Graham & Doddsville An investment newsletter from the students of Columbia Business School
Inside this issue: Issue XIX Fall 2013 Guy Spier P. 4 Guy Spier — Guy Spier is the founder and managing partner of Homex (HMX) Aquamarine Capital, an investment partnership styled Build Your Life after the original 1950’s Buffett partnerships. In 2008 9.75% 2020’s P. 16 Mr. Spier, along with Mohnish Pabrai, had lunch with in a Way That Warren Buffett after submitting the winning bid for Wabash National Suits You Buffett’s annual Glide charity auction. Mr. Spier (WNC) P. 18 completed his undergraduate studies at Oxford and earned an M.B.A. from Harvard Business School.
Active Network Graham and Doddsville (G&D): How did you first become (ACTV) P. 20 interested in investing? What drew you in and what keeps you going? Koch Industries P. 22 Guy Spier (GS): I guess there are some natural proclivities that I have. One is that I don’t like managing people and I’m really bad at executing on stuff. Getting Mr. Guy Spier to have the ambition of building Starbucks like Howard Schultz did would never happen. Guy would still be running some crummy Editors coffee shop because I’m just not very good at execution. I Chris Brigham know that I’m an extrovert, I enjoy meeting people but on MBA 2014 Guy Spier (Continued on page 4)
Jackson Thies, CFA MBA 2014 Koch Industries — Creating Value in Society Jason Yang MBA 2014 Koch Industries is an industrial Matt Ford conglomerate headquartered MBA 2015 in Wichita, Kansas. It is the second largest private Mike Guichon company in the U.S. with $115 MBA 2015 billion in sales. Its businesses range from petroleum refineries and fertilizers to chemicals and fibers, as well as Visit us at: Georgia-Pacific, which Koch www.grahamanddodd.com Dave Robertson Steve Feilmeier www.csima.org acquired in 2005 for $21 billion.
Koch’s recent investments include a $1.5 billion minority stake in Guardian Industries, an architectural glass manufacturer; an investment in Colfax Corporation, a diversified manufacturing and engineering company; and a $240 million preferred stock investment in American Greetings Corp.
Richard Hunt, Graham and Doddsville’s former AVP and a summer business (Continued on page 22) Page 2 Welcome to Graham & Doddsville
It is our pleasure to bring you We also sat down with Koch as to some of the newer and the 19th edition of Graham & Industries Executive Vice less-familiar faces in the Doddsville. This student-led President and Chief Financial investment community. We investment publication of Officer, Steve Feilmeier, as also have a few other ideas in Columbia Business School is well as President and Chief store, so stay tuned for our co-sponsored by the Heilbrunn Operating Officer, Dave upcoming editions. Center for Graham & Dodd Robertson. They discuss their Investing and the Columbia approach to finding investments As always, we thank our Student Investment Management that are not only great interviewees for contributing Association (CSIMA). standalone businesses, but also their time and insights not only ones that can be integrated to us but to the investment As students return to campus into their existing operations. community as a whole, and we here at Columbia Business thank you for reading. Pictured: Heilbrunn Center School, we are reminded and We continue to bring you Director Louisa Serene implore our readers to continue pitches from current students - G&Dsville Editors Schneider. Louisa skillfully the search for what Charlie at Columbia Business School. leads the Heilbrunn Center, Munger has called “worldly CSIMA’s Investment Ideas Club cultivating strong relation- wisdom.” By dedicating our lives meets regularly throughout the ships with some of the to continuous learning, we year, including during the world’s most experienced become not just better summer, and provides CBS value investors and creating investors, but better thinkers students the opportunity to numerous learning oppor- and contributors to the world in practice crafting and delivering tunities for students inter- which we live. investment pitches. Three of ested in value investing. the best ideas from this The classes sponsored by Our first interview is with Guy summer are contained for your the Heilbrunn Center are Spier, the founder and portfolio perusal—long the 9.75% senior among the most heavily manager of Aquamarine Capital. guaranteed 2020 USD notes of demanded and highly rated In a candid discussion with Gra- Homex (EJ0116982), long Wa- classes at Columbia ham & Doddsville, Mr. Spier bash National shares (WNC), Business School. discusses everything from his and long Active Network use of checklists to several of his shares (ACTV). recent investments. Insightfully, he points out that it does little Looking forward to the coming good to aspire to be a different academic year, we are working investor, but instead suggests to to bring you even more focus on creating an investment fascinating interviews; we plan philosophy and portfolio that is to expand our gaze to consistent with who you are. international investors as well
Pictured: Professor Bruce Greenwald. The Heilbrunn Center sponsors the Value Investing program, a rigor- ous academic curriculum for particularly committed students that is taught by some of the industry’s best practitioners.
Bill Ackman and David Winters at the Students waiting to hear the final Omaha Dinner in May presentations at the 2013 Pershing Square Challenge IssueVolume XIX I, Issue 2 Page 3
SAVE THE DATE
17th Annual Columbia Student Investment Management Association Conference
February 7, 2014
A full-day event featuring some of the most well-known investors in the industry, presented by:
The Columbia Student Investment Management Association
and
The Heilbrunn Center for Graham & Dodd Investing
Visit our website for updates: http://www.csima.org
For inquiries contact: Taylor Davis [email protected] Ivan Dias [email protected] Joe Fleury [email protected] Page 4 Guy Spier
(Continued from page 1) think that at the end of the People who go to Oxford some level I lose patience day, it suited my internal are great thinkers, they just with humanity as well. Being wiring. I think I’m aware of can’t get anything done. in a situation where I don’t some of that wiring but I’m That’s a broad have to deal with too many not aware of all of it. generalization. Oxford people if I don’t want to, brought out my proclivity and I don’t have to manage for discussing, writing them is a big plus. So I think essays, all of those things. there are very specific ways “I sometimes ask Harvard Business School on in which it was natural for the other hand, is much me to go into investing. I myself, ‘If you had more practical. It would think it’s something that is have been very hard to suitable for me, but at the the choice between choose between those two. Guy Spier same time the world of investing is broad so you either Oxford/HBS Then I sometimes ask still want to find a niche or a myself, ‘If you had the place in it that suits your and the education choice between either own particularities. that you get around Oxford/HBS and the education that you get Five years ago I asked Warren Buffett, around Warren Buffett, Warren, ‘Berkshire Charlie Munger, Ben Hathaway is structured a bit Charlie Munger, Graham, etc.’ I think hands like the starfish versus the down Charlie Munger, Ben spider?’ The idea is that a Ben Graham, etc.’ I Graham and all of that is starfish, if you cut off a leg, much better, for me at least. it regenerates. A starfish is a think hands down decentralized organism and Charlie Munger, At Oxford, for example, I a spider is not – you pick off studied the Rudi Dornbusch a leg and it doesn’t grow Ben Graham and all exchange rate overshooting back a new leg. model. It’s a beautiful thing Decentralized organisms are of that is much and it might describe some more resilient to having measure of reality. But it’s a their legs cut off and better.” very powerful idea that Berkshire Hathaway is the grabbed hold of the whole same way. It’s very resilient of academic economics, this as opposed to a command idea that you could solve and control organization. I G&D: Can you talk about equations representing the asked Warren, ‘That’s really your background at Oxford economy through time by smart. Did you figure that where you studied assuming rational out twenty years ago?’ And philosophy, policy and expectations, which is now he said, ‘No. I absolutely economics? Did that affect an important part and parcel had not figured any of that your investment of the neoclassical model of out. Berkshire Hathaway is methodology or philosophy? economics. Now you’ve got the way it is because it suits a way of moving things to me. It suits my particular GS: I was lucky enough to equilibrium through time personality.’ I don’t know if attend both Oxford even if people don’t know he actually said it, but he University and Harvard what the outcome is clearly implied that if he had Business School. But I because somehow all the Jack Welch’s personality and sometimes ask myself which actors in aggregate are abilities and internal wiring, I would have chosen if I moving the market price to Berkshire Hathaway would could only do one. Two their rational expectation of have looked very, very very different educations. (Continued on page 5) different. So why investing? I IssueVolume XIX I, Issue 2 Page 5
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(Continued from page 4) things aligned right I could Intelligent Investor – Mr. what it should be. make billions and live this Market, things having incredible life.’ And many intrinsic value, stocks I think that it handicapped people who do value representing part interest in me in a profound way. investing end up living these businesses – are fantastic. Because there I was at incredible lives. And we live But I was in a position ten Harvard Business School long lives is what we’ve years ago not to charge a and Warren Buffett shows figured out. We know from management fee the way up and I have no interest in Warren Buffett that it’s not Warren Buffett did, but I him. I also have no interest was charging a management in the financial markets fee. Why on earth was I because in my rational doing that? I don’t know expectations view, there are how many years ago I met no dollar bills on the “It took me a long Mohnish [Pabrai]. He was ground; they would have not charging a management been picked up by this time to figure out fee. I was an example of the spectacularly efficient that my job is not guy sitting on the other side market. Now I’m sure I of the road at the gas learned plenty at Oxford to be Warren station. You know the Tom and at HBS, but I don’t think Peters story? Mohnish talks they helped me much Buffett or to be Bill about cloning and seeing professionally. I’m sure I’m a whether people are willing better human being but they Ackman. My job is to clone or not. I’m sitting did not help me with there, laughing at all those investing, I don’t think. And to be Guy Spier.” idiots who don’t clone. At I don’t know one person I some point I realized, ‘Wait. studied with who even I’m the guy on the other understands what I do or side of the road who is not understands the basic got to do with intelligence - cloning what is obviously philosophies of value he says some people get it, working.’ There are so investing. They just think, some people don’t. many things that I lost time ‘Whatever. He’s just a with and didn’t learn finance guy.’ I got it, but my God, have I because I had too narrow strayed from the path in so an understanding of the G&D: Not even David many different ways. I had wisdom that was to be Cameron gets it? such a narrow imparted. understanding of the GS: David Cameron is a wisdom that Warren Buffett G&D: You went straight very, very, very smart guy had to impart. If my from being in investment and he understands British investment career is the banking to managing money politics and understands only thing we’re talking raised from friends and what can and cannot be about, I definitely lost at family. What caused you to done with Britain in a way least five years, perhaps do that? that I could be living in more, getting started on it Britain 100 years and not because my head was filled GS: A few things. It took understand. But we with all these ideas of me a long time to figure out underestimate how many efficient markets. But I’ve that my job is not to be people have any clue about lost more time by not fully Warren Buffett or to be Bill the way we feel, which is, learning the lessons that are Ackman. My job is to be ‘Oh my God. This is so available there for all to see. Guy Spier. I’m not going to exciting. There are market do a very good job of being inefficiencies that I can The basic tenets of The (Continued on page 6) exploit. If I just get a few Page 6 Guy Spier
(Continued from page 5) If the first tier is Morgan guy that I should not have Bill Ackman or being Stanley, Goldman Sachs, associated myself with, and Warren Buffett but I’m Credit Suisse, globally in finance especially, your going to do a damned good recognized brand names and associations count. People job of being Guy Spier, then you have a second tier don’t have the time, the better than anybody on the of Robert Baird and energy or the interest to planet. Associates and regional really dig deep to find out if investment banks. Then you this is a good guy or not. Everybody’s path is unique have this third tier doing You don’t have to get and I think it’s really, really things like taking penny yourself burned. If you see “Something I important that we find our stocks public or venture there’s smoke you don’t own path. If I look back at investment banking where have to put your hand in the believe quite the path that I took, there you would take a company fire. The good news is that are many mistakes that I that didn’t have any earnings when you make mistakes strongly is that if made. Many things I would and take it public. After I you want to make them have done differently. But you want to joined, I discovered that early. You want to make that’s yet another thing we there were people engaging those mistakes when you’re understand who an have to learn, to own our in practices which were on 25 and not when you’re 40 path with its mistakes and the borderline of legal. In or 50 or 60. investor is, you need to be accepting that every fact, five years after I left, single person has massive the SEC shut down half of In my case, I was very to understand their mistakes in their path, and the firm. I knew that to go interested in this investing that’s part of life. and join Goldman Sachs I stuff. I started putting relationship to would have been a glorified together mock portfolios. I Leaving business school, I money in general, photocopier or something met some great people on had this pristine resume. I’d like that. I didn’t care what the way, Carley Cunniff was their relationship to worked for a consulting brand name I had, I wasn’t very generous. That’s when firm, had a great doing that. I was doing I started going to the the money that undergraduate degree, something real. That said I Berkshire meetings. I didn’t Harvard Business School should have left that place know anybody, but just they specifically and I wanted to throw up all three months into it started showing up. Then in over anything that had to do because it was a snake pit. my case what happened is manage, and what with the establishment. I that my father notices this. just had no interest. I did the money means What happened to me, and There’s a family business in not pursue interviews with again I’m just describing my London trading agricultural to them.” Goldman Sachs and all of path, was I was reading all chemicals. He had made those people. Which I think sorts of books. I pick up The some money and he started was a mistake. I was feeling Intelligent Investor and a light investing that with me. rebellious and had to break goes on in my head. An aha! From my father’s out of these straight and moment happens and now perspective he wanted me narrow tracks. However, I I’m applying for jobs as an involved, whether think that there’s so much analyst doing what you guys consciously or to be said for being on the do, except that I’d gone to subconsciously, he realized corporate bandwagon for a work for DH Blair. I was that by getting me to invest while and not getting off it interviewing with a number the family wealth he was right away. of places but I wasn’t having getting me back involved. I an easy time of it and these didn’t realize but at that I started working for a guy question marks arose. I point, on some level, I had who was also a graduate of made a very, very, very bad re-joined the family Harvard Business School judgment call in terms of my business. who had his own banking/ own personal reputation. I investment firm, he was had associated myself with a (Continued on page 7) very solidly in the third tier. IssueVolume XIX I, Issue 2 Page 7
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(Continued from page 6) different people. people just go, ‘You know... G&D: How did you feel Warren owned Coca Cola comfortable starting out on I don’t understand some during the period when your own and managing peoples’ approach to Doug Ivester was messing close relations’ money? money. I don’t understand up completely but it didn’t why they love it so much. get under Warren’s skin.’ GS: My father is the kind of Now contrast that with People had to practically person who doesn’t do somebody that we all know read the Riot Act to him things half measure. He pretty well—Mohnish. before he acted to remove doesn’t say, ‘Here’s 10% of Mohnish is on record as Doug Ivester. You have one my wealth and if you do saying that his dad went extreme there and then you well with it I’ll give you bankrupt a number of times have Bill. I think another 10%.’ He dumps all so he’s very familiar with understanding those his liquid wealth on me, having money and not personality traits and which was pretty much having money. And he’s very realizing they are “The investors that everything, which instantly familiar with seeing how his unbelievably idiosyncratic in made me unbelievably risk parents were unchanged each one of us is really we appreciate and averse because I knew through that. His core important to do. exactly what I was dealing family circumstances actually do well somehow with. Then again, I’ve gone didn’t change that much. He G&D: Clearly you’re have found a way back and said to myself, ‘If has a much lower fear of heavily influenced by he would have dribbled it loss of money I think Benjamin Graham and to reflect their out to me, I think I would because of that. The other Warren Buffett, value have been much more thing is when he started investing legends. But what inner life in a very willing to take big gutsy Pabrai Funds it wasn’t Guy’s do you think sets you apart bets.’ In that period I had dad saying, ‘Here’s some from those guys that gives fundamental way in really great investments. money that I’ve made. Invest you an edge in investing? One was Duff & Phelps it.’ It was Mohnish having their investing which is one of the credit sold his business and taking GS: I’m dumber. The moves.” rating agencies. It’s now part a portion of that and Aquamarine Fund is open of Fimalac and that was a investing it. That again is a but I’m not really trying to 7X over three or four very, very different raise money and it’s a years, just a wonderful, psychological relationship to wonderful release because I amazing situation, but I money and I think that don’t care about didn’t invest very much. I drives a huge amount of distinguishing myself and was scared stiff. One thing investment behavior. differentiating myself and all that I’m adamant about is I’ll of those things. Warren leave with one track record I would love to do the Buffett has a 180 IQ, maybe and all of those things go analysis on Bill Ackman on higher. Mohnish has a way into the track record. that front. I don’t have higher IQ than I do; it’s 160 enough information, but Bill or more. If you ask me, I Something I believe quite I think, like me, came from think Mohnish’s IQ is not as strongly is that if you want an environment where high as Warren’s but I tell to understand who an there was established you they’re both streets investor is, you need to wealth. For Bill, money, it ahead of me. Warren runs understand both their seems to me, is the around saying that you don’t relationship to money in opportunity to play out stuff need a high IQ, he’s just general, their relationship to that on some psychological being nice. Having a high IQ the money that they level he cares about. really helps. He says it’s specifically manage, and Misgovernance in the better to be sensible than to what the money means to companies that he follows be super smart – he’s them. Money means very gets under his skin. Some (Continued on page 8) different things to very Page 8 Guy Spier
(Continued from page 7) Buffett has deep respect for particular commodity. I absolutely right. But if you John Bogel. In many ways never thought that I would can be sensible and super John Bogel is not an understand banks and I smart that is definitely investor; he’s just a guy who know that I nailed banks better. runs a machine. two years ago but it was really specific—large The investors that we G&D: How do your American money center appreciate and do well personality and your life banks were unbelievably somehow have found a way experiences manifest underpriced and a really safe Pictured: Bill Ackman and to reflect their inner life in a themselves in your investing place to put lots of money. Louisa Serene Schneider at very fundamental way in decisions? What do you the Omaha Dinner in May their investing moves. At 2013. look for? People jeeringly said to me, the end of the day, every ‘You don’t understand Bank successful investor ends up GS: I don’t like situations of America’s balance sheet.’ differentiating themselves on where there’s a lot of public I’d come right back and say, the unique aspects of their controversy. I get ‘Neither does Brian personality and who they particularly scared when I Moynihan but it doesn’t are. I’m not trying to be the see very smart people on matter.’ I think that what’s best investor. I’m just trying both sides of the equation. I interesting is I have a much to be Guy Spier. If you give know that I’m much more better sense of when me a path in life that comfortable in a place something is in my circle of involves higher returns to where people just aren’t competence and I’m much my limited partners and/or paying attention. That feels more willing to define stuff high returns to me, but it much, much better to me. I outside of my circle of makes me less Guy Spier, I figured out I know competence. wouldn’t take it. So in a absolutely nothing about certain way I guess I retail, that retail is just a In reverse engineering the disagree with the premise of dumb place for me. I’ve Berkshire Hathaway 13-F the question, which is I’m realized that it would not be filing, one of the positions different to all those smart for me to invest in they have is a company investors because I’m Guy the healthcare sector, but I called VeriSign. VeriSign is a Spier and I’m not Ben think I can get through life beautiful, beautiful business. Graham and I’m not without investing in the It’s probably not cheap but I Warren Buffett. I shouldn’t healthcare sector. never thought that a try to out-Warren Warren. company that is in the tech G&D: Which industries space would be within my To compare myself to any attract you more? circle of competence. I gave of those other people is a up doing the work because very dangerous thing to do GS: The core home base it’s too expensive and and probably not helpful for me is branded consumer because allocating one’s actually. But they are all goods. It’s really hard to find time to the stuff that’s smarter than me and they’re something that’s super cheap rather than spending all better investors and attractively cheap but I just all this time studying great that’s okay. I’m comfortable know that I’m on safe businesses is smarter. But I with that. It’s about being territory there. I actually think I would have been the best version of yourself. now feel I’m in a lot safer ready to define VeriSign as That may be investing in low territory in terms of natural being within my circle of cost index funds because resources. They have to be competence. that’s where you’re at in the lowest cost producer, terms of your ability to for example, and we have to G&D: Would you by any analyze and your understand the supply and chance be willing to discuss relationship to money, and demand dynamics of a (Continued on page 9) that’s perfectly fine. Warren IssueVolume XIX I, Issue 2 Page 9
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(Continued from page 8) lot to lose you can counter- This is a huge cost to any current ideas you have? sue each other and you can American industry. On the say, ‘If you’re going to get one side they’re hated by GS: I will tell you that, me on violating this set of people like Apple and the where I am right now, I patents I’m going to get you other large companies and have not found something on others so why don’t we on the other side they’re that I want to put in the just call it a day? You get on the champions of inventors portfolio for quite a long with your business and we’ll who often feel they’ve been time. There’s been quite a get on with ours.’ This is screwed over by big dry spell; it’s not like we’re what usually happens. industry. What Reciprocal not looking. I’m happy with Patent Exchange does is my portfolio the way it is so Then there are these things they go to all these I haven’t done a lot recently. called patent trolls. They companies that are basically I’ll tell you one that I just sue people for settling at the court’s door rejected, but I think it is an violations of patents and or they’re paying these “The idea that interesting business and is collect some kind of companies to go away and such a puzzle. reward. If I’m a patent troll, they say, ‘Why don’t we we’re managing I will acquire a pool of pool our resources?’ To cut The one that came up was patents from somebody and a long story short, it’s some finely tuned Reciprocal Patent Exchange haul Apple into court and I fractional ownership of machine is just not (RPX). So I was introduced say, ‘You’re violating this set patents. Like fractional jet to the whole world of of patents.’ I didn’t invent it, ownership, fractional patent the case. I’m just intellectual property. First of and I don’t have a business ownership. You pay a all, IP is a big deal. What I off it, but I own the IP. The subscription to us, we’ll trying to get it right learned is that 200,000 or law is if you own the IP, acquire all this IP and you’ll 300,000 patents get granted you’re the inventor. The never get sued on account 55% of the time or every year and nobody problem that Apple has is of this IP. It doesn’t take completely knows what the Apple has to go and defend away the legal risk entirely, get it slightly better patent covers or doesn’t that. Now if I was some but it massively reduces the 55% of the time.” cover. But in the US and other operating business legal risk and they now have Western countries, the Apple would say, ‘Let’s sit much more buying power policy is, we grant people down and talk. Let’s see because it’s on behalf of all patents. A patent lasts 25 what you’ve got. Let’s get of their clients and they years. What does that some arbitration, we don’t have something like 200 patent give you the right to really want to go to court. clients. It is a really do? It gives you the right to We can see you’re a small interesting business and it’s pull somebody to court and business, you’re trying to cheap and they generate say, ‘You’re violating my grow this division. Why massive amounts of cash. patent.’ It’s an interesting don’t we buy a whole bunch Really, really interesting, but right and it becomes a lot of stuff from you? Why at the end of the day I put it more interesting or don’t we license you?’ in the ‘too hard’ pile. uncertain when you realize There’s some kind of the scope. At the end of the business arrangement that G&D: What about Fiat, day a judge has to decide settles it out. Not with the would you be comfortable was the patent being patent trolls. The patent discussing that investment? violated or not? What trolls say, ‘We don’t have a happened with Apple versus business. We are secure. GS: What I’d say about Fiat, Samsung is extremely You can’t sue us for I don’t want to talk too unusual because what anything but we can sue you much about it because of happens is like nuclear for that.’ So at the end of commitment, consistency warfare between two the day Apple settles. and all of those things but it countries, when you have (Continued on page 10) two big corporations with a Page 10 Guy Spier
(Continued from page 9) about the money being facts change I change my really is an interesting made or lost. They cared mind. What do you do?’ situation. What I think is about saving jobs. You want to be in a position interesting about Fiat is that to do that. The more what the Italians and the I think there is space on the people who know what Europeans see is some also- planet for one Italian brand. your opinion is on Fiat, the ran European automobile We have four or five less easy it is to change your manufacturer. They see a German brands, global mind. Dangerous stuff. Pictured: Rahul Raymoulik, company that is a much German brands. The only Richard Hunt, and Stephen smaller automobile company that has a chance G&D: How do you make Lieu at the 2013 Pershing manufacturer with sales of being a global automobile your sell decisions? Square Challenge. skewed to Southern brand from Italy and not just Europe, which has been in the high end like Ferrari is GS: Very badly. The idea much worse hit than Fiat. Chrysler does an that we’re managing some Northern Europe. They amazing thing for Fiat. Fiat’s finely tuned machine is just don’t have a clue what business has already not the case. I’m just trying Chrysler is but people here improved dramatically to get it right 55% of the in the United States because they now have the time or get it slightly better understand that Chrysler is ability to allocate costs and 55% of the time. What has a substantial business, they production around the worked for me is first of all, have some blockbuster planet. do not touch the portfolio brands, and it has a real unless you have a clear franchise value. But they Fiat used to be very heavily reason for action. One of can’t invest in Chrysler under the thumb of the the things that I do is I don’t because it’s all owned by Italian government and want to look at the the VEBA, this voluntary Italian unions. Now Fiat can portfolio too often. I know I employee benefits say, ‘Yeah, we’re will perform better if I can association, and Fiat. I think headquartered in Turin but do this. that is one of those unusual we don’t have to situations. manufacture cars in Turin. A lot of the time what We’ll produce them in happens to me is I’m The whole way in which Fiat Brazil and we’ll import them cleaning positions out for acquired Chrysler is very to you...’ Chrysler has given something else. I look at the interesting. Sergio them a global base from investment more as a Marchionne, the CEO of which to really allocate source of performance or as Fiat, comes to the production across different a source of cash. When I negotiating table. They’re factories. I think that takes have a great new idea I’m close to doing a deal for an three or four years to play saying, ‘Where am I going to undisclosed sum of money, out. raise money for it?’ and I but the day before Barack will sell the thing that I Obama says, ‘we’re going to I got the permission from believe is the least save Chrysler as well.’ So the people I did the work undervalued or the least Sergio says to the people with on Chrysler to talk to likely to contribute to negotiating on behalf of the Forbes about it but I think performance going forward. government, ‘Do you really that for me, investment But I’ve been surprised a want to go back to your theses are fragile. I don’t number of times by things president and say that want to say what I just said that I’ve had in the portfolio actually there is no deal and too many times; the more that have gone up anyway. I what the president said to times I say it the more will tell you, an experiment the American public isn’t difficult it becomes should I that is really worth running true? It’s that or you’re want to change my mind. is to pick portfolios by darts giving it to us for free.’ The Keynes said, ‘When the (Continued on page 11) US government didn’t care IssueVolume XIX I, Issue 2 Page 11
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(Continued from page 10) to me made that I from the sugar and sweets or by any other system and understand, and am I to the meat and potatoes. then you just leave those repeating these mistakes? Sugar and sweets is most of portfolios alone, and it’s It’s a bit like the common the stuff that comes up in a often only one or two law. You’re not trying to Google search. It’s designed companies that provide talk in generalities. You’re to get that instant response. most of the performance. I saying, ‘I remember when I Meat and potatoes is down think that meddling just invested in EBC oil and in the 10-K. Reading the 10- ends up reducing returns so someone in management K or reading something I really try to leave it alone was going through a divorce that, because of the process until there’s a compelling and it really messed up the through which it went reason for action. investment. Is anybody here through – e.g. in the case of going through a divorce I the 10-K, legal checking by I’d like to be optimal, I just need to know about?’ I lawyers – to make sure the don’t know how to be remember when I invested claims being made are optimal. I have two barriers, in Lab Corp of America it correct. That’s where we or two difficulties, in doing was over-leveraged. We really want to start. Then “What has that. One is I don’t actually didn’t realize it was over- once we’ve got the solid know if the conclusions that leveraged. It was a great diet, the meat and potatoes, worked for me is I’m drawing are accurate business but the investment we can move on to the conclusions. I don’t know if went down by 80%. Is that sugar and sweets. But if we the information that I have the case here? That’s allow the sugar and sweets first of all do not is the right or the full and definitely one thing. in first, there’s no space for complete information or the meat and potatoes and touch the whether I have enough I will tell you that other we know that what comes information. I don’t know if things I’ve picked up from into our brains first affects portfolio unless I’m analyzing it correctly. Mohnish that are just smart us massively. If I favor the Then there’s overcoming moves. Don’t buy when the meat and potatoes sources you have a clear my bias towards inaction market’s open. Don’t trade of information before other and overcoming all the when the market’s open. I sources of information, over reason for personal psychological don’t like to talk to the a lifetime of decision- biases about endowment traders. I just want to send making, my decision-making action.” effects and all of those them an e-mail. I don’t want will be a little bit better and things - fricking nightmares. any feedback from the that little bit better is what I market or any of those need. G&D: I think there’s an things. investor presentation I Another simple thing is how looked at that had a litany of Sequencing the information one communicates with biases that humans have in that I get is another way. A management, which is part decision making. So what do sales person will get in of this information diet idea. you do specifically to make touch and say, ‘Hey, I want Company visits are a very sure you don’t fall prey to to call you up and talk about dangerous thing. I haven’t those biases? something.’ The standard done a company visit in response is, ‘Please put it in quite a while, but my goal is GS: Suffer. writing.’ Make people not to make a buy or sell submit stuff to you in decision within three days G&D: And use a checklist? writing first because we of visiting a company know that we’re less biased because there are all sorts GS: That’s a great one. A when we get the of influences. checklist is a very personal information in writing. thing for me. It’s what For instance, a company mistakes have I made, what Our information diet goes (Continued on page 12) mistakes have people close Page 12 Guy Spier
(Continued from page 11) cost of production and ‘I’m trying to find out about called Quicksilver some wells are lower cost Quicksilver,’ or ‘I’m trying Resources. I’ve no idea how and obviously you decide to find out about RPX.’ and why it came onto my where to go based on those Instead say, ‘I’ve been doing screen. Another reject. costs. I knew I didn’t have some work on RPX. Looks Very good reputation, family to go any further. like an interesting business. controlled, natural gas, Here are three articles that making a lot of money on The other thing that I would I think are the best articles their hedges. I e-mailed the say is unbelievably critical is I’ve found. Here are some investor relations guy and to have relationships with links. Here are some of the he said, ‘I’m happy to get on the right people. How does things that I’ve learned but I the phone and talk to you one practically do that? I would love to see if you about the company.’ I said, think that this really works; might be willing to ‘That will be great. But if somebody I know is not a contribute to my knowledge before we do that, I just healthy influence on me for or point me in the right have two questions. Maybe decision-making, I’ll respond direction.’ It’s giving value in you have an e-mail answer to their e-mail three or four the e-mail at the same time for me which would be days later. Maybe I’ll leave it as asking for something. If quicker.’ Again, wanting to in my inbox for a month. So anything, you develop your have the written they’ll get a response, but network. communication before the I’m simply prioritizing and verbal communication being mindful and conscious G&D: Honestly, as a because I know this guy can about how and why I’m student you get an almost sell the pants off me. ‘I’m prioritizing. 100% response rate. having trouble understanding how you have In fact, take the people with GS: I would still develop been so successful at whom one can have healthy the habit of adding value to hedging over so many conversations and write them and not just saying ‘I’ll years.’ The price at which them a thank you note be really grateful to you and they’re selling the natural every now and then or send happy to do something for gas is at $2.60 or $2.70 but them something or find a you in the future.’ What it’s coming in with the reason to deepen that you’re doing is building up hedges at $5. But if you’re relationship, even if it’s just your analyst franchise. In doing that year after year a little bit. Over a short five years’ time you want to after year these hedges period of time there’s no be in a place where there must cost a lot of money obvious change but over a are so many people who and I just couldn’t figure out long period of time that can just love you because every where the cash was coming make a massive, massive time you have had a from. And I said, ‘Could you difference. conversation about some tell me what your all-in cost company you have found a of production is?’ No G&D: What other ways way to add value back in response. That shouldn’t besides through your their lives. Your information take more than a paragraph network do you find the flow will be that much to answer. My conclusion right contacts? better than other people was that their cost of who weren’t doing that. production was way higher GS: Something I’ve tried You don’t have much of a than they’d like it to be. If without much success, but way to distinguish yourself you’re doing anything, if is really interesting, is now from many other you’re half doing stuff right, LinkedIn. So pull up the people but over five years you know that number and company, see who’s that makes a big difference. you’re trying to allocate connected to it, e-mail 20 How did I learn this? resources based on it people. But don’t just say, (Continued on page 13) because some wells are high IssueVolume XIX I, Issue 2 Page 13
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(Continued from page 12) idea from Robert Cialdini, and the average person in G&D: Mohnish Pabrai and right? my set of friends is the practice of cloning? incapable of giving it the GS: There’s a huge amount attribution it deserves. GS: What’s so beautiful of wisdom there. I told They’ll say, ‘You’re lucky. about cloning is that it’s not somebody 10 years ago, ‘I’m You’re smart. You’re in the mutually exclusive. The writing 20 thank you notes a right place at the right time.’ more you do it, it’s helpful week.’ And they say, ‘How And I’m like, ‘No, no, no. for the whole community ridiculous. Who are you It’s because I was doing Pictured: Mario Gabelli ’67 and enough of humanity will writing thank you notes to?’ Cialdini for the last five speaking at the 2013 never do it. I’m at the I say, ‘The doorman, years. You can do it too.’ Omaha Dinner. Berkshire meeting with anybody I can put my hands You know, in some way that Mohnish and all of these on really, the person who is even more surprising to people are coming up to served me at the shop. You me than value investing him. He has spent the last name it, left, right and because value investing is a twenty years making people center.’ They’re like, ‘How’s very narrow thing. All we’re feel glad that Mohnish that working for you? Have talking about now is a Pabrai’s on the planet. In you seen any changes?’ Not strategy for anyone to small ways and in big ways, really. They say, ‘What a improve their lives. Finally, just doing it as a habit. So if dumb idea.’ I say, ‘Well, the after ten years of being you’ve been handling people doorman was really nice to married and five years of right for 20 years, you me this morning.’ doing this, my wife gets it. become a very real asset to whatever business you’re a So say I’m writing thank you As you can see, in a certain part of because you’re just notes like that and I attend way I’m more enthusiastic going to get lucky more the Pabrai Fund Annual about this than value often. I’ve experienced that Meeting and I write him a investing. Having read Ben over the last five years. I’ve thank you note, one of Graham would not have gotten luckier with people twenty I wrote that week, helped me if I was a poor more and more often and but that may have been the boy in Bangladesh, but this it’s just a lovely thing. I had only thank you note Cialdini reciprocity stuff is to realize I was not put on Mohnish received from the much more basic and would earth to help Guy Spier. I meeting he held in Chicago. have helped anyone. was put on earth to help And when he was in New Warren has this famous humanity. York for some reason he saying about how he was had the idea to call or to e- very lucky as to where he I’ll give you an example. Bill mail me and to say, ‘Would was born. If he was born in Ackman got into doing this you like to get dinner?’ Bangladesh those good a year or two before me. I These simple changes in business practices wouldn’t knew him; he was a year behavior make such a have made a big difference. above me in business massive difference because school. They had offices in at the time my derisive It’s like Wal-Mart. Sam 245 Park Avenue and he just friend is asking me how my Walton figured something said, ‘Come here, use relationship with the out with Wal-Mart: stack it Bloomberg, spend as much doorman is going, the thank high, sell it cheap, keep time as you like. Really you note to Mohnish Pabrai delivering massive value to happy to have you here.’ I hadn’t been written. the consumer, always give remember that and I would them better value than they leap at the opportunity to I’ll tell you something else. can find elsewhere, work help him out in some way if It’s made me more really hard to negotiate with he asked me to. successful that the average your suppliers to give
member of Joe Q. Public (Continued on page 14) G&D: Mohnish got that Page 14 Guy Spier
(Continued from page 13) people that you want to get to be in the room with you [customers] great stuff at close to? The first natural to mentor to you. low cost. Who would have response is, ‘Nothing.’ But thought that piling it high we can. First of all, thanking Before our meeting with and selling it cheap would people. Every human being Buffett, we sent our bios have developed into the wants to feel thanked. We over. I sent this bio, ‘I grew amazing business franchise were there to say thank you up in South Africa and that Wal-Mart is now. and we were there to Israel, lived in London, and Where I started off on this appreciate him, not just moved to the United little reverie is that we can some idiot on the street, States.’ My wife Lory, the do the same things. I can’t but as people who had only thing her bio says be Wal-Mart and I can’t be studied him really closely. pretty much is ‘born in Sam Walton but my God, I Salisbury, North Carolina.’ have the tools to develop a I sent my most recent Warren had no interest in “My goal is not similar unique Guy Spier annual letter to Debbie the fact that I’d lived in Iran, franchise just by getting Bosanek. Here’s what I said Israel, whatever, but he to make a buy or mind space and getting to Debbie. I said, ‘Debbie, liked the fact that Lory grew people to feel a certain way there’s no wisdom in here up some place. That’s his sell decision about me. It’s just caring Warren’s going to glean, mind-set. He’s not just an about them, caring about nothing about the world American guy; he’s a guy within three days the outcomes in their lives, that he doesn’t already from the American mid- and figuring out a way to know, but I think he might west and he knows what he of visiting a help them. That’s the ideal, enjoy seeing what a likes and he likes what he actually helping them, but powerful impact he has had likes and he’s not interested company the second best is to let on me. This thing has got in experimenting very much them know you would have ‘See what Warren Buffett with other stuff. because there wanted to help them. That’s inspired me to do’ written effectively what a card does. all over it and he might The starfish and the spider are all sorts of I have a rule—every single enjoy it on that level’. that I talked about was person who sends me a job really an awakener for me. application gets an e-mail influences.” I think the mentors that you It was not just what he said, back. It’s particularly and I want, we can’t but the way he said it important for people who necessarily spend every day because he knew exactly apply as analysts because with because they don’t where I was coming from. In they’re likely to go on and have time and you may not a certain way he was do great things so I want know them and they may teaching me a really them to like me. I want to not even be alive. So important lesson. ‘Don’t try help them. studying them really closely to build the best business to get a good sense of the you can build. Build the G&D: Could we talk about answers they would give to business that suits you the the lunch you had with the questions we have is best. Build your life in a way Buffett? Can you give us totally the right track and a that suits you.’ some questions that you very, very smart thing to do, asked him and were you especially with people who Realize you only have one surprised by any of the are not alive. What would life to live on the planet. answers to his questions? Shackleton say? What would ‘Yeah, Berkshire Hathaway Ben Graham say? What is this wonderful big GS: One of the things that would Franklin say? You can company, but it suits me.’ Mohnish did is he set the go to Seneca. You can go to That’s the most important tone of the lunch in the Marcus Aurelius. They’re all thing about Berkshire to right direction. We were available the minute you Warren. So in a certain way there to say thank you. drop the idea that they have (Continued on page 15) What can you guys give the IssueVolume XIX I, Issue 2 Page 15
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(Continued from page 14) she is that she doesn’t mind don’t know. I don’t think I came away with a renewed being perceived as Warren Warren could be who he is appreciation of how unusual Buffett’s assistant. She’s so if Debbie wasn’t who she is. Warren is. Given the choice between building a bigger Something I’ve learned is Berkshire and building a that to say I have a Berkshire more suited to relationship with Warren is him, or building a Berkshire “In five years’ to say he knows who I am. with higher returns, he But if I want a good takes the Berkshire more time you want to relationship with people like suited to him. He said, Warren, the key is to have a ‘We’re not going to make be in a place good relationship with their any decision that would get assistant. And it’s not trying us more money if it means where there are to manipulate them into we lose one night of sleep.’ doing right for you. It’s That’s effectively saying, ‘I so many people really genuinely caring about want this to suit me. I don’t who they are, caring about want to be the best, biggest, who just love you what their job is, and trying fastest.’ to help them to do a good because every job for the guy that they’re That’s just a profound working for. When you get insight and I can tell you it’s them as allies it’s a huge scary for me to stand up in time you have amount of fun and joy. I front of my investors and don’t even address anything say, ‘I’m not trying to have had a to Warren anymore. I the highest possible returns. address it to Debbie. I say, I’m trying to run this in a conversation ‘Dear Debbie dot dot dot.’ way that fundamentally Or I might say, ‘Warren really suits who I am.’ Half about some might want to see this, but your investors leave the only if you’re printing it out room. company you for him and giving it to him at the right time when he’s I’ll just give you one final have found a not busy, when he’s ready thing. We talked about the for a bit of a laugh.’ limits to the size of way to add value Berkshire. For some reason G&D: Guy, thank you for we haven’t had a company back in their your time. that’s broken through a trillion dollars in market cap and somehow that seems to lives.” be the limit to size. The fierce pride with which Warren asserted that much more than that. She Berkshire wasn’t subject to knows everything that’s that was fascinating. going on. It’s impossible for Warren to function if she G&D: What did you learn doesn’t. She’s a repository from Debbie? of a huge amount of knowledge at Berkshire GS: Let me tell you how Hathaway. She’s a special a person Debbie is. repository of many things She’s somebody who’s so that managers at Berkshire self-confident about who Page 16 Homex (9.75% Sr. Guaranteed 2020 US$ Notes) - Long @ 36.94 (5/28/13) Peter Bowley
Peter is a second year MBA student participating in the Value Investing Program. During the summer, he worked at Perry Capital researching high yield and distressed debt Recommendation: opportunities. Prior to BUY Homex (“HMX”) 9.75% Senior 2020 Notes. Even assum- Columbia Business School, ing aggressive down-side scenarios (30% of face tender offer/ he worked at a farmland restructuring or liquidation), making money (on prob. investment fund based in weighted avg. return basis) requires only a 5% probability the Argentina. Peter holds a BS notes remain performing. I estimate this probability as at least from Boston College. 30% due to HMX’s market leadership, relationships with government/domestic and international banks/suppliers, non-core assets available for sale, Mexico’s significant remaining housing supply defi- Peter was part of the 1st cit, continued government subsidy support to subsidize housing demand and Mexico’s favorable mac- place team in Columbia’s roeconomic outlook. Restructuring is a much more likely outcome than liquidation, due to family- 2012 Restructuring Case controlled nature of the company, as well as the significantly larger value of land bank as an on-going Competition. He was a semi concern versus liquidation value. -finalist in Origami Capital’s 2013 Global Investment Background Idea Competition for his HMX is a vertically integrated homebuilder focused on affordable entry-level and middle-income research on water rights. housing in Mexico, as well as a small operation in Brazil. Its tourism development division targets high- Peter is co-President of the income foreigners, and its infrastructure division constructs/operates public-private partnership pro- student-run Commodity jects like prisons. In 2012, HMX operated in 35 cities/22 states, building 46,357 homes (#3 player with Club. 2.0% market share), 91% in the affordable entry level segment. In 1Q13, HMX had a land reserve of 76.7 MM m2 in Mexico, 2.3 MM m2 in Brazil, as well as 0.3 MM m2 tourism-related land bank and a The student pitches hotel. Customer price/sale risk has historically been reduced through federally-subsidized mortgages featured in this issue are a (INFONAVIT/FOVISSSTE) for low-income earners (financed via obligatory payroll taxes), to reduce selection from Columbia Mexico’s 4.3 MM housing unit deficit (+2.5 MM fed/state/muni. formal-sector employees alone). Business School's Investment Ideas Club During 2011-12, leading Mexican homebuilders expanded land banks into 2nd/3rd tier regions. Simul- (“IIC”). If you are taneously, their horizontal row-house building model generally failed as suburban locations lacked interested in hearing more transportation infrastructure for residents to reach workplaces. Many homeowners “mailed back pitches by serving as an IIC keys” (100% LTV purchases from government-subsidized mortgages), turning some developments judge, please contact Ben into abandoned ghettos. Government payments of receivables to homebuilders slowed significantly in Isaac (bisaac14@ 4Q12-1Q13 as ministries transitioned for newly elected President Peña Nieto. To address the failed gsb.columbia.edu) or suburban row-house building model, the government announced homebuilders will be required to Charles Buaron (cbuaron14 build urban vertical developments (more costly; less land available). These factors created a liquidity @gsb.columbia.edu). crunch for Mexican homebuilders, including HMX, which burned (MXN$6.1 BN) and (MXN$3.2 BN) in operating cash flow in 2012 and 1Q13. HMX has MXN$20.6 BN in debt (incl. 1Q13 Inbursa bank debt), of which 56% is Senior Unsecured notes. In April 2013, HMX breached a covenant on US$70 MM of swaps with Credit Suisse and Barclays (who are taking HMX to court for payment remedies), as well as on a loan from a Brazilian bank for HMX’s Brazil operations. Both events could qualify as an event of default for HMX’s Senior Unsecured Notes, including the 2020 Notes. Further contributing to the homebuilder liquidity crunch, in late-May 2013, INFONAVIT (the Mexican government mort- gage credit agency; issues 2/3 of housing sales by HMX) was ordered by courts to suspend payments to homebuilders due to legal actions of foreign/local creditors to the homebuilders. IssueVolume XIX I, Issue 2 Page 17
Desarrolladora Homex (Continued from previous page)
Investment Thesis: A. HMX selling non-core assets and focus on cash flow generation: MXN$4 BN sale of prison assets; MXN$2 BN for debt repayment, MXN$2 BN for working capital; actively marketing tourism land bank (MXN$750 MM market value); owns 2.3 MM m2 Brazil land bank, a 150 room hotel and 2 airplanes B. HMX has sufficient liquidity through 2013E, even in a downside scenario: +MXN$2 BN in new work- ing capital to unlock value from current construction in progress; low capex needs ( Valuation/Recovery Analysis: My liquidation valuation: (i) 70% discount to homebuilding land banks, (ii) 30% discount to tourism land bank, (iii) 40% discount to other assets, (iv) no value assigned to infrastructure division other than the prison service operation. Investment Risks/Considerations: Distressed sale of competitor’s land bank/home inventory: could cause land bank and housing prices to drop Extended suspension of payments from INFONAVIT: past 3-4Q13 could impair HMX liquidity (post non-core asset sales) Collateral value expropriation in a liquidation: CEO/family is controlling shareholder Weak bankruptcy laws/institutions: judgments in pesos; subsidiary guaran- tees/fraudulent conveyance; intercompany debt (Vitro case) Page 18 Wabash National Corp. (WNC) - Long Adam Trivison [email protected] Ticker: WNC (NYSE) Market Cap: $717mm Current Price: $10.47 (7/19/13) Enterprise Value: $1,088mm Shares Outstanding: 68.5mm ROE: 51% (FY2012) Price Target: $14.50 ROIC: 12% (FY2012) Target Time Horizon: One year EV/EBITDA: 6.8x (Consensus NTM) Target Return: 40% NTM P/E: 11.9x (Consensus NTM) Business Description Adam is a second year MBA Wabash National Corporation is a leading manufacturer of truck trailers in the US. Headquartered in student focused on Lafayette, Indiana, the company has leading positions in the Dry Van and platform trailer markets, and investment management. also has top 3 positions in the market for Refrigerated and Dump trailers. The company's customer Prior to enrolling at base is primarily comprised of large trucking fleets (e.g. UPS, Werner Enterprises and Knight Trans- Columbia Business School, portation) and large corporations that own trucking fleets (Dillard’s and Safeway). WNC also pro- he was an investment vides parts and support for its products through a dealership network. With the acquisition of Walk- analyst at Mont Pelerin er Group (specifically its liquid storage business), WNC gained exposure to the chemical, energy, Capital. Adam holds a BS in aviation, and food industries. Finance from California State University. Investment Thesis North American trailer cycle is still in early innings with strong secular and structural supports: Significant underinvestment by trucking fleets during the 2008-2010 time period has lead The student pitches to an elevation of the average truck trailer age to record levels. Currently, the system wide trailer age featured in this issue are a stands at near 8 years old, versus an average long-haul life of 10 years. As trailers age, maintenance selection from Columbia costs increase and the economics of a new trailer purchases improve. Moreover, the US trailer popu- Business School's lation is 10% lower than pre-2008 levels despite the fact that aggregate truck tonnage has recovered Investment Ideas Club to (and exceeded) pre-2008 levels. Purchases thus far in the cycle have only served to replace old (“IIC”). If you are trailers, thus trailer purchase volumes will need to outpace current levels (and expectations) to grow interested in hearing more the trailer population as tonnage continues to increase. Industry organizations currently expect vol- pitches by serving as an IIC umes to remain flat at just under the 250k level; the two most recent cycles have had multiple years judge, please contact Ben above the 250k level. Regulatory pressures, specifically Hours of Service rule changes and CSA 2010, Isaac (bisaac14@ are forcing truckers to increase trailer purchases. The compliance date for the Federal Motor Carrier gsb.columbia.edu) or Safety Administration’s final regulations governing Hours of Service for commercial drivers was July 1, Charles Buaron (cbuaron14 2013. The rule changes reduce a driver’s maximum work week by 12 hours to 70 hours from 84. @gsb.columbia.edu). WNC management has stated that customers have indicated that they will increase the use of drop- and-hook activity (i.e. when a driver simply "drops" his trailer at a customer location and "hooks" to another trailer), which will increase trailer demand. Also, the Compliance, Safety, Accountability (CSA) program, instituted in 2010, has created incentives for equipment replacement through a scor- ing system that is partially based on the fleet condition. The environment for truckers is fairly positive as tonnage has grown consistently since its 2009 trough and diesel fuel prices have stabilized near $4.00. Increased home building activity has added another vector to the growth of tonnage, particu- larly in the flatbed segment of the market, in which WNC has a leadership position through its acqui- sition of Transcraft and Benson in 2007 and 2008, respectively. NTM consensus revenue growth ex- pectations for public trucking companies sit in the mid-single-digit range and NTM EBITDA growth expectations in the mid-teens. Efforts to diversify the business have transformed the firm, creating a more stable cash flow stream: Historically, WNC’s business has been almost entirely reliant on dry van trailer sales. Dry van cycles are extremely volatile and, in the past, the Company regularly incurred large losses during cycle troughs. In 2007, WNC’s management instituted their Next Steps initiative, a plan fo- cused on diversifying the business and improving operations. Since then, the Company has expanded outside of their traditional dry van trailer business through organic initiatives and the acquisition of four businesses. These new businesses create value through synergies that can be broken down into several buckets, including supply chain optimization, commercialization and distribution of new and existing products, back office and administrative consolidation. Moreover, these acquisitions and initi- atives represent significant growth opportunities as they are levered to secular growth drivers (i.e. fuel efficiency, US energy production). Most notably, the acquisition of Walker Group in May 2012, gave the Company a leadership position in liquid transportation systems and relationships with a Blue- chip customer base. Moreover, Walker’s +25% gross margins helped to raise company-wide gross margins. The acquisition should create more than $10mm of annual synergies over the next year. IssueVolume XIX I, Issue 2 Page 19 Wabash National Corporation (Continued from previous page) Profitability will continue to improve as multiple factors drive margin expansion: The Com- pany has also been more selective in terms of the orders they are taking on, raising prices at a mid-single -digit rate. Volumes initially decreased with the price taking, but management has stated that they are beginning to see those customers who initially walked away from the higher prices come back. The price taking has helped to expand their Commercial Truck segment’s margins from the low single-digits in late 2011 to the high-single-digits in the most recent quarter. Ultimately, Commercial truck margins should reach the low-teens later in the cycle as volumes and prices continue to increase. Moreover, aluminum (one of WNC’s primary raw materials) prices have fallen from $0.95 per pound in January to $0.80 in July. The benefit of the decreased cost should be evident in 3Q12 results. The Company has mitigated its exposure to wood and rubber prices through escalators in customer contracts. Competitive Dynamics: The truck trailer market is an oligopoly (four-firm concentration ~65%). Players in the industry offer marginally differentiated products, thus only two criteria matter: Price and Relationships. Scale is im- portant as it drives down cost and allows for profit at market prices, thus all small players focus on a market niches. The largest players include Wabash Nation Corporation (20% of industry market share), Great Dane (20% of industry market share), Utility (15% of industry market share), Hyundai Translead (10% of industry market share), and Stougton (5% of industry market share). Wabash dominates in the dry van, flatbed, and liquid tank categories, while Utility leads in the refrigerated segment. Industry Outlook: Despite popular belief, the amount of tonnage transported by trucks is growing and rail transport is not a threat to trucking volumes. If anything, intermodal transport will cannibalize rail volumes over the next 10 years. According to the American Trucking Association, Truckload volumes will grow 3.2% through 2018 and 1.1% annually between 2019 and 2024. Less-than-truckload volume should grow 3.5% annually through 2018 and by 2.4% until 2024. In general, US Trailer fleets are in decent financial shape in terms of leverage and business outlook. Valuation: WNC offers a compelling risk/reward payoff at current levels as the market currently underestimates future trailer order volumes and thus WNC’s future revenues and profit. WNC can earn an EPS of $2.50 in 2017 based on mid-single digit revenue growth, gross margin expansion in the commercial trail- er segment to prior cycle levels of 11%, and lower interest expense as the Company pays down debt and buys back shares with free cash flow. My price target for the stock is $14.50 based on an 8.0x P/E multi- ple on 2017 earnings, discounted to the present at a discount rate of 10.8%. The 8.0x multiple sits rela- tive to historical peak earnings multiples of 6.0x; the higher multiple reflects the high quality of WNC’s business relative to prior periods. The peak earnings valuation is confirmed by free cash flow valuations as they produce price targets that bracket the peak earnings price target. FCF Valuation In $mm Actual Company Projections Terminal FCF Calculation: 2012 2013 2014 2015 2016 2017 2018 EBITDA 118.4 168.8 205.6 241.5 271.3 295.2 295.2 EBIT 87.7 129.5 167.6 204.6 235.5 260.3 - NOPAT 54.8 84.2 108.9 133.0 153.1 169.2 169.2 NWI 116.8 130.9 142.7 151.6 154.7 159.4 - Change in NWI - 14.2 11.7 9.0 3.1 4.6 - NFA 132.2 128.9 122.2 115.3 108.2 100.8 - Change in NFA - (3.3) (6.7) (6.9) (7.2) (7.4) - Deferred Taxes 64.2 64.2 64.2 64.2 64.2 64.2 - Change in Deferred Taxes - 0.0 0.0 0.0 0.0 0.0 - FCF - 73.3 103.8 130.9 157.2 171.9 171.9 FCF Yield - 10.2% 14.4% 18.1% 21.8% 23.8% 23.8% Discounted FCF - 64.5 84.7 96.4 104.5 103.2 - Tax Rate 37.5% 35.0% 35.0% 35.0% 35.0% 35.0% - WACC 10.8% Competitive Markets EBITDA Exit Multiple PV of yr. 1-10 $453.2 NOPAT for 2017 169.2 EBITDA Multiple 5.0x Peak P/E Multiple TV at 2017 1,573.5 TV at 2017 1,476.0 2017 Earnings $2.55 TV PV 944.3 TV PV 885.8 Peak P/E Multiple 8.0x Firm Value 1,397.5 Firm Value 1,339.0 2016 Equity Price Tar- Equity Val- get $20.40 Equity Value 987.5 ue 929.0 Current Equity Value PS $14.56 Equity Value Per Share $14.74 Equity Value Per Share $13.87 Page 20 Active Network, Inc. (ACTV) - Long on 7/21/13 Wes Aull, CPA Recommendation: Active Network, Inc. (ACTV) has significant upside potential with catalysts in the coming year to realize EBITDA expansion and improved performance. The main catalysts are reduced R&D spend, due to end of a new cloud-based platform imple- mentation, along with improved management after the found- ers’ overdue departure. Increased EBITDA and improved man- agement should further catalyze multiple expansion to valua- tion more in-line with peers. The downside to Active Net- work’s current base revenue is small due to its leading market position and competitive advantages (e.g. sticky customer groups). Wes is a second year MBA student focused on Business Description investment management. Leading provider of SaaS, cloud-based event/organization man- Prior to enrolling at agement in four activity segments: sports, communities, out- Columbia Business School, doors, and business. It’s solutions help over 55K organizations he worked in public process ~90M transactions for 200K+ activities. ACTV’s plat- accounting, beginning at form provides operations management, analytics, marketing, BDO Seidman in assurance. registration, and payment tools. He went on to found his firm (now Aull & Cooper, Investment Thesis CPAs PLLC). Strong Base of Revenue With Leading Market Share in Its Activity Segments, Solidi- fied by Competitive Advantages. He graduated magna cum laude from the University of Kentucky with a BS ACTV has established customers with multi-year contracts in each of its segments: Sports– Iron- Mathematical Economics. man, Little League Baseball, USA Triathlon; Communities–60 of top 100 North American park He also earned his Master’s dept.’s; Outdoors—National Park Service, California State Parks; Business– CISCO Live!, Oracle of Public Accounting at the OpenWorld, Macworld. 25% of revenue derived from corporate conference platforms, seeking University of Texas— best in brand. 25% of revenue derived from state and federal government agencies with sticky Austin. contracts. The student pitches Customer captivity created because of ease in using existing marketing/operational functionality featured in this issue are a for event organizers and their end users year-on-year. Database and tool conversion creates selection from Columbia painful switching costs. Business School's Investment Ideas Club ACTV has a leading market share amongst a fragmented industry. Because of ACTV’s research (“IIC”). If you are and development spend (~20% of sales) with its superior market share, the company has a R&D interested in hearing more lead over most competitors. ACTV’s R&D spend is nearly 2x of Constant Contact, a significant pitches by serving as an IIC competitor. judge, please contact Ben Isaac (bisaac14@ Bar Lowered for ACTV Over FY ‘12 and 1st Half FY ‘13: Expectations That Can Be gsb.columbia.edu) or Beat Based on Founding Mgmt.’s Departing Performance Charles Buaron (cbuaron14 @gsb.columbia.edu). From mid-2012 to mid-2013, ACTV disappointed investors and anchored low expectations be- cause of: Progressively lowered guidance on sales growth from 20-30% to 10-20% YOY. Longer-than expected spend and implement. of new cloud-based ActiveWorks platform, resulting in significantly higher R&D spend over past 2-3 yrs. ACTV founders (chairman and CEO) both resigned in May ‘13 after leading the organization for over 12 years. The stock price has seen a 60% drop during their tenure after ACTV’s IPO in 2011. Poor performance in outdoor (due to cold spring) and one-time marketing svc.’s in Q1 ’13 were outside of normalized earnings. IssueVolume XIX I, Issue 2 Page 21 Active Network, Inc. (Continued from previous page) ACTV substantially undervalued against its peers despite its higher quality earnings. While ACTV has a lower gross margin versus its peers, its EBITDA margin of 7% (vs peer avg. of 2.9%) stands notably higher despite ACTV’s greater R&D spend. Because of ACTV’s scale and lean SGA, it is able to operate with a much lower sales & marketing (as % of sales) versus its peers. In spite of the higher EBITDA margin, the market gives ACTV’s earnings a lower valuation (EV/ EBITDA—9.2 versus 20.3 peer avg.; EV/Sales—1.0 versus 2.3 peer avg.). While sales growth has slowed, it does not justify the dramatic valuation difference. EBITDA expansion and improved management to catalyze stock appreciation. R&D expense will be significantly reduced following implementation of cloud-based Active- Works (end of 2013). Reversion of R&D as % of sales to forecasted 16-17% in ‘14 re- sults in a 23-33% increase EBITDA. New management will improve Active Network, Inc. where prior ‘founding’ leadership was limited or lacked vision/execution. Ripe for a turnaround? Founding chairman and CEO both unexpectedly resigned together, signaling a potential board move after disappointing re- sults in prior years. After their resignation, the stock price did not retreat but celebrated man- agement’s departure. Page 22 Koch Industries (Continued from page 1) key to unleashing those buyer who can do big deals development intern at pent-up ideas and quickly. What sets you apart Koch Industries, sat innovations. The system from not only Berkshire down with Steve allows all of our employees Hathaway, but also other Feilmeier and Dave to share in a portion of the financial or strategic buyers Robertson at Koch’s value that they are creating. when it comes to investing headquarters. Steve It doesn't matter what your in businesses? Feilmeier is Koch’s role is—if you can find ways executive vice president to help us better serve our SF: It’s our ability to tailor and chief financial officer customers so that we profit our investment to the very Dave Robertson and has been with the more, we want you to share specific needs of our company since 1997. in some of that profit. You counterparty to solve the Steve earned his are rewarded like an problem they’re trying to bachelor’s and master’s entrepreneur is rewarded. If solve. A typical hedge fund degrees in accounting you're successful at that, or private equity fund is from Wichita State you’ll do better and if you limited in the types of things University. Dave is fail, then you won’t do as they can do, types of president and chief well. securities they can invest in, operating officer of Koch or the duration of the and started his career Steve Feilmeier (SF): It's investment because they are with the company in also the incentive to speak beholden to their own 1984. Dave earned his up when you think investors who may bachelor’s degree in somebody else’s idea has prescribe certain mandates business administration some limitations—what we or rules. and marketing from call our challenge process. Emporia State Not only do we incentivize We try to listen and will University. people to speak up, but we adapt to meet our also expect the recipient of counterparty’s needs. The Graham and Doddsville that information not to be key is to make sure we’re (G&D): Koch Industries defensive so he or she is being compensated for the has one of the best long- open to incorporating risk that we’re taking. term compounding records, different viewpoints. We'd with mid-teens compound much rather limit the G&D: Koch is in a unique annual growth for over 50 mistake rather than invest in position to allocate capital years. Why do you think it—then you’ve really got a given its diverse set of Koch has been so successful mess on your hands. businesses and significant over the years? capital to invest in new Having an open and honest opportunities. Can you Dave Robertson (DR): culture where we trust each explain Koch’s overall Our management other is key. A lot of capital allocation philosophy, Market-Based companies think they do a philosophy? ® Management , is what good job at incentivizing allows us to achieve those people, then they get in SF: First, you have to be in types of returns over time. here and say, “Wow, it's the right businesses where When we acquire a new night and day.” you have the capability to company, Market-Based create real value. Then, ® Management unleashes the G&D: A recent article in don’t try to optimize and knowledge and ideas that the Wall Street Journal trade in and out of them people in that firm have to talked about how Koch like a private equity firm has innovate and to make their Industries wants to be to do. product or process better. considered alongside Berkshire Hathaway as a (Continued on page 23) Our incentive system is very IssueVolume XIX I, Issue 2 Page 23 Koch Industries (Continued from page 22) trying to pick the ones that typically constrained by As Charles [Koch] likes to provide the best return on whether or not the markets say, it’s hard enough to find the risk that we’re taking. are offering an appropriate good businesses. Why return or whether or not would you want to sell one It’s a little bit of first-come, we’ve got the capabilities to once you already own it? first-served in that when we manage the investment. That is a very important key see good opportunities that When we have more ideas to how you compound—get present an attractive return or good opportunities than good businesses, and then on the risk, then we go after capital, we could always use invest in them for the long them. debt capital but this is rare. run. Our goal is to finance Steve Feilmeier everything with equity. Another critical dimension is to stay very rigorous in DR: Our transaction your discipline. All too “As Charles [Koch] excellence capability is the often, you’ll hear public discipline that Steve’s talking companies acquiring likes to say, it’s hard about. We can evaluate businesses for “strategic each of these opportunities, reasons.” For us, if we’re enough to find good whether it’s a project to add not earning an appropriate on to an existing facility, an rate of return, it’s never businesses. Why acquisition, or an equity strategic. Strategic should investment. We’re putting mean that you’re creating would you want to each of those through the real value in society. If same rigor and analysis to you’re not earning an sell one once you determine the expected appropriate return on your already own it? risk-adjusted return. investment, by definition, you’re not creating value. That is a very G&D: You have said in the past that Koch is not So we stick to our important key to bounded by any industry— disciplines and make sure instead, it’s bounded by its that the returns on risks are how you capabilities. Could you appropriate each and every compound: get describe Koch’s capabilities? time. Then we look at things And given how fast the not through a filter of good businesses, world changes, how do you “who’s going to get how think about developing new much capital this year.” and then invest in capabilities? We’ll fund any and all projects in each of the them for the long SF: Most of our businesses businesses we have that have more in common than meet these criteria. run.” might meet the eye. We take some form of DR: A lot of firms have a commodity and we’ll budget mentality where they process it through a very, say “we’ll give this business very large plant that this much capital,” and SF: We’ve never been in a requires sophisticated we’re not doing that. We situation where our internal technology and analysis to have shareholders who funding hasn’t generated ensure that we have a historically have reinvested enough capital where we’ve competitive advantage and a 90% of the earnings back in been constrained. So we’re capability to go to market in the company. So we’re not constrained by the fact scale. Then we’ll optimize looking at any and all that we’re private. We’re (Continued on page 24) opportunities and then Page 24 Koch Industries (Continued from page 23) money by being excellent at requires looking forward around that processing or getting product to the store and trying to understand the manufacturing process and having the right trends that might really because there is raw inventory at the right place matter, for example, energy material risk, commodity at the right time. And they and agriculture products risk, and counterparty risk. have the scale to do so at should continue to be in low cost, too. high demand. The world is We also have the capability going to need more of the to be very efficient and products from these Pictured: Leon Cooperman effective from a cost industries in the future. ’67 speaking at the 2013 perspective and the “A great business is Omaha Dinner. capability to constantly one where you G&D: How would you innovate because the define a great business? technology changes in these have a significant What are some examples of big plants. We must be great businesses that you adaptable to ensure that we competitive admire? don’t fall from the first quartile to the second, advantage with DR: A great business is one third, or fourth quartile in where you have a significant cost advantage. offshoots that competitive advantage with allow that business offshoots that allow that Our other core capabilities business to grow. That besides innovation and to grow. That advantage could come from operations excellence are a raw material advantage, Market-Based technology advantage, or a ® advantage could Management ; trading; number of other sources. transaction excellence; and come from a raw public sector, which Take our Pine Bend, MN encompasses legal, material refinery. It's a great communication, community advantage, business. We buy relations, and government advantaged feedstocks, relations. technology convert those into very high-value end products, and So, whether it’s crude oil advantage, or a sell them in one of the best going into refined products, marketplaces in the country. natural gas going into number of other That has propelled us into fertilizer, naphtha going into other businesses, like our chemicals, trees going into sources.” petroleum coke business in pulp, metals going into our Koch Minerals. manufacturing businesses— each of these businesses fit SF: When we say the capabilities described We don’t have that “competitive advantage,” above. capability. So there are that does not mean an certain things that we advantage over our Certain businesses simply couldn’t envision—that customer where we can do not benefit from these doesn’t mean that we profit at their expense. It capabilities. We’re not a big, wouldn’t build the capability. means that we have created multi-unit retailer. The We would consider building something that creates a capabilities of the largest capabilities whenever it’s great advantage over the retailers are being very, very evident that society is not way things used to be done sophisticated at information effectively allocating capital or over the way our technology management and to an industry. That (Continued on page 25) logistics. They make their IssueVolume XIX I, Issue 2 Page 25 Koch Industries (Continued from page 24) that Koch often has more to find actionable competition does it today. than 100 companies on its opportunities that would fit As a consequence of that, investment watch list. How our capabilities. We have we're using fewer resources does Koch go about well over 100 business to produce goods or generating these investment development personnel services that somebody will ideas? across all the companies. value. And that's good for society. Everybody wins. DR: We have business SF: We must be able to do Our customers win because development (BD) something with a business they'll participate in that personnel in all of our that the incumbent owners value creation. different businesses. So for cannot, or else we’re not example, Georgia-Pacific has creating any value—they’re We stress this idea to all of a better owner than we are our employees that we’re otherwise. It doesn’t make not seeking the type of sense for us to own advantage where you win anything unless we add and someone loses. Not value to it. every business thinks of it “We must be able this way. We think of this as I’ll give you two examples subsidization or cronyism to do something out of our fertilizer which distorts markets and business. Agrotain, which is not good for society. with a business that produces a specialty the incumbent molecule that, when DR: It’s a great point combined with straight-run because win/lose is not owners cannot, or commodity fertilizer, makes sustainable over time. You a much better product for can’t do what Koch has else we’re not the farmer. With Agrotain done over 50 years by us applied, the amount of winning and our customers creating any fertilizer that actually losing. Competitive reaches the plant goes way advantage assumes that we value—they’re a up, and that creates value can provide goods and better owner than for everybody. J&H Bunn in services to our customers the UK is good at fertilizer and be their best alternative. we are otherwise. It distribution, blending, and The spread in that equation warehousing and dealing is profit, and we believe doesn’t make sense directly with the customer. profit really is the measure of how much value we are for us to own Koch Fertilizer’s core adding in society. competency before anything unless we acquiring these two The only reason a business add value to it.” businesses was having a exists is to make people’s global breadth and depth of lives better. We use manufacturing commodity resources more efficiently fertilizers, and then getting to produce goods and them to market through our services that people want to terminal system and buy. If we do that a BD Team and Flint Hills marketing capability. The effectively, then we are has a BD team. Within Agrotain and Bunn business creating value in society. It’s Steve’s group at a corporate lacked the capability that we an important backdrop to level, we also have a have to reach global this discussion. business development team. markets. Those teams’ daily activity is (Continued on page 26) G&D: Dave, you’ve said Page 26 Koch Industries (Continued from page 25) easy to make a mistake. We You learn a lot about how These businesses came know that our culture is the company treats them. together synergistically unique—we talk about that where we could take a lot. So we’re not going to DR: If we thought a Agrotain, use J&H Bunn’s find someone whose culture company’s culture was one knowledge of blending, fits exactly. that lacked integrity and storing, distribution, and compliance, we'd back away. customer service, and do We try to make sure that We wouldn't do the deal; that globally. their culture isn't so it's not worth it. And that antithetical to ours that we has happened more than That’s what we brought to wouldn't be able to, over once. both of these businesses and time, meld it or blend it into why transactions made our culture. But it's G&D: Given that gasoline sense for all three something that we haven't consumption in the U.S. is in businesses. really been great at. We're structural decline from trying to get better by increases in fuel efficiency DR: We can’t just dream up spending more time and and the shift toward hybrid or manufacture these energy assessing it and and electric vehicles, is the opportunities amongst understanding how different refinery business still a good business development they are, what those business? people. They have to have differences are, and what contacts and relationships in we need to do to bring DR: Yes, depending on the the industry to have the them into our culture. asset. We look at these opportunities shown to us. businesses on a supply stack So it requires a lot of SF: Culture is many from who we think is most different interactions to be different things. For us, it competitive to who we able to size up, screen, and starts with our ten think is least competitive. As think about where the principles. They are each volume shrinks in a market, opportunities might be. important because they you move closer to the work together, but there is more competitive players to G&D: How do you judge one in particular that I pay be able to meet the demand whether or not the culture attention to when we're in the marketplace. As long of a potential acquisition will looking at another company, as you're far left in the be a good fit for Koch? How and that is humility. supply stack, then it can be a do you prevent mistakes? very attractive business. If Being open to challenge is you're far right—if you're a DR: It’s very difficult to do, really important. The way high-cost producer—and and it depends on the type people treat each other is the market is shrinking, then of deal. If it’s a public also really important. I was it's a bad place to be company deal, you get very with a company yesterday because you're going to be little due diligence. You’re where the CEO knew every less profitable, or not going to get a full single person's name that he unprofitable. picture of the culture, other passed by. It tells you a lot! than the feel you get from We feel good about our the handful of leaders that Understanding culture position in the refining you meet. before we acquire a business, but for those with business could be the most marginal assets, it's probably If you’re doing an asset- important thing we do. And not a good place to be. based deal or carve-out, you it's been the one of the may get a lot more time to hardest to do. You have to SF: Having the correct work with the counterparty talk to the employees, vision for the business is to find out what their customers, and suppliers. (Continued on page 27) culture is like. But it is very IssueVolume XIX I, Issue 2 Page 27 Koch Industries (Continued from page 26) engines need higher octane. today, even without key. For example, Flint Hills subsidies or mandates. used to view themselves as A blend of gasoline with strictly a crude-oil-based ethanol to increase the SF: Here are some refined products business. octane level makes sense to numbers to put with that. Now they view themselves feed those engines. So You can buy 87, 89, or 91 as a transportation fuels ethanol has a place in the octane gasoline. That is business. These visions are transportation fuel industry regular unleaded, mid-grade, very different. or premium. One way to achieve 89 or 91 is by When you make that shift in blending a higher-octane how you think about the “We don't spend a component with regular world, suddenly you will gasoline. look at ethanol, biodiesel, lot of energy trying and hybrid vehicles Ethanol has a high octane differently. It's changed the to predict the value of about 99 or 100. way we invest in those future. That goes When you blend it with assets. Time will tell how carbon-based motor good the vision is, but we'll back to getting into gasoline it has the equivalent adapt it again as we need to. of 120 octane value because businesses where of the chemistry. So as the G&D: How do you think engine manufacturers about investing in areas you have increase their compression boosted by big government competitive ratios to get higher fuel subsidies such as ethanol, efficiency, we're going to especially given Charles advantages, where need more octane in the Koch’s free-market views? future. you can build out a DR: We're not in favor of People often look at us and any subsidies or mandates platform, and say, "You guys are where the government picks hypocrites because you're winners and losers. We're where you have investing in an industry that opposed to all of that, even has a subsidy or a mandate." if it’s detrimental to us. The optionality in what That's not why we're ethanol industry is not you do. Then you invested. We're invested subsidized anymore today, because it will be an but it is mandated. It's great can adjust as things important fuel of the future. that the subsidy went away, The industry survives just and we'd like to see the change in the fine without subsidies or mandate go away and let mandates and we advocate ethanol compete on its own economy. We’re for such policies. merits. much more G&D: Given your diverse If you look at the energy effective at doing set of businesses, it seems content in ethanol, it's not like you’d have a lot of as good as gasoline or diesel that than spending insights into the current fuel. But ethanol is a very state of the U.S. economy cost-effective way to get time trying to and where it’s headed. Are octane. To meet the miles there any unique or per gallon requirements, predict the future.” interesting data points you engine manufacturers are look at to get a read on the making smaller engines with (Continued on page 28) higher compression. Those Page 28 Koch Industries (Continued from page 27) perspective, the EPA is measures like rail loadings health of the economy or to promulgating policies might help us manage help you make investment through regulation that they working capital levels or decisions? For example, can't get done through something of that sort, but Warren Buffett often legislation, in my opinion. It long term fundamentals are mentions railcar loadings as makes it very difficult to what matter most. a good indicator of the meet the immediate health and direction of the demands of consumers DR: Many companies economy. when this happens. So, we embark on those things to look at the implications of try to predict the future, SF: We look at our those policies. Do we want but we think the future is business over the next 20 to be an industry like that? If unknown and unknowable. years. We do not worry we can't get a permit to So we don't spend a lot of too much about short-term evolve our assets in a energy trying to predict the data points that might help productive manner, it’s a future. explain our quarterly hard industry to be involved earnings. We worry about with. That goes back to getting the long run and I will give into businesses where you you two examples. have competitive advantages, where you can First, many policies coming build out a platform, and out of Washington are going where you have optionality to distort the economy in a in what you do. Then you big way. For example, the “We take some can adjust as things change very artificially low interest in the economy. We’re rates that are being pushed form of commodity much more effective at on us by the government doing that than spending and the Federal Reserve are and we’ll process it time trying to predict the causing artificially higher future. asset values. through a very, very large plant that G&D: Going back to your It’s interesting to me that comment on the Fed. Steve, they’re doing it as a requires how do you see the response to a problem that unprecedented Fed they created in the first sophisticated intervention ending, and place with the exact same what do you do as CFO of low interest rate policy that technology and Koch Industries to prepare was there throughout the Koch for that eventuality? beginning of this decade. analysis to ensure We now know that much of that we have a SF: There are lots of ways the investment following to manage risk. One way to these low rates was competitive manage risk is simply not to unproductive and take the risk. Here’s an unprofitable. The Fed is advantage.” example. If you invest in an making the same mistake asset, you need to look at over again. what the source of return is from that asset. If you're We are very wary of assets investing in a 10-year with sky-high valuations. We treasury, your source of are not tempted to invest in Those are the return is almost 100% them because it’s going to macroeconomic things we attributable to the duration end badly. look at. Short-term (Continued on page 29) Second, from a policy IssueVolume XIX I, Issue 2 Page 29 Koch Industries (Continued from page 28) them. It is the most from them? of that security and very profitable single item that a little attributable to credit grocery store sells on a per- SF: Well, this is going to risk. If you believe there’s square-foot-of-retail-space- use the rest of the time! much more downside than required basis. (Laughs.) upside because of all the manipulation, don’t try to That’s why the greeting card I think our single biggest time it—just don’t do it section still has massive mistake was the polyester because you can’t time it. amounts of square foot business that we acquired allocated to it, and it is from Hoechst, a German We would rather invest prominently featured so company. We probably got where the source of the you’re likely to walk by it back about 80% or 90% of return comes from the before you leave the the capital we put in the capability or the innovation grocery store. business. That’s definitely a of a project or business. If mistake when you don’t get that means taking on more A reporter commented to your capital back. In this illiquidity or duration risk, me on the day the deal was case, we did not understand those risks are much more announced, “I still don’t get how significantly the palatable in this it. The internet is taking Chinese economy had environment than taking on over this whole space.” And invested in polyester. interest rate risk. That’s I said, “Not really, I don’t how we look at it. That’s think you’re right. The facts how we’re trying to do it don’t bear that out. Let me “The number one anyway (laughs). ask you a question. Are you married?” And the reporter thing that appeals What we’re doing with the said, “Yeah, but what does to the companies American Greetings that have to do with this investment ties into this interview?” I said, we talk to is our idea. Although it is an “Everything. Try sending interest-rate-sensitive your wife a text on her next focus on the next security, the valuation of the birthday. Tell me how that investment will not move works out for you!” And he twenty years, not around very much because said, ” I kind of get it the primary source of now!” (laughs) on the next ninety return comes from the days.” capability of the equity When we see the value investors that we’re that’s being created for their supporting and the customers and the capability capabilities within their of the company to continue When the treaties between industry. to create value through the United States and the innovation, we’re very other WTO countries were G&D: What is the thesis comfortable supporting that put in place, a lot of behind the American investment and earning a polyester started coming Greetings investment? return that’s not 100% tied over to the United States. to the discount rate, but We had no idea how SF: Even though the more tied to the capabilities sophisticated these Chinese industry demand trends are that they have. producers were and how flat, they still create much volume would actually tremendous value for their G&D: Can you share some land on our shores. It customers. They have very of the biggest investing displaced a lot of capacity strong relationships with mistakes Koch has made that existed here that we their retail partners and and what you’ve learned (Continued on page 30) long-term contracts with Page 30 Koch Industries (Continued from page 29) a deal. We don't want to be example, then it's hard to had just purchased. handcuffed in our ability to make the investments in We also didn’t understand invest and do the right new capacity that would get that the rate of learning things for the long-term supply and demand back in within the industry had benefit of the business. balance. This puts upward substantially accelerated. pressure on prices in a For example, a plant that G&D: Corporate profits in supply constrained industry. once cost $500 million to the United States as a build fell to $250 million percentage of GDP are So ironically, the very within three years. currently around 11%, policies that the federal Pictured: Professor Tano which is at all-time high and government is promoting Santos at the 2013 Omaha A couple key lessons came Dinner. well above the average over are causing the opposite of out of that acquisition: one the last 20 years of about their intended effect on was that we must have 7%. Do you guys expect a employment and wages. global knowledge systems, reversion to the mean, and And, when supply and not just regional knowledge how do you think about demand stay imbalanced, systems, and have a much investing in an environment you're going to have higher greater awareness of how when asset values probably profits by definition. globally fungible our reflect these record-high products are. Second, we profits? So that's why we're where must talk to customers, we are as a country and suppliers, and vendors SF: In this part of the corporate America. Will before we do an acquisition business cycle, labor that change? Well, we hope so we can be attuned to the normally starts getting a so. We want less non-value- speed of the technological bigger piece of the overall added bureaucratic change within the industry. GDP via expansion of regulation. We want the employment and wage rates. ability to take care of our DR: Another thing we've customers. learned the hard way is how There are a couple things much debt we are willing to happening that are different This doesn't mean that all put on a deal. Too much than in previous cycles, regulations are bad. But leverage not only stresses a which have caused profits to when you layer on deal, but the associated debt be higher. First, U.S. regulation after regulation covenants also limit your companies aren't just after regulation, it becomes ability to invest for the long competing with U.S. extremely term. During downturns, companies anymore; they're counterproductive. We you start to bump up against competing with global have a lot of that right now. those covenants, and then companies. Even though you become very restricted U.S. workers are much Higher profits will reverse in making good long-term more productive, there is over time as new decisions. still a cap on our ability to economies emerge and pay more to stay compete. Exchange rates So you start making short- competitive globally and to will also eventually adjust term decisions just to make expand employment. and our prosperity will be it through the next quarter challenged without change. to meet those debt A second reason is the covenant metrics. We've uncertainty caused by public DR: Uncertainty is one of learned that it's just policy coming out of the biggest factors as to why inconsistent with our long- Washington. If you don't you see these profit levels. term philosophy, so we're know what the Affordable For example, if you want to going to be relatively Care Act is going to do to get a permit to build a conservative in how much your healthcare costs, for (Continued on page 31) debt we're willing to put on IssueVolume XIX I, Issue 2 Page 31 Koch Industries (Continued from page 30) DR: It hurts the poor. The this company is being forced greenfield facility or to consumers are the ones to let go very highly skilled, expand capacity, you may be who suffer the most great-culture-fit engineers in the permitting process because the goods they within their company— for five, six, or seven years. need just for necessities are people that in the long run more expensive. would create much more To start committing capital value staying employed with to something which may not SF: Any form of a price the company than not. Yet start for seven or eight control causes this they’re letting them go years from now is a very, imbalance. In Venezuela, the because their investors are very high-risk bet because former Chavez putting so much pressure you don’t know what the administration stipulated on the management team environment’s going to be. that, “The price of milk that they have to reduce You don’t know what the cannot exceed X.” Guess their costs to meet short supply and demand balance what happens? There’s no term objectives. is going to be. You don’t incentive for people to even know whether the create milk. And there’s no So they’re making poor product is going to be milk. It leads to scarcity. decisions for the long run. needed that far in the When you have scarcity, Look at how disruptive that future. you have very high profits is. It's disruptive to the for the people that are left company because it is So that dampens additional in the business, and that’s getting rid of capability that investment, which keeps happening on a much larger, it needs. It's disruptive to capacity low and margins more discrete scale here. the family of that employee high. If only the U.S. does that is being let go. We that, then all the G&D: Is there anything else don't need to think that way manufacturing and you’d like to add about here. We look at an production will eventually Koch Industries’ strategy in investment in that kind of an go to other countries that acquiring businesses? employee as an investment are more advantaged, and in the long run. Let’s find we’ll be an importer. SF: The number one thing something that he or she that appeals to the can be working on until the SF: Look what happened to companies we talk to is our market comes back. That is Wal-Mart just recently in focus on the next twenty the number one thing that I Washington, D.C. where years, not on the next talk to people about, and it's the city council tried to ninety days. That unleashes pretty compelling to them. impose upon them a $12 companies to make different minimum wage. So what decisions that they don’t get G&D: Dave and Steve, happened? When that kind to make when they’re a thank you for your time. of regulation came in, Wal- public company under the Mart said, “We’re not scrutiny of an investor base building.” that’s trading, not investing, in their shares. Is that good for the consumers? The rest of the We’re talking to a company retailers have less right now that is in the competition, and prices will trough. Their industry is be higher. So profits are being significantly higher and labor is constrained because there constrained. Those kinds of was overbuilding and regulations are causing demand is weak. As a result these high profits. of this temporary condition, Get Involved: To hire a Columbia MBA for an internship or full-time position, contact Bruce Lloyd, Director, Employer Relations, in the Office of MBA Career Services at (212) 854-8687 or [email protected]. Available positions also may be posted directly on the Columbia website at www.gsb.columbia.edu/jobpost. The Heilbrunn Center for Alumni Graham & Dodd Investing Alumni should sign up via the Alumni website. Click here to log in, Columbia Business School (www6.gsb.columbia.edu/alumni/emailList/showCategories.do), then go to the Uris Hall, Centers’ Suite 2M 3022 Broadway Centers and Institutes category on the E-mail Lists page. New York, NY 10027 212.854.1933 To be added to our newsletter mailing list, receive updates and news about events, or [email protected] volunteer for one of the many opportunities to help and advise current students, please fill out the form below and send it in an e-mail to [email protected]. Name: ______ Company: ______Visit us on the Web The Heilbrunn Center for Graham & Dodd Investing Address: ______www.grahamanddodd.com Columbia Student Investment City: ______State: ______Zip: ______Management Association (CSIMA) http://www.csima.org/ E-mail Address: ______ Business Phone: ______ Would you like to be added to the newsletter mail list? __ Yes __ No Contact us at: Would you like to receive e-mail updates from the Heilbrunn Center? __ Yes __ No [email protected] [email protected] [email protected] Graham & Doddsville 2013 / 2014 Editors Chris Brigham is a second-year MBA student and a member of the Heilbrunn Center’s Value Investing Program. Prior to Columbia Business School, he worked as an equity trader for Bank of America Merrill Lynch and as a research analyst for Tiresias Capital, an event driven hedge fund. Chris graduated Phi Beta Kappa from Claremont McKenna College, where he received a BA in Economics. He can be reached at [email protected]. Jackson Thies is a second-year MBA student and a member of the Heilbrunn Center’s Value Investing Program. During the summer he interned at PIMCO as a high yield credit analyst. Prior to Columbia Business School, he worked in the research department at the Federal Reserve Bank of Dallas. He received a BS in Economics and Engineering from Southern Methodist University. He can be reached at [email protected]. Jason Yang is a second-year MBA student and a member of the Heilbrunn Center’s Value Investing Program. During the summer Jason interned at Development Capital Partners, a concentrated, value-oriented fund investing in sub-Saharan African equities. Prior to Columbia Business School, he worked as a consultant in PWC’s Transaction Services Strategy practice. Jason received a BS in Economics and Mathematics from Yale University. He can be reached at [email protected].