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

Inside this issue: Issue XL Fall 2020 Bill Nygren, Harris Associates

Bill Nygren P. 3 Bill Nygren has been a manager of the Oakmark Select Fund (OAKLX) since 1996, Oakmark Fund CBS Students Invest- (OAKMX) since 2000 and the Oakmark Global ment Ideas P. 20 Select Fund (OAKWX) since 2006. He is also the Chief Investment Officer for U.S. Equities at Harris Ray Kennedy P. 26 Associates, which he joined in 1983; he served as the Sarah Ketterer & firm's Director of Research from 1990 to 1998. Alessandro Valentini Bill Nygren, CFA (Continued on page 3) ’06 P. 38 John Mullins & Dan Ray Kennedy, Hotchkis & Wiley Kaskawits ’11 P. 50 Ray Kennedy serves as a portfolio manager on the High Yield bond portfolios at Hotchkis & Wiley. Editors: Prior to joining the firm, Mr. Kennedy was a

Managing Director, portfolio manager and senior Rodrigo de Paula member of PIMCO's investment strategy group. At MBA 2021 PIMCO, he headed the global high yield business Matt Habig along with managing and overseeing High Yield MBA 2021 funds, bank loan trading and collateralized debt Ray Kennedy, CFA (Continued on page 26) Alison Tien MBA 2021

Bill Ledley Causeway Capital MBA 2022 Causeway Capital manages equities globally with a Tom Moore fusion of fundamental and quantitative analysis. The MBA 2022 firm was founded in 2001 and has $39B in assets under

Franklin Shieh management as of September 30th, 2020.

MBA 2022 Sarah Ketterer and

Alessandro Valentini (Continued on page 38) ’06, CFA Lyrical Asset Management Visit us at: www.grahamanddodd.com As Co-Portfolio Managers of the International Value www.csima.info portfolio, Dan Kaskawits ’11 and John Mullins lead the international investing effort at Lyrical Asset Manage- ment. Dan and John are also Portfolio Managers of the Lyrical Global and Global Impact portfolios, as well as Associate PM’s for the U.S. strategy. Lyrical manages concentrated long-only portfolios, reflecting both deep value and quality/growth. The John Mullins and Dan firm has a long-term orientation with just 15% annual- Kaskawits ’11, CFA ized turnover since inception. (Continued on page 50)

Page 2 Welcome to Graham & Doddsville

We are pleased to bring you the John are co-portfolio managers 40th edition of Graham & of the International Value fund Doddsville. This student-led at Lyrical Asset Management. investment publication of Co- They explained their concen- lumbia Business School (CBS) is trated approach to value in- co-sponsored by the Heilbrunn vesting, which focuses on find- Center for Graham & Dodd ing high-quality businesses Investing and the Columbia Stu- whose secular growth charac- dent Investment Management teristics are underappreciated Association (CSIMA). by the market, resulting in Meredith Trivedi, Managing cheap valuations. We first interviewed Bill Ny- Director of the Heilbrunn gren, portfolio manager of the We continue to bring you Center. Meredith leads the Oakmark Funds at Harris Asso- stock pitches from current CBS Center, cultivating strong ciates. Mr. Nygren discussed students. In this issue, we fea- relationships with some of Oakmark’s approach to value ture two pitches from the 2020 the world´s most experi- investing, which looks past tradi- Women in Investing Confer- enced value investors and tional GAAP accounting to find ence: April Yin ’22, Maria Van creating numerous learning businesses whose potential may Heeckeren ’22, Joyce Zhang ’22 opportunities for students be understated today. Bill shared and Sherry Zhang ’22 share interested in value investing. with us a few sectors Oakmark their long idea on Hanesbrand finds attractive, as well as his (NYSE: HBI), and then Cathy general views on today’s mar- Yao ’22, Flora Chai ’22, Joanna kets and how they compare to Zhou ’22 and Wenbo Zhao ’22 prior periods in his career. share their long idea on The TJX Companies (NYSE: TJX). We also chatted with Ray Ken- We also feature a pitch from nedy of Hotchkis & Wiley. Ray Dickson Pau ’22, presenting his has had an extensive career in long idea on Farfetch (NYSE: the high yield bond markets. He FTCH). shared with us his framework for credit investing in today’s Lastly, you can find more inter- uncertain times, and how his views on the Value Investing with thoughts on the macro environ- Legends podcast, hosted by ment impact his approach. Professor Tano Santos. Profes- Professor Tano Santos, the sor Santos has recently con- Faculty Director of the Heil- Next, we interviewed Sarah ducted interviews with guests brunn Center. The Center Ketterer and Alessandro including Henry Ellenbogen & sponsors the Value Investing Valentini ’06 from Causeway Anouk Dey, Rishi Renjen, Rich- Program, a rigorous academ- Capital. Sarah and Alessandro ard Lawrence, Tom Russo and ic curriculum for particularly described Causeway’s unique Kim Shannon. committed students that is lens on value investing, which taught by some of the indus- combines rigorous fundamental We thank our interviewees for try´s best practitioners. The business analysis with a quantita- contributing their time and classes sponsored by the tive overlay that helps structure insights not only to us, but to Heilbrunn Center are among their portfolios. Sarah and Ales- the whole investing community. the most heavily demanded sandro shared their views on and highly rated classes at some of the hardest-hit areas of G&Dsville Editors Columbia Business School. the market during Covid-19 that may represent attractive oppor- tunities moving forward.

Finally, we got the chance to speak with John Mullins and Dan Kaskawits ’11. Dan and Page 3 Bill Nygren, Harris Associates

Mr. Nygren has received he told me that they were house. We would alter our many accolades during his stocks and that the numbers purchasing habits based on investment career, represented dollars, it prices that were charged. including being named suddenly became very That was how I learned to Morningstar's Domestic interesting to me. So that behave as a consumer— Stock Manager of the Year for 2001. interest in stocks and always trying to expand numbers was there from a what my dollars could buy He holds an M.S. in young age. by being very careful about Finance from the the price that I paid. University of Wisconsin's Applied Security Analysis “We would alter our Additionally, there was a Program (1981) and a B.S. Bill Nygren, CFA family trip out to visit an in Accounting from the purchasing habits based older cousin of mine who Harris Associates University of Minnesota on prices that were was serving in the Air (1980). Force. This would have

Editor’s Note: This interview charged. That was how been, I guess, the tail end of the Vietnam War. The trip took place on September I learned to behave as a 30th, 2020. took us through Las Vegas consumer—always and my dad took my older Graham & Doddsville brother and me into, I think (G&D): Can you walk us trying to expand what what was the Kroger through your background grocery store across the my dollars could buy by and what brought you into street from the Motel 6 that the world of investing? being very careful we were staying in. My dad pulled out five nickels and Bill Nygren (BN): I grew about the price that I he said, "I'm going to show you two boys why you up in a middle-class family in paid. ” St. Paul, Minnesota. In should never gamble." He school, I always did better put the first nickel into a with numbers than words slot machine and seven and baseball was one of my I also grew up in a very nickels came out. Then he passions outside of school. traditional household. My put the next one in and a One of the things that dad worked outside the few more nickels came out. attracted me to baseball home and my mom raised I could see my dad getting was how easily available all the kids. My mom was frustrated because his the statistics were. I played always on a very tight object lesson was going Strat-O-Matic Baseball as a budget for grocery awry. kid and was always looking spending. Therefore, she in our local newspaper at would always shop specials. But I was standing there the full page of baseball box When I was a little kid saying, "Dad, stop. You're scores that they had. getting dragged to the way ahead, stop, stop." And Coincidentally in the St. Paul grocery store with my he just got angrier and Pioneer Press, the business mom, a weekly shopping angrier and threw these section was right next to trip would usually involve nickels in until they were all the baseball box scores and three different locations so gone and then said, "See that section had all the we’d buy the stuff that was boys, you should never stock quotes on it. I was on sale at each store. If gamble." By then my eyes intrigued by this page of grapes were on sale one were huge and I thought, numbers that I didn't know. week and cherries weren't, "This is fascinating. I just When I asked my dad and we had a lot of grapes in the watched my dad make (Continued on page 4) Page 4 Bill Nygren, Harris Associates

multiples of his money. If investing. That's not as important to have an only he hadn't been so heroic as it sounds today investment approach that foolish to throw it all away." because I'm sure the local was consistent with the way library would have hundreds I thought about money and That created a fascination of books on investing. Back all other aspects—trying to with understanding gambling then they had maybe 10 to get the most value for my versus investing. My dad 20 books because it hadn't dollar and applying that worked in the accounting really become the national same process to investing. I department at 3M pastime to figure out how wasn't fighting any cognitive Company. He had a to day trade and invest. battles inside my own head. business background, so I knew he understood “It was important to Once I had the feeling that probabilities and dollars and an investing career is what I what made sense for have an investment wanted to pursue, I thought investing. And here he was it made sense to spend a lot telling me gambling was approach that was of time learning the foolish. So, I started consistent with the way language of investing, which studying all forms of is accounting. I majored in gambling. I learned that I thought about money accounting at the University lotteries gave you an of Minnesota and I had an expected value of about 50 and all other aspects— internship at Peat Marwick cents on the dollar and trying to get the most and Mitchell, which was one horse racing was maybe 83 of the Big 8 eight accounting cents. If you played craps value for my dollar and firms back then. But one of really well, you could get the things that bothered me applying that same that up to 99. And if you about an accounting career counted cards in blackjack, process to investing. I was that it looked like if you you had a chance to get were 10 or 20% better than better than 100 cents. wasn't fighting any the person you were sitting cognitive battles inside next to, you could maybe All these things we called get paid 10 or 20% more gambling had expected my own head. “ than that person could. values less than 100 cents There wasn't leverage. In on the dollar, but the things the investment business, the we called investing gave you In my reading, I was always average investor doesn't more; if you bought bonds, attracted to the people who add any value to an index you would usually come out approached investing the fund, but someone who can just barely ahead of inflation way my mom approached outperform the market can while stocks gave you a shopping. When Benjamin deliver tremendous leverage much more significant Graham said, "You buy on the value of their time expected return. I became stocks when they're on and that had great appeal to fascinated with stocks sale," that completely me. throughout high school. squared with the way I During college, almost all of behaved as a consumer. I And then one last story. My my free time was spent started to believe that my dad was a credit manager at reading investment books style of investing would be 3M. I enjoyed the outward from our local library and value investing. That's not focus of his job. It was an over the course of a few to say that I believe that's interesting contrast years, I read most of the the only thing that can between my dad and one of books they had about work. But for me, it was my uncles who also worked (Continued on page 5) Page 5 Bill Nygren, Harris Associates

at 3M. My uncle managed work on investing the After Wisconsin, I took a the forms department and pension money." And one of job at Northwestern Mutual knew more about the the guys said to me, "If Life in Wisconsin and company than almost any you're really interested in learned two key things other human did because he investing, General Mills during the two short years I helped write the forms that probably isn't the place for spent there. First, it was drove the operations for you. A very close friend of important to me to work at every department. My dad, mine, Steve Hawk, is a company where on the other hand, knew a running this interesting investment results drove little bit about a lot of program at the University of the success or failure of the companies because he had Wisconsin called the firm. Northwestern Mutual to be responsible for credit Applied Securities Analysis was driven primarily by its decisions to 3M customers. Program. I'd suggest you go ability to sell insurance and Anything that was in the down there and interview the brand that it had with business news usually with Steve because I think customers. It was important overlapped with what my that program would be that they didn't screw up on dad was doing. When really interesting for you." the investment side but Chrysler was going through getting unusually good its bankruptcy, my dad was returns was not as involved in decisions about “I loved the external important to them as the whether or not 3M should ability to sell insurance was. continue to sell them focus of having very Secondly, I worked in a product. I loved the broad, but more small department there with external focus of having portfolio managers whose very broad, but more shallow knowledge as investment process was shallow knowledge as kind of a mix of momentum opposed to knowing all the opposed to knowing all investing and trying to use details about one company. the details about one Wall Street buy That cemented that I recommendations to drive wanted to study company. “ what was in the investment investments when I went to portfolio. As an analyst business school. there, my managers and I So I went and interviewed were like two ships passing G&D: How did you decide with Steve. Madison, in the night. I would look at where to attend business Wisconsin wasn't really on something that was on the school and where to launch my radar, but when I found new low list. your investing career? out I could get my master's degree there in 12 months, I I remember looking at a BN: I was at an internship could start right after company called Allied at General Mills the summer undergrad as opposed to Stores, which owned before I started business waiting multiple years and I Brooks Brothers among school. The last couple of could spend most of my other things, and getting weeks there, they had time in a program where excited because I thought executives from different the students got to invest the real estate value of its departments taking us to real money, it was a no- properties was worth more lunch to try and convince us brainer for me to go to the than the stock price. to work for them. I found University of Wisconsin. Nobody on Wall Street was myself saying, "What I'd Looking back, this was one recommending it. I really like to do is work in of the best decisions in my presented my report and the pension department and career. they said, "There just (Continued on page 6) Page 6 Bill Nygren, Harris Associates

doesn't seem to be enough the job. I told him to call statistical and the numerical interest in this stock for us you so I have to hang up side of things. But obviously right now, so let's keep an now." Oakmark is known for not eye on it." The stock did only being a value investor, well and Wall Street started but also looking for high recommending it. They “I learned that being quality businesses that are came back to me saying, well positioned. Could you "Hey, you like this Allied good at executing one’s talk a little bit about kind of Stores, let's look at buying how that transition it." I responded, "Yeah, but I personal investment emerged for you and maybe liked it when the stock was philosophy didn't really delve into the strategy at at $15 and I thought it was Oakmark? worth $30 and it's selling at matter if the people $27 now. I think there are that you worked with BN: I think part of it is just better things we could do." how business has evolved were using a different more than how we have I learned that being good at evolved. If you look back to executing one’s personal philosophy. “ Graham's time, businesses investment philosophy were hard asset-based. didn't really matter if the Fixed assets on the balance people that you worked A minute later Clyde called sheet were depreciated and with were using a different and invited me to come there was a reasonably philosophy. Not that theirs down to Chicago to go out good correlation between was right or wrong; the to dinner with several stock prices and book value important thing was that it Harris partners. They were because competitive was different, so we had a asking about stocks I was advantages that didn't get mismatch. I decided that I interested in and were represented on the balance needed to change firms and genuinely interested in all of sheet tended to be was looking for a company the companies where I was relatively temporary. A committed to value hitting a brick wall at my textile company that was investing, where investment current firm. There was an first to invest in the newer, results drove its success or intellectual meeting of the faster looms for a few years failure. I called Steve Hawk minds that I'd never would have a competitive and told him that I was experienced before. I ended cost advantage. They would going to be looking for up joining Harris in 1983. do really well, then their another position and asked My thought at the time was, competitors would make that he please let me know "I can learn a lot here and I the same investment and if he were to come across know the next three to five they were back to the same anything. years will be good. I don't lousy commodity-based know beyond that." At that business that they had A couple of weeks later, my point, I wasn't worried always been in. phone rang and it was about beyond three to five Steve. He said, “Bill, an years. And here we are But looking for discounts to alumnus you don't know today, 37 years later, and book value tended to named Clyde McGregor I'm still in the same spot. identify average businesses from a firm you've never that were out of favor. If heard of, Harris Associates, G&D: It sounds like you you did that and were is going to be calling you in had the Ben Graham value patient and waited for a a minute about a junior mentality early on and you reversion to the mean, you analyst job. You should take were drawn to the could be successful. In the (Continued on page 7) Page 7 Bill Nygren, Harris Associates

early 1980s, Warren Buffett a subscriber or 11x patent protection and much was instrumental in EBITDA. These were better growth ahead of it. expanding the universe of companies that didn’t look That ability to make what we called value. He cheap on net income or exceptions to GAAP invested in a consumer book value, but there was metrics when we don't business that left a lot of his clearly business value there. think GAAP reflects the real followers scratching their We went through and world carries through to heads because it sold at a reconstructed income today to positions that are multiple of book value. statements and balance important to us, like Buffett's comment was, "If sheets acknowledging that Alphabet, where its you look at the assets on customer acquisition costs spending on “Other Bets” the balance sheet, you had very long-term benefits goes through the income won't even find brand value, and that depreciation of statement, depresses and that's more important cable in the ground was earnings by something like than any of the assets that occurring at a much more $6 a share and is not are listed on the balance rapid rate on the accounting reflected on the balance sheet." That started a move statements than it was in sheet. in the value community to real life. If you made the look for important assets accounting match real life, If Alphabet were investing that weren't part of book these companies had real with Kleiner Perkins value. book value and real instead, it wouldn't be called earnings. an expense and there'd be It could be real estate that an asset on the balance was at a historical cost and sheet called venture capital today was worth way more investments. But they do it “At Oakmark, we were than it was when it went on themselves, which we think the balance sheet. It could always open to the idea is even better because it be brand value that was helps them hire higher created through advertising, that GAAP accounting quality engineers. But as a which was expensed and was not a perfect result, it depresses the not capitalized. The same earnings and inflates the applies to customer measure for how stated P/E multiple. Once acquisition costs and R&D you adjust for that and the expenditures, which not business value was cash on the balance sheet, only didn’t increase book growing.” which earns almost nothing value, but also depressed today, you see that you're earnings. At Oakmark, we really not paying much were always open to the more than a market idea that GAAP accounting We also felt that way about multiple for the Search was not a perfect measure a company like Amgen business. for how business value was where very heavy R&D growing. spending was depressing Another example is Netflix, earnings and making it look which very strongly rhymes One example from the early very expensive relative to with the way we thought days of Oakmark in the the pharma industry. But if about cable TV companies. early 1990s is the cable TV you looked at enterprise It isn’t reporting much in industry. We were seeing a value to EBITDA plus R&D, the way of income and its lot of private market Amgen looked much book value is relatively transactions taking place at cheaper than the pharmas meaningless. A similar enterprise values of $1,000 and it also had much longer company like HBO got (Continued on page 8) Page 8 Bill Nygren, Harris Associates

purchased by AT&T as part G&D: It seems like there ought to sell at 5-6x of Time Warner for a value are situations in your earnings. But we think the of a little more than $1,000 portfolio where you don't industry has changed a lot per subscriber. On that necessarily think that for the better over the past basis, Netflix stock looked analysts’ forecasts for the 30 years. A generation ago, very cheap and based on next few years are GM would design a part the subscribers they were necessarily off base, but you themselves and would put it adding every year, it was think often the multiple out to bid to a handful of selling at a single-digit that's being ascribed to auto parts companies and multiple of the value it was those businesses is too low say, "Here are the specs of adding. We don't think of or people are not what we want, give us a value and growth as recognizing the quality. bid." opposites. Growth is a Could you expand on that? positive characteristic in a Today, they will say, "We company and as long as you “If we can get growth need you to design a thing. don't overpay for it, it's a The thing can't weigh more nice thing to have. and not overpay for it, than this and has to accomplish all these We also owned Apple for a that's a huge positive. I functions." The important long time, although we think there are change is now the finally sold it last quarter. intellectual property is Almost the entire time we mischaracterizations of sitting at the auto part owned the company, it was company. It's not just a race selling at less than a market how value managers to the bottom of who can P/E multiple, yet it was should think—that we be the lowest price supplier always the first question we of a commodity product; got asked by clients or should be confined into these companies are actually consultants. "How can a designing solutions for the this universe of subpar value manager own a auto OEMs. It's important growth company like this?" businesses that are to the auto companies that their suppliers be successful If we can get growth and destined to fail in the because they've realized not overpay for it, that's a long term.” that it doesn't make sense huge positive. I think there to have one company are mischaracterizations of supplying the United States how value managers should BN: I think a lot of Wall and a separate company think—that we should be Street analysis tends to be supplying China and yet confined into this universe relatively simplistic, where another company supplying of subpar businesses that someone will say, "Over the them in Europe. They want are destined to fail in the past 30 years, this industry their parts companies to be long term. That’s not how has averaged X% of a successful global businesses we at Oakmark think of market multiple, and based that can follow them around value at all. We believe on that, the stock doesn't the world. I think the there's a way to value a look cheap today.” We've market has been very slow business fundamentally and been attracted to industries to accept the idea that the if we can buy a stock at a like auto parts where the relationship between OEM big discount to that value, analysts who've covered and parts supplier is no whether it's a low P/E or a auto parts for a generation longer focused on the OEM high P/E, it's a value stock. are basically stuck on the just extracting a few pennies idea that those companies less in costs. It is actually a (Continued on page 9) Page 9 Bill Nygren, Harris Associates

true partnership today and not projecting either peak we believe that should G&D: If you’re right, what or trough returns for a express itself in a higher P/E causes stock prices to company into perpetuity. multiple. eventually reflect that The way we will look at a reality? cyclical company is to try to Banks are another example. make as accurate a guess as We believe the banks that BN: Either the market we can of the next couple have much higher capital changes its opinion and of years of earnings. But as relative to their assets today willingly elevates these we think out longer than than they had a generation companies to higher P/Es or that, we will look toward a ago are substantially less you get in a position like the reversion to the mean of risky businesses. And banks and the auto parts what the company has because of that, their cash companies are in today typically earned on its flows should be discounted where there's almost no use equity or profit margin to at a lower rate and that for capital that can add as try to get to metrics that should result in a higher P/E much to per share value as make sure we're capitalizing multiple. Most of Wall purchasing their own stock. normalized earnings. Street research still Pre-pandemic, we had a simplistically says the number of the large banks As far as disruption risk, industry has typically sold at that were not only paying a some of the auto parts about 10-11x earnings, so dividend yield that exceeded companies that we own, like that is still appropriate. what you could get on a 30- TE Connectivity and Aptiv, year bond, but they were are leaders in electrification. also repurchasing enough of Their content is significantly their share base that they higher on EVs than it is on “We want to invest in had double-digit EPS traditional vehicles. I think companies that will growth, even though top they benefit from line was only growing a disruption. Lear is a utilize their free cash couple percent per year. company we own that's flow to eventually force dominant in seating. I think We want to invest in the concern there relates a convergence of companies that will utilize more to whether we will their free cash flow to end up with a giant, shared business value and eventually force a car fleet in the United stock price.” convergence of business States of autonomous, value and stock price. utilitarian vehicles where nobody's really concerned G&D: With those two about comfort of seating. There's no particular sectors, it seems acknowledgement that the like the market is very I think what people are businesses are better today focused on cyclicality and missing is that as we move and more competitively risk of disruption. Do you toward a more autonomous advantaged with larger scale think those concerns are vehicle, you start thinking of that helps on mobilization, overblown by the market? the inside of your car fraud protection and becoming more like your regulatory compliance. It's BN: I think cyclicality fits living room or your den, why the large banks are well into discounted cash where comfort becomes gaining more share today flow analysis and estimates more important to you without having to buy the of valuation. You just need because you aren't mid-sized banks. to be careful that you are constrained by needing to (Continued on page 10) Page 10 Bill Nygren, Harris Associates

drive the entire time. We evaluate management teams grow that internationally, can see a future where the and capital allocation, and it’s much more attractive. average price of a seat in do you think about capital Netflix is adding something luxury vehicles is multiples allocation differently for like 25 million subscribers a of what it is today because some of the higher growth year, even in non-Covid it becomes an businesses that you own like times. If you believe, as we entertainment center. Alphabet and Netflix versus do, that those subs are some of these auto parts worth $1,000, that's $25 So, I think if we were suppliers and banks? billion of value that they're invested only in auto part adding. Netflix’s market cap companies that relied on is around $200 billion today, fossil fuels and combustion so the annual return on engines, there'd have to be “A company like Netflix spending for customer some concern about growth is 12.5%. That disruption. But given where could report a much organic return is better than we are invested, I don't higher profit today if it what it could likely achieve think our companies face by just buying back shares. that concern. chose to by curtailing For companies like banks, in Shifting to banks, the most spending on acquiring a low loan growth basic function of a bank is to new customers, raising environment, using capital collect deposits and loan to buy back their own them out at a spread. I think prices significantly and business at a discount to the fact that the most stated book value is a very competitively advantaged then generating attractive use of capital, banks in the world today significant cash flow to especially because we are selling at less than a believe that the financials market multiple does a lot repurchase shares.” are worth a significant to discourage anybody from premium to book. We think trying to compete with they deserve to sell closer them. If a company like Ally BN: Our view on capital to 1.5-2x book rather than Financial, which has the best allocation is that it's the three quarters of book auto lending business in the management's duty to that they sell for today. So United States, sells at two deploy capital to the highest the money that they're thirds of tangible equity, long-term return potential. investing in their own stock who in their right mind A company like Netflix is returning twice what would say, "I'm going to try could report a much higher they're paying for it. It’s and replicate that?" I don't profit today if it chose to by very hard to find that kind think a company like Square curtailing spending on of organic growth is really trying to acquiring new customers, opportunity or acquisition disintermediate the retail raising prices significantly opportunity. We don't have deposit to a retail lending and then generating a magic answer of what we business that companies, significant cash flow to want to hear a company like Bank of America, Wells repurchase shares. When doing with its capital, but Fargo, Capital One and Ally, we look at the return that it we want to hear a thought make the overwhelming is getting by giving us process that's consistent majority of their profits bargain rates on Netflix so with maximizing long-term from. that it grows its subscriber per share returns. count as rapidly as it can G&D: How do you and by spending to try to (Continued on page 11) Page 11 Bill Nygren, Harris Associates

G&D: What is your with your original thesis. going up? It becomes a very approach to selling? That's a reason to sell the difficult and very emotional stock. You originally decision if you don't have a BN: I’ve always thought thought management was solid reason for owning that that the reason people have acting in the shareholder stock. so much trouble with the interest trying to maximize sell decision is because they long-term per share G&D: We discussed earlier didn't have a well-defined returns. Then you see them how businesses that have buy decision. If you really issue an undervalued stock become higher quality know why you decide to for a full price acquisition. should merit a higher buy a stock and why you You ask about it and they multiple than they did in the own it, then the absence of can't explain it in terms that past. How do you pick a those reasons becomes the make sense to you. If you've new absolute multiple that a reason to sell. At Oakmark, lost confidence that business should trade in we're looking for three management is trying to order to drive your value things when we buy a maximize long-term value, estimation and your buy / company. that's a reason to sell the sell decision? stock. First, we want a significant BN: We use a lot of discount to current business different methods and try to value. Second, we want that get to a reasonable average. business value to grow over In the auto parts sector we time at a similar rate as the “If you really know why discussed, one thing we S&P 500, so growth in per you decide to buy a look at when comparable share value plus dividend companies get acquired for income must at least match stock and why you own cash is if somebody is willing what we expect from the to pay more than the 5-6x market. And finally, we want it, then the absence of earnings at which analysts a management team that's those reasons becomes are valuing them. We keep aligned with us wanting to close track of acquisition maximize long-term per the reason to sell.” multiples in each industry share business value. because we think a buyer who's paying cash for an If we feel we've lost any one entire business is likely a of those three items, we'll more informed buyer than sell the stock. In an ideal The danger is when people somebody who bought world, we buy something at will buy a stock without 1,000 shares of the stock. 60% of value and it goes up having a really disciplined to 95% of value. If we don't investment philosophy. We'll also look at what think our value estimate has Then they’re at sea when comparable public changed, it's no longer the stock goes up or down. companies are trading for. cheap, so we sell it and we If you buy something at $50 We might argue an auto move on to another cheap and three months later it's parts company today is stock. But you also have $30, that's not what you becoming more like a high- mistakes where you thought signed up for so you sell it. quality cyclical industrial a business was going to be Or if you buy it at $50 and business, which is trading at able to grow and as you're it goes up to $70, then 12x earnings in the tracking the results after you're excited because it's marketplace, instead of 6x. you purchase it, you going higher, and why would decided you were wrong you sell something that is We'll do a discounted cash (Continued on page 12) Page 12 Bill Nygren, Harris Associates

flow analysis. As a value than $70, we'll move on to equities. manager, we think our something else. The crystal ball gets hazy faster precision isn't nearly as than growth managers tend important. It’s the idea that to think, so we'll build a there is a compelling body detailed two-year forecast of evidence that gets to a “The most important and then use a five-year substantially higher number growth rate after that. After than where the market is message back in 2008 those seven years, we offering it to us today. was simply to get your model a regression to the mean because we think it's G&D: What are your money invested in the hard to project for any thoughts on the current business that the advantages environment, and how does market. Today, I don't or disadvantages we see it compare to prior market feel that way at all.” today persist beyond seven environments during your years. We'll set a discount career? rate based on risk levels, informed by where their BN: When people ask bonds trade and where about the current comparable companies environment, especially a This reminds me much trade, and then we'll do a few months ago when more of the market I went discounted cash flow. prices were more through earlier in my career depressed than they are in the late ‘90s, where the If we compare those three today, they would always S&P looked a little high, not different methods and want to make a comparison crazy high, but you had this they’re wildly different, we to 2008. I have a very hard massive divergence between want to understand the time saying that this market where traditional businesses differences. Once we bears any resemblance at all were selling and where dot- understand, we can to 2008. In 2008, if you com stocks or large-cap, thoughtfully say something took a normalized earnings rapid growers were selling. like, "Maybe the acquisition number for the S&P, the price is out of line with the market was selling at 7-8x Banks were selling at 5x others because there's that number. The most earnings and food stocks at always a big synergy important message back 7x earnings, but GE was at opportunity," as opposed to then was simply to get your 50x and Home Depot was computing a naive average money invested in the at 70x. For the fastest of the different approaches. market. Today, I don't feel growers, you couldn't even that way at all. compute the multiple I always find it funny when because they were losing somebody says, "My fair The multiple on the S&P is money. Back then people value estimate for this somewhat higher than the would say, "Well, this business is $74.70." We’re long-term average. I think massive gap is deserved just trying to get into the you can argue that that's because these traditional right ballpark and that's one deserved given the lower businesses are dying, of the reasons we look for interest rate environment, everything's moving online." big discounts. If a stock is but I wouldn’t argue that Having been through that selling at $50 and we can't the current market level is before, it makes me less get pretty confident that so undervalued that you willing to believe it today. there's a way of looking at it should be shifting your asset that says it's worth more allocation much more to (Continued on page 13) Page 13 Bill Nygren, Harris Associates

The chart above compares the divergence has become Eventually you have to multiples on the fastest extreme. Today, that chart return to a world where growers to the lowest P/E of relative multiples has investing is getting a return stocks. If you look at that again gone from 2-3x up to for being willing to defer the over the past 70 years, it 10x. utility of present looks like a sine wave going consumption. To lend between 2-3x. So if the One common argument money long term, people cheapest stocks were at 7x supporting today’s extreme will have to get back more earnings, the most price for growth is that the than they expect inflation to expensive growers were shortcomings of GAAP be. We are not willing to do usually 14x to 21x. The line accounting are even greater a DCF at 3% for a rapid goes crazy around 1998 to today than they were two growth company today. 2000, getting up to about decades ago. As we 10x. In the couple of years discussed earlier, I believe In a normalized after that, it came crashing that as well but not to the environment in which back down and started sine- magnitude that would justify inflation is going to be waving between 2-3x again. these stocks selling at 10x around 2%, like the Fed is greater multiples than low targeting, long government People talk about value P/E stocks. Another bonds would be 1% more underperforming for a common argument is that than that, corporates a bit decade, which is true, but the value of the future more than long bonds and for the first six years of that becomes infinite as interest then equities a couple of decade, there was a pretty rates go to zero. That’s hundred basis points above tight correlation between mathematically true, but we corporates. I think as the Russell Value and the don’t believe it makes sense interest rates recover to Russell Growth. It's really to project interest rates sustainable levels, it makes the last four years where staying at zero forever. sense that this P/E gap (Continued on page 14) Page 14 Bill Nygren, Harris Associates

comes back to normal. letter right now and going looks that expensive based back to comments I made on its projected P/E because 20 years ago about how it's grown so much from the small companies with large time people started “We think this valuations were taking over complaining about how high the large-cap universe. I the multiple was. Those environment is very wrote back then that three stocks alone are a investors who thought they similar to that late pretty big part of the S&P. were getting a low risk 1990s, early 2000 portfolio because it was We owned Amazon at one large cap were actually point. For a brief second, environment.” deluding themselves people thought we were because they were taking on brilliant as value investors a magnified risk with smaller buying Amazon in the The next question businesses that had bigger $200s. We thought that on everybody always asks ranges of fundamental a percentage of sales, it was today and asked me back in outcomes on top of the risk cheaper than the brick-and- 2000 is, “What do you think of very high valuations. mortar stores it was putting is going to cause a out of business and it was reversion?” Even having This analogy is important making an investment lived through it, it is difficult today as we see big decision to depress earnings to pinpoint what caused the businesses that were and grow the scale of the collapse of the dot-com and previously large cap, like company. The stock hit large-growth bubble of Schlumberger, Phillips 66 or $600 within a year as 2000. I think the rubber Dollar Tree, falling out of people started getting really band expanded too far and the large-cap universe and excited about AWS. At the finally snapped. Low-price being replaced by smaller time, we were not equipped companies were able to companies with very high to make a reasonable increase their value more valuations. I think that business value case for through share repurchase creates a dangerous AWS. Our thesis for while high-price companies situation for the large-cap owning it as a retailer was started to make acquisitions investor who thinks they running out. We sold the of more traditional have a relatively low risk stock too quickly. Instead of businesses–like the AOL/ portfolio. being the geniuses who Time Warner merger. In bought it in the $200s, we the midst of it, nobody G&D: Do you think this is became the idiots who sold knew why it was happening, a dangerous environment it in the $600s. But where but that 10x multiple for the S&P index as a Amazon stock is today, I premium that investors whole? think it's tough to make a were willing to pay for value case. growth relative to cheap BN: I want to be careful started to collapse all of a there because we part ways I mentioned Apple earlier, sudden. with a lot of our value peers which we used to own. In who believe the FANG the past quarter, you've We think this environment stocks are grossly seen almost no change in is very similar to that late overvalued. As I mentioned earnings estimates for 1990s, early 2000 earlier, we own Alphabet Apple, yet its price has gone environment. and Netflix, which we think up nearly 50%. It's all are value stocks. Same with multiple expansion. That's a I'm writing my quarterly Facebook, which no longer tough one for us to (Continued on page 15) Page 15 Bill Nygren, Harris Associates

understand at this price. But investor today who owns drive all of your decisions, the craziness to us is not in the NASDAQ, or even the the focus is much more on the FANG names. It's in the S&P, is starting to get a lot what you think the world companies that might have of wealth concentrated in will look like 5 to 10 years $1-2 billion of sales that are just a handful of very large from now than what the now large-cap stocks companies. first quarter of next year because they have will look like. capitalizations over $35 I don't think that's billion. And we think they necessarily a valuation risk, When we went into have the fundamental risk of but it is a concentration risk lockdown in March, we unexpected outcomes that that any problem at one of immediately had our you would expect from those companies can have a analysts change their companies that are that bigger impact on the estimates for companies to small. Most of them have portfolio than you would be based on the Fed's competitors that are very expect for an indexed severe adverse scenario just well funded. You don't portfolio. because we thought that know what the market was a reasonably good share structure of their indicator of what we could industry will look like a expect in this super sharp decade from now, much “The index investor self-imposed decline we had less knowing what the today who owns the in the economy. We demand for the product will modeled a slow recovery be. NASDAQ, or even the with 2022 being the first S&P, is starting to get a year that was above 2019 Those names have very high and then normal growth fundamental risk coupled lot of wealth after that. with very high valuations. That is the area we think concentrated in just a What it highlighted was could be very risky for handful of very large how advantaged the asset- investors. light businesses were that companies.” were in the eye of the One risk I do think is there storm, like the travel and for the S&P investor is leisure areas. We owned concentration risk. We tend American Airlines at the to run concentrated G&D: How do you think time and it looked tough for portfolios at Oakmark. Our the world of travel will them. The stock had been typical peers own something evolve in post Covid-19? selling at 4-5x earnings, but like 150 stocks in their And also, how do you the business has a lot of diversified funds, while we maintain a sense of financial and operating own about 50. We also run optimism in the markets leverage and was entering concentrated portfolios that when something like Covid- an environment they'd have 20 stocks. I can't tell 19 hits in March? never seen before where you how much time and global travel basically went energy we've had to spend BN: Part of what makes to nothing. We didn’t have explaining to people why we that easier is the history and confidence that airlines thought it was prudent to temperament of people would survive, but an asset- have positions that we really who are attracted to long- light, franchise business liked in a concentrated term value investing. In model like Hilton wasn’t portfolio represent over 5% trying to estimate the value even going to lose significant of the assets. The index of a business and having that money. For Hilton, we just (Continued on page 16) Page 16 Bill Nygren, Harris Associates

had to bake in a couple when everything fell by BN: I’ll start by saying that years of lost income. Same about 50%, our immediate the forecast we have of a for a company like Booking move was to analyze our gradual recovery from the Holdings. We thought companies on an unlevered trough isn't a non- Booking would actually basis and see if we had an consensus forecast. There emerge stronger because its opportunity to trade up to are some people who are traditional competitors higher quality balance sheets even higher than we are on were not as well financed now because they've 2021 earnings. We think and had asset-heavier actually become cheaper 2021 starts to make models. than the companies that significant progress back were highly levered. We toward 2019, but is unlikely The fact that our valuation also looked where the to exceed 2019. When you would have to drop by a market was giving us an get into distinctions like, couple of years of lost opportunity to move out of “Could S&P earnings be earnings doesn’t really the eye of the storm to 20% worse than we had change the multiple that we businesses that might thought,” the question I believe these businesses are actually benefit from the come back to is, how worth down the road. lockdown, without having to important is that 20% to the We’ve now had two pay much of a premium. At long-term discounted cash quarterly earnings reports the end of the first quarter, flow value of business? For since we went into our we bought companies like an index that sells at 20x adverse scenario and on Match.com and Pinterest, earnings today, 100% of one average, the analyst while we sold a company year's cash flow would revisions to those estimates like American Airlines. represent only 5% of the have been slightly positive current value. compared to what we Pinterest fell from low $30s estimated back in March. to $14. It had $3 in net cash So I don't think an extra on the balance sheet, so the year or even two years of enterprise value fell more getting past Covid concerns “We are invested in dramatically. With people would change long-term spending more money on discounted cash flow values companies we think can their homes, engagement by that much. The survive even if this was increasing on Pinterest. uncertainty of when Covid We thought Covid might will end, whether it’s at the environment lasts for have increased the business end of this year, middle of several years.” value and instead it fell next year, middle of 2022, is more than the average why we're focused more on stock. That’s the kind of the quality of the balance That’s not what we’re used thinking that went into sheet. We are invested in to. Usually, value investors rearranging our portfolio. companies we think can assume earnings are going My only regret is that we survive even if this to be a lot better for their were moving as fast as we environment lasts for companies than the market could and I wish we could several years. thinks, and over time, those have gone faster. estimates fall somewhat. In That ties back to why we this situation, our earnings G&D: Do you worry about eliminated airline stocks estimates have increased the risks if the recovery early on. We think travel from the bottom. from COVID takes longer will come back because than anticipated? we're all getting sick of In February and March, virtual meetings and we're (Continued on page 17) Page 17 Bill Nygren, Harris Associates

anxious to sit down and America, Wells Fargo and how to create auto loans. meet in a room together. JPMorgan using. Because of that, spreads on We want to do our both new and used auto management meetings in Then you've got the loans are higher than they their offices across the table companies, like Ally and have been traditionally and from them. It might be a Capital One, which are are more reflective of the couple of years until we can more internet-based rates that Ally is paying to do that again. And if it's a businesses. They don't have its retail depositors. Ally is couple of years, most of the the fixed costs, so they can still earning a very good airlines need help to get take the 100 basis points spread income. Additionally, through that period. When that the largest banks are even though Treasury rates you're relying on strangers spending on brick and are down to about zero, it to help you, that's usually mortar and return it to the can still pay 1% because it not good for equity customer as interest doesn’t have the branch shareholders. income. A consumer will network. Ally is still typically earn 1% better by collecting deposits and G&D: Are there any putting money in Ally or lending them out as car particular ideas you want to Capital One than Bank of loans. discuss in more detail? America in exchange for giving up the branch Ally’s valuation is BN: One holding we’re structure convenience. Ally compelling. Book value is excited about is Ally has moved now to where it supposed to be about $31 Financial. Ally's basic is almost entirely funded by at the end of this year and it business is providing used retail deposits. The asset sells at $25 now, so 80% of and new car loans both to side of its balance sheet is book, and that's after taking dealers and ultimate almost entirely car loans. I the hit from all of the consumers. Traditionally, think what investors seem charge offs that they expect Ally had been funded by to question is how a Covid to ultimately cost short-term debt, so there company like Ally can make them. was a risk that when money in such a low markets seized up, it would interest rate environment. Before Covid, Ally earned be unable to roll over all its about $3.70 per share, short-term financing. When which represents about 7x that happened in 2008, it led “Before Covid, Ally P/E at the current stock the company to shift to a price. We expect post- business model that was earned about $3.70 per Covid, it will very quickly funded with customer share, which represents get back to that number. deposits. Ally was using most of its about 7x P/E at the cash flow to repurchase In banking, you've got two shares because that swamps basic business models today. current stock price. We the return it could get on You've got the companies expect post-Covid, it anything else. Because of that are spending about 100 Ally’s leadership position in basis points per dollar of will very quickly get auto loans, we think it ought to be earning a low- deposits on a nice brick-and back to that number. “ -mortar network with teens return on equity. It tellers where you can go should still be selling at a into the bank and conduct discount to the S&P, but if your business. That's a There is not a rush of new the S&P is going to be at a model that we see Bank of money trying to figure out high-teens multiple, Ally (Continued on page 18) Page 18 Bill Nygren, Harris Associates

could sell at a low-teens lose throughout the life of a now have to repossess the multiple. That would equate loan and record that as a car and the salvage value is to 1.5-2x book value, which charge against income. This going to be higher than they is 2-2.5x the current stock impacted Ally heavily over had previously estimated. price. the past two quarters. Second, we get to see how G&D: What’s your view on If we're wrong on P/E its charge offs are the risk of autonomous multiple expansion, the comparing to other public driving, which we discussed company should be able to companies that have similar earlier, disintermediating buy back more than 10% of quality loan books. We're Ally’s business? its stock each year, pay us a comfortable that Ally has dividend that's more than been in line with those BN: It depends on what we could earn on a long- charges. assumptions we need to get term Treasury and have the our money back. With Ally dividend grow by the same Additionally, we listen to selling at 80% of book, if rate that its earnings per what management says there's a disruption risk and share are growing. We when they speak publicly. we all quit buying personal don't need to be right on They have spoken about autos so that Ally doesn’t everything for this to be a how delinquencies have not have a way to grow very good stock from been as high as they thought anymore, simply winding current price levels. they would have been. The down the business and individuals who took decapitalizing both debt and advantage of forbearance equity would get us more have come back current on than our money back, so we “When we look through their loans at a faster rate don't worry too much a pile of hundreds of than Ally had projected. about that as a downside You can never be rock-solid case. We'd worry about it resumes of students certain, but we're hearing a more if Ally was selling at who are interested in consistent message from all 1.5x book and our target of the consumer banks that was 1.75x book. one opening, somebody credit losses do not look as bad as they had originally G&D: What advice would with a strong estimated they would be. you give to MBA students accounting background who are interested in If the consumer doesn't pay, pursuing a career in really sticks out.” the ultimate protection is investment management? for Ally to go back and repossess the car. Back in BN: One thing I'm really March, we were all surprised by is how little G&D: How do you get assuming that used car interest there is in comfortable with the default prices would fall accounting at most schools. risk in their auto loan dramatically because people When we look through a portfolio with wouldn't have as much pile of hundreds of resumes unemployment so high and money. Instead they've risen of students who are all the COVID disruption? dramatically because people interested in one opening, want more private which we are in the BN: Part of it is the transportation than they fortunate position of being accounting rules, which wanted pre-Covid. So the in today, somebody with a mandate that Ally has to worst case outcome is if the strong accounting estimate what it is going to customer stops paying, they background really sticks out. (Continued on page 19) Page 19 Bill Nygren, Harris Associates

I also think it's so important involve either food or wine for people who are going to and one of the reasons I be successful in this business want to keep working is to be passionate about it. If because I don't want to you’re passionate about have more free time to investing, you can’t turn it spend on my hobbies—it off. I can't go into a store wouldn't be healthy! I also without seeing how shelf love sports. Baseball is a space has changed between passion, and despite the different companies. My stock market being super reading list is almost always exciting today, this about things that I think will afternoon, I'm going to be at make me a better investor. a rooftop to watch the Cubs first playoff game. I get puzzled when I'm interviewing a candidate I am also involved in who claims to have that charitable activities. Rather level of passion about than mention any individual investing and you ask them names, I’ll just say that my what they're reading and passion is trying to give they say, "Oh, my reading disadvantaged kids the same time is pretty much educational opportunities consumed by school. I don't that I had. Most of my focus get much free time to read." is on inner city education. When I was in school, I was trying to get my hands on G&D: Thank you very every Wall Street research much for speaking with us. report I could. I was reading investment books that were not part of any course I was taking. That passion comes through in an interview and I think it's really important to be able to demonstrate it. It’s not something to fake because you're going to be miserable in this career if it's not an honest passion you're presenting.

G&D: How do you spend your time outside of work?

BN: I love wine. When I was younger, I had no interest in wine and couldn't understand people who did. Over a generation, it has become a passion. I joke that my hobbies basically Page 20

Hanesbrand (NYSE: HBI) - Long 2020 Women in Investing Stock Pitch Competition

April Yin Maria Van Heeckeren Joyce Zhang Sherry Zhang [email protected] [email protected] [email protected] [email protected]

Capitalization US$MM Financials (US$'M except per share) CY16 CY17 CY18 CY19 Share Price ($ / Share, 10/9/2020) 17.21 Revenue 6,028 6,471 6,804 6,967 FDSO (MM shares) 348 Gross Profit 2,315 2,544 2,692 2,778 April Yin ’22 Market Cap 5,992 Gross Margin 38.4% 39.3% 39.6% 39.9% April is a 1st year MBA student at Net Debt 3,451 EBITDA 1,005 1,030 1,056 1,065 CBS. Prior to CBS, she worked at EV 9,443 EBITDA Margin 16.7% 15.9% 15.5% 15.3% the IFC AMC in DC and Singa- Target Price ($ / Share) 25.70 EBIT 902 908 924 934 pore, investing across the capital Multiples (Consensus) (x) EBIT Margin 15.0% 14.0% 13.6% 13.4% structure in emerging markets. EV/'20E EBITDA 9.2 Net Income 528 82 546 609 April began her career in invest- P/E'20E P/E 11.7 FDSO (M) 385 369 365 366 ment banking at Scotiabank and ROIC'19A 11.7% EPS 1.37 0.22 1.50 1.67 Goldman Sachs. Recommendation: We recommend a long position in Hanesbrands, Inc. (“HBI” or “the Company”). HBI is a market leader in apparel, sportswear and underwear, and we believe HBI’s current valuation does not recog- nize: 1) the growth potential of its business in eCommerce, athleisure, and international markets; 2) the value creation from vertical integration within the supply chain; and 3) the expertise and experience of the new CEO. We believe HBI should yield a ~14% three-year IRR based on a $25.50 target price (based on SOTP valuation).

Business Description: Hanesbrands is a leading global apparel company based in the US. Founded in 1901 and employing ~68,000 employees in 43 countries, HBI designs, manufactures, and sells basic / intimate / ath- leisure apparel in the US and 30+ international markets. Unlike other apparel brands, HBI owns the majority Maria Van Heeckeren ’22 of its worldwide manufacturing facilities which produce 70% of the apparel units it sells. HBI has two key Maria is a 1st year MBA student at CBS. Prior to CBS, Maria brands: 1) Hanes – #1 selling apparel brand in the US found in 9 of 10 US households; 2) Champion – #4 rec- worked as an analyst in the ognized athleisure brand among Gen-Z/Millennials. HBI’s other brands include DIM, Maidenform, BALI, Play- leveraged loan group at Eaton tex, Just My Size, Bonds, Abanderado, Bras N Things, etc. HBI sells through two channels: 1) brick-and- Vance, focused on portfolio management, the healthcare mortar stores of 3rd party wholesale customers (76% of net sales in 2019); 2) direct-to-consumer, incl. its sector, and investing in CLO own offline stores and own & 3rd party e-commerce (24%). Its largest customers include Walmart (14% of net mezzanine tranches. sales in 2019) and Target (11%).

Investment Thesis: 1. The Street is underestimating Hanes’s growth potential from its eCommerce channel, Champion brand, and presence in international markets. We believe there is unrecognized growth potential in three key areas. First, we believe Hanesbrands will benefit from the shift in its sales distribution from brick-and- mortar to online retail. With a recent Amazon distribution partnership, as well as a revamp of Champi- on.com, Hanesbrands witnessed 12% growth in its direct-to-consumer channel prior to COVID-19 (2018 -2019) and 200% growth in sales volumes on Champion.com after the revamp in Q2 2020. Online sales now represent 30% of sales (as of Q2 2020), and HBI products are most frequently represented among “Bestsellers” on Amazon. As a majority of Gen-Z/Millennial shoppers prefer to purchase products online, Joyce Zhang ’22 we believe online retail will grow to be an increasingly large portion of the Company’s overall revenue, Joyce is a 1st year MBA student at thereby increasing growth of the overall business. However, we believe the Street still views CBS. She began her career with Bank of America Merrill Lynch in Hanesbrands as a traditional brick-and-mortar supplier, and as a result does not attribute credit to its their investment banking team eCommerce growth potential. Second, we believe the Champion brand is an undervalued asset with high covering healthcare in New York. growth potential within the overall Hanesbrands business. When surveyed, Gen-Z and Millennials indicat- She then worked at Martis Capi- tal, a healthcare-exclusive private ed high awareness of the Champion brand, and retailers have been increasing store shelf space to cater equity fund in DC. to the increased popularity of the Champion brand. For example, in May 2020 during Walmart’s reset of the branded underwear aisle, Hanesbrands’ share of shelf space grew double digits and took share from Fruit of the Loom. Historically, Champion has grown its global sales at a 3-year CAGR of ~30% from 2016-2019 – a trend we expect to continue going forward. Third, we believe the street is undervaluing the growth potential from Hanesbrands’ international markets. Although the international segment’s rev- enue has grown at a 5-year CAGR of 26%, consensus is only forecasting 4% growth for the segment from 2020-2022. However, Hanesbrands has strong brands across continents, with 19.5% market share as the #1 player in the Australian underwear market. Many of its markets are fragmented with high potential for market share expansion, and others, such as Mexico, are markets where a growing middle class is deliver- ing high single-digit market growth. Sherry Zhang ’22 Sherry is a 1st year MBA student 2. HBI’s large scale global operations and vertically integrated supply chain drive competitive advantage. HBI at CBS. Prior to CBS, she worked is differentiated from most other apparel companies as it owns its supply chain, which includes 40 manu- at Citi HK as a Research Senior Associate covering China finan- facturing facilities and 47 distribution sites worldwide. Its manufacturing facilities are strategically located cials companies and at LyGH in low-cost and tax-advantaged regions in Southeast Asia, Central America, and the Caribbean Basin and Capital, a SG-based L/S equity produce 70% of HBI products. Owning the supply chain results in 15-20% cost savings relative to relying hedge fund, as a Research Analyst. Page 21

Hanesbrand (NYSE: HBI) - Long | 2020 WIN Stock Pitch Competition

on 3rd party manufacturers and allows HBI to capture downstream profits. Its vertical integration also drives its ability to innovate new fabrics (X-Temp temperature control), styles (Tagless shirts), and techniques (reverse weave fleece). HBI’s large scale as the #9 apparel producer in the world gives the Company significant negotiating power with suppliers, as demonstrated by HBI’s ability to set the cost of cotton, its primary input. Cotton represented only 4% of the Company’s COGS in 2019. Owning the supply chain allows HBI to be opportunistic and flexible. During COVID-19, the Company was able to quickly pivot to produce masks and other PPE, generating $750mm+ revenue in 2Q20. The Company’s size and portfolio of valuable brands allow HBI to better negotiate with re- tailers such as Amazon, Wal-Mart, and Target. Recently, HBI ramped up its eCommerce presence through its own branded websites (Hanes.com, Champion.com) in response to consumer demand, capturing upstream profits. The DTC channel allows HBI to observe consumer demand and segment pricing, thereby offering more premium products on their own sites. 3. The new CEO has the necessary expertise and proper incentives to drive growth. Stephen Bratspies became CEO in August 2020, replacing Gerald Evans who became CEO in 2006 after serving as COO and starting with the Company in 1983. Bratspies was most recently Chief Merchandising Officer of Walmart, where he managed $330bn in sales, drove major merchandising transformation initiatives, and accelerated same-stores sales and market share gains. There, he oversaw the basics apparel strategy and overhauled grocery aisles to focus on improving the fresh offering and expanding private brand and global sourcing capabilities. We see this track record as a positive sign that Bratspies is able to proactively drive growth at HBI. We believe the market is underestimating the sig- nificance of Bratspies joining HBI for 3 reasons. First, his annual $9.5mm compensation ($2.75mm cash with $1.1mm base, $6.75mm equity) is higher than what Evans received ($9.0mm total - $2.75mm cash with $1.1mm base, $6.25mm equity), indicating the Board’s confidence in his abilities. His compensation structure incentivizes long-term sustainable growth as of the $9.5mm, $5.0mm is perfor- mance-based and $3.4mm is time-based vesting over 3 years. Second, we believe Bratspies has the skills needed to drive value-added initiatives, including optimizing SKUs, clarifying a good/better/best product architecture, and increasing sales to Walmart through a partnership to tackle the trend towards more premium underwear at a better price point. Third, given Bratspies’ information ad- vantage from his time at Walmart, we believe it is unlikely he would have transitioned to Hanesbrands had he believed HBI was not well-positioned to grow going forward.

Valuation: We derived a three-year $25.50 price target using SOTP valuation, implying a 14.2x NTM P/E and representing a 14% IRR.

SOTP Valuation 2023E EV/EBITDA Mkt Value Global Champion 467 15x 6,999 US non-Champion 416 5x 2,080 Intl non-Champion 251 5x 1,256 Total Enterprise Value 10,335 Net Debt 1,404 Equity Value 8,930 Upside Target Price 25.65 Current Price 17.21 3-year Total Return 49% IRR 14%

Key Risks and Mitigants: 1. Significant slowdown in revenue growth of Champion brand. The possibility that athleisure is a short-term trend and increased com- petition from private labels (ex: Amazon Basics) and online-only brands (ex: Rhone) pose risks to HBI’s business. However, we see the rise in athleisure as a structural shift as evidenced by the 30x increase in Google Search interest between 2010-20. We also note the slowdown in private label apparel sales growth between 2015-19, noting segment market share dropped from 5.1% (in North America) in 2015 to 4.9% in 2019. Brand continues to be a key factor in consumer purchasing behavior, as a former buyer for Ross acknowledged they did not pursue private label innerwear or activewear given consumer demand for a recognizable brand. Addition- ally, the broader macro shift to eCommerce is likely to be a tailwind to HBI and headwind to private labels, as a former Walmart Category Management Lead in eCommerce admitted “private label brands are a little funny – they perform very well in store, but hit or miss online.” Also, HBI’s collaborations with brands such as Supreme and Off-White produced valuable brand equity that is diffi- cult for newer private label or online-only brands to duplicate.

2. Accelerated closure of brick-and-mortar stores could reduce HBI’s revenues given 76% of its net sales are generated by 3rd party wholesale brick-and-mortar stores. However, we see HBI’s major wholesales customers, such as Walmart and Target (14% and 11% of 2019 revenue, respectively), as recession-resilient. Additionally, consumers have strong brand loyalty to Champion and will “actively seek out the brand” regardless of venue as demonstrated during 2Q20.

3. Surge in cotton prices may increase costs paid to yarn suppliers and decrease margins given HBI is unlikely to pass on cost increase to customers. However, cotton only accounted of 4% of HBI’s COGS in 2019. The Company also has the ability to periodically fix the price of cotton to reduce the impact from interim price fluctuations. Page 22

The TJX Companies, Inc. (NYSE: TJX) - Long 2020 Women in Investing Pitch

Cathy Yao, CFA Flora Chai Joanna Zhou Wenbo Zhao [email protected] HChai22gsb.columbia.edu [email protected] [email protected]

Recommendation TJX is a leading off-price retailer in US and international markets. We would like to Cathy Yao ’22 recommend a LONG with a 3-year target Cathy is a 1st year MBA student at CBS. Prior to CBS, she price at $93.98, representing an IRR of 16%. worked as an M&A banker at UBS Securities, and later as a Business Description strategic investor at KE Hold- ings, Inc. (NYSE: BEKE) TJX is the biggest off-price apparel and home fashions retailer in the States with over 4,500 retail locations across 9 countries on 3 continents. TJX generates nearly $42 bil- lion in revenues and $4.1 billion of cash from operations in 2019. TJX ranks No.85 in the 2019 Fortune 500 listings. Investment Thesis 1. Resilient and flexible business model with precise value proposition, world- Flora Chai ’22 class buying organization, efficient sup- Flora is a 1st year MBA student ply chain and distribution network at CBS. She started her career with Goldman Sachs IBD in 1.1 Precise Value Proposition Financial Institutions Group, and later joined Merrill Lynch Equity • Despite prices generally 20-60% below dept stores, TJX offers value instead of simply cheapness to its Research covering Greater customers. It targets 25~54 year old, middle to upper-middle income female who are fashion and value China Bank and Fintech sectors. conscious. Around 28% of TJX’s customers belong to a household income group of above $100,000. • Treasure hunting shopping experience greatly increases turnover and the frequency of customer visits. • TJX is also popular among younger generations as evidenced by rising percentage of Millennials and Z- Generation among customers. 1.2 World-class buying organization • Actively opportunistic buying: over 1,100 buyers actively buying from 21,000+ suppliers across 100 coun- tries; TJX has buying offices in 12 countries and 4 continents. • TJX University: Advanced learning opportunities for merchandising Associates through specialized train- ing, a year-long one-on-one coaching program, and store exercises; Both TJX’s former CEO and current CEO were once buyers at the company. Joanna Zhou ’22 • Direct purchase from manufacturers, supplemented by distributors and private label. Joanna is a 1st year MBA student at CBS. Prior to CBS, she • Buyout purchasing and no request of subsidy from suppliers nurtures good long-term relationships with worked at Fosun Pharma focus- suppliers. ing on healthcare investment in private market. She also worked 1.3 Efficient Supply Chain and Distribution network at Deep Snow Capital (financial • Digital inventory management system: Inventory management system dynamically manages the process of advisory) and Zhong Shan product purchase-store distribution-price adjustment-sales. Securities (IBD). • Well-established warehousing and logistics infrastructure lay the foundation for quick turnover:28 self- owned and leased distribution centers, covering an area of more than 1.6 million square meters; Total investment of US $234.22 billion in warehousing and logistics from 2015 to 2018. • TJX transfers goods from store to store much more frequently than traditional department stores: its “Single-piece purchase" inventory strategy promotes the mentality of FOMO in costumers and push them to make the purchase. 2. Best positioned to capture counter-cyclical opportunities for long-term growth • Off-price tailwind has been accelerated by retail apocalypse during Covid-19. More than 15,000 stores in US are projected to shut down in 2020, with 8,000+ closures announced by far and department stores Wenbo Zhao ’22 suffer from sales plunge (19% Y/Y in the first 8 months of 2020). We believe TJX will be one of the few Wenbo is a 1st year MBA winners during the pandemic with favorable changes on both supply and demand sides. We expect TJX to student at CBS. Prior to CBS, gain share from closing stores. Compared to its peers, TJX’s customers skew towards higher income she worked at China Interna- demographics who shop from department & specialty stores to mass merchants, and their pent-up de- tional Capital Corporation (CICC) in Beijing, providing mand can partially pivot to TJX, especially in the case of a prolonged recession after pandemic. investment banking services for • Our analysis on TJX’s historical performance also shows that, a high and sometimes lagged growth in financial sponsors. Page 23

The TJX Companies, Inc. (TSX: TJX) - Long (continued from previous page)

• We believe TJX has more penetration opportunities in the US especially in states like California, Texas and Florida, where the off- price store coverage is less saturated, and TJX has less store presence compared to its strong Northeastern position. TJX has a solid store pipeline at hand of ~120 signed leases this year, and they are delayed to open next year. We believe when consumption recov- ers, we will see more store expansion. Moreover, TJX can seize better locations from exiting retailers, i.e. opening a HomeGoods in 2021 at a former Bed Bath and Beyond at Stafford Marketplace. • Other short-term opportunities that help start the engine for TJX’s long-term expansion include (i) faster-than-peer recovery with a widely distributed network and thus less exposure to heavily affected states; (ii) negotiation for rent adjustment and payment defer- rals with increasing bargaining power, with estimated 400 stores require rent renewal in 2020/2021; (iii) strong cash position and cash generation capability (~$4B annual FCF in FY22/FY23 by our model). 3. Opportunities to gain share in merchandise supply and build vendor relationship due to regular-price weakness • TJX has the largest buyer network and vendor relationship in the industry and manages inventory with the highest efficiency.  TJX: 1,100 buyers with 21,000 vendors; ROST: 900 buyers with 7,500 vendors • Short-term: TJX is able to grab the excess inventory caused by COVID-19 shut-down in the marketplace, purchasing higher quality brands and merchandise at a lower cost, some of which can even be sold next year at a significantly higher mark-up as packaways. Given its leading position with 4,529 stores worldwide, TJX is the go-to off-pricer for closing stores like Macys’, JCPenny, Pier 1 and Ascena Group. • Long-term: Due to ongoing uncertainty, more and more brands consider off-price as a great channel to quickly get rid of inventory, which is an opportunity for TJX to bring in new brands and build on-going partnership. Meanwhile, apart from specialty and depart- ment brands, TJX also sources manufacturers to produce private label products to fill in a great portion of its assortment. Hit by pandemic, manufactories have production down nearly 50% (apparel) and are desperate for new orders. As the savior to keep the factories running, TJX is able to negotiate better terms and explore new ways of cooperation.  Some brands (e.g. Calvin Klein) will license out the brand to retailors, including off-price. There is some differentiation in the product in texture, craft, etc. They are flexible to work with the off-price to produce at the price point needed. 4. Underpenetrated international market remains a strong growth engine • As the only major brick-and-mortar off-price retailer in Canada, Europe and Australia with no other scaled competitors, TJX takes the leading position to establish the unique off-price model. TJX has an unparalleled market share of 86.3%, 84.5% and 90.5% in East- ern Europe, Western Europe and Canada respectively. • International markets have significant lower off-price penetration rate compared to US, while customers respond to off-price experi- ences “not dissimilar from US”. The brand-dominated retail industry in Europe does require TJX to be intelligent on its opportunistic buying strategy, but COVID-related disruption gives TJX a great breakthrough opportunity. Valuation Analysis With 6%-7% revenue growth and slight margin expansion, we derived a 3-yr $93.98 price target using DCF, P/E multiple and EV/EBIT mul- tiple (implies 21x NTM P/E or 13x NTM EV/EBITDA). We differ from the market on: 1) TJX will soon recover the speed of opening new stores in 2021-2023 to quickly obtain market share from regular retailers. 2) TJX will lock-in long-term lease by leveraging low rent during COVID-19, which will enhance margin by 50-70bp. 3) TJX has raised abundant low-cost debt during COVID-19 to fuel its growth.

Risks and Mitigants • Store opening slower than expected: TJX management has a solid plan for store opening and abundant liquidity on hand. • Store traffic decrease as customers don’t feel comfortable to visit stores and do more online shopping: TJX stores are usually in stripe centers instead of a large shopping mall, which make people feel safer to go. The offline treasure hunting experience cannot be fully replicated online. E-commerce severs more like a supplement to connect customers to physical stores. • Trade dispute and rising tariff: TJX has a balanced mix of close-out purchases which are already in the market and private label production. Its global buyer and vendor network also make it resilient to potential trade disputes between US and other countries. • Lack of inventory depth as COVID created some supply chain/logistics challenges, coupled with retailers over- correcting to get inventory clean as stores re-opened: This can be a relatively near-term challenge as buyers has begun to buy more aggressively and DCs get up to speed. In the longer-term post pandemic, retailer demand and supply will revert to pre- pandemic levels. As TJX’s newly invested DCs come into operation, TJX will have more flexibility in inventory management. Page 24

Farfetch (NYSE: FTCH) - LONG

Dickson Pau — [email protected]

Dickson Pau ’22 Dickson is a 1st year MBA student at CBS. He started his Executive Summary: Farfetch is by far the largest luxury goods online marketplace worldwide. It aggregates career with Deutsche Bank in demand and offers a centralized high-end shopping experience to customers. I believe Farfetch is undervalued their Asset and Wealth Manage- as the market (1) underappreciates its economic moats, (2) overreacted to Amazon’s recent entry ment department as a graduate analyst in Hong Kong. He then to the luxury goods market, and (3) underestimates Farfetch’s growth potential. Through my re- worked at Ascender Capital, a search, I arrived at a 3-year target of $40, representing 48% upside and an IRR of 14%. long-biased investment firm. As a generalist, Dickson covered Asian small and mid caps. Company Overview: Founded in 2008, Farfetch carries products from more than 3,500 brands on its plat- form. The number of SKUs on Farfetch is seven times greater than the closest competitor’s. The inventories are sourced from more than 1,300 luxury sellers, including 900 luxury boutiques and 400 direct brand part- nerships. At any time, customers can access more than $5 billion worth of sellers’ stocks on Farfetch. This large inventory base currently attracts 2.5 million active customers. The customer base is diverse, with the gender split well-balanced at 60% female and 40% male. More than 50% of them are Millennials, and on aver- age, they spend $1,000 on Farfetch annually. As a platform, Farfetch charges an average take rate of 30%.

Investment Thesis: #1 – Farfetch Already Has Highly Defensible Moats Even though the business is subscale in terms of profitability, Farfetch is already leaps and bounds above most other competitors (other than NYAP, which Farfetch is catching up to). As explained in the first point below, the structure and characteristics of the luxury goods industry is not conducive for new entrants . As the in- dustry moves online, I believe the advantages of the biggest players will further improve. As the emerging ag- gregator of demand for personal luxury goods, Farfetch is showing its strength during COVID-19 since it is on track to grow its digital platform GMV by more than 20% while the industry is projected to decline by 25- 45%. The appeal of the platform is clearly reflected by the 500,000 new customers acquired in Q2 2020 alone.

I. It is difficult for a new entrant to replicate the marketplace model of Farfetch, especially not on the same global scale. Building a marketplace entails solving the classic chicken and egg problem. But unlike car sharing or other “commodity-like” marketplaces, you cannot simply throw money at this problem. The luxury brands are highly focused on brand perception on a relevant platform and cautious with distribu- tor selection. It takes time to build trusting relationships with them to access inventories, and it is not possible to subsidize the customers as brands retain pricing control and are strongly against unnecessary discounts. The relationships are also sticky on the boutique side, as 80% of the boutiques sign exclusive contracts with Farfetch. Even though these are one-year contracts, the renewal rate is very high given that there is no better alternative platform that offers the same scale of client outreach globally. The more realistic means to compete in this industry is to become a direct seller. But this either requires too much time to build relationships with brands or takes too much capital to have a competitive offering. It is thus very challenging for direct sellers to compete with Farfetch on product breadth and depth. II. Competition from existing players, for instance department stores which are now pivoting toward online more aggressively, is the bigger threat. Yet, they are also not in a good position to compete against Farfetch. The supply chain of running an e-commerce site is very different from that of the physical retail business. Furthermore, not only is the core business of luxury department stores on the decline, they also tend to be heavily indebted (some, such as Lord & Taylor and Neiman Marcus, even went bankrupt recently), both of which reduce the flexibility they have for investments into online capabilities. Those that are surviving, for instance Harrods, chose to work with Farfetch instead. Harrods is now a main client of Farfetch Black and White, utilizing the technology infrastructure that powers the Farfetch Mar- ketplace to revamp its own ecommerce site. III. More brands could go direct. The biggest luxury conglomerates are investing in their own online capabili- ties, but other than Richemont, which owns YNAP, key players like LVMH and Kering have yet to achieve a scaled-up e-commerce offering. LVMH launched its multi-brand e-commerce site 24S in 2017 and has yet to achieve any meaningful scale. But for most brands without resources, even for Chanel, it is simply easier and cheaper to use Farfetch’s Black and White solutions to operate their own online channel.

Page 25

Farfetch (NYSE: FTCH) - LONG

#2 – The Market Overreacted to the Entry of Amazon in the Luxury Goods Industry In late August 2020, it was leaked that, after several failed attempts, Amazon was again expanding into luxury goods retail. As a result, the share price of Farfetch once declined by nearly 25%. On Sep 15, Amazon officially launched its Luxury Store platform. But to create the feeling of exclusivity, it is now only open to invited customers. In the previous few attempts, Amazon was either more focused on flash sales or gave no control to the sellers on how their digital store fronts are designed. This time, Amazon is taking the Farfetch approach, acting only as a marketplace and allowing brands to design their own digital store fronts. The market clearly is worried that Amazon will finally be able to enter the luxury goods market successfully. I believe the market is overreacting for the following reasons: (1) Despite the dire state of physical retail and a delayed of launch, only 12 brands have agreed to be on the platform and only one at the start, implying most brands remain cautious about selling on Amazon. (2) My conversation with a small luxury brand suggests it remains worried about the clientele on the Amazon platform and the risk of Amazon copying its designs. If a small brand, which has limited visibility, is not willing to take the risk, it is difficult to believe the big brands would consider doing so any time soon. (3) Furthermore, the market is growing rapidly, there is enough room for multiple players. Amazon’s penetration in this market may help grow the pie faster. And (4), more importantly, if Amazon succeeds, I do not believe it will be termi- nal for Farfetch. The impact will be felt on lowering take rates. #3 – Long-term Growth Potential Exceeds Market Expectation The long-term potential of market share is higher than analysts are currently expecting. For instance, GS is projecting an GMV target of $24 billion by 2030, for a CAGR of 25% in the next 10 years. This projection may seem aggressive. But they then put on a perpetual growth rate of 4.5% p.a. afterwards, which effectively assumes minimal market share gains by Farfetch. I think this misses the possibility that Farfetch can potentially grow to become more dominant than any department store chain ever did. Macy’s, the biggest US luxury department store, earned $28 billion in revenue in 2015, the highest in its history. In that same year, global luxury goods market was $289 billion. Assuming 70% of Macy’s revenues come from apparel and accessories, Macy’s had around 7% of the global market, even though it only sells in the US. Farfetch, in contrast, is a global business, with global reach and an unlimited store front. There is no reason why Farfetch cannot grow to become bigger than Macy’s ever was. The digital savvy customers Millennials and Genera- tion Z is expected to become 60% of the luxury goods customer base by 2025, up from the current 39%. In ten years, the global personal luxury goods market is expected to grow to around $450 billion. A 7% market share will result in a GMV of $31.5 billion, which is 31% higher than Goldman’s estimation. The global market share of Farfetch is now around 1%. It is more conservative to assume that it will take more than 10 years to reach a global market share of 7%. If we take the analysts’ estimation from above, then by 2030, the global market share of Farfetch will only be 5.3%. As Farfetch continues to grow faster than the industry, there should be another leg of growth before the perpetual growth rate kicks in.

Key Risks and Assessments: #1 Sustainability of Take Rate Farfetch’s take rate is a major concern to short sellers, as 30% is a much higher take rate than what most other platforms charge (usually 5 -20%). I believe the take rate is reasonable and sustainable for the following reasons: 1) Luxury fashion is a high margin, slow moving prod- uct category. Comparing take rates across product categories is not the correct analysis. Despite a 30% cut, retailers and brands can still make 10% to 20%+ margin. The ability to increase product turnover at lower marketing costs makes it worth selling on Farfetch; 2) The wholesale channel takes a 50-65% cut of the final retail price. Shifting products from wholesale to Farfetch allows most brands to capture a lot more profits. To be conservative, in my base case, I assumed the take rate to decline to 27%. #2 China Risk Chinese consumers make up 35% of the global luxury goods market and contributed to over 90% of the growth in 2019. A major slow- down in the Chinese economy will meaningfully drag down the industry growth. However, a recession in China should reduce outbound travel, which in turn should provide customers additional incentives to purchase luxury goods online. Just as Farfetch has been a significant beneficiary of COVID, Farfetch should then again offer a cost-effective alternative to Chinese customers for buying authentic luxury goods.

Valuation: I derive my base case valuation by looking ten years out. I am expecting the active customer base to reach 14.3 million by 2030, for a CAGR of 20%. With minimal expansion in average order value and a decline of take rate to 27%, I expect Farfetch can gen- erate close to $10 billion in reported revenue, including fulfill- ment. With an estimated operating margin of 11%, the company would be generating $1 billion in EBIT by 2030. Farfetch has no direct comparable. Historically, it has traded from 3-8x EV/ Revenue. With growth slowing down, a conservative and reasona- ble multiple would be around 2.5x, resulting in an EV of $25 billion by 2030. Assuming 2.5% annual share dilution and a discount rate of 9%, I estimated my 3-year target price at $40, representing a 48% upside and a 3-year IRR of 14%. Page 26 Ray Kennedy, Hotchkis & Wiley

obligations. Mr. Kennedy was and that was the early We did a private placement formerly associated with the stages of the Nasdaq, so this for a small firm in Newport Prudential Insurance Company of America as a was kind of a big event. Beach called PIMCO in private placement asset Naturally, I became heavily 1994, when the firm was manager where he was involved in how trading still very much under the responsible for investing and works, how you build a radar and had around $40 managing a portfolio of position and clear a position billion in assets and $500 investment grade and high Ray Kennedy, yield privately placed fixed by the end of the day, and million in high yield. I joined income securities. Prior to that was kind of my first PIMCO’s high yield group in CFA that, he was a consultant for insight about the financial 1995 and took over the Hotchkis & Wiley Andersen Consulting (now global high yield business in Accenture) in Los Angeles markets. 2001. By the time I left in and London. Mr. Kennedy, a CFA charterholder, received 2007, PIMCO was $800 his BS from Stanford I enjoyed that project and billion in size, $60 billion of understanding how markets University and MBA from the which was in high yield. Anderson School of work, so I said, "This is Management at the really fun. Let's go and get University of California, Los an MBA." So, I went to It was a rush being at the Angeles. UCLA and got my MBA. firm during that 12-year

Editor’s Note: This interview During this time the LBO period because we were took place on September 23rd, market was very hot, and making markets and making 2020. the money was with the new products left and right. insurance companies – the We were one of the first to Graham & Doddsville first investor of KKR was do CLOs and CDSs. We (G&D): Hi Ray, thank you actually Prudential, where I were doing synthetic for taking the time to chat worked for a summer. At products because we always with us today. Can you start Prudential, we were among had an incredible need to by telling us about your the first to buy the entire invest the dollars. I always background and how you tranche of an LBO, the described it to people as got into investing? debt, equity and even bank drinking out of fire hoses debt, so I was interacting every morning: you'd sit at Ray Kennedy (RK): I with Drexel and KKR on a your desk until 4:00 or 5:00 came from a pretty different daily basis and investing and you'd realize you just direction than most people. heavily in very leveraged had more hours to work, so I graduated from Stanford situations. most of us came in on with a degree in industrial weekends. But the firm was

engineering in '83 and spent growing so that was the three years doing After UCLA I returned to focus. By now there aren’t operations and actuarial Prudential full time in 1988 many of my generation left programming for Andersen doing private placements in at PIMCO. Most retired, Consulting (now the mezzanine space. Then some started their own Accenture). My second the LBO market blew up in businesses, and I retired for assignment was in London the late 1980s; Drexel went a few years before joining working for the London under, and the insurance Hotchkis. The CEO of Stock Exchange on a project market for investing in the Hotchkis and I were called Big Bang, which was space changed materially. I freshman roommates, and a to design and automate the spent the next four to five lot of my college friends exchange’s equity trading years doing debt and equity from Stanford are at the system. At that time, in investing, but more on a firm. It’s slower paced here, 1986, there was only one private basis. (Continued on page 27) automated trading system Page 27 Ray Kennedy, Hotchkis & Wiley

but we decide what level of G&D: You mentioned that growth, what businesses, PIMCO thought about and what product lines we “In high yield, we view macro as the guardrails of investing. Is that a want. macro as the guardrails framework that you still use

G&D: You spent a big part for investing.” in your day-to-day at of your career at PIMCO, Hotchkis? which is a trading-oriented, top-down focused firm, and One of the strategies the RK: In high yield we say now you are with Hotchkis, firm employed was to buy that you can always buy a which is a traditional off-the-run securities and good bond in a bad bottom-up type of fund. price them to be on the run company or a bad How does trading and to get instant alpha, because management team, or you macro fit into your that's how inefficient the can buy a bad bond in a investment philosophy market was at that time. good company. Getting the today? The other part was also credit right is your number born out of necessity in one source of return, RK: In high yield, we view dealing with the sheer industry sector is the macro as the guardrails for volume of cash movement second, and duration the investing. We wouldn't throughout the day. You third. You can get burned necessarily avoid situations never trade in high yield to on duration, though, as we because we had a negative pick up a few basis points. A have in the last 18 months macro view on a sector, we bid-offer spread is anywhere because we were positioned would just need to be more from 15 to 50 basis points. more for a standard secured or more senior on On a good day, you may get economic growth cycle that an eighth. On a really good the capital structure. sees upward pressure and day, you may get a rates. sixteenth. Contrast that When I was at PIMCO, high with treasuries, where your yield was largely founded by trading positions are 1/64th “You can always buy a value equity managers. The bid-offer spread, and it's guy I worked with, Ben sometimes even 1/28th. good bond in a bad Trosky, was a value equity manager from Merrill, so company or a bad At Hotchkis, however, we the roots of the High Yield management team, or group was driven by view trading as a cost. Low fundamentals. It evolved interest rate environments you can buy a bad bond over time as the asset class often lead to portfolios in a good company.” became more being called as companies commoditized, which is why refinance at aggressive rates. trading has become such an This year alone we probably important part of high yield lost, on average, a third of So that's our framework: and bonds, but we did our names this way. We get the credit right, get the marry the two a bit at then have to play the new sector partially right, at least PIMCO. We were always issue market as our source be aware of what you're given the leeway to focus of ideas. So, coming back to buying into, and the last on research first, but as a Hotchkis has brought me thing is duration. Embedded firm, Bill’s strategy was to back to my roots of in all that is making sure trade around the curve and fundamental research. your structure is correct. interest rates. (Continued on page 28) Page 28 Ray Kennedy, Hotchkis & Wiley

But like I said, you can buy a At Hotchkis we take the Then the second thing is good idea in a bad sector approach of looking at the what we call a business test, and still make money. business, because history which is “do they have a has taught me that a bad reason to exist”? Generally

G&D: Could you elaborate business model will likely be speaking, high yield on the process of getting your killer. The first thing I companies are likely to run the credit right? What's do when evaluating an issue into problems. You're your framework around is to look at the balance dealing in a space where on sheet. If I can understand average 30% of the that? how things move around companies are in secular the balance sheet, I decline. They wouldn't be RK: I’ll share a few different understand the income and junk if they weren’t. We approaches for perspective. I understand the cash flows. used to come across paper At Prudential, we took a If I see receivables go up but companies all the time in structured approach, and no earnings, I know this is high yield. Most of them that's where my grounding not a cash business. have filed bankruptcy by was. We had a statistical now because there's just no framework similar to reason for small paper Moody's, where we bias “At Hotchkis we take plants to exist. Eventually credit ratios based on size the business hits the wall because there are axioms the approach of looking and your recovery is like, "Smaller companies at the business, because literally zero. So you don't have a higher probability of get A+ businesses, and you default and lower recover history has taught me don’t get A+ management rates because they have less teams, but you do try to that a bad business financial flexibility.” Smaller find little gems and little companies can't grab capital model will likely be ideas out there. the way large companies

can, and they have less your killer.” ability to dispose of The third thing is looking at something. That's why it's the history of management The best example is film and the incentives of hard to kill GE. If GE were a accounting. If you look at small company, it'd probably management, because nine the numbers, you would times out of ten, most of be dead by now. But GE, as invest in film and TV a large company, can pull the problems we run into in syndication all day long credit are bad management different levers to keep because they generate bailing themselves out and decisions or bad enormous earnings, but in management teams. In high buying time. reality they are just building yield, there's a cohort of huge assets on the balance management teams that just We also had a matrix we sheet and spending a ton of moves around because, used to determine the cash. For example, Netflix is again, you're not getting implied risk of a specific a horrible credit idea. It's class A management teams rating and whether you're not going to default, but it in this space. So, we really being priced rich or cheap generates basically no cash do focus on incentives of relative to that. So, the because it's constantly management, their statistical approach is one building a stream of shows knowledge base and their way to do it. It works up to and movies that are earned tenacity to work through a point and works better over time. problems, because you're

for investment grade issues. (Continued on page 29) Page 29 Ray Kennedy, Hotchkis & Wiley

dealing with leveraged we're buying credit, so Communications, situations. swinging for the fence at 50 Consolidated cents on the dollar means Communications – they've

my potential return is 2x, all restructured their If you've noticed, I haven't whereas buying an equity at balance sheet. There are mentioned anything about $3, your upside is infinite. also parts of the paper credit stats. I haven't It's a very different return industry that still exist. For mentioned anything about profile. So, trying to find example, a printing pricing, because I'll overpay those companies that have company, LSC for a good credit all day survivability is probably one Communications, filed for long, and there are yields at of the most important bankruptcy. People don't which I just won't buy a bad things you can do. buy books as much credit. In credit, there isn’t anymore, and textbooks always a price at which you especially. can buy something because “One of the great

buying Chesapeake bonds at things about today’s Obviously, you know the 30 cents on the dollar story on retail. Big mall seemed great; well, now environment, which is retail has been in decline for they're worth 5 cents. The unfortunately tied to a a while due to different fact of the matter is you shopping behaviors. You can have to think about the pandemic, is that it blame some on Amazon, asymmetric return profile of but at the end of the day, bonds and credit in general, flushes out the weak they just don't have a which is if things go well, companies. Clearly, reason to exist anymore, maybe on a good day, you'll and COVID has pushed get a 120 or 130. If things we've had a lot of the them to the edge. One of go bad, you're at zero, and the great things about statistically, your historical apparel companies today’s environment, which recovery rate in credit is going or gone under, is unfortunately tied to a about 30, 35 cents on the pandemic, is that it flushes dollar. but one thing that still out the weak companies. Clearly, we've had a lot of has value is brand.” So, buying bonds at 60 cents the apparel companies going or gone under, but one on the dollar on average is a great trade because you're G&D: Are there any thing that still has value is starting from a fairer specific sectors or brand. Take Boardriders, position at 30 points down, industries you view as which is the parent maybe 60 points up. At the difficult businesses to be in company of Quiksilver, they end of the day, one of the over the next five to ten make t-shirts that are screen printed and charge things we do when we're years? $30 for something they looking at this is a Porter analysis: Where are they on RK: Yeah, so we can talk make for $3. So, that's the the cost curve? Do they about current ones and value of the brand. have some sort of then emerging ones. technology that makes them The current ones are things An emerging one we all talk unique? Do they have telecom related, wireline. about is autos. If you customers that make them Just about all of them have compare the auto world unique? Because these are filed bankruptcy now; today against 20 years from the things that will keep the Frontier Communications, now, it's going to be company going. And again, Windstream fundamentally different. (Continued on page 30) Page 30 Ray Kennedy, Hotchkis & Wiley

California announced today completely, or could there because otherwise I'm that no combustion engine be potential opportunities? walking away from 30% of cars can be sold in Or do you think that with the market, and that's just California in 15 years. the secularly challenged not feasible when you're Sounds great on paper, but industries, it's better to just trying to run a high yield it’s going to be very difficult stay away completely? portfolio. to implement. So, you have

to ask yourself who is able RK: It depends. For G&D: How do you think to adapt to that. example, when you look at about these more recent

telecom, wireline is easy to bankruptcies in retail? Is The last one I would add is say no to. I'm sure none of energy. The high yield there anything there that you have a wireline. The you believe is still worth market overinvested in the only people I know with looking into? energy sector and wirelines are my parents. So effectively sparked the Shale that's easy to stay away Revolution. When you look from. That being said, we RK: It has evolved a lot around at the energy sector do have one investment in a because COVID has today, the amount of company called Unity, which changed the parameters. carnage is stunning. owns fiber to the home that First of all, established Chesapeake was a junk they lease to Windstream. brands do seem to have issuer, and so is Aubrey more value. For example,

McClendon, the pioneer in Forever 21 is a retailer that horizontal wells and In the energy space, we has some of its own brands, fracking, who literally own a company called Nine but those are fickle brands. founded the modern-day Energy, which specializes in Limited Brands, on the shale revolution. 20 making disposable plugs that other hand, has Bath & companies filed bankruptcy are used in horizontal Body Works. That part of recently, and we're working drilling, though that one the business is in good on three of them. scares us a bit because if shape. The Victoria's Secret Biden wins, you have to brand also still has value, Between climate change and assume that fracking on but they missed the the shift to renewables, federal lands will be changing tastes in some of we've seen a significant shift challenging. their key product lines. in gas demand around the You'd have to think that if US that indicates we may There are certain apparels they repositioned with the have too many pipelines. right products, they California is now up to 35% that we think are valuable as well, like Quiksilver, which probably could revise that renewables in the form of brand, because it's a good solar, wind, and geothermal. we talked about before. brand name that people like. As a result, all the gas With autos, we own Allison pipelines that were pointed Transmission that toward California are seeing specializes in making not But let's talk about retail excess capacity. So, long- only the standard more broadly. We bought winded answer, but those transmissions used in the first lien bonds for J. C. are the ones that I'd put out combustion engines, but Penney. You’re probably there. also the electronics. thinking, "Are you kidding? Who goes to a J. C. G&D: For the industries So the answer is, again, it Penney?" Well, if you go out you mentioned, would you depends. You try to find the in the Midwest, people shop stay away from them ones that can survive at J. C. Penney. With Sears (Continued on page 31) Page 31 Ray Kennedy, Hotchkis & Wiley

and Kmart out of business, seem to have a reason to incorporate that into they were the last survivor, come back, and they fundamental investing? and the company seemed to probably will with a less have had a chance of making levered balance sheet, RK: The tension between it. In addition, they owned a especially if they can pull off credit and equity is about lot of their properties and the online. path. Equity investors often just the dirt alone would be make assumptions like, "Oh, incredibly valuable. “Right now, the going they can get liquidity. Oh, the banks will roll. Oh,

consensus is to take the there's no shift in quarterly It all seemed good on paper cash flows that will and seemed like the business, split it into potentially starve a investment was working. two, keep the company." In credit we The bonds were in the 80s, think about whether they and we were almost rooting operations alive when will trip a covenant or be up for them to go bankrupt against their bank capacity, because we could just take they have a reason to which means the trade the leases and the could pull their lines. underlying land, and flip it to continue to exist, and

another person. COVID sell off the dead stuff.” So, the path for credit changed the situation investors can be incredibly dramatically because now The sad one to watch is important. Take energy for there is no one to replicate example – we can make the space. Those first lien Nordstrom. Nordstrom has done a great job of very probably correct bonds are now in the 30s, assumptions about the value maybe moving toward the executing both its physical and online presence in an of the resource, but if you teens. It now looks like the can't get there, it doesn't company might be split into Amazon world, but COVID changed the dynamics for matter what the value is. two: the operations will be We had a company that was acquired by mall operators them and they're now a junk issuer. I think they can involved in building a plant, who want to resuscitate the but they just kept running corpse for rent, and the avoid a restructuring, but they need the market to out of cash. With unlimited properties will be turned cash access, they obviously into dark store liquidation. come back to make it happen. The landscape has would have finished the

evolved in terms of how we plant and never would have So, a creative solution to look at retail due to had to file bankruptcy, but dealing with a dead retailer. COVID. Right now, the they ran out of cash, and On the other hand, we have going consensus is to take that is what brings Neiman Marcus, which has a the business, split it into companies to bankruptcy at good brand and good two, keep the operations the end of the day. clientele, but the company alive when they have a was starved of capital reason to continue to exist, But again, remember that in because it was too over- credit, at best I can get 2x and sell off the dead stuff. levered. But if you go into my investment, maybe 3x. their stores, especially in a But in equity, you can get world where there's a lot of G&D: You have said before unlimited. So, equity global travel, they're packed, that the path it takes to get investors are more likely to and people will pay an to a destination matters. make a bunch of these bets, enormous amount for their Could you elaborate on that a few of them flop, but the products. As a result, they in terms of why it is third can be a home run. important and how you (Continued on page 32) Page 32 Ray Kennedy, Hotchkis & Wiley

Credit, you can't do that. If to survive, which means that’s frustrating because you have three bad trades, their equity would survive. you want to do things you're pretty much done. Let's face it, if Carnival fundamentally based, but Cruise couldn't have gotten you can't because you have G&D: With path being the billions that they did, this third party that can something that matters, the equity would be in fundamentally change things. how do you navigate the Chapter 11. Take that Let's say you want to short market in the next 6 to 12 across the entire travel and high yield at current levels. months? leisure sector and the That's a dangerous trade equity market would be at a when you've got someone RK: much lower level than it is with a big balance sheet and It's a great question because today. the willingness to buy we're thinking that through the end of the year. ourselves. Base case is that “But again, remember things start going back to that in credit, at best I So, in essence, you can't normal in first half of 2021. short the market, given that But the base case was also can get 2x my dynamic, and the Fed knows that we’d be back to normal that. But you don't by mid-July of this year. The investment, maybe 3x. necessarily want to be way we've decided to think But in equity, you can aggressive either because about this is to still stay it's a buyer that you don't somewhat conservative and get unlimited. So, know much about and acts senior in capital structures. equity investors are a bit irrationally. No one in If you think COVID is going this current environment is away in the next three more likely to make a comfortable investing, months, you should buy especially on the credit side. unsecured airline paper, bunch of these bets, a We hate it, but we have to Carnival Cruise unsecured few of them flop, but play along. bonds, and the worst part

of the capital structure in the third can be a home the travel and leisure space. There were two axioms I'm not ready to do that. run. Credit, you can't that we stood by at PIMCO. One, don't fight the Fed. We'd rather buy a piece of do that. If you have paper secured by airplanes, Paul McCulley used to say, by routes, by cruise ships, three bad trades, you're “If that’s where the Fed's because there're just too going, you’ve got to be pretty much done.” many things that can come there." The second one is along and make things that technicals become A lot of companies have not fundamentals. This ability to difficult. recovered to pre-COVID raise cash in a very difficult levels, but the Fed has put a environment is The one thing that's made it floor on credit. They did it fundamentally saving these extremely difficult is the both directly through buying companies. Using Carnival Fed. If the Fed hadn't bonds that were Cruise as an example again, stepped in the way they did, downgraded after March I had no idea how expensive neither the high yield nor and indirectly through it is to dock a cruise ship. equity market would not be purchases of ETFs. So, I You don’t just tie it up, turn at the levels we're at today. guess we have to take our off the engine and say, "I'm A company’s ability to get hands off the wheel a bit coming back in six months." cash determines its ability and just ride along, and You have to constantly flush (Continued on page 33) Page 33 Ray Kennedy, Hotchkis & Wiley

it. You have to have crew of and provide a great buying because they weren't ETF 50, 60 people go out at the opportunity for high yield. eligible. This caused some port every day, turn around, Once the Fed came around, strange behavior and I'm come back in, or else one however, those spreads sure the Fed will just say, side can basically get ballast collapsed and now we're at "That's just collateral issues. But a technical bid by 500 off. As investors now, damage in the process. We the Fed caused the new every time you see a sell-off will be out of the market issuing market to be that's event-driven, whether soon and you guys can act supportive, which caused it's the 2008 banking crisis like a normal rationing risk the companies to get cash, or this pandemic, you're market then", but it will which caused them to going to buy the asset class never be the same. even though fundamentally fundamentally survive. the spread should widen. G&D: Does that mean that G&D: With the Fed the Fed can push up stepping up in the risk “The Fed’s ETF program security prices forever, and spectrum and doing things prices will just never go they have never done also doesn’t seem well- down? What are the before, what does that implications from a moral thought-out to me. mean for the market and hazards standpoint? what are the longer-term Instead of buying a slice implications? of everything to show RK: That's the implication. Thank God they didn't buy RK: Well, once you do it, no favoritism, they are equities, but we think that's people will always know buying winners and probably next. That’s been there's a chance you will do the game plan in Europe, it again in the future. So, losers, which is and Japan bought equities to every bond that I think is manage through their going to get downgraded, something that disturbs difficult period. I think you even though I might not a lot of us.” have to assume that’s fundamentally like it, I will coming for the US. It’ll be a look at buying and safer market for investors,

potentially even buy some but if you have a Treasury because I know this player The Fed’s ETF program also crisis, it's going to be a is out there. So, it's doesn’t seem well-thought- disaster for the markets, but fundamentally changed the out to me. Instead of buying no one sees that happening risk of the asset class. And a slice of everything to under the new, modern show no favoritism, they are as a result, the asset class monetary theory. will probably never get to buying winners and losers,

the cheapness that it should which is something that disturbs a lot of us. Second, I had a call with some again. ETFs only represent UCLA professors about the portions of the market. In moral hazards subject, and I For example, I think we had the case of high yield, you think this is in the hands of a thousand basis point have a whole cohort of the academics to make the spread over treasuries, and issuers less than $600 case to the Fed that this historically, hitting 1,600 or million in size, but the ETFs isn't good. Companies that 1,800 was a very possible only buy $600 million in size maybe shouldn't be getting scenario. Our base case and larger, so the bonds of money are getting money. before the Fed stepped in those smaller companies Investors that shouldn't be was that that should happen were not supported (Continued on page 34) Page 34 Ray Kennedy, Hotchkis & Wiley

in risk asset classes are in RK: The situation never looked mispriced, you'd try risk asset classes because seems to change whenever to sell it. For example, we they think you will always you have weak markets. had some aircraft leasing be there to bail them out. The first thing, you never company bonds, and for From my vantage point, yes, have enough cash. Your some reason, at the very we saw bid-offer spreads clients always take cash out, beginning they were still widen out from a normal so your job is to manage bidding like they were 25, 50 basis points to 50 to through the cash flows. We investment grade. No one's 100 basis points, we saw run a product that can't flying, which means there's volumes being challenged at take cash positioning and going to be a ton of times, but what's interesting redeploy, nor do we have bankrupt airlines, which is that when lockdown the ability to call on cash means aircraft lessors are happened in March, there and say, "Hey, market's going to be challenged. So was a rally that was cheap, come in." So really, we let those go. beginning to occur at the you're just in triage mode. end of March, before the Fed announced their Then there were buys that were strange. Charter program in early April. So, “Maybe Carnival would the market was already bonds were off 15, 20 starting a correcting path. have had to pay more points when people were at One of the things I like to home watching cable. If say is that we never have a for the pricing on their anything, there's going to be more demand due to stay liquidity problem in high bonds or given up more yield, what we have is a home orders. We went on pricing problem: at the right equity, but instead they, the offense there. price, there's always a in a way, got a free gift buyer. We are an There were things that established asset class that’s indirectly from the completely caught us off been through a number of Fed.” guard too. We were cycles now, and the market overweight in building would have corrected on its materials and home own. Maybe Carnival would builders, and I was scared have had to pay more for Once we got control of for them at first because we the pricing on their bonds that, the second thing we thought no one would buy or given up more equity, did was a liquidity analysis homes virtually. I was but instead they, in a way, on the entire portfolio. So, obviously wrong. People got a free gift indirectly we just broke it into a risk buy homes virtually all the from the Fed. So, I do think category and said, "Okay, time now, and with the the Fed made a mistake, but based on history, who's additional time on their I'm not sure how we will likely to get hurt the most hands, they’re preparing and realize that mistake in this world, and who's upgrading their homes. So occurred because we could likely to get hurt the least?" that one caught me off be in this place for the next guard. five years. We took every company

G&D: What was your day- and evaluated their credit The cruise lines were to-day like in early March lines, how much they’re probably the most and what was your strategy likely to bleed per quarter, interesting because they in navigating this very who’s going to run out of clearly have to dock the cash first. Anything that ships for 6 to 12 months, unprecedented situation? (Continued on page 35) Page 35 Ray Kennedy, Hotchkis & Wiley

and some think that people time since it all started. The on the board for a privately are never going on cruise plane was clean and there held REIT, and they said ships again. But we’ve been were a lot of people there. their productivity simply through this before with The fundamental questions stopped. I feel the same. 9/11, when everyone swore we’re asking ourselves is, We need to get our people they'd never go to hotels in “Will we ever get back to back into the office to Las Vegas or go on airplanes normal travel mode?” I'm in interact and make decisions again. As we know, they all the camp that says we will together, and I'm tired of did again eventually, and get back to normalcy, that talking to people on the that same thing is going to people will look back and phone when they're walking happen for cruise ships. So, say we overreacted. We their dogs. you can buy cruise ships. will be smarter about it –

Am I going to go buy like how we adopted TSA unsecured? No, but I could after 9/11, we'll adopt a So, I think that, with the go buy secured, and so different travel pattern post exception of travel, we will that's kind of what we did -pandemic. But I'm not sure probably get back to a and saw the bid-offer spread salespeople will ever be normal world. Interest rates widen out and narrow back traveling at the pace they are going to be low for a very long time. The Fed has in. used to. So, that's a wild said that. People are starting card. to really embrace the So, we started with cash modern monetary theory, management, then got our “I think that, with the and it's scary to old people arms around the portfolio, exception of travel, we like myself that you can because none of us flood our world with money anticipated a scenario like will probably get back and there's no this during the initial consequences for it. But for investment decisions. Then to a normal world. the foreseeable future, I just the next thing is look for Interest rates are going don't see that changing. defensive play. You go on Credit still has a role in a defense for some and to be low for a very portfolio, even more so for offense for others. We older and high net worth long time. The Fed has went defensive on the people because they need aircraft lessors and offensive said that. People are income. The losers in these on charters. We were also type of worlds are always trying to pitch and bring in starting to really the people on pensions, new money in the midst of embrace the modern because they need high all this. And then, of course, deposit rates and high you're trying to do all this monetary theory, and interest rates to survive. remotely. it's scary that you can G&D: Shifting gears a bit, G&D: What do you think flood our world with do you have any specific COVID's impact on both investment ideas that you money and there's no the economy and on the are excited about today? world will be? consequences for it.” RK: Well, given that I see RK: I'm still trying to figure I also think people will get travel returning to normalcy that out myself. I am actually back in the offices. eventually, the travel space in Utah right now, and I flew JPMorgan's already said this is still the opportunity, commercial for the first doesn’t work for them. I'm whether it's a Carnival (Continued on page 36) Page 36 Ray Kennedy, Hotchkis & Wiley

Cruise or Delta secured Regional gamers are still ways to travel and not be bonds. I think the other one interesting. I would concerned about a that's interesting is the idea probably stay away from the catastrophic event that this is the end of Las Vegas, because that's occurring. energy, so maybe we're going to be a much slower supposed to be looking for recovery as Vegas is G&D: Got it. Finally, Ray, exits. That’s one I struggle predicated on jamming you come from a business with because we're long everybody in a building and background as well. Are energy, and it's a feeding you drinks, which is there any tips and advice fundamental shift in our something that will take that you have for current thinking. But we're all some time to get back to in students that are trying to starting to really question a post-pandemic world, if go into investing, and whether energy is going to ever. Regional gamers tend specifically high yield fundamentally change. to be a bit smaller and more investing? niche, and people gamble in One bond that we like a lot good times and bad times, RK: The need for credit will is PG&E bonds, post- so that business will increase in this world bankruptcy. We think their continue to exist. Those are because the banks have bonds are really cheap given the ones that stand out. As I pulled back and will that PG&E, as a utility, is a mentioned, high yield tends continue to pull back. The buyer of power generation, to have a lot of secular losers in this COVID world so the business is more challenges, so sometimes it's are not the high yield about the distribution of the a game of avoiding the companies but the middle lines. Their current situation losers. market companies who are struggling to get capital is due to a specific risk situation, rather than being G&D: You mentioned you from regional banks, who don't have the risk tied to macro risks. think travel will return to normal levels of activity, tolerance to provide capital. “The losers in this specifically for cruises. How As a result, specialty credit do you contrast this will continue to grow. Also, COVID world are not thinking that people will as equity markets get increasingly rich and the high yield return to traveling the way that they did before versus concentrated in terms of companies but the people would be a little performance, people will more cautious about going look at ways to invest, and middle market one of the ways to do that into a casino? is through high yield and companies who are RK: That's a good point. My specialty credit funds. struggling to get capital gaming comment is a When we interview people relative one versus an for equity, we always ask, from regional banks, absolute one. If you're going "Which equities do you who don't have the risk to own a gaming company, buy? Which portfolios do many of which are in the 80 you buy?" That's an unfair tolerance to provide cents on the dollar range, question to ask a high yield you probably should own a candidate because you can't capital. As a result, regional versus a Las Vegas. really buy high yield bonds specialty credit will The travel comment is that as a private investor. It's people just like to get out. extremely difficult, continue to grow. Following 9/11, people especially in your 20s, learned that there are safe (Continued on page 37) Page 37 Ray Kennedy, Hotchkis & Wiley

unless you have a million some incredible expertise. career days with them, and dollars or more in assets, so It's a grind, but that's I'm part of a credit pitch you need to get under the probably one of the best contest that they do every wings of somebody else. ways to get expertise if you year. Then it comes down Internships are key, even if can't get your foot in the to interest of sports. My it's through the platform of door on the investment kids are now out of sports, an insurance company. management side. It's hard but I had some very for us to train because we accomplished college don’t have the depth nor athletes, so it was fun to the time, and summer's travel all over the nation “Summer's often a often a strange time for and internationally with credit. It tends to be them. Other than that, I strange time for credit. slower, so it's actually one work out a lot, and I have a It tends to be slower, so of the worst times to learn house in Utah where I do a the credit markets. You lot of outside activities, it's actually one of the want to catch it in the fall hiking, skiing, things like because that tends to be that. And I'm an worst times to learn the where the volatility really intermediate piano player credit markets. You picks up. and I've been taking lessons for about seven years. want to catch it in the G&D: That’s great. One fall because that tends final question, and this is G&D: Thank you Ray, we one we like to ask to just really appreciate you taking to be where the see a different side of the time to speak with us volatility really picks investors. What are some today. things you like to do outside

up.” of investing? RK: Thank you all and good

RK: I have ownership in a luck. real estate brokerage The other path that people business that's actually the should think about more is fifth largest Berkshire the world of distressed, franchise. It's fun and which has gotten bigger and different because you're more involved. We work working in a world that is with a lot of folks from more crude and making real Evercore, Greenhill, -time decisions that impact Houlihan, AlixPartners, and businesses. I'm also on a I think those are great board for a private family training grounds because REIT. They have about a you have to do a lot of billion in assets, but they do models, you have to industrial properties and understand balance sheets, they're one of California’s you see a lot of problems land grant families. really fast. Once you do that, you can carry that I was on the governing body over into investing. I think a for USA Water Polo for a lot of distressed funds tend number of years, and I do a to hire from those firms little bit with the UCLA because they come with business school. I've done Page 38 Causeway Capital

Ms. Ketterer is the chief and has been a portfolio tional equity business there executive officer at Cause- manager since April 2013. using a value investing ap- way, fundamental portfolio proach. This was in the ear- manager, and is responsi- During the summer of ly 90s, where the technolog- ble for investment re- 2005, Mr. Valentini worked ical tools we have today did search across all sectors. as a research analyst at Ms. Ketterer co-founded Thornburg Investment not exist. the firm in June 2001 and is Management, where he a member of the operating conducted fundamental Alessandro Valentini committee. research for the Interna- (AV): I did both my under- tional Value Fund and the grad and master’s in eco- From 1996 to 2001, Ms. Value Fund, focusing on nomics and was planning to Ketterer worked for the the European telecommu- pursue a PhD in economics, Hotchkis & Wiley division nication and Canadian oil until I decided, "You know of Merrill Lynch Invest- sectors. From 2000 to what? Let's do something ment Managers (HW- 2004, Mr. Valentini worked that is not necessarily sitting MLIM). At HW-MLIM, she as a financial analyst at Sarah Ketterer was a managing director Goldman Sachs in the Eu- in an office writing academic and Alessandro and co-head of the firm’s ropean equities research- papers or looking purely at Valentini ’06, HW-MLIM International sales division in New York. theory." So, I joined Gold- and Global Value team. Mr. Valentini earned an man Sachs’s equity sales and CFA From 1990 to 1996, Ms. MBA from Columbia Busi- trading desk to experience a Causeway Capital Ketterer was a portfolio ness School, with honors, more hands-on approach. I manager at Hotchkis & an MA in economics from ended up covering a lot of Wiley, where she founded Georgetown University clients that were value in- the International Equity and a BS, magna cum vestors, which to me yield- product. laude, from Georgetown ed the most interesting con- University. Mr. Valentini Ms. Ketterer earned a BA was inducted into the Beta versations. in economics and political Gamma Sigma honors so- science from Stanford Uni- ciety, is a Phi Beta Kappa I had some clients who versity and an MBA from member, and is a CFA based decisions on momen- the Tuck School, Dart- charterholder. tum—I would provide to mouth College. She is cur- them daily EPS changes that rently a member of the Graham & Doddsville Goldman made, and they Stanford University Board (G&D): Can you start by would base their investment of Trustees, co-chair of the telling us about your back- process on that. That was Los Angeles World Affairs grounds and how you got not interesting to me. But I Council and Town Hall, a director of the Los Angeles into investing? spoke to really, really smart Philharmonic, the Music guys that were value inves- Center Foundation (as Sarah Ketterer (SK): I tors. And it is from those chair of the investment started out in investment conversation that my inter- committee), and serves on banking, which, as you est in value investing devel- the Girls Who Invest Presi- know, is trial by fire—and oped. dent’s Council. there is a lot of fire; I learned so much. I then That led me to apply to Co- Mr. Valentini is a director started a database business lumbia Business School, the and fundamental portfolio which turned out to be cash only business school I ap- manager at Causeway and flow negative, but I sold the plied to. The intention was is responsible for invest- data to an asset manager ment research in the glob- to join the Value Investing al healthcare, financials, and joined them on the in- Program. After graduating and materials sectors. He vesting side. [editor’s note: from CBS, I joined Cause- joined the firm in July 2006 Sarah joined Hotchkis and way in 2006. I am from Italy, Wiley]. I built the interna- (Continued on page 39) Page 39 Causeway Capital

so the international focus of help you understand what again, I like having criteria Causeway made sense; that you own as an investor. that are timeless. If it turns along with Causeway’s value out that investors don't investing approach and loca- think there's any cost of tion in Los Angeles checked “...when looking money, we have a real all the boxes for me. through a 10-K, you problem in value investing. should start from the G&D: Were there any well notes section and work G&D: What are the princi- -known investors or any ples behind the origin of your way backwards specific mentors that really Causeway, and what kind of influenced how you view because most people do value investing approach do not look at the the investment world today? you take? footnotes. These AV: When I think of the footnotes contain SK: Harry Hartford and I Graham and Dodd ap- crucial details that help founded Causeway in 2001. proach, it’s not just about you understand what Our idea was to start with value investing. To me it is you own as an international value equity the basis of fundamental investor.” and create a firm that inte- investing. It is the discipline grated both fundamental of looking at the assets of a research and quantitative company, looking at earn- research. In 2001, nobody ings capacity, and looking at SK: When I was starting in was doing this, and 20 years equity valuation in terms the industry in the 90s, val- later, it's still very rare to that are understandable and ue investing was the domi- see investors meld the two driven by fundamentals. nant and most popular in- together. When we began When I was just starting, vesting style. This was true in 2001, we’d see some sup- this was especially im- right up to the Global Finan- posed stock selection gurus portant to me as I had less cial Crisis, which did, in fact, put together a portfolio, but of a background in account- change everything. Now we where was the risk manage- ing, coming from a more are the few left; it’s very ment? Where was the multi theoretical economics back- strange. -layered understanding of ground. what sort of risks were in But we've gone through a that portfolio? At Columbia, I was lucky to period of massive monetary take classes with Professor creation since 2009, and the That's why when we formed Bruce Greenwald and Pro- pandemic today has only our firm, we started with fessor Greenblatt - those accelerated that—imagine three quantitative analysts classes and investors really having $5 trillion more of on staff, which has since helped me understand what balance sheet assets for the grown to eleven. What they to look for when analyzing Fed, ECB, Bank of Japan and did was to build a proprie- companies. One interesting Bank of China—that's just tary multi-factor risk model. piece of practical advice I shocking. That allowed us to under- received is that, when look- stand, at a very granular ing through a 10-K, you The ramifications of that are level, where we're taking should start from the notes going to affect your careers. systematic risks. And then, section and work your way It's hard for us to imagine as Alessandro noted, it's up backwards because most that undervaluation is mean- to us as analysts to under- people do not look at the ingless, that there's no cost stand the idiosyncratic risks footnotes. These footnotes to capital—that just doesn't of companies and know contain crucial details that make sense to me. But then those companies as well as (Continued on page 40) Page 40 Causeway Capital

any outsider can know make sure we know where lay, at what point does the them. the risk is coming from. quantitative approach come in during the idea genera- AV: The quant risk assess- We make our stock selec- tion process? ment is incredibly im- tions not just based on re- portant. Most managers turns but based on risk- AV: The quantitative ap- build a portfolio and then adjusted returns. As an ex- proach starts at the very look at the risk. That’s like ample, in 2008 and 2009, beginning of the idea gener- finishing a dish and then during the crisis, some of ation whereby the quant checking if you've used the the biggest absolute returns team runs screens. When right amount of spices. You were in banks, but some of we start with screens, we can add some at the end, the biggest risk-adjusted are not looking to disqualify but it's not going to be as returns were in high quality companies (i.e. companies good as if you tasted it industrial companies. don’t need to pass our while cooking it. screens to go on to the You can add risk to a port- next stage). We look at folio, in the form of volatili- screens because we know “The quant risk ty, if you get paid for it. And that metrics such as earn- assessment is incredibly that's really the philosophy ings yield, price-to-book, of how we build our portfo- dividend yield have been important. Most lios and how we think about helpful in terms of identify- ing ideas in the past. We managers build a investments. have general screens for all portfolio and then look G&D: How do you define industries. And then each risk? industry group within at the risk. That’s like Causeway does its own finishing a dish and AV: The ultimate metric of screens. For example, in our risk is permanent loss of financial institutions group, then checking if you've capital, which is not measur- we screen for implied cost able. Volatility, while not of equity. We look at what used the right amount ideal, is the best proxy. the return on equity is, we of spices. You can add make assumptions on When you look at individual growth and we calculate the some at the end, but it's securities over an extended implied cost of equity. period, there is a high cor- not going to be as good I’d estimate 40% or 50% of relation between volatility our ideas are generated as if you tasted it while and possible permanent loss through screens. The rest of capital. Until someone might be from reading news, cooking it.” finds the perfect metric to talking to experts and man- quantify the risk of perma- agements. There have been nent loss of capital for any numerous times when I’ve Thanks to our integrated stock, volatility is the best spoken to the management quant side, risk is an integral proxy for risk. We will take of a target company and part of our portfolio con- on volatility if we get paid ended up deciding to do struction. It's done at incep- for it. work on their competitors tion and then reviewed on a as well. continuous basis; we have G&D: How do you ap- After the quant team runs regular meetings where we proach portfolio construc- examine the risk character- tion? Given Causeway’s val- screens, the analysts do the istics of our portfolio and ue focus with a quant over- fundamental work. We talk (Continued on page 41) Page 41 Causeway Capital

with the company, with we take that name and we third party research, and put it into a ranked list of “The quant side gives us with the sell-side as well. ~200 companies that we We do in-depth diligence to use as the menu to then an indication of form a differentiated opin- form the portfolio. incremental or marginal ion, which is the basis of a At that point, the quantita- successful investment. tive risk assessment and the prospective volatility. In parallel, the quant side fundamental work are ex- The stock should add to starts scoring each company amined together. We deter- on how much risk that com- mine how many units of the portfolio’s risk pany has vis-a-vis the rest of return per unit of risk we the portfolio. The team also are getting from a company, adjusted return. ” uses external data to vali- vis-a-vis the rest of the date our investment thesis portfolio and form a ranking That's where quant kicks in (e.g. using credit card data which we then use to build right away. The quant side gives us an indication of in- to derive insights). a portfolio. cremental or marginal pro- The quant team helps us We believe this helps us spective volatility. The stock with views on emerging with our sell-discipline too. should add to the portfo- markets. They’ve developed The biggest problem for lio’s risk adjusted return. strong models to assess fundamental investors is Granted, the quant view is macro risk, which we use if when is it time to part with theoretical and based on an we're looking at a company a stock that has worked eight-year estimation win- that is either in an emerging well? You can always find a dow where you must be- market or does business in reason to hold on to a win- lieve the past is a good indi- an emerging market. For ner. For us, if it ranks well, cation of the future—but instance, if we look at we will put more capital to that's often the case, partic- BBVA, a bank headquar- work. On the other hand, if ularly with cyclical stocks tered in Spain, which does something ranks less attrac- where history has repeated business in Mexico and Tur- tively, we take capital away itself. key, we use quant models and redeploy it elsewhere. Quant helps us just to get to understand what the And this is a natural pro- fundamentals oriented to macro factors look like in cess—everybody buys into the most efficacious stocks those countries. the process and everybody right away and they also Next, we present the com- agrees. There is a natural help us understand the envi- pany to the entire team. replacement of less attrac- ronmental, social and gov- We have heated discussions tive ideas with more attrac- ernance aspects of the com- about the investment thesis tive ideas. panies we cover. and the assumptions that go into the price target. Usually SK: The fundamental quant Fundamental investing can- we don't reach a conclusion integration is really our se- not be effective without during these initial meetings. cret sauce. You can't just quant to supplement it. And We often need to do more take thousands of stocks, as far as I'm concerned, work after the first presen- screen them and then know quant without fundamental tation. what to do. Let's just say in is just massive numbers and Our goal is to reach a price healthcare there might be statistics without in-depth target that has been vetted 40 interesting stocks. fundamental knowledge. by the entire team and en- Where do you start the sure that everybody is com- research? How do you put G&D: How do you think fortable with it. After that, them in order of priority? about ESG investing? (Continued on page 42) Page 42 Causeway Capital

screening tool; it's not an right there at the forefront. SK: I don't believe ESG is a exclusionary tool. But ra- fad. I think it's here to stay. ther, it's a way for us to say, There's so much that insti- It may get renamed or re- "Here's another risk factor. tutional investors can do to constituted, but for as long Do we have enough return bring about the outcome as I've been managing mon- to compensate our clients we want in ESG and make it ey, governance has been for it? And/or is there coincide with alpha. That's critical. You can't believe in something we can engage critical. It's not just a moral a company where manage- with the company on to principle. It's returns in ex- ment is going to implement make it even better?" cess of benchmark that mat- a poison pill or some sort of ter. awful dilutive effect—what’s Volkswagen is a great exam- even worse is complacent ple. At the end of 2015, G&D: In situations where a management that are pro- they had the biggest scandal fundamental analyst strongly tected by layers of govern- in the whole automotive believes a stock still has fur- ance protection. industry and were poisoning ther upside, but the quant the planet with diesel emis- risk assessment says other- Governance is critically im- sions that they fraudulently wise, how do you reconcile portant and always has withheld. So why would that kind of dynamic? been. Quantitatively, we've anybody want to be any- been able to measure and where near a company like AV: That's the art of port- score environmental and that? folio management. It's not social impact. We have spe- necessarily the case that if cific questions that we ask something ranks as number companies to score them 24 that it needs to be the and we are improving our “We view ESG as 24th largest position in the ability to interpret the out- portfolio. We have meetings put scores to generate al- another risk factor. Do three times a week now we have enough return pha. assessing whether a compa- to compensate our ny belongs in the portfolio, At some point, every com- clients for it? And/or is or whether there are more pany will be reporting ESG there something we can attractive ideas to redeploy metrics, and there will be a engage with the capital to. standard measurement for company on to make it their carbon output. We'll When we have discussions even better?" know, and we'll be able to to exit a position, some- compare it. And efforts are times the decision is not to moving very quickly along do it immediately. We look this. Companies feel a tre- They're based in Europe at issues such as: what does mendous amount of pres- which is at the forefront of momentum of analyst revi- sure. They've never been green policies. We think the sions look like? It's probably more transparent on ESG. company is going to be the less attractive to sell a com- world's leader in electric pany that is not ranking well Companies will be able to vehicles and they'll have the where you're seeing earn- know the ESG metrics of cleanest fleet in the next ings estimates or expecta- their suppliers and their decade. And that's in part tions move up versus a customers and we will have since they're bending to a company that is not ranking a much better sense of how huge amount of pressure well and you're seeing ex- these companies rank. We that came from shareholder pectations move down. don't think of this as a engagement. And we were (Continued on page 43) Page 43 Causeway Capital

We are very strict in terms try selection. But it does ment ideas are so crucial, of adhering to a discipline. not tell us we should have because we don't have an in And discipline only works if higher exposure to a partic- -house economist. you apply it consistently. ular industry. It helps us establish whether the re- We go to these meetings G&D: How does the quant turns justify the additional and we lay out the assump- overlay play into industry level of risk. tions and we are conserva- selection? Value tends to be tive. In our banks models, more concentrated in more we don't have rates going cyclical industries that may up. It would be very easy to be correlated when there's “The quant overlay make a buy case for a bank a downturn. How do you stock saying rates normalize helps us with industry think about that? in two years, but we don't selection. But it does need that in order to own what we own. If I go into a AV: We are really industry not tell us we should agnostic in that sense. We meeting pitching a bank ar- don't build a portfolio say- have higher exposure to guing that interest rates will ing, “Industrials look cheap. increase next year, I'm going Let's find some ideas in in- a particular industry. It to get a lot of pushback. dustrials and allocate capital helps us establish So that's why it's so im- to that area. " whether the returns portant to have those meet- Our process is bottom-up ings because you bring in driven and that's why the justify the additional everybody's opinion. You quant team is so important. can really vet your assump- We think about the margin- level of risk.” tions. You need to vet what al risk. We ask questions your assumptions are and such as: “If I take the n+1 justify them. If people disa- bank that I want to put into gree, you need to defend the portfolio, what does G&D: When you do con- the assumptions. If your that do to the risk on a centrate in certain sectors argument is not strong marginal basis? How much like European banks, there's enough, you need to change does that increase the risk?” obviously a big macro com- your assumptions. And that Adding another security to ponent there as well. Does is the kind of back and forth an industry might increase that go with more of the discussion which determines concentration. In order to fundamental analysis? How the right price target for a justify that increase, we re- big a role does that play? security. quire a higher expected re-

turn. AV: The macro is the mi- G&D: We'd love to hear And that's really what the cro for banks. You're asking your general thoughts on quant team and that margin- about interest rates. It the market, on value invest- al contribution to the risk could be a macro decision, ing and any parallels you see approach really helps us but it's a micro input in between today’s market with. If you have too much terms of our financial mod- environment vs. other concentration in a sector elling. For some of these points in your career. that is cheap, is that still the industries, the top down best opportunity on a bot- macro view blends with the AV: This is not about value tom-up basis? bottom-up approach. But versus growth anymore. It You are right that the quant that's why our internal has become about whether overlay helps us with indus- meetings discussing invest- fundamental investing works (Continued on page 44) Page 44 Causeway Capital

anymore. Value, by defini- that is well managed, well An example of this is tion, is fundamental invest- positioned in its industry, UniCredit in Italy. A few ing. You look at a security, and is a good capital alloca- years ago, a new manage- you look at a company, you tor but is cyclical. It's going ment came on board who do the work, you draw your through an environment identified that non- best conclusion on what where earnings are coming performing loans on the you think the fair value is down, whether it's because balance sheet were weighing and you determine your everybody's staying at down the performance of margin of safety. In our home, because nobody the bank. They made the case, you also look what's takes a flight anymore, or decision to raise capital and your margin of risk, and because nobody orders sell those loans after writing then you make the decision food from the cafeteria for them down. They restruc- whether to invest or not. a meeting. Whatever it is, tured the capitalization— earnings are under pres- the risk was lowered, cost In the current environment, sure. They have the right of equity came down, ROE you cannot just focus on business model, they have went up, and so the multiple arithmetically cheap compa- the right balance sheet, and came up. We find restruc- nies. Just because a compa- eventually earnings should turing value in every sector, ny trades at four times go up, and the multiple including healthcare, tele- earnings, it does not imply it should go up. 2008 and com, and technology. is necessarily undervalued. 2009 was a great period to find companies like that. “In the current You need to go beyond that. And that's the greatest In the other bucket you environment, you evolution in terms of value have restructuring value, investing. And that's why which is companies that are cannot just focus on real value investors focus on almost in the opposite posi- arithmetically cheap the differentiation in the tion. A lot of the banks after investment thesis. What am the crisis were in that posi- companies. Just because I seeing that other people tion. They weren't doing the are not seeing? How can I right thing. They were fo- a company trades at confirm that? cusing on the wrong re- four times earnings, it turns. They needed to Some people think that val- change themselves funda- does not imply it is ue investing is just screening mentally. You most often for everything that trades at need a change in manage- necessarily a low P/E and then building ment in order to have a undervalued.” an investment thesis around change in strategy—and that valuation. Value invest- that's where we get really ing is not just about low P/E; interested. I’ve seen count- In 2008 and 2009, the cycli- it's looking at the margin of less companies that come cal bucket was full. As we safety. through the screens that went through the cycle, look cheap, but where more and more of those Personally, the way I think nothing changes week after cyclical stocks rerated and about value, it's two buck- week for two years. Those came out of the bucket. So ets. You have cyclical value companies qualify as value that bucket grew lighter. and you have restructuring traps. But when real change The restructuring bucket, value. does happen, they can be- on the other end, grew come strong investments. fuller. Fast forward to this Cyclical value is a company year and the pandemic, now (Continued on page 45) Page 45 Causeway Capital

both buckets are full. That's the current environment, if G&D: Do you think that so exciting for value inves- you have a great balance there is a confusion in the tors. sheet, you need to be able market about what's cyclical to capitalize on opportuni- versus what's secular? One of the biggest challeng- ties such as M&A. es we are facing is to find AV: Absolutely, those are the capital to allocate to all SK: You know high quality great opportunities for us the ideas that we have. when you see it, because when the market thinks getting to know manage- something is secular and it G&D: On your website ment is important. That's becomes cyclical. But the earlier this year Causeway one of the reasons why it greatest danger lies in the published an article about takes years, we believe, for opposite situation, when buying high-quality cyclicals someone to move from be- something that we think is during a downturn. How do ing an analyst to becoming a cyclical instead turns out to you make sure that you're portfolio manager. You just be secular. buying a business that will can't get to know that many emerge stronger with more management teams that It’s all about examining market share and better quickly, and AI cannot help competitive advantages. positioning? you. High returns, high sustaina- ble margins, high barriers to AV: If you want to put it When it comes to the rap- entry. If you see more com- down to metrics, that en- port we have with manage- petitors entering the mar- tails a strong balance sheet ment and understanding ket, see if the company can and high ROIC in terms of whatever sort of verbal and hold its competitive ad- the capital allocation. By nonverbal cues they're giv- vantage: see whether the “quality,” we mean compa- ing us, there's no substitute company is forced to nies that are good allocators for just the time and meet- change the way they do of capital, have strong bal- ing after meeting, after business and see if returns ance sheets, can weather meeting. come down, or if margins the pandemic and a market come down. downturn and survive. We are running natural lan- guage processing to analyze For financial institutions, it's You can have the best busi- transcripts to look for very important and it’s ness, but if you're over- changes in sentiment, but something you need to ana- leveraged, then you are not that's all at the margin. lyze case by case. Fintech is in a good position when you What really matters, for an enormous disruptor. And get into an environment like example, is how Alessandro we need to, both on the this. Companies need to has gotten to know the insurance and on the bank have a strong balance sheet management team of one of side, be very attentive in which is often the conse- Japan's largest pharmaceuti- terms of figuring out what quence of good capital allo- cal companies. the opportunity is and what cation. When we talk about the risk is. governance with companies, What really matters is we talk about capital alloca- meeting after meeting trying You think about banks and tion very often. to push management to disintermediation. What has prove the trajectory of happened so far in fintech is In addition, you need com- profitability and cashflow. mostly around payments. panies that have good man- And I don't know how that Nobody wants to get a big agement. That goes back to will ever change. balance sheet that is going capital allocation, because in to be regulated — you want (Continued on page 46) Page 46 Causeway Capital

to be capital light. now is the uncertainty. survive off their balance When are things going to sheet and take advantage of So yes—you have a lot of normalize? This holds true that. competition there. But the for the entire industry in- regulation to some degree cluding airlines, manufactur- G&D: During a period is on your side and disrup- ers as well as tech compa- where value as a style is tion is also what creates the nies (e.g. Amadeus, Sabre). kind of struggling, how do best opportunity. Also, you manage that process sometimes what you think We don't know when things emotionally and psychologi- is a disruptor is just part of are going to normalize. cally? And how do you con- the cycle and you need to What we do know is that tinue to have conviction take advantage of that to some things haven't changed when stuff goes against you? reap returns for your cli- despite the pandemic. Peo- ents. ple still want to travel and AV: Personally, I get very go on vacation. We’ve seen excited in periods like this. it in the airline data in Eu- You need to be a contrari- rope, in China, and even in an. The most dangerous “What really matters is the US as things have im- time in your career is when meeting after meeting proved. We find the most everything feels good, when compelling opportunities in your ideas all seem to be trying to push leisure travel. performing. management to prove So how do you make sure With our process of ranking the trajectory of that when things return to risk-adjusted returns, if normalization you can take something is not ranking profitability and advantage of that, but if attractively, you need to cashflow. And I don't things take longer, are your take it off. That helps with stocks going to be able to our process psychologically know how that will ever survive? You look at the because it really gives you balance sheet, which goes objective parameters. If you change.” back to the point about do the right fundamental quality we touched on be- work and the ranking is at- fore. tractive, it gives you a lot of G&D: On the Causeway support in terms of deploy- website recently, you post- And that's why the work ing more capital. ed an article on aerospace. that we do in terms of Are there particular pieces those opportunities, wheth- G&D: What are a couple of of the aerospace value chain er it's in the aerospace man- investment ideas that you're that you think are especially ufacturing side (e.g. Airbus, excited about? interesting? Rolls Royce), or the airlines side (e.g. Alaska, Air Cana- AV: I'm going to go into my AV: We talk about this da) we want to make sure wheelhouse and talk about pandemic as the GFC for that they have a balance financials, the much- airlines. But it's not just air- sheet that is strong enough maligned European banks. lines. It’s clearly been an that they can survive. That Some investors believe the extremely difficult time for doesn't necessarily mean business model is broken. any company involved in they won’t need to raise We disagree - look at now travel. equity, but we want to en- versus the GFC. Back then, sure that if everything is banks had high expected The biggest problem right delayed for longer, they can returns, but they were very (Continued on page 47) Page 47 Causeway Capital

high-risk opportunities. sis, it trades lower than it As demand for airplane en- did during the GFC. gines returns, cash flow Now you have high poten- should return for Rolls tial returns, but significantly Then on the insurance side, Royce—and that's what's so lower risk. And why is that? where we're seeing oppor- attractive about that busi- Look at the capital levels. tunity is in stocks like AXA ness. Right now, you're see- The common theme is capi- in France. They went ing a market valuation im- tal levels are multiples of through the XL Group ac- plying the end markets will what they were during the quisition, where they clearly not recover - that really GFC. overpaid. Now for the first doesn’t make sense for us. time in 15 years we are see- In addition to that, you have ing a property and casualty G&D: For Rolls Royce, do significantly less risky bal- market where prices are you think the rights issue ance sheets. Balance sheets increasing. removes some of the left haven't grown dramatically, tail risk of bankruptcy? and regulatory changes have Prices are increasing in the What do you think of a forced them to focus on 20% range in the US and in business like that if they lower risk businesses. the mid-teens elsewhere. were performing well post- This more than makes up COVID? That's why UniCredit is for any COVID related and such an interesting oppor- catastrophe losses. AV: Earnings are almost tunity right now. A bloated irrelevant for Rolls Royce— balance sheet, full of mis- One more idea I’d call out is cash has really been the fo- priced assets, led to lower Rolls Royce, which has been cus historically. returns and higher cost of an underperformer this For the rights issue, you can equity for the bank. Now year. They are leaders in never say anything puts all they have gone through a what is a duopoly in engine concerns to bed, but, if suc- painful restructuring, raising manufacturing. The business cessful, that could reduce capital and writing down model is simple: as a new the risk in terms of this in- assets. Management also airplane hits the market, the terim period until flights focused on improving the company designs and manu- start to come back. Manage- corporate governance and factures the engines which ment could've managed the resizing the cost base. And is a big drag on cash. Then balance sheet better. But importantly they bought they sell and install the en- clearly, they recognize the shares in the company, gine while charging mainte- shortcomings, and they aligning their interests with nance fees, and cash comes need to act on it. those of shareholders. pouring through the door. G&D: What's the reason What you have now is a Going into the pandemic, that you prefer the Europe- bank operating in a tough there were a few issues an banks over US based market, but with more at- with the Trent 1000 engine ones? Is it more valuation tractive returns and lower they were installing, which based? cost of equity. They have a delayed their cash flow. less risky balance sheet, That made this a very at- AV: We own both Europe- three times the capital that tractive opportunity for us. an and US banks in our they had before, and a bet- And with the pandemic, or- portfolios. The US provides ter mix of business between ders for plane parts just a blueprint on what we be- fees and interest income. dried up - the business has lieve is going to happen slowed down significantly. longer term to the Europe- And on a price to book ba- an banks. They spent sever- (Continued on page 48) Page 48 Causeway Capital

al years raising capital or Dieselgate scandal, all the cheapest less loved compa- accumulating capital for reg- old management was gone. nies in the industry to what ulatory purposes. We're And it was necessary for is now recognized as an in- getting towards the end of them to move on from that novator. that. crisis. And new management set up very clear expecta- Usually, when it doesn't In Europe, regulators right tions, improved the top line, work is when new manage- now are saying that capital improved the margins, and ment doesn't understand levels are sufficient. What's repositioned the company the business, or when they going to happen to all that as a leader in the EV space. cannot communicate the capital that is being generat- path correctly. It can be a ed now? We've seen what’s matter of not understanding happened in the US—it's “Passion for investing is how deep the issues are. been returned to sharehold- But sometimes new man- ers. And there's massive extremely important...If agement comes in, and the amounts of excess capital as issues are just too deep. you have passion, you we come out of this crisis. That's why it's so important will see those down for us to talk to manage- During the pandemic, regu- ment. The managements lators in Europe have re- days as opportunities. If that really know the busi- quested the banks to con- ness are the ones who are you don't have passion, serve capital by not paying successful. If we have these dividends because of the the best understanding conversations and manage- uncertainty. When the situ- ment seems to be out of ation improves, the situa- of accounting and being touch, or if they're still tion should reverse. the greatest financial learning after a very long period, we see that as a red We still think some US modeler will not help flag. banks are attractive oppor- tunities, especially the mon- you.” G&D: What would be the ey center banks and some advice you have for students of the larger regional banks. at Columbia who are inter- It's a very similar theme: Peugeot is another example ested in pursuing a career in better banks with more cap- of a restructuring that investing? ital and a lower cost of eq- worked very well under a uity than two of the previ- new management. New AV: Passion for investing is ous cycles. management drove aggres- extremely important. sive cost controls. They You're going to have days G&D: Are there any exam- delivered on the targets and when you look at the ples of situations where a the company became screens and the market is company was in trouble and stronger. telling you the opposite of new management came in everything you think is true and turned it around? And AstraZeneca within pharma- about the companies you then on the contrary, any ceuticals also comes to own. And it's very easy to situations where new man- mind. This was a company get down on those days. agement came you thought, that had almost no pipeline. and it turned out badly? New management came on If you have passion, you will board and revitalized the see those down days as op- AV: Sarah mentioned R&D effort. The company portunities. If you don't Volkswagen. After the went from being one of the have passion, the best un- (Continued on page 49) Page 49 Causeway Capital

derstanding of accounting and being the greatest finan- AV: I'm a Juventus fan. It's cial modeler will not help been crushing to never you. make it very far in the Champions League lately. G&D: How you spend your But they have done well in time kind of outside work? the Serie A, especially with Ronaldo joining the team AV: I have two wonderful recently. kids. My son is three and my daughter is seven. She's pas- G&D: Thank you for taking sionate about soccer. I'm the time to speak with us. very active in the local American Youth Soccer Organization (AYSO) as one of the volunteer coach- es. I’ve been doing this for three years. Even in a year like this, during the pandem- ic, we've managed to put together a season in a very safe socially distanced way. We're starting this week and I'm very excited.

So, a lot of my time is just spent training and coaching her team. I have been a long -time fan of soccer, but a very marginal player in the past—hopefully, a better coach. But coaching kids, seeing them develop and get passionate, is an enormous reward.

G&D: That's awesome. Were you on the Columbia soccer team when you were in business school at all?

AV: Like I mentioned, I was and still am marginal as a player. I think I'm a better coach than I’m a player. Hopefully, that's what my daughter would say too.

G&D: How about as a fan, who was your team? Page 50 Lyrical Asset Management

Prior to joining Lyrical, years. That was an incredi- G&D: Where did you two John worked at Elm Ridge ble seat because most of first work together? Management, Orbis Invest- our clients were portfolio ment Management, and managers or chief invest- DK: John and I met at Elm Clearfield Capital. John ment officers, so I got a lot Ridge Management, a hedge graduated from Yale Uni- versity, cum laude with of exposure to leading fund run by Ron Gutfleish, distinction, and received thinkers in the industry at a who worked with John Mullins & his MBA from Stanford young age. After that I went Rich Pzena at Sanford Berns Dan Kaskawits ’11 Business School. to Columbia Business tein in the 1980’s. The CIO School for the Value Invest- of Lyrical, Andrew Welling- Prior to joining Lyrical, ing Program, where I was an ton, was Rich’s first ana- Dan worked at Elm Ridge editor of this newsletter! lyst when Rich started his Management. Dan gradu- own firm, Pzena Investment ated from Tulane Universi- G&D: What about you, Management, so John and ty and received his MBA I actually come from a very from Columbia Business John? School. While at Colum- similar background as An- bia, he was an editor of John Mullins (JM): I gradu- drew. Ron’s good at boiling Graham & Doddsville. ated from Yale and went to problems down very quickly work for Steve Shenfeld and and figuring out what drives Editor’s Note: This interview Phil Sivin at MD Sass in New a business. It was the per- took place on September 16th, York, seeding funds. It was a fect place to get in lots of 2020. great intro to investing; we reps as I dug in on hundreds

Graham & Doddsville looked at everything from of businesses. (G&D): How did you get your classic long/short hedge fund to clean energy G&D: So, how did you end started in investing? VC funds to a fund for in- up at Lyrical? Dan Kaskawits (DK): I vesting in wine futures. Af- went to Tulane University, ter MD Sass, I went to Stan- JM: When we were at Elm where I took an equity re- ford Business School, then Ridge, we both read an in- search class taught by Pe- joined Adam Karr at Orbis terview of Andrew Welling- ter Ricchiuti. I really en- Investment Management, a ton in Graham and joyed the experience but I concentrated, long-only Doddsville. For me, it was a didn't have any relevant in- firm. Adam is one of the light bulb going off. Andrew ternships or connections to great contrarian investors, had come out of this same the industry, so I ended up and Orbis has a perfor- kind of a background in working with a couple of mance-driven culture; on structured deep-value in- financial advisors at day one as an analyst, you're vesting based on five-year Citigroup making cold calls. given a paper portfolio, so if forward earnings. But what It definitely wasn't the ideal you have a view on a stock Andrew realized over time job but as my friend's father and the PM doesn’t agree is that he could improve his said, "It's a lot easier to get with you, you can still go returns and improve his hit the job you want if you have and put that to work and rate if he avoided investing the job you don't want." He have that be meaning- in lower quality businesses was right - after five months ful. Early on I was able to and I was able to transfer get a feedback loop to see more complex situations. I to Citigroup’s equity re- where my alpha came from, was coming to the search department, where I and I learned a lot about the same conclusion in my philo worked with Tobias Levko- power of investing in good sophy. I reached out to An- vich, the chief U.S. equity businesses when they're out drew on LinkedIn and said, strategist for about five of favor. "You don't know (Continued on page 51) Page 51 Lyrical Asset Management

me, but I’m pretty sure we the market, but then looking to buy stocks in the think about the world in the we filter for quality cheapest 20% of our uni- same way, and we should and what we call analyzabil- verse based on five-year meet.” When Andrew and ity, which we forward earnings. The I first sat down and chatted, think dramatically im- cheapest quintile is the best it was an amazing experi- proves our hit rate, re- pond to fish ence because we were turns, and our ability to in, because that segment of speaking the same lan- sleep soundly at the market has significantly guage. We didn't have the night. Lyrical has been run- outperformed historically. same view on every stock, ning the exact same process However, many companies but we had the same view since its founding in 2008, in this group are junk - low on how to evaluate every and it’s the same process quality businesses that likely stock. It was extraordinary Dan and I implement in in- deserve their low multi- to find the perfect home ternational markets. ples. But buried in the junk after honing my investment are some very good compa- philosophy all those years. I nies, the gems. So when we joined Lyrical and I was “We are typically go through our screen, there for about a year be- looking at the cheapest fore I reached out to looking to buy stocks in stocks, we are seeking the Dan to bring him onboard. the cheapest 20% of our gems hiding within the junk.

DK: I learned a lot about universe based on five- G&D: How do you define a Lyrical through John's inter- year forward gem? view process because I served as a reference for earnings. The cheapest JM: A gem to us, simply, is a him. I had also read that good business. While no same interview John men- quintile is the best pond single measure is perfect, tioned, and I was really im- to fish in … we use return on invested pressed with Lyri- capital as our primary meas- cal’s approach. One of the buried in the junk are ure of business quality. We things I learned as an analyst don’t want to touch any is that, with lower quality some very good business that cannot sustain businesses you're more like- companies, the gems.” at least a 10% ROIC, and ly to get the forecast wrong. we prefer to see at least a It's just harder to get right. 15% ROIC. It is more And by adding that quality about avoiding the bad, than bar, it made a lot of G&D: G&D: Could you talk seeking the great. To earn sense, and it was a place more about those three a good ROIC, these busi- that I was also coming to investing criteria – value, nesses must have individually in terms of my quality, and analyzability? a durable competitive moat. own philosophy. And having a durable moat JM: Sure. It all starts with means that a business is G&D: Let’s talk about the value, which is the fuel for more resilient in the face of investment process at Lyri- our returns. We want to economic and competitive cal. own companies with the threats, can grow more biggest discounts to our quickly, and is a lot more JM: At Lyrical we run estimate of intrinsic val- predictable. Because of our a structured deep value in- ue, because the deeper the focus on quality, there vesting process. We start discount, the greater the are some classic val- with the cheapest stocks in return. We are typically ue industries we avoid like (Continued on page 52) Page 52 Lyrical Asset Management

airlines, deep cyclicals, or iting yourselves to certain ment. There are 1,500 com- pure commodities. sectors? panies in our uni- As I mentioned, good busi- verse. We're trying to fill a nesses are more predicta- JM: Think about a financial portfolio of 25 to 40 ble, and that gets to our model. We're valuing every- names that are going to give final requirement, which we thing that we own on its five us a high chance of success. call analyzability. This is -year earnings power. We And there's still a significant about keeping it simple. We need to have a reasonable number of industries and believe the value of anything estimate of revenues, mar- stocks to choose from with- is the present value of its gins, and capital allocation in our framework and future cash for the next five achieve that objective. flows. If we can’t reasonably years. Many businesses have estimate the fu- visibility allowing a model When John and I started the ture cash flows of a busi- like that, many don’t. With international equity busi- ness, we can’t reasonably a bank, we could build a ness we did an interesting estimate what it is worth, model, but the one thing I’d exercise. We went through or whether it’s cheap or know about it is that it the cheapest 300 names or expensive. Now, valuation would be wrong. The inter- so independently and came does give us a margin of est rate matters as much to up with a list of about 75 safety to be wrong to some earnings as any bottom-up stocks each that we thought degree, but we still must be work, and credit risk is a were reasonable candidates in the right ballpark for the huge variable that is very to do a real deeper dive on. investment to be a suc- difficult to get right. We had overlap of about cess. 80% of the names on “We went through the our respective lists. And the As with quality, our focus reason for that is that we on analyzability removes cheapest 300 names or have such a strict definition many industries from con- of what we're looking for in sideration: no banks, no so independently and value, quality and analyzabil- pharma or biotech, came up with a list of ity. With that short list, we no disrupted businesses like started the much deeper traditional brick-and-mortar about 75 stocks each ... fundamental work. retai- lor legacy media. Anything We had overlap of G&D: Can you talk about that is being disrupted is just about 80% of the names an investment that made it not analyzable. We can put through your screen, but numbers in a spreadsheet on our respective lists. didn’t work out, and wheth- and build a model and calcu- er that led you to refine And the reason for that late an EPS, but in the end, your process? we know the chance is slim is that we have such a of that model being right. JM: Late last year, we strict definition of what sold Pirelli, the Italian tire G&D: Could you dive a we're looking for in maker. Pirelli had great re- little deeper on the analyza- turns on capital and strong bility criteria? For example, value, quality and growth over a very on banks, is that rule ever long period. They dominate breakable? And how do you analyzability.” a niche of premium and su- think about portfolio con- per-premium tires where struction when you are lim- DK: We're not trying to brand is important and find every great invest- where operating margins (Continued on page 53) Page 53 Lyrical Asset Management

are very good at 20%+. 75% despite a good return for which is the number two C- of demand is for replace- us. Our Itochu investment is store operator in Japan be- ment tires, making the busi- a good indication of the val- hind 7-11 and is a fantastic ness a lot less cyclical than ue you can find as an outsid- capital-light franchise busi- many believe. er looking into a market like ness. Because of their tex- Japan. tile history, they moved in- G&D: We’ve heard people to brand ownership and pitch the bear case – that Itochu is one of the major now receive high-margin lower quality tire mak- trading companies in Japan, license streams for brands ers were going to move up which originally served to like Converse in Japan. the value chain. import raw materials into Japan when its economy This is a collection of great JM: Agreed. That was opened up in the assets, and they’ve got something that 1800’s. Over time, these great cash-focused capital we were tracking closely. At trading companies typically allocation at the helm. In first, Pirelli seemed unaffect- went more vertical within fact, in many ways their cap- ed by the trend and contin- the products they imported. ital allocation reminds us ued to show its strength at Companies like Mitsubishi of Warren Buffett, who an- the high-end, even as over and Mitsui imported metals, nounced purchasing shares time Korean players like so they decided to move in Itochu in August of this Hankook and Kumho won upstream into mining – year. some pretty good OEM which tend to be low- placements. But then we quality businesses. That’s G&D: Sony has been a big saw the increased competi- why a typical local investor winner for you as well. tion begin to impact their in Japan sees the trading What was the thesis there? business. companies as volatile and driven by raw material pric- JM: If I may, let me insert a DK: On their es. Itochu gets lumped in quick legal disclaimer here: 3Q2019 earnings with this group, but it’s fun- all of our recommendations call, Pirelli highlighted pricin damentally different. – the winners and the losers g pressure in - are available upon request their premium value-add When you look at it from a to [email protected], tires, which had previously bottom-up perspective, you and there’s no assurance been immune. We saw this see a company growing its we’ll continue to hold posi- as evidence that their com- earnings at 10% annually for tions mentioned in this in- petitive moat was diminish- 15 years while generating terview. ing. With the new infor- low-teens returns on equity. mation, we acted very The question for us is al- For us, Sony was an oppor- quickly and sold the stock. ways: why? Well, the histo- tunity to buy one of the ry of Itochu is that they greatest entertainment busi- G&D: On the flip side, can were originally importing nesses in the you give an example of a food and textiles. So, when world at around successful investment? they went more vertical 10x earnings, ex-cash. They they got into brand- are #1 in video games glob- JM: We bought Itochu in ed food and bought the ally, #2 in music rights, and June of 2019 with the Dole brand. When they #3 in TV and film produc- launch of the fund, paying went downstream in food, tion. The low valuation just below 6x earnings. To- they got into convenience came day the shares trade at 9x retailing from several misunderstandi earnings, so still quite cheap and operate FamilyMart, ngs. One was the miscon- (Continued on page 54) Page 54 Lyrical Asset Management

ception that their gaming valued. Do you invest with a and we’re hoping for a re- business is still a cyclical, catalyst in mind for the val- rating - that’s when you re- hardware-driven console ue realization in that busi- ally need a catalyst. business. We think it’s now ness or do you just assume a recurring, software-driven that over time as the music platform business with business or the gam- DK: Japan's been a fruitful strong network effects. ing business performs then area for us. As value inves- Sony has by far the largest people will recognize the tors, we all read about network of monthly gamers value? Warren Buffet and Ben and the best exclusive gam- Graham back in the day be- ing content, with about 15- JM: We don't invest with ing able to find those stocks 20% of PS4 game sales com- catalysts in mind, and I think that are trading for less than ing from Sony studios. Peo- our greatest competitive either the cash or the real- ple want to play on the net- advantage is that we invest izable value on the balance work with the with a truly long-term time sheet. You rarely, if ever, most available players and horizon. In our find those today in the U.S. the best con- U.S. portfolios, we've held market. But in Japan it's tent. People are worried stocks on average for seven been exciting because we Google Stadia will win years. We have no prob- have found a handful of away players from Sony, but lem buying great businesses these. And we haven't just we don’t think that’s the at cheap prices and hold- found these cigar butts that case. Even if Google can let ing them for as long as it are terrible businesses you stream games with the takes. Our best invest- where you might squeak out right latency, they can’t give ments have a 10 or 20% return. As John you the best games or the been ones where there's mentioned, we've found most players. Beyond gam- not some extreme contro- these Japanese businesses ing, of course, you have the versy, it's just that there that have these amazing bal- music label business with might be no catalyst. One ance sheets with net cash Columbia Records, which is reason Sony was so positions but they're also an exceptional business. cheap was that it’s a con- high-quality businesses. glomerate and people didn’t “Our view is that, if a see a path to value realiza- G&D: Let’s talk about one. business is tion. DK: In the cheapest quintile compounding its Our view is that, if a busi- in Japan, you find a lot of ness is compounding its engineering and construc- earnings at a healthy earnings at a healthy rate, tion stocks, but many of rate, the multiple is the multiple is going to con- these are not the type of verge to what is justified by businesses that we want to going to converge the fundamentals. But if not, own. They're very cyclical, what's important is that we with large projects that of- to what is justified by buy compounders. Let's say ten come with a lot of loss- the fundamentals.” that Sony traded at 10x P/E es. The industry is ripe for forever. As long as they're adverse selection – the way growing their earnings at a you win contracts G&D: It sounds like there double-digit rate, they're is through an auction by there's a collection of differ- going to generate an attrac- offering the lowest bid. And ent businesses in there that tive double-digit return. We the lowest bid might just you thought were potential- don't buy value stocks mean that you estimated ly hidden assets or under- where the earnings are flat, the costs wrong. (Continued on page 55) Page 55 Lyrical Asset Management

because of these dominant the EAFE value index have a Nippo is an asphalt and road local positions. On the top- 34% and 29% exposure manufacturing business line, it’s stable growth. Road to Financials, respectively. but, according to standard paving is non-discretionary; We have a more mod- industry classification, it you can’t leave big potholes est 24% exposure shows up in the engineering on the road, at least not in to Financials, but we don’t and construction industry. Japan. There are three enti- own a single bank. But Nippo is not your typi- ties that build roads in Ja- cal E&C business – it’s a pan. There's the federal Instead we own companies small project business that government, local govern- that provide services that generates consistently ments, and then five private are financial. For example, strong returns on capital. toll roads companies. They we own a Canadian compa- It’s a good industry because all put out five-year budgets. ny called Element Fleet it’s a local business, and the You build an industry model Management. This is the market is consolidated. You and see that the revenues in largest commercial fleet can't ship asphalt very far this business are going to management business in because it's heavy and grow at a mid-single digit North America, providing you must keep it hot. What rate for the next five the mission-critical service that means is there's not a years. It’s not hard to imag- of leasing, managing, and lot of competition. And the ine what the revenue and maintaining customer fleets largest three companies in margin for this business will for a blue-chip customer Japan control over 50% of be in five years. base (including Amazon and the mar- their rapidly growing fleet of ket, with Nippo being the DK: We went through each vans). As more and more largest player. of the cheap E&C stocks customers outsource this one-by-one, but when we service, Ele- Nippo has generated 13% dug into Nippo we were ment should steadily grow annualized earnings growth quickly able to see the at- at a mid-single-digit topline over the past 15 years, but tractive characteristics of rate, while taking very lim- what's really exciting is the the business. And this ties ited risk as the company valuation. Nippo trades for back to what I mentioned holds no residual value risk 11.5x forward earn- earlier about repetitions in its vehicles. In the Finan- ings today but adjusting and developing mental mod- cial Crisis, credit losses for the net cash and invest- els. That local market densi- were 10bps of receivables. ments on the balance sheet, ty is a mental model that The ROE is 13%, and we it's under 5x earnings. And you pick up on quickly when bought the stock at 8x 2021 on top of that they have you see it. EPS. This is a secular grow- valuable real estate in To- er with extremely low cred- kyo that's worth about 30% G&D: Are there cer- it risk and clear competitive of the market cap. So we're tain sectors or industries advantages from scale. getting a business that that tend to be more con- should compound its earn- centrated in your hunting A key part of our process is ings for effectively less than ground? sifting through these indus- 2x earnings. tries until we come across a DK: Yes, the cheapest part name, like Element, for ex- JM: Nippo is a great exam- of the market international- ample, that is a high-quality ple of analyzability. When ly is full of banks and cyclical name trading at levels near you think about model- industrial businesses, and many other lower-quality ing Nippo, it's very simple. we don’t own any of them. financial stocks. It takes a Their margins are consistent The cheapest quintile and lot of work to find the easy (Continued on page 56) Page 56 Lyrical Asset Management

investments. avoid businesses that are by having a long-term focus too reliant on local market and the right incentives. G&D: Can you talk about dynamics or local market These companies are not your experience transition- politics. What we end up focused on quarterly re- ing to investing in interna- owning are businesses that sults, they are tional markets? Do macro tend to be more global in not even focused on annual factors in the various coun- nature. For example, we do results. These owner- tries you are investing in own one Italian busi- operators are focused on play into your analysis? ness, Exor, that generates generating wealth for them- less than five percent of its selves for the “When you think about profits from Italy. Is it really long term. Aligning our- an Italian business? Or CK selves with these types of why these businesses Hutchison, a Hong Kong CEO’s fits well into our business that generates long-term approach. perform so well, I more than 98% of its profits think it’s been driven outside its home country. A good example of that is a company that trades in by having a long-term G&D: Did anything strike France called Bollore, which you as different in terms of is a holding compa- focus and the right the opportunity set in inter- ny controlled by Vincent incentives … national markets? Bollore and his family. The stock trades for 6x our These owner- JM: As we transitioned to estimate of 2021 earnings, international markets, one despite being a collection of operators are focused interesting thing we found two very good business- on generating wealth was a lot of cheap owner- es. Half the earnings come operator businesses. They from Bollore’s 27% stake in for themselves for the exist in the U.S. but they're Vivendi, which controls Uni- long term. Aligning not typically cheap. As we versal Music Group, the were combing through our number one music label in ourselves with these universe and saw these the world. UMG owns the companies, we wondered if rights to 8 of the top 10 types of CEO’s fits well they were a fertile hunting artists of all time. Every into our long-term ground for us: are we fishing time you listen to a Jay-Z in the right song on Spotify, UMG earns approach.” pond? So we looked at busi a high-margin royalty nesses where the chair- stream. They’re in the busi- man or CEO owns at ness of monetizing iconic DK: We weren’t interna- least five percent of the content, and other people tional investors prior to company or a family like Spotify do the work for running this fund, but we owns at least 20%. If you go them. Ten years ago, people were international business back and look over 20 didn't think this was such a analysts. The revenue years, those businesses have high-quality business be- of our U.S. stocks that are outperformed the cause we weren't paying for sourced from outside the MSCI World Index by more music, but Spotify and U.S. is 40%. So we have a than 1,000 basis points an- streamers have changed lot of experience studying nually. When you think that and over the last five businesses over- about why these businesses years we've seen the oper- seas. Because of our analyz- perform so well, I ating profit in that business ability focus, we strictly think it’s been driven more than double and (Continued on page 57) Page 57 Lyrical Asset Management

there’s a long runway to go. ferent than the “economic” Records is going to over- The third player in the share count which nets out whelm any potential deteri- space, Warner Music, the crossholdings. We see oration in economics for trades for 50x earnings. the stock trading at around the labels. 3x our estimate of its five- The other half of Bollore's year forward EPS, and we G&D: How did you navi- earnings come think it’s worth about 150% gate the market turbulence from its African logistics and more than where it trades resulting from the pandem- transport business, which by today. ic? its nature is volatile but a fast grower that has com- DK: We know we own pounded EBITDA at a high- “We’re patient and good companies, have a single digit rate historical- margin of safety with low ly. Bollore was early to truly long-term valuation, and on average West Africa (where people investors... our portfolio earnings are predominantly speak less economically sensitive French) and has been in- But, we can move quick than the EAFE index. That vesting $250 million a year said, COVID was something in building out African ly when a stock meets no one had ever seen be- ports, logistics and infra- our criteria for value, fore. Our priority was structure over many dec- to stress-test every business ades which gives them a quality, and and balance sheet and speak wide moat. It can be hard to analyzability.” to every compa- get a package from point A ny to confirm our under- to point B into and across standing of how COVID the continent, which gener- should impact their busi- ates a wide competitive G&D: Given that the music ness. Through this process moat and solid mid-teens label business appears a we sold four stocks. We returns on capital for an couple of times in their also went hunting for new expert like Bollore. portfolio, how do you think opportunities resulting from about the industry profit the turbulence. From mid- When you put it together, pool evolving over time, March to mid-April, over you get two great growth especially as potentially the course of five weeks, businesses here for a cheap Spotify contin- we added five stocks to the price. ues aggregating demand and portfolio. One investment growing in relevance? was NXPI Semiconduc- DK: There’s also tors. this unique corporate struc- JM: Spotify is a 20% cus- ture, known as “Breton Pul- tomer of the major music NXPI was on our radar leys”, which allows the Bol- labels, and the music labels since last summer, but lore family to maintain vot- provide about 75% of Spoti- it was never cheap enough. ing control despite owning a fy listening time. For now, We had done work on it, minority of the shares. we think the balance of we had engaged with the We’ll spare you all the de- power remains squarely compa- tails, but effectively the Bol- with the labels, but the ny and its competitors, and lore parent company owns more important point is we had a strong under- shares of holding companies that the rise of streaming standing of the business. that in turn own shares of and the resulting near 100% We’re patient and truly long Bollore. This means that the incremental margin profit it -term investors – on aver- reported share count is dif- brings to UMG or Columbia age, in our U.S. fund, we’ve (Continued on page 58) Page 58 Lyrical Asset Management

only made four new invest- tinue taking market world industry. If you want ments per year. share. In the U.S., only to rent a forklift, you can But, we can move quickly w about half of equipment is use the app and schedule hen a stock meets our crite- rented, compared to the to receive the forklift at the ria for value, quality, and UK and Japan at 80- exact time you need it. The analyzability. 85%. That doesn’t make a smaller players can’t offer lot of sense. Most compa- that. And Ashtead has sen- JM: April was a great time nies should not own equip- sors installed on its equip- to buy compounders on ment like scissor ment so that if it is about to sale. NXPI is a global leader lifts or industrial power gen- fail, the customer is alerted. in sensors and technology erators. By renting, custom- This reduces downtime and that are part of a secular ers get 24/7 service and improves safety. trend towards safer driving support, avoid maintenance, with auto-braking and driver and free up their balance G&D: It makes sense that assist leading eventually to sheets. Over time, the rent- customers would want to autonomous driving. Be- al penetration rate in the rent rather than own, but cause 50% of their business U.S. should continue to in- how do you think about the sells into autos, NXPI sold crease. capital intensity of Ashtead, off with all the other auto especially in the context of cyclicals. We bought G&D: What’s Ashtead’s its cyclicality? it at around an 11x P/E. I market share? think there's a misunder- DK: The beauty of standing today that if you're DK: Ashtead has 10% mar- Ashtead’s business is that a value manager, you own ket share and the top two they can cut all orders sleepy, old-world companies companies control about for new equipment with just that are getting disrupted one quarter of the mar- 45-60 days’ notice to any of and that's just absolutely ket. The rest of the industry their suppliers. That’s criti- not the case. With discipline is smaller regional players cal. In a period like the cur- and patience, you can buy and mom-and-pops. This is rent environment, Ashtead businesses with strong secu- a tremendous opportunity can slash their capex. In fact, lar growth. It takes a lot of for Ashtead that al- this year, capex is expected work to find them, but they so should fuel its future to decline by 75%. And that are out there and you just profit growth. Ashtead has leads to countercyclical cash don't have to overpay for significant ad- flows. EBITDA is expected them. vantages over its smaller to fall 12% this year, but competitors. As a national free cash flow is expected G&D: What’s another ex- player, they can offer their to increase by 63%, result- ample of a secular grower in larger customers a single ing in a 10% free cash flow the portfolio? point-of-contact for tool yield for the stock. This sta- rentals across the en- bilizing feature of the busi- DK: Another good example tire country. And, by follow- ness model is under- is Ashtead. Ashtead is a tool ing a “cluster” strategy appreciated by many. rental equipment compa- where they enter a market ny that operates under the and build out store density, Ashtead also offers specialty Sunbelt brand in the U.S. they can lower their cost rental equipment like cli- The industry will benefit base and optimize their in- mate control and power/ from secular growth and ventory. HVAC, which is a lot more Ashtead is one of two na- stable. Even from February tional organizations that is Ashtead also is applying through April of this year, in the best position to con- technology to an old- specialty rental revenue (Continued on page 59) Page 59 Lyrical Asset Management

grew 10% year-over-year. annual EPS growth over that we're focused on is five time. And yet we trade for years out. And we say, if JM: We also own their 12x P/E, well below the we're going to get the earn- competitor, United Rentals EAFE’s 16x. And this is what ings right, we're going to in our U.S. portfolio. So it's you get when you add quali- eventually get the invest- a business model that we're ty and analyzability to the ment right. And if it's a vola- familiar with, and we value factor; you get an un- tile path on the way to hav- think that these two compa- common combination of ing a good five or ten-year nies are going to be the long value and growth. investment return, we'll al- -term winners with a lot of ways take that over a po- “We haven't seen an open space to go. tentially more stable but opportunity in lower return. Being able to G&D: Fast forwarding to invest with a long- today, what do you think value like this in 20 time horizon requires being about this current market at the right organization. environment? Obviously, years.” We’re fortunate the market has been very that Lyrical’s founders – bifurcated for a while be- G&D: How do you get Andrew and Jeff Keswin – tween growth and value, so comfortable investing in have built a firm that allows curious what your view is light of the uncertainty us to invest with this mind- on the overall market envi- around how the pandemic set. ronment, how it compares will unfold over the next 12 to prior periods in both of -18 moths? G&D: Dan, can you talk your experience. about memorable classes or JM: Buying businesses for experiences at CBS that JM: We haven't seen an the long-term requires you have impacted your invest- opportunity in value like to buy resilient business ing career? this in 20 years. You have to structures that can adapt go back to the tech bubble and manage through very DK: There were two clas- to find value stocks trading challenging periods. This ses that were the most in- at such a wide discount ver- means good balance sheets, fluential. They were sus the broader mar- flexible cost structures, low both during my second ket, and historically each capital intensity. As COVID year. time the value factor has hit, we exited gotten so dislocated, it has from four companies we The first was Applied Value been an incredible time to thought could be materially Investing taught buy. We don’t impacted by the pandemic, by Artie Williams and think the value factor itself and we believe the rest will T. Charlie Quinn. The real is broken, but it’s also im- manage well through the value from that class was in portant to note that we crisis. how to form a thesis and don’t own those typical val- how to really develop a per- ue stocks. While we buy DK: And it goes back to suasive pitch and analysis. stocks from the cheapest our competitive edge and It's awesome if you find a part of the market, our being long term in nature great investment, but most companies have compound- and the way that we define of us are going to be work- ed their earnings at a risk. We don't define risk as ing for other people and 5.5% rate from 2007 volatility; we think risk is with other people. It's through 2021 estimates, or simply the permanent loss not valuable to find a great about six percentage of capital. We're not investment if you can't con- points above the EAFE’s path dependent. What (Continued on page 60) Page 60 Lyrical Asset Management

vince someone else to buy on why. It's a tough indus- into it. try but full of motivated, passionate, brilliant people. The second was Advanced Try to find the right people Investment Research taught and the right strategy for by David Greenspan who, at you. the time, was working at Blue Ridge. And G&D: Thank you very the reward there was a little much for your time. bit different. We spent the entire semester working on just one stock. The real val- ue was in the primary re- search and differentiated quantitative analysis and how to go deep, and how to think differently, while fo- cused on only the two or three key investment ques- tions that truly matter. And you come up with your own financial forecast based on the independent work that you're doing. That ob- jectivity has really provided me with the foundation for the work that I've done over the last 10 years.

G&D: What advice do you have for business school students who want to pur- sue a career in investing?

JM: I think one of the most important things that you need to figure out as an in- vestor is where your alpha comes from. There're lots of different ways to in- vest. The question is what are you really good at and how can you apply that to picking stocks and doing it in a successful and repeata- ble way? One of the best ways to figure that out is go and buy some stocks and have some winners and losers and really reflect Get Involved:

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Contact Us: Graham & Doddsville Editors 2020-2021 [email protected] [email protected] Rodrigo de Paula ’21 [email protected] Rodrigo is a second-year MBA student, a Meyer Feldberg Fellow and a member of Columbia Business School’s Value Investing Program. During the summer, Rodrigo worked as an equity analyst at MFS Investment Management. Prior to Columbia, he worked at Clayton, Dubilier & Rice as a private equity associate. Rodrigo graduated from the University of Pennsylvania with a B.A. in Philosophy, Politics and Economics. He can be reached at [email protected].

Matt Habig ’21 Matt is a second-year MBA student and a Columbia Fellow. During the summer, he worked in the Restructuring Group at PJT Partners. Prior to Columbia, Matt worked for six years in the Institutional Equity Division at Morgan Stanley, most recently spending three years in their Special Situation Group. Matt graduated from Dart- mouth College with majors in Economics and Engineering Sciences. He can be reached at [email protected].

Alison Tien ’21 Alison is a second-year MBA student and a Columbia Fellow. During the summer, Alison worked in the Equity Investment Group at T. Rowe Price. Prior to Columbia, she worked in portfolio analytics at Capital Group in their Los Angeles office. Alison graduated from the University of California, San Diego with a concentration in Economics and a minor in Accounting. She can be reached at [email protected].