million of EBITDA, there isn’t typically a huge bench of future CEOs. I view this as both a risk and an opportunity. I believe that attributes trump experience over time. If you take a high-attribute person, they will learn the business and eventually outperform a lower-attribute incumbent team.James Emanuel: Constellation and Berkshire intend to hold forever. Currently, you have an eye on exits, though you mentioned search funds often exit too early. How do you think about the benefits of compounding?JT Fitzgerald: I would challenge the view that we are looking to exit. Ultimately, an exit is just a capital allocation decision based on the risk-adjusted opportunity cost of capital. While traditional search funds have hard-wired requirements to exit, our ideal holding period is forever. We are not forced to sell to generate liquidity. We enter these investments wanting to own them for a very long period.James Emanuel: Programmatic acquirers often prefer products over services because of operating leverage and stickiness. You have both software and service businesses, like plumbing. What is your thinking there?JT Fitzgerald: Our filter isn’t product versus service; it is criticality. Is the demand recurring? Does the company have pricing power? We focus on low capital intensity. Manufacturing can be R&D intensive and complex. Service businesses generally have lower capital intensity. If you combine mission-criticality with repeatable revenue and strong margins, you get enduringly high returns on tangible capital.James Emanuel: You currently have seven platforms in development, including skilled trades and IT services. What is the criteria for rolling businesses into a platform versus keeping them standalone?JT Fitzgerald: We are programmatic acquirers at the platform level. Some of those platforms can then become serial acquirers. For example, in skilled trades, organic growth can be limited by geography. Inorganic growth becomes the natural lever. However, we only do this if there are actual benefits to the platform, such as back-office synergies, purchasing power, or specialized marketing and recruiting.We practice “hard-form decentralization.” Decisions should be made as close to the customer as possible. In skilled trades, businesses operate under their own local brands. We just bring best practices and technology to the point of impact.The Supervisory Board and IncentivesJames Emanuel: Your supervisory board includes Will Thorndike, author of The Outsiders, and Tom Joyce, former CEO of Danaher. How do you scale oversight as you grow to 20 or more companies?JT Fitzgerald: We don’t intend to scale the board for governance; their role is coaching and sharing best practices. Oversight comes from the structural design of the system and incentives. We structure compensation so operators behave like owners. They don’t have enormous salaries, but they have annual bonuses tied to cash flow return on invested capital.James Emanuel: Will Thorndike was the first institutional investor in search funds. How did he become involved with Kingsway?JT Fitzgerald: Will has been one of the most prolific investors in search funds over the last 30 years. He was the one who did the primary research on the returns to the second group of owners. The idea of a permanent capital vehicle to own these businesses for a longer period was exciting to him because of the power of compounding over longer holding periods. Both he and Tom Joyce are shareholders.The Warranty Segment and Net Operating LossesJames Emanuel: You have two reportable segments: KSX and extended warranty. The accounting for warranties can be distorting because premiums are received upfront but recognized over years, while costs are recorded immediately. How should investors value this segment?JT Fitzgerald: Most people in the industry use “modified cash earnings” or EBITDA. This accelerates the revenue associated with the administration fee to the day the contract is sold while continuing to defer the portion associated with future claims. It’s a better proxy for operating cash flow. We speak to these trends in our earnings calls. You can also net out changes in deferred revenue and deferred acquisition costs on the balance sheet to find the true cash generative power.James Emanuel: Do you view those premiums as float, similar to the Warren Buffett style?JT Fitzgerald: Yes. A portion of the premiums are set aside in a claims reserve which is invested. We get the investment income, and since claims duration is typically two to three years, we benefit from that investment float.James Emanuel: Regarding the $620 million in NOLs—these are a massive structural advantage, but they are a wasting asset. About half expire in 2029. How do you balance this?JT Fitzgerald: It is a wonderful asset, but it has a finite life. It is unlikely we will generate enough earnings growth to consume all the NOLs before they expire. Therefore, we may monetize some assets to use the NOLs against capital gains. Our focus is fully on growing the KSX segment, and you can reasonably infer what that means for our strategy regarding other assets.The Vision for the FutureJames Emanuel: You have developed the Kingsway Business System (KBS), inspired by Danaher. How long does it take for a new acquisition to adopt these principles?JT Fitzgerald: It depends on the maturity of the business, but we use a “crawl, walk, run” framework. It starts with a foundation of trust, authenticity, and visibility of KPIs. It generally takes a couple of years to fully install the chassis and have it operating effectively.James Emanuel: You own 5 percent of the company, and insiders own about 35 percent. Do you intend to run this into your eighties and nineties like Buffett?JT Fitzgerald: That is ultimately a board decision, but I hope to contribute for as long as I can. We are building an incredible group of young leaders, so succession will naturally come from growth within.What I want people to take away is that we have elements of a programmatic acquirer with a decentralized philosophy and a unique tax asset. We are currently hard to find and hard to understand because of the “hangover” of the old insurance business. Personally, my aspiration is to transform 50 lives—to support 50 amazing leaders who achieve life-changing success. That is what I get excited about.James Emanuel: JT, thank you for your time. As a shareholder, I’m excited about the future.JT Fitzgerald: Thanks for having me, James. I really enjoyed the conversation.Receive more like this direct to your inbox: Get full access to Rock & Turner Investment Analysis at rockandturner.substack.com/subscribe