Graham & Doddsville An investment newsletter from the students of Columbia Business School
Inside this issue: Issue XXII Fall 2014 Wally Weitz — Omaha Dinner P. 3 Power of Good Management 5x5x5 Student Value Investing Wally Weitz is the Founder and President of Weitz Fund P. 4 Investment Management, an Omaha-based fund manager with over $5 billion in AUM. Influenced by the value investing Wally Weitz P. 6 philosophy of Benjamin Graham and Warren Buffett, Mr. Weitz started his career as a securities analyst in New York Guy Gottfried P. 14 after earning a BA in Economics from Carleton College in 1970. He then joined Chiles, Heider, & Co. in Omaha, Columbia IIC working there for ten years before starting his own fund in Meeting Ideas P. 22 Wally Weitz (Continued on page 6) Development Capital Partners P. 26 Guy Gottfried — Editors: The Value of Capital Allocation Matt Ford MBA 2015 Guy Gottfried is the Founder and Managing Partner of Rational Investment Group, LP, a Toronto-based investment Peter Pan firm following a concentrated, risk-averse value approach. MBA 2015 Prior to founding Rational, Mr. Gottfried was an analyst at
Tom Schweitzer, CFA Fairholme Capital Management. He began his career at MBA 2015 Veritas Investment Research, Canada’s largest independent equity research firm. Mr. Gottfried graduated with a BBA Brendan Dawson with Honors from the Schulich School of Business at York MBA 2016 Guy Gottfried University, where he was a President’s Scholarship recipient.
Scott DeBenedett (Continued on page 14) MBA 2016
Michael Herman Development Capital Partners — MBA 2016 The Changing Landscape in Africa
Visit us at: Development Capital Partners (DCP) is a New York- www.grahamanddodd.com based investment manager focused exclusively on Afri- www.csima.org can markets. The fund was co-founded by Paul Tierney, Matt Tierney ’02, Gordon McLaughlin ’11, and Matt Magenheim ’11.
DCP Team
Graham & Doddsville (G&D): Could you start by explaining how you became inter- ested in investing?
Paul Tierney (PT): I got started in the investment business with no background in investments. I graduated from college having studied philosophy, and then went into
(Continued on page 26) Page 2 Welcome to Graham & Doddsville
It is our pleasure to bring you They think I’m a book with a Development Capital Partners the 22nd edition of Graham & couple of legs sticking out.” shared with us the excitement Doddsville. This student-led Indeed, continuous reading and and challenges of investing in investment publication of learning is critical to succeeding companies across the African Columbia Business School (CBS) as an investor, and we thank continent. is co-sponsored by the Heil- you for counting G&D as part brunn Center for Graham & of your reading regimen. Lastly, we continue to bring Dodd Investing and the Colum- you pitches from current stu- bia Student Investment Manage- For this issue we spoke with dents at CBS. CSIMA’s Invest- ment Association (CSIMA). six investors from three firms, ment Ideas Club meets regular- each with a distinct investment ly throughout the year, includ- To recap the happenings since style and focus. We believe ing during the summer, and our Spring 2014 issue, the Heil- you will enjoy our interview- provides CBS students the Louisa Serene Schneider brunn Center hosted the fifth ees’ diverse set of perspectives. opportunity to practice crafting ’06, The Heilbrunn Center annual “From Graham to Buffett and delivering investment pitch- Director. Louisa skillfully and Beyond” Dinner in Omaha, Wally Weitz, Founder and es. In this issue, we feature two leads the Center, cultivating held on the eve of the Berkshire President of Weitz Investment ideas from our classmates Kev- strong relationships with Hathaway Shareholders’ meeting Management in Omaha, NE, in Lin ’16 and Sisy Wang ’16: some of the world’s most and featuring a panel of re- was our first interview. We long Countrywide PLC (LON: experienced value inves- nowned speakers. Photos of the discuss how Mr. Weitz’s invest- CWD) and short B&M Europe- tors, and creating numer- event can be found on page 3. ment philosophy has evolved an Value Retail (LON: BME). ous learning opportunities over time, his views on valua- for students interested in We also proudly announce the tion, and assessments of his We strongly believe in the value investing. The classes formation of our inaugural stu- past and current holdings. value of diversity of thought sponsored by the Heil- dent-run Value Investing Fund, and experience. These insights brunn Center are among made possible by a generous gift Guy Gottfried, Founder and come from a variety of sources, the most heavily demanded from Helibrunn Center Advisory Managing Partner of Rational and we look forward to bring- and highly rated classes at Board Member Mr. Thomas Investment Group, shares ing you these unique perspec- Columbia Business School. Russo and his wife Georgina. some of his key investing les- tives and fresh ideas during this Please read more on page 4. sons with us, including the academic year. importance of partnering with As our fellow students begin strong management teams and As always, we thank our their Fall courses at CBS, we are maintaining a high level of in- interviewees for contributing reminded of a humorous quote vesting discipline. their time and insights not only from Charlie Munger: “In my to us, but to the investment whole life, I have known no wise And as we look for investors community as a whole, and we people who didn’t read all the with a global perspective, Paul thank you for reading. time...my children laugh at me. Tierney and his partners at - G&Dsville Editors Professor Bruce Greenwald the Faculty Director of the Heilbrunn Center. The Center sponsors the Value Investing Program, a rigor- ous academic curriculum for particularly committed students that is taught by some of the industry’s best practitioners.
The Heilbrunn Center Team, Julia Renowned Columbia Business School Kimyagarov, Louisa Serene Schneider ’06, alumnus Mario Gabelli ’67 shares his and Marci Zimmerman, at the May 2014 experiences as a panelist at the May 2014 Omaha Dinner Omaha Dinner IssueVolume XXII I, Issue 2 Page 3
“From Graham to Buffett and Beyond” Omaha Dinner 2014
Dinner panelists included Bruce Greenwald, Wally Wally Weitz offers his thoughts alongside Bruce Weitz, Bill Ackman, Tom Russo, and Mario Gabelli ’67 Greenwald and Bill Ackman
Tom Russo of Gardner, Russo & Gardner, LLC Bill Ackman, Louisa Serene Schneider ’06, Paul Hilal ’92, and Alex Rodriguez converse during the reception Page 4 5x5x5 Student Value Investing Fund
Tano Santos, Tom Russo, and Bruce Greenwald at the Louisa Serene Schneider ’06, Glenn Hubbard, Tom Russo, Value Investing Program Welcome Reception. Mr. Russo and Bruce Greenwald at the official inception of the 5x5x5 donated a generous gift to create the first-ever student Student Value Investing Fund value investing fund: 5x5x5
Columbia Business School is delighted to announce the formation of its inaugural student-run Value Investing Fund. This innovative fund was made possible by a generous gift from Thomas Russo and his wife Georgina. Mr. Russo is a frequent guest lecturer at Columbia Business School, and a member of the Heilbrunn Center Advisory Board. Thanks to Mr. Russo’s creativity and leadership, this unique entrepreneurial fund is both long-term and aligns with the fundamental principles of value investing, making it unlike any other student-run fund. The Russos’ gift affords Columbia’s value investing students the opportunity to connect value-oriented investment theories to real world practice as they apply their classroom learning in the management of this fund.
The 5x5x5 Student Value Investing Fund was introduced by Mr. Russo to the Heilbrunn community at the Value Investing Program Welcome Reception on September 12, 2014. In addition to Mr. Russo, the 5x5x5 Fund Board will consist of five students from the Value Investing Program along with Bruce Greenwald, Robert Heilbrunn Professor of Finance and Asset Management, and Louisa Serene Schneider ’06, Senior Director of the Heilbrunn Center. During the Spring 2015 semester, students in the Value Investing course taught by Bruce Greenwald and Tano Santos will have the opportunity to submit their investment ideas to the 5x5x5 Board. The Board will then choose among these investment ideas and will articulate five reasons behind each investment. Five of the stocks will then be selected and invested in for a period of five years. At the end of five years, the original amount, accounting for inflation, will be invested back into the 5x5x5 Fund and the remainder of the gains will be used to support current-use scholarships for students interested in investment management. As alumni, program students will remain active managers of the 5x5x5 Fund, continuing their support of, and connection to, the Heilbrunn Center and Columbia Business School.
Tom Russo discussed the details of the newly created Bruce Greenwald provided an overview of the structure of 5x5x5 Fund with value investing program students and the 5x5x5 Fund to students and alumni from the alumni Columbia Business School Value Investing Program Page 5
SAVE THE DATE
18th Annual Columbia Student Investment Management Association Conference
January 30, 2015
A full-day event featuring keynote addresses and panel discussions from some of the most well-known investors in the industry.
Presented by:
The Columbia Student Investment Management Association
and
The Heilbrunn Center for Graham & Dodd Investing
Visit our website for updates: http://www.csima.org
For inquiries contact: Calvin Chan [email protected] Lou Cherrone [email protected] James Leo [email protected] Page 6
Wally Weitz
(Continued from page 1) firm in 1970 when I graduated. only three outside 1983 with $11 million in I worked at G.A. Saxton, a shareholders. As you can assets under management small OTC trading firm. It was guess, the meeting has changed at the time. a terrific training ground. My over the years. boss, Artie Dunn, followed the Graham & Doddsville five hundred stocks we actually I have paid attention to (G&D): We would love to made a market in and you can Warren over the years. A lot hear about your background. imagine how deeply we of what I try to do has roots in How did you originally become covered them. I’m not sure if what I've learned from him. I interested in investing? he knew who Ben Graham don’t claim to do it as well or was, but he was intuitively a to be as disciplined, but I Wally Weitz (WW): My value investor. always feel like he’s looking mother was a single parent and over my shoulder as I invest or a social worker so my as I write our investor letters. Wally Weitz grandparents gave her a small lump sum of money and That brings us to 1983 when I introduced her to their stock was thirty-four years old. I left broker to make sure she “I have paid the brokerage firm to start my would not have trouble making own investment firm. A group ends meet. She and I went to attention to Warren of clients invested $11 million lunch with him, and by the end into three partnerships. We of it, she was bored stiff while I over the years. A lot kept it simple with a flat 1% was fascinated. of what I try to do management fee and no “carry.” Over time, we On the way back from the has its roots in what converted the partnerships meeting, I started reading How into mutual funds, and, thirty- To Buy Stocks by Louis Engel, I've learned from one years later, we have 11 which you can still find on funds, primarily focused on Amazon. It explained the him.” equities. basics of what a stock is, what a bond is, and so on. I started The firm now has roughly $6 investing two shares here and billion in assets with an ten shares there. The ideas investment team of 11. We’re mainly came from the broker It was supposed to be a a little unconventional in that in New York. summer job, but I just didn’t we’re willing to hold cash, we leave, and nobody really run concentrated portfolios, That was when I was 12, and I noticed. I stayed for almost and we don’t manage to any became hooked. I went three years before getting particular benchmarks. through a charting phase, and I married and leaving New York Everybody at Weitz has was keeping 100 charts a day for Omaha. I joined a regional virtually all of their investable and trading on them using brokerage firm and was asked funds and all of their technical indicators. Tuition to cover local companies. retirement assets invested in was cheap in retrospect, but Fortunately, one of those local our funds. Eating the home losing $50 in the ‘60s seemed companies was Berkshire cooking is true for us. We do tragic. Hathaway. our own thing, and I feel fortunate to get paid to do my Anyway, I stumbled on Ben One of my mentors in New hobby. Graham when I was at York, Frank Monahan, told me Carleton College, and I read about Warren Buffett, and my G&D: What was the Security Analysis. Then, I took a boss in Omaha was a good inspiration to strike out on correspondence investment friend of Warren’s. He took your own? course with the New York me to the Berkshire annual Institute of Finance, giving me meeting when it was held in WW: When I was at Saxton, the credibility (as to initiative, the National Indemnity the head of the firm called me not knowledge) to get a lunchroom, and there were (Continued on page 7) summer job with a Wall Street Page 7
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(Continued from page 6) business model and its “paying up” for stocks, because in one day and said, “You’re competitive “moat.” We try to history has shown that when doing fine, we’re not paying have a general sense of the the weighted average price-to- you much, so there's no economic environment, but we value of our portfolios rises, problem, but what do you do not want to depend on the returns over the next six want to do with your life?” making correct macro- to twelve months tend to be economic predictions. In short, lower than when we start I said, “I’d like to manage if the price of the stock is well from lower P/V levels. If this money like Harold and Frank.” below what an intelligent were not the case, we would owner would pay today for the have to find a new investment He said, “Great, go get some.” whole business, the odds are method. strong that something good That was the cold slap in the will happen with the stock. G&D: Could you talk about face that helped me realize I That's the basic idea. how your investing philosophy needed to figure out where has changed over time? For the capital would come from if example, you became more I wanted to make investment comfortable paying higher decisions and manage money. multiples for higher quality “We try to have a businesses. Companies like My wife and I preferred the Google and TransDigm may Midwest to New York so we general sense of the not have been in the portfolio moved to Omaha where a 25 years ago. regional brokerage firm agreed economic to let me do research and try environment, but we WW: I've been paying very to find accounts to manage. close attention to Warren for For the next ten years, I do not want to 40 years. I heard him say early managed accounts as a broker, on that Munger taught him that but I thought I could do a depend on making a great business is worth better job for clients if I could paying up for. In one of his pool the accounts and charge a correct annual reports, he talked about fee rather than transaction- economic goodwill as based commissions. So, I macroeconomic distinguished from accounting started Weitz & Co. in 1983. predictions.” goodwill. Economic goodwill measures the franchise value, G&D: Could you talk about or the ability to charge the specific style of investing at premium prices, because of your fund and your your moat. philosophical approach? G&D: How much of a At an intellectual level, I’ve WW: We try to think like discount to intrinsic value or been aware of that concept for business owners. We believe private market value is 40 years. I’ve also been familiar that the value of a business is required to get you interested? with the idea of picking stocks the present value of the cash as if you only had 20 “punches” the business will generate in WW: We always used to say on your investing ticket. Being the future. Investors use we wanted a 50% discount, able to act that way has only varying definitions of “cash and for years we found that come gradually over time. flow” or “free cash flow,” but kind of bargain. In recent years, Value investors can be drawn we focus on “discretionary we have found ourselves to the “statistically cheap,” like cash flow” – money that could paying 60% or 70%. Valuations a moth to the flame, but be taken out of the business have risen, and it’s possible our eventually the pain of living but which the owner might valuation methods have been with mediocre companies voluntarily reinvest in the too conservative (We use a catches up with you. Learning business. In making estimates 12% discount rate when we do where to draw the line of future cash flows, we have discounted cash flow models.) between paying up for quality to make judgments about the At any rate, we are wary of (Continued on page 8) sustainability of the company’s Page 8
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(Continued from page 7) will try to understand the companies, maybe you would and accepting a flaw because of company’s business model and not build in much buyback. a cheap price is part of the fun the degree to which it has Judgment is required. We of investing. control over its own destiny. eventually get to a model that Then they'll start developing a we discuss among ourselves. I would also say that model. We try to estimate the We argue and develop some management is a major future cash flows that we can level of confidence that we Mr. Weitz discussing his consideration. Warren has said count on. have an approximately correct investment experiences that it is good to buy a appraisal number for the with attendees at the 2014 company that any idiot can business. Omaha Dinner. run, because sooner or later, an idiot will be in charge. Fair That might take a month on a enough. But if we’re buying new company that no one companies that generate “Learning where to knows much about, or it might excess cash, it’s terrific if we take an afternoon if it's an area can trust management to do draw the line we're pretty familiar with and something smart – accretive to between paying up we know the people involved. per share business value – with If a stock has fallen out of bed that cash. Warren Buffett and for quality and for some reason that we John Malone have done believe is temporary, we can wonders with discretionary accepting a flaw act pretty fast on it. cash over the years. Most others have not. because of a cheap G&D: Is there any part of that process you would say G&D: Can you take us price is part of the distinguishes Weitz from other through your investment fun of investing.” investors? process? Perhaps starting from idea generation through WW: Our process is probably establishing a position. similar to that of other value managers. What might WW: The ideas come from all I think the most useful part of distinguish us is temperament. over. We don't do much building the model is making We are not just knee-jerk mechanical screening. We're sure we understand the contrarians, but we are willing aware of a number of relationships among the to be early and out of step companies as a result of variables. We need to know with the market at times. It’s assessing the businesses we what is important to the future often a good sign when own, their competitors, and success of the company and investors and analysts agree the ecosystem. Also, how realistic our assumptions that “the stock is extremely everybody is reading are. Precise predictions are cheap, but we shouldn’t buy it interviews and thinking about not required (or possible). We yet because there might be companies all the time. We believe in the adage: “It’s another bad quarter coming.” pay attention to a handful of better to be approximately other investors that we right than precisely wrong.” G&D: You spoke previously respect. I think the initial idea about how you try to poke may come from any number of Capital structure is also holes in an investment thesis. places. important. Is the balance sheet Is there a way to systematically appropriately levered? How approach that? When it's a company that's much option dilution will we really new to our analysts and face? Can we expect WW: I know that others have new to me, the analysts will opportunistic buybacks? If a process where they assign a read all the filings for the last we're dealing with a Malone devil’s advocate to look for few years as well as transcripts company, I think it's okay to trouble. We don’t formalize of conference calls and assume some stock buybacks that. With a group of eight to investor days. They will read over time. If you're dealing ten of us, each one coming about the industry and talk to with many of today’s tech (Continued on page 9) others in the business. They Page 9
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(Continued from page 8) make no pretense about being or they go sideways for a while from a different place and able to predict the next six or so that business values can background, we are pretty twelve months. For what it’s grow into their stock prices. good at poking at the story. worth, the view that seems We have that debate and, at generally correct to us is that Being reasonably optimistic some point, if we decide we’re the economy is okay, and so about the environment, if the comfortable with our appraisal, companies have some control stock market dropped 10% to we buy the stock. But there over their destinies. 20% tomorrow, we might be often may be multiple rounds Companies with competitive willing to be 90% to 95% of research work that come advantages will continue invested. It wouldn’t take a out of the initial meeting. performing well and becoming move like the one we saw in more valuable, so I’m not 2008 and 2009 for us to get G&D: Could you elaborate on bearish – I’m actually pretty excited about some of the how you view the cash portion optimistic. companies we follow. of your portfolio? Is it optionality on future However, it seems as if stock G&D: How do you define and opportunities or just prices have moved faster than think about risk? Is it in terms representative of a lack of underlying intrinsic values. The of volatility, permanent loss of current opportunities? Fall of 2011 was the last time capital, or some other way? any of us around here were WW: Well, we would be really excited about price WW: It's absolutely not quick to say it’s not a market levels in general. Since then, volatility. Howard Marks has timing call. It’s just a residual almost all our companies have written about this extensively. that comes from selling things done just fine, but their share He explains it so well that I when they get expensive and prices have gone up faster than like to point people towards not finding cheap enough his stuff. He has a new essay replacements. We try as hard that focuses on various types as we can to be fully invested, of risk. It's all about the risk of and the cash represents failure permanent loss as opposed to to find opportunities that we “It’s often a good volatility. really like. sign when investors We love volatility. We try to G&D: What is the range of and analysts agree appraise a company’s business cash that you are willing to value and its likely growth hold? that ‘the stock is path. The stock price should be loosely tethered to the WW: We may hold as much extremely cheap, but business value over time, but as 30% cash. We have one volatility around that value fund that’s allowed to borrow we shouldn’t buy it gives us the chance to buy at a and sell short, and that fund is discount and sell at a premium. currently 63% net long. Most yet because there of the funds have around 20% might be another In late '08 and early '09, what to 25% held in cash at the was then called Liberty Capital moment. bad quarter got down to around $3.50. That was fabulous. The G&D: Do you have a view on coming.’” successor to that is now about where you think we are in the $150. Volatility is terrific. economic cycle? Does that What we don't want is the view impact your portfolio? permanent loss. In that recent Marks essay, he goes into all WW: I’m very skeptical of my their business values. We have the different ways you can own or anybody else’s ability gone from 60 cent dollars to suffer permanent loss. He talks to predict the direction of the 90 cent dollars. It seems very about having leverage risk, stock market. We try to have plausible to me that either liquidity risk, credit risk, a sense of whether we face stock prices drop back down (Continued on page 10) headwinds or tailwinds, but we Page 10
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(Continued from page 9) rates, one popular notion that cable companies borrowed interest rate risk, basis risk, may have been carried too far huge sums to build out their and all those things. Those are is buying “high quality dividend- systems before they had many all variations that can cause paying stocks.” High quality subscribers. Interest costs and permanent damage. depreciation created large losses in the early years. You have people risk too. You “I like Liberty Global However, cable is a have situations where subscription business with low managers push too hard on the because they build “churn” rates, and cable underlings to perform. I think companies developed new that's where you get the out cable systems products (telephone, pay per Enrons and the Worldcoms: view and broadband) that they the frauds. using a lot of could deliver over their existing plant. Cash flow Professionals engage with There are all sorts of ways you leverage, generate each other during the eventually turned positive and can incur permanent loss, but Omaha meetings. huge amounts of the stocks went up several- that's what we're talking about, fold. We had a similar not volatility. free cash flow, and experience with cellular telephone and benefitted when G&D: You’ve mentioned in then buy back lots of the industry consolidated. the past that you view disproportionate overreactions stock.” G&D: Speaking of cable to stock market selloffs as companies, we noticed that ideal opportunities. Given the one of your larger positions is reduction in quantitative companies that are growing in Liberty Global. Could you easing, are you positioned to value may be good investments discuss your general thesis on try to take advantage of a if bought at reasonable prices, that company? potential market reaction? but the success of the strategy will not be based on their WW: I like Liberty Global WW: We joke about that. At dividend yield. Cynical because they build out cable some point, rates have to go managements have raised a lot systems using a lot of leverage, up. It’s inevitable. of cheap capital by using the generate huge amounts of free MLP format to sell over-priced cash flow and then buy back When that happens, some securities that look attractive lots of stock. Their balance people will probably be to unsophisticated investors sheet is highly levered, but surprised and unhappy. We are because of their high current they have a very tax efficient not positioning the portfolios yields. The most extreme case way to generate equity value for a particular market may be those royalty trusts per share. reaction to rising rates. We which will become worthless consider the likely effect on in a few years yet sell at high That's great when you have each company of future rate prices, because of their current Mike Fries who is really a good increases, but we are simply dividend payments. operator and John Malone who trying to hold companies that is making sure that they're are cheap in relation to the G&D: Are there common managing that balance sheet. I future values of the businesses. characteristics in some of your might not be interested in the most successful investments same company if it were run G&D: Do you have a view on over time? by some other people. current popular investment Management makes a huge themes where people think the WW: We have done really difference in all kinds of ideas are good, but they are well trading financials when the businesses and it is critical actually just bad ideas in Fed was raising interest rates. when you're dealing with disguise and may be exposed at We have done very well over leverage. some point? the years with cable TV companies. Investors were They've been very efficient on WW: Over the last several skeptical in the early years as (Continued on page 11) years of unusually low interest Page 11
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(Continued from page 10) They get terrific margins and when that makes sense. We the cost structure. They are their business is almost like a generally won’t have a lot of cost conscious operators and, subscription business. If you advice about how to manage with Malone, you are also are the sole supplier of the business, but we will let dealing with hypersensitivity to seatbelts or some type of them know how we feel about taxes. Their recent merger fastener that has to be bought, strategic direction and capital with Virgin Media provide it can be a great business. allocation. major tax advantages. They have high debt on a per share We like managements that are Management is not going to basis, but the debt is focused and demanding, but it call us for advice in times of compartmentalized in that can be dangerous if there is crisis or of great opportunity, each part is attached to a too much pressure to “make so we want to know them well different system. They hedged the numbers.” Mae West said, enough that we will trust them currency and the interest rate “Too much of a good thing can to make the right decisions in risk. They have paid up in the be wonderful.” Maybe so, but those critical times. last few years in order to lock we try to be alert to the in long term interest rates. possibility that a corporate G&D: You’ve talked about overachiever may be pushing Valeant in the past. Could you We value it in the mid-$50s too hard. share your view of the and the stock is around $40. investment case with and without the Allergan deal? G&D: Many of our readers Would the failure to complete know about Buffett and the deal change your opinion Malone, but are there any “We like to invest in any way? other underfollowed CEOs or management teams that you with managers we WW: Well, it would be great think highly of? if Valeant is able to acquire trust to treat us Allergan. Given the kinds of WW: In the banking world fairly – to treat us as businesses they're in, Allergan the Wells Fargo culture is has been a natural target for impressive. They've had three partners rather than Valeant. I don't know what the or four CEOs since we got odds of success are at this involved a couple of decades necessary evils.” point. They are probably not a ago and each has been a strong lot better than 50/50. leader. They have a culture that's very different from many But if they don’t buy Allergan, other major U.S. banks and they will buy something else. I that's served them very well. G&D: What is your approach get a little queasy when a When certain large banks got in dealing with management company announces an crushed in the 2008 and 2009 teams? acquisition and both the buyer period, we were comfortable and the target go up. The with Wells. WW: We like to invest with implication is that there's some managers we trust to treat us magic there. The “magic” with Nick Howley at TransDigm is a fairly – to treat us as partners Valeant is that the earnings of very disciplined buyer and rather than necessary evils. the target company increase, strong operator with a private We want to know if they have because of Valeant’s cutting of equity mindset, but he's a good, long-term business bloated cost structures. The collecting companies to keep plan and have a sense as to bear case is that they cut too instead of selling them a few whether they will execute it far and there’s no real organic years later like most private well. We want to trust them growth. equity players. He's buying with capital allocation – companies that are typically investing in the business when I do feel as if we're riding a sole suppliers of aftermarket there are good opportunities tiger with Valeant. It's not the airplane parts. Then once he to compound value and to give same as Berkshire Hathaway buys them, they just squeeze capital back to shareholders (Continued on page 12) the costs out year after year. Page 12
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(Continued from page 11) other kinds of payment because we took more risk or a Liberty company. systems, but we were just not than we realized in buying willing to pay the price. Maybe those stocks. Those banks G&D: Has your team looked someday we will. It's always a were often over-levered and at Allergan on a standalone tug of war between the poor loan underwriters, but basis? Would that be a comfort of owning a great they (and we) got away with it Tano Santos and value potentially interesting business and the temptation to because home prices always investing program students investment even if the Valeant buy the statistically cheap rose. Foreclosed properties at the 2014 Value Investing deal doesn't close? business. In the '70s, I bought a could be sold at minor losses Program Welcome Recep- few things that were literally (or sometimes gains) and the tion where the 5x5x5 Stu- WW: Our analyst that net-net Ben Graham stocks. risks didn’t catch up with the dent Value Investing Fund specializes in healthcare has They were cigar butts. banks. Until they did… in 2007 was announced. liked the business, but not the Hopefully I’ve gotten over that. -2009. We foresaw trouble in price. It seems as if the the mortgage business, but we promises they're making now G&D: Can you give an owned some financials that we about how they're going to be overview of an investment that thought were strong enough more efficient, have better didn’t go as anticipated, what to survive and take advantage margins and grow faster are a lessons you learned from that, of the problems of their little too late. It makes you and how it improved your weaker competitors. When wonder why they weren’t investment process? losses came in 10-20x as bad doing that before. as ever before, our “strong” companies were swamped by G&D: What would you say is their losses and we suffered the most important factor for some permanent loss of a great business? capital.
WW: Well, monopolies are From that experience, we great. We also like “It's always a tug of learned to be much more subscription businesses. The imaginative about what can go cable model is a very good war between the wrong with a business. one. They had local comfort of owning a monopolies on pay TV in the G&D: Munger has this past and, although they face great businesses and concept of lifelong learning more competition today, they that he has talked about. What still have great business the temptation to do you do or read to make characteristics. You want the sure you keep getting better all company that has the great buy the statistically the time? Is there some area asset that everybody has to where you think you’ve really have and where you have cheap business.” improved over the years? pricing power. But then those things tend to trade at pretty WW: We read all the time. high prices. Although we like We travel around and see the comfort of having the great companies, and we read. I’ve business at a fair price, which tilted a little more toward Munger talks about, we are WW: Over the years, we business history or biographies really looking for mispriced have had a series of successful lately. A book like The assets. The best of the best trades – buying banks and Outsiders is a good example of rarely look cheap. thrifts after the Fed raised what I like to read. It uses interest rates and those stocks eight case studies to illustrate We've come close on some fell. Six to nine months later, how unconventional managers great businesses like Visa and the Fed always lowered rates can make a huge difference in MasterCard a couple of times again and the financial stocks creating per share value for when there were fears that rallied. I now consider those shareholders. they would be forced to cut trades “bad ideas we got away prices or that they would be with.” They were bad ideas (Continued on page 13) hurt by competition from Page 13
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(Continued from page 12) been able to buy it at a Hopefully by reading about the discount to the present value successes and failures of of its assets, we have. We others, and examining our own don’t know what the Ventures mistakes, our investment team portfolio will own in future has learned to be more years, but we trust discerning and realistic about management, in this case, to the companies we research. make good investments on our behalf. G&D: Is there a more recent addition to the portfolio that G&D: This has been great. you’d be willing to discuss? Thank you for taking the time with us, Mr. Weitz. WW: A spin-off of the Liberty complex, Liberty Ventures, is complicated but potentially interesting. Through a series of acquisitions, Liberty had accumulated stock positions in companies they didn’t really want to keep. In order to extract the value of these assets in cash without incurring capital gains taxes, they sold exchangeable securities that are convertible into those shares. The bonds had 25 to 30 year maturities and very low coupons. But, because of the optionality involved, Liberty imputed a 9% interest cost that they deducted from their earnings. So they have more tax savings than they have coupon costs. They got all the value out in cash by selling these bonds, but they have a negative cost-of-carry. In a sense, they receive additional zero interest loans each year from the government. In 20 plus years, Ventures will have to pay off the principal of the bonds and the deferred taxes, but in the meantime they can invest the cash any way they wish.
Very few people will want to bother to figure this one out, but I think it’s an interesting investment that is really a blank canvas for Malone and Maffei. There has been some speculative interest in Ventures, but when we have Page 14
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(Continued from page 1) anything I could get my hands wouldn't have guessed back Graham & Doddsville on: Greenblatt, Klarman, then that I'd one day be a (G&D): Can you tell us about Fisher, OID, articles and regular speaker at that very your background and how you interviews. At Veritas, we had conference. became interested in a career access to an article database in investing? called Factiva. Any time I'd In any case, within a few come across a value investor months of joining Veritas full- Guy Gottfried (GG): It was or manager that seemed time in 2004, I was promoted during the junior year of my interesting, I'd search for every to sector analyst covering undergraduate studies in article that had ever been Canadian income trusts. It was Toronto when I realized I had written about them and every a solid position for a twenty- to get a good summer interview they'd ever done and four year old, but the more I internship in order to land a just devour them. delved into investing, the more Guy Gottfried desirable job after graduating. motivated I became to excel at Everyone at my school was it, and by 2006 I resolved to flocking to accounting, work for a prominent value marketing, or investment investment firm to further banking, none of which hone my skills. Fortunately, I appealed to me. One of my “I read Security managed to join Fairholme as professors that year, Anthony Analysis, followed that an analyst. Despite having a Scilipoti, was (and still is) a multi-billion dollar asset base, partner at Canada's largest up with every there were only five of us on independent investment the investment team. Everyone research firm, Veritas Berkshire Hathaway else was roughly twice my age Investment Research. I worked and I learned some valuable hard to excel in his class and, letter to shareholders, lessons there. through that connection, was able to summer at Veritas. I and by that point I G&D: How did you get ended up parlaying that into a was hooked on value introduced to Bruce Berkowitz full-time position. and the Fairholme Team? investing. I simply I enjoyed the work right away GG: I knew that I was and toward the start of my couldn't fathom how competing with Harvard, summer position, I decided Columbia, and Wharton MBAs that, if I was going to any other approach with serious work experience, potentially pursue investing, I and here I was with an should learn as much as I could could even be undergraduate degree from a about the discipline. I asked considered investing.” Canadian school that many the president of the firm if Americans had likely never there were any books he could heard of. I recognized that I recommend, and he suggested needed to distinguish myself Graham's Security Analysis. I somehow. With that in mind, read that and followed it up I also went to the very first in 2006 I wrote a with every Berkshire Hathaway Value Investing Congress in comprehensive research letter to shareholders, and by 2005. I paid for the tickets report on a stock in order to that point I was hooked on myself and flew from Toronto illustrate what I could value investing. I simply so I could learn first-hand from contribute and sent it to 12 or couldn't fathom how any other the likes of Klarman, Einhorn, so firms that I thought would approach could even be and Ackman. The cost to be great to work for, one of considered investing; as attend the conference was a which was Fairholme. Charlie Munger once said, "All lot of money for me back then. intelligent investing is value Like a true value investor, I G&D: Can you share some investing – acquiring more than stayed in Midtown Manhattan key lessons you learned while you are paying for." at a two-star hotel, which was at Fairholme? really a quasi-hostel with From there, I gobbled up shared bathrooms. I certainly (Continued on page 15) Page 15
Guy Gottfried
(Continued from page 14) more than the average fund, that it was like nothing I'd ever GG: As I mentioned earlier, I the need to understand the experienced. There was one had long been a voracious insiders' backgrounds, week in particular – the week reader of books, articles, and operating style and capital of October 6 – when every interviews by and about allocation throughout their stock I was following fell 10% a countless great investors, going careers and in different day. I decided that the back decades. I picked up their business environments. valuations I was seeing were unique insights and too good to pass up. perspectives on investing and G&D: You launched Rational I launched Rational in early applied them to my own Investment Group in 2009. 2009 with $500,000 in outside portfolio. My time at Fairholme What factors led you to launch capital from one investor. I reinforced many of those ideas your own firm? knew this would be a difficult and gave me the opportunity climate in which to raise to be immersed in value GG: I'd always had the desire capital, but I figured that either investing every day. to start my own fund and the whole world was coming hopefully one day become a to an end, which was highly For instance, Fairholme respected value investor in my unlikely and in which case reinforced my appreciation for own right. I distinctly you'd be screwed no matter the value of cash. The first remember one day in the what you were doing in life, or reason is obvious: it's better to summer of 2005 when I was this represented an earn nothing in cash than to thinking about the last few extraordinary chance to potentially lose money by market crashes and the exploit some unbelievable making a risky investment that bargains and to start building a isn't up to your standards. strong record. Second, and perhaps less intuitively, cash is a weapon. Since inception, we've When a general market generated net returns of 21% a dislocation erupts or a “When a general year. That compares to 13% compelling individual for the TSX Composite Index opportunity arises, it is only market dislocation in Canada, where the vast those who have cash – majority of our portfolio has precisely when everyone else erupts… it is only been invested over the years. lacks it or is afraid to use it – those who have We've beaten the index by who are able to capitalize. This about 8% annually while was an important concept at cash… who are able averaging 24% cash. Fairholme, and it's a lesson that has served me well. to capitalize.” G&D: How would you characterize your investment Also, one of the attributes that approach and philosophy? originally attracted me to Fairholme's approach when I GG: One of my favorite researched the firm was its investing quotes comes from disproportionate emphasis on tremendous investment Benjamin Graham, who wrote management. At Fairholme, we opportunities that they in The Intelligent Investor, wanted to understand exactly created. I recall reflecting on "Investing is most intelligent with whom we were how rarely these events when it is most businesslike." partnering and to whom we occurred and thinking that the Suppose you were a were entrusting our capital, next time something like that businessperson considering just like any sensible happened, I'd do my best to taking a stake in a private businessperson or private pounce on it. company. What are the investor would want to do. Of questions that you'd ask course, none of this came at After Lehman collapsed in late yourself? Chances are you'd the expense of studying the 2008, the markets’ reaction ask, do I understand this business, industry, accounting, was so severe, and the fear business? Is the balance sheet valuation, and so on. But I'd say and irrationality so rampant, (Continued on page 16) that Fairholme prioritized, Page 16
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(Continued from page 15) start by screening for stocks trusts. Income trusts sound? Am I partnering with with low multiples to their resembled REITs and MLPs in the right people – is earnings or free cash flow. But that their structure allowed management capable and does the most attractive companies to avoid taxation. it allocate capital shrewdly? opportunities often involve However, in a Canadian twist And, of course, am I getting a businesses that are under- that was subsequently barred bargain? earning or even losing money by the federal government, any Bruce Greenwald discusses and that therefore won't be business in any industry could competitive strategy with a And chances are that as a second-year MBA student found in a screen. For become a trust. at the 2014 Value Investing private businessperson, you'd example, when Warren Buffett Program Welcome Recep- probably insist on all of these first invested in GEICO for Since income trusts tended to tion. criteria being met to your Berkshire Hathaway in the trade at premium valuations, satisfaction; it would be too many companies adopted the risky to do otherwise when trust structure, including some tying up your hard-earned “Knowing that you that had no business paying out capital for multiple years. If you all of their earnings. However, think about it, as a long-term can always change if a trust ever reduced or, God value investor in the public forbid, eliminated its dividend, markets, that's exactly what your mind and sell its shares would be cut in half you're doing. Yet in the public like clockwork. When I was markets, people often out of a position still at Veritas, I noticed that compromise on one or more there were almost no of these criteria. For example, creates a subtle, professional investors who they'll say, "This isn't as subconscious systematically sought out undervalued as I'd normally trusts that stopped paying like, but I really like the temptation to loosen dividends or cut them business," or they'll invest in a substantially. This unique highly leveraged or your standards, special situation became a mismanaged company because source of a plethora of it's statistically cheap. That especially when the bargains over the years, happens all the time and it's including several in Rational’s arguably due to the illusion of market is strong, and early days. liquidity. Knowing that you can that's often where always change your mind and Another example involves sell out of a position creates a people go wrong.” dilutive debt recapitalizations. subtle, subconscious Suppose that a company has an temptation to loosen your upcoming debt maturity that it standards, especially when the 1970s, it was mired in red ink cannot pay off or refinance and market is strong, and that's and was facing financial is therefore forced to settle often where people go wrong. difficulties. It is very doubtful that debt with shares. As an I've found that it's rarely worth that GEICO would have shown equity holder, few things are making exceptions and that if up on a computerized screen, likelier to make you cringe you're going to commit your but it was arguably the greatest than your investment being capital to an investment, you investment that Berkshire ever massively diluted. However, a should insist on the complete made. debt recap is like a built-in package. catalyst because the event Because the best investments itself can eliminate the very G&D: What is your process don't necessarily stand out by problems that precipitated it. It for identifying opportunities? conventional means, I try to will often leave companies with look for special situations that a clean balance sheet and be GG: First, you can't do the are relatively unrecognized and accompanied by the arrival of same thing as everybody else underexploited. For instance, intelligent lead shareholders and expect different results; it as I mentioned earlier, I and the replacement of is going to be difficult to find formerly was a sector analyst incumbent management that truly compelling investments covering Canadian income (Continued on page 17) that way. Many investors might Page 17
Guy Gottfried
(Continued from page 16) for $1 billion, for a gain of discussed publicly, The Brick got the company in trouble in $800 million. Consequently, I and Holloway Lodging the first place. Further, since looked further into Riddell and suspended their dividends, firms that need to be found out that in the prior half underwent dilutive recapitalized tend to already a year, he had bought 15% of recapitalizations and had trade at depressed valuations the outstanding shares of excellent lead shareholders and the announcement of the another Canadian public come aboard in conjunction recap will cause their shares to company called Newalta on with their respective recaps. plunge further, they can still be the open market. Riddell, who quite cheap despite the had been a Newalta director G&D: These are great dilution. So here's another case for 20 years, had spent some examples, specifically with how of a situation that causes $65 million on these purchases you identified Newalta. It indiscriminate selling and can at double or triple the price at reminds us of a recent therefore be an attractive which it was trading at the comment from Seth Klarman source of undervalued time. about how "pulling threads" on investments. an existing investment leads to additional investment Another example arises when opportunities. you identify great owner- operators or controlling GG: That's right, and by the shareholders. Brilliant “Brilliant managers way, there's no shame in using managers and capital allocators the same method multiple are rare, and when you find and capital times. It's so difficult to find one, it can pay to ask, "What allocators are rare… truly compelling ideas that you else is this person involved have to take them any way you with?" On occasion, you'll find it can pay to ask, can get them. When I find that this individual may be some way of simplifying the present at other undervalued ‘What else is this process of locating bargains, companies. For example, in I'm unapologetic about reusing 2009, we invested in a person involved it for as long as it works. Canadian energy company called Paramount Resources. with?’” G&D: Can you share with us a Paramount was founded and current idea in your portfolio? remains controlled by a phenomenal owner-operator GG: Holloway Lodging is one in the Canadian energy space of the ideas that I presented at named Clay Riddell. What I delved into Newalta and the recent Value Investing initially drew my attention to found that it, too, was dirt- Congress. Holloway is a the stock is that it appeared to cheap, trading at just 3x to 4x Canadian hotel company that have a single asset that was free cash flow despite having a had historically been worth more than the market near duopoly in its core mismanaged. The company ran value of the company, giving business of outsourced oilfield into severe problems last you the rest of the business for waste management. Rational decade after the financial crisis free. ultimately invested in both and had to eliminate its companies and made dividend (Holloway used to be As I dug into the company, I approximately 170% on a REIT). That obviously hurt. was increasingly impressed Paramount in nine months, and The situation became even with Riddell's capital allocation. 175% on Newalta in a year-and worse in late 2011 when Most notably, Paramount had -a-half. Holloway announced that it leased a significant amount of would have to pay off a acreage in the Canadian oil In exceptional cases, you'll find maturing debenture entirely sands in 2001, before people one security that exhibits with shares, diluting existing were even talking about the oil multiple special situation shareholders by some 90%. sands. Then, in 2007, when the characteristics. For example, The stock traded at $5 at the oil sands were all the rage, it among investments that I've (Continued on page 18) sold a portion of its acreage Page 18
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(Continued from page 17) What makes Royal Host such a and banquet hall, while time of my presentation tremendous opportunity for Holloway's has no food and compared to the $150 range, Holloway? The company was beverage offerings. Yet Royal split-adjusted, before the crisis. very poorly managed for close Host's hotel only generates Our average cost is around $4. to a decade. From 2006 to around 30% more net Along with the recap, an 2013, it had three presidents operating income despite being activist investor took control or CEOs whose average double the size and having the Students in the 2014-2015 of Holloway in 2012, replaced tenure was just 13 months, and food and beverage business. Value Investing Program management, and significantly discuss potential investment the rest of the time it was run Second, Royal Host had a hotel ideas. improved the operations. The by committee with no effective it recently sold in Chatham, company's legacy portfolio is leader prior to the current Ontario, where it was paying performing very well today. chairman. Without adequate nearly double the property Where it gets really management, Royal Host didn't taxes of another hotel in interesting, though, is that pay attention to costs, Chatham owned by a rival Holloway just completed a underinvested in its assets and company. Same city, same type transformative takeover whose generally failed to do the basic of hotel, similar size, and Royal potential I don't think the blocking and tackling of Host was paying approximately market has caught on to. operating a hotel business. $100,000 more a year in Specifically, it just closed the property taxes. Amazingly, the acquisition of another hotel company just never bothered company called Royal Host. to check competitors' Although Royal Host doubled “It's so difficult to property tax records and Holloway's size, it generated appeal its own taxes. Royal less than 20% of its free cash find truly compelling Host has since made these flow due to extreme ideas that you have appeals and was able to receive mismanagement. The deal prior-year refunds for a creates tremendous value, to take them any majority of its hotels and which I'll demonstrate shortly. generate ongoing savings of way you can get several hundred thousand At the time of the dollars annually. presentation, the stock traded them. When I find at 7.7x free cash flow based The magnitude of the cost- only on Holloway's and Royal some way of cutting opportunity at Royal Host's combined trailing simplifying the Host is enormous. Some of results, without any further these initiatives have already adjustments. That compared to process of locating been achieved but have yet to 11.7x for Holloway's publicly- flow through Royal Host's traded peers. If you normalized bargains, I'm trailing financials, let alone the results for actions that are Holloway's, as the acquisition already being taken to improve unapologetic about only closed on July 1. Others Royal Host, the stock would are being worked on as we trade at just 5x estimated free reusing it for as long speak. Holloway is addressing cash flow. as it works.” virtually every major cost item at Royal Host such as property Further, if you ignored Royal management, food, insurance, Host altogether and pretended wages, etc. Overall, Holloway the acquisition never I'll give you a couple of can generate millions of dollars happened, Holloway was still examples that illustrate the in annual cost savings, a valued at 8.4x, equivalent to a mismanagement. Both Royal significant amount for a 12% free cash flow yield and a Host and Holloway have hotels business with $12 million in 28% discount to its peers. In in Yellowknife, Northwest trailing free cash flow. And other words, the market was Territories. Royal Host's hotel none of these measures are giving you Holloway at an has 129 rooms; Holloway's has herculean – this is just the attractive price and throwing 66. Royal Host's is a full- result of running the business in Royal Host for free. service hotel with a restaurant (Continued on page 19)
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(Continued from page 18) assets. Factor this in and you bought 9.5% of the company the way it should be run. I wind up with an estimated on the open market since May. should also add that these are valuation of 5x free cash flow. after-tax improvements, as Then, beyond Royal Host, G&D: How have you evolved Holloway will not be cash Holloway's management is very as a professional investor, and taxable for the foreseeable capable and allocates capital what are some lessons you future. intelligently, as the Royal Host have learned at Rational? acquisition attests. You have a As another case study, for multi-year horizon over which GG: I launched Rational during years Royal Host under- management can continue a very anomalous time when I invested in its most valuable executing accretive deals. If was only twenty-seven years asset, the Hilton in London, Holloway can grow its old, so I was bound to learn a Ontario, which is now portfolio from 33 (including thing or two. I'd say that one Holloway's most valuable asset assumed near-term of my greatest regrets has as well. Management estimates dispositions) to 50 over four been not reaping the that by spending $5.5 to $6 appropriate rewards on some million renovating the hotel, it of my highest-conviction ideas, can boost net operating and that relates to the issue of income by $1.5 million per portfolio concentration. annum. At a 9% cap rate, you'd “...just one get a $17 million increase in It's fashionable to say you're a property value on a $6 million unnoticed or concentrated investor, but in investment. practice it's very challenging. misinterpreted detail Rejecting an investment that Royal Host also has numerous can result in making clearly has a poor margin of hidden assets: it has a hotel safety is easy. The hard part is near Toronto's Pearson the wrong finding an idea that actually is Airport which only earns cash attractive and still turning it flow (net operating income investment or down because it isn't up to less capex) of $300,000 to your high standards and you $400,000 a year, but could passing up the right can do better, be it by adding probably be sold for $15 to your current best holdings million due to its real estate one.” or by waiting for future value. If Holloway can divest opportunities whose timing this property and redeploy the you can't know, but which proceeds into hotel invariably come around from acquisitions at a 10% cap rate or five years, think about what time to time. That takes great with a 55% LTV mortgage at free cash flow will be then. discipline. 6%, it would add $2 million to Ultimately, this stock will trade its free cash flow. And again, at a low single digit multiple, G&D: What is the size of we're talking about a company which is hard to find in any Rational's team now? with $12 million in trailing free business nowadays, let alone a cash flow, so each of the real estate heavy company GG: It's just me and our CFO. actions I've discussed will that's very well run and has It's unconventional, but I'm a provide a sizeable boost. years of growth ahead of it. control freak when it comes to There are likely $20 to $25 What'll the stock be worth at the research process and being million in disposition that point? Should it trade at entrusted with other people's opportunities in Royal Host's 8x, 10x, or 12x? It's hard to capital. I'm very cognizant of portfolio. say, but it doesn't really the fact that just one unnoticed matter; the point is that your or misinterpreted detail can So you have this huge growth margin of safety is huge and result in making the wrong opportunity due to the Royal that it's hard to find a scenario investment or passing up the Host acquisition that won't where the shares don't right one. Don't get me take anything heroic to realize; skyrocket. And insiders seem wrong, our due diligence is it's just cutting costs and to agree: six of them have (Continued on page 20) capitalizing on under-earning Page 20
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(Continued from page 19) unheralded is the tremendous Imagine that a market heavily dependent on the focus and productivity he dislocation arrives and instead knowledge and insights of an achieves on a daily basis by of being able to take advantage, extensive network of people, structuring his life so that he you're forced to use your cash including management teams, can virtually always do what he to meet redemption requests industry specialists, fellow enjoys and actually wants to from panicky investors while investors, and others who may do. I think I still have a long the opportunity passes you by. Bill Ackman converses with be familiar with a given way to go before I perfect this, Not only is it counter- guests at the 2014 Omaha business. You can't attain and but that's how I try tried to productive, but also Dinner. sustain the necessary arrange things here as well. psychologically, the anguish and conviction level in an helplessness of being investment entirely on your handcuffed can leave you own. People are a critical part “It's fashionable to vulnerable to becoming of the process; it's just that for irrational and making bad us, it's been more external say you're a decisions. It is much easier to than internal in the form of cope with temporary losses having a team of analysts. That concentrated when you feel that at least said, I certainly wouldn't rule investor, but in you're capitalizing on the out adding an analyst or two environment. over time under the right practice it's very circumstances. G&D: We noticed you are challenging… The one of the key speakers at G&D: Other than your Canada's Capitalize for Kids presentations at the Value hard part is finding Investor Conference this Investing Congress, you tend October. How do you view to keep a low profile. What is an idea that actually this philanthropic endeavor? your view on publicity as an is attractive and still investor? GG: There are countless turning it down prominent investing GG: Actually, even the conferences in the US, so this Congress opportunity came because it isn't up to may be hard to believe, but about by happenstance, after I Capitalize for Kids is probably was introduced in 2011 to the your standards… the first large-scale investment organizer, John Schwartz, by a conference in Canada, let mutual friend. But you're quite That takes great alone one that is devoted right, I do tend to keep a low discipline.” entirely to a philanthropic profile. Rational doesn't have a cause. What attracted me to website and it isn't unusual for Capitalize for Kids when I was me to be contacted by One of the advantages of not first contacted about it by Kyle prospective investors doing much marketing is that MacDonald, one of the co- apologizing for calling or the people who do tend to founders, was that it targeted emailing me directly because locate you are more likely to specific areas within The they couldn't find any other be like-minded investors. I'm Hospital for Sick Children in contact information and asking really thrilled with Rational's Toronto that it identified as me to forward them to our IR capital base – we have being underfunded or in need person (which, of course, we unbelievable partners. It's very of special attention. The folks don't have). easy to take such things for at Capitalize for Kids put a granted, but it's important to great deal of thought not only I've worked hard to structure stress that regardless of your into organizing the conference my life and work in a way ability as an investor, you itself, but also into how to best where I can focus on being won't be able to execute your allocate the proceeds. I was efficient, eliminating waste and strategy successfully over the impressed by that. clutter and being in total long haul without a stable control of how I spend my capital base. time. Of all of Buffett's great (Continued on page 21) attributes, one of the most Page 21
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(Continued from page 20) sure turns some people off. I G&D: Can you share any could go on, but you get the advice with our readers? idea. You'll go farther in the long run – and have a great GG: In one of his old deal more fun – if you do what partnership letters, Buffett resonates with you instead of makes the important point that worrying about convention and in investing, there's a difference how you look in the eyes of between being conventional others. and being conservative. Since convention is dictated by the G&D: That is a valuable piece crowd, following it will of advice and a great way to frequently lead you in the conclude our interview. Thank wrong direction. This is in you for your time, Mr. keeping with his philosophy of Gottfried. having an internal scorecard – of doing what makes sense to you and judging yourself by your own standards rather than the standards of others. This has been a guiding principle for me in building Rational. I've often done things that didn't exactly help our marketability because they were right for me and enabled me to create an environment that was suited to my investing philosophy and personality. For instance, Rational has never engaged in short selling. Some allocators consider this blasphemous, and there's no lack of managers who short mainly to justify their fees. Personally, I consider it virtually impossible to find any short that can come close to matching a well-researched long; not only is the upside capped and downside unlimited, but even those who do find great shorts tend to size them so small that they'd arguably be better off avoiding them. Sure, shorting can reduce volatility, but over time it's nearly destined to underperform. There are many ways to get to heaven in the industry, but that's what makes sense to me.
Similarly, I don't have a team of analysts for the reasons I articulated earlier, which I'm Page 22
B&M European Value Retail SA (LON: BME) - Short
Sisy Wang [email protected]
Thesis Key Statistics B&M is an over-hyped IPO story stock (“Dollar General of the UK, with Tesco management as chairman”). At 25x FY14 and 20x FY15 Share Price (10/7/14) £ 265 Sisy Wang ’16 EV/EBITDA, the stock price is discounting very bullish assumptions Revenue (FY14 - March) £ 1272M around TAM and market share relative to a small and saturated UK Sisy Wang is a first-year MBA market. Meanwhile, saturation of the concept will intensify competi- Adj. EBITDA margin 10.2% student at Columbia Business tion and drive down margins (at peak today). There is also a stock Market Cap: £2650M School. Prior to CBS, Sisy was lock-up that expires Dec 2014. an Analyst at Delaware Enterprise Value: £3030M Investment’s Emerging Markets Background 3-month avg. daily volume: 4M Fund and a pre-MBA Summer B&M is the #2 UK general merchandise discounter (pound store) FY15 EBITDA (my estimate): 20x Analyst at Plymouth Lane by sales, with a similar operating model as dollar stores in the US. Capital. Pound stores’ value proposition is price + convenience. They have a small number of SKUs (3000-5000 vs. 30K for a discount store), which allows them to sell only the most profitable SKUs (highest turn consuma- bles, highest margin general goods). B&M was acquired by two brothers in 2005, and the store base has grown 18x since (21 to 373). IPO’ed in June 2014. CD&R bought half of the company in 2013 from management and installed Tesco’s ex- CEO Sir Terry Leahy as Chairman.
Competitive Landscape – why B&M is not the next Dollar General DG benefited from white space in the US – small, rural populations that were not profitable enough for big box. Given the country’s large size, DG and FDO could grow profitably within their own geographies with- out much direct competition. Dollar stores mainly gained share from grocery stores, a fragmented and less-
efficiently run group. Operating Metric Comparisons The UK retail landscape is much smaller and more B&M PLND DG FDO concentrated. 50% of the UK population shops Store count 373 458 11,215 7,916 for non-food items in just 90 locations. Unlike in the US, the grocer space is concentrated (Big 4 Sq ft / store 14,145 5,143 7,400 7,200 Sales / store £3,410 £1,922 $1,561 $1,313 has ~75% share) Gross margin 34.0% 36.7% 31.1% 34.2% Pound stores also face 2 sets of unique competi- EBITDA margin 10.2% 4.9% 11.8% 8.8% tors that US dollar stores didn’t have: grocery discounters (Aldi, Lidl – a category that largely Turns (on Tang IC) 7.4x 19.5x 5.6x 4.5x doesn’t exist in the US) and the “express” ver- PP&E as % sales 5.1% 4.3% 11.9% 16.7% sions of Tescos (Wal-Mart and Target are later to NWC as % sales 8.3% 0.8% 6.0% 5.5% small format convenience stores vs. UK big box CROTIC (EBITDA / Tang IC) 76.0% 95.7% 66.2% 39.6% retailers). Net Debt / EBITDA 2.9x (0.3x) 1.4x 0.4x Within pound stores, competition is also fiercer. The sector as a whole doubled store count since 2008 (+1,100 stores total), and the main players are plan- ning to double store count again (implying UK pound store penetration at 3x that of the US on a % of retail sales basis). Converging geographical expansion: B&M stores are mostly in Northern UK / Midlands, but they are now expanding into Southern UK. As they expand, they will face more competition from Poundland (national player) and 99P (Southern UK focus), who are in turn starting to enter B&M’s geographies. Recession retail bankruptcies created a one-time land boon for pound stores (around 1/3 of B&M’s leases today). However, bankruptcies peaked in 2012 both in number and size. Going forward, B&M will face a lot more pressure on finding cheap leases (rent at 4% of sales is much lower than older competitors).
Management & PE Cashing Out IPO was 93% secondary with both management and PE halving their stakes. Although CD&R has a track record of creating value, they held this investment for only 1 year (doubling their money). The extent of their value-add seems to include a small German acquisition (to sell a longer- term international story) and installing ex-Tesco CEO, Leahy, as Chairman. Leahy (ex-Tesco) holds no shares in B&M. He is a CD&R advisor and owns shares in the 2009 fund. He sits on the board of 4 other companies (2 of which he actually is a significant direct investor). US margins from the low-20s to the mid-/high-20s is just now getting started in IssueVolume XXII I, Issue 2 Page 23 B&M European Value Retail SA. (Continued from previous page) Valuation Even putting aside issues on competition, the current valuation barely justifies the most bullish long-term growth assumptions Valuation methodology: I focus on the time it takes for the stock to re-rate to a reasonable multiple (I use DG’s 10x EV/EBITDA from before the M&A talk) and where CROTIC (cash ROIC) will go. I assume 50 stores per year (management’s goal is ~40). High Case: To stretch the bull case, 8 years for the multiple to erode to a normalized level and CROTIC to expand to 100% (beyond PNLD’s 96%). This is a scenario where B&M outcompetes its competitors to become one of the dominant players in the UK, thus retaining profitability as it grows. Low case: 3 years for the multiple to erode and CROTIC to mean revert to 60% due to market saturation, increas- ing competition, and less profitable geographies (still a good return vs. DG’s 66%, FDO’s 40%).
Catalysts CD&R’s 180 day lock-up expires Dec 2014 Growth slows due to less available space (fewer bankruptcies) High margins mean-revert due to competition and industry saturation
Risks Continued strong growth in short-term from new store opening. Strong return profile / cash flow generation – management has set dividend payout at 30-40% ratio Technical risk: B&M may get added to FTSE 100 index if market cap reaches £3 billion Page 24
Countrywide, Plc. (LON: CWD) - Long
Kevin Lin [email protected]
Recommendation Market Overview Buy Countrywide (LSE:CWD) equity with a 12/31/18 base case price Stock Price (10/8/14) £4.73 target of £8.35. This represents ~90% upside from the current share Shares Out (Diluted) 226 price, including dividends. The investment thesis has five main points: Equity Value £1,067 1) Countrywide should benefit from a recovery in housing transac- Less: Cash (44) Kevin Lin ’16 tion volumes in the U.K., which currently sits ~15%-20% below Plus: Debt 118 historical levels Enterprise Value £1,141 Kevin Lin is a first-year MBA 2) The cost structure has changed post recession, with ~40%+ student at Columbia Business incremental margins and long term margin targets well in excess Current Valuation (Consensus) School. Prior to CBS, Kevin was of prior 2006 peak an associate at Sansome EV / 2014E EBITDA 9.0x Partners, a long only family 3) The business will generate high FCF (~£400m over next 5 Price / 2014E EPS 11.8x years), and the Company has directed 35%-45% (but up to 70%, Dividend Yield 2.4% fund. barring any acquisitions) of net income to be returned to share- holders 4) Countrywide continues to find opportunities to “roll up” rental businesses at 20-25% return on acquisitions (within 2 years) and believes there is room to double its market share over time 5) Management incentives are aligned with shareholders, with options based off EPS and TSR targets Business Description Countrywide is the largest real estate agency in the Revenue / EBITDA Breakdown (LTM 6/30/14) United Kingdom, operating ~1,370 branches and 47 100% brands. The Company has 6% market share of UK LSH LSH Conveying housing transactions, followed by LSL Property Ser- 90% Conveying Surveying Surveying vices (3%) and Connells (estimated ~3%). The Com- 80% Financial pany was acquired by Apollo in 2007 (Oaktree and 70% Financial Alchemy took stakes in 2009), and IPO’d on the 60% £660.5Lettings London Stock Exchange in March 2013. LTM Lettings 6/30/2014, Countrywide generated £661 million of 50% £105.2 London & 40% £105.2 revenue and £105 million of EBITDA. Premier Countrywide is the dominant player in a cyclical 30% London & Premier industry that is operating below historical norms. 20% Following the recession, the Company restructured, Real Estate reduced fixed costs, and improved employee 10% Real Estate productivity. In addition, the Company has diversified 0% by growing its lettings (rental) business, which is Revenues EBITDA countercyclical to transaction volumes and now accounts for ~1/4 of EBITDA. I believe Countrywide has significant operating leverage and will be able to generate strong earnings growth as the market recovers. The Company enjoys economies of scope (provides surveying, conveyance, and financing ser- vices in conjunction with real estate brokerage) as well as economies of scale (national back office infrastructure). Combined with low capex requirements, good reinvestment opportunities, and strong shareholder alignment, I believe Countrywide can compound at double digits over the next 4-5 years. Investment Thesis 1) Rebound in Housing Transactions Transaction volumes in the UK were ~1 million in 2013, and are estimated to be ~1.2 million this year. This com- pares to long term averages of ~1.4 million (after factoring out the number of transactions associated with increas- ing home penetration levels). Residential investments sit at 4.0% of GDP, compared to 4.5%-5.0% pre-recession (7% at peak), and UK household turnover has fallen to 4.1%, versus an estimated 6.9% average since 1971. The current rate implies households will now move every ~25 years versus every ~14 years pre–recession. As UK’s economy recovers over the long run, I believe credit will loosen and the volume of transactions will move closer to the norm. In addition, the government has signaled its support for first time home buyers through its Help To Buy programs, and UK’s own Office for Budget Responsibility forecasts >1.5 million property transactions by 2018. The Royal Town Planning Institute also suggests that there may be a ~375,000 shortfall in UK households. 2) High Incremental Margins Coming out of the recession, Countrywide has reduced its fixed cost base by closing unprofitable branches, con- solidating its IT infrastructure, and outsourcing back office functions . Incremental margins over the past 3 years IssueVolume XXII I, Issue 2 Page 25 Countrywide, Plc. (Continued from previous page) are in the neighborhood of ~40% (the Company guides to 40%-60%, exclusive of investments in personnel that are cur- rently ramping up). Incremental margins are high since the current infrastructure can support higher transaction volumes , and only ~half of staff costs (56% of revenues) are variable (though it will begin to fall if volumes come back in such a way that additional headcount is needed). 3) Free Cash Flow and Shareholder Returns Countrywide has historically been a very capex light business, but will be ramping capital expenses for the next 2 years to implement its IT transition (~£20m a year). Post this, capex is expected to tail off. I believe the Company will be able to convert ~90% of its net income to FCF as provisions wear down over time (2014E FCF yield of ~6%). On the first half 2014 call, Countrywide stated it would return 35-45% of net income back to shareholders, and up to ~70% barring any major acquisitions. In July, the Company declared a special dividend from the liquidation of a portion of its Zoopla stake (recently IPO’d real estate portal CWD owns ~4% of). The Company also commenced a £20m share repurchase program on October 1st. 4) Investment Opportunities Post IPO last year, Countrywide’s debt has fallen to less than 1x net leverage. The Company is using FCF and a new term loan to buy up lettings agencies (in conjunction with its own organic growth in existing real estate branches). The Compa- ny made 28 lettings acquisitions in 2013 and 16 in the first half of 2014. Management believes the opportunity to roll up small lettings businesses will persist for years. Countrywide targets a 20% to 25% return on acquisitions in the second full year of ownership (and which management confirms they are in line to achieve). The Company is able to acquire at such low multiples since 1) it changes the cost profile of the acquired business by stripping out and outsourcing the costs (sometimes the entire business is lifted into an existing branch), and 2) it has tons of visibility into the lettings market, and acquires businesses that are currently under- priced and have room to increase rental fees over time. 5) Management Incentives 2/3 of long term share incentive awards (up to 300% of salary) are subject to absolute EPS targets. “25% of this part of an award will vest for EPS of 57.6 pence increasing pro rata to 100% vesting for EPS of 70.4 pence for the year ending De- cember 31, 2016.” The remaining 1/3 is based on relative TSR versus the FTSE 250, with 25% vesting if performance is the median of the group. Key Risks The UK could very well be in a new normal where housing transactions are permanently below historical averages. How- ever, the shares don’t appear to be too expensive even at 2014’s estimated 1.2 million homes, and both commissions and lettings should serve somewhat as a natural hedge in a lower-level environment. Discount brokers could potentially take share, but I believe people will inherently want an agent to be involved in the sale of a home (~90% of sellers are fairly/ very satisfied with their agents). The UK has already has one of the lowest commission rates (1.5%, vs. the U.S. at 5%-6%) in the world , so online brokers like Redfin seem to be less economically viable. In the UK, property portals Zoopla and Rightmove control the market and charge real estate brokers monthly fees to list homes on their sites. The companies have been increasing ARPA rates at double digit percentages due to their dominant positions. I believe a 10%-15% increase in rates would increase Countrywide’s advertising costs by ~£1 million. To combat this, six real estate agents (including Savills) have gotten together to launch an alternative (non-profit) 100% agent owned portal. The portal plans to launch in January with ~5,000 participating branches, and should alleviate the existing duopoly pricing pressure. Valuation My £8.35 price target is based on roughly 14x 2018E diluted EPS £0.58. I assume transaction volumes return to 1.4 million by 2018, commission fees fall from ~1.75% to 1.5%, while average prices post 2014 increase at 2% (this compares to OBR and Savills projections at 3.5%-4% pricing growth). For London and Premier, I am predicting 2% pricing and transaction growth and flat commission rates. I model incremental margins at 35%, falling to 30% over time, and assume the Company keeps leverage at 1x net, using FCF to buy back shares and make tuck in acquisitions. Barring another global meltdown, I believe a downside case could involve a new “normal” of ~1.1-1.2 million transactions, no growth in price or transaction volumes, and a higher stabilized commission fees. At a 12x 2018 exit multiple, I believe investors could still achieve a high single digit IRR. Restated Projected 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E Revenues £477.9 £509.1 £524.7 £584.8 £705.3 £730.8 £755.8 £780.1 £803.9 % Growth 6.5% 3.1% 11.4% 20.6% 3.6% 3.4% 3.2% 3.0% Total EBITDA £63.6 £56.4 £63.0 £86.6 £120.2 £133.3 £146.8 £159.6 £172.9 % margin 13.3% 11.1% 12.0% 14.8% 17.0% 18.2% 19.4% 20.5% 21.5% Diluted EPS -£0.05 -£0.02 -£0.02 £0.17 £0.34 £0.40 £0.45 £0.51 £0.58 % growth 104.8% 16.4% 14.6% 12.6% 12.4% Free Cash Flow -£91.6 £0.3 -£16.0 -£38.3 £39.6 £45.0 £54.2 £59.6 £67.5 Page 26
Development Capital Partners
(Continued from page 1) neur. I wanted to financially That firm was the originator of the Peace Corps for two years. back and invest in lots of differ- a whole variety of investment In the Peace Corps, I had in- ent businesses, participating in partnerships, which all tended tended to pursue a career in a whole portfolio of creative to have something to do with economic development. While activities, rather than just tak- corporate reorganizations, there I observed that there ing a concentrated shot at one activist investing, mergers and were an awful lot of smart, thing. acquisitions, risk arbitrage or well-intentioned people in the Development Capital event-driven marketable secu- field of economic development, Partners Team That interest continued to rity purchases. There was a (from left to right): but collectively there were grow in the next few stages of little bit of private investing, Jason Yang ’14, very few practical skills in the my career. I went from doing but for the most part it was a Gordon McLaughlin ’11, community. It was full of PhDs that with the New York entity, private investing approach to Paul Tierney, in Economics and Political Sci- to helping start a merchant marketable securities. Matt Magenheim ’11, ence but had very few people bank in London, which in turn Matthew Tierney ’02 with training or experience, financed lots of entrepreneuri- It was pretty successful. In the
the sorts of things that make al activities worldwide. Then, late 90s, we decided to shut privatizations work, or that after spending one year in the down the partnerships that we enabled cooperatives of small, federal government on a quix- had with outside limited part- poor farmers to make a living. ners and I began a private of- fice to invest my own capital After leaving the Peace Corps, together with friends and part- I won a Ford Foundation fel- ners that I had known. I formu- lowship to go to graduate “I made an lated an emerging market spe- school. There were about ten cialty investing my own and other winners and all of the important decision, some friends’ capital outside of others went into programs in the United States — usually in Political Science and Econom- that instead of being conjunction with local partners ics. I chose to go to Harvard or money managers in those Business School, which was a an entrepreneur and countries. We spread from very suspect decision to the China to Russia, then Latin fellowship. Consequently, I had building or starting a America. Then about five years to take extra courses and find ago, I started focusing on Afri- a mentor at the Kennedy business, I would be ca. School. a financial Part of my reason for being Through the program, I be- entrepreneur. I interested in Africa was the came very interested in entre- fact that I had been Chairman preneurship and investing. I wanted to financially of TechnoServe for a long started a PhD Program at Har- time. TechnoServe is a not-for- vard, but never finished it be- back and invest in profit organization that does cause I started working at an lots of different economic development work investment firm in New York. in Africa, Latin America, and That’s about the time when I businesses.” India. It started in Ghana and is got more interested in invest- now in 33 different countries, ing. most of which are in Africa. I’ve had a long-standing in- Since I can remember, I have volvement in Africa and an on- been interested in creative otic venture, I joined White the-ground experience with it. things: the creation of value, Weld, an investment banking the creation of new entities, firm in New York. I was a jun- Due to my long involvement in the creation of new businesses. ior partner of that firm until the region and what I observed At that time I made an im- we were acquired by Merrill there, I thought Africa was the portant decision - instead of Lynch, at which point I left to place that had the greatest being an entrepreneur and start my own firm with two opportunity and where I had building or starting a business, I other partners. (Continued on page 27) would be a financial entrepre- Page 27
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(Continued from page 26) were happening in emerging Matt Tierney ’02 (MT): the greatest personal interest. and frontier markets. Ultimate- DCP was created to employ a And so three years ago, the ly, I decided to go back to similar investment strategy to four of us began Development school to try to find an area in what Paul, Gordon and I had Capital Partners. emerging and frontier markets been doing, but was organized to apply the security analysis as a new entity to bring in out- Gordon McLaughlin ’11 skills that I had been develop- side capital and be a standalone (GM): When I was in high ing. That's how I ended up at business. I knew I liked Gor- school I worked part time in- Columbia Business School and don when I first met him and I stalling software systems in the in Paul’s class on investing and found out he had run a person- homes of Radiologists so that entrepreneurship in Africa. al stock portfolio since high- they could view images from In Paul’s class, I was exposed school. home at night as opposed to having to work “on call” at the You'd asked how we got inter- hospital. I became so interest- ested in investing. I grew up in ed in the software and hard- a household where investing ware I was installing that I “We quickly became was talked about a lot. My opened a brokerage account more and more brother, sister, and I would sit and invested a few hundred around the table on Sunday dollars in two of the compa- interested in Africa night at dinner, and Paul would nies that owned the technolo- be talking about a deal that gy. Eventually my consulting after we saw a lot of was being done. gigs dried up, but I ended up making more money on the the macroeconomic There are two things that got companies I’d invested in. That me to where I am with DCP. experience really planted the changes taking One, I have been interested in seed of my interest in invest- place, which entrepreneurship and investing ing. since a young age. Two, I have eventually led to the a passion for international af- My first real professional role fairs and emerging markets. I after college was working for formation of DCP.” went to Georgetown, where I an economic consulting firm studied international relations providing valuation analysis on with a concentration and focus patents, trademarks and early on Latin America. After under- stage technologies. But I always to CEOs running highly profit- grad, I wanted to gain experi- knew that ultimately I wanted able companies across Africa. I ence in emerging markets, so I to get into the investment in- was also able to study the in- worked for TechnoServe in dustry and make decisions as a vestment management industry Peru for a year. I ended up principal as opposed to as a in Africa and observed that the working with small businesses, service provider. relative intensity of competi- primarily in the agricultural tion of investment manage- space, that TechnoServe was After a couple of years of con- ment in Africa seemed less consulting with, both in Peru sulting, I joined an investment than in other geographies. and across Central America. manager in Chicago called Se- curity Capital, which is part of All of these observations about During my second year at JP Morgan. At Security Capital Africa were very appealing to TechnoServe, I focused on I was able to get formal train- me. By the time I hit my last Africa and conducted cost- ing in the areas of investment semester at Columbia, I was benefit analysis of Tech- research and security analysis. I quite keen on the opportunity. noServe’s programs across the also spent a couple of years in I started spending three days a continent. I had been to Africa London leading an effort for week working with Paul and before, but that was the first Security Capital researching Matt Tierney identifying invest- time I spent a lot of time there real estate companies across ments in Africa, and that led to professionally. I realized rather Europe and Asia. The interna- my involvement in helping to quickly that there's only so tional work allowed me to form DCP. (Continued on page 28) witness a lot of the things that Page 28
Development Capital Partners
(Continued from page 27) perfect information, but it was on and so forth. Here it would much you can learn from an stimulating, rewarding work. have been an easier task. analysis standpoint at a non- And during my time there, I profit, so I joined an analyst quickly recognized that these While sophisticated financial program at Credit Suisse in markets would offer some of analysis is an important part of New York. I worked in the the most attractive financial what we do, the ability to get global corporate finance group returns. data and information to inform Bruce Greenwald, Wally for a few years, before going your assumptions and view of Weitz, and Tom Russo at to Columbia Business School. My career path was somewhat the business and management the 2014 Omaha Dinner. I graduated in 2002 and joined backwards in that my financial is a more important differenti- Paul and a couple of other analysis skills were mostly de- ator. Of course, you never folks to help start a health care veloped after Mongolia, during want to take a framework or venture capital initiative called my time at Morgan Stanley and lens from one country or mar- Aperture Venture Partners. I ket and apply it blindly to an- enjoyed doing venture capital other, but I believe there are deals, but after several years, I “While sophisticated skills beneficial for investing or realized that health care was doing business in imperfect, not something that I wanted to financial analysis is inefficient markets that can be spend the rest of my life on, an important part of transferred across geographies. and I missed the emerging markets aspect of what I'd what we do, the After Columbia Business previously done. School, I knew I wanted to ability to get data focus on emerging markets Thus in 2008, Paul and I start- investing. Given the nearly four ed talking more about what we and information to years I had spent living and could do in emerging markets, working in Central and South- and began investing our own inform your east Asia, I was leaning to- capital through various means, assumptions and wards Asia. However, as part by taking direct or indirect of Paul’s class, I traveled to positions across EM, in both view of the business Ghana to work on a project public or private opportunities. with a mortgage company Then we quickly became more and management is based in Accra. I added two and more interested in Africa weeks in East Africa to my trip after we saw a lot of the mac- a more important and spent the time both on roeconomic changes taking safari and meeting numerous place, which eventually led to differentiator.” medium and large companies in the formation of DCP. Tanzania and Kenya. I was im- Columbia Business School. pressed by the managers I met Matt Magenheim ’11(MM): However, I believe my earlier - from a banana beer entrepre- My passion for emerging mar- jobs overseas provided much neur to the CEO of a major ket investing was developed more valuable learning experi- East African bank - and the early in my career. Six months ences. These jobs trained me opportunities for growth they into my first job, I was sent to to build contacts and find data saw. I came home and imme- Madagascar to work with the and information in developing diately began to focus my job Malagasy government on an countries, a task which is much search on Africa-focused in- undersea cable project. After- less straightforward there than vestment firms. wards, I spent 15 months in it is in the US. For example, Mongolia setting up two busi- when I needed to find staff for Following graduation, I joined nesses for a MENA (Middle our halal abattoir in Mongolia, I Allan Gray, a Cape Town East-North Africa)-based in- had to visit a funeral in a town based asset manager that was vestment group. I was hooked with a large Kazakh population attractive for the quality of the by the massive opportunities in order to speak with the investment team and the firm’s and challenges that these mar- local imam. He referred me to value-oriented strategy. I kets provide. It was difficult to someone, who then referred worked there until I got a call land in a foreign environment me to someone else … and so (Continued on page 29) with limited contacts and im- Page 29
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(Continued from page 28) not set up to allow the easiest New York. The access to in- from Paul about what the team raising of capital, but we didn't formation is getting better. was planning in DCP. The want to compromise the struc- There are publicly available chance to work with these ture of the fund in order to documents that you can pull guys was too good an oppor- make it easier to market. from Bloomberg. You can get tunity to pass up, and I was We wanted to be able to make them off websites, but that soon on a plane back to New good, long-term investments information is often limited. York. with high rates of return and There are several companies not have structural impedi- which only give half year or G&D: Your investment philos- ments get in the way. annual results. Those are the ophy is probably a little differ- types of companies where you ent than some of the tradition- GM: At the heart of it, we have to actually go and gather al value managers that we have really formed the partnership more information. Aside from featured over the years. Could to invest in the best companies the analytics and the numbers, you give us an overview? and the best management it's really important to go and teams at the best price that we decide if management is good PT: Well, we are similar to or not. That's where our net- other value investors, but per- work comes into play, which is haps different than other inves- really helpful. It's not just tors in Africa, in that our pri- “At the heart of it, meeting the CEO; we look to mary focus is on a concentrat- understand mid-level manage- ed portfolio of publicly traded we really formed the ment, the board’s corporate long positions. We normally governance policies and other have 20 to 25 positions. partnership to invest factors in finding strong, for- tress-like companies. Because we deal in markets in the best with a lot of volatility, we have GM: I would add that another an initial two year lockup on companies and the element of the diligence pro- the capital. It was my feeling best management cess that's somewhat unique is that the fund structure would accessing publicly available in- make it more difficult to raise teams at the best formation. Information is theo- capital, because people want to retically available to all, but it believe that there is daily li- price that we could sometimes takes extra work quidity even if it doesn’t always to access in Africa. Even for exist. We are allowed to have find.” simple things like finding long up to 20% of our partnership histories of annual reports, capital invested in non-quoted sometimes you have to go securities. We didn't want to could find. The philosophy is knock on the broker’s door in pass up special investment op- not terribly different from order to find an actual hard portunities that we wouldn’t what you would find in the copy from six years ago. Some- be able to cover, nor did we value investment community. times you can call someone want to do them on the side When we decided to form the sitting in Lagos and have it with some carve-out where partnership, we said we just scanned to you in a 100 mega- the general partner could do wanted the 10 to 20 best long- byte documents. These things some things in the partnership term investment ideas we can be frustrating at times, but and some things out. All four could find in Africa. we think they enhance the of us have extensive relation- potential of a strategy like ships all over Africa. If one of G&D: Tell us a little about ours. them happened to be a great your investment process and chief executive officer running the diligence you perform. PT: You can’t have it both a company where all we could ways. You can’t have the bene- do is invest privately, I didn’t MT: There is certainly a lot of fits of being in an inefficient want to let that go by the travel involved. There are simi- market with maybe a little low- board. larities to the analytical pro- er level of competition and
cess, which we do here in (Continued on page 30) Our partnership was certainly Page 30
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(Continued from page 29) market efficiency or decreases public offerings have taken also have access to easily ac- in potential opportunities? Do place and markets have risen, cessible information. This is you think that there's still a there's more competition probably a generational thing, long runway to finding mis- there. It's similar to elsewhere but I'm amazed at how much priced securities? in the world when good com- information is available even if panies start to show what they it's somewhat difficult to ob- PT: I think there's still a long can do and capital markets are tain. Ten or fifteen years ago, runway, but there's also been broadened, more and more you couldn't do what we’re more capital and more atten- money flows into them. The doing now. tion being paid to the region. dynamism of the region cre- The whole region from the ates a continuous stream of MT: Even five years ago. Middle East down to South opportunities. Paul Hilal ’92 at the 2014 There's been a really big Africa is dynamic and the op- Omaha Dinner. change in the level of interest portunity set changes on an MT: Obviously there are 54 in Africa, especially in the US. I ongoing basis. Periods of fear countries and they're all quite think Europe definitely had and optimism tend to get exag- different. There's not too more interest in Africa from an much correlation when you investment standpoint. About look across regions in Africa. five years ago, I remember Dislocation in one country going to a conference and “You can’t have the from a macroeconomic stand- there were maybe twenty peo- point oftentimes creates a lot ple in the room. It was a gen- benefits of being in of opportunity from a pricing eral conference about Sub- standpoint. There's typically Saharan Africa. Two years ago, an inefficient market something wrong somewhere there was a conference across in our universe. Asset prices the street with two hundred with maybe a little may be rising in one area people just on Kenya alone. lower level of where you’ll also see IPOs, There's definitely a lot more which we've seen taking place interest, a lot more infor- competition and also over the last year. At the same mation available, but nowhere time, you can see pricing of near what you get in devel- have access to easily great companies drop in an- oped countries. other area that is experiencing accessible a more volatile period. Falling GM: One other important prices often draw our atten- component of our work is information.” tion. accessing people. Getting the first interaction with a manage- GM: Some of the scariest mar- ment team can be a significant gerated. Egypt is one of the kets to us exist when every- challenge. We often work three largest capital markets, thing is perceived to be calm through existing relationships and Egypt has been very vola- politically and the prices of to facilitate introductions to tile over the last several years. assets get too high. certain management in order This year, Egypt is the first or to get a first meeting. Once we second best performing public- G&D: Outside of South Afri- have the first meeting, it's very ly-traded index on the conti- ca, what are the market cap easy for us to establish a rap- nent. We shifted our attention sizes of these countries? What port and the trust level re- to Egypt pretty early and have are the investable opportuni- quired to develop an ongoing some great holdings there. ties in places like Ghana, Ken- relationship. As the years go ya, Tanzania, Tunisia, et cetera? on and accessibility increases, When the Arab Spring went it's advantageous to have de- through North Africa, one of MT: Our investable universe, veloped relationships earlier the most misunderstood areas including some opportunities on than later. was Tunisia, which has proven that we see that aren’t listed in to be a place where there's Africa, has a total market cap G&D: Given the interest in been a lot of opportunity and of about $1.4 trillion. Africa over the last few years, not too much competition. As (Continued on page 31) have you seen any changes in Page 31
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(Continued from page 30) face interactions are critical, countries where there's a local especially when building new exchange. Then there's often- GM: If you break it up, though, relationships. All investors times surrounding countries it's really about $130 billion of typically meet with the same where a company is working in market cap in North Africa four or five individuals on their and so we'll take a trip there. and then approximately anoth- first visit to a new country. Ethiopia, in particular, is very er $150 billion in Sub-Sahara The key is getting beyond this interesting and we’ve spent a excluding South Africa. There first wave. It is great to have a lot of time there. I wouldn’t is near $1 trillion in South Afri- network of key contacts that say we're experts in every ca. The liquidity is also a more we can call from New York for country, but the ones where challenging element than over- quick feedback, but we are the companies are located we all market cap. For example, if definitely have an institutional you exclude South Africa from knowledge base, which is help- the other exchanges in Africa, ful. the approximate liquidity for all the markets is approximate- “Some of the PT: There are changes occur- ly equal to that of a single US ring and some government stock like Home Depot. scariest markets to regulations and restrictions, which make countries more PT: Another part of our strat- us exist when attractive at one point in time egy is to know a lot about Afri- everything is than another. The changes in ca and then find ways of taking Egypt are pretty obvious. Ethi- advantage of that knowledge – perceived to be calm opia, which Matt mentioned, is knowing about an opportunity another big country and big despite the fact that the com- politically and the opportunity, but it’s currently pany might not be traded on closed. It's a tough place to do an African exchange. It might prices of assets get business and a tough place to be traded in London or Mum- acquire assets. The country bai, but have growth potential too high.” still has a government- and strategic focus in Africa; controlled telecommunication that's part of our universe and system. That can't continue that enlarges the pool a lot. into the future.
G&D: We imagine you must always looking for new per- Tanzania had limits on foreign travel a lot. How much of your spectives. Meeting with suppli- ownership, but they recently time is actually spent on the ers, customers, former em- dropped the 60% maximum ground there and how do you ployees and mid-level manage- foreign ownership position. So approach it? ment is invaluable to under- you had situations where non- standing a company, and these Tanzanian investors were ne- GM: In general terms, one or conversations can frequently gotiating with each other to more of us is in Africa every only be done in person. buy stock that was available month and each of us probably because both of them didn’t spend 25% or 33% of our time G&D: Are you at the point qualify as Tanzanians, and there on the ground in Africa. Each where you have some level of are similar kinds of changes in trip is, on average, two to four institutional knowledge of eve- Saudi Arabia now, so this countries, a lot of times in a ry country in the continent? makes certain countries and region, because it's easier to Are there some areas where certain exchanges more inter- cover ground that way. you're still developing exper- esting. Angola has no ex- tise in the companies that are change, but has plans to set PT: We've never had a day in available in those markets? one up. which we've sat down and said,
you know, we have spent MT: North of South Africa, G&D: Some investors look three weeks and nobody has there are about 16 exchanges into countries that have re- gone to Africa. that we would consider, so cently had poor economic per- MM: Though the flights can be we're primarily focused on the (Continued on page 32) painful sometimes, the face-to- Page 32
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(Continued from page 31) for everybody. As new, unin- companies, it’s pretty interest- formance. Do you have a simi- formed money entered the ing to see any potential change lar framework for identifying region, certain companies with that’s taking place that will new opportunities – is it more a good franchise and all the affect the larger economy. systematic? Or more organic other qualifications – we al- There have been a lot of ex- as opportunities arises? ways mention Nestle Nigeria ploration and gas discoveries in as an example – became the East Africa over the last five PT: We meet regularly. We fashion of the day. It might be a years. We’ve looked at those have scheduled meetings and good company, but is it a good companies and then tried to then we have a million un- enough company to purchase figure out what related indirect scheduled meetings. I would at 40 times earnings? investments might do well as a say we all have a nose or an result of that. As the economy interest in countries where the Ken Shubin Stein and Bruce While we’re still interested in grows, how is it going to affect Greenwald at the 2014 market has been smashed and consumer products companies, the consumer? What industries Omaha Dinner. things are very cheap, and it doesn’t constitute as big of a are going to grow as a result? skepticism about things that percentage of our portfolios as Many of them are the ones have gone up too quickly. Our it used to. We’re also not gen- that Gordon mentioned. choice of investments is all bottom up, but our instinct, or GM: There are many indus- smell, increases when we see tries where we believe latent situations that are either too demand exists, but where good or too bad and we look “We like transparent products and services aren’t into them. reaching the population. For companies that have example, with retail, which is We also follow themes of in- good corporate an industry that we like a lot, vestments that we like, so if an estimated 90% of trade out- we've observed a certain type governance, audited side of South Africa in Africa of consumer products compa- occurs in informal settings. ny or telecom or financial insti- statements and good Purchases of basic food, for tution be successful in one example, don’t generally occur country, we will look for more and deep in an organized grocery store. opportunities with similar pro- Oftentimes these situations files in neighboring countries. management have evolved in other parts of teams.” the world and by studying his- G&D: Given that you invest in torical trends, we inform our Africa, you have a limited in- view of what might occur in vestment universe. Natural Africa in the future. resource and other commodity erally commodities players. type companies have a large We try to buy into companies G&D: How do you think presence. Can you elaborate that provide a product or ser- about investing from a top on the types of opportunities vice that generates good cash down perspective? Are there where you have been success- flow. countries that hold a greater ful? What do you like and what appeal for you now that you do you look for in the compa- GM: None of us have a deep may want to consider investing nies that you typically invest in? background with commodity- in? And, conversely, are there based businesses. We see large other countries that you want PT: We like transparent com- opportunities in healthcare, to avoid given macro factors panies that have good corpo- retail, financial services, even and geopolitical stability? rate governance, audited state- industries that support infra- ments and good and deep structural development like PT: We unanimously agree on management teams, but in cement. what companies we sell and terms of industries, when we what companies we buy, but I started, one of our priorities MT: As has been mentioned, don’t know if we’d all unani- was looking at fast-growing we’re bottom-up, but from mously agree on a macroeco- consumer products companies. looking at natural resource (Continued on page 33) Guess what? It was a priority Page 33
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(Continued from page 32) what we think the long-term but as far as the ones that nomic profile of each country. drag from that currency will we’re close enough to that One of the biggest risks in our be. Ultimately, our considera- we’d have regular dialogue portfolio is currency risk, and tion of currency risk manifests with and would have come we often debate and make itself in the rate of return that make presentations in the US, decisions on the currencies in we are requiring on invest- say at Columbia Business Africa. For example, Ghana has ments that derive their income School, that would probably be been the worst performing in a given currency or curren- around half of them. market in Africa this year cies. For example, we might from a US dollar perspective, make an investment in Botswa- GM: It’s a requirement that mainly due to currency depre- na where we are expecting an we understand their motiva- ciation. 18% Botswana pula return tions, incentives and general ethos, but it’s not necessarily a We followed Ghana closely requirement that we have an and have a lot of friends there. extremely special relationship We have a lot of first-hand with them. information, not inside infor- “Finding ways to use mation, but information on PT: A couple of things that are how the Ghanaian government management’s time different about publically trad- makes decisions. We had a ed marketable securities in- large concern regarding the efficiently, asking the vesting in Africa is access to currency and were lucky and people, because they must feel smart enough to exit our in- right questions and somewhat like purchasing vestments in Ghana before the winning their agents that are besieged with cedi started to unravel. On the neophytes who are coming in other hand, we started to build confidence is part of who want to talk to the com- positions in Tunisia and Egypt pany. Somebody sends in a quite soon. Personally, I’m very what we have to junior guy to see whether they worried about South Africa's ought to have a fund in Africa political and macro environ- do.” and he calls the CEO and ment. However, there’s a big thinks he’s going to be treated enough investment universe like royalty. Well, these are that I don’t think that a top very sophisticated people run- down approach in South Africa ning key organizations in their is worth very much for us. over seven years, but we might countries, so they don’t have require a 27% return for in- time to meet with everybody G&D: Can you speak to the vestments in companies that else. Finding ways to use their process of managing currency earn Ghanaian credits. As Paul time efficiently, asking the right risk? Do you take a view based mentioned, we also limit our questions and winning their on a macro assessment, or do overall exposure to various confidence is part of what we you take a different approach? fiscal and political regimes de- have to do. pending on our views. PT: It’s very hard to hedge The other thing is that sourc- our currency risk. We try to G&D: You alluded to the fact ing stock is not so easy, be- have diversification in the port- that you have close relation- cause there’s not much liquidi- folio with different currencies ships with the management ty in many of the markets. It’s represented and manage our teams of many of the compa- nothing like calling a broker level of cash, but we don’t do nies you invest in. When ana- and placing an order with a any currency hedges. lyzing a business, how close do limit. It’s often necessary to get you typically need to get with some help. Some of these GM: Generally speaking, when the management team and companies have chief executive we are looking to make an understanding their strategy officers who have had a mean- investment, we consider the before you actually invest? ingful personal family stake in expected return on an invest- PT: Well, we try to meet and their businesses for a long ment in its local currency. know every management team, (Continued on page 34) Then we’ll also have a view of Page 34
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(Continued from page 33) ing the UN General Assembly. months or more to get com- time. They might know that fortable with a particular team, one of the family members GM: We don’t think it would no matter how good the busi- who’s ill or wants to sell his be an advantage to have an ness fundamentals are? stock, or some institution that office in Kenya and be investing backed him five years ago, who in Nigeria. It would be very PT: It can be. I would say that now has made 10 times his different types of companies money, might want to sell. Mario Gabelli ’67 at the require attention to different They can help you source 2014 Omaha Dinner. areas of management. Some stock, or brokers can because companies require attention to they want to work with you, mid-level and front line man- or know that you’re for real if “It was a tactical agement. For example we you indicate an interest. were interested in a company choice for us to have in Kenya, Equity Bank, which is G&D: How have you thought run by a guy named James about potentially having an all key decision Mwangi. We have known office in Africa? There are ob- makers sitting next James for a long time. The viously pros and cons. Could question is not whether James you explain how you decided to each other. What is a smart guy. Helios Invest- to be in New York? ment Partners owns 25% of we face is a constant the company. In this instance, PT: We’ve thought about it a the relevant question is also million times. Currently we stream of complex not whether the Helios team is rely heavily on a network of a great team or that the direc- relationships in each of the decisions that need tors that they have on the important countries, in places to be made with bank are great. Equity Bank has where if we want to use a grown into an extremely large friend’s office we can, and re- limited emotion.” and fast growing company. The ciprocally when they come relevant question for us with here, we’ll help them. With the regard to management is how relationships these guys have deep the team is, and how with all of the business and deep the bench is where some investment community there, I of the riskier day to day parts think we might even be at an difficult to fund and manage a of the business are being run. advantage. It’s the sort of thing local presence in all of the dif- That can take a while to ana- that Warren Buffett talks ferent countries we’re invest- lyze and then the question is about by being in Omaha and ing in right now. It was a tacti- valuation, right? having a better perspective cal choice for us to have all key than being in New York. decision makers sitting next to Then there are some other We’re not as much in the ru- each other. What we face is a companies for which it takes mor mill perhaps. constant stream of complex us a while to get to know key decisions that need to be made individuals. For example, there MM: After spending nearly five with limited emotion. There is a retail company in Botswa- years as an expatriate in Asia are always complicated situa- na that is more of an up-and- and Africa, I appreciate the tions that we need to get our coming, more entrepreneurial extremities of the highs and heads around, so it’s really company. We have all visited lows when living in the devel- important that we sit next to the company several times. oping world. When battling the each other and debate solu- The head of the company has daily logistical and infrastruc- visited us here in New York. ture challenges, it is sometimes tions and decisions. He is coming back again soon. difficult to keep perspective G&D: Management is clearly We also want to know our and detect the incremental important to you for investing. other partners that are invest- improvement. New York also How often do you meet with ed in the business including in attracts more private and pub- management over time? Is this this case the private equity lic sector leaders than most a process that will take you six (Continued on page 35) African capitals, especially dur- Page 35
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(Continued from page 34) markets that we're in. IRRs drop below 10% in local firm that is invested in the currencies. Of course whenev- company. That can take quite a GM: We try to use as many er we find something that we long time. tools as possible when consid- really love, we start kicking out ering valuation. We look at the the lower return ideas – it’s a Then there are some business- fair value of a company based constant competition of ideas. es, not many, that aren't as on forecasted models. We also management-sensitive. They look at historical ratios, peer Aside from simply valuation, are relatively easy to under- analysis and the multiples that one of the things that we really stand and might be a listed the company is trading on. look for are businesses that affiliate of a foreign company, Generally, when we invest, a are efficient with their capital. such as Nestle Nigeria. You five-to-seven year expected We are interested in deter- are pretty sure that the finan- IRR is a critical point of discus- mining, at the unit economic cials are clean, the manage- sion. level, what kind of return on ment is at least competent and its capital a company can earn. they might have licenses from We are probably more inter- the parent company. ested in this than things like multiples, in many cases. MT: In fact, for subsidiaries of multinationals it is quite com- “Exceptional A big difference between com- mon for there to be a rota- panies in Africa and those in tional program. You will get to management teams most other parts of the world know a CEO, but he or she in Africa can do is that debt costs are still ex- may leave in a year or two. tremely high for most of these You can check the back- extraordinary things companies. They really can't grounds on them, but they are finance growth projects with usually at a certain level, which and create a lot of debt. For example, health care you could feel more comforta- companies in Nigeria are pay- ble with maybe faster. value. Investing the ing around 20% interest on their debt. That’s an enormous GM: Management talent is time to get to know burden on any company and scarce in Africa and exception- them yields large it’s a death sentence for capital al management teams can do intensive or inefficient compa- extraordinary things and cre- dividends.” nies. ate a lot of value. Investing the time to get to know them G&D: Can you speak about a yields large dividends. recent success and take us through your process? G&D: What is the valuation
criteria that you focus on? If you look back and say, GM: Sure. There's a listed What would be an interesting "What's been the average ex- company in Nigeria called Stan- investment from a valuation pected rate of return in your bic IBTC. It's a listed affiliate of standpoint? Is there a minimum base case for all the invest- Standard Bank, which is a hurdle that you view as appro- ments that you've made?" The South African company. It's priate for the fund structure answer would be between 20% really a financial services com- that you have? to 30% in local currencies. pany with three lines of busi- Selling tends to be much more ness. It make loans to individu- MT: Gordon touched upon difficult. We don't simply sell if als and small enterprises and the expected returns from a the expected IRR goes below provides financial related ser- local currency perspective, mid-20s for example. vices to those groups of cus- which of course vary depend- tomers, it has an investment ing on where we are. But the Generally, the heated discus- bank which serves large com- fund is in USD. From a US sions around selling a position panies, and it has the dominant dollar perspective, we're look- from a valuation standpoint asset management franchise in ing for high rates of return have occurred when expected (Continued on page 36) given the riskiness of different Page 36
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(Continued from page 35) think that people are underes- preneur. The current CEO Nigeria, which is the real rea- timating the overall potential moved from India to Botswana son we love the company. of the asset management in- about 20 years ago, and one of dustry in Nigeria. Even after 10 his first assignments upon ar- In 2004, there was a major years of 30% AUM growth, riving was to audit this particu- pension industry reform. Since pension assets only represent lar business. that time, pension assets in around 5% of GDP. By con- Nigeria have grown at about trast, Kenya's are 18% of GDP, At that time, Choppies only Louisa Serene Schneider 30% a year, every year, and we South Africa’s are 67%, and in had one or two stores and was ’06 and Tracy Britt Cool at don't see asset growth ending the United States pension as- nearly insolvent. Despite this, the 2014 Omaha Dinner. for a long period of time. the CEO saw a big opportunity in retail and decided to join the When compared to other business. He has since grown banks in Nigeria, Stanbic looks “We still think that the company into the leading relatively expensive on a price supermarket chain in Botswa- to book multiple, but the asset people are na. The CEO is essentially a management business gener- founder and he owns a large ates more than a 50% ROE. It's underestimating the piece of the company. not appropriate to apply bank overall potential of book multiples to an asset We started tracking Choppies management business. the asset about three years ago when it IPO’d on the local Botswana Additionally Stanbic’s been management exchange. It was raising capital investing heavily in people to to expand into the northern grow its two banking divisions. industry in Nigeria. section of South Africa, which We view these investments as it has done successfully. It’s a form of capex in people and Even after 10 years interesting because there's infrastructure as the bank of 30% AUM growth, obviously a very mature mar- grows. But the expenditures ket in South Africa compared flow through the company’s pension assets only to other parts of Sub-Saharan income statement and have Africa. The CEO thought he dragged the profitability of represent around 5% could compete in the rural those divisions as they are markets of South Africa against growing. of GDP.” the larger format stores of, say, ShopRite or Massmart, The historical result has been which he's successfully doing. that analysts see a sub-20% Choppies typically has a small- ROE bank and a relatively high sets are over 100%. There's a er footprint store. book multiple. We looked at it lot of room to grow in the and saw a dominant, fast- Nigerian asset management GM: The payback on a new growing, pension management industry. It could easily be a Choppies store is typically one business, with huge opportuni- $150 to $250 billion industry to three years with an ROIC ties in other wealth manage- in terms of assets and today of around 25% to 40% at the ment business lines. We also it’s $30 billion. store level. saw quite clearly that the com- pany’s ROE was subdued by G&D: What are some other MT: So it’s pretty attractive. investments it was making in investment ideas that you He should be breaking even in future growth. could share with us? South Africa soon. Botswana's quite profitable and he's also It's been a very good success MT: One investment, which expanded into Zimbabwe. for us as the fruits of the com- we've alluded to in the conver- Those countries are all in the pany’s investments started to sation, is Choppies. It's a food same region and an important materialize and investors and retailer which is based in Bot- part of any food retailer is the analysts perceptions of the swana. It was started more distribution network, which he business have changed. It's one than 20 years ago by an entre- (Continued on page 37) that we still like a lot. We still Page 37
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(Continued from page 36) taken more than seven years South Africa, it's significantly spent 15 to 20 years building to build. higher because there’s been up. A lot of goods come in more development of formal from southern South Africa MT: We like the smaller foot- retail. South Africa is closer to and feed right into his depots print model that can go up 60% formal. in northern South Africa that almost anywhere, and he has service the entire region, so he various price points that serve MM: This story is also not can still expand further into different customers. We think unique to retail. With in- Zimbabwe as well as other that it's the right model to creased urbanization and surrounding areas of southern growth in the middle income Africa. segment, we are seeing similar trajectories in ICT adoption, GM: It also has a relatively banking penetration, and con- small base of stores, so it sumption of many consumer should be easier to grow from “At that time, goods. Since 2000, African a 100 stores to 1,000 stores Choppies only had mobile phone penetration has than it would if you had 1,000 gone from less than 2% to stores growing to 10,000. One one or two stores more than 80%. The growth of the reasons that the ROIC rates in other areas have not at the store level is so high is and was nearly been as profound as that found that he does not really have a in the telecommunications credit card infrastructure, so insolvent. Despite sector, but we know where his customers pay cash and he the trends are heading. We gets supplier terms. The stores this, the CEO saw a just need to find the brands, are actually working capital big opportunity in distribution networks and positive to him. The growth most importantly management essentially finances itself after a retail and decided to teams that are best positioned time. We really like that. to leverage these opportuni- join the business. He ties. G&D: Are there other com- petitors that have come close has since grown the G&D: For our readers that to Choppies in Botswana? might be interested in becom- company into the ing investors in frontier mar- GM: There is definitely com- leading supermarket kets, what sort of advice would petition in Botswana. There's you give them? another local company called chain in Botswana.” Sefalana, and South African MT: Well, investing in Africa is retailers are also active in Bot- difficult. It's amazing we got to swana and other parts of where we are in creating this southern Africa. South African fund. We looked at every pos- retailers are much larger than expand across Africa, certainly sible entry point and there's a Choppies and have tended to southern Africa and potentially limited sphere of public equity focus on putting up big box beyond. funds, which are hard to access stores. as an individual, and then G&D: What's helped pene- there's really only a handful of MT: One challenge for these trate this food supermarket or ETFs. bigger retailers in South Africa retailing, generally speaking? to expand to the rest of Africa You mentioned that lots of GM: If you are looking to start is basically finding enough retail markets are very informal. a career investing in Africa, space, because there's not that What is the penetration of there are probably more funds much commercially developed organized food retailers in the from South Africa that are real estate. total market? looking for investment talent. Generally Africa and frontier GM: Development of new GM: Across the continent, it's funds are unlikely to come to space is not trivial either. close to 10%. In Botswana and (Continued on page 38) Some malls in Nigeria have Page 38
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(Continued from page 37) campus, but that's where I'd be writing letters and making calls.
MM: Do your homework and be proactive. I was a bit naïve when I started my search for Wally Weitz at the 2014 Africa funds. I remember being Omaha Dinner. initially amazed that there were South African firms like Allan Gray with $40 billion of AUM. As capital markets and pension systems mature across Africa, you will find more large, indigenous funds in Nigeria, Egypt, Kenya and other mar- kets. Have a local stock pick, preferably a write-up. It can set you apart from other appli- cants.
MT: There is definitely a lack of high quality talent across the continent from corporates to investment firms, so certainly people who are willing to go live there or travel extensively there could be successful.
GM: It's a strange dynamic because it's a small universe so there are a relatively limited number of spots that come up, but I guess there's also fewer people looking. On the other hand, there's also an extremely limited set of very experienced people, so I think it's a path worth pursuing, though I’m obviously biased. I guess we have to hustle a little bit, but it’s worth it.
G&D: Thank you very much to all of you for taking the time. Get Involved:
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Would you like to receive e-mail updates from the Heilbrunn Center? __ Yes __ No Contact Us: [email protected] [email protected] Graham & Doddsville Editors 2014-2015 [email protected] Matt Ford ’15
Matt is a second-year MBA student and member of the Heilbrunn Center’s Value Investing Program. During the summer, Matt worked for Signpost Capital, a New York-based long/short equity hedge fund. Prior to Columbia, he worked as an analyst at Reservoir Capital, Farallon Capital, and Bain Capital/Sankaty Advisors. Matt graduated from The Wharton School of the University of Pennsylvania with a BS in Economics and BA in East Asian Studies. He can be reached at [email protected].
Peter Pan ’15
Peter is a second-year MBA student and member of the Heilbrunn Center’s Value Investing Program. During the summer, he worked for Fidelity Management & Research, where he evaluated securities across the capital structure. Prior to Columbia Business School, he worked at Wells Fargo, where he structured and executed LBO financings. Peter graduated from the University of California, Berkeley with a BA in Inter- disciplinary Studies. He can be reached at [email protected].
Tom Schweitzer ’15, CFA
Tom is a second-year MBA student and member of the Heilbrunn Center’s Value Investing Program. During the summer, Tom worked for Centerline Investment Partners, a New York-based equity hedge fund. Prior to Columbia Business School, he worked at Citigroup and Munich Reinsurance. Tom graduated from Columbia University with a BS in Applied Math and a minor in Economics. He can be reached at [email protected].