Graham & Doddsville An investment newsletter from the students of Columbia Business School
Inside this issue: Issue XXVIII Fall 2016
Omaha Dinner P. 3 Stadium Capital Value Investing Management Reception P. 4 Stadium Capital Management, LLC was Stadium Capital P. 6 founded in 1997 and specializes in investing in micro/small-cap public Student companies using a rigorous, research Investment Ideas P. 20 based, long-term oriented investment Neal Nathani P. 26 strategy.
Chris Weldon ’12 P. 35 Alex Seaver Brad Kent
(Continued on page 6) Editors:
Eric Laidlow, CFA Neal Nathani of Totem Point Management MBA 2017
Benjamin Ostrow Neal Nathani is the Chief Executive Officer, Managing Partner MBA 2017 and Portfolio Manager for Totem Point, where he is responsible John Pollock, CFA for investment decisions across a variety of equity sectors, MBA 2017 including the technology, telecommunications, business services, consumer, and media sectors. Prior to co-founding Abheek Bhattacharya Totem Point in 2013, Mr. Nathani was a Senior Analyst at Axial MBA 2018 Capital, a Long/Short equity fund seeded by Julian Robertson. Neal Nathani Prior to Axial, Mr. Nathani was a Partner at Venesprie Capital, Matthew Mann, CFA also a Tiger-seeded fund. He joined Venesprie from MBA 2018 (Continued on page 26) Adam Schloss MBA 2018 Chris Weldon ’12 of Stamina Capital
Visit us at: Christopher Weldon is the Founding Member and Portfolio Manager of Stamina Capital LLC. Mr. Weldon founded Stamina www.grahamanddodd.com Rolf Heitmeyer www.csima.info Capital, LLC in 2016. Prior to founding Stamina Capital, Mr. Weldon worked as a senior analyst at Aravt Global, a long/short equity hedge fund manager from 2013 to 2016. Before joining Aravt Global, Mr. Weldon was a founding partner at Incline Global, a long/short equity and opportunistic credit fund from 2012 to 2013. Prior to Incline Global, Mr. Weldon served as a Chris Weldon consultant to both Viking Global and Hound Partners, both long/short equity hedge funds. Prior to his time investing in public markets he spent three years working as an associate at Oak Hill Capital, a private equity firm from 2007 to 2010. Prior to Oak Hill Capital, Mr. Weldon
(Continued on page 35)
Page 2 Welcome to Graham & Doddsville
We are pleased to bring you the investing. The two partners investing in compounders, iden- 28th edition of Graham & detail their transition from tifying quality transitions, and Doddsville. This student-led in- private equity investing to the how Stamina will benefit from vestment publication of Colum- public markets in order to find both by utilizing an extended bia Business School (CBS) is co- more attractive opportunities. investment horizon. sponsored by the Heilbrunn The team discusses the evolu- Center for Graham & Dodd tion of Stadium’s strategy, the Lastly, we continue to bring Investing and the Columbia Stu- methodical research and valua- you pitches from current stu- dent Investment Management tion process, as well as the dents at CBS. CSIMA’s Invest- Association (CSIMA). firm’s reluctant, but ultimately ment Ideas Club provides CBS successful activist campaigns. students the opportunity to Meredith Trivedi, the Since our Spring 2016 issue, the practice crafting and delivering Heilbrunn Center Director. Heilbrunn Center hosted the Neal Nathani of Totem Point investment pitches. In this is- Meredith skillfully leads the seventh annual “From Graham Management shares his per- sue, we feature ideas from a Center, cultivating strong to Buffett and Beyond” Omaha spective on utilizing industry Women’s Investment Ideas relationships with some of Dinner. This event is held on the trends and rigorous research Club event, the 2016 Pershing the world’s most experi- eve of the Berkshire Hathaway to find value and growth invest- Square Challenge, and the 2016 enced value investors, and shareholder meeting and fea- ment opportunities. Neal dis- Ross Investment Competition. creating numerous learning tures a panel of renowned cusses what he learned in eval- Jocelyn Doman ’17, Maria Mul- opportunities for students speakers. Additionally, Professor uating business quality from ler ’17, William Hinman ’17, interested in value invest- Bruce Greenwald was honored witnessing the dot-com bubble Mark Shohet ’17, Kenneth ing. The classes sponsored with a Lifetime Achievement and in building complementary Chan ’18, Anton Korytsko ’18, by the Heilbrunn Center Award. teams from watching Wayne and Alexander Teixiera ’18 are among the most heavily Gretzky. Neal also shares an share their ideas for Live Na- demanded and highly rated In this issue, we were fortunate investment idea, Analog Devic- tion Entertainment (LYV), Sky- classes at Columbia Busi- to speak with four investors es (ADI), a semiconductor works Solutions (SWKS), and ness School. from three firms who provide a company that is at reduced AMERCO (UHAL). range of perspectives and invest- cyclical risk and is not com- ment approaches. Despite differ- moditized. As always, we thank our inter- ing strategies and processes, all viewees for contributing their see unique benefits from deep Chris Weldon ’12 of Stamina time and insights not only to research and having an extended Capital discusses the launch of us, but to the investment com- time horizon for investments. his fund, the evolution of his munity as a whole, and we investment strategy, and the thank you for reading. Alex Seaver and Brad Kent transition in skills and tempera- of Stadium Capital Management ment needed to go from an - G&Dsville Editors discuss their concentrated, value analyst to a portfolio manager. -oriented approach to small-cap Chris shares his experience Professor Bruce Greenwald, the Faculty Co-Director of the Heilbrunn Center. The Center sponsors the Value Investing Program, a rigor- ous academic curriculum for particularly committed stu- dents that is taught by some of the industry’s best practi- tioners.
Bill Ackman and Mario Gabelli ’67 Meredith Trivedi with Professor Bruce presented as panelists at the May 2016 Greenwald at the Value Investing Omaha Dinner Program Welcome Reception Volume I, Issue 2 Page 3
“From Graham to Buffett and Beyond” Omaha Dinner 2016
Panelist Mario Gabelli ’67 interacts with other speakers Panelist Bill Ackman shares his views at the Omaha at the Omaha Dinner Dinner
Budge & Carol Collins. Budge serves on the Heilbrunn Ajit Jain mingles with other investors in Omaha Center Advisory Board
Professor Bruce Greenwald moderates a panel discussion with Bill Ackman, Mario Gabelli ’67, Jan Hummel, and Tom Russo Page 4 Bruce Greenwald’s Lifetime Achievement Award Presentation & Value Investing Program Welcome Reception
Bruce Greenwald gives a speech after accepting his Ben Ostrow ’17, Evan Zehnal ’17, and Marc Grow ’17 at Lifetime Achievement Award the Value Investing Program Welcome Reception
McCoy Jen ’17, Nick Yuelys ’17, Elizabeth Broomfield ’17, Mark Shohet ’17, Noah Scherz ’17, Nielsen Fields ’17, Alexandra Cowie ’17, and Audun Nordveit ’17 Kevin Barberich ’17, and Dan Yu ’17
Bruce Greenwald speaks with students and alumni at the Value Investing Program Welcome Reception Volume I, Issue 2 Page 5
SAVE THE DATE
20th Annual Columbia Student Investment Management Association Conference
February 3, 2017
A full-day event featuring some of the most well-known investors in the industry, including keynote speakers:
David Abrams of Abrams Capital
Mohnish Pabrai of Pabrai Investment Funds
Presented by:
The Columbia Student Investment Management Association
and
The Heilbrunn Center for Graham & Dodd Investing
Visit our website for updates: http://www.csima.info
For inquiries contact: Noah Scherz [email protected] Chris Stonerook [email protected] Nick Turchetta [email protected] Page 6 Stadium Capital Management
Alex began his career at the Advisory Committee program that was still a Goldman, Sachs & Co in of Coliseum Capital novelty. There were six of us New York in 1982 in Management, LLC, an in the program and there were Corporate Finance and investment firm based in two or three the year before. Mergers & Acquisitions. Stamford, CT that focuses The program grew Alex subsequently spent 10 on special situation and exponentially when they years in the private equity distressed investments in realized that slave labor was a and venture capital smaller capitalization valuable resource. It turned industry in the Bay Area at companies. out to be a great win-win for Hambrecht & Quist and everybody. We were InterWest Partners. In Prior to forming Stadium knuckleheads out of college, 1997, Alex co-founded Capital, Mr. Kent was a quickly learning the lingo and Alex Seaver Stadium Capital general partner working on interesting deals. Management, LLC, where of InterWest Partners Back then, Goldman was a he is a Managing Partner. where he focused on non- very small firm; it was a In 2005 Alex also co- technology acquisitions, partnership and had a very founded Coliseum Capital recapitalizations, and late- collegial atmosphere. I had an Management, LLC, where stage venture capital opportunity to stay there he is remains an owner as investments. From 1989 beyond the analyst program to well as a member of the to 1992, Mr. Kent was a be a “lifer.” As much as I loved firm’s Advisory Project Manager for the people I worked with Committee. Alex is also an William Wilson & there, it wasn’t what I wanted investor and/or board Associates, a commercial to do, so I applied to business member in a variety of real estate firm where he school and decided to attend earlier-stage private was responsible for Stanford. companies, primarily developing, financing and through Gold Bench leasing office development I attended Stanford GSB in the Brad Kent Capital, LLC, which Alex projects. From 1987 to mid-1980s, so it was a very also co-founded. 1989, Mr. Kent was a interesting time for venture member of the Morgan capital and technology out Alex graduated from Stanley Merchant Banking there. In spite of what was Harvard College cum Group. probably a natural orientation laude in Economics in to value investing, I was 1982, and The Stanford Mr. Kent earned a enamored with the venture University Graduate B.A., with distinction, in capital industry, but I didn’t School of Business in 1986, Economics and a M.S. in know how to break into it. As where he continues to be a Industrial Engineering a finance guy in the land of guest lecturer in from Stanford University electrical engineers, I thought I Investments/Finance as in 1987 and a M.B.A. from had absolutely no qualifications well as in Corporate Harvard Business School, and, at least back then, it felt as Governance. Alex is with high distinction though you really did need an married to Christine (Baker Scholar), in 1993. engineering background. I Noyer Seaver, also made a decision to try to back Stanford GSB ’86. Alex Graham & Doddsville into venture capital a different and Christine lived in Palo (G&D): Could you tell us way and at the time there Alto, CA from 1984 until more about your background were several, very successful, 2001 when they moved and how the two of you Silicon-Valley-focused back east to Connecticut started working and investing merchant banks, with both with their four children. together? investment banking and principal investing operations, Mr. Kent is a Alex Seaver (AS): When I such as Hambrecht & Quist, Managing Member and co- graduated from undergrad at Robertson Stevens, and Alex Founder of Stadium Harvard in 1982, I went to Brown. These merchant banks Capital Management, work in M&A and Corporate catered to the emerging LLC. Mr. Kent serves on Finance at Goldman Sachs, a growth companies of Silicon (Continued on page 7) Page 7 StadiumHarvey Sawikin Capital Management
Valley, but they also took investment business as a junior suburban office buildings in the advantage of the proximity and at Stanford, working part-time Bay Area. It sounded pretty relationships to deploy capital. for one of the pioneers of interesting to me. Real estate H&Q in particular had a pretty venture investing, Melchor is obviously a very different big venture operation, with Venture Management in Los asset class, but it is a similar over $500mm of capital. Back Altos, reviewing business plans investment analysis to a private then that was a lot of money, for them. equity deal. The cash flow especially in venture capital. I generating asset is a property went to Hambrecht & Quist rather than a company, but the and made a deal to spend “First piece of advice: analysis is similar. Howard some time in investment hired me to be a project banking, because I had some marry up… second… manager, which was one of the training at Goldman Sachs, hire people who are best jobs ever because you do before ultimately moving into all the same investment work the venture investing business smarter than you are.” that we do here, but you also there. I also made the best get to touch elements of the decision of my life in 1986 and business with a more creative married my classmate and love When I graduated with my side. The architect and the of my life for thirty years, Masters in 1987 and all the broker salesforce reported to Christine. I’m not sure how I consulting firms and me. I got to do the investment convinced Christine to marry investment banks came to work, which we find familiar me, but somehow she fell for recruit, I knew my number one here, but I also got to work it. First piece of advice: marry priority was to be an investor. closely with other functions. It up. was great fun. Morgan Stanley hired me for Less than a year later, a pure its merchant banking group, In 1991, two things happened. investing/venture firm, which consisted of an LBO One, the real estate market InterWest, recruited me. fund and a venture fund. I was terrible so we were not InterWest was interesting thought I was going to work building new office buildings, because it invested in areas on the venture fund, but I appropriately. If you are a outside of what I thought ended up working on LBO project manager for a venture funds liked. The firm investments. Morgan Stanley development firm and you are not only made more traditional had just raised what I think not building, you either find venture investments but had a was the largest private equity something else to do or you major focus in non-tech fund at the time, $1.5 billion, are unemployed. I transitioned companies. There weren’t which sounds quaint now. I to an asset management role, many firms like that, who worked on a number of LBO which was fine but not as invested in various phases of transactions, ranging from much fun. Two, my wife development, from venture $200 million to $3 billion in decided that she wanted to go investments in technology enterprise value. to business school. I already companies to LBOs of mature had a master’s degree and non-tech companies. I did not intend to go back to didn’t feel a need to seek business school. I knew I another one. But if my Melissa Brad Kent (BK): I am from wanted to continue investing, was going off to Harvard Oregon originally and I was a although I didn’t care much Business School, I wanted to member of Stanford’s class of which asset class. I liked the be there to protect my turf! So 1986. Stanford had a program investment mindset and we both headed off to HBS in to study for an undergraduate conducting investment 1991. and graduate degree at the research. But I wanted to go same time, so I was an back to the west coast with I had no interest in changing economics undergraduate and Melissa, who would become careers, but my wife got a industrial engineering masters my wife. A partner at Morgan summer internship for Apple student and I finished both Stanley introduced me to a guy and I needed to work in the degrees a year later in 1987. I named Howard Wolf. His real Bay Area, so I joined actually started in the estate firm mostly built McKinsey. It was a fine (Continued on page 8) Page 8 StadiumHarvey Sawikin Capital Management
experience, but I knew I been fortunate to guest lecture got our attention. As we like wanted to be an investor so I in his class for the better part to say, nobody fools the two started looking for interesting of thirty years. He’s also on of us more than 100 times in a opportunities while I was our advisory committee at row. there. Stadium Capital. Most Stanford MBAs who end up in the BK: This is different than AS: I joined InterWest in 1987 investing world take his class. when we were working and in 1991 we needed more It is so popular that they have separately in private equity, resources on the team. I to use two classrooms, one when I was at Morgan Stanley interviewed a number of live and one next door with a and Alex was at InterWest. In candidates and in the summer video stream. those days, public companies of 1992, a very good friend of typically traded at higher mine, who is now the Part of the attraction is the valuations than the private president of the Stanford quality of guest lecturers, deals we did. Part of the appeal Alumni Association, Howard present company excluded. In of private equity, of course, Wolf, introduced me to Brad. 1985, we had a guest lecture was that you could buy a When Howard heard what we from someone well known in company at a lower price than were looking for, he said, the investment world, but who the public comps, leverage it, “Hey, I’ve got your guy.” was otherwise relatively and then make the assumption unknown then, a guy named that it would approach the Brad and I met in August of Warren Buffett. I was very public valuations later. That 1992, in the middle of his two affected by his talk but also was the normal operating years at Harvard Business Jack McDonald’s entire course. procedure. By the mid-1990s, School. Brad came to work He is an evangelist for Buffett- that wasn’t the case at all. with me and we’ve been style investing and the Money flowed into the private business partners for almost spectrum of value investing equity business, as you would twenty five years. going back to Graham and predict, and almost everything Dodd. In spite of my desire to became an auction. In an BK: I started working give venture capital a shot, this auction, you’d pay 6x, 7x, 8x remotely for InterWest during mentality and approach was EBITDA and we would see my second year at HBS and as always in the back of my mind. public comparable companies a result I did not have to traded at 3x or 4x. We started recruit. Around the time that Brad asking ourselves, “Why are we joined InterWest, we were doing this? Why are we paying AS: Brad was working 20 to traveling the country looking at 8x when we can buy a 30 hours a week for us but still companies that, had they been company just like it for 4x? Is managed to be a Baker publicly traded, would have controlling the company worth Scholar. The second piece of been called microcaps, that premium?” advice I can give anyone is to somewhere between $50 hire people who are smarter million and $500 million in AS: During this time, we than you are. enterprise value. Of course the started to talk to some of first thing we would do in these smaller public companies G&D: How did the two of evaluating private investments because, naturally, they might you transition from private was look at comparable be attractive take-private equity investing to the launch companies in the public candidates in our private of Stadium Capital? market. We began to notice, in equity business. What we the mid-1990s to late-1990s, a discovered was that many of AS: At Stanford Business pattern of public companies the management teams were School, I took a class with trading at much lower nervous about exploring a sale, Professor Jack McDonald, valuations than their peers in largely because they feared where I was also a Case the private market. We that the process could deviate Writer for him. He’s a legend weren’t sure why that was the and eventually result in a at Stanford. He is now in his case. Not all companies were strategic sale in which 49th year as a professor in trading at discounts, but it management loses their jobs. Investments & Finance. I’ve happened often enough that it At the same time, if we (Continued on page 9) Page 9 StadiumHarvey Sawikin Capital Management
approached them as pure spreads. This change short-term incentives. public market investors, we represented an enormous loss were welcomed with open in profitability for the Microcap portfolios at places arms and a red carpet. brokerage community. like Fidelity had two to three hundred positions, which in Brad and I were essentially In what the world calls our view makes it nearly agnostic investors by mentality. “microcap” – which ironically impossible to cover individual If a great, publicly traded would have equated to fat, companies in any depth. We business with durable, beefy private equity deal sizes also discovered that portfolio defensible, and high free cash for us in our old business – the churn was 100% or more, flow was simply a public public companies were annually. What we observed market investment generally considered to be was a universe of relatively opportunity, then so be it. It detritus. Given the lower float thinly traded public companies, might not be a private deal and liquidity in microcaps, turned over massively by opportunity, but it might be a these companies didn’t get institutions, and little company- great investment. much love from the buy-side specific knowledge given the and sell-side to begin with. constraints of portfolios of this We also began to explore why Disappearing trading spreads size. this valuation discrepancy were the nail in the coffin. existed. As Brad mentioned, When we made calls to buy- on the private equity side, a lot side owners to learn more more people had entered the “...the Holy Grail for about their views on these fray. The market was more companies, it would often take competitive and the marginal an investor, from our several migrations to find the price setter in private appropriate portfolio manager. opportunities tended to be an point of view, is to find Often the PM was relatively array of very smart private a less liquid market junior, relegated to microcaps equity firms. These firms were as a way to train them so they not only competing with each where there is couldn’t do too much damage. other free-form, they were The PMs would earnestly try being choreographed by the inefficient short-term to answer our questions but bankers to compete with each even if they owned 10% to other. By the end of a process, pricing behavior.” 15% of these companies, there sophisticated, well-tuned typically wasn’t an individual investors were the marginal investment hypothesis. You price setters. The smartest, The buy-side institutions were could often hear the papers most sophisticated investors dropping coverage of massive rattling in the background as were setting the price, with swaths of microcaps. At the they tried to figure out what leverage as a booster. same time, the sell-side the company did. research, which had not been On the public side, Brad and I especially good to begin with As an example of the odd discovered a few critical for these companies, more or behavior in this market cap elements that captured our less vaporized. The segment, we would often talk attention. First and foremost, opportunity for us, of course, to sell-side analysts with sell the way that public equities was that these companies ratings for companies we were traded was changing were still public. In stark thought were actually pretty dramatically. In 1997, contrast to our former private attractive. We thought they the order handing rules were equity world, the marginal might know something we changed from trading one- price-setter in the microcap didn’t. Instead, the head- eighth increments to one- public market tended to be the scratching answer we often got sixteenths. It was also generally least informed and in many was, “No, no, no. This is a acknowledged that this was a cases least sophisticated buyer, great business. I would own it step towards fractional, or with an increasingly myopic, all day in my personal decimal trading and another impatient investment horizon portfolio. Unfortunately, I have massive reduction in trading and radically different set of to issue a sell rating because I (Continued on page 10) Page 10 StadiumHarvey Sawikin Capital Management
don’t see a near-term catalyst We back-tested the data and When we meet with in the next three to six ran hypothetical screens for management, we have a list of months.” good businesses trading at low questions that we think any valuations. As it turned out, smart, long-term investor The lightbulbs were going off the economics work. If the would ask. They are the same for us because the Holy Grail companies performed well and questions we had pursued as for an investor, from our point continued to be good private equity investors. of view, is to find a less liquid businesses they couldn’t market where there is possibly stay at those values, What kinds of questions? As a inefficient short-term pricing and they didn’t. We convinced thought exercise, imagine the behavior. One of our ourselves that something hypothetical of only being fundamental core beliefs is that would happen that would allowed to invest $50 million markets can be inefficient in reprice these companies, dollars once in your life, in one the short run but efficient in eventually. business. Tasked with that, the long run. The more time what kind of work would you we studied the public market, The problem for most do? How much work would the more we discovered investors is trying to figure out you do? Odds are it would be dynamics that tended to create when that will happen. That is a lot. It would be your one short-term deviations from where most people, especially shot. You’d take your time. intrinsic value — there were those who mark to market You’d talk to customers, you’d time horizon issues, there every day, get caught up. They talk to the supply chain, you’d were liquidity issues, there not only have to figure out talk to competitors. You’d do were compensation issues, whether something is all the things you felt were there were portfolio undervalued, they also have to important to have conviction construction issues. All of this figure out when it will get along with a price that afforded created a situation where buy- revalued. Figuring out if you a sufficient margin of and sell-side participants in the something is undervalued is safety. This investing approach microcap segment made much easier than figuring out seems like basic plumbing to us decisions that frequently did how and when something will but this was radically different not seem rational to us. We be revalued by the market. We than the preparation that believed that focusing on this didn’t, and still don’t, know management teams we visited less-well covered, less-liquid how to do that. Instead we had experienced. market, combined with a looked for a structure that longer-term horizon offered a would allow us to release that We would ask fundamental great opportunity for us. time constraint. We knew if questions that to us weren’t we could do that we could put novel, or unique, or esoteric, G&D: Even if you had ourselves in a business that but simply put the business in a confidence that you found had an advantage. three to five year operating companies trading for a context. Generally the CEOs discount, what made you AS: The other thing we were blown away. Many had believe this mispricing would noticed is that many people never had investor correct itself? were not doing fundamental conversations like that. They work. We always travel to had never gone to the BK: That was the dilemma for meet management teams. We whiteboard with someone like us. We saw great businesses never have meetings in the us to lay out the current and trading at absurd valuations office. We are always going to long-term competitive and thought, “How could this learn more when we are in landscape, or to draw out the be?” Then we would ask, “If it their native habitat. There is organizational chart and how it is mispriced, how is it going to also the potential to spend might look in the future. It get repriced? Maybe it is more time than if the seemed as though every other mispriced because it is small. management team is rushing meeting we had, a CEO would But if it is going to stay small, between meetings. We might say something like, “You know why won’t it always be even get to see a facility or to the last meeting we had, the mispriced?” meet more people. investors hadn’t even read the 10-K.” We were stunned the (Continued on page 11) Page 11 StadiumHarvey Sawikin Capital Management
first few times we heard that. company data. There were no products than have access to insider trading issues. We the detailed internal financial The more time we spent doing generally got whatever data we statements. this, the less interesting our wanted. When we started old jobs seemed to be because investing in public companies, The other interesting part of it on the public side, we were no we were concerned that we is that we had no idea how longer dealing with bankers, or would not have enough many people would talk to us. lawyers, or accountants, or information to make good Let’s say there is a software anybody else. It was simply us, decisions. We thought we company and we really want to an open field, as much work as would be making decisions on speak to some of its we wanted to do, as much inferior information, but it customers. What are we going time as we wanted to take, and actually just turns out to be to do, get on the phone and no mandate to be invested. different, maybe even better, call their customers? Sure, let’s information. give it a try. Turns out, many “The minute you of them do talk to us, at What you give up by not length. Surprisingly to us, most expand your time getting detailed inside financial people give us the time to horizon to be multi- information, you gain in the answer our questions. When ability to talk to whomever you do the work to be year in orientation, you want. In a private equity informed and to be an process, generally you are educated counterparty, they volatility instantly constrained as to whom you stay with you even longer on a can contact, both internally call or at a trade show. transforms from a and externally. You feel like you get a lot of information, That was one of the big “ah- problem to a huge but you only get what they are ha’s” for our business. We are potential going to give you. When you not stuck with just public are on the public side, you financial statements. There’s opportunity.” don’t get the inside data, but this whole world of you can talk to whomever you information out there that we We also believed in a focused want across the landscape of can go get. It takes work but portfolio. In order to build an customers, competitors, it’s not hard to find good appropriately diversified suppliers, industry experts, all information, it just takes a lot portfolio, it turns out you only of them, at whatever pace of time. You may have to need about twelve companies makes sense. reach out to 300 enterprise mathematically to have full customers, for example, to company diversification. It also You can spend several days on have 50 to 100 useful turns out that it’s a lot easier rooftops with customers conversations. Those 50 to to stay on top of businesses installing telecommunications 100 conversations can tell us a when the portfolio is more equipment to learn how they lot about product quality and focused. There’s no need to operate and why they chose a service, competition and have thirty, fifty or three certain manufacturer. For a switching costs, or hierarchy of hundred positions; in our view retailer, you can conduct store need questions. that is just an AUM-gathering checks and talk to whomever contrivance. you want. The company may AS: We are very methodical have a policy that won’t let about what we do and we are G&D: Did you feel like you store employees talk to you, very process-oriented. To were losing an ability to but they can’t stop you from make judgments, you have to research companies thoroughly talking to customers, have sufficient data that is well because of the restrictions on understanding inventory organized. So we write up outsiders in public markets? management, discounting, or every research conversation the competitive landscape and management meeting that BK: Coming from the private locally. I’d rather know what a we have in thorough detail. equity business, we were used hundred of a company’s Over the years we see to getting full access to inside customers think about its businesses over and over and (Continued on page 12) Page 12 StadiumHarvey Sawikin Capital Management
we have incredibly valuable to advancements in fMRI as an investor and what your time series of information to technology and brain scans. time horizon is. I can imagine use. When we go out to visit a that volatility is an important management team for a fourth People are prone to making measure of risk if you have time, we have the full details of pro-cyclical decisions based on short-term needs. The minute the three meetings we might emotional centers, alarm and you expand your time horizon have had over the prior nine alert portions of the brain that to be multi-year in orientation, years. It certainly helps kick in under stress. When you volatility instantly transforms contextualize management’s see a stock that you own go from a problem to a huge performance and execution down 20% in a day, which potential opportunity. There credibility. happens all the time in our are all kinds of reasons why a world, it messes with you. Loss business’s stock price can G&D: It seems like you are aversion is a big deal, people dislocate rather quickly in the able to capitalize on market hate losing money, even if the near-term and a lot of reasons, swings but how do you manage losses are actually temporary. if the fundamentals are still the emotional component? right, why it will revalue itself Now imagine you are a eventually. AS: When markets are portfolio manager at a large gyrating, our research matters institution with a portfolio of We have seen plenty of a lot. In order to have one, two or three hundred investors that want to move conviction about a business, positions. One position turns into small-cap stocks from you need to have access to blood red on your screen on a private markets and then they information that matters. So if 10x volume day and is down are totally thrown off by a company’s stock price is 20% or 30%; since you don’t volatility. They will tend to down 25% in two days of know enough about the make very irrational decisions. trading, we are not panicking, business to make an educated They know something is looking at the screen. We are choice whether it is an undervalued but will refuse to actually typically on the phone opportunity or a falling knife, invest for fear that it might go with the company’s customers, you’re going to tend to make down further. If an asset is around the world. the decision to sell. By doing trading at a steep discount to so, you are also going to intrinsic value, the reaction One of the biggest issues compound that selling volume, should actually be, “I want to surrounding our business is which is why these things can own it. It may get cheaper, in volatility. If you’re invested in a move so quickly. The reaction which case, I’ll buy more.” private business, you don’t is to think, “Somebody else have to deal with volatility; it is must know more about this The reason we have stuck to not part of your psyche every than I do. They’re selling this this universe of small and day. You are not being faced aggressively. I need to get out.” microcap stocks for almost with a green or red flashing Particularly if one’s twenty years is that volatility is number telling you if you are compensation and incentives very pronounced. Anybody smart or stupid. We know are near-term in orientation, who pushes the sell button in now, with tremendous that investor doesn’t want to our world affects the price. advancements in research of get stuck with a bad mark in Last time we ran the numbers, the brain, that most human the portfolio, so the position we found that every quarter, beings are wired to be really gets flushed. 56% of the companies in our bad investors. We have a lot of universe see a stock price reactions to stimuli that are BK: Of course, the next change of at least 20%. A very really bad for investing. iteration was to program a large proportion see a stock Benjamin Graham knew that. computer to do that price change of more than 30% Warren Buffett has always automatically. in a given quarter. So if you known that. But it turns out to don’t like volatility, this is not be true and we now have the AS: The question is whether your market. If you think science to back it up. The volatility is a problem to be volatility is a big opportunity, literature is extensive and solved or an opportunity. The this is your market. fascinating, thanks in large part answer depends how you think (Continued on page 13) Page 13 StadiumHarvey Sawikin Capital Management
G&D: What allows you to company decisions lead to necessarily the right thing. embrace volatility when others being in cash rather than We hear this all the time. cannot? investing, then we are in cash. People will ask, “How risky is Over the past several years, it?” What they always mean is, AS: We started our business we have probably averaged “How volatile is it?” We have to manage our own capital in 50% cash. It has been tough for to ask them to clarify, because the late 1990s. We had no us because it has been a rising risk and price volatility are not intention to manage outside market and environment in the same thing. We get into money but we wanted the which we are not dialed-in to odd conversations with ability to do so if we chose. win. It is overvalued, it is rising, institutional investment For almost twenty years, that and we are sitting in cash. But managers because they will talk is still our mantra. We have a a lot of this capital is ours; that about their private equity lot of our own capital in our is how we will always choose portfolio being less risky than strategy and we have an to invest. their public equity portfolio extraordinary group of even though we know they investors who think the way If you believe that over the have similar companies, we do. Probably 75% of our next five years the Russell sometimes even the same investors by number are 2000 will compound at 12% to companies, in both portfolios. exceptional investors in other 15%, which is roughly what it It’s just that if you don’t mark asset classes like private equity, has done over the past three your private investments, venture capital, distressed, and to five years, then we should there’s no volatility, so it is not even public equities. all just buy the Russell 2000 as risky. But how does that and go home and play golf all make any sense? “There is no pitch day long, because that is the smart thing to do. Maybe then AS: People would say in the mentality. It is the we wouldn’t be such lousy 2008-2009 market crisis, “The golfers. Of course now we see draw down in our private opposite. It is a desire front page news every day portfolio was substantially to seek the truth, about passive versus active less.” Really? You had public management. A lot of this companies trading for 1x to 2x whatever that may behavior seems pro-cyclical. It EBITDA. You had private is a function of four or five companies with 4x or 5x be.” years of rising markets and leverage, so the equity value that’s tougher for active should have been marked to We can’t be big. Our strategy managers. Active managers zero. is to stay in microcaps. If our tend to succeed in more median market cap has been volatile markets. One of the big developments $500 million and our core in our world, which Brad positions average 10% to 12% BK: Somehow, many people eluded to, is the change in our of the fund, this confines the have convinced themselves counterparties. Fifteen to AUM we can manage. That’s that it is true that volatility twenty years ago, we executed another reason why many equals risk, which is convenient natural trades with often people don’t stay in this in developing an economic uninformed managers with business; they want to manage model. It follows that hundreds of positions. This more capital and that’s never something with higher risk model has been largely been core to our aspirations at should require more return. replaced by platform and all. But then you scratch your algorithmic trading. Roughly head and think, “How are we 70% to 80% of our We also consider cash to be going to measure risk? Well, counterparties today are an asset class. It is an active the one thing you can measure machines instead of people. investment decision for us. We is the changes in mark to The algorithms trigger very don’t make macro decisions to market prices. So wouldn’t it quickly. go into cash in tough markets, be great if we could use that.” we make individual company But while it is the one thing we A company we know quite decisions. If the individual can measure, it is not well that typically trades one (Continued on page 14) Page 14 StadiumHarvey Sawikin Capital Management
to two million shares a day summaries for every US and By the time it gets to this point recently announced Canadian company between in the process, we all think it is disappointing earnings and a $50 million and $5 billion in a pretty good business, or it modest revision to guidance. It market capitalization. We split wouldn’t be there. We are was already significantly up the pile in two and Brad frequently checking into the undervalued but it traded 40 and I each go through them research and if it was going million shares in two days as one by one. poorly, if customers hated the everybody piled on to get out. product, we wouldn’t still be “It’s a miss. Blow it out. Shoot BK: Once in our official working on it. When we revisit them all and let God sort it process, someone here will a company with additional out eventually.” That business spend the time to go through research, we try to take is now trading for 3x EBITDA. the financial statements and qualitative issues and research the company’s information and map those There are times when we want market to lay out a “One into a financial model. At the to speak to other Pager,” which is really closer end of the day, it has to come shareholders. Seven out of ten to forty pages. When we come out to a price. The model times, there is no one there. to our weekly investment includes various operating The best you can do is to get committee meeting we can scenarios, often three, but in touch with a compliance have a discussion based on the sometimes more. We person. That continues to be One Pager to kill it, to spend construct the cases so that we an opportunity for us and one time to research it now, or to can have rational discussions we could not have expected put it on the watch list, about individual levers. when we started this business because it might be attractive twenty years ago. at a different price. Alex might think that a company will grow at 2x GDP, G&D: How does your If we want to continue work given particular tailwinds, and philosophy influence and drive on a company it goes into our others might disagree. After the investment process? primary investment research discussing the levers in various process. This typically includes cases, we probability weight all BK: Our process starts with a a CFO call to answer any scenarios. Only then do we company idea. We either see a questions we might have up know the outcome of our company in a screen of our front regarding the financials. valuation. Our order is universe or we get it from Later, we follow up with a intentional because we try to somewhere else: a friend, a company visit. Obviously, the be very objective about our newspaper article, etc. Once management team is absolutely assumptions. There are some we identify a company that critical to our confidence in companies we may really like might match our investment their free cash flows. and we at that time we may be style, normally Alex or I will holding a lot of cash, but you look at the financials and basic Meanwhile, we continue to add don’t want to solve for owning business model before putting to our primary research. This something. You want to solve it through our formal process. will almost always include for getting valuation right. customer calls. Often we AS: Now that we are almost attend industry conferences People make this much more twenty years into the business, where we can get to a complicated than it needs to the majority of our ideas are concentrated group of people be. You determine what not off blind screens. The ideas who know something about something is worth and if are from our own lists. Twenty the industry. We sometimes market participants sell it to us years ago we didn’t have these hire outside consultants. At for less than it is worth, we’ll lists, they’re huge now. Plus, the end of that research, which buy it. If they want to buy it for we run screens of all different is often after two or three much more than it is worth, kinds to test for durable free months, we can circle back to we’ll sell it to them. It’s really cash flow and high returns on the idea in an investment not more complicated than capital. That being said, we committee with more that. The hard part is, at any miss things. So at least twice a information. time, determining what a year, we print out single-page company is worth and tracking (Continued on page 15) Page 15 StadiumHarvey Sawikin Capital Management
to see if the valuation should is below that we are delighted trigger to start buying is at $11 change. We always try to keep to hold. for a $10 valuation and the our valuation current and let stock price has fallen from $15 the market do whatever it will AS: Third piece of advice: to $11.48, we don’t buy it. We do around that price. make sure you know what have gone through a rigorous your firm’s core principles are. process and if we want to buy AS: The market does provide Every investment business it, it might be possible to start opportunities often. The truth needs to have a set of well- down a slippery slope if we’re is, we are not “buy-and-hold.” defined core principles that are not careful. When our real We buy and we are prepared well understood and price trigger to buy is $11.00, to hold. That is a major consistently applied. Here, one but we somehow relax the distinction. Going back to our of those core principles is that constraints to buy it at $11.48, time horizon, we are willing to a business is worth the present then where does this stop? hold things for many, many value of its future free cash We have to be disciplined, years as long as it is trading flows. otherwise all hell could break below what we think it is loose. worth. “The truth is, we are BK: In a way, you almost run BK: We struggle to see the not “buy-and-hold.” the risk of behaving like a merits of being buy-and-hold. If momentum investor. Prices you think something is worth We buy and we are might go up in a position you $10 and someone will buy it think is worth around $10 and from you for $15, leaving aside prepared to hold... we you are supposed to sell at taxes, why does holding it for are willing to hold $11, but you feel good because five years help you? We it just had a 30% run. But if you struggle with that concept. We things for many, many let yourself start thinking like don’t struggle with the idea that, pretty soon you have put that you ought to value years as long as it is yourself in an entirely different businesses using long time business. Then you’re in the horizons, that makes perfect trading below what we business of trying to decide if sense to us. But once you the market will continue to go determine what a long series think it is worth.” up. of cash flows is worth, what is the merit of making yourself The process that Brad You have to pick one or the hold it when you don’t have described is a very lengthy other. You are a value investor to? process that involves many or a momentum investor, it’s steps, almost every one of pretty dangerous to try to be AS: To put it another way, if which is subjective and both at the same time. With all you believe that a security is involves judgement. This is all the information we had worth $10 and it is trading for layered into a framework that yesterday, we thought it was $15, at this price it is trading we can use rationally to make worth $10, and we’re selling for a negative expected return, our decisions. But all the accordingly. It may have gone relative to your hurdle rate. inputs rely on judgments about up 30%, and who knows, it That said, for many businesses, all the inputs, like growth may go up another 30%. But if we have happily held onto rates, margins, working capital, you start putting yourself in them for five or ten years if we and CapEx. We try to imbue the position to be momentum felt they remained all of those numerical investors, that is a different undervalued. assumptions with the realities business. There may be people we’ve studied, with the who can do that very well, but BK: That’s because they have research we’ve done. that’s not how we operate. traded for less than they are worth. Both of those things The assumptions we make lead G&D: You mentioned the change over time. Our us to a range of prices where process of actively refreshing valuation could be going up, we are willing to start buying. research and valuation. How but as long as the market price Hypothetically, if that initial do you avoid biases when (Continued on page 16) Page 16 StadiumHarvey Sawikin Capital Management
evaluating businesses you have There is no pitch mentality. It activist investors. Not because held for long periods or seen is the opposite. It is a desire to we think there is anything many times over the years? seek the truth, whatever that wrong with the business may be. It seems like the right strategy. There are certainly BK: I don’t think there is a way to invest and a pure way plenty of companies that could magic bullet to keep you from to think. If that leads us to an use activist investors to having biases. I think one of the answer that says, “Great demand the corporate best ways to do it is to invest business, wrong price,” the governance they already with your own money so you company goes on our watch should have. In general, we are are focused on being right, not list and we wait. supportive of activists, but it is necessarily on being invested; not something we typically at least you get the motivation Brad mentioned that we hand want to do ourselves. right. We’re not in the out pricing sheets after the business of investing, we’re in discussion, after we have First, being an activist investor the business of investing talked about the cases and had requires a different staffing properly. It is our partners’ the debate about assumptions. model and a lot of resources. money and it is our money. This is another attempt to In order to have an activist make sure that our strategy you have to build a So you get the motivation right conversations are as unbiased much larger team. Second, and then try to check yourself as possible. For example, Brad being an activist puts you in an at all times to make sure you might think that we ought to adversarial position and as a aren’t holding onto biases. be more aggressive and that day-to-day life preference, we Every time you get new data, we should assign more weight didn’t want to go into work you make sure that you are to the upside case and I am every day and spend our time being rational. Sometimes, we more conservative and want to in adversarial conversations realize that we have to do a bit assign less. with management teams, of a reset to make sure. We boards, and attorneys. That have to make sure that we are But if we saw in advance that isn’t how we wanted to live. not projecting same-store sales this difference in our points of to grow at 3% a year just view might have resulted in a We have roughly 2,500 because we always have. We price difference of $0.25 on a companies in our market have to be careful that we are $20 stock, we might think that segment and we have not just staying with the same the discussion doesn’t matter. maintained the point of view assumptions in the absence of For pricing it might not matter, that we are going to be able to new data, when the initial but it can be necessary to have find plenty of companies who assumption might have been those tough conversations are already doing things closely wrong. because something interesting aligned with the way we would might come up. Brad’s views of like them to be done. We’d AS: We try to organize higher growth for the business prefer to just invest in ourselves around that bias could be based on things that I companies with management potential. There are many had not previously considered. teams and boards that we firms who have portfolio Or it might stimulate another believe in. That’s worked managers who hear pitches partner to raise questions or pretty well for us. from analysts. Analysts concerns. research these ideas and We’ve invested in over 150 present these ideas in hopes of G&D: Part of your process is companies and we have done a getting capital because they are to engage with management. pretty good job avoiding public going to get measured by their On rare occasions you have conflict. In the last few years individual performance. That pushed for change as activists. there have been a couple of pitch mentality is antithetical to Could you talk about these cases where we had to be how we operate here. scenarios and what changed more active. We were your approach? reluctant to do it, but we felt We invest all of our capital like that these were situations together. So we all have to BK: As a general matter, we where corporate governance make decisions as a group. have tried to avoid being was inappropriate and where (Continued on page 17) Page 17 StadiumHarvey Sawikin Capital Management
we had to exercise our public letters rather than shined on them, particularly in fiduciary responsibility to our private communications was the microcap universe. A lot of investors. We wouldn’t seek very different for us. That is companies still have significant to do it again, but we’ll do it if not our normal M.O. Typically legacy founder or family we have to. for an activist, the investment ownership structures. The hypothesis is predicated on odds of seeing funky AS: They’ve been very changing something: the board, governance dynamics are high. successful. the management, the strategy. Our world is not based on BK: Most of the time, it is BK: Yes, the campaigns were that. We want good benign. But in some cases it is successful, but we still don’t management, good not. want to have to do it again. opportunity, good company, and an attractive entry point AS: We’ve been very G&D: Do you want to dig into by price. successful but selective in our any of the campaigns in more activism. But, I would echo detail? It just turned out, in a couple Brad’s comment that we are of long-term investments, we not looking to do it again. We AS: Sure, we can talk about thought we saw big enough have not screened for Insperity (NSP) as an example. upside from the changes we situations where we think NSP is a professional thought were necessary, we there is bad governance where employment organization. The had big enough positions that it we’d want to go in and change company acts as a co-employer was an appropriate use of our it. of its customers’ employees to time, and we could make a reduce healthcare plan difference by raising the noise G&D: We saw in your 13-F premiums and provide shared, level. But we only did so after that you added some relatively outsourced human resource thoroughly exhausting every large positions recently. Do functions. In NSP, we were other possibility. you want to talk about any of shareholders for over six years them? and we were the largest In Insperity, the management shareholder. We had many team and board knew exactly AS: I’ll talk about one of them interactions with management how we felt. We tried every contextually. We have a new and colossal amounts of angle to avoid a public conflict. core position in a business that research, with hundreds of But it met all three criteria and we first looked at eight years B2B customer conversations. we were not getting anywhere ago. This goes back to our Eventually, we became privately. I have to look back at patience, both entering and increasingly frustrated with sub the price when we went public exiting. The price was always -optimization of a great with our concerns, but it was too high and it had been on business in a great market. close to $20. We’ll take a fair our watch list for years. It is an Also, we were frustrated with amount of credit for opening enterprise software business. the governance structure that up the shades and letting the The company executed a allowed this to happen. We light in on that one. major acquisition and bought a were concerned about competitor for a pretty big management compensation In Big 5 Sporting Goods price. It might not be shocking and perks. Compensation did (BGFV), we’ve been investors but they stumbled on the not appear to be sufficiently for eight or nine years. One of integration; it was not fatal, but tied to the company’s our partners, Dominic the company stumbled enough performance. The more we DeMarco, has been on the to cause a disruption in dug, the more concerned we board there since 2011. When expectations. Our view is that became. we went on the board, the the acquisition still makes company was valued at around sense, even though it may take There are public letters from $8 or $7.50 per share and it is longer to integrate and March and April of 2014 that close to $17 now. We worked uncover all the synergies. The lay out our concerns in that one pretty hard. As Brad stock was hit earlier this year extraordinarily gory detail. The said, there are many to the point where it began to fact that those letters were companies that need the light hit the top end of our buy (Continued on page 18) Page 18 StadiumHarvey Sawikin Capital Management
range, so we began to buy a but the things we know we can us. If we’re trying to build a little bit. do to research and underwrite five-year model for a cash flows will be a very small technology company where Recently, the company piece of that puzzle. The bigger the product life cycles are announced a quarter that piece is something that we just three months, and disruption upset the market and the stock don’t know and can’t know. happens all the time, that’s a dropped another 30% or 40%. tough one to underwrite. Now, you’ve got to be careful, you don’t buy just because it “...we saw big enough G&D: Stadium now has a fell. If the stock price has European version of the dropped into our buy range, is upside from the strategy. What began this the business still worth what process and how does this fit we think it is worth? After a changes we thought in with the rest of the firm? lot more work, including about were necessary, we one hundred customer AS: We thought about it over conversations, we determined had big enough the years, mostly because that the business was trading some of our investors below our view of intrinsic positions that it was encouraged us to do so, both value. This is also after layering in terms of the market in our typically conservative an appropriate use of opportunity and the manager assumptions to generate set. There do not appear to be additional margin of safety. our time, and we could a lot of people who do what make a difference by we do in Europe apparently. This investment decision was We have looked at Europe not based on the price raising the noise level. many times over the years. dropping alone, but the Then we have typically decided confirmation with research But we only did so to lie down until the feeling that the underlying value had went away because we have not deteriorated dramatically. I after thoroughly always had plenty to do here in think that stock is down over the U.S. Ten or twelve years 50% from the start of the exhausting every other ago we took a very hard look calendar year and time will tell possibility.” at it. At that time, we satisfied if our point of view is right or ourselves that there was an wrong. opportunity and the ability to So, Oil and Gas, probably no. do research was reasonably G&D: We talked about your Semiconductor manufacturing, attractive. universe with respect to probably no. But that doesn’t company size. Are there other mean there aren’t companies Three years ago, an investor of limitations to what you will or in those industries or ours requested that we look won’t research? connected to those industries again and we took the where we could get excited. opportunity to refresh our BK: We always look for areas We would be delighted, for point of view on the number of where we can thoughtfully instance, to invest in a systems potential opportunities and construct long-term cash flow software company that has an where they might be. All the models. That leaves out some Oil and Gas customer base same opportunities had even companies where thoughtful with attractive economics and less friction for research, but models would rely on industry long-term product cycles. the question was, “Who is or commodity dynamics that going to do this for us?”, we can’t predict. The obvious AS: The half-life of the because none of us was industries might be those research has to be long. We’ve interested in re-potting related to the price of crude had great investments in ourselves in Europe. But we oil, which we just can’t predict software businesses and in found an exceptional individual three to five years from now. shoe companies. The durability in the UK whom we had Some might be great of the cash flows, based on our known for fifteen years and businesses over long cycles, research, is what matters to teamed him with an analyst (Continued on page 19) Page 19 StadiumHarvey Sawikin Capital Management
who had been here in see your security down 50% Connecticut with us for two and still be OK in order to be years. They are doing an a public market investor, and outstanding job scouring the it’s still true. There are many investment landscape in ways to invest and you have to Europe and the UK. be honest with yourself about which one is right for you. We usually discuss four to six companies every week in our BK: Also, make sure you join investment committee an organization that invests in meetings and at least one or a way that you would invest two of them are European personally. There are lots of companies, sometimes more. ways to invest and there are As we are developing our organizations that do lots of knowledge base over there we very different things well, but if have invested in a couple of you are not suited to what businesses there already. It they do well, you could be remains to be seen how much miserable. That’s part of the of a long-term opportunity trick. It is not the easiest there is for us in Europe. The business to enter and if you get universe of publicly traded in by joining a company that microcap companies is smaller, isn’t a good fit, it might not probably 30% to 40% of the have gotten you anywhere. It is number of companies in the not just about getting into US and Canada. But we are investing, it is about getting happy we are taking a into a place that fits. Make sure thorough look. you are doing what matches with you and not with G&D: Do you have any advice someone else. for students or anyone else looking to work in investment G&D: Fantastic. Thank you management, particularly with both for your time. a value orientation?
AS: The first question anyone should ask himself or herself should be, “What kind of investor do I think I am?” If seeing red and green flash in front of your face all day long doesn’t scare you, if you’re prepared to think about volatility as your friend, then the public market is a fun place to be. But you have to be honest with yourself, because it is not for everybody. If you believe that facing a portfolio down 20% in a quarter will wreak emotional havoc on you and prevent you from making smart, rational decisions, then you shouldn’t be in this business. Ben Graham said that you need to be prepared to Page 20
Live Nation Entertainment, Inc. (NYSE: LYV) - Long 2016 Women’s Investment Ideas Club
Jocelyn Doman [email protected]
Executive Summary HIGH QUALITY ASSETS: Leading global live entertainment company across four harmoniously integrated business segments (Concerts, Ticketing, Artist Nation, Sponsorships & Advertising), playing melodic syner- Jocelyn Doman ’17 gies and economies of scale. Jocelyn is a second-year IMPROVING ECONOMICS: Revenue CAGR of 9% through 2018, with EBITDA margins expanding MBA student at Columbia 55bps results in a $2.95 of FCF per share by 2018, thus turning up the volume on FCF generation and Business School. Prior to ROA. CBS, Jocelyn worked in communications marketing ATTRACTIVE VALUATION: Target price of $32.50 a share, representing an 18% upside – I recommend for Edelman. This summer a LONG on Live Nation Entertainment, Inc. she interned in digital busi- CAPITALIZATION FINANCIALS ness development for Shares outstanding 202.5 2011 2012 2013 2014 2015 2016E 2017E 2018E Paramount Pictures, and is Current share price (10/19/16) $27.58 Revenue 5,384 5,819 6,479 6,867 7,246 8,198 8,773 9,387 interning in product devel- Market Value $5,584 Cons. 7,980 8,289 8,718 opment and strategy at Total debt $2,045 EBITDA 438 459 505 555 578 658 726 799 Non-controlling interest $5 EBITDA Mgn: 8.1% 7.9% 7.8% 8.1% 8.0% 8.0% 8.3% 8.5% NBCUniversal this fall. Less: Cash & equivalents ($1,305) Cons. 641 705 761 Enterprise Value $6,319 FCF 28 243 296 138 158 458 454 594 Target Price $32.50 FCF per share 0.15 1.30 1.53 0.69 0.78 2.28 2.26 2.95 Potential upside 18% KEY STATS SHARE PERFORMANCE
52 Week High 29.68 52 Week Low 18.77 30 28 26 Short interest 2.6% **Editor’s note: LYV 24 originally presented in Avg. Daily Volume (mm) 1.24 22 March 2016 at a share 20 price of $22.73 with a 18 Price/2017 FCF 12.29x target of $31, repre- EV/2017 EBITDA 8.71x senting a 36% upside.** PRIMARY RESEARCH Contacts: former board member of LYV, CBS media and entertainment professor
Business Description Live Nation Entertainment, Inc. (LYV) is the largest live entertainment company worldwide with nearly 530M fans in about 37 countries, and is the only publicly traded live music company. It operates four segments: concerts (global promotion of live music events, operation and management of music venues, production of music festivals), ticketing (primary and secondary ticketing platforms for live events), Artist Nation (management services to music artists and other clients), and sponsorship & advertising (creates and main- tains relationships with sponsors, offers advertising ser- vices), comprising 68.5%, 22.6%, 6.0% and 4.6% of 2015 revenues, respectively. Revenue has grown consistently since the Live Nation/Ticketmaster merger in 2010 at a CAGR of 6.9%. With an integrated suite of services in live entertainment, LYV is best positioned to capture incremental value from concert and festival-going con- sumers. The secular shift toward live tours and music festivals, where LYV has a dominant share, offers superi- or margins and the opportunity to expand their pres- ence in sponsorship and secondary ticketing. This makes LYV uniquely positioned to rock and roll in its growth in the live entertainment space.
Investment Thesis LYV is a high quality live entertainment company, delivering positive growth and margin expansion, with grow- ing Concert market share and four (4) key factors that are in tune to make LYV a high conviction investment at this time:
1) Live entertainment industry trends will drum up consistent revenue growth for LYV. Live touring is on the rise and is the biggest moneymaking venture left in music business, which will result in greater concert and festival opportunities and thus revenue growth. Over the past 10 years, live shows
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have expanded to become the main revenue driver for musicians, growing from $10 billion in 1999 to $30 billion in 2015 in gross ticket sales. Artists now make the majority of their income (70-80%) through touring and thus are motivated to do live shows. With this upward trend, each concert ticket is bringing a greater return over time while each album sold is bringing a declining return, thus driving the live music business. Millennials highly value experiences and are increasingly spending time and money on them, which will provide continued revenue growth for LYV across its portfolio of music businesses and all events offered in ticketing. Millennials (born 1980-1996) are the largest gener- ation by population in the U.S., and currently produce an estimated $1.3T in total consumer spending. Since 1987, the share of con- sumer spending on live experiences and events, such as concerts and music festivals, relative to total U.S. consumer spending has increased 70%. With millennials’ increased interest in events and ability to spend, they are driving the growth of an experience- oriented economy, directly benefitting the number of events and thus revenue growth for LYV.
2) The income statement disguises the true cash generation. LYV has unique working capital dynamics in which they are able to collect money well in advance of paying vendors, consistently increas- ing the number of days, and ultimately being positive in days of cash cycle. Asset turnover has increased by 50% since 2010 largely as a result of better working capital management. Throughout this growth process, management has shown a consistent ability to deploy capital in a more efficient manner, which has led to a doubling (2x) of return on net assets. I predict the returns will continue to improve in line with the business growth.
3) LYV takes share in the secondary ticket market. Research and Markets forecasted secondary (aka “resale”) tickets for 2016-2020 and concluded the global market for these tickets is expected to exhibit significant growth during this time (19% CAGR by 2020), largely from the associated growth in the number of sporting and live events. LYV is gaining market share in the secondary market, poised as the second largest player after StubHub (approx. 20% vs. 50% market share, respectively). In 2015, LYV’s secondary ticketing business delivered 32% growth in gross transaction value over 2014. Both companies grew faster than the overall market in 2015 and LYV will continue to grow its share and drive scale economies – by effectively allowing the company to earn money on ticket transactions twice.
4) LYV is growing its festival portfolio, offering improved margins. Music festivals are a booming business, growing exponentially because they reflect how fans consume music in a streaming world through sampling in an immersive, social setting, and for promoters, established festivals offer improved profitability versus traditional shows. Since December 2014, LYV has rapidly built out its festival portfolio and now owns four of the top five music festivals in North America by attendance (Lollapalooza, Bonnaroo, Austin City Limits, Electric Daisy Carnival), among others. Compared to traditional concerts, festivals offer better margins to pro- moters like LYV. By owning top, established festivals and continuing to broaden its portfolio with successful festival franchises, such as Gov- ernor’s Ball, Live Nation can continue to amplify its margins in the Concerts segment and grow its Sponsorship business, which already produces high margins (68%).
Valuation KEY ASSUMPTIONS My price target is based on a multiple over the FCF per share for 2018, resulting Bear Case Base Case Bull Case in a target price of $32.50 representing an 18% upside. This valuation method is Revenue CAGR 15-18 5.1% 9.0% 10.2% appropriate for LYV given the working capital dynamics of the business. The EBITDA Margin 2018 8.0% 8.5% 9.1% street overlooks this element and mainly focuses on P&L metrics. I believe LYV FCF per share 2018 2.38 2.95 3.48 sings a compelling long, with a large moat and comfortable margin of safety. P/FCF 10.0x 11.0x 12.0x Price Target 2017 23.80 32.50 41.76 Key Risks Upside (Downside) -13.7% 17.8% 51.4% Potential slowdown in U.S. consumer spending from a global recession could impact LYV’s revenues across segments. While LYV has a dominant market share in ticketing, new competition could gain on LYV’s ticketing position and affiliated business segments. Significant event/tour cancellations could result in revenue loss and potential reputation damage.
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Skyworks Solutions (NASDAQ: SWKS) - Long 2016 Pershing Square Challenge
Maria Muller CA(SA) William Hinman, CFA Mark Shohet, CFA [email protected] [email protected] [email protected]
Recommendation I recommend a long on Skyworks Solutions (SWKS) with a price target of $127, offering 63% upside from today’s price of Maria Muller ’17 $78 with desirable upside/downside dynamics. There is a sig- Maria is a second-year nificant revenue growth runway as the dollar content of RF MBA student at Columbia components increases sharply as smartphone technologies Business School in the progress from legacy 2G products to LTE and 5G. SWKS has Value Investing Program. excellent operating economics and deployment of capital, Prior to CBS she worked coupled with no leverage and a $1bn war chest of excess cash at Prudential Investment ready for a strategic acquisition. Managers in South Africa on their Africa fund. She spent the summer at T. Business Description Rowe Price in London. SWKS is an industry leading designer and manufacturer of integrated RF (radio-frequency) technologies for a broad range of electronic devices from mobile phones, to integrated “Internet of Things” products. It operates in three main seg- ments, namely Integrated Mobile (52% of Revenue), Power Amplifiers (26%) and Broad Markets (22%). Their primary segment, Integrated Mobile, is where their true competitive advantage lies. SWKS leads the industry in their ability to produce extremely complex RF integrated circuit boards which are currently in premium smartphone manufacturers’ products. By packaging and integrating the different components of the circuit board, SWKS sets themselves apart from their competitors due to their William Hinman ’17 superior technologies and execution. SWKS’s main customers include Apple, Samsung and Google. There are only three competitors who are capable of producing RF products comparable to those produced by SWKS’s, William is a second-year MBA student at Columbia namely Avago (Broadcom Limited), Qorvo and Murata. Business School in the Value Investing Program. Investment Thesis Prior to CBS he worked as 1) Market underappreciates revenue growth opportunity a Managing Consultant in The market has overreacted to a recent slowdown in Apple smartphone sales (Apple is 42% of reve- the Forensic Accounting nues in 2015), and the stock is down 36% from its 12 month high. The market is failing to appreciate the long practice of Navigant Con- runway of revenue growth from continued growth in the dollar content of RF parts in smartphones, sulting. He spent the sum- which more than offsets potential declines in unit sales growth over the coming years. Furthermore, SWKS mer interning at Red Oak has consistently proven its ability to diversify away from key customers, as it did with Nokia 5 years ago, and LLC in New York. as it is proving in the large growth in absolute $ revenue from other customers.
SWKS operates in a four-player oligopolistic industry with huge barriers to entry (i.e. technology, time, dollars), and this scale and expertise means that losing a single supplier may cause unacceptable shortag- Adam Xiao ’17 es for OEMs. Exploding demand for streaming data content has necessitated increasingly complex RFFE com- ponents. OEMs needs have rapidly shifted from discrete components towards custom integrated solutions and they prioritize performance over price, will not compromise on mission critical components.
Mark Shohet ’17
Mark is a second-year MBA student at Columbia Busi- ness School in the Value Investing Program. Prior to CBS he was a manager in Structured Finance Trans- actions at EY. He spent the summer interning at Ever- core Partners in New York. Source: Statista, Jefferies, Broadcomm
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Skyworks Solutions (SWKS) - Long (Continued from previous page)
2) Increased profitability and returns profile SWKS has excellent operational economics with best in class revenue growth (42% in 2015), profitability and incremental returns on capital, all with no leverage. Their unique competitive advantage lies in their ability to package the various RF components in smartphones. They are the most fab-focused (controlling own production) of all competitors, exemplified by their award-winning Mexicali plant.
Management have consistently demonstrated an excellent ability to deploy capital, both in respect to returns to shareholders, and in respect to capital expenditures on accretive additions to the business. Most recently SWKS entered into a strategic joint venture with Panasonic, enabling access to high performance TC-SAW filter technology. The company has initiated a new dividend program and has also consistently returned excess cash to shareholders in the form of share buybacks. They currently have $1bn of cash on the balance sheet which could be used for a strategic acquisition in the future. Source: Company Reports
3) Attractive diversification opportunities: SWKS has a long runway of attractive opportunities to diversify away from integrated mobile in their “Broad markets” segment, where their core competencies in RFFE techonology components are used in “Internet of Things” products. SWKS has recently won contracts with Volkswagen, Fitbit and other major manufacturers in this high growth, high margin segment. By 2020 75% of all cars shipped will be connected, and there are big opportunities in a wide variety of industries such as medical, automotive and connected homes.
Valuation Various valuation models were used in the analysis of Skyworks, including a DCF and comparable analysis. The model was constructed using a bottom-up fundamental analysis focused on the underlying economic drivers of the business. Based on the DCF and comparable analysis methods employed, I estimate a target price of $127, 63% upside as a base case. Potential for multiple rerating once fears of lackluster industry growth subside, and as unit economics improve. Significant margin of safety due to long runway for growth and margin expansion in next five years.
Key Risks RISK MITIGANT Customer concentration: In FY 2015 44% Proven ability in past to diversify away from key clients (Nokia was a significant cus- of total Revenues were from Foxconn tomer in 2010/2011) and increased absolute revenue from other customers – Sec- (Apple’s producer) ond tier smart phone clients. Furthermore, Apple and Samsung smartphone cycles run in different seasons, diversifying seasonality in sales Competition: Qualcomm, a semiconductor Qualcomm have yet to develop/acquire appropriate RF technologies, and even when giant has been researching RF technologies they do it will take a number of product cycles before they become an established for years and could finally get it right name in the parts that Skyworks manufactures Missing a product cycle (No long term There are currently only three main players in the RF front-end market, and if an customer contracts in place): Not being OEM were to cut one of them out, they would not only depress innovation, but also included in an Apple or Samsung smartphone run the risk of reduced quality in products – Unlikely that an OEM would risk prod- would significantly decrease Skyworks reve- uct failure over $6 of parts in a $260 smartphone. 3 year visibility on OEM product nue for a number of years cycles and once included in a design, have contract for lifespan of that model
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AMERCO (NYSE: UHAL) - Long 2016 Ross MBA Investment Competition - 2nd Place Finish
Kenneth Chan Anton Korytsko Alexander Teixeira [email protected] [email protected] [email protected]
Recommendation We recommend a long on AMERCO (UHAL) with a 2-year price target of $477, offering 40%+ upside Kenneth Chan ’18 from today’s price of $338. Kenneth is a first year MBA student at Columbia Busi- Business Description ness School. Prior to CBS, UHAL is North America’s largest “do-it-yourself” he worked as a private moving and storage operator with a fleet of over equity associate at Sun 250,000 vehicles and with almost 50 million net renta- Capital Partners in New ble square feet of personal storage space under man- York. Kenneth graduated agement. UHAL also has insurance subsidiaries, oper- from The Pennsylvania State University with a M.S. ating in the life insurance and property & casualty and B.S. in Accounting. insurance segments.
Investment Thesis 1) Strong Self-Rental Revenue Growth Will Sustain Over the Medium Term UHAL has grown revenues at an 8.3% CAGR over the past five years; we believe the company is poised to continue growing at a 6-8% rate over the next 3-5 years, driven by secular demographic changes towards renting vs. home ownership, market share gains, modest price increases and improved truck utilization.
Over the past 15 years, the share of households rent- ing vs. owning has steadily shifted from 31% to 36%. The age groups showing the highest change in share of Anton Korytsko ’18 household rentals are 25-29, 30-34, and 35-39: young Anton is a first year MBA professionals are gravitating towards urban areas, student at Columbia Busi- which has led to more household rentals. Housing ness School. Prior to CBS, Vacancy Surveys and Current Population Surveys have Anton was an equities estimated that the average annual growth in renter portfolio manager at a households since 2010 has more than doubled from Russian pension fund previous decades to 1.0 mn households. Renters are Blagosostoyanie in Mos- 4x more likely to move than home owners, which cow, Russia. Anton is look- ing to work for a value- leads to more rental transactions for UHAL. We be- focused emerging markets lieve this trend is a sustainable, secular change that investment manager. will persist for the foreseeable future and will contin- ue to benefit UHAL.
UHAL has greater than 50% of the self-move rental market; the firm’s closest competitors are Avis Budg- et Group (CAR) and Penske Automotive Group (PAG), both of whom have roughly 10% market share. CAR’s rental truck fleet has declined from 32,000 trucks in 2012 to 21,000 in 2015, while we estimate that Penske’s has stayed roughly flat at 15,000 over the same time period. Conversely, UHAL’s truck fleet Alex Teixeira ’18 has increased from 106,000 to 139,000. It is clear that Alex is a first year MBA student at Columbia Busi- UHAL has taken tremendous share from both com- ness School. Prior to CBS, petitors and CAR’s decision to continually reduce its fleet size suggests the company is in the process of exit- Alex worked as a research ing the business altogether. We also believe that UHAL has taken market share from “Mom-and-Pop” opera- analyst on the buy-side at tors, who can’t compete with UHAL’s dealer network, service quality, and prices. We think UHAL will contin- Standard Life Investments. ue to take market share, which gives us conviction in our above-market growth forecast of 6-8%. Alex intends to work for a value-focused investment manager this summer and Lastly, UHAL’s dealer network and strong brand provide the business with high barriers to entry. UHAL has after graduation. 19,500 independent dealers and 1,700 company-owned locations, which totals to over 8x more locations than CAR or PAG. This gives the company an exceptional advantage in the one-way move market: renters really Page 25
AMERCO (UHAL) - Long (Continued from previous page)
value having a convenient way to drop off the rental truck after moving, and only UHAL’s dealer network can consistently provide this convenience. Second, the UHAL brand has been around for 60+ years and is synonymous with self-moving – we believe this is an underap- preciated element of UHAL’s competitive moat. As UHAL continues to gain market share and cements itself as the dominant player in the market, we think that the company will be able to enjoy more pricing power than it has historically.
2) Expansion into High-Quality Self-Storage Business UHAL has aggressively invested in its self-storage business over the past several years, which will lead to higher margins, stronger revenue growth, and further improve UHAL’s value proposition to its customers.
UHAL has invested over $1.2bn in its real estate business over the past 3 years, which is about 4x more than the company invested from 2010-2012. The company is aggressively adding to its portfolio of owned self-storage locations (generally through renovations or new- builds), which naturally compliments the self-rental business. Roughly 25% of movers choose to use a self-storage facility, and about 80% of renters stay for 12 months or longer. The self-storage market is very fragmented, but UHAL is the 3rd largest player in the market, behind Public Storage and ExtraSpace Storage.
The pure-play public storage REITs generate EBIT margins of roughly 50%; UHAL does not disclose its storage margins, but if we assume they are somewhat similar to the peer group, we should expect significant margin expansion over the next sev- eral years as the storage business becomes a larger percentage of UHAL’s overall revenues.
3) Compelling Valuation Given the Growth Profile UHAL trades at a steep market discount (6.7x forward EV/ EBITDA and 12.5x forward P/E), despite having attractive re- turn metrics of 11% ROIC and 21% ROE, modest leverage of 2.0x net debt/EBITDA, good growth prospects, and high barri- ers to entry into its core business.
We believe that UHAL’s valuation massively underestimates the company’s intrinsic value and can only conclude that the market is uncomfortable with the asset intensity of the core business and potentially believes that UHAL’s current margin level is unsustainable. The business earns good returns on invested capital and maintains a modest asset/equity ratio of 3.5x, and for reasons mentioned above we not only believe that UHAL’s margins are sustainable, but we also think they will expand over time. As UHAL continues to post strong revenue growth and healthy margin expansion over the next several years, we expect UHAL’s valuation to move to parity with the overall market, a roughly 25% increase from current levels. Page 26 Neal Nathani (Continued from page 1) Williamson McAree Invest inspiring just to speak with him that were working, but by the ment Partners, where he briefly and hear how he time I left Silicon Valley, half of was a Partner and thought about the world. In them were out of business. It Managing Director. many ways, it served as a allowed me to appreciate Mr. Nathani began his catalyst for me to get even businesses that can be great career in Credit Suisse more interested. longs and great shorts. First Boston's Technology Investment Banking Group After I graduated Wharton, I After investment banking, I in Palo Alto. went to Silicon Valley as a came to New York and joined Mr. Nathani graduated technology investment banker a firm called Williamson magna cum laude from and worked for Frank McAree Investment Partners, The Wharton School at Quattrone. I had grown up which was run by two former Neal Nathani the University of fascinated by the Commodore senior investment Pennsylvania. He was an 64 and C++ programming, so professionals who worked at Adjunct Professor of going out to Silicon Valley Tiger Management. This was Finance at the Columbia during the first technology an opportunity to learn from Business School in the boom was a great opportunity. guys who had themselves been Value Investing Program trained in a fantastic from 2009-2013 and still environment, and hence really “Sometimes you can guest lectures regularly. learn about the investment take advantage of business. Graham & Doddsville (G&D): Could you tell us how inflection points and Within the Tiger ecosystem, I you started your career and learned about growth how you ended up where you find a growth investing. But I also teach value are today? investing at Columbia. That's company that emblematic of our process at Neal Nathani (NN): I grew Totem Point, because I think up in Canada and went to becomes a value stock we’re very balanced between Wharton for my and a value company being value investors and undergraduate studies. During growth investors. We can my senior year at Wharton, I that becomes a growth swing to both sides of the did research with a professor opportunity set pretty on hedge funds. Thanks to stock.” effectively. that, I view the world of investing very much in an Those experiences, in many G&D: Do you think there are academic and intellectual light. ways, shaped how I thought contradictions between For my senior research about the world. I was out in growth investing and value project, I was doing work on Silicon Valley at a time when investing and, if so, how do long-short ratios as well as there were all these disruptive you resolve them? how to think about shorting shifts occurring within stocks, how to think about technology business models NN: Value investing is about hedging positions, and how to and within the consumer looking at very contrarian think about using quantitative space. That provided the names, having margins of metrics to ascertain the framework by which I've been safety, understanding asset qualitative elements of a investing over the last decade, value, and understanding business model. That project by looking at businesses within liquidation value. Growth laid the foundation for me to the technology or consumer investing is thinking about the be intellectually curious about sectors that are going through world two or three years from investing. innovative shifts. now, and what the revenue and earnings CAGR for a Around that time, too, I came The time in Silicon Valley business could be. It’s about to New York on a school field allowed me to be really what kind of multiple you can trip, and met Julian Robertson objective when analyzing earn on a business, and how for the first time. It was businesses. I saw businesses that business is disrupting (Continued on page 27) Page 27 Neal Nathani
certain business models. eclectic line of two Finnish characteristics, and our variant wingers, Jari Kurri and Esa perception. I've found that some of the Tikkanen. best value investments turn We use this scoring system for into growth investments. And These players were very, very all of our positions, for both some of the best growth different from each other but value and growth names, and investments over time become also very, very complementary for our shorts. That’s our great value investments. in terms of their skills, and benchmark by which we grade they evolved a process over ourselves. I very much look at the world time. Wayne thought about of investing like I would the team by playing from One of our hallmarks is that marketing. In marketing, behind the net, as opposed to we love to focus on industries there’s an S-curve that people behind the blue line. He always that are going through use. They analyze businesses at wanted to think about where structural change or an early growth phase, at the the puck was going. disruption. We have got maturation phase, at the decades of experience in areas declining phase, and so on. like technology, Sometimes, you can find “We’re ‘backpack telecommunications, and growth businesses that are in consumer sectors that we the beginning phase of that S- guys.’ We like getting think are going through a lot of curve. Sometimes you find the on the road all the change, but which the market value businesses in the is struggling to predict and declining phase. And time with backpacks price accurately. We love sometimes you can take changes of that kind. advantage of inflection points and Birkenstocks. and find a growth company The second thing that we that becomes a value stock and We’re at trade shows really focus on is value-added a value company that becomes research. We’re “backpack a growth stock. We’ve actually and events, going to guys.” We like getting on the used those contradictions and product road all the time with those differences to our backpacks and Birkenstocks. advantage, as opposed to demonstrations, We’re at trade shows and shying away. events, going to product learning about demonstrations, learning about G&D: Thinking back to when businesses. We’ll go to the you started Totem Point businesses.” Olympics of Printing every four Management, versus where years in Dusseldorf, Germany. you are today, do you feel as if That’s how we thought about For us, it’s about really your strategy and philosophy the Totem Point Management understanding the nuts and have changed at all? Can you team, too. For us, when I think bolts of businesses. also walk us through the major about our organization and aspects that set you apart from process, it has evolved over Also, we like to stick within other places? time. We’ve refined it. Our our core strategy. In a lot of process has made us a little bit investment processes, I think NN: Our processes are not different. people skew when they find static, they’re evolving. I think different areas of interest. We also that the team has evolved In essence, we focus on both know what we’re really good in a way that is particularly the quantitative and qualitative at, and we know what we’re special. I grew up in Canada elements of a business, and we not good at. We haven’t really playing ice hockey. I idolized put it all in an “Idea Matrix,” skewed toward the areas that Wayne Gretzky. Wayne which we have refined over we don’t think we’re Gretzky was the guy you the past decade. An Idea particularly good. watched when you were a kid Matrix scores business growing up in Canada in the characteristics, growth We love thinking about variant 1980s. He had this really characteristics, management perception. We really try to (Continued on page 28) Page 28 Neal Nathani
avoid things like group-think or awful lot of time analyzing objective and we’re trying to anchoring. We’re always proxy statements. figure out what the business is thinking about contrarian ultimately worth. We will be ideas, and how we can be I focus on this analysis in my candid with our approach, but different. Some of the names class, especially understanding I don’t think we’ll ultimately that we initially thought may how people are incentivized tell them that we’re short the have been shorts for us turned and what makes them tick. I business. We’ve never gotten out to be fantastic longs. We like to know the metrics by into a circumstance where love to be very objective, and which management gets paid. we’ve been actually cornered not stubborn. We always want Do they get paid on cash flow? into saying whether or not to put ourselves in position to Do they get paid on the we’re short the business. play offense. organic growth rate? Generally, how someone’s paid G&D: When evaluating the The last thing we think about changes his or her focus. quality of the business and the are the three Rs: revisit, returns on capital, how do you refresh, and regenerate. In our think about software Idea Matrix, we always think “Software companies companies? This is a sector about how we can revisit where, from a traditional existing names. Some of our are hard. I think that’s accounting point of view, many best ideas come from names have negative invested capital. we looked at three years ago. where it comes to We don’t constantly feel as if NN: Software companies are we have to go out there and balancing both value hard. I think that’s where it fight for new ideas, because and growth investing.” comes to balancing both value there are names we’ve worked and growth investing. There on in the past, that we scored, are certain metrics that you and that we think are The most interesting thing can use intelligently with value particularly compelling now as about the investment investing that you can’t really opposed to maybe three years management industry is that use with growth investing. ago. you’ve got to put your money Doing asset tests on a where your mouth is. You’ve software company is very G&D: You and your team try got to put the vast majority of different from doing asset tests to take an objective, your capital into this business on a semiconductor company, methodical point of view. How because you believe in it. You where they have fabrication much does qualitative research have high conviction in your plants that you can analyze in matter, especially regarding research, your process, and all different locations, where management? your team. So when you find you know that there’s management teams that do the liquidation value. NN: In our Idea Matrix, we same thing, it’s very, very measure three things: growth compelling. You feel like We try to isolate, once again, a characteristics, business they’re with you for the long value name from a growth one. characteristics, and run. If things don’t go well, We’re not comparing a management. They are actually they also feel it. Every year, we semiconductor company to a equally weighted in our matrix. can’t wait for these proxies to cloud software company. We In terms of management, it’s come out to do that work. would be debating every single very important for us to meet day about what we think the the teams and understand the G&D: Do you also meet with metrics of one are versus the organizations they’ve put in management if you are short a other. place. We’re investors in these company? How do you businesses for long periods of approach that? We isolate businesses that we time. We’re not renting them. think are value, where we Owning something, we feel as NN: I don’t think we’ve ever think we can do real analysis of if we have to understand the told a company directly that assets, versus ones where we management and how they’re we’re short. What we’ll tell can’t really analyze returns on incentivized. We spend an businesses is that we’re invested capital intelligently, (Continued on page 29) Page 29 Neal Nathani
because there isn’t invested compare a growth name offers us great longs and great capital. versus a value name; we’ll shorts. compare a growth name G&D: How do you fight some versus another growth name. One theme that we’ve of the biases and the anchoring explored a lot since our regarding companies that On the short side, we’ll inception is the world of you’ve looked at in the past compare a tactical short — a grocery stores. One company when you revisit them? business that is over-earning was Empire, a grocery store in — with a similar tactical short. Canada. Now they’re the NN: In our scoring system, we owner of Sobeys and Safeway try to take relatively qualitative in Canada. Empire was parts of our research and “Structurally declining feverishly trying to put out quantitative parts of our fires on every single front. The research and make them very, business lend company was on the losing end very mathematical. Within themselves to a lot of of an escalating price war growth, we’ll identify organic among large incumbent growth characteristics, secular cash flow work. Many Canadian grocery stores. They versus cyclical, how they're were facing pressure from growing the last several of these old-world Walmart and Costco. They quarters, and how growth is have a lack of sizeable discount inflective. companies have brands. They were exposed in Western Canada, which has We’ll also study the complications such as been challenged. Same store management. We will go pension issues, sales have declined 3% to 4%. through and look at how the They acquired Safeway’s assets proxy statement has changed, dividend problems, in 2013 and have been how incentive structures have consistently writing down changed, and how management high leverage, and assets. ownership has changed. In the case of business quality, covenants in danger of We obviously found challenges we ask, “All of a sudden, have in that grocery business model. their businesses become more getting breached.” And our work on Empire led recurring than they were three us to do work on other years ago? All of a sudden, We won’t compare a tactical grocery stores in Canada. It have their contracts changed? short versus a name we think led us to other businesses like All of a sudden, have they is an accounting shenanigan. Metro. That work led us to increased pricing?” We always try to stay even still other businesses that we and balanced in terms of found in terms of We are constantly monitoring names we’re trying to opportunities facing disruption. all these elements as well as compare. We’ve had grocery-store our variant perception. We opportunities in the U.S and keep asking, “What does the G&D: You mentioned that grocery opportunities in rest of Wall Street think you look for overall themes Eastern Europe. versus what we think?” and changes in an industry. How do you typically express Sometimes, when we dig down We go through this process this analysis in the portfolio? deep in an area and find one or literally every earnings season two great names, it leads us to to update these numbers. If a NN: On the short side, we’re extrapolate many, many more. company scores extremely much clumpier and more In this case, we unfortunately differently and more thematic. On the long side, I weren’t able to find great compellingly, in terms of risk/ like to think about value names names on the long side in reward, then we’ll revisit it. versus growth names. We grocery stores. Sometimes, don’t do pair trades per se, but that mismatch occurs. What we do to keep ourselves sometimes we’ve dug so deep Nevertheless, I think when you honest is that we won’t into a particular vertical that it spend six, seven, eight months (Continued on page 30) Page 30 Neal Nathani
on a particular name, especially very differentiated with our things get impacted. We’re on the short side, it does you themes on the short side. If we looking for degradation in the justice in being able to find feel like we’re different and we business model. other names very quickly. have high conviction ideas, our themes get pretty big in size. We want to see businesses G&D: How do you think where the detrimental markers about sizing positions and G&D: When you look at a are getting worse over time portfolio construction? How business model that is and the company will do you manage exposure to potentially flawed or potentially violate some of individual companies, experiencing challenges, but these covenants. We’re also industries, and themes? does not have an identifiable seeking opportunities where catalyst, how do you think we think dividend or cash flow NN: Our average long is about that? needs will ultimately be the around 4% or 5% of capital. demise for many of these Longs can get as big as 10% of NN: For our short book we’ll companies. capital. We’re not afraid of have maybe 50% of our concentration. I'm a big positions that are in this G&D: You brought up the believer in high conviction by structural declining phase. We idea of areas of strength for concentration. On the short may have 20% in more tactical the team versus areas outside side, we also believe in shorts that we think are over- of your core expertise, tending concentration. We may have a earning. Then we have a to stay away from the latter. lot more shorts than we do couple percent in what we Can you give some examples longs, but we probably only think are accounting problems. of places where you tend to have seven or eight themes on We may have some positions not play and the reasons why? the short side. Each theme in businesses where their could represent anywhere growth rates are being NN: It all depends on what we from 3% of capital to as high as distorted by acquisitions, or as a team think we can 10% of capital. businesses that are being hurt research and understand, often by the high-yield markets. leaning to areas that are much When we think about shorts, We’re very, very flexible with more secular in nature. We it really comes down to how we think about shorts. don’t make any macro bets conviction, research, and a here. We have no big currency very, very strong variant positions. What we do a very perception. We always grade “Analog Devices is good job at is understanding ourselves on our goal of a 50% unlike any other the structural dynamics of return over two years, both business models and the for our longs and our shorts. semiconductor secular trends that are But in the world of shorts, occurring. We avoid you’re fighting dividends and company. It’s not very businesses that we think are borrowing costs. Therefore, too cyclical for us. For every the bar is higher to justify our cyclical, nor is it very single name we have we shorts, as we have to identify what percent of the overcome these costs. capital-intensive.” business we think is secular Obviously, we’re in an versus cyclical. When we environment where short Structurally declining analyze our portfolio, we try selling is challenging for many businesses lend themselves to to isolate how much of the people. I think low interest a lot of cash flow work. Many portfolio is exposed to secular rates make that a little bit of these old-world companies issues versus cyclical issues. more challenging. We’ve have complications such as We monitor this to make sure always found that we’ve pension issues, dividend that we’re never imbalanced generated a good number of problems, high leverage, and and have a factor risk that ideas and success from both covenants in danger of getting we’re dealing with over time. our value and growth names breached. For us, monitoring is on the long side, by thinking key to fully comprehend the G&D: When you think about very tactically, and by being path by which many of these different risks and isolating (Continued on page 31) Page 31 Neal Nathani
specific factors, do you try to It’s not very cyclical, nor is it two customers. On the other hedge out anything that you very capital-intensive. The hand, Analog’s business is very, don’t want to capture in the company has had positive cash very diverse. When you need a investment? flow every year for the last 30 piece of machinery to run for years, and because analog the next fifteen to twenty NN: We generally don’t have companies are not years, where you require any strong opinions in commodities, they’re not better power or better currency, so we’re always constantly chasing Moore’s amplifiers, you’re not looking trying to balance that out to law. to save a couple cents on a the best of our abilities. Aside data converter. These aren’t from that, we don’t do that Analog Devices has 70% gross businesses that are subject to a much. Let’s say there’s a margins. Intel has 62% gross significant amount of business that has a stub asset margins. Intel, as we all know, commoditization. that we don’t like and we want is a virtual monopoly. Intel to hedge it out, we usually spends 15% of its revenue on Within this world, Analog’s don’t do that. Nor do we ever capital expenditures. Analog devices are dominant in data get into situations where it’s Devices spends 4% on capital converters and amplifiers. so cumbersome that we have expenditures. As a result, the Analog Devices and Texas to hedge out a variety of returns on invested capital for Instruments together own 80% assets. Candidly, we like Analog Devices have ranged of the market. A lot of businesses that we think we from 45% to 50%. companies have tried to enter understand, sectors we know this market and have failed. well, and industries and “This business is National Semiconductor, businesses that we think have Intersil and Microchip lots of structural trends. hardest when you feel Technology all tried to do it. We were attracted to this G&D: Are there any like you need to be business for all of those investments that you want to characteristics. More recently, share? emotional or irration- Analog combined with what had been the other poster I spent a lot of time for the al. This business be- child of this trade, a company past fifteen years, particularly comes so enjoyable called Linear Technology. over the past couple of years, in semiconductors. To many and so satisfying when Linear is an incredibly high- people that seems to be a quality business. They have crazy, esoteric area. To us, it’s you can take that 75% gross margins, which something we do a particularly allowed the combined gross good job on both the long and away and just make margins to accelerate into that the short side. A couple of 70% range. They’re very strong years ago, we had a very clear, logical, rational in power management, an area strong opinion that the DRAM that Analog isn’t. The product decisions.” cycle was peaking, and we mix, the cross-selling thought many people believed opportunities, and the margin it was doing fairly well. We The business has very high opportunities here are were very confident in our barriers to entry. Analog tremendous. They’re view, and I spent a lot of time semiconductors are chips that combining what I believe are on the short side of that. It are highly customizable and are two of the real geniuses of was very fruitful. More typically produced in small semiconductors over the last recently, one name that’s been batches going into all sorts of 30 years. It’s a business that really interesting to us in applications. Analog has over we think has earnings CAGR semiconductors is a company 100,000 customers. Many of about 20% over the next called Analog Devices. companies make couple of years. They can do semiconductors that are mass- $5 in earnings power on a Analog Devices is unlike any produced, interchangeable, and price of $60. We think that’s other semiconductor company. highly dependent upon one or incredibly attractive. (Continued on page 32) Page 32 Neal Nathani
Semiconductor businesses are Virtual reality and augmented and Oculus. I wouldn’t be an area that we know really reality are still pretty early, but surprised if we see something well and lend themselves to I think their applications within out of larger companies like the diligence that we like to gaming and within the Google or Amazon, so all of do. In many ways, Analog consumer space will be very, these companies will move Devices is a value name. It’s a very real. into the space. What’s business that’s growing very, extraordinary about Elizabeth Gao ’17 and Nick very nicely. But For us to understand the technology is that the world O’Sullivan ’17 celebrate at semiconductors go through space, we actually start with has gotten a lot more the Value Investing Program periods where they’re in favor competitive, but the world has Welcome Reception semiconductors and chips. and out of favor. These aren’t What excites me about gotten a lot more businesses that are growing semiconductors is that they concentrated as well. There like Priceline. They go through are the lifeblood of consumer are only a handful of cycles. We feel like we’re electronics. companies that have the getting the opportunity to buy balance sheet, R&D expertise, a business like this where “Jeff Bezos has said and the vertical integration to we’ve got a tremendous perform all of the necessary margin of safety, where we can something to the tasks very, very quickly. This is do a lot of work like value going to allow just four or five investors, and take advantage effect of, ‘If we have a companies to compete for of it. products in these core areas, good quarter, it’s and I think they can do it. Big G&D: You mentioned in some Technology is really exciting of your letters that you’ve because of the work right now because the done work in the virtual reality we did three, four, and companies are also incubators space. Did this take you to any for talent and product ideas. specific areas of opportunity? five years ago. It’s not VR may be an exciting area, or NN: We went into virtual because we did a good it may not take off. The area reality when we started doing will either pick up dramatically work in the world of gaming. job this quarter.’” or it won’t work. Many areas What’s amazing about gaming simply don’t work. Google is that there are 170 to 180 When chips reach certain Glass didn’t work. We’ll see million gamers globally. The levels of speed and success, what happens to Snapchat average gamer spends then we know whether or not videos. I think we’ll see a lot of anywhere from 25 to 30 hours these opportunities are real. products over the next twelve a week playing games, which is We’re still early on in the to eighteen months. New absolutely crazy. The other research. We don’t have a offerings will emerge and it will stat we find incredible is the very strong opinion on those either be a new killer app for highest grossing movie of all two areas, but we’re excited the world of technology, or time, I think, is still Avatar in about them. The way we’re we’ll forget about it. the neighborhood of $3 billion. going to monitor them is by Grand Theft Auto is the looking at the chip companies. For us, it’s all about who we bestselling game franchise of all There are a few names that think has the greatest amount time. Over the last three or we’re doing work on, but of scale, who is in the right end four years, it has grossed close nothing we’re excited about -markets, and can garner the to $4 billion. The world of right now. most market share. Right now, gaming is extraordinary. we see the opportunities G&D: Sony is a company you primarily in gaming for VR That led us to do all sorts of have spoken about publicly. Do because we are still in the early work on gaming companies in you have any thoughts about stages. A lot of these the past. Whether it’s gaming- their push into VR? companies haven’t really come software companies or console out with real products yet, so makers like Sony. It led us to NN: You’ve seen the first few it’s still very early. We need to do work on virtual reality. entrants in VR, including Sony see consumer demand. We (Continued on page 33) Page 33 Neal Nathani
need to see users start to that are made all around the money every day when you are accelerate. We love to look at world. Consumer electronics short. If you’re in a structural inflection points in users. is an area that lends itself to a long, these are names where lot of great value-added we can go for long periods of The other thing we’ll monitor research. time if the thesis is still intact. for all technology companies is We’re constantly pushing inventory. These are On a drawing board, we map ourselves with regard to target businesses that often get all the different areas we’d like prices and thesis creep. customer cycles right, but to research and the there are many that get information we need. Over a If something has reached our customer cycles wrong. We period of several months, we target, and the thesis hasn’t like to monitor not only try to triangulate all of the data changed, then we won’t be demand from the end that helps us make the most there anymore. If it’s reached customers, but also how these sense of the puzzle. our target and the thesis has businesses are able to manage Sometimes, we get it right, and gotten better, we’ve got to re- customer demand and sometimes we get it wrong. evaluate our target. Well, we inventory. Over the next six to For us, it’s about triangulating may still hold it. We may twelve months we’ll spend a as much data as possible that actually buy more of it if the tremendous amount of time we can analyze quantitatively. thesis has gotten better. We’re on both of those areas. Our We’re math guys here. We always evaluating our battle will be figuring out love to take qualitative findings probability-weighted upside- whether there are more and boil them down downside versus our thesis. opportunities outside of quantitatively. gaming, and who we think can In the world of technology, be exposed to it. Right now, This business is hardest when things are innovating and our belief is that, of the areas you feel like you need to be changing so quickly that a we follow, gaming is the most emotional or irrational. This business may have a 20% likely to have the greatest business becomes so enjoyable upside target in one year. But impact. and so satisfying when you can then, they’ve made an take that away and just make acquisition and moved into a G&D: For these large clear, logical, rational decisions. new vertical, spent an companies, how do you parse Our entire process, our incremental amount of money out details like product-specific scoring matrix, how we lay out on R&D and, all the sudden, inventory when so much is these chart boards is taking the thesis has gotten consolidated into the something qualitative and incrementally better. In that financials? Is this where the making it quantitative. That case, we’ll re-evaluate our value-added research is so allows us to embrace volatility, upside and we may think the valuable? rather than run away from it. company is even more compelling. Because we’re so NN: Absolutely. What we G&D: You also touched on focused on areas like love to do is triangulate embracing volatility. How long consumer technology, it plays research, for lack of a better do you typically look to hold to our strengths because I word, whether it’s talking to on to these investments? think we have a pretty good customers, reading trade vantage point to see where the publications, attending NN: Our goal is to have a long puck is going, as opposed to conferences, or understanding generate a 50% return over a where it has gone. the supply chain. Within two-year period. We think technology, at least in about holding our investments G&D: Given the pace of consumer electronics, there’s for a similar time horizon. In disruption in technology, so much research you can do shorts we expect similar would you prefer to be closer because you can track the results, but you’re obviously to the consumer side, even semiconductor sales. There battling things like borrowing though that might be changing are retailers that are selling costs and dividend yields. very quickly? Or would you these actual products. There You’ve got to be cognizant of rather be closer to the chip are all of these components that because you’re paying side, where companies can play (Continued on page 34) Page 34 Neal Nathani
it from different angles, and place which you can adhere to might not be as exposed to during periods of volatility. Jeff one specific product or cycle? Bezos has said something to the effect of, “If we have a NN: The consumer — by good quarter, it’s because of definition — is very fickle. On the work we did three, four, the names that are very and five years ago. It’s not consumer-focused, you can because we did a good job this probably make a lot of money, quarter.” We like to really but also lose a lot of money. think about that when we We found some of our best think about our process. Our ideas when they were success comes from the work consumer-based. There are we do laying the seeds during definitely consumer-facing periods of challenges and areas where we felt like the volatility. I think if you can idea could lead to a short. adhere to a process and start Particularly, if you have to develop one as a student, it themes, you can make a lot of will help you over time, and money on the short side. allow you to embrace volatility.
On the long side, finding things The other thing is to always that are a little bit off the radar try to have a variant has actually been a sweet spot. perception and think Some of these names are in differently, not just about technology, or investments but about semiconductors, or software. If everything you pursue. I you can find them within the graduated at a time when food chain that people really Silicon Valley was the place to don’t understand, then you can be. By the time I got there, and have that real variant went through the experiences, perception. the world was ending in Silicon Valley. I was passionate. I love Also, because these areas are C++ programming. I love so innovative, and because talking about data networking. some of these businesses have I was and am a computer geek more diverse customer bases, at heart. I pursued technology you can avoid major problems because I was passionate about because these companies offer it. But I think there are many a better margin of safety. We people who pursued it because always like to think about the they thought it was the hot margin of safety. It obviously thing out there. determines how much money you can make, but also how One, go with what you’re much money you can lose. If passionate about. Two, think we get our margin of safety about something where you’re right, we can be aggressive and not just following the herd. Or play offense all the time. if you do follow the herd, do it because you’re passionate G&D: Do you have any advice about it. That will help you not for current students and only when you choose your others looking to work in jobs, but actually how you investment management? invest day to day.
NN: First, I think it’s very G&D: Thank you for your important to have a process in time. Page 35 Chris Weldon (Continued from page 1) worked as an analyst at businesses slowed we had to sector headwinds and tailwinds Lazard Freres in the recapitalize them. The and managing gross and net Technology, Media and experience was formative in exposure and factor risks. Telecom mergers and developing an understanding of Through that experience, I acquisitions group. Mr. the business cycle and capital recognized that portfolio and Weldon earned an MBA markets and it defines how I risk management were critical from Columbia Business think about risk and pieces to a successful fund. Chris Weldon ’12 School in 2012. While at uncertainty. They also taught me that sizing Columbia, he completed and timing investments was the Value Investing Before I came to Columbia, I critical, because slugging ratio Program administered by decided I wanted to start is way more important than the Heilbrunn Center for down the public market batting average. Graham and Dodd investing path and worked as a Investing. He received a consultant at Hound Partners. Midway through my second B.A. in Finance from The Hound was an amazing year, I got a call from a fellow Stern School at New York opportunity, as I got to work value program colleague about University in 2005. alongside some of the most a new start-up fund called thoughtful investors in the Incline Global. He told me Graham & Doddsville industry, a number of whom I that the fund was being started (G&D): Can you tell us a little consider mentors. They taught by a former partner from bit about your background and me to focus on process over Appaloosa and that they were how you got your start? outcomes and explained the looking for another analyst to importance of doing value come on as a partner. I figured Chris Weldon (CW): I went added research and developing that graduating business school to undergraduate business a variant perception. They was as good a time as any to school at NYU’s Stern School. also taught me about how they take a risk and looking back Upon graduating in 2005, I identify successful short today, I do not think that I worked as an analyst at Lazard investments. could have made a better in the TMT group. In decision. retrospect, 2005 was a I came to CBS knowing that I fascinating time to study wanted to join the Value Incline was an early stage start- traditional media businesses as Investing Program. I spent the up. In the beginning, we all the internet was in the process first year also working in an huddled around a conference of dramatically changing the internship with an analyst at room table with Bloomberg competitive landscape. another large tiger cub. He terminals working on was one of the most outside-of investment ideas. Jeff Lignelli, After banking, I decided to -the-box thinkers I had ever the PM, had a lot of pursue my first role in principal met and was formative in experience, but like all start- investing in private equity at developing my screening ups we had to figure things out Oak Hill Capital. I started in process. He explained the as a team. We had to think 2007 in what was one of the power of mental models and about how we wanted to run most bullish times in decades how reframing investments as our investment process. How and within eighteen months we analogies can help give you a we would go about building were in the thick of the great radically different view on how and training a team and what financial crisis. I was incredibly things will play out. resources we needed. Going fortunate, as we had a very through the start-up process strong balance sheet and I got During the summer between was amazing as it taught me to see some of the most first and second year I worked about all of the pieces it takes bullish and bearish times in a at Viking Global. Despite the to build a successful investing very short period. fact that I was only there for a business beyond the research short while, I recognized that functions. How to think about Over the course of three years Viking’s competitive advantage human resources, fund raising, we acquired a number of was different from some of the vendor relationships. Jeff also companies with significant other tiger cubs. Viking was allowed me to co-manage our amounts of debt and as the extremely good at identifying short exposure which was an (Continued on page 36) Page 36 Chris Weldon ’12
amazing learning experience. It At its core, the investment people have shifted their allowed me to work on a large business is about decision consumption of media to the number of ideas in a short making and we believe the internet, advertising dollars period of time and understand operating system can improve have followed and the unit on a relative basis what makes return on time and drive to economics of the entire for a successful investment. better decisions. industry have shifted.
Two years into my experience The shift to digital advertising at Incline, I met with another “That’s where the is the thematic construct, but CBS colleague who told me how do you take that to the about another exciting start-up mental models come specific investment level? called Aravt Global. He told That's where the mental me that Yen Liow was building in. By studying history, models come in. By studying a team to focus on mental we can find patterns history, we can find patterns model oriented investing and that can help us understand he had an amazing group of that can help us what will happen in the future. capital partners. They were The key, of course, is to look looking for a senior analyst to understand what will at many industries, time come and help them build out periods and geographies to the frameworks. While I loved happen in the future.” understand the common Incline and consider Jeff a characteristics of great friend and mentor, the G&D: If we think about the investments. Our fund plans to opportunity was too exciting different elements of your focus exclusively on one long to pass up. process, how did you mental model, “the developed them and what compounder.” The For the better part of the last were the influences? characteristics of the three years, I have been at compounder are (i) a durable Aravt Global helping manage CW: In my opinion, screening competitive advantage, (ii) a investments across a wide is where investment analysts large total addressable market group of sectors. It was an differentiate themselves. There with significant share potential, unbelievably rewarding are tens of thousands of and (iii) strong unit economics experience as I was fortunate different securities. Where do that drive high returns on to work with some of the best you spend time? That's really incremental invested capital. and brightest across all the hardest part. It's saying, In fact, the name Stamina functional areas of the "What is my power zone?”, Capital refers to the businesses business. I also was able to and matching that up with the we plan to invest in—these are spend a significant amount of opportunity set the market is businesses that we believe will time developing and deepening providing. outlast the competition. our investment frameworks. The Stamina Capital screening One current example is Spending the past ten years process was most influenced Facebook as it fits the working in both public and by Oak Hill, where we were framework well. Facebook’s private equity at both start-ups thematically focused, and Aravt competitive advantage stems and established firms has given where we utilized investment from its network effects on me the tools and the frameworks. Through both the supply (users) and confidence to launch Stamina developing investment themes, demand (advertisers) sides. Capital. Stamina aims to take we can identify long-term The total addressable market the best practices from each of tailwinds and headwinds that for advertising is >$500 billion my experiences to create an will influence profit pools globally, of which Facebook has operating system that defines within an industry. a low single digit share of processes for screening, One multi-decade theme that I revenue despite significantly investment research, sizing and first experienced in the TMT more time spent. The returns timing, and portfolio/risk group at Lazard was how the on incremental invested capital management. rise of the internet was going are extremely high as the to impact advertising. As company enjoys significant (Continued on page 37) Page 37 Chris Weldon ’12
volumetric and price growth this case is “the fad” or “the you think about whether a with little incremental story stock.” position is a 1% position, a 5% investment. position, or a 10% position? The investment process is the That's a function of business Of course, identifying these bread and butter of what quality and risk/reward. It's characteristics is the easy part. analysts do. It's taking the also understanding price The hard part is understanding insights from the framework implied expectations and the what price implied and defining the key qualitative catalysts that can expectations are and whether investment factors, the key ultimately influence security this would be an interesting areas of primary research, and pricing. As we talked about investment. the most significant risks. The earlier, slugging ratio is investment process provides a everything, so knowing when This is where studying Google, checklist on how to execute to flex the position is critical Walmart, O’Reilly, Transdigm, this in a time-efficient manner. to monetizing your ideas. Inditex, and many other It's blocking and tackling. successful compounders of the Just as important is past plays a role. While the recognizing, as quickly as rest of the world frames the “[The process] is possible, when you are wrong investment based on 2017 or actually meant to kill and exiting the position. We 2018 P/E or free cash flow, we have developed a systematic know that we need to expand ideas rather than let way to drive the decision the playing field and ask what making which was influenced the business will look like in them through the by working with great 2020 or 2030. This is a critical portfolio managers. goal of Stamina, to use time- funnel.” arbitrage. While some would Our portfolio management argue Facebook looks There's a little bit of creativity process is very much expensive on traditional, in this process, but it's really influenced by my time at Viking shorter-term valuation meant to be very formalized Global. I remember the team metrics, if I look further out, it and, as a function of that, recounting what they were looks incredibly cheap. scalable, because it can be doing in 2008, in the thick of taught in a very systematized the financial market turmoil. The key question the stock is way. The irony is that the They explained what they asking is what is the mature investment process is the were seeing during that time total addressable market gauntlet and is actually meant that impacted their decisions penetration and what is the to kill ideas rather than let around gross and net. Through free cash flow that Facebook them through the funnel. We intuition and pattern will generate at that point in need to keep the bar recognition they recognized time. If we assume that extremely high as we plan to the environment had changed advertising dollars follow time be concentrated and for every and that they were no longer spent and Facebook garners a new investment that comes getting compensated to take significant and growing amount into the portfolio we need to risk. They reduced exposure of that time, Facebook could force curve something we love significantly and in turn, see its revenue double and out. As I mentioned earlier, performed extremely well earnings quadruple over the Hound had the greatest through the worst sell off in next five years. influence on this part of the modern history. process. You need to be extremely While we recognize market careful when using mental Then, you have sizing and timing is extremely challenging, models, as you can easily use timing. This is one that I think we believe we can use the the wrong framework. That is is a super-critical component framework oriented process why we also have to run the that few people talk about to improve decision making. investment idea through the publicly. To some extent, I Accordingly, we went back and counter framework, which in consider this the special sauce studied the majority of the of investment firms. How do financial crises over the past (Continued on page 38) Page 38 Chris Weldon ’12
three decades and identified a industry. As a function of that, monetize the short side much number of quantitative and ideas have become more more opportunistically. qualitative signals that we plan crowded and returns are being to use to improve portfolio competed away. The one framework we plan to and risk management. use on the short side is “the We define everything we do at cyclical peak.” Over the past Paul Fanelli ’17 and Maryam G&D: You've mentioned time Stamina by return on time and few years, we have developed Badakhshi ’17 take a break arbitrage, an ability to think on that metric, short selling is a power zone identifying and from talking with their peers further out. What gives you inferior to long investing monetizing them and believe at the Value Investing Pro- the ability to do that? Is it the because you cannot compound that they lend themselves to gram Welcome Reception selection of your limited capital. In many cases short our thematic/framework- partners? What's the process selling also acts more like gross oriented process. to ensure you can do it? exposure, rather than reducing net, which can lead to G&D: Can you elaborate on CW: That is a great question suboptimal portfolio levels in shorting cyclical peaks? and one that we are, candidly, times of volatility. working through. Our goal is CW: The cyclical peak to operate like a private equity That being said, I think that typically starts with a period of firm in the public equity short selling is a critical piece strong demand that drives markets. We recognize that of a successful investment capacity utilization higher. As we can only have assets with management business. Not utilization tightens we typically the same duration as our only can you generate see prices increase. Returns on liabilities and plan to only take significant alpha but it also capital for incumbents expand capital from partners that are helps you be more skeptical in causing other industry aligned with this strategy. your long underwriting. It participants to take notice. This likely means we are going makes you very skeptical of Once returns on capital to say no to a lot of different everything. It makes you expand wide enough, both providers of capital. Despite question management, incumbents and new entrants the fact that this will likely question the analysts that are start to add capacity. But that make the fund raising process feeding you information from capacity takes a period of time harder, it’s something that we Wall Street, question your to add. The lag typically drives believe we need to do to give friends who are pitching you more capacity to be added us the best chance to be their book. than is needed. During this successful long-term. period, demand is likely In my experience, short selling growing, but in many cases, G&D: Switching to shorts for returns are highly cyclical. demand flattens out or a moment, it's not a situation There are times when the ultimately falls. Meanwhile the where you're getting paid to market is giving you great supply starts to come to be short anymore. You're opportunities to short but, market in an accelerating paying to be short pretty much more frequently, times when it fashion. everything, how do you think is dangerous to be short. This about that in terms of timing? is why we plan to be highly Once the supply comes, you How does that change your opportunistic in short selling see volume growth slow as process and mentality when and treat it like a “best ideas market share becomes more you're thinking about shorts? fund.” By removing the need to competitive. Then you see be short, I believe we remove prices correct. Frequently you CW: Short selling has become one of the inefficiencies in the see operating dis-leverage, and extremely challenging because traditional hedge fund model. ultimately financial dis-leverage, of competition. The hedge if the projects were credit- fund industry is not dissimilar I also believe we have to treat financed. from any other industry, short positions differently than returns were extremely high, longs. While we plan to be The reason we like this and lots of capital came to the long-term oriented investors in framework is that there are industry; a lot of smart, young the long book, we plan to many ways to monetize it. people have come to the Generally during the peak (Continued on page 39) Page 39 Chris Weldon ’12
earning phase, incumbents’ CW: Frankly, it's the hardest accordingly. You have to market capitalizations get part about being an analyst or respect the market and completely out of whack and portfolio manager. When understand that you're going there are lots of different something goes against you, to be wrong frequently. The companies that have come to how do you react? My thought key, once you have cut, is to re the market as new IPOs. You process has evolved over time. -underwrite the position with a can opportunistically look for The way that I would have fresh set of eyes. On the short the ones that are the most traditionally reacted was to re- side, it's doubly hard, but that's skewed. For iron ore, for underwrite. Go back and see if not to say that you can't come example, it was Cliffs Natural I missed anything, if the key back to it. Some of the best Resources, it was Rio, it was investment factors changed, or ideas that I've been involved in BHP, it was Vale. There were if I missed a key factor. went against me numerous hundreds of billions of dollars times before they worked. of market cap that we were “Some of the best able to amortize the thesis With short selling, it's all about over. In the case of oil, it was ideas that I’ve been sizing and timing. If you can even bigger than that. find a good idea and track it involved in went over six months or a year, and The key is really to find ideas then look for when price that are so big and have so against me numerous implied expectations are much market cap that you completely out of whack, you don't need to deal with the times before they can make a significant return. crowding issues as much. The worked. With short- The key is to identify when the critical thing is that this is moment of truth is coming, about trading, and so, to some selling, it’s all about and flex up to capture the extent, it is all about what's alpha burst, that's really where priced in. If you stay too long, sizing and timing.” all the value is added on the you're inevitably going to see short side. some level of mean reversion. The issue with that is, in the What was a cyclical peak can case of short selling specifically, G&D: You’ve stressed making become a cyclical trough over you could see a stock move sure that you enter or exit different periods of time; you against you 50% or 100% in a investments at the right time, just need to be really careful. short time period. My thought especially on the short side. Is Price implied expectations are process has evolved to cut first it similar, then, on long critical, and, ultimately, you and do the analysis afterwards. investments? need to be out before the rest of the world is out, because It’s very much a function of CW: In our case specifically, once things get really exciting, respecting markets, and I’d say it's less important. The short interest goes to 20% or studying how some of the core of our portfolio is going 30% and it causes short great traders deal with risk. to be high quality businesses squeezes. Those short They know that even the best that have become cheap for an squeezes can take mark to analyst hit rates are 55% or idiosyncratic reason. With high market losses and turn them 60%, and so they respect the quality businesses time is your into permanent capital losses, fact that when something goes friend, as the floor continues if you lose conviction at the against you, you might be to rise through most parts of worst possible time. wrong and so you should cut the economic cycle. That being fast. said, we constantly need to ask G&D: You mentioned the when we want to have a 3% pitfalls of losing conviction at G&D: Do you use stop-losses, position on versus a 10% the worst possible moment, technical triggers, or similar position? To that end it is how do you approach a mechanisms? critical to understand what's position that has moved against priced into the stock relative you? CW: I set a general range for to what expectations are. If what I am willing to lose and you see a significant disconnect then size the position over the next 18 to 36 months (Continued on page 40) Page 40 Chris Weldon ’12
you likely want to be big. In mean that they're not really with wider bands of volatility. many cases, it's not actually good compounders. I think, valuation-dependent per se, it's that to some extent, a lot of Another quality transition more about the world is the world thinks that these are example from earlier this year expecting “X” and I think “Y” boring, but boring is beautiful. was in energy infrastructure. and here's my informed reason While in general we believe why: I've spoken with ex- The other piece of the book, the majority of businesses in employees to understand which is more differentiated, is the industry are lower quality/ competitive dynamics, I've what we call “quality commoditized, we identified a talked to competitors, I've transitions.” Quality transitions number of midstream talked to suppliers, and I've can be earlier stage businesses with strong talked to customers, in order compounders that are in the competitive advantages and to conclude there’s something process of proving out their large addressable markets mispriced. That's really where moats. Alternatively, they where they could grow. They you can create a lot of could be more mature have incumbency in places that incremental value. compounders that are in you literally could never industries that are out of favor. rebuild the infrastructure that G&D: We’ve discussed your they have. As a function of power zone when shorting; that, they actually do fit into how does it compare to longs? “...when things tip and the category of long-term What do you look for in long- compounders. But they're in term investments? the signpost ultimately an industry that has gone out of favor due to the high CW: The focus of Stamina on avails itself, forget volatility in oil and gas prices. the long side is the compounder framework. about valuation for a Timing is critical with these These come in a few different investments as you do not flavors. The two that we plan period of time and want to catch a falling knife. to focus on are the mature say, ‘This has just That being said we love when compounders, these are the risk is being sold off Visa’s, the MasterCard’s, the changed, it has shifted indiscriminately and we can Google’s, and the Facebook’s, take a longer-term view and but there are many other the probability tree say, "Gosh, this is significantly businesses that are more off below fair value." It's going to the beaten path like the dramatically.’” have higher volatility, because, Interactive Brokers’s or Henry frankly, there's more Schein’s. Frankly, everybody controversy. The real key with knows they're really good In the case of the earlier stage this one, specifically, is terminal businesses, everybody knows compounders we try to figure value, “r – g.” You need to that over a five- or ten-year out what the business will look have a great deal of comfort period, free cash flow per like once they get through that you can get a business that share is going to grow their investment phase. We is still growing, because, as you strongly. The key is using use analogies to understand know in the discounted cash market volatility to our how things may play out. Some flow model, so much of the advantage. We plan to buy current examples: Can value ultimately resides the in when there is some form of Workday be the next Oracle? the terminal value. controversy that allows us to Can TripAdvisor be the next pick them up cheaply. Priceline? These require a heck G&D: How do you gauge of a lot more work to management quality, especially Those are what I would define understand where fair value is for incumbents going through as lower variant perception. and how things are going to an investment phase where You're not going to have a evolve over time. These there’s execution risk? dramatically differentiated view investments have the potential on what's going to happen in for much higher internal rates CW: So to back up, when I the business, but that doesn't of return but, of course, come speak about the investment (Continued on page 41) Page 41 Chris Weldon ’12
phase, what I mean is a and plan to size back up as you The second one is if a key company that is forgoing some see the signposts line up. investment factor changes. level of profitability today to That is super critical. In the grow its moat, either for G&D: This goes back to your case of Facebook, one of the defensive or offensive reasons sizing and timing argument. key investment factors is over the long-term. It's never Having prepared and having pricing. We believe that they easy to assess management in done the work, if and when have the ability to increase the moment, but I think it's a those opportunities present prices to industry level CPMs combination of two things that themselves, you size up? over time. If you saw that they can give you comfort. have tapped out pricing, it's CW: That's exactly right. In going to be extremely The first is the track record of fact, the critical piece is that challenging for them to the management team. Have when things tip and the continue to compound free they made the right decisions signpost ultimately avails itself, cash flow per share at the over a long enough period of forget about valuation for a levels we have underwritten. time? Have they dealt with period of time and say, "This We would be forced to do enough of these similar has just changed, it has shifted significant primary research to decisions to make the right the probability tree understand whether this was call? We do case studies on dramatically." temporal or more permanent. every idea. We look back over If it was more permanent, ten, twenty years, and say, The downside cases have now what is the fair value under the "What are the decision points moved up significantly and the revised set of assumptions. that are similar to this, and upside cases have also moved how have they evolved and up dramatically. That's one of G&D: What advice do you changed?" The second piece, the hardest things to do from have for students? which is equally as critical, is an analytical perspective, speaking with industry because this is a whole new CW: I think the key to being participants, and asking, "Does world. The world may never successful coming out of this make sense?" The best believe it could happen, but in business school is to frame people to speak to are fact, it happens quite your career appropriately and competitors as they are frequently. If you look at the be dynamic. This is a typically biased to be skeptical. Amazon’s of the world, the challenging time for active Netflix’s of the world, the investment management and A lot of it is actually talking to Google’s, Facebook’s, nobody you should be realistic that the real people in the industry and thought that these were going first opportunity you get might asking them if it makes sense. If to be 10, 15, 20, 30, 50 times not be perfect. If you frame it went wrong, what is the pre- the size that they were five or your career as a continuum of mortem? What should you be ten years ago. learning, then this is just one tracking to understand if it did step in a long-term process of go wrong? Then you line up G&D: How do you think continuous improvement. If the signposts and track them about exiting investments? Is it you continue to learn and over time to see if things are looking at relative implied grow as an investor you will playing out as you expect. expectations as you're doing ultimately find a great work on new names and new opportunity to deploy your Sizing and timing are very themes? Is it valuation driven? skills. important during the investment phase. The case CW: There are a few different For me, there have been two studies show that this phase is reasons to exit a position. We primary ways to learn and I volatile as the public markets talked about one earlier, suggest using both of them to are very skeptical of short- where it's more formulaic. your advantage. The first is term pain for what is hopefully Something goes against you, finding a great mentor. When longer-term gain. What we and you ultimately decide you selecting a firm, prioritize have found is that you may want to re-underwrite from an people first. If you find the want to size down while the unbiased position. right people, your learning will company proves out its case accelerate. The next is to learn (Continued on page 42) Page 42 Chris Weldon ’12
by doing. I suggest keeping a journal and doing a personal review every six months. Journal about every investment you look at, about your process, about decision making, about every book you read. Whenever you hear someone speak that inspires you note it in the journal. This will become your greatest resource and will help you define your power zones.
The second key to your success is in defining a style that is authentic to you. This is what I mean when I say “power zone.” Some people gravitate towards value while some people gravitate towards growth. Some people love to short sell and others use frameworks/mental models. There are many ways to skin the cat.
Try to think about yourself, and what makes you tick, because this whole business is about finding your circle of competence, and then matching that up with the opportunity set the market gives you. That'll allow you to be more concentrated and, most importantly, it will give you greater conviction when things go against you.
G&D: Thank you very much for joining us.
CW: Thank you guys very much. I appreciate it.
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Contact Us: [email protected] Graham & Doddsville Editors 2016-2017 [email protected] [email protected] Eric Laidlow, CFA ’17
Eric is a second-year MBA student and member of the Heilbrunn Center’s Value Investing Program. During the summer, Eric worked for Franklin Templeton Investments. Prior to Columbia, he was an equity research analyst at Autonomous Research and a senior port- folio analyst at Fannie Mae. Eric graduated from James Madison University with BBAs in Finance and Financial Economics. He is also a CFA Charterholder. He can be reached at [email protected]
Benjamin Ostrow ’17
Ben is a second-year MBA student and a member of the Heilbrunn Center’s Value Invest- ing Program. During the summer, Ben worked for Owl Creek Asset Management. Prior to Columbia, he worked as an investment analyst at Stadium Capital Management. Ben gradu- ated from the University of Virginia with a BS in Commerce (Finance & Marketing). He can be reached at [email protected]
John Pollock, CFA ’17
John is a second-year MBA student. During the summer, John worked for Spear Street Capital. Prior to Columbia, he worked at HarbourVest Partners and Cambridge Associ- ates. John graduated from Boston College with a BS in Finance and Accounting. He is also a CFA Charterholder. He can be reached at [email protected]