Graham & Doddsville An investment newsletter from the students of Columbia Business School

Inside this issue: Issue XXXIV Fall 2018 From Graham to Tweedy, Browne Company Tweedy, Browne Buffett and Beyond Company is a value- Omaha Dinner P. 3 oriented asset manager that Howard Marks manages domestic, Book Signing P. 4 international, and Tweedy, Browne global equity portfolios for Company P. 6 individuals, family Student groups, and Investment Ideas P. 17 institutions from all over the world. The Scott Miller P. 21 firm was one of the Clockwise from top left: Roger De Bree; Andrew Ewert ‘07; Frank Hawrylak, few investment firms Steve Tusa P. 28 CFA; Jay Hill, CFA; Bob Wyckoff; John Spears; Tom Shrager; Amelia Koh ‘16 mentioned by Warren Buffett in his Editors: (Continued on page 6) Ryder Cleary MBA 2019 Scott Miller, Greenhaven Road Capital

Gregory Roberson, Esq. MBA 2019 Scott Miller formally launched long-biased value hedge fund Greenhaven Road Capital in 2011. Prior to founding David Zheng Greenhaven, Mr. Miller was the Co-Founder and CFO/Chief of MBA 2019 Strategy of Acelero Learning, a Head Start education services

Frederic Dreyfuss company that has grown to over 1,200 employees. He was MBA 2020 previously an Analyst at Litmus Capital, an Associate at NewSchools Venture Fund, and has further experience as a Sophie Song, CFA business owner-operator. Mr. Miller earned a B.A. in Political MBA 2020 Science from the University of Pennsylvania, an M.B.A. from Scott Miller the Stanford University Graduate School of Business, and an John Szramiak MBA 2020 (Continued on page 21)

Steve Tusa, Wall Street’s GE Bear Visit us at: www.grahamanddodd.com Rolf Heitmeyer www.csima.info JP Morgan’s Steve Tusa is Institutional Investor magazine’s #1 ranked analyst covering the Electrical Equipment & Multi- Industry sector. He has covered the sector since 1998, with lead coverage since 2005. In 2017, he gained notoriety for being Wall Street’s lone outspoken bear on GE, when the stock was trading in

(Continued on page 28)

Page 2 Welcome to Graham & Doddsville

We are pleased to bring you members of the investment As a sell-side equity research the 34th edition of Graham & committee: Roger De Bree, analyst at JP Morgan, Steve Doddsville. This student-led Frank Hawrylak, Jay Hill, Tusa has gained notoriety as investment publication of Co- Tom Shrager, John the lone bear covering GE. lumbia Business School (CBS) Spears, and Bob Wyckoff, Since he first recommended is co-sponsored by the Heil- along with a pair of CBS an Underweight rating in May brunn Center for Graham & alumni who are currently 2016, the stock has fallen Dodd Investing and the Co- working as analysts at the more than 60%. Wall Street lumbia Student Investment firm: Andrew Ewert ’07 commentators have called it Management Association and Amelia Koh ’16. In the “one of the greatest stock Meredith Trivedi, Managing (CSIMA). interview, we discuss the calls of all time.” Steve runs Director of the Heilbrunn legacy of Ben Graham, the through his research on GE, Center. Meredith skillfully Since our Spring 2018 issue, dynamics of international the legacies of Jack Welch leads the Center, cultivating the Heilbrunn Center hosted investing, the firm’s invest- and Jeff Immelt, his prepara- strong relationships with the eighth annual “From Gra- ments in companies like Au- tion for TV appearances, and some of the world’s most ham to Buffett and Beyond” tozone, WPP, and Baidu, and the importance of patience in experienced value investors Omaha Dinner. This event is changes in the equity markets an investing career. and creating numerous held on the eve of the Berk- since the firm’s last G&D learning opportunities for shire Hathaway shareholder interview in 2010. Lastly, we continue to bring students interested in value meeting and features a panel of you stock pitches from cur- investing. renowned speakers. The Heil- We sat down with Scott rent students at CBS. In this brunn Center also hosted a Miller, the founder of issue, Winter Li ’19 and presentation and book signing Greenhaven Road Capital, a Shengyang Shi ’19 present by best-selling author How- long-biased value hedge fund. their long thesis on JD.com ard Marks after the release of The fund’s impressive track (JD), and Michael Wooten ’19 his new book Mastering the record since its founding in shares his long idea in the Market Cycle. 2011 has drawn notable at- semi-conductor company tention from the investing Qorvo (QRVO). Our first interview is with community. Scott discusses Tweedy, Browne Company, his background as a business We thank our interviewees one of the few investment operator, the prospects for for contributing their time firms mentioned by Warren autonomous vehicles, his and insights not only to us, Professor Tano Santos, the Buffett in his 1985 speech The philosophy on position sizing, but to the investment com- Faculty Director of the Heil- Superinvestors of Graham & as well as his investments in munity as a whole. brunn Center. The Center Doddsville, from which this companies like Etsy, TripAd- sponsors the Value Investing newsletter gets its name. We visor, Schein Vineyards, and Program, a rigorous aca- demic curriculum for partic- sat down with six of the seven Fiat Chrysler. - G&Dsville Editors ularly committed students that is taught by some of the industry’s best practitioners. The classes sponsored by the Heilbrunn Center are among the most heavily demanded and highly rated classes at Columbia Business School.

Second-year Value Investing Program Meredith Trivedi with Professor Tano students chat with CBS Professor Kian Santos, Faculty Director of the Heilbrunn Ghazi at the 2018 Value Investing Center for Graham and Dodd Investing. Program welcome reception.

Volume I, Issue Page 2 3 Page 3

“From Graham to Buffett and Beyond” Omaha Dinner 2018

Professor Bruce Greenwald presents at the annual Mario Gabelli ’67 addresses the crowd Omaha dinner and shares some words of wisdom

Professor Bruce Greenwald, Mario Gabelli ’67, Jan Professor Bruce Greenwald signs a copy of his book Hummel, and Thomas Russo share a laugh

Omaha attendees enjoy some downtime during the reception

Page 4

Howard Marks’ Mastering the Market Cycle Book Signing and Discussion

Mastering the Market Cycle, the newly released follow-up Howard Marks discusses markets and cycles in a to Marks’ highly regarded The Most Important Thing discussion moderated by CBS professor Ellen Carr

Professor Tano Santos introducing Howard Marks to an Howard Marks signing a copy of his book alongside his excited crowd of students and professionals at Columbia associate Caroline Heald

Former Graham & Doddsville editors Adam Schloss ‘18 (left) and Abheek Bhattacharya ‘18 with a copy of Mastering the Market Cycle

Volume I, Issue Page 2 5 Page 5

SAVE THE DATE

22nd annual Columbia Student Investment Management Association Conference

February 15, 2019

A full-day event featuring some of the most well-known

investors in the industry, including keynote speakers:

Jan Hummel of Paradigm Capital,

Susan Byrne of Westwood Holdings Group,

and

Richard Pzena of Pzena Investment Management

Presented by:

The Columbia Student Investment Management Association

and

The Heilbrunn Center for Graham & Dodd Investing

Visit our website for updates: http://www.csima.info For inquiries contact:

Shara Singh [email protected] Matthew Stevenson [email protected] Page 6 Tweedy, Browne Company (Continued from page 1) 1985 speech The Jay Hill joined Tweedy, Institute of Business Superinvestors of Graham & Browne in 2003 and is a Administration, Drexel Doddsville from which this member of the Investment Institute of Technology, newsletter gets its name. Committee. He previously and The Wharton School Founded in 1920, Tweedy, worked at Banc of at the University of Browne Company now has America Securities LLC, Pennsylvania. 53 employees. Credit Lyonnais Securities (USA) Inc., and Providence Bob Wyckoff has been at Roger De Bree has been at Capital, Inc. Mr. Hill holds Tweedy, Browne since Roger De Bree Tweedy, Browne since a B.B.A. from Texas Tech 1991. He is a Managing 2000. He is the firm’s University. Director, a member of Treasurer and a member both the Investment and of the Investment Amelia Koh joined Management Committees, Committee. Mr. De Bree Tweedy, Browne in 2016 and Chairman and Vice previously worked at ABN as an Analyst focused on President of Tweedy, AMRO Bank and global companies. She Browne Fund Inc. Mr. MeesPierson Inc. He holds previously worked at Wyckoff previously worked an undergraduate degree Deutsche Bank Securities at Bessemer Trust, C.J. in business administration Inc. Ms. Koh holds a B.A. Lawrence, J&W Seligman, from Nijenrode, the from Macalester College and Stillrock Management. Business School in and an M.B.A. from He holds a B.A. from Breukelen, Netherlands, as Columbia Business School. Washington & Lee Andrew Ewert ‘07 well as an M.B.A. from University and a J.D. from IESE, the University of Tom Shrager has been at the University of Florida Navarre Business School in Tweedy, Browne since School of Law. Barcelona, Spain. 1989. He is a Managing Director, a member of Graham & Doddsville Andrew Ewert joined both the Investment and (G&D): How relevant is Ben Tweedy, Browne in 2016 Management Committees, Graham’s philosophy today? as an Analyst focused on and President and Director global companies. He of Tweedy, Browne Fund Tom Shrager (TS): I would previously worked at Inc. Mr. Shrager previously argue that Graham’s Equinox Partners, L.P., worked in M&A at Bear philosophy is still fully Ruane, Cunniff & Goldfarb Stearns and as a consultant applicable today. He was one Inc., MTS Health Partners, at Arthur D. Little. He of the first investors to create Frank Hawrylak, L.P., and Bear Stearns. Mr. holds a B.A. and a Masters an investing framework that CFA Ewert holds a B.B.A. from in International Affairs made sense. Graham came Emory University and an from Columbia University. from the credit side of M.B.A. from Columbia investing and, as a fixed income Business School. John Spears joined investor at that time, your Tweedy, Browne in 1974. downside protection was Frank Hawrylak has been He is a Managing Director, either the collateral put up at Tweedy, Browne since a member of both the against the loan or the bond. 1986 and is a member of Investment and He later applied that the Investment Management Committees, framework to equity investing Committee. He previously and Vice President of and argued that the collateral worked in the investment Tweedy, Browne Fund Inc. value of an equity investment is department at Royal Mr. Spears previously the intrinsic value of the Insurance. Mr. Hawrylak worked for the investment business. The value of the holds a B.S. from the firms Berger, Kent business could be its net asset Jay Hill, CFA University of Arizona and Associates, Davic value, it could be its book an M.B.A. from the Associates, and value, or it could be an University of Edinburgh, Hornblower & Weeks- earnings-based valuation. Scotland. Hemphill, Noyes & Co. He studied at the Babson By thinking in terms of (Continued on page 7) Page 7 Tweedy,Harvey Sawikin Browne Company

business value and buying at a companies on EV to NOPAT, do that. You could find a stock discount from that value, a how does it shape up in that was trading at 60% of net diversified portfolio of comparison to deal valuations? current assets, and you might undervalued securities should glance at the annual report – earn an adequate return. That TS: However, we don't go which used to be 18-20 pages framework hasn't changed. As much below an 8% owner instead of 250 pages – to get markets have evolved, there earnings yield. You have to be an idea of what the business are fewer net current asset reasonable and say, “If did. All you had to do was get stocks and book value stocks multiples in the market are 20x comfortable with the inventory Amelia Koh ‘16 that you can invest in today. EBIT, we are simply going to or accounts receivable. That said, we do find them pass on that because it doesn't from time to time in places like make any economic sense, G&D: How has this impacted Japan and Hong Kong, but our assuming some normalization valuation? current investments are in interest rates.” The analysis overwhelmingly trading at is both absolute and relative. BW: The valuation framework discounts to an earnings type remains the same – we’re still valuation. “It became clear to us trying to buy companies at significant discounts from a G&D: What types of valuation that value investing, at conservative estimate of the metrics do you use? underlying intrinsic value of the least empirically, business. We tend to be pretty John Spears (JS): We look conservative appraisers. Today, Tom Shrager for “a satisfactory owner appeared to work as we often value businesses at 10 earnings yield.” For example, if -13x pre-tax operating income you take a company’s well outside the US as it – compared to 6-8x when I operating income after tax and did domestically.” first started at Tweedy in 1991 divide that by its enterprise – and try to buy those value, and that produces an businesses somewhere owner earnings yield of 8-10%, G&D: How is the process for between 6-9x. The expansion you’re getting a pretty good earnings-based valuation in our valuation multiples is return. different? largely due to this march to the bottom in interest rates. In Jay Hill (JH): Another recent Bob Wyckoff (BW): 1980, when I arrived in New change is that tax rates have Earnings are less predictable. In York, the prime rate was been going down around the conducting our analysis on north of 20%. You see what world. One advantage of this earnings-based businesses, we has happened since then. John Spears owner earnings yield metric is spend a lot more time today Interest rates, with a hiccup that it gives a company some on qualitative factors, factors here and there, have been in credit for falling tax rates. All that might impact that earnings decline for over 35 years, and things equal, we believe that stream over time. that has had a significant lower tax rates lead to higher impact on what people are net income and higher free We try to estimate the willing to pay for a business. cash flow. earnings power of the You see it in corporate business, the sustainability of transactions and the values G&D: How do you use that earnings power, and what people are willing to pay in NOPAT (Net Operating Profit the growth of that earnings acquisitions. Debt to EBITDA After Tax) to EV (Enterprise power might look like over multiples in leveraged buyouts Value) in evaluating time. It does involve an are very high today. Invariably, opportunities? Do you evaluation of qualitative factors if interest rates are low, people compare it to long-term which might not have been as are going to borrow a lot of Bob Wyckoff government bond yields? prevalent in our analysis 40 or money, and that's going to 50 years ago. inflate multiples. JS: To an extent. We also look at it relative to other Frank Hawrylak (FH): We've incrementally increased companies. If you rank 100 Previously, you didn’t have to our appraisal multiples over (Continued on page 8) Page 8 Tweedy,Harvey Sawikin Browne Company

time, although reluctantly and pressure that were trading at the Amazon of its day, back with a lag. I think a lot of discounts to book value. when the tech bubble was people would still consider us nearing its peak in 2000. It was relatively conservative on that TS: Digital Equipment was the world’s largest company – front, and we demand a one, I recall. profitable, but trading substantial discount off those somewhere around 180x appraisals. BW: Yes, DEC. We bought it earnings. Then the tech bubble after it had rolled over and burst in March of 2000 and, G&D: What other recent was trading at a discount to before long, Cisco was trading changes have you seen in the book value. We didn’t know it at a fraction of its bubble price. markets? at the time, but we were basically buying a cigar butt. We got an opportunity to buy BW: Over the past 25 years Luckily, we bought it pretty our shares in 2011 and 2012 we’ve become more of an cheap and were able to make a when it was trading at roughly international investor – our little bit of money on it, but 10x earnings with over $40 client portfolios were primarily that isn’t the way investors billion dollars of cash on its made up of U.S. equities up currently target technology balance sheet. It was still until the early ‘90s. You may stocks for growth. What has dominant in routers and have seen a booklet we put changed recently is that we switches at the time, even together called What Has have found some businesses though growth had slowed Worked In Investing. That with world-class technologies significantly. It may not have booklet was a compilation of and long runways for growth – been growing at a Google-type 40-50 empirical studies looking but the key is that we have rate, but we thought that at at value-oriented investment been able to purchase them at the price we were paying, we criteria that, when back-tested, prices that fit our valuation were getting a lot of value. We looked like very good framework. paid an average cost around predictors of outperformance. $17-$18 a share. Today, Cisco And about half of those studies We bought Google in 2012 at is trading in the high $40s. We were done in markets outside a very attractive valuation – still own the stock. That the United States. It became somewhere around 9-10x investment has worked out for clear to us that value investing, forward EV to EBITA and 12- us, but again, it’s a technology at least empirically, appeared 13x forward earnings. It was stock that we were able to buy to work as well outside the US also compounding its value at at a very attractive valuation. as it did domestically. over 20%. It was cheap. G&D: It sounds like you found Today, most of our assets JS: Especially considering the a solid margin of safety. under management are cash on its balance sheet and invested outside the US, as we the low tax rate. BW: We did. We did not often find greater pricing have to tie ourselves up in inefficiency in non-domestic BW: And we still own Google knots trying to develop a markets. Now, that’s all today, despite a higher rationale for owning Cisco. evolving as the world becomes valuation. It’s what we call a Companies like Amazon and more global and more people compounder. Google is Netflix are a much harder begin investing in equities. But I compounding its underlying proposition for us given the think in general we continue to intrinsic value at a very, very way we value businesses. They find the most opportunities rapid rate, and in our view, don’t fit our framework. We internationally. there is still a reasonable also recently bought a couple relationship between the value of Chinese technology Another thing that has changed of the business and its current companies, including Baidu, in the past half-dozen years is stock price. which a lot of people refer to our increased allocation to as the Chinese Google, and technology stocks. We have We also bought shares in Sina, which is a holding owned technology stocks in Cisco – the router and company that owns a the past, however, they were switching company – about six controlling interest in Weibo, often businesses under to seven years ago. Cisco was one of China’s most popular (Continued on page 9) Page 9 Tweedy,Harvey Sawikin Browne Company

social media businesses. You the summer of 1993 that products abroad and can might refer to Weibo as ... hedged its foreign currency compete in the international exposure, which was quite arena. If you research the TS: … the Twitter of China! novel at the time. Even today, Japanese market, you'll find a there are very few lot of cheap stocks that don’t BW: Exactly. Through our international funds that fit that criteria. investment in Sina, we own an consistently hedge currency interest in Weibo at an exposure. Investors tend to FH: Typically, Japanese attractive price. As with most look in the rearview mirror, companies aren’t as profitable of our tech investments, Baidu and since the dollar declined as other companies around the and Sina have advertising-based against most major currencies world based on return on business models. That makes between 1986 and 1992, the capital. Ben Graham wrote an sense to us. It's not gadgets general feeling in the summer article in the 1930s about the and software. of 1993 was that the dollar US stock market when a lot of was toilet paper. People are companies were selling way TS: And they're very driven to make investment below book value. Essentially, profitable – insanely profitable. decisions based on their most the title was, “These recent experiences. companies are worth more BW: So that's another thing dead than alive.” Liquidate that has changed. We have a “We own a few more them. They're not doing few more technology stocks anything for the shareholder. today than we have had in the technology stocks now In Japan, a number of past, but we haven't had to companies fall into that abandon the framework or the than in the past, but category, but nobody cares. valuation discipline to They don't buy back stock accomplish that. we haven’t had to even though it's trading at a third of book value, half of Roger De Bree (RD): I want abandon our valuation which is cash. The culture is to add another thing that discipline to just different. makes it significantly easier to invest large chunks of our accomplish that.” G&D: How do you get personal money and our comfortable with international clients’ money in non-U.S. accounting and auditing? equities. That is using forward G&D: On the international currency contracts to hedge side, are there additional TS: Good question. I foreign currency exposure measures you incorporate into remember when I first joined back into our base currency – your process? the firm, Will Browne said to the U.S. dollar – to get rid of me, “Tom, you're a foreigner. most, if not all, of the foreign JS: Yes. Japan, for example, is Start looking at these foreign currency risk. Investing globally somewhat unique and has companies.” I was gives you more opportunities required additional analysis. overwhelmed because almost to find bargains, and by For one thing, there are fewer every country had its own hedging, you can eliminate the deals in Japan. accounting standards. Over risk that movement in time, I began familiarizing exchange rates could severely TS: You also need some sign myself with the idiosyncrasies. dilute the local returns earned that they think the When I studied British annual on your stocks. Our clients shareholders are alive. reports, I was continually can choose whether to hedge Japanese companies are often struck by how optimistic their portfolios depending on if under-levered and carry too certain accruals appeared. they want foreign currency much cash on the balance German accounting was, by exposure for diversification sheet, which depresses design, very conservative. purposes. returns. In our international Their income statements and portfolio, we want exposure balance sheets were presented TS: We launched an to international markets – in a way that a bank would international mutual fund in companies that sell their prefer. What you had to know (Continued on page 10) Page 10 Tweedy,Harvey Sawikin Browne Company

was that located at the bottom growth. We gained confidence In some ways, these entities of the income statement was because we used a similar are the “national champions” an adjustment to reported valuation framework when we of China. While they are quasi- earnings that was supposed to previously looked at Google, protected – meaning we can't reconcile the underlying but we also had to get own them directly – the profitability with the reported comfortable with Baidu being government does want them profitability, but the adjusted in a communist country where to succeed, and from a economic profitability was the government could shareholder’s perspective, invariably higher than the potentially interfere. perhaps there is a benefit to reported one. Swiss them being sanctioned accounting, in the late ‘80s and Andrew Ewert (AE): The monopolies. You just have to early ‘90s, didn't tell you what Chinese technology live with the compromise of operating income was. They companies, even though not having direct ownership. only disclosed revenues and they're listed in the United Maybe those things balance profits. They didn't even tell States, are deemed strategically each other out, but we also you what taxes were. important companies by the bought them at what we feel Chinese government. This were very attractive valuations. Unraveling international means that non-Chinese These firms have high returns accounting used to be very citizens can’t actually own on capital. The advertising difficult. It became a treasure them. The shares listed in the industry in China is more hunt in the more conservative US represent companies that nascent than in the US and is countries and an exercise in have contractual arrangements growing at a double-digit rate. dodging land mines in the with Variable Interest Entities Search engines are a proven looser ones. Eventually, (VIE) in China. For example, business model, given what international accounting Baidu has contracts with the we've seen with Google. To be standards began to converge, VIEs to receive Baidu’s able to buy this kind of but you still have cultural economic rights instead of company at a low double-digit differences on a country-by- direct ownership in the operating income multiple – country basis even today. company. So you, as a after adjusting for some of shareholder, own a structure their money-losing subsidiaries As far as your question on with a contract. You don't – helped outweigh some of the auditing is concerned, it’s OK actually own the underlying compromises we were making. in the developed world. business. It wasn't easy though.

G&D: What about China? Do TS: Like a non-voting share. Amelia Koh (AK): We you have any concerns there? thought a lot about the AE: Or a tracking stock even. Chinese government. Yes, it’s TS: There have been these big You kind of own a synthetic a communist country, but it's scandals, of course, and that's company. It’s not the real also a very capitalist country. one of the risks of investing in business. You’re not a The internet sector is deemed China. In our case, our shareholder in the true sense strategically important by the companies have good auditors of the word. This is a legal government, and the with international experience, construct to attract capital government has recently been but it’s a different without giving up direct trying to promote Chinese environment. ownership or control of the technology and their domestic companies, because the champions. If the government BW: China is a relatively new Chinese government sees were to take actions that place for us to invest. We had these industries as strategically would jeopardize the VIE to get comfortable with the important to their country’s structure, they would severely different ownership structures. development. It’s obviously limit the ability of these Andrew and Amelia partnered difficult as a shareholder to companies to raise capital and on the work in Baidu, which think like an owner when you also undermine their we thought was trading at an don’t technically own what international credibility. That is attractive valuation with a you’re buying. not an outcome they want. terrific runway for future (Continued on page 11) Page 11 Tweedy,Harvey Sawikin Browne Company

G&D: How do you manage worth 12x EBIT. To find the disclosed every quarter, along the risks of owning Chinese value compound, take EBIT, with all of the determinants of companies? multiply by 12, subtract the net the numerator and debt, and divide by the number denominator – signaling that BW: We manage our risk by of diluted shares outstanding. management understands the limiting our exposure to China, We apply that same valuation importance of returns. being very selective in the methodology over say the last process, and being stingy on 10 years and observe how that Free cash flow is important to price. We’ve taken a roughly value has changed over that us, particularly free cash flow 1.5-2% position in Baidu. Our period, and how much conversion. One of the things maximum position size is 3-4%. volatility there was from year we consider is how well a We like diversification by issue to year. To avoid a flawed company converts its net so we'll often start with a 1-2% analysis, you need to make income into free cash flow position. We’re not going to certain that the first year and over time. We all know that have a significant percentage of the final year of the period do income statements are full of our portfolio in China, because not represent trough or peak assumptions and accruals. We of the risks. earnings. What you’re also know that most growing essentially trying to determine companies, on a multi-year JH: To add one final point: a is, if you owned this business cumulative basis, generate less lot of people are drawn to free cash flow than net income. these internet-oriented At AutoZone, cumulative free companies for the moonshot “People are driven to cash flow has essentially been subsidiaries – the businesses equal to reported earnings that haven’t yet produced make investment over the previous decade, earnings but could or should at which is indicative of high some point in the future. Our decisions based on their earnings quality. valuation of Baidu attributed no value to those secondary most recent We also like that they take investments. We were really experiences.” every free dollar of cash flow just valuing the search business and use it to buy back stock. and buying it at an attractive From 1998 through 2017, multiple. over a long time, how would AutoZone reduced diluted the value have grown? In shares outstanding from 153 TS: For a real business that AutoZone’s case, if you look million shares to 29 million made money. over the previous 11-year shares – an 81% decline. period, its intrinsic value grew Combined with growing BW: Right. The point we're by 16% per annum, with a profits, these share trying to make here is that you significant percentage of that repurchases have substantially can invest in technology growth driven by share increased shareholder wealth. companies and still be price buybacks. The historical sensitive. record also revealed a stable G&D: Does AutoZone pay a and defensive business. Same dividend? G&D: Can you talk about store sales at AutoZone have your recent purchase of grown in 19 out of the last 20 JH: They do not. Management AutoZone? years, including in 2008 and believes they can create more 2009. value, in a tax efficient way, by JH: AutoZone is the largest repurchasing shares. Avoiding aftermarket auto parts retailer AutoZone has also historically a dividend is also beneficial for in the US and has a fabulous produced high returns, with a management’s stock options long-term track record. When 14% ROA (return on assets) because option strike prices we study a company, one thing and a roughly 30% lease are not adjusted lower for we like to examine is the long- adjusted ROIC (return on dividend payments. term historical value invested capital). The company compound of the business. communicates in a very G&D: How did you determine Let's say we think AutoZone is transparent way – ROIC is when to start building your (Continued on page 12) Page 12 Tweedy,Harvey Sawikin Browne Company

stake in Autozone? the urgency of the need. If deliver it to me?” His your car breaks down and you expectation is to receive the JH: In the first half of 2017, can’t get to work, you need it part within thirty minutes, not AutoZone’s stock price fell fixed immediately. Two-day the next day. Even if Amazon from roughly $800 to $500, shipping from Amazon Prime is has two-hour delivery in major mostly due to Amazon irrelevant to you. Second is the cities, that is still not going to concerns. AutoZone even convenience factor. AutoZone cut it, because the independent reported negative organic has approximately 5,500 stores mechanic cares about turning growth one quarter – a rarity in the United States. 85% of over his service bays. He wants for the company. With the the population lives within five to repair as many cars as stock trading in the low $500s, minutes of a store. That’s hard quickly as possible in a day. the business was trading 9.5x to beat, especially if your EBIT, 8x EBITDA and 12x problem is unplanned and your G&D: Are there any earnings, yet M&A deals in this need is immediate. Third is the contractual relationships industry had generally been technical assistance AutoZone between mechanics and done at 13x EBIT. Applying a provides. Most people know AutoZone or are they all one- 12x EBIT multiple to they have a problem with their off transactions? AutoZone – a small discount car but have no idea how to fix from observed deal multiples – it. Therefore, the expertise of JH: They’re all one-off we thought the stock was an auto parts professional is transactions. The goal of the worth at least $750. highly valued. Moreover, for auto parts retailer is to some repairs, a customer become the first-call supplier, The narrative in the industry looking to fix her own car but having the needed part is a was that growth was slowing would have to buy expensive huge challenge because there due to Amazon disruption. tools that she’s only going to are so many makes and Amazon was not a new market use once. AutoZone can lend models. The SKU proliferation entrant; they had been selling you the tools and provide is unbelievable, so the key to aftermarket auto parts for a instructions on how to make success is having custom long time. But we are all keenly the repair. In fact, for many of inventory at every store that aware of Amazon’s willingness the parts AutoZone sells, an reflects which cars the locals to forgo profits in the pursuit employee will just come out to drive. of revenue growth. Further, the parking lot and fix your car cursory research revealed that for you. To achieve this, you have to Amazon’s prices were on study the local car market average 10% to 20% cheaper The remaining 20% of demographics and identify, for on identical branded products. AutoZone’s revenue comes example, whether people are from the do-it-for-me segment driving Ford F-150s or Honda We saw things differently, of its business, which consists Civics. You also need to know ultimately concluding that the of selling parts to independent the year and make of the slowdown was more likely the auto mechanics. This portion models. Each store has an result of weather and car of its business concerns inventory that is customized to demographics than consumers who don’t want to the local car mix. A large store competition from Amazon. fix their own car but are network helps. Many areas Amazon’s major point of looking to save some money have multiple stores that can differentiation is price. But for relative to what a car share parts. If one store AutoZone customers, there dealership would charge. doesn’t have a specific part but are a few factors that are even the one across town does, it more important than price. In the do-it-for-me segment, will deliver it. the customer is typically a Consider the do-it-yourself professional mechanic who G&D: What do you believe segment which represents 80% cares primarily about inventory were the real reasons for the of AutoZone’s revenue. In this availability and speed of industry slowdown? segment, there are three delivery. He calls up AutoZone things more important to the and asks, “Do you have the JH: Weather was definitely a customer than price. First is part and how fast can you factor. Mild winters in 2016 (Continued on page 13) Page 13 Tweedy, Browne Company

and 2017 hurt auto part JH: This summer we looked at learned that following retailers because extreme the drug distributors: Amazon’s purchase of online temperatures often lead to AmerisourceBergen, Cardinal, pharmacy PillPack, Amazon parts failure. The presence of and McKesson. The stocks acquired the ability to snow and salt trucks is like were down partly due to fears eventually sell generic drugs to Christmas for auto parts that Amazon would enter the consumers at cash prices retailers. Those trucks create drug distribution industry or below the cost of a co-pay potholes, and the salt gets into the retail pharmacy industry. using insurance. When the underbelly of cars and We knew Amazon was consumers realize they can leads to rust. The combination planning to enter healthcare in cash buy generic drugs on of a more normal 2018 winter some fashion – it was already Amazon at prices even lower and improved growth at the announced that Amazon was than using insurance co-pays, auto parts retailers led us to teaming with JPMorgan and retail pharmacies are at risk of believe that weather was truly Berkshire Hathaway to form a losing some volume. In part of the problem. healthcare joint venture. addition, a growing number of Amazon was wreaking havoc consumers now have Another reason behind the among many traditional pharmaceutical deductibles as slowdown was a car distribution businesses, and part of their health insurance, demographic problem. The after a good bit of study we which likely means they will sweet spot for spending on concluded that it was very shop around for the lowest after-market auto parts is possible that Amazon could price when purchasing drugs when a car is between 6 and disrupt pharmaceutical for chronic conditions. Since 10 years old. Below 6 years, distribution. drug distributors ultimately sell the car is probably still under to retail pharmacies, they warranty and the owner will “Don’t sell short the could be negatively impacted. go to the dealership. Between 6 and 10 years, the car is likely traditional, long-only Another key profit pool is not on warranty anymore, but independent pharmacies. is still new enough to justify way of investing. It’s Independent pharmacies do repairs. At some point, the car not make up a significant gets too old, and repairs end not a lost art. As the portion of pharmaceutical up costing more than the car is distributors’ revenues, but they worth. If you look at 2017, world becomes more account for an inordinate cars aged 6-10 years old were share of profits because cars that had been sold new passive, we think the they’re high-margin customers. between 2007 and 2011 – a market will ultimately Independents rely on period when new car sales distributors for additional collapsed because of the present more services like business financial crisis. New car sales consulting and insurance picked up dramatically opportunities for reimbursement support. beginning in 2012, making it a Independents are already mathematical certainty that the people like ourselves.” slugging it out with Walgreens 6-10 years-old cohort will and CVS and there is evidence grow in the next several years, that they are slowly losing which will benefit all of the Pharmaceutical distributors market share over time to the auto parts companies. make a lot of money selling large chains. We concluded generic drugs to retail that Amazon’s recent entry G&D: Could you tell us more pharmacy customers, but they into online pharmacy will likely about this idea that some make a disproportionate speed up the demise of the companies can survive an amount of money distributing independent pharmacy. It Amazon threat because price products and services to won’t happen overnight, but is not the differentiating factor? independent pharmacies as we think it represents a long- Are there any other companies opposed to national chains like term headwind to the that fit that theme? CVS or Walgreens. With pharmaceutical distribution respect to generic drugs, we model. (Continued on page 14) Page 14 Tweedy, Browne Company

AE: Another source of The perception is that agencies short-term profits was another opportunity is technological sell commercials, but in reality, blow to advertising agencies. disintermediation. We recently they act more like consultants invested in WPP, a large in helping clients define their Anheuser-Busch InBev now advertising firm in the UK. To audience, select appropriate sells 50% less beer in the some degree, we got this messaging, and target United States than they did six opportunity from the market’s customers. We think they will or seven years ago. Part of that fear of Google and Facebook still fill this role in the future, may be due to the rise in disrupting the advertising but in a different way. A recent popularity of micro brews, but industry. But after conducting advertising book quotes the their decreased advertising analysis similar to our founder and former CEO of budget was also likely a factor. AutoZone research, we WPP, Martin Sorrell, saying, This is a wind that has blown concluded this idea was a bit “75% of what we do has through the entire fast-moving overdone. nothing to do with Don consumer goods industry. Draper. He wouldn’t even Companies lose shelf space, Still, advertising faces issues on recognize it.” business shrinks, and two fronts. First, marketing is shareholders are unhappy. We increasingly moving online, Another issue is that Martin think the pendulum will swing because that’s where the Sorrell has recently left the back, which will help WPP, audience is. In the next few company, creating uncertainty whose biggest clients are years, over half of marketing about future management. As a companies like Unilever, spend will be digital. Google result, the stock is selling at an Procter & Gamble, and Nestle. and Facebook are a duopoly in attractive price, and we’re digital, so advertising is not willing to wait for things to G&D: You are long Unilever only moving online but it’s improve. Are the threats to and Nestle, right? moving exclusively to two the industry temporary or players. Second, the internet secular? We’re betting they’re BW: Yes, as well as Heineken. has lowered the barriers to temporary. The agencies have They’ve almost become semi- entry for many companies. A evolved with their clients and permanent holdings. We have lot of WPP’s clients are are able to go where the owned them for 15-20 years. consumer branded goods business opportunities are. If They have durable competitive companies that are currently they’re not able to do this, advantages that allow them to experiencing increasing then their clients won’t see compound their underlying competition from smaller them as offering a valuable intrinsic values at an attractive upstart brands. As a result, service. Mark Read just took and predictable rate. It's a very these large companies are over as the new CEO and has tax efficient way to invest. cutting their ad budgets as already announced some their businesses slow. changes in strategy. Ideally, the We’ll sometimes trade around management turnover will their intrinsic value, meaning Due to these headwinds, WPP allow the company to focus we’ll trim the position if the trades at just over 9x earnings more on making the necessary stock price moves ahead of with a 5% dividend yield and an changes their clients need and intrinsic value and add to the almost infinite return on capital want. position if the stock price (excluding goodwill). These drops below. These companies financial characteristics are RD: Changes in the consumer also give us exposure to faster very attractive, provided the goods industry have also growing parts of the world. current issues are not secular affected advertisers. 3G When growing middle classes and that clients will continue Capital, which owns Heinz, around the globe get more to deem agencies as valuable Kraft Foods, and Anheuser- discretionary income, they intermediaries to help them Busch InBev, moved to a want a better beverage and a solve modern problems. model where companies better food product. These Marketing is constantly ratchet up their prices, cut companies are serving that evolving, yet agencies have costs, including advertising, and demand, which is growing all always occupied the role of choose the short-term over the time. trusted advisor. the long-term. The focus on (Continued on page 15) Page 15 Tweedy, Browne Company

G&D: How do you handle Though we are a small place, hard and challenging work, but disagreements on your the organization has been the risks are reasonable, and investment committee? through multiple generations, the stress is manageable. It’s proving the efficacy of the also incredibly rewarding, TS: We would characterize value investing approach. This more stable, and allows you to the decision-making process as firm has lasted so long because have a nice balance between a consensus building exercise. people with the right your professional and family The Investment Committee temperament collaborated to life. says yea or nay, but it’s a implement an approach that process. An analyst or a works and is sustainable over FH: To echo what Warren partner starts the process by the long term. Buffett has said to countless presenting an idea. Following numbers of students: integrity that initial vetting, the analyst We have nothing against hedge matters. At Columbia, there's or partner begins the research funds – we think it’s great that plenty of intellectual process, which culminates in a many investment partnerships horsepower and there’s written memo that includes a have popped up over the tremendous energy. We have valuation model, a competitive years. Many are managed by a culture in which honesty and analysis, a complete very talented investors, and humility are important examination of the drivers of MBA students are obviously elements of our success. the business, and any other drawn to them. Yet our advice When you’re given difficult pertinent findings. The idea is would be to not sell short the choices, take the high ground. then debated in a respectful traditional, long only way of and collegial manner with the investing. It’s not a lost art. As TS: Coming back to success. entire investment team. the world becomes more First, you have to be lucky. It's passive, we think the market better to be lucky than smart. People often ask us, “How can will ultimately present more Next comes hard work. It you be efficient in reaching a opportunities for people like means working as hard as you decision by consensus?” We ourselves. possibly can, finishing before believe the process is similar you are expected to, having all to the College of Cardinals You are coming out of a your t’s crossed and all your i’s without the Pope. It’s easier to fantastic MBA program that dotted. It means having a reach an agreement when you firms like ours believe passion for what you do, even look at the issue through the produces capable and if you may not be initially same lens. We might disagree passionate value investors. You rewarded. on price, or someone may have a material advantage over want additional questions most people in the country in JH: I would add: be persistent. answered, but we use a getting a job in a value shop. Several of us got to Tweedy, framework we all believe in. Our advice is to think long- Browne by writing a letter or Also, most of us have type B term. If you do that, your contacting somebody cold. personalities. It’s easy to work competition will be more Don’t just contact once. We together because we respect limited. Think about getting try to make it a point to help each other’s judgment. If you rich over a lifetime by doing people who contact us, but we have the good fortune of something that’s repeatable can’t get back to everyone, or becoming a member of the and sustainable. Investing on a sometimes we forget about it. Investment Committee, it highly concentrated and But the people who are means you’ve shown good leveraged basis may allow one persistent, who circle back judgment and have proven to beat the market by a with the second email or third yourself over the years. substantial margin from time to voicemail, those are the people time with great subsequent we eventually call back. Those G&D: Do you have any advice reward, but the risks and are the people we think really for MBAs who want to break stress are considerable and want it. I wouldn’t worry into the industry? sometimes consequential. At about bugging somebody. firms like ours, you can spend Worry about not being BW: In 2020, Tweedy Browne a lifetime building wealth by persistent enough. will celebrate its 100th birthday. doing what you like to do. It’s (Continued on page 16) Page 16 Tweedy, Browne Company

RD: The greatest gift is just curiosity about what the dynamics of the business are. This keeps you going during dry patches, instead of simply thinking that you have to find a stock to buy or sell. Discipline is essential. If you can combine that sort of curiosity with the right temperament, you’re in a lucky spot.

G&D: Thank you for your time.

Page 17

JD.com (NYSE: JD) - Long Winter Li, CFA Shengyang Shi [email protected] [email protected] Recommendation We recommend a long position on JD.com (JD) with a price target of $80 in 2022 or 27% IRR. We believe the recent sell-off in the stock is an overreaction and the current risk/reward is extremely Winter Li ’19 attractive. Our valuation is based on a Winter is a 2nd year stu- sum-of-the-parts analysis. After stripping dent at CBS. Prior to CBS, out JD Finance, JD Logistics, other in- Winter was an Investment vestments and net cash, JD’s core busi- Associate at MFS Invest- ness is only trading at 5x owner’s earn- ment Management, where ings (assuming 3% normalized net mar- he also interned this sum- mer. At CBS, Winter is a gin), which grows at 20-30%. We believe member of the Value In- JD’s core retail and advertising business vesting program and serves deserve to trade at 15x and 12x EV/ as the Co-President of the EBIT, respectively, at maturity. We sanity checked that valuation against justified multiples and other peers. investment management club (CSIMA). JD & Chinese E-Commerce Overview JD.com is a $35B market cap B2C online retail company serving the vast and growing Chinese consumer mar- ket. It is the largest online direct retailer (1P) and second largest e-commerce company in China. Relative to other e-commerce players in China (e.g. Alibaba), JD has a reputation of selling a diverse selection of authentic products at competitive prices. JD is differentiated through product quality and its own distribution infrastruc- ture that results in speedier deliveries. Its main revenue sources are: 1) online direct sales (1P business; main categories include electronics, appliances, apparel and FMCG), 2) online marketplace (3P business; commission -based), and 3) advertising (cost-per-click model and long-term brand advertising).

When e-commerce began in China, offline retail had low market coverage and was highly fragmented (53% of grocery sales were from mom and pop stores vs. 18% in the US; also, the top 20 traditional retailers in China only had 12% market share). The fragmented nature of the industry paved the way for growth of e-commerce platforms. Online penetration rate has grown at over 50% CAGR over the last few years and is expected to Shengyang Shi ’19 grow from 20% today to 30% by 2022. Euromonitor estimates China online retail sales will grow at mid-teens Shengyang is a 2nd year CAGR over the next five years. That projection is on track as online retail sales grew 29.3% y/y in H1 2018. student at CBS. Prior to CBS, Shengyang was an Investment Thesis Investment Associate at 1) Underappreciated business model: Many investors think that Alibaba (BABA) has already won the e- Baring Private Equity Asia. commerce war in China and that e-commerce is a winner-takes-all market. From conversations with mer- This summer, he interned chants and ad agencies, we believe there is room for multiple players. Merchants have a vested interest in at Mercator Fund and Cath supporting multiple platforms. Additionally, many higher-end and foreign brands prefer to be on JD over BA- Kidston, a portfolio compa- BA because of JD’s reputation of selling higher quality, authentic goods with faster distribution. ny of Baring. At CBS, Shengyang is a member of Investors often pick between JD and BABA to gain exposure to the Chinese online retail growth theme. Many the Value Investing pro- investors prefer BABA’s asset-light business model relative to JD’s. We believe investors underappreciate the gram and the Private Equity value of JD’s business model. JD has spent over a decade building a national logistics distribution network that Fellows Program. Sheng- yang also leads the Invest- covers over 99% of districts in China. JD’s logistic network differentiates it from other Chinese e-commerce ment Ideas Club (IIC) players through faster delivery and superior customer experience, which are important to succeed over the within the investment long-term. In China, a regular work day is extremely fast-paced with little down time during or after work. As management club (CSIMA). such, speed of delivery and the shopping experience are crucial, especially in top-tier cities, where JD is the preferred online retailer. As China continues to urbanize, we expect even more people will switch over to the Primary Research: 1. Ex-external consultant “JD experience”. While not completely comparable, JD is built similarly to Amazon whereas BABA is more to Alibaba and JD like eBay. 2. Advertising agency exec- utive 2) Variant view on margin expansion potential: After its growth stage, JD can raise profitability by in- creasing margins via multiple methods such as less discounting to suppliers, similar to what Amazon did. A 3. Ex-JD senior executive more overlooked margin growth driver is advertising revenue growth. We expect advertising to grow faster 4. Expert in Chinese e- than consensus expectations, and the mix shift should contribute to margin expansion. Ad revenue only ac- commerce counts for 3% of consolidated revenue and is thus often lumped in to “other revenue” and ignored by the 5. Senior executive within a investment community. Given advertising’s margin profile (~50%), it accounts for 11% of gross profit despite large global merchant only 3% of total revenue. That deserves a deeper dive, which is what we’ve done in our primary research. 6. E-commerce manager at an international apparel E-commerce platforms in China are also enjoying macro tailwinds in ad revenue share. We’ve seen e- brand commerce websites take a bigger share of the growing advertising revenue, mostly at the expense of search

engines, and that trend is widely expected to continue. Page 18 JD.com (JD) - Long (Continued from previous page) JD’s ad revenue as a % of GMV is at 1.2%, meaningfully lower than both Alibaba’s and Amazon’s. JD only began charging ad fees in 2014. Per our conversations with ad agency execs, JD’s ad revenue is lagging Alibaba’s primarily because of technological differences in the mag- nitude of three to five years. But there is no reason why JD cannot catch up. Beginning in the second half of 2016, JD started to invest aggressively into advertising capabilities including investments in a team of externally-recruited engineers, AI technologies, a real-time bid- ding platform, and tools and analytics for merchants. Subsequently, cost-per-click revenue has been growing triple-digits over the last few quarters. There is still low-hanging fruit left. For instance, T-mall of Alibaba requires its merchants to place ads in order to be listed on its platform. JD initiated a similar initiative in 2017 and is only charging 30% of what Alibaba charges on those ads. JD has set up strategic part- nerships with Tencent, Baidu, NetEase, Qihoo, and Toutiao to reach 100% of online consumers in China via multiple platforms including WeChat, search engines, media, video streaming and gaming. JD’s broad coverage makes it an attractive platform to advertise on.

In our base case, we assume JD’s ad revenue as a % of GMV will increase to 2.1% in five years, still lower than BABA’s current 2.5% and lower than Amazon’s projected percentage. Should that scenario play out, JD’s ad revenue would become 5% of revenue mix and 17% of gross margin mix by 2022E. The advertis- ing segment is asset-light and trades at a higher multi- ple. If JD’s advertising grows, the mix change should also result in multiple expansion.

3) JD’s core retail business is undervalued after backing out JD Finance and JD Logistics: JD’s long-term competitive advantage lies in its integrated model of retailing + logistics + finance. However, the market is penalizing the company for its negative profitability and low cash flow because the latter two segments (logistics + finance) are dragging down overall financials, as the Street has failed to clearly separate out these two loss-making segments. After backing out JD Finance ($5.0/sh), JD Logistics ($7.6/sh), other investments ($2.2/sh), and net cash ($1.4/sh), the core retail business is only trading for $8.2/sh (~$10bn). This is very cheap considering the core generates $70B revenue in 2018E and is growing at 30% a year. For reference, Amazon is trading at 4x 2018E revenue with a similar growth profile. With an assumed 3% owners’ earnings margin (conservative), JD’s core retail and advertising segment is trading at 5x earnings. We believe JD’s long-term true earnings power could be even higher than the assumed 3%. Value could be unlocked if the company separates out segment financials and investors start seeing the true performance of all business segments. Alternatively, JD could spin-out one of the non -core segments to realize its market value and highlight the mispricing in the remainder of the business. Note: JD management has publicly discussed divesting JD Finance/Logistics, partly to surface the value of the underlying business.

Metrics Val. JD Val. to JD as % of Valuation Method Multiple US$/share Comments (US$mn) (US$mn) stake (US$mn) Total JD Retail (1P+3P) EV/EBIT 3,321 15.0x 49,821 100% 49,821 34.3 47% Assumes breakeven for 1P and 15x on 3P 2022E EBIT of $3.3bn (62% EBIT Margin) JD Advertisng EV/EBIT 2,838 12.0x 34,057 100% 34,057 23.5 32% 12x on 2022E Advertising EBIT of $2.8bn (38% EBIT Margin) JD Core EV/EBIT 6,159 13.6x 83,878 100% 83,878 57.8 80% Blended 13.6x on 2020E EBIT Margin of 2.4% JD Finance Market Value 20,000 36% 7,200 5.0 7% Financing round in Jul 2018 (CICC Capital, CITIC Capital and Bank of China's Investment Arm) valued it at US$20bn JD Logistics Market Value 13,500 81% 10,989 7.6 10% Financing round in Feb 2018 (Hillhouse and Sequoia) valued it at US$13.5bn JD Cloud P/S 110 10.0x 1,099 100% 1,099 0.8 1% 10x on 2022E JD Cloud revenue; Ali Cloud's valuation estimate of $67bn (MS Research) is 33x on its 2017 revenue of $2bn Minority Investments Market Value 2,623 1.8 2% Farfetch ($0.8), Yonghui ($0.7), Bitauto, VIPShop, Tuniu, Kingdee, Dada Nexus Net cash 10,937 7.5 10.4% Accumulated $10.9bn of net cash by 2022E; Currently JD has net cash of $3.8bn Market Cap and Target Price 116,725 80.4

Valuation We used sum-of-the parts to value JD as it best captures the value of each segment. For the core business, we assume breakeven for 1P and 62% EBIT margin for 3P (blended EBIT margin of 2.4%) in 2022E and apply a 15x EV/EBIT multiple. We also apply 12x EV/EBIT on 2022E ad EBIT of $2.8bn (38% margin). These multiples are calculated based on justified multiples and relative to peers, with a conserva- tive bias. We derive our target price of $80 (or 27% IRR) when we add together JD core’s 2022E value ($57.8/sh) and other parts of the business in current market value (JD Finance, JD Logistics and other investments) as well as net cash accumulation through the five years. At the current price of $24.5/sh and based on JD’s current net cash position, JD’s non-core businesses (finance/logistics/cloud/minority investments/net cash) add up to $16.2/sh, implying JD’s core (1P/3P/advertising) is worth only $8.2/sh (or 5x earnings assuming 3% normal- ized net margin), which we consider to be meaningfully undervalued.

Major Risks Key man risk: JD has a dual class share structure, where Richard Liu, Chairman and CEO, controls 80% of the voting rights. The bench after him is rather shallow. Mr. Liu was arrested in Minnesota on suspicion of criminal sexual misconduct on August 31, 2018. Although he was not charged with any offense at the time and was released the next day, JD has lost $10bn of its market cap ($7/sh) due to concerns over losing him if he is convicted. We think a $10bn loss in market cap more than factors in this key man risk and that further downside is limited. Even if JD loses Mr. Liu, its shareholders might actually benefit with a more returns-focused management team, as Mr. Liu has fo- cused more on growth and less on returns on invested capital and profitability of the company.

Intensified Competition: Major competitors such as Alibaba and Suning have large offline presences and are competing against JD across all major categories with the “New Retail” omni-channel initiatives. New competitors such as Pinduoduo compete against JD ag- gressively in lower-tier cities and rural China. However, we believe JD’s advantage lies in its integrated retail model with powerful econo- mies of scale. Its logistics and distribution network, which took over a decade to build, cannot be easily replicated. Page 19

Qorvo Inc. (NASDAQ: QRVO) - Long Michael Wooten, CFA [email protected]

Michael Wooten, CFA ’19 Investment Thesis Michael Wooten is a 2nd year student at CBS and a Qorvo Inc. (“QRVO”, or the “Company”) currently represents an attractive investment opportunity within member of the Value In- the semiconductor sector given its unique position in radio frequency (“RF”) technologies and idiosyncratic vesting Program. Previous- operating tailwinds which should drive increased profitability and strong cash flow generation over the next 5- ly, he worked as an Associ- 10 years. Despite significant sector tailwinds, historical operational issues, customer concentration concerns, ate at Corrum Capital and cyclicality fears have largely held back investor sentiment. My contrarian view is that the above factors Management and as an have created an opportunity for a patient investor to buy a quality and improving business 50% below intrin- Analyst at Reicon Capital. sic value at a time when strong secular growth and industry positioning provides a sufficient margin of safety. This summer, Michael was an intern at WEDGE Capi- Investment Summary tal in Charlotte. 1. Secular tailwinds in high-growth parts of the RF industry: 5G, 4G LTE, and Internet of Things (“IoT”) 2. Idiosyncratic tailwinds: drive margins higher while winning back market share 3. Limited number of true competitors: Oligopolistic market with increasing demand for RF solutions 4. Favorable Risk/Return profile: 40-50% undervalued, 4.1x up/down ratio, and healthy balance sheet

QRVO stands to benefit from its position in high-growth segments of the complex radio frequency market, which will be primarily driven by 5G adoption, 4G LTE expansion in China, and increased defense spending (proliferation of gallium nitride), and to a lesser extent, IoT, advanced automotive connectivity and Infotain- ment, and the development of Smart Homes. 5G represents a global economic catalyst for devices requiring RF components with data rates 100x faster than 4G, extremely low latency and the capacity to support bil- lions of networked things.

QRVO has numerous company-specific factors which should drive organic operating margin growth going forward. These include: 1) higher utilization at its fabs after hiring a new Head of Global Operations, rational- izing its manufacturing footprint and outsourcing non-core product components; 2) increasing wafer sizes for its filters (6” to 8”) and gallium nitride (4” to 6”) chips which will expand gross margins; 3) revenue mix shift to higher margin products; 4) economies of scale/operating leverage given duopolistic/oligopolistic positioning in a growing industry; and 5) the adoption of Lean practices.

QRVO offers differentiated and integrated connectivity solutions to solve some of its customers’ most com- plex problems. These solutions are critical functional components in their respective devices and customers have historically shown a high willingness-to-pay for best-in-class technologies due to rising expectations from end-consumers and pressures applied by carriers, whose brands are at risk with end-consumers. In high-end 4G smartphones, RF content has replaced the baseband (where Qualcomm dominates) as the most critical and difficult component of phone development and it now commands premium prices.

QRVO’s early adoption and heavy investment in the development of two key technologies has created a com- petitive advantage relative to QRVO’s closest competitor, Skyworks Solutions (“SWKS”), who does not cur- rently have these capabilities, as new wireless devices will require exponentially more RF content that is small- er, more powerful, more energy efficient, while operating at wider range of frequencies. These technologies are broad acoustic wave (“BAW”) filters and gallium nitride (“GaN”); both are expected to deliver strong growth from 5G. Based on recent design wins and consistent quality of customer feedback, I believe QRVO has a superior technology portfolio and is well positioned to win back market share in next-generation connectivity products.

QRVO trades at an attractive valuation based on forecasted FCF estimates and current multiples of 11-12x NTM P/E relative to the broader semiconductor industry. This opportunity exists for three primary reasons: 1) QRVO has suffered from execution mishaps since the 2015 merger between RF Micro Devices and TriQuint Semiconductors and investors are skeptical about management’s ability to hit margin guidance; 2) The Company has significant customer concentration risk with approximately 36% of its revenue coming from Apple (or known Apple suppliers), and roughly 50% of its revenue coming from its top three customers; Page 20 Qorvo Inc. (QRVO) - Long (Continued from previous page) and 3) the company operates in the notoriously cyclical business of mobile phones.

Company Overview QRVO offers a broad portfolio of RF solutions, differentiated analog semiconductor technologies, deep systems-level expertise, and scale manufacturing to customers in high-growth markets, including: smartphones and other mobile devices; defense and aerospace; Wi-Fi cus- tomer premises equipment; cellular base stations; optical networks; automotive connectivity; and smart home applications. The Company focuses its efforts on the most complex and fastest growing segments of the RF market. QRVO competes with SWKS and Broadcom in the RF space.

The Company operates in two segments, Mobile Products (“MP”) and Infrastructure & Defense Products (“IDP”). MP is the Company’s largest market (~70% revenue), in which it provides cellular RF and Wi-Fi solutions into a variety of smartphones, notebook computers, wearables, tablets, and cellular-based applications for IoT. 5G phones are expected to have substantially higher content values than current premium generation 4G LTE phones. IDP (~30% revenue) is a leading global supplier of RF solutions with a diverse portfolio of solutions that “connect and protect,” crossing communications and defense applications.

IDP contains six of the Company’s seven strategic end markets: 1) Defense and Aerospace - Capabilities include satellite, radar, electron- ic warfare and communications systems, such as found on submarines, navy battle ships, or F-35 fighter jets. The DoD has certified QRVO’s GaN fabrication and production capabilities at Manufacturing Readiness Level 9, the highest in the industry; 2) CPE Wi-Fi; 3) Cellular Base Stations - 5G network will require exponentially more base stations and RF solutions than previous generations; 4) Optical; 5) Automotive Connectivity - More connected device with the addition of multiple RF-based connectivity solutions such as satellite radio, in-car infotainment, and LTE connectivity solutions; 6) Smart Home.

The Company was formed by the merger of RF Micro Devices, Inc. and TriQuint Semiconductor, Inc. in 2015 to achieve: economies of scale; competitive advantages in manufacturing; better financial performance from ~$150M of expected cost synergies and best practices sharing; and leveraging one another’s unique technologies to create the most comprehensive portfolio of RF solutions to mobile and infra- structure customers. Since the merger, operating margins for the whole industry have substantially improved due in part to better supply/ demand dynamics.

*Competitor A is Skyworks and Competitor B is Broadcom

Despite having the most complete portfolio of RF technologies, BAW and GaN are expected to be QRVO’s main growth drivers. BAW demand is expected to escalate in the future as the shift to 4G LTE and 5G will require more band width at the higher end of the spec- trum above 2 Gigahertz, where surface acoustic wave (“SAW”) is unable to perform. GaN is used in QRVO’s IDP segment in place of silicon when high-power and high-frequencies are required, and quality performance is more important than cost efficiency. GaN has his- torically been used in the defense and aerospace sector (fighter jets, satellites, etc.) but is being adopted at a greater pace into other infra- structure applications like base stations given the increased performance needs at high-power/high-frequencies due to increased data traf- fic.

Valuation I arrived at my valuation target range of $100-$110 (40%-54% upside) through a combination of DCF scenarios and a sum of the parts valuation based on MP & IDP’s 2020E operating incomes. In my base case, QRVO generates a 10.7% topline 5Y CAGR while through -cycle operating margins expand from the idiosyncratic tailwinds described above. I believe this is a conservative forecast compared to the 10-15% expected industry growth rate and operating margins generated by close competitors.

The valuation implies a 9.0x 2020E EBITDA of $1.5B and 13.0x 2020E EPS of $8.35 vs. consensus $7.11. In the sum of the parts valu- ation I assign IDP a higher 2020E EBIT multiple of 16x vs. a 10x multiple for MP given IDP’s more attractive fundamentals and sticky busi- ness. 2020E FCFF of $860M implies a 9.3% FCFF Yield based on QRVO’s current enterprise value. The weighted average of my bear cases ($60 target) represent a 16% decline while my bull case ($150 target) represents 110% upside to intrinsic value. Page 21 Greenhaven Road Capital (Continued from page 1) M.A. from the Stanford One of my first tasks there Capital. They actually valued a University Graduate was to take the Kleiner non-cookie cutter background, School of Education. Perkins frameworks for took a chance, and hired me. evaluating investments – Dan and Keith are very Graham and Doddsville looking at product, market, talented investors and opened (G&D): Scott, could you start team, and execution risks – my eyes to the opportunities by introducing yourself, and apply them in a social in special situations. including how you first got into context to education investing? businesses like charter school I loved my experience at management organizations and Litmus. Unfortunately, my Scott Miller (SM): I majored various educational software timing, yet again, was not great in political science at the companies. Those frameworks because I was there for the Scott Miller University of Pennsylvania and were very helpful in organizing financial crisis. Afterwards, graduated into a recession in a set of investing principles, Litmus didn’t need me the early 1990s. Between my and I still use them today. anymore, and I predictably poor job searching skills and couldn’t get a job in a post- the economic environment, Around the same time, I also crisis hedge fund market with the only job I could get was started investing in the public too many analysts and far too managing a small family-run equities market, applying what few job openings. manufacturing business. Instead I had learned at Stanford and of doing the typical two-year what I was learning at After some outstanding analyst program at Goldman NewSchools. I had a fair returns in my personal account Sachs, I did four years in a amount of success investing my in 2009 and 2010, I finally said, paper bag factory in Yonkers, personal account. I was “I can do this myself.” So, in New York. Given my concentrated, owned the right 2011, I cobbled together ten background, I probably have companies, and was limited partners (so it wouldn’t more operating experience compounding at multiples of just be my personal returns than the typical portfolio the market. I remember one anymore) and for the first four manager. Spending four years year where I was up over 40% years ran the fund on the side in the retail packaging industry in my personal account while while I had a day job in an gave me a front row seat to my roommate from college, operating business that I co- how a bad business operates – then working at a big fund, was founded. While I knew how to one with low barriers to entry, up 15%. My numbers were invest on the side and was cyclicality, anemic margins, and basically 3x as good as his, yet having success, I was not commoditized products. Not he still took home $4 million raising any additional capital the type of business I would that year – many multiples of while holding an operating job. invest in today. what I made. That’s when I About three years ago, I decided I wanted to work at a decided to pull back to an I eventually helped sell the fund and invest more than my advisory role at my business manufacturing business, which I own capital. and transitioned to make guess was a good enough story investing my full-time focus. to get me into Stanford At this point, I was thinking For students wondering how Business School, where I went more about investing than my they are ever going to start a through the value investing main job. I wanted to invest fund: if you invest in a track with Professor Jack professionally. But even though concentrated manner with low McDonald. After Stanford, I I had a prestigious business turnover, it is possible to form worked for a venture degree and an outstanding a partnership on the side for philanthropy nonprofit called personal track record, I was friends and family and develop NewSchools Venture Fund, still coming from an operating a track record. You can even which was founded by John role, and no fund wanted to get this data audited at a later Doerr and Brook Byers from hire me. I reached out to two date, or at least have it in a Kleiner Perkins. It was double former Stanford classmates – useful form for any investor bottom line investing before it Dan Carroll and Keith who wants to do some due was trendy. Our primary Fleischmann – who had diligence. It de-risks the mandate was social return. recently founded Litmus process. (Continued on page 22) Page 22 Greenhaven Road Capital

G&D: What was the biggest investors have subscribed to a ownership, recurring revenue, lesson you learned at Litmus? three-year lock up. The and operating leverage. arrangement is ideal because SM: I learned how important the stickiness of our capital Today, there are increasingly it is for your investor base to allows me to buy low liquidity better tools out there that be aligned with your investing names with confidence and make it much easier to access strategy. At Litmus, our two minimal distractions. Many and process information. primary LPs had very generous companies we own are devoid Communities like Manual of liquidity terms – they could of short-term catalysts but are Ideas, SumZero, Value Investor effectively pull their money attractive long-term Club, Corner of Berkshire and whenever they wanted to. opportunities. I make no Fairfax, and even Seeking Alpha When the world was blowing promises to my investors have exponentially increased up in 2008 and 2009, and idea flow relative to when I people were taking liquidity started. Along with my greatly wherever they could find it, we “The ability to be expanded personal network of became very concerned that comfortable with a incredibly talented investors, the LPs would pull their capital. these resources give me a This shortened our investment divergent opinion, torrent of idea flow to sift horizon. I couldn’t present an through – far more than was idea that I thought would work the ability to not available when I first started in three to five years because out. we didn’t feel like we had panic...I think you three to five years. I started In terms of sizing, my sweet looking for ideas that could either have those spot is between 12 and 18 work very quickly, such as qualities or you companies. If my mandate those focused on earnings were to outperform the beats and misses. The terms of don’t.” market by the most dramatic our money at Litmus ultimately amount possible, I’d own one encouraged us to play a very about short-term performance, stock. But I wouldn’t sleep at difficult short-term game, a instead focusing on longer- night. This is still very style I am not suited for. term returns and the power of concentrated by most compounding. The strategy standards, but given that I The way I set up and have and the capital base are well- generally hold names over grown Greenhaven Road was aligned. longer time periods, I can be informed by my reactions to extremely selective about the Litmus experience. We G&D: Can you touch on your where I actually deploy capital. don’t have “hot” money. investing philosophy and if Greenhaven Road has about anything has changed since Overall, I believe that having 140 LPs, a majority of whom you’ve started investing? the right temperament is are high net worth individuals critical for investors, and I such as portfolio managers and SM: At my core, I’m a value don’t think that changes over former portfolio managers. investor. When I first started, I time. The ability to be We do no outbound loved 50-cent dollars – comfortable with a divergent marketing, active follow-up, situations where the valuation opinion, the ability to not capital introduction, gap may close by the dollar panic, the ability to buy more if networking, or cold calling. declining in value – but as I’ve there is an overreaction to People read the letters and can evolved, I’ve become more prices – I think you either have go on our website enamored with higher quality those qualities or you don’t. (www.greenhavenroad.com) to companies that I can hold for fill out a form requesting more longer. I’m attracted to G&D: In addition to having information. They choose to network effects, two-sided your traditional fund, you also invest because the thought marketplaces, and platform manage a fund of funds. What process and philosophy companies – these are the is the Partners Fund? resonate. It’s a very stable modern monopolies – as well capital base – nearly all of our as businesses with high insider SM: The Partners Fund is a (Continued on page 23) Page 23 Greenhaven Road Capital

boutique fund of funds focused time very well spent. so good for so long, and the on emerging managers whom I fund has enough AUM. believe are talented, G&D: Are there synergies for Nobody gets fired for investing underappreciated, and well- idea generation from the with a billion dollar hedge fund. positioned for long-term Partners Fund? The incentives are to keep success. The data suggests that your job and not stick your smaller managers outperform SM: It was a combination of a neck out for an emerging larger managers, but the glaring opportunity that I didn’t manager. Interestingly, when dynamics of capital allocation think others were seizing – people are investing their own make it so that some really investing with small managers personal capital, the calculation talented portfolio managers in a fund of funds structure – is different. For example, one are running peanuts and, for a of my LPs runs a multi-billion variety of reasons, investors “I often compare dollar family office. He is don’t want to take the headline comfortable putting his money risk. But, ironically, that’s performance and in the fund, but not that of the where the opportunity is. I’ll family he works for. Part of take hungry over fat and happy quality of ideas against what we’re doing in the any day. The Partners Fund Partners Fund is accepting invests in managers that are AUM and generally find some of the risks that come similar to Greenhaven Road in with smaller managers in that they meet the following a disconnect. I don’t exchange for hopefully criteria: an investment believe allocation of outsized returns. My diligence committee of one, process for the Partners Fund concentrated holdings, assets to fund managers is also much different than that reasonable AUM, significant of many allocators. It is less personal investment, original is as efficient as it quantitative and more focused thinking, and a mindset where on individual ideas and the getting rich is not the point. should be.” entire thought process. I would much rather have three Now, a fund of funds focused an opportunity for years of investor letters than on small managers is not a very diversification for my family, return statistics. good business – charging a few and a potential source of ideas. basis points on relatively It didn’t hurt that I thought it G&D: In general, what’s your modest amounts of capital is would be fun and interesting. research process like from not a great set-up. Thus, most sourcing ideas to making an funds of funds want scale. They G&D: Why do you think the investment? need hundreds of millions of market for allocating to funds dollars to make the business is skewed such that larger SM: The research process work, which means they need funds get the vast majority of depends on both the source of to invest larger checks in the assets? the idea and how close it is to larger managers. I didn’t launch something we’ve done in the the Partners Fund to make SM: I often compare past – effectively how much money on fees; I launched it to performance and quality of domain knowledge I have. In formalize my relationship with ideas against AUM and general, I’m trying to get select other managers and give generally find a disconnect. I comfortable with product, my LPs access to them as well. don’t believe allocation of market, team, and execution assets to fund managers is as risk. For me, the Partners Fund efficient as it should be. allows me to collaborate I look for certain attributes to frequently with whom I Part of the challenge is if you filter ideas quickly. For consider to be some of the are a gatekeeper, the accepted example, I prefer high insider most promising investors of strategy is to wait until the ownership, asset-light business my generation. If I get one statistical evidence is models (even though Fiat good idea a year that finds its incontrovertible – when the Chrysler – which we own – is way into our main fund, that is performance of a manager is not asset-light) recurring (Continued on page 24) Page 24 Greenhaven Road Capital

revenue, expanding margins, platform, as the 5% rate is still and have an asset-light model and the potential for operating very competitive compared to with real barriers to entry. leverage. alternatives. A potentially greater than 50% increase in G&D: What are some other The other piece is what revenue with no associated examples of under Murray Stahl calls invisible expense increase is a great set- monetization? companies – companies that up. However, the increase in don’t screen well, aren't revenue won’t immediately SM: TripAdvisor only necessarily telling their story drop to the bottom line, as monetizes somewhere around well, and aren’t covered by Etsy will reinvest a significant 1% of their traffic. Now, some analysts. In those cases, the portion of the revenue into of that traffic they can’t research process is initiated by building out the demand side monetize; for example, if a other people explaining the of the platform. traveler searches for best idea to me. Then it becomes, places to take a hike in a “What are the pieces I have to At the end of the day, Etsy has specific destination. But fill in?” a very attractive, niche TripAdvisor is working hard to business that can grow many get bookings – restaurants, G&D: What are some themes multiples of where it is today. museums, attractions – done you’re seeing in the market There is room in the world for directly on the site, so I think today, and where are you an Amazon alternative. Last it’s quite likely they’ll succeed finding opportunities? year, I needed an outfit for an in increasing monetization rates with attractions. SM: We’re nine years into a bull market – it’s expensive. “The opportunity for Like Etsy, they sit between However, I’ve found improved earnings consumers and businesses. It’s opportunities in companies a very valuable resource, and that are under-monetizing without massive TripAdvisor has an excellent either assets or transactions in ecosystem with the most some way. Under-monetized spending—taking downloaded travel app and the companies can be attractive deepest reservoir of content because you can have earnings what you have and related to travel. The question growth without a significant is: can they get more booking increase in capital spending or just monetizing it—is activity on their site? If they SG&A. Success is dependent attractive and can improve the monetization on making tweaks to existing of their existing traffic, I think products or pricing. carries less execution the investment will work out Additionally, fixing quite nicely. monetization generally has risk.” lower execution risk. G&D: Is under-monetization ‘80s costume party. Naturally, I the main theme in your G&D: Your Etsy investment searched “’80s costume” on portfolio? aligns with this under- Amazon Prime and received monetization theme. Can you my shipment in two days. It SM: Since I have the vast discuss your thesis there? couldn’t have been more majority of my life savings in convenient. The only problem the fund, my interests are SM: Prior to this year, Etsy’s was that every other guy at the highly aligned with my commission fee has been set at party did the same thing. One investors, so I don't want to 3% of sales since the guy had the exact same only own companies that are company’s launch. A big part of costume as me, and I under-monetizing. the stock’s appreciation this recognized the costumes of a year was driven by the dozen other people. I don’t I see value in diversification company’s decision to raise its shop on Etsy for every across investment theses, commission fee from 3% to 5% purchase, but if I want market caps, and even with no expected decline in something special, I go there. geographies, but I do think the number of sellers on the They operate in huge verticals under-monetization is one of (Continued on page 25) Page 25 Greenhaven Road Capital

the current main themes. The Lancias to high margin Jeeps clearly prefers asset-light opportunity for improved and Alfa Romeos. The margins businesses as he has invested earnings without massive on a Fiat Panda are sub-5% in media, reinsurance, and now spending – taking what you while the margins on a Jeep startups. I don’t think Elkann have and just monetizing it – is Wrangler – although the ultimately wants to own Fiat attractive and carries less company doesn’t disclose them Chrysler or its parts unit execution risk. – are probably around 35%. If because it’s not a great you focus solely on car volume business—it’s cyclical, and over We own Scheid Vineyards or top-line and don’t want to the cycle it should have which is a growing sum-of-the- focus on the mix of what those relatively low returns on parts story. It is a family- cars are going to be, you miss capital. I think spinning off the controlled wine company a major part of the parts business makes it easier where the land value is worth opportunity. Fiat Chrysler is to sell the entire company. 2x the share price. So, this is reducing the low margin fleet an example of a 50-cent dollar, business by getting out of Charlie Munger discussed that but what’s interesting is that sedans and focusing on SUVs, over a 40-year period, returns they are transitioning from aligning themselves with start to mirror return on selling grapes to selling their customer preferences and invested capital, regardless of own branded products. They higher margins. They are also what you pay for the company. have gone from a standing going to either spin off or sell I think Elkann wants to reset start to selling 600,000 cases of their parts division. If you back what they’re invested in. He finished goods per year. They out the parts business, you're won’t give Fiat Chrysler away, have the capacity to produce getting the core business for but I suspect that over the approximately two million less than 3x earnings excluding next couple of years, Elkann cases with minimal incremental net industrial cash and the will be out of the parts capex. If they are successful in parts business. That’s an business and will sell the core their continued path towards attractive multiple for a auto business to another OEM selling more branded products, growing earnings stream and a so that he can redeploy the the economics should work business that should remain capital at higher rates. Keep in out well for shareholders. profitable even if US new car mind – combining large OEMs sales decline by 30%. will yield enormous savings. G&D: Fiat Chrysler is one of your top five positions. Can G&D: You mentioned in your G&D: You mentioned that you walk us through your last letter the importance of you really admired late Fiat thesis? understanding the motivations Chrysler CEO Sergio of key actors. Can you expand Marchionne. What specifically SM: Let me start by saying this on that in the context of Fiat did you like about him? idea lacks some of the criteria I Chrysler? discussed before in terms of SM: To me, Sergio was like a recurring revenue, but it does SM: A large part of this job is five-tool player in baseball. have high insider ownership trying to put the puzzle Those are the guys that can hit and operating leverage. I have together – trying to for power, hit for average, run, owned Fiat Chrysler since it understand what the key throw, and field. At Fiat, he was just Fiat and traded only in players’ incentives and executed at the highest level. Italy. Despite returning preferences are. Fiat Chrysler He led the acquisition of multiples of our original is controlled by the Agnelli Chrysler without having large- purchase price already, I still family. Their holding company, merger experience. He spun believe it is very attractively Exor, holds 30% of the stock. off Ferrari and articulated a valued. This is a company that vision for increasing volumes has a portfolio of valuable John Elkann inherited the Fiat and expanding margins. He brands yet is also a turnaround holding from his grandfather. created so much value over his story with legs. They are However, the investments that time. Shareholders got over a making a very accretive shift in John has initiated during his 30x return. I also found his manufacturing capacity away time as chairman of Exor are speaking on conference calls to from low margin Fiats and decidedly not industrial. He be operatic. He was (Continued on page 26) Page 26 Greenhaven Road Capital

enthusiastic, dismissive, and competitor was the Yellow advertisers as well as the honest in a way that felt Pages, which was sold on lifetime value of those authentic. You don't see that twelve-month contracts. advertisers. They have a long very often. He would be on my Initially, Yelp matched this time runway. Mount Rushmore of CEOs. frame and went to small businesses saying, “Don't G&D: That’s the type of thing G&D: Given your position in a quant model would not pick CBS students Matthew the auto industry, do you have up on, as you discussed in your Stevenson ‘19, Jade Hu any views on autonomous “If you’re just letter, because the historical ‘19, and Victoria Gu ‘19 vehicles? data doesn't give any indication socializing at the 2018 investing to make that it’s occurring. How do Value Investing Reception SM: I’m very skeptical about you evaluate a business that’s autonomous vehicles. People money, the guy who growing intrinsic value per have this vision that eventually share that doesn’t show up in loves investing and is we are not going to own cars GAAP financials? because there are going to be thinking about his on-demand fleets. As it stands, SM: In general, most of the autonomous vehicles don’t portfolio while he’s in companies we invest in have work except for in the most progress that doesn’t mundane conditions, such as in the shower and while necessarily show up on the Arizona where there are no earnings line. We own a pedestrians, snow, or rain. In he’s walking his dog is marketing automation software additional to the technical company SharpSpring that is challenges, there are also probably going to acquiring customers at one- economic challenges because kick your ass.” sixth of their lifetime value. I the LIDAR (Light Detection think the most rational way to and Ranging) components are operate that business is to not currently cost-effective. advertise in the Yellow Pages. acquire customers. The ROI Assuming you solve the Give us $3,000 or $4,000 and on marketing is fantastic. As technical and financial issues, advertise on Yelp for the long as marketing efficiency there are still regulatory year.” That's a fairly big ask does not deteriorate, they hurdles, consumer depending on the size of the should acquire, acquire, preferences, and execution business. Eventually, Yelp acquire. In fact, I would risk surrounding production. started testing month-to- borrow money to acquire Last year, the former head of month and even day-to-day customers, which is what they Waymo (Alphabet’s advertising and found that eventually did. However, this autonomous driving subsidiary) shorter, more flexible time company will screen poorly on forecasted no legal periods returned greater traditional value metrics. autonomous level-five vehicles customer lifetime value than Earnings? They have none. before 2030. annual contracts. This Book value? Their main asset is effectively reduced the cost their customer base, which is I’m currently teaching my 16- and risk of a trial period and, not valued on the books at all. year-old daughter how to not surprisingly, more But, there is enormous value in drive. Believe me, I wish we businesses turned to Yelp. the customer base if their had fully autonomous today. They knew that churn would lifetime values are anywhere Fiat Chrysler will be sold long go up, but bet that would close to right. With these before the autonomous fleets ultimately be outweighed by technology companies, I end are swarming our streets. the increased number of up looking more at customer advertisers. Yelp has also retention rates, net dollar G&D: Can you run through started rolling out a non-term retention, customer acquisition your Yelp thesis? model this year. As costs, and growth rates. penetration increases, I think SM: The thesis on Yelp is there is an ongoing G&D: I notice you’ve been a straightforward. When Yelp opportunity to radically lot more active on the long started, their primary increase both the number of side in recent years. How do (Continued on page 27) Page 27 Greenhaven Road Capital

you allocate your time, in important thing to do is to terms of idea sourcing, invest your personal account. between long ideas and short You learn far more from ideas? Is there a systemic owning stocks than anything reason why you’re not as else. involved on the short side recently? I would also say, quite frankly, that there are higher callings in SM: We’ve historically had a the world. If investing doesn’t long bias. Our longs can be really compel you and keep 15%+ (as a percentage of the you up at night and excite you, portfolio) positions. For an go do something else. There individual company short, we are a lot of ways to make tend to take a 1% or 2% money. If you’re just investing position. The upside on a long to make money, the guy who can hopefully be 5x, while the loves investing and is thinking upside on a short is a double – about his portfolio while he’s at best – if it goes to zero. We in the shower and while he’s end up spending a lot more walking the dog is probably time on the longs. I’m not going to kick your ass. Only do trying to be market neutral. it if it absorbs and compels you. G&D: Do you short indices? If yes, can you talk about why G&D: Thank you so much for and how? your time.

SM: There are a couple reasons why we may short indices. Sometimes we want to take risk off without triggering a tax event. We are heavily long-biased and own many positions with large embedded gains. It’s not a perfect hedge, but shorting indices versus selling and going to cash allows me to sleep better. We don’t take on a lot of leverage – we might be 110% long and 12% short. It’s pretty slim; it’s not our core business.

G&D: Any advice for students who are trying to get into the investment industry? How would you suggest they develop their investment philosophy?

SM: In my experience, the hiring process is very idiosyncratic, so I would not read too much into inevitable rejection. If you think you really like investing, the most Page 28 Wall Street’s GE Bear (Continued from page 1) the $30s. After the stock the shackles are off.” The bulls EPS through cost cuts, capital dropped by more than were saying that the deployment, and end market 60%, some Wall Street divestiture was going to growth. The stock was in the commentators labeled the unmask all the great things high $20s at the time, and the call “one of the greatest about GE Industrial. bull case applied a 20x P/E stock calls of all time.” multiple to $2 in EPS to get to Note: This interview We went on restriction $40. What we noticed was the occurred on September 5th, because of the deal. You're not industrial cash flow was not 2018. allowed to do much when growing as fast as the earnings you’re on restriction because suggested. Graham & Doddsville of the wall between banking (G&D): In May 2016, you and research, but you can At that time, our tagline was, Steve Tusa went from having a No Rating watch the stock and you “Estimates are too high and on General Electric to an continue to maintain a model. cash is too low.” We basically Underweight rating. Can you You certainly don't send that thought that their EPS would talk about your research model out, and you certainly come in closer to $1.80 than process and what prompted don't talk to clients, especially $2, of which cash flow would the call? about things other than pure be closer to $1.50-$1.60. That facts. But it was instructive may not sound like a big miss, Steve Tusa (ST): Absolutely. being on the sidelines and just but in the context of my I got the senior position [at JP watching for the better part of coverage universe, where a lot Morgan] in 2005, and we have a year. of companies were beating been covering GE since then. numbers and many had above We went on restriction After GE unloaded GE Capital, 100% conversion of cash flow because JP Morgan Investment the company started talking a on earnings, we thought that Bank helped them divest most lot about their digital platform either the stock was dead of GE Capital, so that's why we – that’s when IOT started to money on a modest earning didn't have a rating in 2016. emerge on the scene, and GE miss, or it could drop by 10- Actually, right before they was making a big pitch around 20% on a more significant announced the GE Capital IOT – which many investors earnings miss. divestiture, we put out a were buying into. Since we presentation that was one of were on the sidelines, we got Our process for GE was not our “Where we could be to really step back and absorb typical for most of the Street. wrong” reports. The report what was going on with related Our initiation report was 200 basically said, “Look, we're expectations. Yes, they were pages because a) a lot had negative today. We understand losing a lot of earnings and happened between the time the stock is cheap. We’re cash flow with GE Capital, but we went on restriction and the trying to get positive, but here they said they were going to time we came out are the reasons why we can’t.” backfill some of those earnings Underweight, and b) when and cash flow with buybacks making a call like this, it’s A few weeks after we put out and capital deployment, important to be extremely that report, GE announces the meaning less dilution, while open and honest with clients GE Capital transaction. The their positioning in IoT would and the company. Lay it all out stock goes up a lot because drive a higher multiple. there. Show them your work the negative thesis on GE in so they can agree or disagree. the past was that they have a What we saw was a growing big finance arm that nobody discrepancy between a) That 200-page report was just understands, which is a big earnings expectations and what the start. You start by pulling a risk, and therefore the stock the end markets were little bit of string, but soon you deserves a significant discount suggesting, and b) earnings try to pull as much as you can. on earnings. That had been the expectations and cash The more you pull that string, drag on GE forever. When generation. Back then the big the more your knowledge base they announced they were expectation was $2 in earnings enables you to understand data getting out of GE Capital, the per share (EPS), and everybody points and news flow and put market reaction was, “Okay, believed GE could get to $2 in them in the proper context. (Continued on page 29) Page 29 Wall Street’s GE Bear

For example, we had a couple our research and cut his price people, “No! Here’s how you meetings with financial services target by 20%. The key is to be walk to my free cash flow people regarding GE Capital out in front of those guys. numbers.” I wasn’t even talking and its downturn, and I could about a dramatically tell right away that its scope G&D: Was the rest of the differentiated view, I was just was beyond me. But I had Street bullish when you came explaining the numbers and enough of a background to out with that first Underweight reporting structure. I mean, know exactly where to dig and rating in May 2016? even as recently as last year, go deep, and soon enough I there were competitor reports became like a financial services ST: Everybody was, yeah. showing historical free cash analyst. With GE and the size flow conversion that included a of its legacy financial services G&D: What kind of pushback GE Capital dividend. business, mastery of the did you get? balance sheet becomes crucial; The other big pushback was you have to understand the ST: The pushback was that I was too negative on the complexity of how it all fits interesting because there were oil and gas market. Looking together. As you go through a lot of generalists in the stock, back, that was probably the the process – we’ve written and generalists don't tend to easiest layup in this whole 1500 pages on GE in the last dive as deep as the analysts do. analysis. The rest of the stuff two years – it allows you to Our initial call was on cash was a little more nuanced. recognize the next step of the process because you’ve done “Understand that this G&D: When a company is the work. But again, the point cutting costs, how can you tell is that we didn’t know is a very long game. if they have cut too far? everything in 2016. You begin to see the whole picture as Nothing comes in the ST: You have to know the you work through it, and this business well enough to be in time, probably the biggest first several years. I touch with the channel. swing factor has been the think it takes six years, Feedback from the channel will Power business. Here, because either reveal a dip in service of the work we’ve done, almost a full cycle, for quality or a lack of buzz executives from GE’s around new products. Often, competitors like Mitsubishi somebody to really you’ll see it in growth rates Heavy and Siemens will read versus peers, sales per our work, and they actually learn the business.” employee versus industry- start emailing and calling us to specific peers, and SG&A as a talk about the industry. flow. When GE sold GE percentage of sales. GE was Capital, they sent all the cash pitching SG&A reductions, but The research builds on itself in from those sales up to the their SG&A was around 12% so many different ways. The parent as a dividend, and their while peers were around 20%, key to it all is learning; if you're cash flow guidance included and a big part of SG&A was still learning something, you those dividends. If you were pension expenses which is not keep going. You don't know just looking at Bloomberg you really something you can cut. when it's going to pay off, but would’ve seen about $25 Again, if you know the the depth always pays off at billion dollars of free cash flow, channels you're going to hear some point. For example, a but that included the massive feedback regarding the quality bunch of Power data points dividends from GE Capital. of the service, and you can have come out in just the last Inherently, that was a one-time judge from that whether they three or four months, and item. So, if you were a need to spend more money. we've written three reports in generalist and you were the last three months about looking at GE on Bloomberg, G&D: What were Jeff how Power is going to get you would’ve checked the box Immelt’s major missteps before worse before it gets better. on free cash flow and said, he stepped down? And just today a competitor “Yeah. Okay. Fine.” I came out essentially reiterating remember explaining to ST: I think everybody would (Continued on page 30) Page 30 Wall Street’s GE Bear

agree that when you come in about GE’s lack of external company with structural as a new CEO and replace a hires. It’s hard to change a overcapacity, mostly in Power, legend like Jack Welch, it's culture with people that have oil and gas, and very hard to walk the fine line been there for decades. I’m transportation.” Can you of not “resetting.” I don’t think skeptical that they can change expand on that? there was a real reset. He quickly without some fresh must have known that Welch’s blood. Now, 30% of the board ST: At GE’s peak in 2000 – performance was is new, so they've got fresh when Jeff took over – GE was unsustainable. A wise man blood there. And I really trading at around 40x earnings. once said that being CEO of admire Larry Culp – I think That was clearly unsustainable. GE is like being a head of state. he's the best CEO our sector How do you take a $150 It’s a very hard, complex job has ever had – but I think it billion company and grow it with many different takes more than a couple of into something that can constituencies. board members to change the actually sustain that multiple? culture of a large organization. They started moving further I think one of the big issues That's going to be a long, long out on the risk curve by was the culture. Most people process. placing bigger bets in very who worked there will tell you visible ways. Typically, those that bad news was not G&D: Didn’t they reduce the bigger bids are going to be tolerated, and if bad news size of the board too? more competitive. GE went were to arise, they would try into Saudi Arabia to try to help to do something to make it ST: Yes, they reduced the size them build their Power look better. For example, GE’s of the board as well. It’s hard infrastructure, but Mitsubishi Alstom purchase, as part of the to make quick decisions with a and Siemens were there in the Power business, was not a board of 18 people. The old same conference room, good strategic decision – $10.5 bidding for the same projects. billion of cash they really could “The point is that GE GE winds up announcing a $5 have used is currently billion deal to build the facility, generating negative cash flow. went everywhere to and they hire 700 locals to get Same thing, quite frankly, with the deal done. their Baker Hughes acquisition. grow revenue just to Baker Hughes cost them $7 Now what happens to that billion of cash to try to patch justify the multiple. business? If there’s no follow- up the oil and gas segment as When you do that, you on order in the next two that market collapsed on them. years, or if there are a bunch I think those moves are move further and of follow-on orders followed probably a result of the by a collapse in oil, you know cultural mindset. I wasn't further out on the risk that they have set up shop for covering the company when 50 years but ultimately Jack Welch was there, but the curve.” probably only have enough to culture probably needed to fill up half of it. You have to go change over time. Their new board had some very through each press release and management has acknowledged legendary people on it, but I understand what the makeup that. They’re working to think the new board is much of each deal is, and then you change it, but it’s a hard more lean and agile. have to watch to make sure problem to address with a there are follow-on orders, 300,000 employee company, G&D: Here’s a quote from and you have to track the and it's especially hard to one of your reports: “Put returns over time. The Middle address over a nine-month simply, poorly timed East was 35% of demand for period when you are investments to catch up in gas turbines for several years, constantly putting out fires like emerging markets, optimistic while GE is sitting there with internally-sourced CEO John growth assumptions for this plan to build and service Flannery was. resource-rich countries, and a gas turbines that suddenly corporate imperative for aren't being ordered. I've been vocal in our research market share have left the Again, you have to track (Continued on page 31) Page 31 Wall Street’s GE Bear

everything. Everybody is businesses. They’re leaders, ST: Yes, 100%. They’re a very probably bullish when that and they're optimistic people good marketing company – press release comes out. But by nature. But you’re in a seat ecomagination is brilliant, right? you put that in the back of to take a differentiated view, Those leading digital industrial your mind and say, “Saudi and if the numbers show you TV commercials are great. Arabia, is that really something different, go with it. Outside of marketing, you sustainable? Is it dependent on Don't worry about what other have this financial beast with oil prices?” And ultimately, people are saying or what's three different balance sheets. when oil prices go down and driving the stock’s initial When you combine people are worried about return. If your thesis is right, complexity and marketing – I selling Schlumberger, you think the stock is going to go where don’t think we'll ever see this in the back of your mind, it's supposed to go. confluence again. Look at “Wait a second, didn’t GE have Apple – they’re not that to build that plant and book When you have a better base complex, right? You just need that order in Saudi Arabia? of knowledge than anyone else, to predict how many iPhones How much demand was that go all in and be as vocal as they will sell. Stock going down for them?” You start possible. I don't want to in a company the scale of GE – connecting the dots and overstate the drama, but that's this has been a confluence that realize, “Wow! That’s probably it. And by the way, GE’s stock I don’t think I’ll see again in my not going to end up looking didn't go down until about one lifetime. like a good investment.” And year into the call. But by the sure enough, there was an time something finally started G&D: How do you prepare announcement in the press happening in the second for a media appearance on two months ago that Saudi quarter of last year, we had CNBC where you only have Arabia is now bidding out the already developed a honed-in three minutes to deliver your service work on GE’s gas view of the power market and pitch? What is your mindset? turbines in the Kingdom, which were able to see through the is the more profitable part. noise. When they made ST: Well, I’m supposed to cautious comments on the wear a suit and tie, but I always The point is that GE went second quarter 2017 call, we change into a golf shirt and everywhere to grow revenue knew right away what the issue vest. Just kidding. No, I just just to justify the multiple. was. I remember pinging my make sure I have the talking When you do that, you move associate Rajat, saying, “Wow, points in my head. When you further and further out on the this is it. It’s happening.” talk about something that you risk curve. Meanwhile, most of the people know, you don't need to recommending the stock prepare. This job is a lifestyle. G&D: What are your big probably just asked the It doesn't consume me all the takeaways from covering GE company about it and were time, because I love my family for the past two years? told something like, “Well, and there are other things I we’re still in good shape, and like to do, but it does fill the ST: Read everything you can. this is temporary.” But we gaps. I was a radio host in Know the balance sheet and knew exactly what was college and like to talk, so that the cash flow statement inside happening. Again, we had read also helps. and out. Most companies are through utility filings to figure not this complex and don’t out what they were doing with I interviewed at another bank a have this many moving parts. their Power upgrades and how long time ago, and the product GE’s 10-K is 270 pages, the accounting works. manager there had a great whereas most 10-Ks are closer Fundamental research – in- saying: “Make ‘em think, make to 100 pages. Talk to depth fundamental research – ‘em laugh, make ‘em money.” I everybody in the channel. absolutely works. think that’s the key to this job. Learn about the business and There are a lot of people who do your own work. G&D: Do you think GE was are fun who you wouldn’t ripe for a differentiated view mind grabbing a beer with. Management teams are going because of how complex the Then there are some people to be bullish about their company was? who do really good work who (Continued on page 32) Page 32 Wall Street’s GE Bear

can make you think. But there managers, all that stuff. I really job in front of him is nothing are very few who can really do believe though, that if you like the one he had at make people money. work hard for a long period of Danaher. That was all about time in this business, it’s how effective he was at But if you can do all three of worthwhile. deploying an abundance of those? That’s what I try to do. available cash from operations I didn’t go to an Ivy League “When they made and the balance sheet, as well school which I think gave me a as building on good businesses little bit of a chip on my cautious comments on and a great operating culture. shoulder. That kind of drives This is the exact opposite – you to work harder than the the second quarter essentially a work out situation other guy. And I do believe with 50% of the businesses this GE call has been about 2017 call, we knew highly challenged and hard work. It’s not about me generating negative cash flow, being brilliant – you should see right away what the and a highly levered balance how I handle my personal issue was… sheet that needs to be financial statements. It’s not unwound from years of pretty. Meanwhile, most of cultural financial engineering.

G&D: We usually close by the people Once again, the Street is asking for general advice for getting bullish simply because MBAs heading into the recommending the there’s a new CEO. We investment management haven’t even seen how bad the stock probably just industry. numbers are, and we have to asked the company note that GE further cut ST: Wow. Pray that fees already-low guidance when stabilize. Just kidding, don't and were told announcing the new CEO. write that. I think intellectual Weak free cash flow and high curiosity is key, because that’s something like, “Well, leverage is a bad combination ultimately what will drive you. that we think will ultimately Be intellectually curious, but we’re still in good resolve itself in a dilutive way also understand that this is a for shareholders. The new very long game. Nothing shape, and this is CEO is a start to the healing comes in the first several temporary.” process, but unwinding this years. I think it takes six years, financially engineered almost a full cycle, for ecosystem is going to require somebody to really learn the [Editor’s Note: The initial more than just cost cuts. It’s business. I got the senior job at interview occurred on going to take time, and JP Morgan in 2005 and have September 5th, 2018, probably much more capital. In been covering this group since before Larry Culp was the end, we think things get 1998. It would have been very named CEO. The following materially worse before getting hard to make a call like this in comments were provided better. 2008. So, don’t sacrifice the to G&D on October 15th.] long term for the short term, G&D: Thank you. and build a strong base of G&D: What are your knowledge so that when the thoughts on the recent time does come, you’re development of Larry Culp dangerous. I can look back and replacing John Flannery as GE think about all the different CEO? paths I could have taken, but this is the only path that would ST: As I highlighted back in have led me to this call. It September, Larry Culp is one comes down to your body of of the best CEOs ever in our knowledge, the team you build, sector. However, this is a big, the support from your complex ship to turn, and the Get Involved:

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Graham & Doddsville Editors 2018-2019

Ryder Cleary ’19 Ryder is a second-year MBA student. During the summer, he worked in Equity Re- search at JP Morgan. Prior to Columbia, he was a Captain in the Infantry branch of the US Army. Ryder graduated from the United States Military Academy at West Point with a BS in Systems Engineering with a mathematics concentration. He can be reached at [email protected].

Gregory Roberson, Esq. ’19 Gregory is a second-year MBA student and a member of Columbia Business School’s Value Investing Program. During the summer, he worked in the Investment Banking Division at Goldman Sachs & Co. LLC. Prior to Columbia, he worked as a corporate attorney specializing in mergers & acquisitions and corporate finance. Gregory stud- ied finance and economics at the University of Cincinnati and received both his JD and LLM (Taxation) from Georgetown University Law Center. He can be reached at [email protected].

David Zheng ’19 David is a second-year MBA student. He spent last fall through this summer working as a Consumer Analyst at Balyasny Asset Management. Prior to Columbia, he was a Portfolio Manager at Peak6 Investments focused on single-stock volatility and special situations. David studied economics, political science, and business institutions at Northwestern University. He can be reached at [email protected].