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

Issue VII Fall 2009

Inside this issue: “Do an Excellent Job at a Few Things ” — Howard Marks

Amedysis Home p. 12 Howard Marks is co- G&D: Can you tell us about Health Svc. Stock founder and Chairman of your early career and what Analysis Oaktree Capital Manage- got you interested in invest- ment. Founded in 1995, ing? Care Investment p. 14 Trust Stock Analysis Oaktree manages over $60 billion of investments HM: Well, I’m not one of in a variety of less effi- those guys who started buy- Dave Samra— p. 16 cient arenas, including ing stocks at the age of six. Artisan Partners High Yield Debt, Dis- The key is that unlike the tressed Debt, and Private rest of the guys you talk to Kevin Dreyer— p. 22 Equity, among other as- who liked investing all of GAMCO Asset set classes. Oaktree’s their lives, I did not. It was Management excellent long-term track something I discovered late. record and Mr. Marks’ My dad was an accountant. I went to Wharton and Howard Marks, Portfolio Editors: unique investment phi- losophy have resulted in planned on majoring in Ac- Manager - Oaktree Capital Matthew Martinek a loyal following of in- counting, but I got more MBA 2010 vestment professionals. interested in Finance and I had a summer job in the Clayton Williams Since starting his career changed majors. In those investment research depart- MBA2010 in 1969, Mr. Marks has days we went straight to ment at First National City Bank (now Citibank) in 1968. James Dunavant seen a range of ups and grad school, so I went to the MBA2011 downs in the financial University of Chicago where When I was getting out of markets, from the I did major in Accounting to grad school, I had no idea Garrett Jones growth of the high yield complement my degree in what I wanted to do, so I MBA 2011 bond market to the cur- Finance. interviewed with one large Dan Kaskawits rent leverage meltdown. (Continued on page 2) MBA 2011 Welcome Back to Graham & Doddsville Contact us at: [email protected] Oaktree Capital Manage- philosophy. Mr. Samra and As we enter our fourth year, ment. His client memos his co-Portfolio Manager Visit us at: we are pleased to present www.grahamanddodd.com you with the seventh issue of have become must-reads for Daniel O’Keefe were named their insightful thoughts and 2008 International-Stock www0.gsb.columbia.edu/students/ Graham & Doddsville , Colum- entertaining commentary. Fund Manager of the Year by organizations/ cima/ bia Business School’s student -led investment newsletter We are privileged to have Morningstar . him share his investment co-sponsored by the Heil- Finally, we interview Kevin brunn Center for Graham & philosophy with us. Dreyer ‘05, a recent alum of Dodd Investing and the Co- Dave Samra ‘93, a CBS alum the Applied Value Investing lumbia Investment Manage- and portfolio manager for Program to gain the insight ment Association. Artisan Partners’ Interna- of a recent alumni whose This edition features an in- tional Value and Global Value career has spanned a very funds, provides some unique interesting time in financial terview with Howard Marks, insights into his investment the founder and Chairman of (Continued on page 2) Page 2

Welcome to Graham & Doddsville (continued from page 1)

(Continued from page 1) markets. Kevin provides an interesting perspective for investors and students alike. Along with providing our readers with insightful inter- views, we also aim to offer specific investment ideas that are relevant today. Inside are two student in- vestment recommendations, Amedisys (AMED) and Care Investment Trust (CRE). Please feel free to contact us if you have comments or ideas about the newsletter, as we continue to refine this publication for future edi- Seth Klarman, David Abrams, and Howard Marks at the 2008 tions. Enjoy! Security Analysis 75th anniversary symposium.

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(Continued from page 1) took place during this pe- were considered major re- management consultant, one riod. Citibank was a growth sponsibilities for both small management consult- investing shop and practiced budget and people, and it ant, one investment bank, what was called “nifty-fifty” was my job to know two one public accounting firm, investing. As a result, eve- sentences on three hundred one corporate treasury op- ryone who was in the non- companies – which I found eration, one investment growth areas – oil and gas, very unsatisfying. It was a manager, and in the end, I basic materials and so forth period in which I would say ended up going back to Citi- – kind of slipped away, and that I was disaffected. One bank because it had been a by the time the embargo of the great challenges in good experience. happened, we had no en- investing is captured in the ergy analyst, forest products saying that an analyst is So I started off 40 years ago analyst, chemicals analyst, someone who knows a in September of 1969 as an metals analyst, etc. So I was great deal about a few equity analyst following con- asked to put together en- things and learns more and glomerates and office equip- ergy and basic industry re- more about less and less ment other than computers, search groups, and it was until he knows everything which meant mostly copiers great to study the cyclical about nothing. And a port- and facsimile. I did invest- businesses to compliment folio manager knows a little ment research from 1969 the growth research. bit about a lot of things and until 1975 when I became learns less and less about director of research. One In 1975 I became director of more and more until he of the things that really research and that was a job knows nothing about every- added to my experience that I sorely disliked. I was thing. That is a dilemma, was the oil embargo that a 29 year old guy with what (Continued on page 3) Volume III, Issue 1 Page 3

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(Continued from page 2) able” and know it better quality of life, but there goes and I was very unhappy than others do. my career.” However, it is knowing a little about a lot. very important to be doing We had a new chief invest- High yield bonds have given what you like in circum- ment officer join in 1977, me the best possible seat stances that you like if you Peter Vermilye. Since we for observing what took can arrange it. I stayed with had been practicing “nifty- place in finance over the last Citi until 1985, and then I fifty” in a terrible environ- 31 years. was hired by Trust Com- ment for it, our perform- pany of the West (TCW) to ance was terrible, so the build their high yield bond whole existing team de- department. In 1987 my served to be sacked. I was “The single partner Sheldon Stone and I very fortunate that he asked decided to start a fund for me to start up a portfolio of most important distressed debt, and that’s convertible bonds, which I when I joined up with Bruce did on August 1, 1978. adage in the Karsh. Then a couple of months later Peter came to me and investment It helps to be early. I think said, “there is some guy both our high yield bond named Milken or something world is “what fund at Citi in 1978 and our out in California and he distressed debt fund at works with junk bonds – the wise man TCW in 1988 were the first whatever that is – and can funds of their kind to be you figure out what that is does in the offered by mainstream finan- because one of our clients beginning, the cial institutions. The single asked for a junk bond port- most important adage in the folio.” fool does in the investment world is “what the wise man does in the So I started managing both end.” beginning, the fool does in high yield and convertible the end.” I don’t know how portfolios. I went from hav- wise it was – maybe it ing these big organizational should be what the lucky responsibilities to just being G&D: Why do you say man does in the beginning, me at a desk, knowing all I that? the fool does in the end. could about some narrow But by the time all the fools market niches, and I was HM: Everything interesting jump on a trend and take it ecstatic. In our business, has taken place via the high to excess, it is a disaster. I success is a relative game. If yield bond market – buy- left TCW in 1995 with the you know X and everybody outs, recaps, and leverage. MDs who reported to me else knows X, then you The private equity industry and we started Oaktree. haven’t succeeded because has had a very significant The rest is recent history. you don’t have an advan- effect on altering the finan- tage. The key to success in cial landscape. For all of G&D: When did you read our business is beating the these things, the high yield Security Analysis? other people. To do this, bond market gave you a you have to know more front row seat. HM: While at Wharton, I than the other people. The took an undergraduate smaller the arena you try to In 1980 I asked the bank to course in investments in know about, the more it is move me out to California 1965, when there was no possible to know more than because I didn’t like New talk about CAPM or effi- the next person. So our York anymore. I said to cient markets or any of that motto is “know the know- myself, “I’ll have a great (Continued on page 4) Page 4

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(Continued from page 3) write about it, I was pleased is your attitude toward tak- stuff. You learned security to find that my recollection ing risk (and what is the analysis. They held up a was erroneous. attitude of your clients)? piece of paper and said, Are you a high-risk, high- “this is a security certifi- G&D: You have mentioned return manager or a low- cate” and they held up a in your memos that the risk, low-return manager? picture and said, “this is the number one priority at And if you think you can be stock exchange. And if you Oaktree is to avoid losses. a low-risk, high-return man- want to buy this, you call Can you talk a little bit ager - Good luck! It is not over there.” It was very about the role of risk man- hard to have a beta of 0.5 nuts and bolts, like being in agement in your process and return half of what the trade school. “This is an and how you think about index does, or a beta of 1.5 income statement and this is risk? and return 150% of what a balance sheet. You take the index does. The chal- this number and you multi- HM: I wouldn’t say prevent lenge is to have a return ply it by six and divide it by losses. I would say control that is more than commen- that” – very real world and risk. The two are different. surate with your beta. The non-theoretical. So yes, You can make sure that you difference is alpha, and if “What we want to Graham & Dodd was re- never have a loss in a bond you produce it consistently, quired reading in my first portfolio by buying Treasur- then that is the mark of a practice is the investments course. ies. What we want to prac- true professional: producing intelligent bearing tice is the intelligent bearing return that is more than G&D: Did it have any im- of risk for profit – not the commensurate with risk. It of risk for profit — pact on your investment avoidance of risk. Investing is hard to do. philosophy or discipline? deals with the future. Deal- not the avoidance ing with the future means So we are not a “low-risk” HM: I would say, not in its dealing with risk. investor. It is easy to say of risk.” specifics. Remember, I read “low risk.” It only takes it in 1965 and started man- What does risk mean? I’m two words. It takes a lot aging money in 1978. That’s not talking about standard more words to say “risk a lot of water under the deviation or volatility. Peter less than commensurate bridge, and I forgot a lot of Bernstein once said that with our return,” but that is the specifics. Have you read “risk means more things can our objective. my chapter in the new edi- happen than will happen.” tion? That is the way to think G&D: It seems that most about risk. There is a range investors focus more on the G&D: Yes of possible outcomes. return side of the equation What does that range look than on risk, whereas you HM: The main thing I re- like? What is the breadth of take the opposite perspec- membered about Graham it? How many of the poten- tive. and Dodd was the feeling tial outcomes are positive? that there were too many How many are negative? Is HM: That is important, and absolute rules. Do this. Do it a narrow or wide distribu- that is one of the reasons that. Multiply by three. tion? How many outcomes we are still around. Sun Tzu Divide by six. Don’t buy if are in the middle, and how said if you sit by the river the ratio exceeds 1.7x. I am many are in the tails? These long enough, you’ll see the an enemy of generalizations are the things that an analyst bodies of your enemies float and constants. As I men- or portfolio manager should by. The key is “long tioned in my commentary, think about. enough.” If you live long however, when I re-read enough, you have to be the the book in preparing to The other question is what (Continued on page 5) Volume III, Issue 1 Page 5

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(Continued from page 4) opinion like operating with- that are completely ineffi- survivor. When I was a kid, out a net. You can do it cient. It is all a matter of we didn’t have the video spectacularly . . . for a little degree, but I do think that games you have today, so while. There’s an old saying the public stock market is we used to listen to comedy in the business – “There are generally more efficient – records. One of the great- old investors, and there are especially as you get into est ones was Mel Brooks bold investors, but there are the larger stocks. It is cer- doing the 2000 year old no old, bold investors.” It is tainly more efficient than man. Carl Reiner says to very simplistic, but I think other markets. We are not him, “how did you get to be in public stocks and we are that it’s true. Columbia Business School is the world’s oldest man?” not in high grade bonds. If a leading resource for invest- And he says, “Simple. Don’t Back in the days when we you go back 30 or 40 years ment management profession- die.” How do you get to be were trying to get business ago, saying that you were an the world’s oldest investor? in US high yield bonds, investor meant that you als and the only Ivy League The answer is don’t crap which we largely stopped bought high grade bonds business school in New York City. The School, where value out. doing in 1998, we used to and stocks. These are the investing originated, is consis- compete in dog-and-pony things that people have been So if you look at distressed shows that the consultants very comfortable doing for tently ranked among the top debt where we started in would run. Consultants the last hundred years. Inef- programs for finance in the 1988, I could tell you who would bring in ten high yield ficiency largely comes from world . our number one competitor managers and they would the fact that people don’t was in every year through come to us afterwards and know about a market, don’t 1995 and not one is a main say, “Howard, you got the understand it, don’t have competitor today. And it’s job of being the core man- the relevant information, not because of what we did; ager – the steady-Eddie, the aren’t comfortable with it, all we did is perform consis- dull guy – and you’re getting or have some kind of preju- tently. They crapped out. $50 million. Bob and Carol dice against it. These are It sounds simplistic to say, are each getting $25 million the factors that create ineffi- “There’s an old but the first requirement for and they are the satellite ciency. You’re less likely to saying in the success is survival. And I managers. Their job is to find that in the mainstream think the best way to en- have more aggressive port- markets – stocks and bonds. business – “There sure your survival is to put folios and juice up the re- an emphasis on risk control turn.” I can’t tell you how G&D: I think that a lot of are old investors, – not on achieving high re- many times those people value investors would say turns. Controlling risk is disappeared. To have the that their key advantage is and there are bold our number-one goal, and I job of being a high-risk man- their time horizon. They investors, but there believe if more people had ager is risky business. play a so-called time horizon that as their number-one arbitrage by being willing to are no old, bold goal, we wouldn’t have ex- G&D: On your website you look a little further down perienced the crisis of the contrast inefficient markets the road and wait. That is investors.” last two years. People for- where Oaktree operates certainly something Oaktree got about risk control and with so-called efficient mar- does as well. risk aversion, and they em- kets where it is hard to gain phasized return maximiza- an advantage. Why does HM: I think that is true, and tion. Return maximization Oaktree not do more with one of these days we could and ensuring investment public equities, and do you conclude that being a long- survival are mutually exclu- believe that public equity term value investor in mid- sive. That is very important markets are efficient? cap or small-cap stocks is to bear in mind. consistent with our philoso- HM: There are no markets phy. It is not impossible. Being a high-risk, high- that are perfectly efficient, Up to now though, we’ve return investor is in my and there are no markets (Continued on page 6) Page 6

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(Continued from page 5) that’s fine. That’s a legiti- ent areas know how much had a lot to chew on in the mate point. On the one capital they have. How markets we are in. Every- hand, there can be return would you like to be in the thing we do is pretty much from reallocating capital. leveraged loan department related to credit, and we’ve We understand that some at a fund and all of a sudden gotten pretty good at that. people are interested in the manager says, “I’m not I don’t know that we’ve pursuing that. On the other going to own any loans for milked all of the opportuni- hand, we think there’s merit the next two years, so have ties with that. It is not im- in setting up individual pools a nice life.” Or, “you can portant to do everything. In continue doing your analy- the investment management sis, but regardless of what business, there are two you suggest, I’m not going Howard Marks at the Secu- kinds of people: investment to buy any of it because I rity Analysis 75th Anniver- managers and asset gather- think MBS is cheaper.” At sary Symposium. ers. We don’t want to be “In the our firm, each team has its the latter. The latter have capital. They know what an emphasis on doing every- investment their capital is. They don’t thing and getting every dol- have to fight for capital. All lar that is available for it. management they have to do is optimize Point one under our busi- the investment of that capi- ness philosophy is excel- business, there tal. Neither approach is lence in investing, and we’d right or wrong in my opin- rather do an excellent job at are two kinds of ion. They’re two different a few things than try to but potentially valid ap- cover everything. people: proaches.

G&D: You offer special- investment G&D: Switching gears a ized, niche products and little bit: You have said in allow the client to handle managers and the past that the third and portfolio weightings and last stage of a bear market is allocation. Many investors asset gatherers. when everyone believes that like the flexibility of moving things are only going to get to the markets where the We don’t want to worse. Do you think that opportunities are the best. we’ve had that point and How do you think about be the latter.” that it happened in March? that? HM: When you say March, HM: That is certainly a you are talking about the valid discussion point. I can stock market, which is not think of one investor in par- my main area of operation. ticular that said, “we aren’t I equate the final stage of going with you because you of capital so that the clients the bear market with the have these separate pools know what they are going fourth quarter of 2008, and we have to decide on a to get and managers don’t when most people thought fixed allocation between change the composition of that the world was going to them. That is too rigid for the portfolio without the end and the credit markets us because you won’t move client’s knowledge and when bottomed. If company XYZ from A to B if B gets the client doesn’t want it to had been bought by a buy- cheaper. We like Bob over change. out firm one or two years there; he can do A, B, and C earlier at $10 billion, you and he’ll move the money Our approach also lets the could buy a senior claim on around and so forth.” I say people who work in differ- (Continued on page 7) Volume I,III, Issue Issue 2 1 Page 7

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(Continued from page 6) saying it today . . . and the ones that they decided not it through the first-lien bank markets continue upward. to support went bankrupt debt for $2 or $3 billion We have macro opinions, or were bought out at low dollars in November of but we don’t base our ac- prices. 2008. That was a bear mar- tions on the assumption ket blow-off. The funda- that they are correct. So It is very hard to analyze mental outlook was terrible. we haven’t been selling or financials. They just don’t The psychology was miser- refusing to buy in the last have analyzability. Earlier able. The technicals were four or five months. We’ve this year, there was an arti- horrible, because there was just been increasing our cle in the New York Times a lot of forced selling from level of scrutiny. Sunday Magazine section hedge funds getting redemp- about the last weekend of tions and CLOs getting mar- G&D: Given the rebound in Lehman Brothers. Bank of gin calls. That is the kind of the markets, are you seeing America and Barclays were buying opportunity that any investment opportuni- the two primary candidates “We remain fairly every value investor dreams ties? to buy it. They took a look of: people assuming that the at it and saw there were allergic to financials outlook was terrible and HM: I don’t think that there two million interest rate could only get worse – for- are great opportunities, in swaps. How long would it because financials ever. terms of whole asset take you to figure out the classes. You can find great net exposure of two million are very, very hard G&D: Do you think the individual opportunities, but interest rate swaps, forget- to analyze pendulum has swung too far not the opportunities you ting about all of the other in the other direction now? see in phase 3 of a bear derivative positions they had compared to market. We have already on the books? In total they HM: Well, that is my per- passed that – between Sep- could be very strongly bull- industrials.” sonal view. The reason we tember 15 and December ish on rates, very strongly got into this crisis was that 15 of last year in the world bearish on rates, or neutral, up until the middle of 2007, of credit. but you would have to ana- everything was priced for lyze them all to know which perfection. Then of course G&D: During that time, was the case. That is a her- by the end of 2008, it got there were lots of disloca- culean task if you are inside priced for the end of the tions in financial institutions. and have access to the data. world – which so far hasn’t That must have created If you are on the outside, happened. Now it isn’t some interesting investment then how can you ever fig- priced for perfection, but it opportunities. Were you ure it out? That is just one is priced for prosperity. able to capitalize on what example from one part of Everybody is comfortable was going on in financials the balance sheet. assuming that there will be a given your historical exper- recovery and it will be a tise in more industrial areas? We generally consider the vigorous, normal recovery. analysis of financials incom- When the expectations that HM: We remain fairly aller- patible with our approach are factored into prices are gic to financials because to investing. What is a fi- overwhelmingly sanguine, as financials are very, very hard nancial institution? Number I think they are today, then to analyze compared to one, it is opaque. Number the risk is on the side of industrials. Under the con- two, it borrows short to paying too much. Another ditions of the fourth quar- lend long. Number three, it important investment adage ter, most financial institu- is subject to a run on the is “Being too far ahead of tions existed largely at the bank. Number four, it is in your time is indistinguish- pleasure of the government. the risk assumption busi- able from being wrong.” The ones that they decided ness. How do you make We started saying this to support survived and are money doing financing? You around April and we are still now doing better, and the (Continued on page 8) Page 8

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(Continued from page 7) don’t kill people; people say, “I expect 15%, and if I put it out at returns that using guns kill people. Lev- double up by borrowing at exceed your cost of capital. erage kills people if used 5% and investing at 15%, You borrow at low risk and wrongly. Leverage does not then I’ll get 25%.” But they lend at high risk. You are a improve investments. It forget that part of their risk assumption machine. only magnifies gains and probability distribution con- We rarely get comfortable losses. So when people get sists of losses, and leverage with that. The things that I silly and think leverage is a will more than double the say don’t imply that we are good thing and forget to be losses. This is why people right and others are wrong. risk averse, they take on must remember that maxi- There are lots of ways to too much leverage. When mizing returns and ensuring skin a cat, and that’s why you take on too much lev- investment survival are in- there are so many kinds of erage and things go bad, compatible. investment firms. then it can be a disaster. “It is important to I think another important However, in the fourth I mentioned two adages lesson that has been under- remember to be quarter of 2008, there were earlier – “what the wise stood at Oaktree for a long glaring opportunities, even man does in the beginning, time is that the key to in- skeptical. It is in financials. We bought the fool does in the end,” vesting is not the art called debt of profitable non-bank and “being too far ahead of portfolio management. The important to not subsidiaries of banks and your time is indistinguish- key is risk management. insurance companies. We able from being wrong.” You can’t just buy some US invest in things you bought debt of holding com- Well, the third important and some foreign, some don’t understand. panies that had unprofitable adage is “never forget the large and some small, and bank subsidiaries, because man who was six feet tall some industrial and some It is important to we thought that there was who drowned crossing the financial and then think enough value in other as- stream that was five feet you’re safe. You can’t be so remember that sets. We invested in non- deep on average.” It is not simplistic. You have to bank finance companies out- sufficient in the investment thoroughly understand the leverage is not a right. So, there were things world, or any other world, risks in the portfolio. good thing or a bad for us to do in financials, but to survive “on average.” limited in number. You have to get through the G&D: Some say that one thing.” low points and the bad days. thing that the US needs to G&D: What lessons do you What leverage does is that do is to reduce consump- think we should learn from it reduces your ability to tion both at the individual the crisis and what changes survive the bad day. So you and governmental level and should be made in re- have to realize that using increase savings. However, sponse? leverage is a tradeoff. it seems that much of what the government has done so HM: I wrote a memo called It’s interesting if you think far has been to avoid that “The Lessons of 2007.” about it. As investors, we adjustment by spurring Most of the lessons sur- only enter into investments greater consumption. Do round risk aversion. It is that have positive expected you think this action might important to remember to returns, right? If something be setting us up for an even be skeptical. It is important has a positive expected re- greater correction in the to not invest in things you turn and you add leverage, future? don’t understand. It is im- then the expected return portant to remember that will be even higher. This is HM: This is a great chal- leverage is not a good thing the trap. All of these things lenge. One example of the or a bad thing. It is like they are very simple. This is not conundrum is that we want say with gun control. Guns a complex business. People (Continued on page 9) Volume III, Issue 1 Page 9

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(Continued from page 8) thoughts on this trend and G&D: There has been consumption at the macro its importance to our eco- some finger pointing, argu- level, but at the micro level, nomic outlook? ing that investment manag- we need savings. The US ers should have been much will be a risky place until we HM: That scares the hell more conservative leading have more savings, but the out of me – on the eco- up to the crisis. However, Professor Bruce process of creating those nomic side – more than only near-Armageddon sce- Greenwald savings will be a drag on the anything else. I wrote a narios would have prepared economy. So what do we memo in August of last year people for what actually Bruce C. N. Greenwald do about that? That is a called “What Worries Me.” happened. So how do you holds the Robert Heil- real conundrum. Everybody It’s not that the market is at Oaktree balance being brunn Professorship of knows that the economy going to decline by a few conservative with remaining Finance and Asset Man- needs a stimulus, but the percent, or that Oaktree competitive in a more nor- agement at Columbia stimulus will be designed to will lag by a few percent, or mal environment? Business School and is support consumption. that some employee will the academic Director of quit. It is not that bus that HM: The main thing is that the Heilbrunn Center If I run a business and my everyone asks about – we tell clients that we are for Graham & Dodd revenues are off because “what happens to Oaktree not high-octane investors. If Investing. Described by the economy is bad and I when you go under the you want high-octane, there the New York Times as want to support my profit- bus?” One of the things are managers you can call. “a guru to Wall Street’s ability, then the best way to that worry me is this: what There are clients who don’t gurus,” Greenwald is an do that would be to fire a does it mean to have an want to optimize and en- authority on value in- few folks. That would be economy that doesn’t make sure survival, but we don’t vesting with additional good for my business and anything? I do your taxes. have any difficulty populating expertise in productivity bad for the economy. So You do my legal work. our clientele. We say we the government might cre- Somebody else cuts my hair. give good returns with less ate a tax credit for every Somebody else flips the bur- than commensurate risk. If person that I hire. That gers, or drives a taxi. But the market booms, then would be good for the what supports all of us if somebody else may do bet- economy and bad for my our economy doesn’t make ter. But if the market col- business in the long run, anything? I am not smart lapses, we’ll probably lose because it might cause me enough to know the an- far less. The good news is to keep employees that I swer, but I worry about that, once we’ve enunciated otherwise wouldn’t. There that. that position, the people are no easy answers to who come to us are the these problems. If you be- In addition, in the industries people who want that. lieve we need more savings where we are still trying to Then, if we give it to them, and less consumption, then make things like cars, our they say, “thanks a lot.” that implies that we are not workers expect the highest going to have the usual snap wages and highest standard There might be a boom year back in business, and we of living in the world. How in which we do 25% and should be cautious at the do you compete in a world somebody else does 30%. prices at which assets are where everything is fungible I’ll call up the client and say now selling. and transportable and yet “sorry it wasn’t 30%.” They your salaries are the highest say, “we got what I ex- G&D: Over recent dec- in the world? How are you pected.” There is nothing ades, manufacturing indus- going to be able to compete better for a money manager tries have been declining in with your higher wages to hear than, “thanks, we relative economic impor- unless your cars are vastly got what I expected.” It tance versus service indus- superior? It is not clear. would be great to be able to tries. What are your (Continued on page 10) Page 10

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(Continued from page 9) You never see a picture of ment tree. Those branches beat the market when it the manager who had the are subject to cracking un- does well and fall less when lowest risk, or the best risk- der all that weight. There- it does poorly, but it is al- adjusted return; just the fore, until conditions most impossible. What we one with the highest return. change, I suggest something generally deliver is market People flock to him, and the closer to the ground.” performance or a bit better next year he drives off of a in the good times and dis- cliff. It is part of the popu- G&D: That is a great anal- tinctly above-market per- larization of investing. We ogy. formance in the bad times. had a long period from 1982 The clients who want that to 2007, with a couple of HM: People forget. That is come to us, and we give it months of exceptions, why Buffett’s greatest quote to them. The best formula where investing worked and is, “the less prudence with in this business is to tell the aggressive investing worked which others conduct their “The best formula clients what you can and will better. So people tended to affairs, the greater prudence do, and then do it. If you forget to be scared. But with which we must con- in this business is to just follow that formula, risk aversion is the most duct our own affairs.” you’ll avoid 80% of the important element in a ra- When other people are tell the clients what problems that arise between tional investment market. petrified, then we can be clients and managers. I’ve aggressive. When other you can and will do, been in the money manage- You know that in the capital people are aggressive, then ment business for 40 years, asset pricing model, the line we should be scared stiff. and then do it. If and I have never had a client slopes up to the right. The People forgot to demand you just follow that say “that wasn’t what we reason is that people are risk premiums in 2005-07. expected you to do.” To risk averse and demand The great thing is that risk formula, you’ll me, if a client says that, it’s higher returns on riskier aversion is observable. You the kiss of death. That investments. When they can see it in the yield pre- avoid 80% of the means you mis-advertised forget to be risk averse, mium on high yield bonds. what you were going to do. then the line flattens out as When people are feeling problems that arise it did in October 2004, sanguine, high yield bonds G&D: Why do you think when I wrote my memo yield 250 basis points more between clients and your clients are so different “Risk and Return Today.” than Treasuries, and when managers.” from shareholders? If Dick What I said in the memo is: people get terrified, they Fuld or Chuck Prince had demand 1000 basis points said something similar, they “Not only is the capital mar- more than Treasuries. would have been fired. ket line at a low level today That’s an indicator of risk They would not have lasted, in terms of return, but in aversion. Your relative re- because they would have addition, a number of fac- turns improve as the risk been underperforming. tors have conspired to flat- premium at which you buy ten the line. That is to say increases. That is a simple HM: Right. To some ex- that the slope of the line is truth which is very impor- tent there has been a low. Meaning that for each tant. dumbing down of the main- unit of additional risk as- stream investment business. sumed, you get little incre- We say we are not market Too much emphasis on the mental return… The com- timers – we are market short term, and too much bination of low expected observers. We try to ob- on return rather than risk returns on safe investments serve the behavior which is control. It is too easy to and high recent returns on going on in the market and put the highest returning risky investments is pushing figure out what that means manager in a given year on investors to dangerously for risk premiums. We try the cover of a magazine. high branches of the invest- (Continued on page 11) Volume III, Issue 1 Page 11

Howard Marks (continued from page 10)

(Continued from page 10) ments are meant to be all- is, “he thinks the same as to be aggressive when risk inclusive. There are good me.” When I was a kid fol- premiums are high and de- guys and exceptions to eve- lowing Xerox in the 1970s, fensive when risk premiums rything I say. If you look at a portfolio manager at Citi- are low. the mutual fund industry, bank came to me and asked, how many of them beat the “who’s the best Xerox ana- G&D: With the dumbing S&P? How many of them lyst on Wall Street?” And I down of investors and eve- produce a superior risk ad- said, “the one who agrees rything that investors have justed return? How do they with me the most is so-and- been blamed for over the advertise? They say, “our so.” Isn’t that our definition last year, do you think in- mutual fund does better of someone who’s bright: vestment managers serve a than the other mutual the one who agrees with us? societal purpose? funds.” Few hold them- You read other people and selves to an absolute stan- you dismiss those who dis- HM: I have more bad to dard. Are the fees the right agree with you and respect “I spend a lot of my say than good to say. fees? Do they charge the the people who agree with time reading There’s a problem: An in- same fees to the mutual you. vestment manager has lots fund as they do to their newspapers and of occasions where his in- institutional clients? If not, I spend a lot of my time terests are in conflict with why not? Some mutual reading newspapers and magazines, because those of his clients. When funds charge clients 150 magazines, because I think those moments arise, the basis points. Is that really a the most important thing is I think the most question is, how does he reasonable price for the to try to figure out what is deal with those conflicts? service? going on around us. When I important thing is Does he put the client first was a kid in the early 1960s, or himself first? Who was Some money managers for- there was something called, to try to figure out ringing the bell in 2005, got their role as a fiduciary. I think, the Johnson Infer- what is going on 2006, and 2007 saying “this When you are a fiduciary, ence Service. I always loved is risky, you shouldn’t do your first responsibility is to that title, because what we around us.” it”? Who was turning away someone other than your- should do as an analyst is to money? Who was returning self. How many people try to infer what is going on. money to clients? Some acted that way in the lead- Everybody can see the head- mega-buyout funds kept up to the crisis? Not very lines. The challenge is to raising more and more many. infer what they mean. money as the prices of the When you saw a headline in companies they were buying G&D: Your memos have 2006 saying that there was a went higher and higher. Did become must reads in the worldwide wall of liquidity they serve the clients? They investment community. coming toward us and it either didn’t know what was What investors do you like was going to raise the price going on or they knew and to read and tend to follow? of assets and lower risk didn’t cut back anyway. forever, the most important HM: I like to read Jim thing was to infer from that In theory, it is helpful to Grant a lot. I read Seth that we were living in a society to help people par- Klarman at Baupost. For world in which there wasn’t ticipate in the profits from color, I read the Gloom, enough worry and enough the capitalist system and, in Boom, and Doom Report . respect for risk. theory, money managers However, if you read other help them do that. In prac- guys, you have to be careful. G&D: Thank you Mr. tice, I don’t think the indus- When I read Seth Klarman, I Marks. try has always done such a say, “this guy’s a genius.” great job. None of my com- But what I am really saying Page 12 Amedisys Home Health Services Buy Recommendation—Price Target: $54 (37% upside)

Kenneth Leslie September 2009 [email protected]

Thesis Summary : The current AMED share price implies little to no revenue growth, presumably due to margin contraction as a result of potential Medicare reimbursement reform. I believe that margins will remain static to expansionary in the near future. These perceived negatives present an opportunity to buy a best in breed, regional to national growth story with a reasonable margin

of safety. Amedisys (AMED) Price: $39.55 Investment Overview: (Sept 11, 2009) Underestimated Growth Opportunities : Amedisys is growing revenues and earnings through acquisitions, a deep pipeline of startup agencies, new services targeting Ken is a second year MBA preventative medicine, a growing Medicare beneficiary student and a participant in population and improved operational efficiencies. Columbia’s Applied Value Amedisys is capitalizing on the inability of smaller agencies Investing Program. Over to operate efficiently without economies of scale or the summer he worked in knowledge of how to navigate changing Medicare the Specialty Pharmaceuti- regulations. Amedisys has ~160 pipeline startup agencies cals and Generics equity awaiting regulatory clearance, which would grow their research team at UBS. agency number by nearly 30%. New startups require Prior to school, Ken ~$300k in investment, and the payback period for these worked in breast cancer agencies is ~2 years. After 2 years, these agencies contribute more than $250k of EBIT each year. At the research at the Memorial same time, established locations are growing revenues by treating a sicker patient population and providing Sloan Kettering Cancer preventative services such as their “Balance for Life” program targeting falls in the elderly. Lastly, large Center. acquisitions in both 2005 and 2008 hide the true operational efficiencies realized by established Amedisys locations. As the large 2008 acquisition is fully incorporated, margins should exceed 15%, and may even Ken is a New York Native reach 16% in my estimation. and received a BA in Mo- lecular Biology from Ken- Information and Infrastructure Advantages : Amedisys has developed a proprietary “Point of Care” yon College. IT infrastructure which standardizes treatment protocol, documents services performed and provides a framework in which to remain in full compliance with Medicare standards. Additionally, this system ensures that physicians can view services rendered to prevent accusations of “up coding” patient conditions. The result is excellent transparency, superior patient outcomes and expanding operating margins. This system allows for rapid integration of changing Medicare regulations and faster accretion of acquisition and startup locations.

Uncertainty is an Opportunity : Uncertainty of the direction of healthcare reform and the reasons for recent management departures weigh on AMED shares. Home healthcare and hospice represent a cheaper alternative to traditional inpatient hospital care and represent a solution to the Medicare liability. I expect any healthcare reform to incorporate proposals by the Government Accountability Office, the Independence at Home Act of 2009 and the Baucus Bill. Any of these measures would be neutral to potentially positive to Amedisys. I believe that any Medicare reform will adopt a pay for performance reimbursement structure. This would also benefit Amedisys, as their care profile displays better outcomes than the national average in spite of the fact that they treat a higher acuity patient (Amedisys has >10% Case Mix Acuity Index relative to the industry average; http://www.medicare.gov). Further scrutiny into compliance and billing practices should not affect Amedisys. Their IT systems lend transparency of billing and services to the referring physicians and ensure that up-coding and overbilling are avoided.

The previous corporate structure was sufficient for a small to mid cap company. Amedisys is now a billion dollar company and needs management with experience and an understanding of operations on this scale. The market sold off 25% (intraday) of the AMED market cap with the announcement of the COO departure. I feel that this magnitude of drop was in expectation of greater problems in either compliance or financial manipulation, but neither are on the table.

Background : Medicare pays providers under a prospective payment system for 60 day episodes of care based on assumptions of the severity of each patient. Episodes of treatment with higher acuity patients Volume III, Issue 1 Page 13 Amedisys Home Health Services (Continued from previous page)

(sicker) are reimbursed at higher rates. Amedisys is one of the largest providers in the highly fragmented home healthcare and hospice industry with ~7% market share. They have made accretive acquisitions to increase their geographic footprint from a regional player in the southeast United States to a national enterprise. Revenue growth is fueled by increased admissions, increased patient acuity and increased recertifications for additional episodes of treatment. New trends in healthcare and proposals by government officials focus on preventative medicine. Amedisys is in tune with this trend and is rolling out multiple programs, including their “Balance for Life” program, which focuses on preventing falls among the elderly. This program is reimbursed at higher than average Medicare rates and has already been introduced to 50% of Amedisys agencies. Non-organic growth is accomplished by acquiring non- performing, smaller home healthcare and hospice agencies. These agencies are unable to operate efficiently without economies of scale and an understanding of how to navigate Medicare regulations, yet can be easily integrated into Amedisys’ Point of Care system.

Risks to Thesis : Healthcare reform could induce cuts to Medicare reimbursement rates, lowering operating margins across the sector. In years past, any cuts have been offset by increases in the market basket (inflationary index). A second risk is that Amedisys may be unable to successfully integrate future acquisitions. Finally, the recent management departures could have a negative affect on the efficiency of operations going forward or be an early indication of issues yet to be realized by the public.

Catalysts : Medicare reimbursement for 2010 should be announced in October, and further clarity into healthcare reform legislation should be forthcoming. The announcement of a succession to the COO/CIO positions would impact AMED shares. The announcement of additional acquisition targets in more profitable geographic regions, or an illustration of further accretion of past acquisitions would also benefit shares. Finally, opening of agencies in their startup pipeline would fuel growth in the immediate future.

Industry and Competitive Overview : Home healthcare providers operate at lower costs to the Medicare system than inpatient hospital care while maximizing patient comfort. There were 9200 home healthcare agencies and 3000 hospice agencies in the United States as of 2007 and 2006 respectively. The industry is highly fragmented and consolidating. There are few barriers to entry, although some states require a Certificate of Need (CON) to operate under an agency number. Agency numbers allow providers to service patients within a 50 mile radius of the agency. Many agencies are single site locations which lack the scale and ability to navigate a changing Medicare reimbursement landscape. I predict that healthcare reform as it pertains to this sector will focus on improving transparency, limiting the ability of companies to game the system through overbilling and focusing on reimbursing providers based on the quality of their care and the outcome of their patients.

Valuation : I approached the valuation of AMED shares in three ways:

1) I acknowledge that forecasting operations into the future is a difficult exercise. To be conservative, I used an earnings power Earnings Power Valuation valuation based on expected 2009 revenue and a trailing 2009E Revenue 1484 twelve month EBIT margin. I used an 11x multiple for this EBIT margin (TTM) 14.3% EBIT 212 calculation. Tax rate 38.7% 2) I utilized a DCF sensitivity analysis with 10% WACC and 2% NOPAT 130 terminal growth rate. My terminal rate is in line with a Earnings Power at 11x 1431 doubling of the number of Medicare beneficiaries over the 2009 EPV Valuation $51.47 next 40 years. A 13% EBIT margin reflects a 2.5% Medicare DCF Sensitivity Analysis (10% WACC; 2% Terminal Growth Rate) reimbursement rate decrease without a concomitant increase in the price basket. I see this as a worst case scenario for the Forward 5 Year Operating Margin 13% 14% 15% near future. I utilized a 14% margin to reflect the impact of new acquisitions and pipeline growth opportunities operating 5 year 10% $46.51 $51.86 $57.22 at lower margins. I project that Amedisys will grow at 15% Growth 15% $57.77 $64.32 $70.87 over the next 5 years due to acquisitions, pipeline startups, Rate 20% $71.07 $79.02 $86.97 preventative services and a higher acuity population. 3) Finally, I used a comparative multiple valuation to value AMED DCF Valuation $61.05 shares using the industry average forward P/E of 11x based on 11x Industry Earnings Multiple Analysis 2009 estimated earnings. EPS 2009E $4.92

2009E Multiple Valuation $54.12

Levered Market P/E FCF Gross Op. Company Price Cap EV LTM P/E For EV/EBITDA P/B Margin Margin Margin ROE ROA Amedisys $39.50 $1,098.7 $1,340.4 9.6 8.0 6.0 1.7 10% 52.5% 14.6% 19.7% 12.0% Gentiva Health Services $22.75 $662.3 $797.1 4.0 10.6 6.3 1.2 6.90% 49.1% 8.4% 38.0% 6.6% LHC Group, Inc $29.53 $544.8 $561.9 13.1 13.4 6.7 2.6 11.30% 50.9% 17.1% 22.6% 21.0% Almost Family, Inc $28.42 $232.4 $261.9 11.0 10.3 7.1 2.2 5.80% 53.7% 13.6% 22.4% 16.8% Page 14

Care Investment Trust (LONG)

Eric DeLamarter September 2009 [email protected]

Trading Summary (US$ in Millions) Ticker CRE CRE - Stock Performance Stock Price $7.40 13 Book Value per Share $11.79 12 Est. NAV $10.53 11 10 Shares Out. (Basic) 20.1 Care Investment Trust 9 (NYSE: CRE) Market Cap $148.4 8 Price: $7.40 Net Debt $28.4 7 (Sept 21, 2009) Enterprise Value $176.9 6 5 Price / Adj. LTM FFO 13.5x 4 3 Price / 2009E FFO 13.7x Eric is currently a member 8 8 8 9 9 9 9 9 Price / Book Value 0.63x /0 /0 /09 /0 /0 /0 /0 9 2/0 1/09 1 2/09 3 4 5/09 6 7 7/09 8 of the Applied Value Invest- 10/08 11/0 1 Price / NAV 0.70x ing program at Columbia Business School. This last Thesis : summer, between his first I propose a long position in the common shares of Care Investment Trust (NYSE: CRE or the Com- and second year, Eric was a pany) as the stock is meaningfully undervalued on the basis of its assets and near-term catalysts lead- summer analyst at the long/ ing to value realization are probable. short hedge fund Stelliam Investment Management in Background : New York. At Stelliam he Care Investment Trust is a healthcare focused REIT. Following the evaporation of the securitization focused on the transports and repo markets the Company has repositioned itself from a finance/ mortgage REIT to an equity and industrials sectors. REIT focused on direct ownership of property. The Company has a high quality asset base consisting Prior to Columbia, he spent of $101M in first mortgages to skilled nursing and assisted living facilities with a weighted average LTV two years as an associate in of 78% and coverage ratio of 1.5x, $106M in wholly-owned, single tenant, triple net leased assisted private equity and three living facilities and a $61M JV (85% equity interest) in third-party managed class A medical office build- years an analyst in invest- ings. CRE itself is externally managed by CIT Healthcare, a subsidiary of troubled CIT Group. ment banking. Investment Overview & Catalysts : Eric holds a BA from the • Depressed Stock Value: CRE is an under-followed orphan and mis-priced for the following rea- University of Michigan. sons: 1) most coverage has been discontinued and interest has been lost as it is no longer classi- fied as a finance REIT; 2) analysts that do cover CRE value it on FFO, seem to overlook the un- derlying asset value and likely lack an understanding of the healthcare sector; 3) concerns sur- rounding the solvency of external manager CIT and; 4) misperceived risks associated with healthcare reform/ regulation. Consequently, CRE currently trades at 63% of book value and 70% of my estimated NAV. • Catalysts: CRE is in the process of harvesting assets and returning capital to shareholders. Start- ing on December 31, 2008, CRE reclassified its mortgages from held-to-maturity to held-for-sale and has subsequently sold-off $67M or 35% of its mortgage portfolio (representing $101M of its $268M in real estate related assets at 6/30). The Company has an agreement to put an additional $80M of mortgages to CIT by September 30, 2009. There is pressure to realize value in the near -term by: 40% shareholder CIT Group who is facing insolvency and a looming deadline from regulators to present a capital plan and hedge fund groups (GoldenTree and SAB) holding 35% of CRE’s shares. • Strong Balance Sheet & Liquidity Position: Unlike many REITs, CRE has no debt due before 2015, over $53M in cash and total debt of $83M. Its current fixed charge coverage ratio is 1.5x . • Dividend: The Company’s dividend yield is 10%. Should a partial or complete liquidation occur, this would obviously increase meaningfully.

Volume III, Issue 1 Page 15

Care Investment Trust (Continued from previous page)

Valuation : On the basis of conventional FFO, CRE is trading slightly above most of its peers. However, FFO is not the appropriate metric to use. The most likely scenarios facing the Company over the next 6-months are an outright sale or liquidation. Assuming a 90% recovery value, the implied value for equity holders is $9.92 per share, representing an upside of 34%. CRE’s discount to book (which should be a good repre- sentation of value since mortgage loans are marked-to-market) and estimated net asset value provide substantial margin of safety should assets sales not materialize or if operating results were to deteriorate. It should be noted that CRE is one of only several REITs identified that is not facing solvency challenges and is still trading below book value.

NAV / Portfolio Liquidation Value (US$ in 000s) Liquidation - Percent Recovered Est. NAV 100% 90% 85% 80% 75% Mortgage Loans 101,199 122,501 110,251 104,126 98,001 91,876 Owned Real Estate 103,116 106,020 95,418 90,117 84,816 79,515 JV Investments 54,758 60,842 54,758 51,716 48,674 45,632 Less: Est. man. Term. fee (15,400) (15,400) (15,400) (15,400) (15,400) Less: Accrued exp. payable (1,137) (1,137) (1,137) (1,137) (1,137) (1,137) Plus: Accrued Int. Rec. 557 557 557 557 557 557 Less: AP (6,029) (6,029) (6,029) (6,029) (6,029) (6,029) Less: Other Liab. (2,803) (2,803) (2,803) (2,803) (2,803) (2,803) Plus: Cash 53,751 53,751 53,751 53,751 53,751 53,751 Less: Total debt (83,445) (82,183) (82,183) (82,183) (82,183) (82,183) Net Value 219,968 236,119 207,183 192,715 178,246 163,778 Value Per Share 10.53 11.30 9.92 9.22 8.53 7.84 Premium to current Stock Price 42.3% 52.7% 34.0% 24.6% 15.3% 5.9%

Notes: Mortgage loans are classified as held-for-sale and listed at book value for NAV calc Owned RE is undepreciated with 10.2% cap rate applied to NAV calc JVs almost exclusively consist of interests related to Cambridge Holdings, discounted 10% in NAV calc Debt for NAV calc is the LTM average

Risks to Thesis : • CIT Bankruptcy: The original impetus for the CIT-CRE relationship was to enable CIT to take ad- vantage of REIT tax benefits and concurrently provide CRE with access to CIT’s loan origination network. Since CRE no longer originates loans, CRE’s reliance on CIT has declined. If CIT Group were to file for bankruptcy the external manager may need to be replaced at an estimated termina- tion fee of $15M (3x average annual management fee received during two years). Depending upon the scope of the bankruptcy and terms of the arrangement, this compensation could potentially be avoided and even serve as a catalyst for the sale of the Company. CRE also has a mortgage purchase agreement with CIT whereby it has agreed to buy $80M of CRE’s mortgage loans. CRE’s depend- ence on this source of liquidity is mitigated by the fact that it could sell these mortgage assets or simply its entire business in the open market. CRE has already marketed its mortgage portfolio to 83% of cost (ie. taken $23M of valuation allowances), so a sale would likely result in minimal dilution to book value/ NAV and possible accretion given the recovery in the mortgage market.

Page 16

“Points of Leverage” - Dave Samra

David Samra is the lead class. The project was to the faculty. So we tried to Portfolio Manager for select a pharmaceutical firm promote value investing the Artisan Interna- to analyze and I was paired through the Investing Club tional Value Fund and is up with a guy who picked and we brought in Jim also a Portfolio Manager Merck. At that time, Merck Rogers, Chuck Royce, Leon for Artisan’s Global was a growth business that Cooperman, Mario Gabelli, Value portfolios. Mr. traded at a very high multi- and other investors to Samra and co-Portfolio ple. I selected a company speak to us about value in- Manager Daniel O’Keefe named A.H. Robbins; a vesting. were named 2008 Inter- company I think eventually national-Stock Fund went bust. They were being Shortly after we left school, Manager of the Year by sued for problems with one the Robert Heilbrunn seat Morningstar. From its of their products. But if you for value investing was en- 2002 inception through looked through the litigation dowed and filled by Bruce Dave Samra—Portfolio 2008, the Artisan Inter- and looked at the valuation Greenwald. Once he got Manager, Artisan Partners national Value Fund has you were paying for the involved, he turned that International Value and returned a total of 126% underlying business, it was program into something of Global Value funds. vs. 43% for the MSCI extremely cheap. For what- much higher quality than EAFE index. Prior to ever reason, my natural anything we had while we joining Artisan, Mr. inclination was to look for were there. I think the ad- Samra was a portfolio cheap equity. ministration eventually real- manager and a senior ized that there was an un- analyst at Harris Associ- When I finished under- derlying base of interest in ates. Mr. Samra holds a graduate school, I started an value investing. BS from Bentley College investment club with some and an MBA from Co- friends. Four or five years While I was at Columbia, lumbia Business School. later, with mainly just ac- the most profound influence counting experience, I ap- was actually an adjunct in- G&D: Tell us a little bit plied to Columbia. It was structor named Joel Stern, about your background, the only school I applied to who was basically an effi- how you got interested in because of its rich invest- cient markets guy. Joel was investing, and how your ment history and because mainly a management con- time at Columbia Business it’s where Benjamin Graham sultant who worked with School has influenced your taught and Warren Buffett someone named Bennett investment philosophy. went to school. I spent two Stewart, who wrote a terri- years there and worked for fic book called The Quest DS: I first got interested in Gabelli [GAMCO Asset for Value. They coined the investing when I was an un- Management] on Fridays. I EVA concept that, from a dergraduate, when I realized also wrote the newsletter financial standpoint, helps that my finance professors and ran an investment club you to understand the dif- were, in general, much during that time period. ference between a good wealthier than my account- When I got out, I took a job business and a bad business. ing professors. That at- at a place called Montgom- What matters to you as an tracted me to the finance ery Asset Management. investor is how that differ- business. ence, compounded over The interesting part about time, can be very beneficial It became immediately ap- Columbia while I was there as it accrues to the share- parent to me which style of is that it was more or less holders of that business. investing I was interested in an efficient market program. Marrying the concept of because of the first project Back then, the value invest- investing in a good business that I had in my finance ing concept had been lost by (Continued on page 17) Page 17

Dave Samra (continued from page 16)

(Continued from page 16) erage where you have a high multiple should be much at a cheap valuation is what fixed cost base, so when higher because, longer-term, has driven my philosophical revenue grows, profitability it’s actually a high quality approach to investing, both swells and you benefit from business and has the ability as an analyst and now as a that form of leverage. The to grow and the returns on portfolio manager. third point of leverage is the business will become through valuation. very high. That’s what I call G&D: That’s a great transi- multiple leverage. The last tion to some questions point of leverage is earnings about your investment phi- growth on a non-financially losophy and style. You leveraged basis. mentioned that you look to invest in good businesses. As you develop your style What are some of the char- “Marrying the within investing, you eventu- acteristics that you most ally pick a point along that like to see in a business? concept of investing scale. If you are a growth stock investor, often times DS: In business school you in a good business you’ll buy a company at a have to sift through all of fair valuation and look to the concepts to find what is at a cheap underlying earnings growth truly valuable. The concept to generate returns as the of investing in good busi- valuation is what value of the business grows. nesses is what I gravitated Another style, if you don’t towards. Once you get out has driven my mind financial leverage, is to in the real world, identifying buy highly operational and good businesses using ratios philosophical financially leveraged busi- is the easy part. Identifying nesses on a highly diversified a great business by under- approach to basis. Then you just play standing the reality of the the odds that if you pay low marketplace in which a investing, both as enough multiples, enough of company operates and the them will work out, and you sustainability of that model, an analyst and now will do well overall. along with how much you should pay for it, is the art as a portfolio What we have developed which we exercise on a day over the years is a style that manager.” in and day out basis. is much more reliant on underlying earnings growth The way to generate re- on a financially unleveraged turns over and above mar- basis combined with lever- ket returns over time has to age that we are getting do with leverage. There are through valuation. So what a lot of points of leverage in Let’s say you identify a busi- we try to do is to skim off which to operate in the ness with economics that the top by running a rea- investing world. The easy would imply a relatively low sonably focused portfolio of one to identify is financial multiple on earnings, be- companies that fit between leverage, where if a com- cause in the short-term the the juxtaposition of high pany has a lot of debt and is business is being hampered, quality and cheap valuation. growing rapidly, the equity either cyclically or for com- The way we generate our value of that company will pany specific reasons. How- returns is from growth of grow in a magnified way. ever, the work you’ve done the underlying value of the There’s also operating lev- suggests that the valuation (Continued on page 18) Page 18

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(Continued from page 17) flow. We also want to see lio in ten equities, so we business, along with valua- strong management teams aren’t looking for hundreds tion leverage because we that are wisely allocating of stocks. There are lots of are buying at a cheap price. that capital. We think this reasons that a good busi- type of portfolio will gener- ness can trade at cheap The reason we invest the ate very good absolute re- valuations. One of the obvi- way we do is because of turns over time. ous reasons is macro issues. risk. If you look at the other ways to generate re- One example was late last turns—take financial lever- year;s we bought Google age for example. The obvi- below $300 per share, ous consequence of owning which was implying around a financially leveraged busi- “I would argue 13x earnings. You could ness is that, if you get it argue that the whole market wrong, you can put the that the single was undervalued and it business in a challenging probably was. But the point position. It may not be able most common is: we were picking up a to raise capital and because great business, with a terri- the equity is a relatively error in the fic secular profile, that small portion of the capitali- investment dominates its industry, with zation, very small move- a very high level of profit- ments in the operating per- industry is a ability, and we picked it up formance of that business at a very un-demanding can have a damaging impact failure to price. Clearly, it was a on the equity value. We macro shock that led to an have a very broad and large distinguish undervaluation of the busi- universe, so we don’t need ness. to get involved in those between types of investments. We Other events can lead to can find cheap equities fundamentals these situations: manage- across the spectrum. ment makes a bad acquisi- and tion or poor strategic deci- With regards to investment sion, the government styles that rely on leverage expectations.” changes the rules on a busi- through earnings growth, in ness, management changes. most time series, you’re There are a variety of differ- subject to valuation risk. So ent reasons good businesses if the high rate of earnings G&D: You want to find can get cheap. growth declines, the multi- high-quality businesses at ple is also likely to shrink, low valuations, but theoreti- G&D: A lot of value inves- which results in a perma- cally, these opportunities tors fared poorly in 2007- nent loss of capital. We shy should be rare. Where do 08, but your fund per- away from those two forms you find these ideas and formed very well despite of leverage, financial or op- what types of situations give being fully invested through- erating leverage and earn- rise to these opportunities? out the period. To what do ings growth at a high P/E. you attribute your stronger DS: The world is a large performance? We want to build a portfo- place and we have a very lio of undervalued busi- large universe from which DS: We don’t feel that we nesses that are good com- to choose. We typically are particularly good at call- panies that generate cash have 40-50% of our portfo- (Continued on page 19) Page 19

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(Continued from page 18) any traditional banks. We to be a terrific investment. ing market tops and bot- spent an enormous amount We also have a long-term toms. What we do is iden- of time going through a lot holding in Arch Capital, tify certain investment pro- of the banks, but because which is one of the pre- files that make sense to us. the financial system was so mium franchises in the We always make sure to close to melting down, it Property & Casualty insur- really look under the hood came down to pure specula- ance business. We bought of the companies we are tion. Instead, we took ad- Arch at a cheap price-to- buying. book, at a time when the book value was understated For example, we were because some of the invest- largely absent in the highly- “Commodity ments they had in their leveraged financials space, portfolio had been marked such as banks and insurance businesses are down unnecessarily, in our companies. We were un- opinion. comfortable with the not good amount of leverage that had We didn’t buy equities in built up in these companies. businesses at the the areas with the most We viewed this as nothing leverage points, though we short of a carry trade exer- end of the day; did increase our weight in cised by borrowing short the surrounding area. and lending long, particularly they’re capital These turned out to be in an environment which good investments. was much less liquid outside intensive, the the US in terms of securiti- The oil industry is another zation. In the end, earnings products don’t area we were largely absent. growth was overstated What we knew about the quite a bit because there have any price of oil at $150 per bar- weren’t enough loss provi- rel was that it was way sions going through the bal- differentiation, above the marginal cost of ance sheet. A lot of value production. When com- investors thought they and returns tend modities are priced at that looked cheap. For instance, level, it typically encourages the price-to-book looked to be low over production and discourages out of whack. But the rea- time.” consumption. This is a les- son they were cheap is be- son in value investing: you cause of their considerable can’t just look at the num- leverage and their earnings bers. All of the oil stocks were overstated. vantage of financial services looked really cheap when oil companies outside of the was at $150 per barrel. We G&D: When the financial traditional leveraged finan- didn’t know if oil was going stocks collapsed earlier this cials. to $200 per barrel, though year, did you look at that as we didn’t think so. Either an opportunity to buy them We bought a meaningful way, we didn’t take much of at really cheap prices or stake in IGM Financial, a position on the direction were you just not comfort- which is in the money man- of oil at all. We did make able with the highly lever- agement business in Canada. the determination that the aged financial model at any It is a terrific business that price of oil was well above valuation? has a strong balance sheet the marginal cost of produc- and a very good market tion and that we did not DS: We didn’t step up into position. That turned out (Continued on page 20) Page 20

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(Continued from page 19) some of the integrated oil are higher today than they want to own these stocks companies more recently. were in the earlier part of with oil at those prices. Do you need to get com- the year. But we have tran- Commodity businesses are fortable with macro back- sitions that we go through not good businesses at the drop before you can be from time to time in which end of the day; they’re capi- confident enough in their our cash position may build tal intensive, the products sustainable earnings power temporarily. Typically, we don’t have any differentia- to invest? are either working on tion, and returns tend to be something new or waiting low over time. We’ve de- DS: We haven’t found it to for better entry points on cided that we would only be a valuable use of our particular stocks. The cash get involved in commodity time to try to forecast any increase is not a call on the businesses if we can identify macroeconomic outcome. market; it’s more a reflec- the low cost producer, the We did look at the marginal tion of what we currently commodity is priced well cost of production per bar- have on our plates and also below the cost of produc- rel of oil and compare that from exiting a couple of big tion, and the balance sheet to the price of oil that was positions. IGM rallied from is clean. implied in the equity valua- the mid-$20s to the low- tions. We made the deter- $40s, which we think is As we went into the com- mination that $40 oil, which fairly valued, so we sold out modity downturn, we pre- was where the price of oil of that position. As we go ferred to own a company was when we bought these through the process of rein- like Samsung Electronics. equities, was below the vesting that capital, the cash We believe that’s the same marginal cost of production. position will increase some- type of business as oil or Oil reached nearly $150 per what as part of that process. copper; at the end of the barrel and bottomed near It’s definitely not a market day it’s a commodity. Most $35, but over the last ten call. of Samsung’s competitors years, our internal models were operating with nega- have assumed that the mar- G&D: You made an inter- tive gross margins. Samsung ginal cost of production has esting comment in one of was break-even or barely moved up to $75-$80 per your shareholder commen- making money, so they are barrel. There has been taries, regarding the govern- the obvious low-cost pro- above trend inflation in the ment’s impact on the econ- ducer. They also have a cost of doing business in the omy and financial markets. very strong balance sheet. oil space, so we estimate Your point was that the We were simply waiting for that a more accurate mar- massive government inter- what inevitably happens ginal cost is probably closer vention is emerging as an with a very low-priced com- to $65-$70 per barrel to- immediate risk to earnings modity: consumption is en- day. power and valuation. What couraged and capacity did you mean by that and started coming off-line. The G&D: Your cash position how have you adjusted your increased consumption and has moved up to approxi- investment process to ac- decreased production even- mately 10% of the portfolio, count for that risk? tually moves the market which is the top of the back in-line. As this oc- range you target, according DS: Government changes curred, Samsung turned out to the fund’s prospectus. Is are slow and they frequently to be a good investment this an indication of your encroach on businesses in through the downturn. view of valuations in the less than obvious ways. The equities markets currently? most obvious impact is on G&D: Back to the oil indus- our healthcare stocks. try, you have been buying DS: Obviously, valuations (Continued on page 21) Page 21

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(Continued from page 20) profitability. businesses that are well We’ve seen bills come out placed to grow, even if of congress and a proposed We share others’ views that someone builds a brick wall $4 billion per year tax in- ROEs will be lower, growth in front of them. crease on medical device will be slower, consumers stocks. Covidien is one of need to deleverage, and the G&D: Given our huge and our largest positions and government is going to be growing national debt, an- one of the largest medical other issue we potentially device companies in the face down the road is infla- world. It’s a global business, tion. In another share- but a meaningful portion of “We share others’ holder commentary, you its revenues come from the referenced a 1977 piece by U.S. The question becomes, views that ROEs Warren Buffett regarding how much of any tax in- inflation’s negative impact crease gets passed on to the will be lower, on stock returns. Do you end consumer. It could think we could be heading really hurt the business in growth will be for a similar environment to the sense that there will be the 1970s – a period of high less money to spend on slower, inflation and poor equity R&D and that profitability returns? will simply decline. We consumers need think current valuation mul- DS: We just don’t make tiples already reflect the to deleverage, macro projections. What market’s concerns about we wanted to do was create the resulting impact on and the awareness among our growth, profitability, and shareholders that this is one cash flows associated with government is possibility that could these businesses. emerge as a result of the going to be more current environment. We We’re also hearing a lot of haven’t changed anything noise about clamping-down interventionist.” that we own in our portfo- on compensation structures, lio. We think that if you not only in the US, but also own competitively well po- across the globe. I also more interventionist. The sitioned businesses that think the cap-and-trade bill government is imposing have a relatively low level of could do significant damage itself on the economy more capital intensity, you are to the Midwest manufactur- and more, which will have better placed than most to ing base, because it penal- an impact on the underlying retain the returns of the izes smaller power compa- growth rates of businesses. business. It doesn’t mean nies that rely on coal plants. As a result, it is ever-more that you won’t be impacted, Sometimes I don’t under- important to make sure that just that you are better po- stand what politicians are you own good businesses, sitioned. We aren’t sure thinking: on one hand, they that are attractively priced, that this will happen; we just want to create jobs, but that have good management think the odds are higher then they are doing things teams, that can creatively now than they were when that are obviously bad for figure out ways to grow we were running smaller job creation. I’m concerned their businesses, whatever deficits. It is very hard to that the current administra- the headwind might be – predict these things. tion’s strong focus on labor whether it’s macro, micro, could start to have a nega- or government. The key for G&D: Thank you Mr. tive impact on operating us is to make sure we own Samra. Page 22

Lessons of an AVI Alum—Kevin Dreyer, GAMCO

Kevin Dreyer is an Asso- There are only a handful of important for students to ciate Portfolio Manager publicly traded firms glob- talk to a lot of people at of both the Gabelli Asset ally, so it is a pretty small firms for informational in- Fund and the Gabelli sub-industry, but Mario terviews. Some people I Healthcare and Well- wants us to dominate the know didn’t find their jobs ness Fund. Mr. Dreyer knowledge of an industry. It until late in the spring or received his undergradu- turned out to be an active even until the end of sum- ate degree from the area since 2005, with Wrig- mer after graduation. University of Pennsyl- ley being acquired by Mars vania and holds an MBA last year and Cadbury in the G&D: What was your ex- from Columbia Business news right now with Kraft perience with the AVI Pro- School. offering to acquire the com- gram and how did that help pany. We were involved in prepare you for your cur- Kevin Dreyer (’05) — both of those companies. rent role? G&D: Can you tell us a From there, I ended up fol- Associate Portfolio Man- little bit about your career lowing a broader section of KD: It helped me get used ager, GAMCO Asset before business school and food and beverage compa- to doing full and complete Management. how you got interested in nies globally. In addition to analysis on companies and investing? my analyst role, I took on a writing them up and talking few Associate Portfolio about them. The Applied KD: After completing my Manager duties – on the Value Investing course that I undergraduate degree in GAMCO Global Opportuni- took with William von engineering at the Univer- ties Fund and a sector fund Mueffling was the best sity of Pennsylvania, I went called the Gabelli Health- course I took in school. I into investment banking care and Wellness trust. As really learned how to be an with Bank of America Secu- of last month, I am also an analyst. We were essen- rities. I worked in M&A Associate PM on the Gabelli tially functioning no differ- advisory for three years, Asset Fund. ently than if we were work- which gave me a good intro- ing as analysts following an duction to finance and un- G&D: What was the job industry, and we met some derstanding companies. market like coming out of great guest speakers. The After some time, I decided school? Greenwald value investing that I wanted to actually use seminar was also terrific. It that analysis to make invest- KD: There were some op- was interesting to hear the ment decisions as opposed portunities. In my first year perspective of all of the to just giving advice. I read at school, the hedge fund great value investors. Eve- the Intelligent Investor and industry was just starting to ryone has their own flavor started getting hooked on boom. The big mutual fund of investing and it helps to the value investing books companies and some hedge crystallize where you want and applied to Columbia. funds came to campus to to gravitate towards and Fortunately, the value in- recruit. Investment man- what makes the most sense vesting program was just agement has always had a to you. starting to become formal- much different recruiting ized. I was in the first class process than other business G&D: Is there any investor to go through the program school career paths like that made a particular im- in its current form. Follow- banking, trading, and con- pression on you? ing school, I went to work sulting. A lot of internships for Gabelli covering food and jobs were secured KD: Well, obviously Mario and beverage companies. through job postings and Gabelli. The whole notion The first companies I looked networking rather than for- of Private Market Value with at were confectioners. mal recruiting. It is really (Continued on page 23) Page 23

Kevin Dreyer, GAMCO (Continued from page 22)

(Continued from page 22) view being an analyst or a As I mentioned earlier, a Catalyst was not that portfolio manager very dif- Mario wants us to dominate much different than the way ferently. It is just that you the knowledge of a particu- that I had looked at compa- are looking at more compa- lar industry. At school, I nies as an M&A banker. nies and more industries. initially had this notion that That was helpful for me in Mario would probably still you just do screens and try transitioning into investment consider himself an analyst. to find some cheap stocks, management. Tom Russo We are very stock specific whereas we really want to was also very interesting. and bottom up. We focus know everything there is to He follows a lot of the same on what private market val- know about an industry and companies that I do. I also ues are, particularly if there what the dynamics are and liked how he took a global is an opportunity to realize how those are going to play approach. those values through either out over time. We meet a financial or strategic trans- with management and talk G&D: Do you still interact action. to competitors, suppliers closely with the other AVI and customers to get an students from your class? informed view of what is going on. Focusing on that, KD: I do. Right out of regardless of what the mar- school, a group of us would ket is doing is of critical try to get together every importance. few months or so to talk “As an analyst, it about stocks and how our G&D: Often analysts make jobs were going. As you get is really easy to recommendations to buy older, it becomes a bit more what they think are the best difficult to meet up, but I put your head ideas in the industry and not definitely still keep in touch buy the worst ideas, but with quite a few people down and just be they fail to take a step back and think about the macro from the AVI program. thinking about position of the industry and G&D: Are there quite a your industry. It whether you want to be few AVI alums at Gabelli? involved in it at all. How is always much do you think about KD: There are a few. We the macro issues when you recruit at Columbia every important to step are covering an industry? year so we are always add- ing people from Columbia. back.” KD: It depends what you mean by macro issues. If G&D: It sounds like you you mean the external fac- have been pretty successful tors that are going to affect in your career, progressing an industry and all of the from being an analyst to companies in an industry, I having an increasing amount G&D: What have you would say yes. If you are of portfolio management learned from Mario? talking about short term responsibilities. Can you fluctuations in stock prices tell us some more about KD: First, that it is impor- for particular sectors, I your progression and how tant to define your circle of would say no. In food and you think about those two competence and stick to beverage we are definitely different roles? what you know, and to thinking about consolidation learn something in particular of retailers, input cost infla- KD: I don’t know that I and know it extremely well. (Continued on page 24) Page 24

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(Continued from page 23) ommend a company within 20x EBITDA which is what tion or deflation, or any of your industry just because Pernod paid for Absolut. I those types of macro fac- you are given a certain in- wouldn’t instantly put a 20x tors. However, we aren’t dustry to cover. multiple on any spirits com- sitting around thinking that pany. Each company is dif- we need to be defensive so G&D: When you are think- ferent and unique. Absolut we need to buy more con- ing about private market was a very unique asset that sumer staples this quarter. value, a lot of times transac- all companies were willing There are quite a few peo- tions take place at elevated to pay up for, and Pernod ple in the industry who do earnings or elevated multi- was willing to pay up the think like that though. ples. How do you make an most.

As an analyst, it is really Today, in a very different easy to put your head down environment, Campari paid and just be thinking about “We focus on what 12x for the Wild Turkey your industry. It is always bourbon brand, which is a important to step back. private market less dynamic brand than The advantage that we have Absolut. Looking back his- at Gabelli is that we are values are, torically, 12x to 15x has getting grilled by Mario on been more of a norm for these questions every single particularly if there acquisition multiples and day. What is the company more in the range that we worth? Who would buy it? is an opportunity to would use. Finally, don’t What will earnings and cash leave your brain at home. flow be over the next five realize those values You don’t take the highest years? That keeps us hon- multiple that is being paid in est and prevents us from through either a a bubble environment and having tunnel vision. use that forever. You try to financial or be conservative and look for G&D: How much do you a margin of safety. We are think about comparing your- strategic looking three years out and self to a benchmark and expecting 50% upside on underweighting or over- transaction.” our investment. weighting various sectors? G&D: Are you just using KD: The firm has an abso- adjustment for whether or these multiples as a bench- lute return goal of 10% an- not a comparison transac- mark or reference or are nually, plus inflation. When tion makes sense? you actually looking for a you have consultants or KD: First, it depends on specific transaction that will clients, they want to bench- what kind of acquisition it is. realize the valuation? mark you against something. Is the company giving shares We don’t really care what it or paying cash? Cash acqui- KD: Both. We always look is, whether it is the S&P 500 sitions tend to be a lot at it as a benchmark, but or Russell 2000. We are more meaningful. You also practically speaking, some long only but still really fo- don’t just look at these companies are not going to cused on absolute returns. things once. You look at be acquired. However, we If you don’t think you them over time and how get very interested when a should buy any companies in they are trending and if they company trades at a mean- your industry, you can say are being reaffirmed. In the ingful discount, we like the that as an analyst here. You spirits industry, you have internal dynamics of the don’t feel pressure to rec- had acquisitions as high as (Continued on page 25) Page 25

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(Continued from page 24) have a 50% stake in Crown some, like Hardys, didn’t go company, and we also think Imports, which is the im- well at all. They are also it could be acquired. Cad- porter of Corona and the fairly highly leveraged and bury is the best example of other Grupo Modelo beer were really punished for that kind of company that I brands. that at the end of last year. follow. A few years ago it Finally, there are some dy- was Cadbury Schweppes For a bunch of reasons, the namics with their beer busi- and had a confectionary stock had gotten very ness that aren’t well under- business and a beverage cheap. The company is con- stood. So concerns about business. We thought that management, acquisitions, they weren’t getting credit leverage, and the general for their confectionary busi- consumer environment ness, and they subsequently “Don’t leave your pushed the stock as low as sold off their European and $10 or $11. We had been Australian beverage busi- brain at home. negative on the name but nesses and spun-off their started looking at it again in America’s business as Dr. You don’t take the that range. Pepper Snapple Group. This left Cadbury as a pure highest multiple For their core wine busi- play confectioner, which is a ness, the trade down to less very attractive business. that is being paid expensive brands is actually They are a major player, benefiting them as a lot of have good brands and are in in a bubble the wine that they sell is in attractive markets. So, for the $6 to $12 per bottle Cadbury we did think that environment and range. The people that typi- they were an acquisition cally shop for $20-$25 bot- candidate and that Kraft was use that forever. tles of wine are now looking the most logical buyer. You try to be at bottles like a Clos du Bois for $10 or a Wood- G&D: Do you think that a conservative and bridge for $6.50. As a re- deal will eventually get sult, those brands are actu- done? look for a margin ally doing well in this envi- ronment. KD: I do. I think that Kraft of safety.” will just have to bump up G&D: So comps in the their bid a little bit. wine business have been holding up through the G&D: What other ideas trolled by the Sands family. downturn? are you excited about? Richard Sands is the Chair- man and Robert Sands is the KD: Yes, growth has KD: Generally speaking, CEO. They have super- slowed for the industry and valuations are still pretty voting stock so that they for Constellation, but some reasonable although obvi- can nix any potential deal. brands are doing well. In ously less attractive than They have rolled up a lot of aggregate, sales are hanging they were a few months wine brands over the years in there and certainly have- ago. One company that I and were what you would n’t fallen off a cliff. like is Constellation Brands call a “serial-acquirer.” (STZ). They have the larg- Some of those acquisitions G&D: Given the trade- est wine business in the US. worked well, such as Mon- down to lower-priced bot- They have a small spirits davi, although they paid a tles, have margins con- business. And then they very high multiple. And (Continued on page 26) Page 26

Kevin Dreyer (continued from page 25)

(Continued from page 25) the whole company. If that somewhat hamstrung right tracted at all? happens, they would proba- now with regards to big bly be precluded from tak- acquisitions. Debt-to- KD: There has been some ing over Crown outright EBITDA is around 4.3x, so I gross margin pressure, but because they already have don’t think management the company is also going 50% market share in beer in could make any big moves in through a cost-reduction the U.S. the near-term. program. They’ve found ways to offset the margin The wine & spirit business is G&D: As an Associate pressure. They’ve also sold worth $14-$15 per share. Portfolio Manager, what is off some brands, such as the The beer business, in a your role at Gabelli? Do value spirits and wine port- worst-case scenario, is you have a specific portion folio, and reconfigured the worth $4-$5 per share, just of the capital that you man- reporting segments some- based on the cash flows to age directly or is it more of what, which has had an im- 2016. If the beer contract is team-oriented, round-table pact on margins as well. But renewed in 2016, it bumps type of process? overall, EBITDA margins for the value up to at least $8- wine and spirits are in the $9 per share. We think this KD: It depends on the mid-20s, so it’s not like this is also based on conserva- situation. One of the funds is a low margin business. tive multiples. At the time, is the Healthcare & Well- It’s also not nearly as capital the stock was trading at $11 ness Fund, for which I man- intensive as one would -$12 and I thought it was age a portion of the assets think, because most cases worth $18-$19 conserva- of the fund. Another fund, they are sourcing their tively; maybe $24 or more the Global Opportunity grapes as opposed to own- in an upside scenario. The Fund, is managed by Caesar ing the vineyards. stock has moved up a bit Bryan. That fund is more of since then, but there’s still a a cooperative style, where I Transaction multiples for good deal of upside. will pitch stocks. For the for wine and spirits compa- Asset Fund, which is a nies have historically been in Talking to other investors newer role for me, I am the 12-20x multiple range, about the stock, the bear managing a portion of the but I use 10x to be conser- thesis was very well known. assets of that fund. vative and because it’s family However, most people controlled and there won’t missed some of the changes G&D: Is the Asset Fund be a take-out. Applying a that were going on inter- Gabelli’s primary fund? 10x multiple to the wine nally. The company brought business, the current mar- in a new CFO, sold off KD: It was our first mutual ket valuation implies you are some low-return brands, fund and has about $2 bil- getting the beer business for and increased its focus on lion in assets. We have a free. In 2016, Constella- return on capital, generating total of about $21 billion in tion’s JV partner, Grupo cash, and paying down debt. AUM – it’s split roughly Modelo, can take over We thought management 50/50 between mutual funds Crown Imports at book had a good understanding of and separate accounts. We value, pay 8x EBIT and what needed to be done to also have a small hedge fund switch to another partner, increase the value of the business as well. or renew the contract. But business and were moving in no matter what happens, it’s the right direction. G&D: As a PM for the all upside. Also, A-B InBev Healthcare fund, have you has a 50% economic interest The final point is that risk is done a lot of work in the in Grupo Modelo, and may somewhat mitigated by the healthcare space? be interested in acquiring fact that management is (Continued on page 27) Page 27

Kevin Dreyer (continued from page 26)

(Continued from page 26) roughly in line with a lot of attractive investments as its food and beverage peers, well. KD: It’s really a Health and but it has a natural top line Wellness fund, so my por- growth rate that is 2x to G&D: Any final words for tion has more of a con- 2.5x as fast. We thought it business school students? sumer theme. The health- would be an attractive ac- care portion is managed by quisition candidate, and a KD: Do as much research someone else. I manage the few years ago Pepsi was as you can and try to come consumer portion of the looking at them. up with strong stock ideas. fund. That is how to differentiate G&D: How do you think yourself– to show that you G&D: What are some of about international invest- can do the job from day the names in the consumer ing? one. Try to find your edge, portion of that portfolio? something that you can do KD: We follow companies better than someone else. KD: The largest holding of on an industry basis so to a That is how you can add mine is Danone, the leading certain extent you have to value to an investment man- global yogurt manufacturer. agement firm. They’ve done a reconfigura- tion of their business; for G&D: What characteristics example they used to have a should we be looking at in biscuit business, which they “We follow investment firms that we sold to Kraft. They bought are targeting for recruiting? Numico, which is a baby companies on an food business. It’s a grow- KD: I think the biggest thing ing category and they pro- industry basis so is investment philosophy. vide a healthy product. It You guys are in the AVI has attractive returns, not to a certain program so I am guessing just for their business, but that is where your interest also for the retailers as well extent you have is. Within that context, due to the negative working there are different styles of capital for both their busi- to be value investing. Some firms ness and for the retailers as focus on a particular market well in the fresh dairy cate- international.” cap range. Some are long gory. There are a lot of only and others are long reasons why the category is short. Making sure that you growing. Per capita con- are comfortable with a sumption is much lower in firm’s particular style is im- the U.S. and emerging mar- be international. If you are portant. A big part is also kets than in Western following the spirits indus- personality. If you are going Europe. From a strategic try, you can’t just follow to work for a portfolio perspective, they are the Brown Forman and Fortune manager, you have to be clear leader and can spend Brands. You need to know able to get along. That will more on R&D than anyone what Diageo is doing and make or break how success- else, which leads to block- what Pernod and Remy are ful you are. buster-type products with doing. You have to follow specific health benefits, such the companies anyway be- G&D: Thank you Mr. as Activia, which helps with cause they are competitors. Dreyer. digestion, and Actimel, So from there, it is a natural which helps immune de- extension to evaluate fense. The company trades whether these would be Page 28

AVI Class of 2009

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Graham & Doddsville 2009 / 2010 Editors

Matthew Martinek is a second year MBA student and a participant in the Applied Value Investing Program. This summer he interned with William von Mueffling at Cantillon Capital. Prior to Columbia, Matt worked for three years with the small-cap value team at T. Rowe Price. Matt received a BBA in Finance and Accounting from the University of Wisconsin-Madison in 2005.

Clayton Williams is a second year MBA student and a participant in the Applied Value Investing Program. This summer he interned at Brandes Investment Partners in San Diego. Prior to Columbia, Clayton worked for four years in fixed income research and portfolio manage- ment at Martin & Company, a regional investment management firm in Knoxville, TN. Clayton received a BS in Finance and Accounting from the University of Tennessee in 2003.