Graham & Doddsville An investment newsletter from the students of

Inside this issue: Issue XXIX Winter 2017 Kingstown Capital G&D Breakfast P. 3 Management Kingstown P. 5 Rupal Bhansali P. 15 Michael Blitzer and Guy Shanon are the Managing Partners of Kingstown Simeon Wallis P. 23 Capital, a value-oriented investment Student Ideas P. 38 partnership that focuses on securities across the capital Jared Friedberg P. 44 structure. The firm was founded in 2006 with strategic backing from Studness P. 51 Michael Guy Gotham Capital and currently manages $1.8B. Michael and Guy both hold Blitzer ’04 Shanon ’99 (Continued on page 5) Editors:

Eric Laidlow, CFA Rupal Bhansali Simeon Wallis MBA 2017 of Ariel of ValorBridge Benjamin Ostrow Investments Partners MBA 2017

John Pollock, CFA Rupal J. Bhansali is ValorBridge MBA 2017 executive vice Partners, a private

Abheek Bhattacharya president of Ariel Investments, a founded in 2004, MBA 2018 money owns, operates or Matthew Mann, CFA Rupal Bhansali management firm is an active investor Simeon Wallis MBA 2018 headquartered in in several private (Continued on page 15) companies; it is also a passive investor Adam Schloss, CFA (Continued on page 23) MBA 2018 Jared Studness Capital Management Friedberg of Mercator Visit us at: www.grahamanddodd.com Rolf Heitmeyer www.csima.info Jared Friedberg is the Founder & Portfolio Manager of the Mercator Fund and the Managing Partner Jared of Sycale Advisors. Charles Roy Friedberg ’99 Jared was Studness PhD ’63 Studness ’06 previously Co- Founder and Charles began his career teaching (Continued on page 44) (Continued on page 51)

Page 2 Welcome to Graham & Doddsville

We are pleased to bring you the vesting to international oppor- family of investors combine 29th edition of Graham & tunities. The CIO of Interna- their industry specializations to Doddsville. This student-led in- tional & Global Equities applies invest opportunistically in these vestment publication of Colum- the lessons of Warren Buffett two domains. bia Business School (CBS) is co- as well as George Soros, whose sponsored by the Heilbrunn concept of reflexivity is critical Lastly, we continue to bring Center for Graham & Dodd for understanding financial cri- you pitches from current stu- Investing and the Columbia Stu- ses. dents at CBS. CSIMA’s Invest- dent Investment Management ment Ideas Club provides CBS Association (CSIMA). Simeon Wallis of Valor- students the opportunity to Bridge Partners discusses the practice crafting and delivering Meredith Trivedi, the Heil- In this issue, we were fortunate unique opportunity to redeploy investment pitches. In this is- brunn Center Director. to speak with seven investors cash flows from the company’s sue, we feature ideas from the Meredith skillfully leads the from five firms who provide a primary portfolio company, 2017 Heilbrunn Center for Center, cultivating strong range of perspectives and invest- ApolloMD, into public and Graham & Dodd Investing relationships with some of ment approaches. All of these private investments. This flexi- Challenge and the 2016 the world’s most experi- investors benefit from applying bility allows the organization to Darden @ Virginia Investing enced value investors, and fundamental research to special- beneficially allocate capital to Challenge. Zach Rieger ’17, creating numerous learning ized investment areas that other the most attractive opportuni- Alexander Levy ’17, Abheek opportunities for students funds cannot explore. ties and to share valuable in- Bhattacharya ’18, Harsh Jhaveri interested in value invest- sights across asset classes. ’18, and Ryan Kelly ’18 share ing. The classes sponsored Michael Blitzer ’04 and Guy their ideas for Foot Locker by the Heilbrunn Center Shanon ’99 of Kingstown Capi- Jared Friedberg ’99 of Mer- (FL), Axalta Coating System are among the most heavily tal Management return to dis- cator shares how a (AXTA), and Cardtronics demanded and highly rated cuss the benefit of longer time- can use its permanent capital to (CATM). classes at Columbia Busi- horizons in special situation benefit from special situations ness School. investing. The team discusses and long-term compounders. As always, we thank our inter- the evolution of Kingtown’s Additionally, the company can viewees for contributing their strategy since our last interview creatively invest across the time and insights not only to in 2010. Additionally, they share , to find value us, but to the investment com- insights regarding complicated “obscured by complexity.” munity as a whole, and we and overlooked situations, in- thank you for reading. cluding international privatiza- Charles Studness and Roy tions. Studness ’06 of Studness - G&Dsville Editors Capital Management demon- Rupal Bhansali of Ariel Invest- strate the benefits of investing ments shares her perspective on in negatively correlated indus- applying fundamental value in- tries: utilities and banks. The Professor Bruce Greenwald, the Faculty Co-Director of the Heilbrunn Center. The Center sponsors the Program, a rigor- ous academic curriculum for particularly committed stu- dents that is taught by some of the industry’s best practi- tioners.

Prem Watsa and Ajit Jain pose for a Regina Pitaro ’82 with Professor Bruce picture at the 26th Annual Graham & Greenwald enjoying the G&D Breakfast, Dodd Breakfast held at The Pierre Hotel Volume I, Issue 2 Page 3 26th Annual Graham & Dodd Breakfast— October 28, 2016 at The Pierre Hotel

Columbia Business School Dean Glenn Hubbard Professor Bruce Greenwald, Prem Watsa, and VJ addresses the crowd Dowling share their views at the G&D Breakfast

Professors Tano Santos and Kent Daniel in discussion at Ajit Jain and Mario Gabelli ’67 pose for a picture the G&D Breakfast

The crowd listens to Professor Bruce Greenwald, Prem Watsa, and VJ Dowling discuss this year’s theme: Finding Value Through Specialization Page 4

Save the date for the eighth annual

“From Graham to Buffett and Beyond” Dinner

Friday, May 5, 2017 6 p.m. to 9 p.m. The Omaha Hilton 1001 Cass Street • Omaha, Nebraska

Tickets will go on sale in March at www.grahamanddodd.com

Page 5 Kingstown Capital Management (Continued from page 1) MBAs from Columbia Most of these securities are in offs and distressed . Business School where the $1B to $10B enterprise they participated in the value range for both equities MB: Also, there's a big, timely Value Investing Program and debt, though credit debate right now about active and have taught Applied securities can be smaller. Being versus passive investing. Value Investing as adjunct bigger also gives us research Passive has come into a lot of faculty. Michael currently resources and access we just popularity. When we started serves on the Executive didn’t have when smaller, and twelve years ago, we Advisory Board of the the structure of the industry is maintained the premise that Heibrunn Center. making it harder for very small the markets are very efficient. funds every year. Our strategy is to be Graham & Doddsville exclusively focused on very Guy (G&D): How did you both G&D: Why have you focused small pockets of inefficiency Shanon ’99 meet and how did the fund get on that particular size? within what is, generally, a very started? efficient market. We have to GS: I think one of the things have the flexibility to go after Michael Blitzer (MB): Guy we learned is that it is not so companies that are smaller and I have known each other easy to make money with than $10B or $20B for a very long time. We both super small caps. You see a lot went to CBS. I was '04, Guy of questionable management GS: And don’t have twenty was '99. We didn't know each teams and very low quality sell-side analysts covering other while we were at businesses which have not them. Columbia, but at that point become bigger for what are AVI [Applied Value Investing] usually good reasons. Then of G&D: As the number of was a very small network. course you have all of the special-situation funds grew, extreme technical aspects, like how has this impacted Guy Shanon (GS): So if liquidity dries up that makes Kingstown? Have you been Michael everyone knew each other it even harder. Yes, there are able to maintain an advantage? Blitzer ’04 from different years. sometimes great opportunities, and we look at small caps all MB: The longer we do this, MB: Guy's class had six the time, but they aren’t giving duration of capital and time people. They were the only six it away by any means, and horizon has actually become people at Columbia who were focusing exclusively can be a more and more of a interested in value investing – tough way to make money competitive edge. We've it was 1999. There was no over long periods of time. always defined the strategy as AVI. The program really grew kind of having a medium-term from there. We don’t think of ourselves as time horizon, generally one to a big fund, and we think we can three years. These securities GS: Our initial investors and make the best risk-adjusted tend to have larger mispricings. employees came from that returns in the size range we A typical example is a situation network of students and currently target. The current that has a known or likely professors. portfolio runs the gamut from catalyst but unknown timing— $300mm in market cap to you know it will happen G&D: We last spoke with you $50B, so the range is wide and sometime in the next three in 2010. How has the fund we look at everything. But the years, but it could be changed since then and what sweet spot tends to be this tomorrow or it could be years have you both learned? middle range which are small from now. Given the structure enough to still experience the of the industry and GS: The fund has grown but technical factors that often the structure of capital, this the strategy and portfolio lead to mispricings but sort of patience becomes structure are exactly the same. large enough to have quality of harder and harder over time We still run a long-biased and business and management. This unless you align yourself with concentrated portfolio of size also tends to have a larger long-term capital. So we're special situation securities pipeline of the special situation clearly shorter-term focused across the capital structure. categories we track like spin- than a firm. But (Continued on page 6) Page 6 KingstownHarvey Sawikin Capital Management

there are very few investors in MB: In addition to size and approach. We've never had a the public markets right now duration of time horizon, it's formal IR effort. You end up who can take a one to two to also been concentration. We with a certain type of partner three-year time horizon. Most run a fairly concentrated and by way of hiring a professional can hardly take a month or a flexible mandate where we marketing person. We have week. To take advantage of look across industry, personal relationships with all most of the mispricing, geography, and capital of our partners. We spend a particularly in the special structure. We think it is also a lot of time talking to them situation space, you have to big advantage that we can about how they think about have that kind of runway. Also evaluate the risk-reward investing. Not surprisingly, there is a lot of capital coming across these different areas most of our partners have a out of event-driven strategies, and pick our spots very value bias in their portfolios. which overlap somewhat with precisely. Then obviously we But investment philosophy what we do, this is very good combine all of this with what aside, a direct relationship with for us. we like to think is a fairly deep partners creates more research process. But you can transparency for them and GS: In the past twelve years only do that level of research if keeps the alignment of since we started, time horizons you're concentrated. When very close; have become a lot shorter. As you group it together, these sometimes having a marketing students at Columbia and with things differentiated the firm person between us inserts the value-oriented internships initially and have been another agenda into the mix. you’ve had, you might not fully consistent through the life of We think our approach is best appreciate the low tolerance the business. for our partners’ returns over for volatility. If you go to some the long run. of these large multi-strat funds, time and volatility are very “...risk and volatility are MB: It's just taken time and a relevant because they're very different. A lot of lot of energy invested in running massive amounts of getting to know our partners capital. In fact, they've the returns that we've and how they think about attracted so many assets made have been either investing. We've gone through because they manage volatility periods where, for many years, so tightly. If you went to work averaging down or we didn't talk to anyone about there as analysts and you drew new capital. We also learned down a couple of percent in a buying things that were by watching what didn't work month, you get stopped out. down.” for other funds. But ultimately But then what do you do with this has led to a small group of that cash? You have to find partners who have stuck with another trade tomorrow – is G&D: How did you develop us over time. And with less that better than staying with and cultivate an investor base time spent on marketing and the business you owned the that allows for your strategy? investor relations, there is day before? It just feeds the invariably more time spent on volatility. I think the fact that GS: From the start, we've investing and the portfolio. we only focus on very specific been very conscious of the special situation categories also importance of having the right G&D: Going back to volatility, makes us unique. We don’t do partners. I think it mostly came how do you think about risk in risk-arb for example. We are from some humility. We your investments and how do just looking at certain areas understood that it is very hard you exit positions that are where we know there are to beat the market and you going against you? chronic mispricings. A lot of need help from your structure fire directed into a small area. and partners. You have to MB: We mostly define risk as That is what we do. And we match the duration of your permanent impairment, which I have been doing it for a while capital with your investments. think is very different than and it works, and we get Going back ten years, we've most people who view it in better at it every year. turned down money from terms of volatility. We take the people that didn’t share this approach that risk and (Continued on page 7) Page 7 KingstownHarvey Sawikin Capital Management

volatility are very different. A but it's very hard to have three a great book. We've both read lot of the returns that we've of the three because it's a it. I read it over and over and made have been either mixture of a bunch of I’m still learning, it’s not averaging down or buying personality traits that are not exactly beach reading. But we things that were down. On a often on the same gene. But don't have any formal short-term basis, it's very you need all three. framework. Anyone who says challenging to time tops and that they do, that's more of a bottoms. I think a lot of people Part of temperament is being marketing gimmick. We're very have failed doing that. One of able to be self-critical. Many aware of the behavioral stuff, the approaches of having a people in this industry have it’s important. It is possible longer-term strategy and been very successful all their that managing our own longer-term capital is that you lives. They have always been at behavior effectively is the can withstand those periods of the top 10% of everything they single most important thing we volatility and take a view over have done. All of a sudden, a do as investors in public a number of years. position is going against you markets at the end of the day. and you have to really break it Having said that, being very down and be honest with MB: Also the analysts here patient and permanent yourself. Or you have to take a know that they're not going to impairment often become the view that is vastly different do well unless they start with same thing eventually. We take from what the “smart” people the risks and the downside. the approach here that we are are saying, what your smart Before we figure out how re- every single friends who are making money much we can make in an idea, position every single day. If the this year are saying. A lot of we have to discuss what all the facts change, we have to be people have never done that possible risks are that may or intellectually honest and before. You have to be very may not happen. I am not sure reevaluate that, otherwise you critical and skeptical all the if I would call that a “pre- are just hoping. It's a time, but also know when not mortem.” combination of research and to be. And how you go about portfolio management. that has a big impact on GS: Pre-Mortem? We see that performance over time. term a lot, it’s part of a GS: It’s easier said than done, checklist that people but when something is going MB: You have to put up walls interviewing for jobs have against you, you have to fight and blinders to eliminate decided they need to have in off the urge to ignore bad behavioral biases when these anything they write, it has news. As Mike said, be brutally things happen. Of course, become part of hedge fund honest with yourself whether when something goes against analyst culture, like it’s some or not what you thought was you in a meaningful way, the kind of innovation. But really going to happen actually did market is usually not that it’s common sense—if you are happen or is happening. wrong. At the very least, it's going to put a substantial down for a reason. Stepping amount of your net worth at Over the years, a lot of our back and understanding what risk, wouldn’t you think former students have asked us that reason is. I think the only through how it could go about starting funds and how way to do that is through a terribly wrong, and what the we would evaluate somebody constant re-underwriting first signs of that would be? who is starting a new fund. I process and a diligent research The answer is yes, and it’s think there are three parts. process. probably a good idea to write There's being a good analyst, it down. and then there's being a good G&D: Do you have any portfolio manager, which is formalized systems or MB: It's also a little naïve. actually a pretty different skill processes in place to eliminate When most people have lost set. Then there's the third these biases when making money, us included, it is often part, which is temperament. tough decisions, like a “pre- not from any of the twenty The big intangible. There are a mortem”? possible risks you listed in lot of people who have one of advance. When the bad the three or two of the three, GS: Thinking, Fast and Slow is outcome happens, you'd be (Continued on page 8) Page 8 KingstownHarvey Sawikin Capital Management

shocked how often it was process of weighting factors. them, pulling the threads for a related to something that Often we all have very similar thesis that might be missed by wasn't on your original list. information, but the rub is, most others. how do you weight it For us, this is why it all comes differently in a decision to get If you just keep looking at back to . Being a good better outcomes, that is the these categories and you own investor requires you not only Kahneman stuff too. You the good ones, unlevered and to be wrong in ways you didn't should get better at that every at good valuations, and you can anticipate and still not lose a year and as you live through be a little patient, you have a lot of money. I think the only more things. But then again, good chance of outperforming way to do that is to buy things you don’t want to be over- in the market. very, very cheaply. For most influenced by an unusually investments that haven’t good or bad experience, “...we want to be right worked, we have been very because outcomes are more wrong on a number of things like the mean than the there on the front line. If and still not taken a large exception—again, Kahneman. impairment. one of our investments is G&D: Would you mind not working, we can be GS: I think that’s called walking us through an “margin of safety.” The closest investment from the screening decisive and we can thing we have to a formalized and search process to actually process is our emphasis on putting capital to work? make a decision that we written memos. For any can live with.” position of a decent size, we GS: As we discussed earlier, write very detailed memos. our view has always been that We date them and we update the markets are very efficient. How does an idea go from them, so that six months or They get more efficient every there to the portfolio? I think eighteen months later we can year. There are lots of smart we are unique in that we go back and see what we people out there working on screen for situation first, not thought was going to happen. lots of names. We have to ask valuation. What you might find From a psychological ourselves, “Well, how are we is that a lot of value guys will standpoint, you can play all going to make money in a just look at the new lows list. kinds of games if your market that is generally There are reasons that's investment ideas are all in your efficient? How are we going to dangerous, the biggest being head, which is bad for do it consistently?” Anybody value traps. performance. could do it for a short period of time. First, we look at the situation MB: It also makes you refine and see if there is somebody your thinking. By writing We have to look in places stampeding out of the stock or something down you are where there is chronic . Do we understand why? forced to focus your thoughts mispricing. You have to keep Yield breaks are good in a way that verbally you looking in those places over examples. Every time a yield cannot. and over again. You have to equity or credit is keep the fund size small downgraded, there are GS: Yes many times I have had because the bigger you get, the obviously structural reasons this experience: I decide I like fewer places you can look. All why people have to sell. That something, then I write down we do is look at a couple of will pique our . the bull and bear cases for it, areas of special situations. We go back to it a few times over look at every spin off. We look Then we'll start looking at several days, adding things, and at every bankruptcy or valuation on an absolute basis, then I think, you know what, I stressed credit. We look at to the enterprise. We don’t don’t like this so much every rights offering. We look use relative valuation here. If anymore. Writing things down at every privatization. Anyone the valuation on an absolute brings more precision to your can get a list of these, but we basis is cheap, then we start thinking and helps in the are really, really looking at doing fundamental research, (Continued on page 9) Page 9 KingstownHarvey Sawikin Capital Management

which includes a lot of primary Then they look to the analyst valuation to approximately 4x research. And the primary and ask, “Is the analyst good?” to 5x earnings late in 2016. research is something we have Then they start thinking about But, if you look at the gotten better at over time, it’s the idea in the context of the company, there are many something you only improve at analyst. “How has the analyst competitive barriers to entry by doing over and over and done recently?” This actually in an industry dominated by figuring out ways to gather but reduces to a kind of two main players and the also prioritize information. momentum that analysts get business is actually more of a inside funds, which influences high-return just-in-time If it's a liquid equity, we're not investment decisions and is logistics provider and supplier in a rush to buy it. We'll have a kind of crazy when you step than an old-line manufacturing fully blown research process back and think about it. We company. The prior Vice first. We’ve met with are trying to reduce the Chairman of JCI is the new management, interviewed a behavioral stuff between us CEO of ADNT. He has a very large number of former and the idea, and want to be significant compensation employees, done a lot of work right there on the front line. package that he converted on business competitors. We'll We want to be fully informed from JCI that we think aligns do that before we own it. and decisive. We don’t have to well with future growth wait for a committee meeting opportunities. Credit is different because it's or consider the internal such a choppy market. politics of an investment Incidentally, one of the biggest Sometimes we'll own credit decision, because we have knocks against ADNT and a lot when we're pretty sure it's neither of those. of the auto companies is the good. We're 90% sure, but we disruption and potential change have to take advantage of the G&D: Do you have an in the industry. But ADNT is a liquidity at that moment and investment idea you want to big beneficiary of the move to then we'll backfill our work. share? autonomous vehicles. Number You also have more structural one, they have a position with and legal protections here if MB: Our largest position right every single manufacturer. So, you are wrong. Generally, now is Adient (ADNT). ADNT regardless of how market we're fundamentally driven and is the largest manufacturer of share changes with we know the investments very auto seating in the world and autonomous driving well before we buy them. virtually every auto company is technology, they're—bad a customer. Johnson Controls pun—going to have a seat at G&D: Is a position fully sized (JCI) spun out the company in the table. ADNT and Lear at this point in the process? October of last year. From an (LEA) control a majority of the initial search process, it's an global market. As these GS: A lot of times what we're example of something that vehicles become more doing is averaging down struck our interest given the autonomous over time, one of because we own something structure and nature of the the big differentiators is going and it's the exact opposite of spin off. It was a much smaller to be the interior package, and momentum. So we save room subsidiary, it was in a different seating is the biggest to average down. industry, and it was an component of that. underinvested business of the I think we are also unique parent. We like the business a lot. In because Mike and I work on an equity market that generally the names with the analysts. It's also a very misunderstood is pretty fairly to over-valued, The two of us are intimately business. Like many of its auto it's unusual to get an above familiar with everything in the part competitors, it's viewed as average business for a third to portfolio. I think that's a very low quality and cyclical a quarter of the S&P P/E important because at a lot of business and thus not favored multiple. But I think it also fits funds, if a name goes against by JCI investors. This bias in well to what Guy was saying the portfolio manager and he along with a lot of forced about the search process: how or she is reminded they just selling, because it is no longer the name was identified, what don’t know much about it. part of the S&P 500, pushed we like about it, why it was (Continued on page 10) Page 10 KingstownHarvey Sawikin Capital Management

mispriced, and how that flows They are also making real GS: The reason the through the process. progress selling seats into non- opportunity exists is exactly car markets, like trains and related to your question about G&D: How concerned are planes. the cycle. If you went to your you about the auto cycle and PM at most hedge funds until where we sit today? MB: Units aside, the trend for very recently maybe, you interiors is towards bigger cars would be told that you can't be Elizabeth Gao ’17, Maria GS: That's the bear argument, and higher value content. long auto because SAAR is Muller ’17, and Maryam but there are two parts to it. That's all to the benefit of “peakish,” in fact can you come Badakhshi ’17 celebrate at First, the industry is cyclical in seating. If you look at back with some shorts here. the The Heilbrunn Center for Graham & Dodd Invest- general. Then there's the idea autonomous concept vehicles, Maybe we get some bad ing Stock Challenge of a SAAR Wall. That is the the entire dash and driver numbers on SAAR over the classic bear argument. We display is stripped out, and the next several quarters – we don't think SAAR is going to interior is basically four high- aren’t saying that won’t plummet. There are a lot of end seats like a living room. happen. But this is a business people with short term trades Unless people start sleeping or that should grow sales over based on where SAAR will standing in cars, ADNT will be the next five years. As a move. We think SAAR levels a beneficiary of this change. private business that is how it out at around 17 million in the Adient also has a pretty would be thought of, and we , but quite significant opportunity to go try to think about it that way possibly more. Regardless, into adjacent markets, whether within the practical limits of ADNT can make a lot of it's train or aerospace or more being a public market investor. money with SAAR just sitting industrial applications. They where it is right now or if it historically have not been able We do have this moderately falls somewhat. ADNT also to invest in these areas hedged because of Trump Risk. makes a good amount of because of capital constraints We could start having issues revenue outside of the U.S. while under the JCI umbrella. with Mexico or China where The dynamics of production in the Chinese get mad at us and Europe are different. There are On the unit volume issue, at try to penalize us with auto reasons to think that least in North America, there somehow. And, as Mike was production can grow in are cycles, but the growth saying before, it's always the Europe. Also, even the skeptics over time is still up and to the thing that you didn't see say that China is going to grow right. It is a function of cars on coming. car sales for a long time, and the road and population. The ADNT is generating a good common mistake is to look at G&D: Now that ADNT is amount of its cash flow from units pre-financial crisis, which independent, how will this China. was nearly ten years ago now, impact the business? and to think that SAAR has to go back to that number. But MB: We think ADNT is going “There is no investment there are so many more to generate $9 in earnings this is without risk. But people and units required at year. Their margins are a lot this point. If you look at it on a lower than Lear’s despite the paying 4x earnings replacement cycle basis, it's fact that ADNT is significantly unclear that even the current bigger and there are real eliminates a lot risk.” level of units can sustain that benefits of scale in this demand. business which favors large global platforms supplying very The other interesting wrinkle Yes, it is certainly a risk. There large customers. These lower is the growth in content per is certainly a cyclical margins just relate to under- vehicle. In an extreme case, component. But the investment in the business they can triple content per car geographic diversification and while controlled by the prior in some markets over the next the significant tailwinds they parent. Management has a plan five or so years. Even if unit have in content and technology over the next couple of years volume decreases, it’s possible and where cars are moving are to at least match Lear’s ADNT can actually grow sales. major pluses. margins, which at current (Continued on page 11) Page 11 KingstownHarvey Sawikin Capital Management

volumes would take them from the industry have changed so cost, which also discourages $9 to $12 or $13 a share or it’s not clear that the future the OEM from trying to kill more. This was a stock that will look just like the past if them on price and creates got as low as $45 in unit volume goes down with some stickiness. November and is still only $60 respect to profitability – it’s today. I think it's a unique quite possible return on capital MB: There is no investment example of being able to prospectively is much better, that is without risk. But paying purchase something with a which does wonders for a 4x earnings eliminates a lot pretty attractive growth stock price. risk. opportunity at a mid-single digit earnings multiple. MB: Seating is one of the G&D: You mentioned hedging better auto supply businesses this investment. Can you talk G&D: Lear and Adient control to be in, but there have also specifically about this and also most of this market. What not been stand-alone Kingstown’s overall shorting does the competition between businesses historically. Pre- strategy? the two of them look like? financial crisis, these businesses were grouped together with a GS: Our short exposure is MB: It's been very rational. bunch of lower-quality, lower- generally zero to 25%. The The good news is that they're return businesses like interiors majority of our hedging is both big public companies. or metals or other where we think we can isolate They both have margin targets. commodities. We are in a industry risk. We want to be It's also a business where very unique situation where you very specific, we're not looking few awards switch between have two seating-focused to hedge the volatility of a the two of them. The companies and everyone particular name. We're looking incumbent has such a assumes their performance is to tease out some exposure significant advantage in this temporary and cyclical because that may worry us. Usually you industry because winning these types of companies have can't do it, that's why we don't business requires you to spend never been able to sustain do a lot of them. a significant amount of capital returns for very long. But it and build your plant within the has always been the other For ADNT, some of the things physical confines of your businesses that have taken that we worry about will also customer. When work is re- them down in past cycles. hammer Lear and some other bid, the incumbent is always auto part suppliers, so we're going to be at a cost advantage. GS: The other interesting short a couple of them. But we thing is that this is a very low still have a very meaningful net The only time you see gross margin business, which if exposure to ADNT. platforms switch is if there's a you were a new value investor, move in location or a massive you might say, "Oh, that sucks, G&D: Is there a component re-engineering of the platform. it's a bad business." But it’s to your short book that is not Traditionally, most of the actually pretty good because paired with your longs? significant competition has the gross margin is mostly low been on new platforms. Even because most of the costs are GS: We do some alpha shorts, then, there has either been passed through to the but we don't do a lot. We enough business to go around customer, yet it discourages don't have a formal process for or the share has come out of other competitors from getting it. Sometimes in our work on smaller players. Outside of into the business. With two longs we find something that is North America, the majority companies that control a a screaming short. We've of seating is still done in-house, majority of the business in a actually made a good amount so there's still a big low gross margin industry, of money in absolute terms on opportunity to outsource there is not a screaming siren our shorts over time. Because, more to both Lear and Adient. saying "Come compete with unlike a long-short fund, where us." The seat, in part because you're under constant GS: Returns on capital for it’s so safety-centric, is a very pressure to maintain a certain both companies are OK over a important part of the car and short exposure, we don't have cycle, and these businesses and it’s also not a big part of the to keep loading the short book (Continued on page 12) Page 12 KingstownHarvey Sawikin Capital Management

with God knows what. If we than valuation. doesn't necessarily understand think something is ridiculous the culture and, by the time and we're trembling with G&D: Could we talk more you hear about something, greed, we'll do it. Otherwise, about privatizations and some everybody in the country has we'll just do nothing. That's of the unique features? Perhaps heard about it. The bar for us kind of how we think about it. talking about specific ideas and to invest internationally is case studies would be helpful. definitely higher. G&D: You tend to look for things that you feel have GS: Privatizations are MB: Sometimes you have bottomed-out but you’ve also interesting for a couple of some interesting incentives. If I mention that timing is reasons. First, they're usually take my tech company public, I incredibly difficult. How do try state-owned enterprises, which want to get the highest to manage these two means that they've been poorly valuation possible, because my elements? run. So there are usually net worth goes up. When the opportunities once you get a state owns the business, they GS: We're not an algorithmic real corporate governance don't necessarily care that strategy, so the answer is that structure and management much about the IPO valuation. we just don't know and we just incentives. Then they can take They just want people to say do our best. Sometimes we out a ton of costs or do things that the privatization worked bought something all the way that should have been done out well and the stock price down and we just have to stop. ten years earlier. That is not went up after the IPO. It Sometimes we buy something always the case, but if you look doesn't really matter what the and it goes up 50% and it was at ten privatizations, you're base point is. small, because we never got going to find one or two like the chance to make it big. Both that. They’re similar to spin offs in bad scenarios. After doing it that you often have a non- for a while, we just assume it Second, they tend to be economic seller, a all averages out. We're not unlevered because they were misunderstood situation, and a going to own something unless owned by the government. We number of catalysts, that Guy there's some reason to think hate financial leverage. We mentioned, for future it's really misunderstood or have no leverage on the improvement. really overlooked, and we are portfolio. We're usually confident the market is wrong, carrying net cash and most of I don't think we want to talk that’s the bottom line. the companies in the portfolio about the specific name, but an are not levered so that really investment we made recently MB: You have to use valuation should help us in any kind of was in a railroad company in as an anchor. That's not to downturn. Japan with a monopoly mean something like ADNT, business in a certain part of the trading at $60 and 5x earnings Third, these tend to be strong, country. The government can't go to $45 and 4x. Things monopoly-type businesses. It’s priced the IPO artificially low can always get cheaper, but the railroad, it's the mail because the entire purpose Joel Greenblatt used to say delivery system, it's the electric and mandate for this that it's more binary. Things companies. privatization was to spur local are either cheap or they are retail ownership in the stock not. And if its cheap you G&D: The stock exchange? market which is currently very should just buy it. If you can low. Their primary goal was make a lot of money and you GS: Yeah, it's companies that not to raise the most money have a significant hurdle that are incumbents because they possible. The primary goal was you're reaching for, it should were originally funded by the to spur investment in the stock be pretty clear. Back to Guy's state. The international aspect market by locals and to have a point, that doesn't mean you is very tough. You have the successful track record so they never can lose. currency issues. But more could do this again in the importantly, you're always the future. GS: When we say “bottomed guy who knows the least. out,” we mean more sentiment You're the idiot foreigner who Then you take a business that (Continued on page 13) Page 13 KingstownHarvey Sawikin Capital Management

was being run for no profit good idea to listen more. Two, for interviews, we meet historically, because the Analysts in this business, they hundreds of people who share mandate was just to allow for get to a meeting with investment ideas and they all cheap travel. Now, with a management and so much of it sound exactly the same. It's profit maximizing management is about promoting themselves. very rare that somebody and aligned incentives, it can comes into a meeting with lead to a business with much “...unlike most other some kind of actual insight. better economics in the future You get a unique insight than existed in the past. But professions, there's no because you have been some overlook this thinking about this information opportunity and other specific experience differently or you found new privatizations because all you required. My advice for information through primary can see is the historical research. You visited 25 performance. MBAs is to appreciate stores, you met some customers, you filed a FOIA G&D: Outside of not finding how much you don't request, whatever. And it led the right valuation, what are know...” to some kind of insight. If you examples of privatizations that can do that, you're going to are not good investing have a lot more success than opportunities? Let’s face it, what are you most of the candidates will. taught at Columbia or any MB: There are big differences other business school? You’re Any monkey can generate in the businesses that are taught to network and to EBITDA multiples and slap privatized. Buying a monopoly promote yourself. Students them on slides with bullets. railroad in a specific country and former students view More kids are going to with no competition is very every interaction as a way to undergraduate business school different than buying the state show how smart they are. than ever before. There are owned oil company. Even People actually spend so much thousands and thousands of though it may be the only oil of their energy in a meeting people who know Excel and company in the country, it still talking but very little listening. have taken . You are operates in a globally I've had so many experiences not going to set yourself apart competitive industry. where someone comes out of that way or be successful, and a meeting and only absorbs even when you get the job, It basically comes down to 20% of what was said, and it these are the kinds of things how much control the should be closer to 80%. you have to keep doing and get government has over it and Instead of thinking about your better and better at. whether the market is local or next question or insightful global. The last thing is related observation, just listen. MB: It's a weird industry to the incentives of the because unlike most other government and the new It may lead to something else professions, there's no specific management team. In the past, that is useful even months experience required. My advice there have been privatizations later, or stick in your head even for MBAs is to appreciate that were vehicles for forever. These are simple how much you don't know and governments to raise capital things but if you want to to find a place where you can from foreigners, but still become a good analyst, you learn but also where you share maintain most of the can benefit very much from a common investment economics without doing it. It also helps in the philosophy. If you don't have a shareholders benefiting. rest of your life. I tell myself common philosophy with the there is going to be a test after fund and a real passion for G&D: Do you have any advice every meeting and I need to investing, it's not going to for students and other people retain like my life depends on work. You can’t fake passion entering the industry? it. It really works. Listen with and fit. your ears, not with your GS: I have two pieces of mouth! Also, given the popularity of advice: One, I would say it’s a hedge funds over the past (Continued on page 14) Page 14 KingstownHarvey Sawikin Capital Management

decade, a lot of people have come into this industry because it's the next logical step or the way to become wealthy. It’s what was before that. So it has attracted very high performing individuals many of whom have never experienced a setback or disappointment. But, this business humbles people very quickly and how you deal with these initial setbacks will determine success or failure. So we end up focusing on and asking about these disappointments when we interview these high performing candidates that go from the Ivy League to bulge bracket Wall Street firms then to hedge funds. The setbacks and how they have learned to think about risk and reward and their lives in general are what differentiate people in our experience.

The only other thing that we tell every person that we've hired, no matter how old or experienced he or she is, is that you have to bring a notebook to every single meeting and you have to write everything down. You'd be shocked how few people do that and how helpful it can be. You'll never miss something and if you do exactly what your boss wants you to do, it'll put you in the top 10% right out of the gate.

GS: Are you guys writing this down?

G&D: Thank you for your time.

Page 15 Rupal Bhansali (Continued from page 1) Chicago, Illinois with CFA Institute, Morningstar accounting at age fourteen. offices in New York and and Schwab. Looking back, one of my best Sydney. The firm offers six decisions was to start working, no-load mutual funds for Fluent in several Indian not only during summer breaks individual investors and languages including Hindi, but also when school was in defined contribution plans Rupal earned a Bachelor of session. I did a lot of as well as separately Commerce in accounting apprenticeships in finance— managed accounts for and finance, as well as a whatever I could get my hands institutions and high-net Master of Commerce in on. I worked on leasing, worth individuals. As chief international finance and , foreign investment officer and banking from the exchange, investment banking, portfolio manager of University of Mumbai. She stockbroking. Ironically, the Rupal Bhansali Ariel’s multi-billion dollar later earned an MBA in one thing I could not get my international and global finance from the hands on was investment equity strategies, she University of Rochester, management. Entering this oversees Ariel’s New York where she was a Rotary profession is a “Catch 22.” If based global equities Foundation Scholar. you don't have the experience, research team. you can't get in; of course, if Graham & Doddsville you can't get in, you don't have Rupal joined Ariel in 2011 (G&D): Rupal, thank you for the experience! after spending 10 years joining us today. Would you with MacKay Shields, mind starting with an overview I was fortunate to get my where she was senior of your background and how break a few years after I managing director, you became interested in finished my MBA. My portfolio manager and investing and got into graduation coincided with a head of international professional money nasty recession in 1992 so I equities. Prior to that, she management? took any job I could just to spent 5 years at stay afloat. Luckily my job Oppenheimer Capital, Rupal Bhansali (RB): My involved covering emerging where she managed background is unusual in that I markets on the sell-side and I international and global have worked on both the sell- knew if I worked hard it could equity portfolios and was side and the buy-side, in prove to be my launch pad to promoted to co-head of investment banking and in the buy-side. At the time there international equities. investment management, on was not much published Additionally, she has held the long-only side and the long research on emerging markets various roles at other -short side, on developed so I was a jack of all trades— financial services firms markets as well as those that researching ideas and writing since she began her career are emerging. I have up notes at night and pitching in 1989, including Soros researched scores of sectors ideas to clients by day. Soros Fund Management. and thousands of companies Fund Management was one of and covered close to 50 my clients and they liked my In 2009, Forbes countries over the years. My work and asked if I wanted to International Investment varied, hands-on experiences join them—I obviously jumped Report named her a over the past 25 years have at the opportunity. That's how “Global Guru,” and in helped me understand the ins my career in investment 2015, Barron’s recognized and outs of investing from a management started out. her as a “Global very deep and broad Contrarian.” Rupal is a perspective. G&D: What do you think has frequent guest on premier allowed you to have a shows such as Bloomberg, I got interested in investing successful investment career? CNBC Squawk Box and because I grew up in a family of Fox Business News. She is bankers and brokers. From a RB: In every job throughout also a sought-after speaker young age, I knew I wanted to my career, I tried to have at prestigious industry be in finance, and that gave me varied work experience and conferences including the a head start. I studied ensured I learned something (Continued on page 16) Page 16 Rupal Bhansali

different. For example, in my from other people. Investment and learning are cumulative in job working on leasing in management and equity nature. That foundational, undergrad, I learned how to research are not things you formative experience is critical. identify when an APR is being can teach; they have to be You don’t want to end up in manipulated by adjusting the learned. When you work the wrong place in your early residual value. among smart, talented people, years. I've seen a lot of careers you become smarter yourself. I end up in a dead end because At Soros, I learned a lot about chose to work in some great people didn't choose well early risk management and downside organizations where people on. protection, because in the were so talented that it rubbed hedge-fund world, there's just off on me. You rub off on G&D: You talked about crises much more intensity and rigor other people and you become and how you were able to around that compared to the a person who can make others benefit from past episodes traditional long-only world. around you better. you've seen around the world. Because I covered emerging Was there something in markets for such a long time in I'm always surprised that particular that happened in the my career—and grew up in students spend so much time past that allowed you to see one—I learned a lot about figuring out which college to the financial crisis coming dealing with crises. The one attend, but when it comes to before it occurred or was it constant about emerging work, they don't do as much more about how you markets is that there's always homework on their positioned yourself once you something going wrong prospective employers and the were in the center of the somewhere in the world. Your people who work there. It storm? antennae go up for those becomes a passive exercise of events. looking at what job postings RB: Oh, no! When it comes are available as opposed to an to risk management and Covering crises in emerging active exercise of finding out, protecting a portfolio, it has to markets really helped my “Where do I want to work be a preemptive strike. There's clients in a year like 2008, and how do I get admission to not much you can do after the when developed markets had my dream firm?” Figure out fact. You always have to be on their big financial crisis after a the kind of investment firm, the lookout for things that can very long time. I had seen that philosophy and culture you go wrong before they actually playbook before and we were want to be part of and then try go wrong. Frankly, we could able to do very well by our to work yourself into it, as see things going wrong as early clients and protect them opposed to waiting for it to as 2006 and we took proactive during that crash. The markets happen to you. action in our client portfolios. were down 43%; we were We sold off a lot of our down 24%. I remember getting banking well before phone calls from our clients “I'm always surprised people became aware of the asking "are your performance mess in mortgages and the numbers correct—have you that students spend so subprime housing loan crisis. I guys made some calculation much time figuring out think that these things are a error?" Turns out our confluence of many performance was such an which college to attend, developments brewing over outlier amongst what they time—they don’t happen were seeing, they thought our but...they don't do as overnight. The Lehman stellar performance must have much homework on their bankruptcy may appear to be been a typo! the catalyst but it was actually prospective employers the culmination of a lot of The other thing that was very things that happened prior. helpful, and something that I and the people who The Lehman downfall feels like think all investors should find a work there.” a shock catalyst because in that way to harness, is the power one stark moment the of osmosis in this profession. systemic risk became glaringly You really learn on the job and Keep in mind that investing obvious to all. But the risk was (Continued on page 17) Page 17 Rupal Bhansali

there all along, and it was print, and lo and behold, they off-balance sheet leverage was building over many, many were assuming very high exit even greater. Investors also fell months, even years. You can multiples on the real estate for a recency bias and assumed actually see it coming if you're they had acquired in the the ratio of non-performing on the lookout for it. This terminal year of their forecast loans would remain low due to allows you to prepare for it and that obviously worked out benign conditions—this is a instead of being blindsided. to a high IRR (internal rate of classic example of circular return) on the investment. logic. Now most businesses The challenge though is that They were touting this high can afford to make some you pay the price for such IRR to unsophisticated retail mistakes and not have to pay proactive risk management investors who did not know or too much for them. However, with inferior performance, understand the difference in the world of banking and until the risks you are worried between a forecasted IRR and , you can't make a big about actually manifest an actual one. I knew this was mistake because you have a lot themselves. If the time gap is not a sustainable business of leverage on the balance too wide, your clients can fire model and avoided the stock sheet. A small mistake is you in the interim. You need despite its apparently high automatically multiplied and courage to stay the course growth and ROE. The stock magnified into a big mistake even if the very clients in was among the first to collapse through the power of leverage. whose interests you are acting in the financial crisis as they And a big mistake becomes a don’t see it that way at the could no longer palm off the mega mistake. If your equity is time. Being a contrarian is not expensive real estate they had very small, you're going to get easy, but it is right. overpaid for at a profit and in wiped out. At that point, fact had to book large losses. equity is nothing but a binary G&D: What exactly did you By the way, this is the power option with a very, very high see coming that others didn’t? of fundamental research—a strike price because there are quantitative model cannot a lot of claims ahead of you. RB: My prior experience uncover these types of And that binary option may working in various facets of questionable business expire worthless! finance helped me smoke out practices. potential rip-offs. Here is one example. I remember talking to Additionally, we saw that too “Investors [in banks] fell a marquee financial institution many people in banking were for a recency bias and whose stock was a market focused on VAR, or value-at- favorite because they were risk. Value-at-risk is a statistical assumed the ratio of non- generating tremendous fee construct that always appears income which investors loved very low when things are performing loans would and put a high multiple on. On benign. So, if you don't remain low due to benign further investigation, I found understand the context, you that a lot of those fees were will be misled. It's not that conditions—this is a generated by promoting closed regulators, rating agencies, -end real-estate funds to investment banks, and even classic example of circular investors. Knowing real estate investors, were not paying logic.” was overvalued and illiquid, I attention to risk. But they was curious why anybody were being academic as would want to buy a closed opposed to practical, and Risk assessment boils down to end fund that itself was an single-dimensional instead of looking at the right things in illiquid vehicle! Nonetheless multi-faceted, and that led the right way. We were relying the company was clearly seeing them to looking at a single and on the power of good a lot of demand and the facts wrong risk metric—VAR. research. It's not about finding didn’t square with common the answers, it's about asking sense. And that is the first clue We looked at other metrics the right questions. That's to a scam—something does and saw that leverage on what led us to understand that not add up. So I read the balance sheets was increasing there was way more risk in the prospectus to check the fine on an absolute basis, and the system and in individual banks (Continued on page 18) Page 18 Rupal Bhansali

than the market understood, grain. It also takes patience. In and applies everywhere—so I so we actually got out of our fact, in investing, stomach and applied his intrinsic value positions and protected our stamina are more important investing approach to clients. We didn’t own a single than smarts or spunk. international markets. My bank that went under, and investment track record is that's from our first rule of Finally, it was not my father’s testament that it absolutely investing: instead of focusing successes alone, but rather his works abroad as well. on making money, first try not ups and downs that have also to lose it. shaped my investment thinking. Other individuals that were I'm a big believer that failure among my biggest influences G&D: Who has made the teaches you more than and deserve my utmost greatest impact on your success. It’s what you get gratitude are all my former and career? wrong, not just what you get current bosses. They were all right that matters in investing. very demanding and expected RB: My earliest influence was a lot of me, but frankly, I my father who is now a retired “With every company we would not have it any other stock broker and investor. He way. If you're a high achiever, unknowingly gave me my first look at, our attitude is: you want to make sure you taste of equity markets have a boss that doesn’t cut because he used to work from ‘You're not good enough you slack, but holds you to a his home office which doubled for us. You are too risky.’ high standard and gets the best up as my bedroom. I grew up out of you. That’s the listening to stock stories and We are thinking about contrarian in me talking—most was exposed to contrarian people want the path of least investing, because he was an all the things that can go resistance and prefer independent thinker. He wrong.” compliments to critique and marches to his own tune in easy wins instead of tough most things in life and investing challenges. But going for the was no exception. The second influential person opposite will make you way was George Soros. Before I better! Remarkably, my father had the joined Soros Fund foresight to know that if his Management, I had not G&D: If you were to look at kids were going to be understood the role of your process and how you independent minded, they had behavior and psychology and invest, what sets you apart to be given independence. He the notion of reflexivity in from others in the profession? made sure there was no markets. Markets are not just “helicopter parenting” imposed made up of stocks, but of RB: I think the single biggest on us. Making decisions, people. Their reflexive difference is in what we look including and especially tough reactions can cause for. I feel that most long-only investment decisions, comes movements in stocks and a managers think about what can easy to me because I have had divorce from fundamentals. If go right and how much the to make and be responsible for people have not read Soros' stock can go up. By contrast, my decisions my whole life. book on reflexivity, The with our approach we first Alchemy of Finance, it's not a think about what can go wrong The things that I learned from bad idea to read it. Although I and how much can the stock observing his investing career don’t agree with everything go down. We pay more is: a) how important it is to be a that he says in the book, it is attention to risk management contrarian to make money in an interesting perspective. because risk is the permanent markets, and b) how hard it is impairment of capital. That's to be a contrarian. I saw the I know a lot of people talk what I think is really different triumph of being a contrarian about Warren Buffett, so I about us, that we think about but also, the tribulations. It's won't mention him being an risk before we think about not for everyone because it influence because it's obvious. I returns. requires a great deal of was convinced that Buffett’s fortitude to go against the way of investing is universal For most people, risk is an (Continued on page 19) Page 19 Rupal Bhansali

afterthought. For us, it's a think and what the market Frankly, I find a lot of preemptive strike. We try to thinks, happens to be the same consumer staples around the avoid risk and eliminate it from – a.k.a., it’s a consensus view world to be very expensive. the get-go because if you don't and already in the price. That Just because the quality of the swim in shark infested waters, said, because we look at business is good and you are the chances of you being bitten thousands of companies and not taking business risk, does by a shark are very low. only need to own a handful, not mean you're allowed to there are enough companies take valuation risk. Risk is risk. If you think about the with low risk that have It doesn't matter in what form motivation of a typical analyst compelling returns and growth it comes—you're still going to at a traditional long-only profiles that are not well lose money if you're shop—it is to pitch an idea to understood by the markets. overpaying. your portfolio manager to buy. Obviously, your modus That's where we find our On the other hand, we found a operandi is to look for things sweet spot and do a much number of technology to like about that business deeper dive to understand companies that are great because that's what you want what that risk and reward look companies but overlooked. to tell your portfolio manager, like, and quantify it in an Microsoft comes to mind. so that he or she puts it into investment write-up and Many people pooh-poohed us the portfolio. This financial model. I want to when we bought the stock conventional process underscore that we don’t about five years ago and didn't automatically creates a blind waste our intellectual buy Apple. Through our spot in one’s research because firepower on the “obvious” contrarian lens, we saw instead of first thinking about high-quality businesses but use Microsoft as an enterprise staple what can go wrong, you're it to identify the “not so and knew it deserved the now thinking about what can obvious” quality businesses. multiple of a consumer staple. go right. That creates a confirmation bias. You're “Many people pooh- If you go to any enterprise, looking for things to like and if you will find that people use you find them, you're going to poohed us when we Outlook, Word, PowerPoint, like it. Excel. I know a lot of college bought Microsoft about students and non-professionals In our process on the other five years ago and didn't like to use the Apple software hand, we are actually looking and Apple gadgets, but in the to reject, not to select. That buy Apple. Through our corporate world, Windows means that with every and Office 365 rules. They company we look at, our contrarian lens, we saw have the leading enterprise app attitude is: "You're not good Microsoft as an ecosystem, so it's very sticky enough for us. You are too and results in a recurring risky.” We are thinking about enterprise staple and revenue stream. In our book, all the things that can go Microsoft was an enterprise wrong. Generally speaking, knew it deserved the staple but the market viewed it about two-thirds of the multiple of a consumer as a high risk and volatile companies in our universe technology company that was tend to get eliminated based staple.” losing out to Apple and on risk. Google. Both were false notions as the latter only With the third or so that Let me give you an example. A succeeded in the consumer remain, we find that about half lot of people love to own market and made no inroads of them are companies that we consumer staples. I mean, who into the enterprise market judge to have low risk and doesn't? Warren Buffett of where Microsoft rules. As our good returns, but so does the course, has talked about how thesis was borne out, we made market. These companies are they are such great franchises. our clients a lot of returns and unlikely to be a source of alpha They have moats. But all this is with low risk. That's the generation because what you very obvious and well known. power of doing research in a (Continued on page 20) Page 20 Rupal Bhansali

different non-consensus way. industries are exposed to texting and we certainly regulatory risk. weren't using video. Most of us G&D: When you are Telecommunications is a great in the U.S. now have a screening for risk, what types example. Even though it's a smartphone as opposed to a of risk are most important? low-risk business with feature phone. Think about subscription revenue and China as America eight years RB: Risk is not statistical services in high demand, ago. The usage of data is metrics such as beta or there's a great deal of risk extremely low today, but we standard deviation or tracking from regulatory intervention. think it's going to go up a lot. error. I know that's what's taught in the CFA & MBA You can also have a lot of Monthly phone bills in the U.S. programs but as a practitioner disruption risk and most are around $60. In China, the I can tell you that is not the investors are vigilant about this equivalent bill would be closer definition of risk. For an risk in, say, the technology to $10. The GDP per capita is intrinsic value investor, risk is sector. Another industry that different in the two countries, losing money permanently. was very exposed to this risk, but in China you don't have as but not perceived by investors many fixed lines as in the U.S.. That said, the word, as such, lost investors a lot of For people in China, their cell “permanently,” is very money when it materialized. phone is often their sole important. You can always That industry is retailing. As access to the internet, to e- have short-term volatility—i.e., we know, brick and mortar has commerce, to watching video, you can lose money moved to e-commerce. That etc. You can see why we temporarily, but not proved very disruptive to believe the monthly bill has permanently. A lot of people retailers. By paying attention to significant headroom to grow. confuse short-term volatility business risk, we avoided and long-term risk. People are owning value traps and saved Despite these compelling so afraid of volatility that a our clients money. When it prospects, the company's contrarian investor can actually comes to risk management, a valuations are quite attractive. take advantage of this dollar saved is a dollar earned. The market is implying a low behavioral bias and still avoid single-digit growth rate in risk. G&D: Would you mind earnings, but we are focusing sharing some current on the double-digit growth We think of risk in the investment ideas? rates in free cash flows. underlying business. For Currently, the company is example, if you're a RB: China Mobile (CHL) is a making large upfront pharmaceutical company with a leading wireless carrier in investments in the network, single product, even if that China. Think of it as a Verizon but in the future such capital product is very successful, times four because they have expenditures will fall. It is when the patent expires and over 750 million subscribers. similar to the cable TV you have nothing to show for a China Mobile enjoys a companies in the U.S.—they successor, you're a very binary whopping 66% market share in are cash machines. The beauty company. You could make the country, which obviously of China Mobile is almost one- great profits today, covering makes it dominant. They have third of its market cap is sitting your , generating installed the 4G network well in cash, but they are looking to lots of ; that is a ahead of their peers and are in increase their low low risk company, financially the early innings of Chinese payout ratio of about 45%. speaking. But because it's single consumers migrating towards product and it has no smartphones. The reason why we think the successor drugs or pipeline, it's market doesn’t agree with our actually a highly binary and If you think about the playbook assessment is that historically, risky business, so we would in the U.S., about a decade ago, some EM governments—the eliminate it. we were still using feature Chinese government in phones to mostly make voice particular—have had a history Also, risk is very different in calls, and we were not using of intervening and preventing different industries. Certain data plans. Data was really SMS the industry from earning (Continued on page 21) Page 21 Rupal Bhansali

super-normal returns. That's China so late. end and retreaded tires. The something that the market is reason why those low-end unduly concerned about, but in The government learned from tires don't end up hurting the our opinion, even if they earn that mistake and they allowed high-end and mid-end tires is normal returns, that's good China Mobile to develop a that a tire is very crucial to enough for us. variant of the standard 4G achieve high fuel efficiency and Finalists Zach Rieger ’17, which is much more in line safety. The emission standards Alexander Levy ’17, Eric We love the fact that it holds with the global standards. As a and the fuel efficiency Laidlow ’17, and Marc net cash, which provides a result, the equipment and standards in the developed Grow ’17 celebrate with margin of safety in a world that handset costs came down and world keep increasing. Geoffrey Hulme (middle) has gone on a debt binge. We made the service much more after the The Heilbrunn love the fact that it's well affordable. You're absolutely There are a couple of ways to Center for Graham & positioned from a network right, government intervention crack the code on improving Dodd Investing Stock Chal- perspective and from a was a risk, but once that risk is fuel efficiency. You can lenge consumer preference behind you, you don't want to obviously try to reduce the perspective. They don't take double count it. weight of the car, you can shortcuts in investing in the improve the engine efficiency network at the expense of G&D: Thank you. Any other and clearly there's a lot of generating free cash flows. ideas you would like to share? effort that goes into it. But They do both and that's why physics has its limits. The it's a high quality business. The RB: We are also positive on humble tire came to the low valuation gives us a good Michelin. Many high-end cars rescue. If you have good air upside-downside ratio. are fitted with Michelin tires or pressure in the tire, that alone brands owned by them. One can make a remarkable G&D: How do you think thing you will find about tires is difference in fuel efficiency. about country risk in China? that they have pricing power. China has this habit of rotating A pair of good tires can easily Michelin is not well its preference among its state- cost you a couple of hundred understood as a company owned enterprises. How do bucks. because for years, being a you think about this problem French company, it was family- where even though it's an owned, and managed in a oligopoly and it is government “We are also positive on patriarchal way. A couple of controlled, we don't know Michelin. Many high-end years ago, the company which of the three mobile appointed professional players the government may cars are fitted with leadership that has been trying prefer on any given day? to improve manufacturing Michelin tires or brands efficiency and addressing a RB: Sometimes when owned by them. One bloated cost structure. The government policies align with stock had sold off because the what the company wants to thing you will find about street was very concerned accomplish, it stops being a about an imminent downturn risk; it's a source of return. tires is that they have in the auto industry. It is true One of the drivers behind the pricing power.” we are closer to the peak than opportunity in China Mobile the trough and we admit that developed precisely because of the auto industry is cyclical. what you just referenced. The But what is misunderstood is government forced China Tires appear to be a low-tech that tires are an after-market Mobile to invest in a product. But if that is the case, product. It doesn't matter if proprietary 3G network, and how are there only four new cars are not sold; as long because they forced this, the players in the world making as you drive, you need to country suffered because tires, when there are dozens replace your tires. It's a nobody in the world made that can make cars? It suggests consumable. When investors handsets which were that there's a high barrier to mistakenly threw this baby out compatible with that network. entry. Indeed, the Chinese and with the bathwater, we picked This is why the iPhone got to the Indians make a lot of low- it up. (Continued on page 22) Page 22 Rupal Bhansali

G&D: What advice would you prerequisite to success in this Also, I am very fortunate that I give those interested in the profession. You should read a have a life partner who knows investment management wide range of topics, not just that my career is very profession and what specific finance. When you're important to me. I did not advice do you have for women researching businesses, it's not have to make sacrifices that I in the industry? just about numbers, it's about know many others might have business and management to make if they don't have that RB: First and foremost, strategy. It’s about kind of support. For women, in investment management is understanding change as particular, because this is a learned on the job. You cannot opposed to the status quo. very demanding profession, learn it from a textbook. You make sure that you set cannot learn it from reading I hope this advice helps both expectations with your friends Warren Buffett’s annual genders but I think it applies and family and build a support letters. If you tried selling your more to women. One of the system around you. degree on eBay, nobody would things that I always did was to pay you a dime for it. But if raise my hand. I never shirked G&D: Thank you so much, it you apply what you have from taking on more has been a pleasure. learned, then your employer responsibility, even though and clients will pay you for it. there were times when I had Knowledge is what you pay for, no idea how I would fulfill it. application of knowledge is Raising your hand is a big deal. what you get paid for. I remember in the late 1990s, when I was working at I think that too many people Oppenheimer Capital, we lost think that just by getting a the person on our team degree or reading a lot of the covering Japan. I raised my literature they know investing. hand and was given the But, it's about the rubber responsibility, knowing fully meeting the road. This is like a well that it was one of the sport. You don't learn hardest markets to cover. swimming by reading about Mind you I never spoke swimming. You don't learn Japanese and prior to that I how to become better at had never covered Japan. As it baseball by reading about it. turned out, we did You actually have to do it. spectacularly well in Japan that year, which I attribute to hard So my biggest career advice for work as well some rookie students is to start working. luck! You are going to learn on the job so make sure that you In a country like America, if work in the right place. It you work hard and you work should be a place that appeals smart, there is nothing that is to your investment sensibility beyond you. Don't hold and philosophy, because yourself back. Don't think you without the right platform and can only cover something that your peer group around you, it you know. Take on a challenge. just doesn't happen. This is You may not know exactly about osmosis. Start working how you're going to overcome as soon as you can because that challenge, but if you don't that's where your education give yourself the opportunity and training really begins. It's to test yourself, you'll never not in the classroom. know whether you could have been successful or not. “Raise The other thing I would call your hand,” is my most fervent out is that a love of reading is a advice to women. Page 23 Simeon Wallis (Continued from page 1)

in a select few private He earned his MBA from business world and investing. companies as well as The Wharton School of opportunistically invests in the University of During my semester studying publicly traded securities. Pennsylvania with a abroad in Australia, I walked concentration in Finance into a bookstore and came Atlanta, GA-based and his undergraduate across a book, which would ApolloMD is ValorBridge’s degree in History, from shape my world view. That Simeon Wallis original portfolio company. Duke University, cum book was Den of Thieves by ApolloMD is a laude. James B. Stewart, a Wall Street multispecialty physician Journal reporter at the time. services company that Graham & Doddsville Den of Thieves recounted the provides emergency (G&D): Thank you for joining great insider trading scandals medicine, hospitalist, us Simeon. We really of the 1980s, and in doing so, anesthesia and radiology appreciate your time. Could detailed the history of activism, services to hospitals, you tell us about your the corporate raiders, the use health centers and surgery background and how you of the highly leveraged finance, centers across the United ended up at ValorBridge? , and States. It is one of the . That really most successful firms in Simeon Wallis (SW): I grew resonated with me. I believe the physician services up in Manhattan. My father had part of the fascination was outsourcing industry, as worked on Wall Street but had growing up in New York with evidenced by its history of left by the time I was born. I those familiar names, but also strong organic growth. always grew up with him the idea of mixing business and investing on the side. We had a history, and understanding Simeon Wallis currently family business, which was a how things came to be within serves as Investment small chain of retail apparel the business world. Director at ValorBridge stores, which, in retrospect, Partners. At ValorBridge, was not a good business. I Afterwards, I immersed myself he is responsible for our learned that entrepreneurship in different aspects of business research process, is filled with highs and lows, history. Within my Markets & investment origination and and our family Management program, my due diligence. He is also a reflected that. My father’s thesis analyzed the leveraged member of the portfolio investing was a huge benefit— phenomenon through management team and that always stuck with me. the early 1990s, using KKR’s serves as a board member bid for RJR Nabisco as the for several of ValorBridge’s Growing up I had exposure to lens; there was an outstanding companies. Prior to investing with friends whose book, Barbarians at the Gate, by ValorBridge, Simeon parents were on Wall Street. I Bryan Borroughs and John advised value-oriented was one of those kids at 10 Helyar. My paper evaluated the hedge funds and asset years old who enjoyed stock- market for corporate control, managers with security picking contests. The first time basically activism in today’s analysis. He helped I started paying close attention vernacular. I was intrigued with manage Lateef Investment to the market was at 13 years how business and history Management’s multi- old when I received shares in intersected, and how history billion dollar concentrated Disney as a gift and followed could translate into future portfolio in San Francisco Disney for the next decade. investments. I learned that the and was an analyst with context behind events deeply Cramer Rosenthal I went to Duke for undergrad matters. McGlynn, Asset and majored in history. Duke Management, and Gabelli is a liberal arts school, with no Coming out of Duke, I worked & Co. in New York. undergraduate business school, in management consulting for Simeon has been a guest but it had what was essentially nearly three years in Atlanta. I lecturer at the Columbia a minor, called a certificate in then returned to New York to Business School in its Markets & Management, that work on private-market Value Investing program. provided exposure to the investments in earlier-stage (Continued on page 24) Page 24 Simeon Wallis

technology with a venture the business never really got management were about $3B fund, named Dawntreader. It the legs underneath it, and at the time and rose to $4B. It provided a very different eventually it was folded. It wasn’t a good cultural fit. My experience in terms of remains a lesson that wife and I moved back to New analyzing smaller companies, randomness and luck, such as York, where I worked on where managing cash flow was timing, can play a huge role not projects for several small cap critical and management had a just in investing, but in careers. managers—Wynnefield “make or break” impact. Capital, Candace King and However, I realized that I was After Evercore, I moved to Amelia Weir at Paradigm not exclusively a venture Cramer Rosenthal McGlynn, Capital Management, and Ken investor at heart and chose to which is a more established Shubin Stein at Spencer pursue my MBA at Wharton value manager. There were Capital—before connecting before returning to the public about 20 analysts, and it was with ValorBridge, which was side of investing. roughly $10B in assets under based in Atlanta. I joined in management when I joined. May 2013 and I worked After business school, I CRM was mostly long-only remotely in New York for worked for Mario Gabelli ’67 with a small long-short several years before relocating covering autos, trucks, heavy product at the time, and to Atlanta last summer. equipment manufacturers, and looked for businesses that the whole value chain. The were undergoing change. That ValorBridge is a private holding value chain encompassed the change would be difficult to company. It was started by parts suppliers, the global model, or may not have been accomplished entrepreneurs original equipment appreciated in sell-side models, and operators who built manufacturers, aftermarket so these were neglected ideas. successful private healthcare parts distributors, and auto Often these were value businesses. The operating retailers. Autos and trucks opportunities, names that companies generate excess were one of the first industries maybe didn’t screen well, but cash that we use to make that Mario followed. I was occasionally an analyst could either investments in private literally 40 years behind him, find interesting angles to healthcare companies where and essentially, was challenged gather insights. we feel we have some to win any arguments about competitive advantage from the subject with him. “I was intrigued with our understanding of specific customers and pockets of From there, I joined Evercore how business and history opportunity, or we make long- Asset Management, which was term investments that would a start-up launched by four ex- intersected, and how diversify away from healthcare Sanford Bernstein buy-side history could translate into businesses with investors, who had received comfortable risk-reward funding from Evercore into future investments. I profiles. Partners to build an institutional investment learned that the context We also invest in publicly management business. It was a behind events deeply traded companies, depending very intellectually and upon our projected return analytically intense place in a matters.” profile. We can move our great way. It was very capital back and forth between thorough research. If we were public and private markets three years earlier or three After a few years at Cramer because it’s all internal capital. years later, it would have been Rosenthal McGlynn, I received We’re not a general partner to a tremendous success, but an opportunity to work with a any outside investors, and when we launched the small- friend at a 40-year old firm in there are only two situations cap value and small- and mid- the Bay Area. This was a where we are a limited partner cap value long-only products in concentrated fund, 15 to 20 in another fund. Over time, my early 2006, the business timing names. There were three role has evolved from being was completely wrong. investment professionals. I was pure public markets within Because the timing was poor, the fourth, and assets under ValorBridge to straddling both, (Continued on page 25) Page 25 Simeon Wallis

and when need be, stepping business that had not been of Shareholder Activism. into an operating role. We improved with all of the debt believe our differentiation is issued. It’s the worst of all Could you walk us through the wearing several hats— worlds. In good situations— big lessons you learned operators, public equity and there were many—an throughout your career and investors, private market outside investor would come how you apply those to public investors—where we take our in and say, “You’re essentially and private markets today? knowledge in the private in four different businesses. companies and apply it to There’s very little synergy SW: Mario had a pool of public companies and vice between any of them.” fifteen to twenty analysts who versa. would sit around a table every It’s a reflection of the morning and he would G&D: That’s a great overview. conglomeration movement of Socratically ask us about our Could you talk more about the the 1960s and into the 1970s. coverage universe. I followed academic work you did The company and its the automotive value chain, the regarding activism and the stakeholders were generally heavy-truck manufacturers, implications of that today? better off spinning off the such as PACCAR and Navistar. assets or putting the assets I also covered heavy- SW: A professor named into the hands of those who equipment manufacturers, such Michael Jensen coined the would value it more highly via as Caterpillar, as well as term “the market of corporate divestitures, and use the cash agricultural equipment control,” which is an academic to find one or two businesses companies, such as John way of saying the actions of to grow. Deere. What unites that corporate raiders and activists. coverage universe was they He believed in the efficient In situations when activists shared common parts markets perspective that all came in with a mindset focused manufacturers. They had a assets are properly valued in on capital allocation and long- common supply chain but free markets, including term value creation, it was different distribution. What I corporate assets. My incredibly beneficial. In learned was there were a perspective was different in breaking up companies, the variety of business models that I believed there were assets went to owners that within a specific industry. The times when the market for either understood those business models had different corporate control and activism businesses better, or you’re margin profiles, different were beneficial to most able to take capital and give it capital intensities, different stakeholders involved; to those who can grow their growth opportunities, and however, in the 1980s, there businesses in healthy ways. I therefore they needed to be were points when I believed it don’t believe one could valued differently. I started to was detrimental. definitely say that activism on think more horizontally about the whole was good or bad. the nuances of understanding a An example when it was There were benefits and trade- different business model as detrimental was when offs. I would argue that the opposed to the conventional corporate raiders used good instances greatly wisdom of categorizing greenmail. was benefitted the U.S. economy companies by industries. known as one of the leading over the long term. protagonists; greenmail was Mario’s known for his acronym when a raider would buy a G&D: Interestingly, there’s an “PMV,” private market value, stake in a company, threaten a adjunct professor at Columbia, which is a sum of the parts of a hostile take-over, and Jeff Gramm ’03, who wrote a business based upon what an management would lever the book about a lot of these same intelligent buyer would pay to company up in order to pay issues. acquire that business. In the greenmailer off to go away, addition to thinking about the all at a premium to other SW: Was that Dear Chairman? balance sheet, we looked for stockholders. What the hidden assets or off-balance remaining stockholders were G&D: Exactly, Dear Chairman: sheet liabilities, and put that all left with was a highly levered Boardroom Battles and the Rise together to understand the (Continued on page 26) Page 26 Simeon Wallis

real value to the owner. To manufacturers. We’d compare G&D: Can you provide some think about businesses that the fully loaded labor costs or comments from your way was very valuable because healthcare benefits to retirees experience at Evercore? having a differentiated per car that the consumer is perspective is one of the few paying for, yet not receiving SW: At Evercore, I worked ways to outperform peers and any value from. That’s a for Andrew Moloff, a portfolio the market over time. competitive disadvantage manager who, better than relative to another company anyone I’ve known, For example, John Deere had that spends that same amount persistently questioned his manufacturing operations and a on what drives future value for analysts to help them finance business, Deere the company, such as R&D. understand what the key Finance, which provided drivers to an investment were. dealers and end customers He was a teacher. Andrew’s financing. Screening on “I don’t believe one approach was comparable to Bloomberg or CapIQ, Deere could definitely say that what I would eventually learn would show significant debt in studying Lean management and appear levered; however, activism on the whole as the “5 Why’s” by going diving into the SEC filings, an through ideas with the analysts analyst would realize those are was good or bad...I through repeated questions to two separate businesses. The would argue that the understand what the finance arm could be valued as investment controversy was, a finance company, such as at good instances greatly often better than management book value or determine what benefitted the U.S. understood it. an intelligent buyer would pay for that portfolio of assets. economy over the long The methodology was very similar to Rich Pzena or Then one would evaluate the term.” Andrew Wellington at Lyrical capital structure of the where the analysis is driving manufacturing business. Often toward deriving normalized there would be net cash as At Gabelli, we invested time earnings in five years based opposed to net debt, and an analyzing on a per-unit basis of upon the capital structure and analyst could decide what is value creation or, alternatively, margin profile of the business. the right multiple to pay on its we would determine what an The objective is to understand mid-cycle operating earnings acquirer would pay for that whether the reason the stock or EBITDA. So by valuing one unit of value. Mario found price is currently depressed is part of Deere on book value industries that were based upon a temporary factor and another on operating consolidating and determined or a structural change that earnings plus the net cash, an how an acquirer would define would be difficult to fix. It was investor could derive a value. For instance, in the cable a great lesson in understanding valuation materially different industry, he’d ask, “What’s the the questions “What’s the relative to where the market per subscriber right valuation?” And “What was valuing it, especially if the that’s in the subscriber are the right earnings to market looked at it on a P/E network, and where should it assume in a normalization ratio basis. Deconstructing be?” He found huge disparities process?” businesses and valuing them between the current market with the appropriate methods value of a subscriber and the G&D: Your team can invest in based upon the attributes of value on a per- the public market, in private the underlying business models subscriber basis. If there was a market investments, and proved tremendously valuable. large spread, that was really reinvest funds back into the appealing. This EV and underlying business itself. How The other big lesson from transaction value per do you decide where to Mario was understanding the subscriber could be used to allocate capital? unit economics of the business. value any subscription business Let’s say we were looking at model. SW: We do a back of the one of the Big Three auto envelope IRR calculation, (Continued on page 27) Page 27 Simeon Wallis

thinking five years out. On the as earnings will probably revert incredibly appealing. public side, our holding period back to a normal level. might be three to five years. It In the private markets, there’s might be on the early side of G&D: Are there times when a deal process. Deals can take that five-year IRR. Price will be you’re comparing the public two or three months, at a a component of the process. and private opportunities side- minimum. They can take six to With the private investments, by-side? Is there a certain nine months with the due we actually expect to hold amount of capital that you diligence and negotiations. It’s longer than five years; there’s want to allocate to each part slower than public market more opportunity to influence of the market? investing, and valuations can the outcome because we’re still move during the process. going to have more control. SW: We ask ourselves, We look at IRR based upon “What’s our opportunity cost? our opportunity set. Additionally, we can invest What’s the risk-reward from anywhere in the capital being in the public markets G&D: What does a typical structure. We can provide versus private markets? What private market investment capital as debt, mezzanine is our IRR in the public look like for ValorBridge? securities, or common equity. markets and the private We have a lot more flexibility markets?” One of the SW: On the private side, I’ll in our ability to mitigate risk advantages of being in the break it into healthcare and on the private side. The private markets is by definition non-healthcare. The two tradeoff is, of course, that it’s they’re less efficient. They’ve founders of ValorBridge, Chris not liquid. If we’re in the public become far more efficient and Beau Durham, have a markets and we realize we because now 100 private background in healthcare. Both made a mistake, you can just equity firms will look at the have law degrees and Beau also sell. However, on the private same deal, but proprietary has an MBA, but they both side, we have to invest deals still come through ended up going into healthcare significant time to exert relationships. over time. influence and affect change. In the public markets, there’s Within healthcare, we are far For private investments, we nothing proprietary. Today it is more comfortable finding concentrate on the harder to find compelling earlier-stage companies that compounding of intrinsic value opportunities for us given are attacking a market niche through owner earnings valuations. Whereas on the where we see a big growth. It’s more of a growth private side, we can find one- opportunity based upon our perspective and operating off opportunities that might be knowledge of the healthcare perspective, whereas on the more compelling. For example, industry. We can leverage our public side, we are more of a there could be times when our existing relationships, such as price-sensitive investor, where own portfolio companies can our relationships with hospital we’re looking to double our make a tuck-in acquisition and systems, to accelerate the money over three years. A pay 3x trailing twelve month growth of these smaller bigger driver of that in our pretax earnings, adjusted for companies. In the last year, we public investments is the amortization. It’s hard to beat purchased a hospital out of normalization of the earnings that. That’s inherently (with no bankruptcy, where we were multiple, as opposed to growth growth) a 33% pretax return. already a service provider in of earnings or cash flow. There Then add growth or cost that facility. We own a web- are two levers to returns—the reductions from synergies, and based scheduling company for earnings or free cash flow and return on capital can rise to emergency rooms that the multiple. On the private 80% or 100% quickly. It’s functions similarly to side we focus on growing cash difficult to find those OpenTable with a comparable flows. On the public side, we opportunities in the public value proposition. A patient tend to focus on situations markets, but if we were in gets hurt, knows that s/he where we expect that the 2009-10, and we were to see should go to the ER, goes onto multiple will rise to some level great valuations combined with the local hospital’s website and where it historically had been ample liquidity, then that’s schedules a time to go into the (Continued on page 28) Page 28 Simeon Wallis

ER (assuming the injury isn’t We’re less willing to go with a Therefore, in sustainable life or death), and can go home startup or a very young team growth businesses, profitable to rest on his/her couch in in that type of situation. growth accrues more and front of the TV as opposed to more to the shareholder. sitting in the emergency room G&D: At what point do you for 4-5 hours. We own the begin considering exit Look at John Malone and look majority of a tele-health or opportunities? How do these at the team at TransDigm. mobile health company. We factor into the IRR What they understand is that if can leverage a network of consideration? an investor considers how doctors with whom we already enterprise value compounds have relationships. Due to SW: Our perspective going over time, with the these capabilities, we’re willing into an investment is that we appropriate leverage structure, to invest in earlier stage wouldn’t invest in any business equity compounds even faster healthcare companies. that we wouldn’t be over time to the owner, comfortable holding for a very assuming returns greater than For our non-healthcare long term, at the very least, the cost of capital. Liberty and investments, these are in more longer than the typical private Transdigm can run at higher established businesses that equity fund’s investment cycle. levels of leverage because in should grow free cash flow at We won’t buy with a cable and in aftermarket nice levels for owners based perspective of when or if to aerospace, the revenue growth upon our research that the exit. That said, we’re all doesn’t have to be fast. Modest management team is far rational capitalists. We’re organic revenue growth, superior to its competitors’. approached all the time about combined with operating We directly own stakes in an acquisitions of a portfolio leverage works to have an industrial distribution and company, and if we receive an extraordinary impact on the service company for gas offer that is extraordinarily per-share growth of equity. stations and fuel depots. We compelling, we have no own a sizeable stake in a problem consummating that At the same time, in more company that buys distressed transaction. But the bar is high. cyclical businesses, it’s pretty consumer credit portfolios Very rarely do you find buyers foolish to employ even a from issuing banks that are in who are willing to pay up for moderate amount of leverage. charge-offs, where we can five years’ worth of free cash These cyclical businesses are purchase them for pennies on flow growth and place a fair often asset-intensive and have the dollar and manage the multiple on something five greater operating leverage. collections process. I consider years from now. What’s helpful to me is to this an investing business at its understand the reason for the core. We own passive stakes G&D: How much leverage leverage—is it to fund in other companies, such as an does ValorBridge employ? operations of a capital- industrial gas distribution intensive business or is it to company and the largest SW: I believe private equity create a more efficient capital manufacturer of wine bottle investors understand this structure for the equity closures in the world. In our aspect well while a far smaller holder? Not appreciating this is established company percentage of companies in the how an investor ends up in investments, we focus on EBIT public markets truly appreciate trouble. We realized that with somewhere between $1 this. Leverage should reflect our businesses, with the more million and $10 million. We the cyclicality of the business’ cyclical ones, we will be target companies with well-laid cash flows looking full cycle, overcapitalized with equity at out growth opportunity, especially at the trough, not points in time. Given our where there’s nice organic just the most recent few years’ inability to accurately predict growth and potential for tuck- or trailing twelve months’ changes in demand, we’re in acquisitions. We seek EBITDA. Leverage magnifies comfortable with the businesses run by highly skilled returns—good and bad—to overcapitalization because it’s owner-operators within their the equity holder. The more our capital that’s on the line. niche and who think about the stable the business, the more world in a similar way to us. leverage it can carry. There are other businesses (Continued on page 29) Page 29 Simeon Wallis

where we can run at 3.5x financing and testing the management wanted to stay EBITDA and feel pretty waters, do you determine that engaged in the business. comfortable with the growth you don’t want to invest the They’re just looking for a in that business, knowing the equity? different partner. pipeline and competitive positioning. It’s dependent on SW: Very rarely. It might have We can install incentives that taking a long-term view of the happened once in the four focus them on profitably variability of unlevered free years that I’ve been here. It growing the business over time cash flow. reflects the due diligence so that the owners will see process that we do with very good rates of return on G&D: When you decide to management before making the their capital. We don’t want to invest in a business but have a mezzanine investment. We come in and buy 80% of a variety of options of where to won’t go into a situation to company and have invest in the capital structure, provide mezzanine financing management take too much how does your team make that where we don’t like the skin out of the game. decision? management team. There are one or two situations where It speaks to one of the mental SW: Mezzanine financing has we’ve done both mezzanine models that we use in both been the initial way we’ve and equity at the same time, private and public markets. I established a relationship to and the mezzanine ends up call it the “3 P’s”. We think help us understand whether protecting the equity if things about price, process, and we like management and to go sideways for some period. people. The people part is tied determine their ability to run a We protect the equity slice to incentives. The price is tied business. Often we can provide with the mezzanine because to the IRR, or if it’s an mezzanine capital at terms there are going to be acquisition or internal capital below what the company could convertible features for project, what’s our return on receive from a traditional capturing equity if there is a investment. The process part mezzanine lender. We might . is thinking about the charge 200 or 300 basis points competitive advantage that we below market; but to establish see. 3Ps is really IRR/ROIC, that relationship, it’s still a “We seek businesses run competitive advantage, and good coupon for us. We’re by highly skilled owner- incentives. collateralized well. In the capital structure we’re above operators within their G&D: How much do the the CEO and the founders private and public investments who own common equity so niche and who think influence one another in terms that helps us to get insight into about the world in a of lessons learned or themes? how they run the business. similar way to us.” SW: They influence each Later, we would have other greatly. A mental model additional discussions about we use, which we first keeping the mezzanine piece, G&D: How do you and your employed on the private side, but also investing in the equity team properly incent the is a deep understanding of the to help facilitate growth, or do operators? “drivers of value creation for a swap. It’s the “crawl, walk, the equity holder”—three of run” perspective of establishing SW: Our best situations have the four are operating drivers a relationship. If we do like been when management has and the fourth relates to each other, then we’re happy not taken very much capital— capital allocation. to help them grow by in the form of equity—off the providing additional forms of table. Reducing equity stakes is On the private/operating side capital, whether that’s usually a yellow flag, if not a there are three drivers of preferred or common equity. red flag, for us. More often profitable growth—the first is than not, management had a revenue growth, or gross G&D: How often, when you different shareholder that profit dollar growth for certain are providing mezzanine wanted to exit, and types of businesses. The (Continued on page 30) Page 30 Simeon Wallis

second is operating margin competitors. This leverages VSD framework. expansion and the third is the concept of starting with reducing the capital intensity of the end in mind. We put more faith in excellent the business, often reflected in managers than many traditional improvements in working The Strategy answers the investors, especially value capital turns. For the public question “How are we going investors. Management, in our companies, we add a fourth to achieve our vision?” belief, matters more the longer driver: shareholder yield. Namely, it identifies what are a position is held. In our the key operational items the opinion, the premium the Shareholder yield is often company will need to execute market pays for outstanding revealed in the Financing on, what are the key capital management relative to section on the Statement of and operational investments average management is Cash Flows. Is money flowing that will have to be made to frequently too narrow. out of the business, and is it support the executing the paying off debt and reducing priorities, how competitors On the public side, we typically the share count? Or is money are likely to react and what are buy what we believe is the best being brought into the the trade-offs that will have to management team in an out-of- business, increasing debt, and be made, since everything has favor industry. We have raising share count? It’s an opportunity cost. deeper conviction that they’re traditionally been owner- going to make owner-friendly friendly when you reduce the Lastly, the Drivers are the decisions and less likely to amount of capital in the critical activities that impair capital. It’s also a belief business. management will focus on and that management can make a that can be measured in order difference in key situations. We also use another mental to execute the strategy. As we That comes from operating model that started with how developed this framework, we companies, allocating capital, we work with our private saw how it is applicable to and serving on boards companies, but has transferred evaluating publicly traded overseeing executives. The to evaluating public companies companies, especially in difference can be dramatic and their management teams. conversations with particularly the decisiveness We uncreatively call it “VSD”: management. If a management and focus on the critical few Vision-Strategy-Drivers. John team can’t credibly and lucidly decisions and inputs that can Wooden famously used a describe how they are have disproportionate impact pyramid to explain his drivers allocating their key resources on profitability and of success. We borrowed that. toward specific objectives that sustainability of the returns on Vision would be at the top of they want to achieve over the capital. the pyramid, Strategy would medium to long term, I believe support the vision and the any investment thesis beyond G&D: How do you evaluate a Drivers would be the base, reversion of the earnings management team when you’re supporting strategy. multiple is difficult to make. trying to look at so many This is particularly true for different options in the public For our established companies, compounders. space? What tools do you use? we want them to have a ten- year, high-level vision that The last few years I’ve guest SW: I don’t want to visit or helps employees, key suppliers lectured at Columbia in the speak with management until and customers, as well as the Value Investing Program in I’ve thoroughly researched board, have a good sense of Chris Begg’s section of them and the investment where our management team Security Analysis. I use 3G’s controversy. I want to avoid is taking the company. It Ambev investment and Heico their influence in how I motivates employees that they as case studies—from annual approach thinking about the are part of a special company. reports, interviews, business. I want them to It distinguishes us in our shareholder letters and address my critical questions customers’ eyes because we’re articles, one could clearly see and I need to spend time to seen as more aggressive in where management was taking determine what those are addressing their needs than those companies using the beforehand. (Continued on page 31) Page 31 Simeon Wallis

A great executive can simplify advantage and focus the shares. Returns on capital.” I the business and her thought business’ resources in that believe that ultimately burned processes in her area. A great example is many fundamental value communications. She remains GEICO and Berkshire. Buffett investors because management consistent in how she talks understood that the direct-to- lacked a true understanding for about the business and what consumer model enabled the why the actions of The she is focused on. She company to avoid higher cost Outsiders mattered. As Seth communicates in easy-to- distribution than competitors. Klarman has said, you either understand terms devoid of As a result, he could 1) invest get value investing or you company and industry jargon. some of the savings in lower don’t. This was the same Decisive in actions, makes prices for customers and 2) thing—it wasn’t internalized. difficult decisions quickly and is increase spending on customer An investor who sat down candid about industry acquisition in the form of with management probably conditions. She is honest and advertising that GEICO was a could have determined this if transparent in better value proposition for they applied the “5 Whys” line communications. I determine consumers. of questioning to why this this by reading ten to fifteen approach to capital years’ worth of shareholder “Our best situations deployment was correct. letters, interviews, and conference call transcripts. have been when After looking over longer management has not periods of communication to I ask, “Is the management team assess authenticity, I focus on focused on the key drivers of taken very much the proxy filing to evaluate the business? Do they incentives. Performance-based understand what their relative capital—in the form of compensation tied to return competitive advantage is? Its equity—off the table. on invested capital and free- source? Are they focused on cash flow growth are great. the same metrics year after Reducing equity stakes is Ignoring the balance sheet or year?” This sense of what to capital base is a red flag. do and why do it is usually a yellow flag, if Adjusted EBITDA is a negative internalized. One lesson I’ve not a red flag, for us.” for that reason. Adjusted EPS learned in operations is that is even worse. it’s very difficult to manage and influence employees. If he was thinking short-term, G&D: Can you talk a bit about Simplifying and creating clarity GEICO’s advertising budget the types of companies that in terms of where a business is would have grown at a far you’re looking at for the public headed and what matters slower pace than it has. But portfolio? enables organizations to take Buffett sees the tie between actions more quickly and to be the competitive advantage and SW: On the public side, we’re more responsive to changing the long-term value of an value investors. We focus on dynamics. Great managers additional policy holder to buying companies that are at understand a business creates GEICO’s intrinsic value. modest valuations relative to value satisfying customers or either their normalized adapting to the marketplace, I’m sure many value investors earnings or normalized free not at the headquarters. The have been fooled when cash flow, three to five years frontline people need to management teams say the out from now. We’ll place a understand what management right things. After William modest multiple on that profit is thinking because they reflect Thorndike published The or free cash flow, credit management’s thought process Outsiders, value and management for share around what matters. Clear fundamental investors were repurchases if that’s part of the communications and incentives telling management teams, company’s history and are the best way to do that. “You have to read this book. determine, given our This is the way to do it.” The expectations, whether we Great managers understand management teams listened could double our money in their relative competitive and spouted out, “Buying back three years or quadruple it (Continued on page 32) Page 32 Simeon Wallis

over five years. G&D: It seems like a lot of comfortable quickly. Then your analysis regarding we’re just seeking to Since our capital is more management is comparative understand the idiosyncrasies. permanent, we take a longer across companies within a time horizon. We tend not to certain industry. Does that For example, on the public and trade around our positions. require your team to focus on on the private side, we’ve Geoff Hulme presents the We focus on industries that a certain number of industries invested in insurance winner, Zach Rieger ’17, don’t have structural change, that you know better than companies. There are niche and runner-up, Alexander where demand may be cyclical, others? Do you tend to aspects of insurance Levy ’17, of the The Heil- yet the product or service compare management across companies, and there are brunn Center for Graham that’s offered is a necessity. verticals? different types of insurers, but & Dodd Investing Stock We seek returns on capital or at its core, an insurance Challenge returns on equity over a cycle SW: We probably haven’t company has certain traits. It’s that are slightly above average. consciously compared about risk transfer. It’s about We’re not trying to outsmart management teams across assessing how well a company the market, just take advantage different industries. We focus has priced and managed risk. of swings in the psychology of on business models. For Insurance companies are just a others by being more patient. example, it is better to pool of capital. A policyholder We look through what the compare the unit economics is giving capital upfront in investment controversy is in and performance of the CEO return for the promise that it order to determine whether it of AutoZone to the CEO of an will receive a payoff if an event is temporary or structural. auto manufacturer or to the occurs. There are nuances, but CEO of an industrial at its core an insurance We’re buying companies that distributor? I’d argue it is the company and financial services we believe have a competitive latter. If we’re looking at a firms are not inherently very advantage, are the lowest cost management team that’s in a different. operator, and/or have the best distribution business, we management team in their believe we understand what Some of the industrial industry. We look at the the right incentives should be. businesses that we’ve been margin profile and return on involved in, or even consumer capital within the industry to We’ll use that information with packaged goods, often take a see who’s at the higher end. our private companies too. commodity, process that We’ll look at the unit We’ll say, “If I understand the commodity and sell the output economics and productivity business model dynamics in in a brand. Commodity to metrics, such as revenue per public companies and the two value-add. A skilled investor employee or profit per or three things that matter, needs to understand the employee to compare quality how can I apply that operating dynamics of that of operators in an industry. knowledge to some of the type of business. Brands are private companies, where I’m about trust. So it is important In some situations, all of these not confident that industry to understand how the brand will align, where the management teams are is perceived by its customers investment controversy is thinking that way?” and potential users, not what temporary and we can look the company says itself. past it. We’ll buy the best Once we understand certain manager and we are willing to industries or business models, We’re willing to admit that pay a turn or two more on these fall into our circle of there’s a pretty large “too- earnings for the better competence. There are hard” pile relative to the time management team, as we complexities to the business, we want to spend. There is an believe over the long-term, but the complexities in most opportunity cost for time and they’ll out-execute situations don’t dictate the we want it to be high enough competitors and the profitable outcome; the 80/20 rule so that only ideas that can earnings growth will be there. usually applies. Once we meet our self-imposed return The multiple premium may understand the core pieces of hurdles can make it through. expand. information and levers in the There are certain businesses business model, we get where if we can’t get our head (Continued on page 33) Page 33 Simeon Wallis

around it relatively quickly, it’s Institutional investors typically sub-$100 million market cap just not worth our time. want to see certain items, such companies and we passed on as benchmark weightings. We both. We’ve owned companies If we give up some of the don’t care about that because with $100B market caps opportunity set, that’s just a this is our capital. We want because we felt the concerns tradeoff in how we do the best IRRs, and we’re willing were over short-term issues. business. We want to try to to hold longer term and look keep things relatively simple. like an ugly stepchild. G&D: You mentioned We pick our spots. We would activism, which occurs on the rather benefit from the fear private side often. How does and greed psychology that is “Great managers your internal team approach reflected in the multiples that that regarding public others will pay for quality, well understand a business investments? Do you look for -managed businesses, than to creates value satisfying specific activist opportunities? try to get complex situations right. customers or adapting to SW: You mentioned private equity, and there are many G&D: How do you size the marketplace, not at cases where public equity positions and how do you the headquarters.” investors will say they take a determine the composition of “private equity approach” to the public portfolio overall? investing because they employ a long-term holding period and SW: In our public portfolio, in We try to use what we after significant fundamental a steady state, we’d have about perceive as disadvantages in research. I believe that fifteen positions, of which the the system to our benefit. perspective is off the mark. top five would be over 50%. Where we have a weakness, Value creation in the private Because we are not we just try not to be there. equity business model comes constrained by the We don’t have 20 analysts, but from the willingness to engage expectations of volatility or we can go after companies that at a board level and control concentration risk, we can be the sell-side hasn’t focused on two key things. First is having more aggressive in allocating to much, or invest in significant influence over positions where we think the opportunities that U.S. capital allocation decisions, and risk-reward is more compelling investors may not consider. second is having significant or let our winners run a little influence over the management bit more. For example, we owned team, including picking the C- Norbord, a Canadian-listed suite and the incentives that One core practice at company that had a are implemented. In the public ValorBridge is to determine disproportionate share of its markets, this only occurs if an where we can align our operations and profits tied to investor joins the board for relative strengths with what the housing rebound in the several years. we see as institutional U.S. weaknesses in different aspects The firms that I believe have of investing. For example, G&D: Does this also allow executed this “private equity in private and public investors you to be more involved in the public markets” model almost never have a fluid flow small-cap companies? effectively are ValueAct in mid- of information and to-large cap companies and in communications between SW: Yes. At the low end, small caps, it’s Wynnefield them. we’ve invested in market caps Capital. Wynnefield, which flies between $150 million and below the radar, has been How can we put ourselves in $300 million. We do want around for about 25 years with the middle and use the some level of liquidity. phenomenal returns. Nelson information from the private Obus and Max Batzer have side with public companies, Twice we conducted due done a really tremendous job. and vice versa? diligence with the thought of becoming activist; those were To do this effectively, a firm (Continued on page 34) Page 34 Simeon Wallis

has to devote the resources to we know would be an ally to when FNFV traded below be involved three to five years help us run the business. intrinsic value. He acquired at a board level. That’s the Down the road, there might be previously spun-out technology right mindset. We try to a real opportunity for us to businesses when valuations determine how we can have an exert that type of influence. were depressed, and he’s impact on operating But given current multiples and spinning that out again as Black improvements, incentives, and debt levels, it’s probably not Knight Financial Systems. capital allocation decisions. At very fruitful now. That’s one of those structural the same time, we have to be aspects that we try to take willing to accept a lack of G&D: Would you like to talk advantage of. Many investors liquidity because that’s a trade- about some past public market are wedded to how financial off for joining the board. investment ideas? models look in spreadsheets. Yet our operating experience We haven’t found the right SW: On the public ideas, one has taught us that business is situation where we’ve been that ended up being very not linear and often value able to partner with a fruitful for us and is creation doesn’t model well. management team where they representative of our approach wanted to bring in a was the title insurance We bought FNF at 8x to 10x concentrated investor to help company Fidelity National our estimates of normalized build the business in the public Financial (FNF) in 2013. FNF earnings, and we received all of markets. In one situation we operates in a relatively Foley’s capital allocation considered, it was an industry consolidated industry. It prowess for free. We held executive that had followed provides a necessary service FNF for about two-and-a-half the target company for years, unless there are legal changes years and when we started to knew that the existing to eradicate title insurance, sell the publicly traded management was ruining the which we didn’t see on the portfolio, we exited FNF. With business, and sought capital to horizon. Bill Foley ran the the spin-off of FNFV and other help effectuate change. We company, and if you look at his maneuvers, FNF was a very came close as the valuation track record, it is very similar good investment for us. was incredibly compelling if we to John Malone’s at Liberty. could change management, but Foley has deftly used the public Foley represents another we passed due to our markets to buy and sell assets, aspect that we look for with research. We realized that the timing the markets very well to managers, which is managers business was inappropriately create significant value for his from outside of an industry, levered, and the more work shareholders. He’s willing to who can apply what they’ve we did on the operations and run with some leverage and learned from outside that capital structure, the more we make very difficult decisions industry to the new industry. became uncomfortable with very quickly. He simplified his That allows the manager to do existing management’s ability business. He very much fit the things that are different from to generate ample cash to profile of what we were the conventional wisdom. service the debt. We didn’t looking for. It was pattern Foley’s background was in the think our new management recognition. He’s created, I military. He has a law degree. team would have the time and believe, close to $40B worth He eventually bought a title balance sheet necessary to of enterprise value from deals insurer out of bankruptcy, and realize the company’s intrinsic and compounded returns for then proceeded to roll up the value. shareholders at very high rates. industry. It was a very different perspective from the When we look at small caps, He built a company called traditional, slow-moving we’re looking for good Fidelity National Information insurance company managers who would be good Systems which he eventually competitors and the partners, as opposed to an spun out. He has used a executives who grew up in the antagonistic situation where tracking stock for his financial industry. we’d become activists. It’s crisis-era investments, FNF really special situations where Ventures (FNFV), to highlight G&D: Any current holdings or we have someone in place that value and repurchased shares ideas? (Continued on page 35) Page 35 Simeon Wallis

SW: Currently we don’t have at it, about 18 months ago, was not the right risk for us. any investments in the public a double. The stock price was market. One thing that’s been around $65, and we thought it On the private side, valuations on our radar is another could be worth upwards of are not great either, but insurance company, Assurant $125 to $130, looking out occasionally we find ideas from (AIZ). Assurant has been a several years. The process is proprietary or quirky, niche insurer that has still going on. Assurant is about provide capital to our consistently evolved the $95 a share now, and we operating companies for tuck- products and services that it’s believe that there’s still upside. in acquisitions at 3x pretax insuring. Occasionally it We haven’t allocated much profit. As I mentioned before, becomes very cheap when into the public markets that’s hard to beat. investors believe that a line of recently because we’ve had business AIZ is in is about to some private opportunities G&D: That definitely sounds fall off a cliff. Management has that are more compelling. compelling. Do you have any been very good capital advice for students? allocators, knowing to repurchase shares when “A second piece of SW: For students who want investors price in Armageddon to get into this business, the and to increase the dividend critical advice I have is business is changing when investors are not the importance of significantly on the public side. concerned. Over the last I see parallels between what’s decade, AIZ had been an removing one’s ego. Ego occurring with the traditional aggressive cannibal of its own retailers and the threats posed shares, as share count has is the driving force to asset managers and hedge declined greatly when AIZ behind most intelligent funds. Competition is emerging traded below book value. from low-cost sources and people’s mistakes.” technology; for retailers, the About two years ago, the chief threats are the Costcos, Dollar of strategy, Alan Colberg, was Trees and Aldis of the world, promoted to CEO. Colberg G&D: Is that more a and for investment firms, low- came from outside the consideration of how good the cost passive vehicles such as industry. He was an ex-Bain private deals are, or are you ETFs and index funds. It’s also partner who possessed a just not seeing adequate coming through technology- materially different perspective returns in the public markets? driven interaction with the end for growth, and quickly made user, whether it’s Amazon and difficult decisions to exit legacy SW: It’s the latter. Generally, the Internet-based direct-to- businesses that were we haven’t seen compelling consumer business models in structurally challenged; valuations. As I mentioned, in retail, or quants, factor-based Assurant received good value the last year we purchased a investing, and robo-advisors in exiting them. hospital we knew out of with computer-driven investing bankruptcy. Several portfolio models for the traditional An investor could follow companies had reinvestment investment firms. Colberg’s playbook, which was opportunities at rates well taken out of one of Bain’s above what we could receive These competitive threats may published books, Profit from the in the public markets. In the result in fewer analyst Core. He focused on providing public markets, we’re looking opportunities; anyone who additional services to existing to double our money every wants to join our industry customers in highly profitable three years. We generally needs to be 100% committed niches, where he could make don’t like when there’s a very to it, and eat, sleep, drink, and tuck-in acquisitions and use levered balance sheet. What’s breathe investing, and capital to grow in a relatively been cheap the last few years understand their own personal low-risk way. When we is where there’s been some points of differentiation for a normalized for the different balance sheet concern in potential employer. Our segments of the business, the addition to being in a industry attracts a upside when we were looking commodity business. That’s concentration of type-A driven (Continued on page 36) Page 36 Simeon Wallis

people because of the financial active to passive settles down analytics. The value over time rewards it traditionally offered. a bit? will come from the qualitative The past may not reflect the insights that drive future, so someone SW: I still don’t know performance. considering an analyst role has whether this is secular or to be comfortable that salaries cyclical and I believe we’ll learn For example, the ability to ask may decline. I believe it’s just this when stock prices decline specific questions of being cognizant that there has 30% or 50%. Traditional active management teams, of industry to be a true love for investing. managers need to demonstrate consultants, of expert their value through significant networks, that will have a lot A second piece of critical outperformance to justify their more value going forward than advice I have is the importance fees over the full cycle. If they the financial model. Active of removing one’s ego. Ego is can outperform in that managers need to focus on the the driving force behind most environment, it will benefit the opportunities that won’t score intelligent people’s mistakes. industry. If there’s not that well on factor models but To quote Ryan Holiday, “Ego is significant gap between what where there’s a high the enemy.” It’s a desire not to an index and what active probability of market-beating look wrong in front of peers. management is able to returns. It’s uncommon that the simple generate during a downturn, question that’s in the back of then fee pressures will others’ minds is asked publicly. continue. “We want the best IRRs, Nobody wants to look like they didn’t get an investment The cost structures of twenty and we’re willing to hold absolutely right. The more that or more analysts, a full sales a person can take ego out of team, and all the compliance is longer term and look like the decision-making, I believe just not realistic unless the firm an ugly stepchild.” the further a person will go in has hundreds of billions in this business. AUM. I envision the industry ending up with more boutique Understanding as early as managers that have between G&D: You mentioned cultural possible what the most three and seven investment mismatch earlier. Any thoughts important question to ask that professionals, including PMs, on that subject for students? identifies the critical few data who may have a little bit more points or research topics that compensation at risk. They’ll SW: Culture is the most your superior—PM or senior carry lower overhead and be important thing to understand analyst—focuses on will go a able to compete more on fees. about a company, and to long way. Invariably, your boss, For investment management understand about one’s self. and to whom he or she firms the incremental dollar Everyone should understand reports, are your customers that comes in really flows to his or her strengths and and if you make your the bottom line. There’s weaknesses, and seek customers happy, you’ll be significant operating leverage. environments that allow successful. The better you can Assets have been trending strengths to thrive. There’s a make them look, the better down for active managers. self-awareness component, and you’ll look. Cost structures have to perhaps I didn’t have enough decline to mitigate the impact self-awareness earlier in my The mistakes that I’ve made and labor is a large percentage career. have been not focusing my of the cost base. attention around getting the Every organization is political right information quickly so I don’t know how valuable the and understanding the politics that I could have a deeper and tenth or twentieth analyst on of people and personalities is more productive conversation. the team, who covers a tiny critical. Coming back to the slice of the market, really is, difficult situation that I placed G&D: Do you have any especially when much of the myself in, the nature of that thoughts on what the industry initial financial analysis can be organization was that there looks like when the shift from done better with computer were strong egos. I tried to (Continued on page 37) Page 37 Simeon Wallis

overcome other people’s egos it’s a great opportunity, it’s by arguing my perspective with probably not the right objective, quantitative data; opportunity. that wasn’t how arguments were won in that organization. G&D: That’s excellent. Thank I should have done a better job you so much again for your of finding former employees time. who had worked there to get a better sense of how decisions were made, and the relationship between senior management and others in the organization. There wasn’t an investment style difference, but there was a research difference, whereas at Evercore, I believed there was an emphasis placed on very deep-dive research, which tended to be very quantitative and analytical. Why is this number volatile? Why is that changing? Let’s go back four annual reports, make all the adjustments, normalize it, and understand what was going on in the spreadsheet, and let that analysis drive qualitative questions.

The San Francisco situation was a very small team. There’s a dichotomy in how organizations will handle differences of opinion—some say, “Culturally, we want to have a diversity of thought and opinion.

While others will take the other side. “We want to make sure everybody is exactly on the same page when thinking about this.” I misread the situation. I thought it was the former, and it was more the latter. My strengths did not align with what they wanted for how their team was constructed. It comes down to culture and how much research you can do on your own strengths and weaknesses that tie into that culture. If there’s not a good fit, even if Page 38

Foot Locker (NYSE: FL)—Short 2017 The Heilbrunn Center for Investing Stock Challenge—1st Place Finish

Zach Rieger [email protected]

Recommendation Current Capitalization Recommend a short on Foot Locker Share Price 1/20/17 $69.14 (FL) with a price target of $55, offering DSO 134.0 20%+ downside from today’s price of Market Capitalization $9,265 Zach Rieger ’17 $69. Plus: Debt 128 Less: Cash (865) Zach is a second-year MBA Business Description Enterprise Value $8,528 student at Columbia Busi- Foot Locker (“FL” or “the Company”) is ness School. He spent his the largest specialty retailer for athletic Trading Statistics summer internship at Owl footwear in North America and has 52 Week Low - High $50.90 - $79.43 Creek Asset Management. benefited from secular trends towards Avg. Daily Volume ($ in mms) $79 Prior to CBS, Zach worked more casual footwear and healthy life- in private equity at Short Interest as % of Float 6.4% PineBridge Investments style. The Company has 3,401 stores globally with ~13mm square footage and Dividend Yield 1.7% after spending two years in Net Debt / 2016E EBITDA (0.6x) BAML’s technology invest- FY 2015 revenue of $7.4Bn. FL operates ment banking group. He a number of different concepts including holds a BA from the Uni- Foot Locker, Champs Sports, Lady Foot Summary Valuation 2016E 2017E 2018E versity of Pennsylvania. Locker, Eastbay, Six:02, and Runner’s Point. Each concept has a different tar- Base Case get customer and slightly different inven- EV / EBITDA 7.5x 7.9x 8.0x tory mix but footwear represents 82% Price / Earnings 14.8x 15.3x 15.2x of revenue. FL also has a very concen- FCF Yield 5.8% 5.8% 5.8% trated supply base with Nike represent- Consensus ing 73% of revenue and the rest primari- EV / EBITDA 7.3x 6.8x 6.5x ly coming from Adidas, Under Armour Price / Earnings 14.5x 13.2x 12.0x and a few other players. Price / Earnings (ex. Cash) 13.0x 11.8x 10.8x vs. Consensus Investment Thesis 2016E 2017E 2018E 1) Key Suppliers Such as Nike and Revenue - ZDR $7,690 $7,806 $7,923 Under Armor Want to Grow Revenue - Consensus $7,778 $8,147 $8,531 Their Direct to Consumer % Difference from Consensus (1.1%) (4.2%) (7.1%) (“DTC”) Business Foot Locker’s largest supplier is Nike, EBITDA - ZDR $1,143 $1,085 $1,066 with 73% of sales. Nike is increasingly EBITDA - Consensus $1,168 $1,251 $1,319 trying to grow their direct to consumer % Difference from Consensus (2.1%) (13.3%) (19.2%) business due to the higher margins, which puts it in direct conflict with Foot EPS - ZDR $4.67 $4.53 $4.55 Locker. Foot Locker’s key advantage vs. EPS - Consensus $4.76 $5.24 $5.74 e-commerce is the exclusive inventory % Difference from Consensus (1.9%) (13.5%) (20.8%) they have, which may slowly be evapo- rated away as Nike attempts to use that inventory for their DTC business. In order to reach their $16Bn DTC goal by 2020, NKE needs to grow 20% per year, implying that there will be a lot of pressure to enhance and grow this business from management.

2) Average Sale Prices (“ASPs”) are plateauing / declining for Nike Basketball Shoes Basketball shoes have seen a major increase since 2010, which has generated much of the success at Nike and Foot Locker. The trend towards basketball shoes as a fashion item helped to increase the ASP at Foot Locker as basketball shoes are ~14% premium to casual sneakers and 38% premium to running sneakers sold at Foot Locker. The key driver of this basketball trend has been the growth and popularity of Jordan Brand sneakers. Nike also has a number of other superstars in its stable including LeBron James, Kobe Bryant and Kevin Du- rant. However, over the past year the sneakers for these stars have not been as popular and other brands have taken some market share, driving down ASPs. On top of the issue with basketball sneakers declining in popularity, Nike has lost market share with the resurgence of Adidas and Puma and emergence of Under Armor in the sneaker space. Nike has started to see a deceleration in both unit growth and ASPs over the last four quarters. The ASP growth is largely ex- plained by lackluster performance in basketball shoes, as a few of the marquee shoes (LeBron’s, KD9, etc.) were not as successful as anticipated. The decline in unit growth is likely explained by market share losses as Page 39

Foot Locker (FL)—Short (Continued from previous page)

Adidas and Under Armour have taken share in Nike Futures Growth Gross Profit Decline from Nike Shift and ASP Declines Nike as % of Total the space. Both of these have important im- 14.0% 0.0% 57.0% 62.0% 67.0% 72.0% 77.0% 12.0% (10.0%) (14.4%) (14.1%) (13.8%) (13.6%) (13.3%) pacts to FL’s P&L: (5.0%) (8.7%) (7.9%) (7.1%) (6.3%) (5.5%) 10.0% Nike ASP 0.0% (2.6%) (1.3%) 0.0% 1.3% 2.6% 5.0% 3.7% 5.6% 7.5% 9.3% 11.2% 8.0%  Nike ASPs are ~32% higher than Adidas 10.0% 10.4% 12.8% 15.3% 17.8% 20.2% and other shoes (calculated by taking the 6.0% 4.0% top sellers on Footlocker.com and averag- 2.0% Every 5% ASP decline at Nike is ~7% decline ing for both Nike and Adidas) so the de- 0.0% Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 in gross profit, while Nike share shifts are cline in Nike share hurts Foot Locker’s '13 '13 '14 '14 '14 '14 '15 '15 '15 '15 '16 '16 '16 '16 '17 only ~1% -2% declines. With operating Unit Growth ASP Growth leverage, the EPS hit is even larger gross margin dollars ~1.3% for every 5% Nike loses.  More importantly, a decline in ASPs (due to mix shift) in Nike more directly hurts Foot Locker, and every 5% ASP decline is ~7% in gross profit dollars.  FL’s cost structure is largely fixed, so these declines fall almost entirely to the bottom line.

3) Foot Locker Store Base is Mature and Efficiently Run, Leaving Little Square Footage Growth 2020 Financial Objectives (2015 Investor Day) Room for Growth Upside Foot Locker’s revenue growth has largely 14,500 come from ASP increases as they have 14,120 2020 Goal 2015A 14,000 shrunk the store base. Foot Locker is also 13,501 Gross Margin 33.5%-34% 33.8% 13,500 a mall-based retailer, facing general indus- 12,955 12,918 EBIT Margin 12.5% 12.7% try headwinds on mall traffic. While the 13,000 12,635 12,705 12,734 12,451 Net Income % 8.5% 8.1% Company has been able to succeed despite 12,500 12,316 these headwinds, and remains a destination 12,000 11,500 for many shoppers, there is only so much Foot Locker’s 2020 Financial Objectives Were FL can do to maintain traffic and volume 11,000 Largely Achieved in One Year 2007 2008 2009 2010 2011 2012 2013 2014 2015 momentum going forward.

“I think it will be hard for them to grow at the same rate as they have been after 6 years of topline gains. They are run pretty efficiently, when the economy was in rough shape we managed a lot of the costs and got very efficient…but I think mid-single digit growth is going to be really hard, low single digit is more likely.” – Former President and CEO of Foot Locker

4.) Border Adjustment Tax Could Provide Meaningful Downside and Erode Foot Locker’s Profitability Nike is responsible for 73% of Foot Locker’s sales and manufactures a 2017E EPS majority of their footwear overseas. Under proposed new tax reform, Border Tax Adjustment Increase to COGS imported goods would not be deducted from COGS, materially in- $4.53 0.0% 5.0% 10.0% 15.0% 20.0% creasing Nike’s overall COGS. Given their dominance in the relation- 15.0% $5.93 $4.48 $3.03 $1.58 $0.13 ship, this would likely be passed on entirely to Foot Locker, who Corporate 20.0% $5.58 $4.22 $2.85 $1.49 $0.12 would then have to pass on to the customer or eat the cost increase. Tax 25.0% $5.23 $3.95 $2.67 $1.40 $0.12 This provides meaningful downside, as certain scenarios would erode Rate 30.0% $4.88 $3.69 $2.50 $1.30 $0.11 35.0% $4.53 $3.42 $2.32 $1.21 $0.10 most of FL’s profits.

Valuation Base Case Return Potential: FY ‘17 EPS of $4.53 at 12x EPS is $55 (20% downside) Bear Case Return Potential: FY ‘17 EPS of $4.33 at 10x EPS is $43 (37% downside) KEY ASSUMPTIONS Bull Case Return Potential: FY ‘17 EPS of $5.93 at 15x EPS is $89 (30% upside) Bear Case Base Case Bull Case There is additional downside from the border adjustment tax, but that is not bakedRevenue into the CAGR operating 15-18 assumptions5.1% at this9.0% point as it10.2% is not clear what tax reform will look like. This is a key part of the on-going thesis. EBITDA Margin 2018 8.0% 8.5% 9.1% FCF per share 2018 2.38 2.95 3.48 Key Risks P/FCF 10.0x 11.0x 12.0x Secularly Growing Industry: Foot Locker benefits from the trend towards casualPrice footwear Target 2017 as consumers purchase23.80 more32.50 and more41.76 sneakers. As the largest specialty retailer, they have and will continue to benefit fromUpside this (Downside) trend. -13.7% 17.8% 51.4% Clean Balance Sheet + Capital Return: FL has a net cash position and low Net Debt / EBITDAR which allows free cash flow to go towards share buybacks and International Growth Opportunity: Foot Locker has an opportunity to expand through new stores internationally which should en- hance the growth profile vs. a relatively mature store front in the U.S. Page 40

Axalta Coating Systems Ltd. (NYSE: AXTA)—Long 2017 The Heilbrunn Center for Investing Stock Challenge—2nd Place

Alexander Levy, CFA [email protected] Executive Summary Axalta is an undervalued, misunderstood coatings company with durable competi- tive advantages that also generates prolific FCF. The market perceives a cyclical Alexander Levy ’17 chemical company that sells into the economically sensitive auto end market, par- ticularly in the U.S.. On the contrary, only ~32% of sales are to auto OEMS and Alexander is a second year MBA student in the Value only ~10-15% of sales are to auto plants in N. America. Axalta’s core business Investing Program at Co- (~50% of EBITDA) caters to the more stable auto refinishing market (repair work lumbia Business School. He driven by collisions), where the company’s customer base is fragmented and less spent last summer at Arbi- price sensitive given the importance of flawless refinish work. Axalta occupies a ter Partners, a New York leading position in most of its markets, which are also highly consolidated. Given based hedge fund. Prior to pricing power, EM exposure, and current end market outlooks, investors can expect GDP+ (3-5%) sales CBS, Alexander spent four growth. years at Morgan Stanley in equity research covering Ongoing cost cutting initiatives are expected to add ~$200M of EBITDA (~30% of 2013 starting EBITDA) by coal, steel, and iron ore. year-end 2017 following the company’s 2013 divestiture by DuPont. Management is streamlining operations in He graduated from Duke what was formerly a small business lost in a corporate behemoth. Axalta has dramatically improved its lever- University with a degree in age profile, with debt almost at target levels of 2.5-3.0x EBITDA and no maturities until 2020. Purchase ac- political science and is a counting obscures the company’s true economic earnings power by inflating depreciation and amortization and CFA® charterholder. depressing GAAP ROIC due to the re-marking of assets after the company’s sale. Investors are currently able to buy a stake in a durable franchise with a tangible ROIC of ~20%+ at an attractive 8%+ levered free cash flow yield. My $35 price target implies ~20% upside and assumes a 6.5% 2018e FCFE yield or ~11.5x EBITDA.

Company Description Axalta is a global manufacturer of coating products used to paint or refinish autos. Axalta was formed by to acquire DuPont’s Performance Coatings business in 2013 and completed its IPO in 2014. Carlyle has since exited its investment, but Berkshire Hathaway currently owns a 9.8% interest. The Perfor- mance Coatings segment sells coating solutions to auto refinishing (42% of sales) and industrial (16%) custom- ers. The Transportation Coatings segment sells coatings to OEMs of light (32%) and commercial (10%) vehi- cles.

Investment Case: Long Favorable Market Structure Axalta holds a leading 25% global market share in its core auto refinish end market and a 2nd place 19% share in the auto OEM market. As a result, Axalta has the global reach and scale to serve large global OEMs. The markets in which Axalta operates are also highly consolidated, with 67% of the refinish market and 74% of the OEM market served by the top four players. Increased market concentration reduces competition and in- creases pricing power. In the OEM market, carmakers looking to retain multiple coating suppliers distribute business broadly to the leading players, reducing internal industry rivalry and price competition.

Refinishing Business is a Durable Franchise with Barriers to Entry and Low Cyclicality Axalta’s core refinishing business constitutes ~42% of sales and ~50%+ of EBITDA. The refinishing business has more favorable characteristics than direct to OEM. First, refinishing is less cyclical. Collisions occur re- gardless of the state of the economy and continue to require repair. Accordingly, refinishing revenue tends to have more recurring or maintenance-like characteristics. Second, the refinishing customer base is extremely fragmented. Axalta sells to ~80k auto body shops that have very little pricing power over a consolidated stable of coating suppliers. While there is a trend toward multi-shop operators (MSOs), it is unlikely to lead to major changes in market dynamics given the long runway for consolidation. In addition, as a market leader, Axalta is well positioned with MSOs, meaning the company will likely pick up market share.

Third, coating refinishing makes up only ~5-10% of the total cost of an auto repair. Accordingly, Axalta has flexibility to implement price increases and pass through raw material costs without dramatically affecting end customer costs. Furthermore, refinishing is one of the most critical parts of an auto repair, since the exterior is the most visible part of the car. Any flaws in paint or color matching are generally unacceptable, making quality more important than price. Fourth, through its refinishing business Axalta offers body shop customers not only the actual coating product used but also a range of services. The company provides technical support and training to customers as well as color matching equipment and software. The company has an extensive library of 4m color variations. As mentioned above, successful color matching is imperative. These services deepen relationships and make switching more difficult, risky, and time consuming for customers.

OEM Business Has Healthy Competitive Dynamics While more competitive than refinishing given the smaller customer base, there are several factors that help Page 41

Axalta Coating Systems Ltd. (AXTA)—Long (Continued from previous page) protect returns in Axalta’s OEM business. First, the high level of market concentration (see above) helps with pricing power. Second, coatings are only ~1% of the total cost of a car, meaning OEMs are not able to win big savings by pressuring coating suppliers. Axalta has been successful in passing through raw material costs. Third, value-added relationships and on-site placement of technical staff at OEMs increase customer stickiness. Some relationships with automakers date back 90 years.

Exposure to OEM Auto Sales is Geographically Diversified ~32% of total sales are to auto OEMs, but only ~10-15% of sales are to N. American auto plants. As a result, while certainly important, U.S. auto sales are not the dominant earnings driver. The company’s OEM portfolio is well diversified, reducing the risks posed by any one region: ~9% of sales are to automakers in EMEA (flat to modestly positive sales outlook), ~5% of sales are into the LatAm OEM market (likely near trough after steep declines in 2014-2016), and ~5% of sales are to Asia Pacific OEMs (~4% expected annual sales growth). In all, ~31% of Axalta’s sales are to emerging markets, which are seeing increasing auto penetration, providing a long growth runway.

Cost Cutting Initiatives Provide Self-Help Route to Higher Earnings; Costs are Highly Variable and Capex Intensity Low Under DuPont, Axalta was not optimally run. Post-LBO, Axalta has two ongoing cost cutting initiatives that have already yielded results but also have more runway. “Fit-for-Growth” and “Axalta Way” are expected to yield ~$200m in cost cuts by YE 2017, ~$150m of which should be in place by YE 2016. The results are already tangible, as EBITDA margins have improved to 21.3% YTD vs. 20.3% in 2015, 19.0% in 2014, and 17.5% in 2013. Margins could reach ~22.5% by 2017/2018. In addition, raw materials (~70% oil and gas linked) represent ~50% of cost of sales, meaning half of costs are variable and fluctuate with production levels. As a result, Axalta has some ability to adjust its cost structure with changing demand. Capex intensity is low, with maintenance capex estimated at ~$60m/year or ~1.5% of sales.

Recent Currency Headwinds Unlikely to Persist Over Medium to Long Term A strong USD has been an earnings headwinds for Axalta given ~66% of sales are outside N. America, but these issues should prove tran- sient. The DXY index is near five year highs, meaning Axalta’s foreign earnings translate into fewer dollars. 2015 sales fell 6% while actual- ly rising 5% ex-FX. In 2016, the company expects flat sales compared to a 4.5% increase ex-FX. The economic impact of currency fluctua- tions will be smoothed out over time as FX rates normalize, removing the negative optics of falling or flat headline USD sales.

Purchase Accounting Obscures Attractive Returns & Robust Free Cash Flow When Axalta completed its LBO, its assets were re-marked to fair value. While the physical assets remained the same, their book value increased, lowering accounting returns. As a result, GAAP ROIC stands at a mediocre ~9% in 2016e, but removing and intangi- bles yields an attractive ~19%/21% ROIC in 2016e/2017e. LBO purchase accounting also inflated D&A, which totaled ~$320m in 2016e vs. capex of ~$160m (including only ~$60m maintenance capex). As a result, FCF runs well in excess of net income, making Axalta appear expensive on a P/E basis. The company trades at 21x 2017e EPS (~5% earnings yield) compared to a more attractive ~7% FCFE yield.

End of Deleveraging Bodes Well for Capital Deployment & Cleaned Up Balance Sheet Reduces Cyclical Risks Since the LBO in 2013, Axalta has been working to reduce its leverage to a more prudent level. Starting from an initial 5.6x net debt/ EBITDA, the company has reduced leverage to 3.3x TTM EBITDA. Management is targeting net leverage of 2.5-3.0x EBITDA, which will likely be achieved by early to mid-2017. Once this goal is met, management has publicly stated that the company will consider capital re- turns (dividends or buybacks). In addition, the next debt maturity is not until 2020 and the revolver was extended from 2018 to 2021. Axalta was able to lower its average cost of debt from 4.7% to 4.0%, and interest coverage is healthy at 4.3x EBITDA/interest in 2015, 4.9x in 2016e, and 5.9x in 2017e.

Room for Continued Accretive Tuck-In M&A Axalta will likely continue to allocate to tuck-in M&A given the long time horizon of shareholders like Berkshire. The company has spent ~$104m on acquisitions YTD in 2016 at an implied multiple of ~1x sales and ~5x EBITDA (given acquisition margins roughly in-line with company margins). As a result, M&A can be very accretive given that Axalta trades at ~11x 2016e EBITDA. The company focuses on targets that produce specialized products or offer geographic diversification.

Valuation My $35 price target implies ~20% upside to intrinsic value and is derived from a relative valuation based on FCF and EBITDA checked against a DCF. I apply a 6.5% yield to my estimate of 2018e FCFE, which implies an ~11.5x EBITDA mul- tiple. Peers trade at an average 2018 EBITDA multiple of ~10.5x and 2018 FCFE yield of ~5.5%, including diversified competitors, but coating focused peers (PPG, RPM, Sherwin-Williams, Valspar) trade at 10-12x. In fact, Sherwin-Williams is buying Valspar for 15x 2016e EBITDA or 10.9x post-synergies. I believe that Axalta can also compound intrinsic value over time at 10-12%+ annually given 6.5% FCFE yield, 3-5% sales growth (GDP plus share pick ups in the MSO refinish market, EM growth, and depressed starting points in LatAm, commercial, and energy exposed end markets), and 0-2% earnings growth from M&A and cost cutting.

Upside Catalysts 1) Feb 22 analyst day; 2) Cost execution; 3) Hitting leverage target; 4) FX nor- malization; 5) Commercial vehicle rebound

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Cardtronics (NASDAQ: CATM)—Short 2016 Darden @ Virginia Investing Challenge—Finalist

Abheek Bhattacharya Harsh Jhaveri Ryan Kelly [email protected] [email protected] [email protected]

Summary Market Metrics Cardtronics is the world’s largest non-bank ATM operator, with over 225,000 ATMs across the U.S., Europe and Australia. The Company typically owns or manages ATMs placed in retail outlets (CVS, Abheek Bhattacharya ’18 Walgreens, etc.) and off-site ATMs for banks. While Cardtronics’ pri- Abheek is a first-year MBA mary revenue streams are surcharge fees from customers and inter- student at Columbia Busi- change fees from banks, it also earns revenue from bank branding on ness School. Prior to CBS, ATMs and management fees. The short thesis for Cardtronics is based he wrote for the Wall on declining cash usage, limited organic and inorganic growth opportu- Street Journal in Hong nities and the loss of its largest customer (18% of revenue), which will Kong, most recently for its also lead to increased competition in this space. Cardtronics is current- flagship Heard on the ly trading close to its 52-week high and is valued at 25x FY16E earn- Street investment column. He studied philosophy at ings. Yale University. Investment Thesis 1) Cash usage is on a decline globally, both as consumers switch to debit cards and as digital payments rise. ATM cash withdrawals in the U.S. declined nearly 1% from 2009-2012, based on the latest Federal Reserve data available as of November. According to Accenture, North Americans using cash for transactions will decline from 66% in 2016 to 54% in 2020. Other reports by Euromonitor and McKinsey also highlight similar trends.  Cardtronics’ performance has mirrored the trend in declining cash usage, with same-store cash with- drawal transactions going from 4-8% growth in FY11 to negative growth.  ATM unit economics have also significantly deteriorated with revenue per ATM decreasing from $14,335 in FY11 to $7,534 in FY15, as CATM expands with machines were it only manages the services (and col- Harsh Jhaveri ’18 lects a ). These have grown from 10% of total ATMs in FY12 to 60% of all ATMs in 9M Harsh is a first-year MBA FY16 and earn ~5% the level of the average Cardtronics ATM. student at Columbia Busi- ness School. Before that, 2) Cardtronics will lose its largest customer in mid-2017, which paves the way for increased competition he worked with Fidelity’s  Cardtronics’ largest customer 7-Eleven, which contrib- and growth uted 18% of revenue, has decided to terminate its Financial Snapshot private-equity fund, and contract in July 2017. It will switch to FCTI, a company Barclays’ investment bank- owned by Japan-based Seven Bank, whose biggest ing team in India. Harsh 1500 10% shareholder is 7-Eleven’s holding company. While the received a B.S. in Electrical 1,200 1,260 revenue impact from the loss of this contract is Engineering from Yale 1200 1,055 8% University. known, its impact on profitability is even higher. The 7- 7% 876 6% Eleven contract likely earns higher margins given 7- 900 6% Elevens receive higher foot traffic than Cardtronics’ 4% other retail locations and that the ATMs in 7-Eleven 600 3% 4% included a $50M bank branding fee with Citi.  Cardtronics’ remaining top four retail customers (19% 300 2% of revenue) have contracts due for renewal in an aver- age of three years. They potentially now have more 0 0% bargaining power with Cardtronics post the loss of 7- FY13 FY14 FY15 FY16E Eleven and can threaten to defect to FCTI. Revenue ($M) Net income margin

Ryan Kelly ’18 3) Cardtronics has masked its inability to grow organically by acquiring 14 companies since 2011. But acquisition opportunities will be limited in the future: Ryan is a first-year MBA  In its most recent deal, Cardtronics agreed to acquire one its largest rivals DirectCash (expected closing student at Columbia Busi- in January 2017). The $460M transaction, which included $205M debt from DirectCash, was funded pri- ness School. Prior to this, marily by cash and additional debt from Cardtronics’ existing lenders. Cardtronics’ proforma net debt / he worked as a consultant EBITDA will be 2.6x, close to triggering the 3x covenant on its revolver. Further, Moody’s undertook a at Deloitte, most recently in Philadelphia. Ryan holds review of Cardtronics’ rating for a downgrade after this transaction announcement. This will prevent a B.S. in Finance from Cardtronics from exploring any significant acquisitions in the future. Villanova University.  Cardtronics’ own M&A binge has reduced acquisition opportunities in the future.

Page 43

Cardtronics (CATM)—Short (Continued from previous page)

4) Cardtronics management’s interests are misaligned with shareholder interests:  Management advertises adjusted EBITDA and adjusted net income in all its interactions with shareholders. From the proxy state- ments, it is evident that their compensation is also linked to these adjusted profitability metrics, allowing them to ignore actual GAAP profitability. Revenue breakup  The CEO currently owns just 0.6% (1% including unvested shares) and the ex-CFO owns 0.2% (0.3% including unvested shares). The ex-CFO retired and has recently been replaced.  The CEO has sold 51,714 shares (~18% of his ownership) worth $1.7M in the last two years

Valuation Based on CATM’s 2-year average forward P/E of 21x, we ascribe a 21x multiple to FY19 EPS This results in a price target of $30.3, a 36% downside. Exit multiple 19x 20x 21x 22x 23x Price 27.4 28.9 30.3 31.7 33.2 Downside (42%) (39%) (36%) (33%) (30%)

Catalysts  The impact of the loss of the 7-Eleven contract on profits will only be understood in the 2nd half of 2017  The remaining 4 of Cardtronics’ top 5 customers, which comprised 19% of revenue, will renew—on average—in the next three years. These contracts will be under competitive pressure since FCTI has entered the fray.

Risks  Cardtronics may announce another large acquisition. Mitigant: Given that Cardtronics’ credit rating was recently reviewed by Moody’s for a downgrade and its pro forma net debt / EBITDA position is 2.6x, which is very close to its 3x revolver covenant, it seems unlikely that they will make any major acquisitions in the near future. Further, given that Cardtronics has acquired 14 companies since 2011, there are practically no large acquisition targets remaining.  Cardtronics may partner with a big bank Mitigant: Partnering with a bank would help Cardtronics earn managed services revenue or a bank-branding fee, but revenue per managed services ATMs is only 5% of the revenue earned from the average Cardtronics ATM. It is also questionable whether banks value a long- term bank-branding relationship with Cardtronics given that Cardtronics is both a competitor and a partner. An example of this is when Chase can- celled its partner- ship with Card- tronics to manage its off-premise ATMs in 2014.  Cardtronics expands into emerging mar- kets Mitigant: Regula- tions regarding ATMs in emerging markets are more stringent, probably the reason why most independent operators have focused on devel- oped markets so far. Page 44 Jared Friedberg (Continued from page 1) Partner of Compass Global hundreds of businesses, and to fortune to be sitting on a lot of Investments LLC, a single- own businesses and be forced cash. We started to consider family investment to live with those investment where to deploy that capital in company based in New decisions; a valuable such a distressed environment. York. Prior to Compass, experience in seeing patterns And when we considered the Jared was a Principal at in investing. You tend to think risk positioning of certain , a U.S. about risk and the potential for managers that we were Jared Friedberg ’99 middle-market leveraged capital impairment differently invested in—both into the buyout fund where he was when you're buying something crisis and then their business involved in a myriad of and putting a lot of debt on it. stability and psychology when industries including opportunities presented healthcare, retail, and What happened afterward was themselves during the crisis— value-added an interesting life event. In we found ourselves less than manufacturing. Jared has 2006, my father-in-law and my satisfied. also held positions in the wife started the process of M&A group at Salomon setting up a single-family office. G&D: How so? Brothers and in equity My father-in-law was a Latin research at Brown American industrialist and, JF: Certain managers were Brothers Harriman & Co. starting as early as the 1980s, reaching for risk too much on Jared earned his MBA had been investing in the way into the crisis, and not from Columbia Business alternative assets. They were reaching for it enough on the School and graduated essentially taking their holdings way out. Of course, you don't magna cum laude from the and putting them under one always know whether that is University of Pennsylvania roof. Throughout the course purely psychology or whether with a B.A. in Diplomatic of that year, as they were that is driven by a lack of History. putting the pieces together, I stable capital, or both. became interested in the family Graham & Doddsville office as a platform for G&D: So is this when the (G&D): Could you tell us investing. I liked the intellectual Mercator Fund came about? about your background? What honesty that you could bring brought you to investment to bear using that platform and JF: Yes, a family office provides management? What was the the focus on capital a great stable capital base for origin of the Mercator Fund? preservation that investing taking advantage of mispriced your own capital requires. opportunities with an Jared Friedberg (JF): I uncertain time horizon. So we graduated from Columbia At the end of 2006, I left set up a series of managed Business School in 1999. I was Cortec to help set up the accounts for the family, with very interested in learning how family office. I liked the the mandate of taking my to analyze businesses using a prospect of having a seat private equity and debt value investing philosophy. I where you are looking at other experience, and applying that focused on finding work in investment managers, both on to public market opportunities. private equity, on the the private equity and public side. My logic sides. You get to see what From the outset, we wanted to was to see many kinds of they're doing well, what you be able to invest across the businesses in tremendous think they're doing incorrectly, capital structure. It was clear detail. Coming out of business where your philosophy jibes that the opportunities weren't school, I got a job at Cortec with theirs, etc. It was very only in equities. We were Group, a middle-market interesting for me to go from witnessing some incredible leveraged buyout fund. It was a my previous micro-level fixed income opportunities at hands-on, operationally analysis of companies to that time. By going higher in focused firm. thinking more broadly about the capital structure, we could capital allocation. get access to returns that were Over the course of my seven very attractive, so we were years there, I had the As the financial crisis hit in initially more heavily weighted opportunity to analyze 2008, the family had the good to fixed income, with the (Continued on page 45) Page 45 Jared Friedberg

rationale being, why take more realized that when an asset is rational. If we identify a risk if we don't have to? The for sale in the way that private company that is becoming other factor central to the companies are today, there are more dominant or growing strategy relates to my private typically many middle-market faster than the industry, equity days. If you think about buyout funds that are looking especially with pricing power, private equity dynamics, a at a given opportunity. we continue our work. And if private equity fund raises a Proprietary sourcing of deal the dynamics we described are pool of capital and they have a flow is challenging. resulting from a sustainable time limit to put that to work. competitive advantage that we You put that money to work In private equity, you're can identify, that’s where we or you're out of business as creating this environment of really get excited. you won’t be able to raise the perfect competition when next fund. The incentives are you’re looking at an asset. I “In private equity, you’re not ideal. We don't have those realized quickly that in the incentives. We felt that part of public market, the competition creating this environment being intellectually honest had is sometimes less perfect than I to be that we didn't have to be would have expected and of perfect competition fully invested. If we weren't sometimes things are out of when you’re looking at finding compelling favor in ways that are opportunities, our strategy irrational. You can take an asset.” was, and is, that we don’t have advantage of this dynamic in a to invest the capital. very fluid way, which you rarely can in private equity. Now, within that dynamic, you G&D: So you’ve been around do not often find those for eight years and have a solid G&D: What is the Mercator opportunities undervalued. But track record, yet you seem to Fund’s investment approach? we don't approach sourcing be quite under the radar. compounders from a value JF: We operate in three asset perspective, we come at it JF: Yes, until very recently we classes—equities, fixed income, from a quality perspective. We primarily managed capital for and cash. It is important to us are doing work on the family and some business that there be no preset opportunities irrespective of partners with similar allocation among the three. the value today. The idea is to philosophies to ours. And in Within equities, we're really create a backlog of businesses 2013, we converted the trying to do two things: we're that you dream of owning managed accounts into a fund seeking underappreciated when they are temporarily and spun out of the family compounders, which means misunderstood or out of favor. office. The family remains our something specific to us, and largest investor, but now we special situations. Special situation equities are also have some high net-worth more amorphous. We're individuals, other family offices, In terms of compounders, generally looking for situations and a couple endowments as we’re always looking out for where value is obscured by investors as well. We are systemically important complexity. That can come in a seeking to grow the capital in a businesses whose existence is lot of forms; there are gradual, disciplined manner. critical to their industries. Our scenarios we see repeatedly to markets are developed help us identify such situations. G&D: How did your markets with good legal Let me provide a few background in private equity regimes like the U.S., Canada, examples. inform your worldview and and Western Europe, which your investment process for provides us with multitudes of First, liquidations. We recently public securities? industries and thousands of identified REITs that we publically traded companies to thought would be prone to JF: When I graduated business explore. We pay attention to liquidation and got involved school, I had the idea that industries, even niche with them, owning them into a private equity was a less industries, that are growing potential liquidation, and then trafficked area. Then I quickly and where competition is throughout the process. This (Continued on page 46) Page 46 Jared Friedberg

allowed us to buy groups of and 2012, there was a lot of down, the points at which quality assets at significant investor fear. The bonds of we’re making it larger are also discounts to intrinsic value very stable businesses were predetermined. The strategy is where that value is realized in trading at attractive yields with executed unless the thesis has an idiosyncratic way. So the what we believed was minimal changed. correlation to other assets and risk of capital impairment. the markets is limited. We have gravitated to this Another area we source such price discipline because we Another area of opportunity is opportunities is the publicly have also found that it helps us businesses that have assets in traded debt of private manage our psychology. We one country but are publicly companies. We have found the use the same discipline when traded in another. For debt of private companies can deciding when to trim or exit. example, we own a U.S. be particularly interesting as When other people are cinema operator with information is not readily freaking out and an asset is on operating and real estate assets available. Just having to get sale, that's when we want to in Australia and New Zealand. approval from the CFO of the have the psychological The complexity makes these company to get the wherewithal to step up and assets difficult to own, which information removes a lot of buy it. And the converse, has led to a dislocation in the competition of people we’re reinforcing our value. looking at such opportunities. psychological wherewithal to sell when others are too We also look to identify “We rarely make an sanguine. hidden assets that do not appear on the balance sheet of investment decision that G&D: For your stressed a company. For example, we credit investments, how do were recently involved with a does not have a 12 to 36 you think about where you publicly traded restaurant month timeline.” want to be in the capital franchisee, where the market structure? did not appreciate that the company had a right of first G&D: Across all categories, JF: We look across the capital refusal to buy other how do you think about entry structure of an enterprise. franchisees in their network. points? And how about Take the special situation This right has tremendous catalysts and timing? restaurant equity I mentioned value but is not recognized on before that had a right of first the balance sheet. JF: We rarely make an refusal to buy other investment decision that does franchisees. We felt that the G&D: And what is your not have a 12 to 36 month equity was undervalued and we approach on the fixed income timeline. Our stable capital would be able to own it for a side? base gives us the flexibility to multi-year period. That not be pressured on timing. company also came to the JF: On the fixed income side, Even in those situations where market to refinance its debt in we explore distressed there may be a catalyst, we feel March 2015. At the time, there opportunities, but our main like that catalyst being a year was momentary fear affecting focus has been on what we call or two away often gives us an credit markets and the stressed credit, a situation advantage. company had to settle for a where we feel the bonds are higher interest rate than they pricing in real risk where we In terms of entry points, we expected. We already knew believe the risk is limited. We are disciplined about the price the business and the are looking for areas of stress, levels where we get involved management, and with minimal and this can come in a lot of with any investment. We risk we could earn an 8.5% forms. It can be idiosyncratic document where we would return. In a sense, we looked to the company, or our buy the security at such an at that and realized that 8.5% is sourcing can also be more attractive discount that we’re actually more attractive than macro. For example, during comfortable making it a the double-digit return we're the European crisis in 2011 predetermined size. If it trades going to get in the equity. (Continued on page 47) Page 47 Jared Friedberg

G&D: Regarding your quality in the risk of capital That said, we're obviously not compounders, how do you impairment we’re taking inflexible, but you can't cheat determine when they are too relative to the return we yourself. That’s why we write a expensive? If it’s a truly expect. So by definition, every memo with the thesis, risks, dominant company, wouldn’t a idea is always being compared signposts, etc., explaining why ten-year or longer discounted to the others. This dynamic is we believe the asset is Zach Rieger ’17 presents his cash flow (DCF) analysis with also what primarily defines our mispriced. If we are shifting winning investment idea at reasonable scenarios still show position sizing decisions. our approach, we have to The Heilbrunn Center for upside? Something with a low risk of clearly explain why the thesis Graham & Dodd Investing capital impairment and with an has changed—it may be that Challenge JF: We always conduct a DCF attractive return is apt to be growth is accelerating or the on compounders, because it sized larger than something company has a new forces you to think through where both the risk and return development. assumptions and about the are higher. growth trajectory and drivers I woke up one morning last of that business. We use a When we can’t find week to see that one of our more conservative discount opportunities that meet our European compounders had rate to be on the safe side. It criteria, our allocation to cash announced a transformative boils down to whether we is going to be larger. This merger with a complementary think the compound annual approach has been heavily business. We went through rate of return that we're influenced by the family office the process of thinking about getting, relative to the emphasis on capital what it meant to put the uncertainty of all of those preservation and has allowed businesses together and what assumptions that we just made, us to generate equity-like value would be created. The is worth the risk. returns while taking less-than- thesis had changed and we typical equity risk. couldn't, with a high level of It's more art than science, but I confidence, get to a place can tell you if I'm making an G&D: What is your decision where we were nearly as assumption on something process in buying and selling? excited about the deal as the that's five, six, or seven years Do you have a process to market. The intellectually out and I'm only getting a mid- guard against thesis drift? honest thing to do was to sell to-high single-digit compound the position and re-evaluate annual return, that’s not JF: We make decisions whether the combined entity attractive enough for me. We collectively. We've tried to met our standards as a can probably find ways to create an intellectually honest compounder. generate those kinds of environment. It is not about returns, taking less risk, being the smartest person in G&D: Can you talk a little bit elsewhere. We always ask the room; we simply want to about how you get a research ourselves whether we can get get to the right answer. Ideally, edge? those rates of return we protect each other from elsewhere with greater our own biases. JF: I think that MBAs often certainty and less risk. assume that most professional Before we invest in anything, investors conduct a lot of G&D: When you are looking we’ve determined the price primary research to gain real at a special situation or a levels at which we're buying insights into a business and an compounder, do you stack and selling. There's only one industry. But we find it’s not those up against each other or real question when the price always the case. For example, do you have more absolute hits our target, which is: has one great way to get an edge is metrics to judge by? the thesis changed? If the to get off the island: to go to answer is no, we are selling. industry conferences and JF: We don’t have any high- This is about forcing yourself engage with industry level preset allocation among to be disciplined. It is not participants. The reality is that our asset classes. Our capital always easy but it is important many investors don’t go that flows to investments where we to have a plan in black and extra mile. Let me give you a have a high level of confidence white in front of you. specific case. We have been (Continued on page 48) Page 48 Jared Friedberg

following the deathcare space year. requirements, and zoning since 2014. The industry is restrictions. Funeral homes primarily made up of funeral G&D: Can you discuss the and cemeteries also have high home and cemetery operators, investment in depth? fixed costs. Now, if you which may be the least sexy imagine the incremental businesses to be talking about. JF: Sure. As I mentioned, we volume that's going to be The industry only has a few find the underlying coming through these homes public companies and doesn’t fundamentals of the industry to with Baby Boomer deaths, it fit into typical sell-side be quite attractive, such as the will be at high incremental coverage so few analysts expected demographic margins because these are follow it. We attended the tailwind. The average life under-utilized assets. So you largest industry conference and expectancy for a person in the have businesses with pricing it was pretty clear there was U.S. right now is about 80 power, high incremental nobody from Wall Street in years, so the average person margins, and demographic attendance. The attendees dying today was born in 1937, tailwinds that are hard to were all funeral home which is right in the middle of escape. directors and they are usually the Silent Generation, before thrilled to talk to an industry the Baby Boomer generation. In addition to organic growth, outsider interested in their Even though this isn't a cyclical this is a consolidating industry work. That's where you can business in the traditional where 80% of the market is begin to develop a research sense, you can imagine the still owned by independent edge, by understanding the demographic trough we're in families, mom-and-pop shops. dynamics of an industry. right now and the massive Carriage Services (CSV) is the upturn Baby Boomer deaths name we currently find most There are also analytical will bring over the next attractive. The Company owns insights from publicly available decade. 170 funeral homes in 28 states information. The CDC, for and 32 cemeteries in 11 states, example, reports death “We saw other investors so about 200 properties. statistics weekly and you can They're about one-tenth the learn a lot from tracking such extrapolate the results market cap of the largest data. Last year was the player in the space, Service weakest flu season in five years and over-react to what Corporation (SCI), which and, because there is a high we viewed as temporary manages 2,000 properties. correlation between flu severity and number of deaths, and extraordinary What makes Carriage special funeral homes reported in the deathcare space is both disappointing results. We circumstances.” the management team and the expected this to happen. We business model. The saw other investors We spent a lot of time looking management team is really extrapolate the results and at funeral homes and focused on buying best-in-class over-react to what we viewed cemeteries to understand the assets. They do not acquire as temporary and economics of the businesses businesses for the sake of extraordinary circumstances. and how they make money, consolidation; they only look and found that they can be for great local businesses with This was our chance to own a very high-quality businesses pricing power and attractive target in our backlog at our with significant barriers to local demographics, and great predetermined price. The entry. A quality funeral home entrepreneurs to run those industry has very attractive in a local town can almost be a businesses. Their model is underlying fundamentals, is in monopoly with customer completely decentralized, the middle of major stickiness going back many meaning they're buying these consolidation, and has a couple generations. You're not going businesses and letting them of high quality companies. We to see new funeral homes run on their own. One of the were very excited to initiate an come and take its business. things that attracts these investment when the stock Even fewer cemeteries pop up entrepreneurs to sell to price became dislocated last because of the land and capital Carriage is that they allow the Page 49 Jared Friedberg

homes to maintain their local, assets at a reasonable price. 42,000 potential members. We family business feel. SCI, on the like the stable, recurring other hand, is highly We have actually increased revenue nature of the business. centralized, with a corporate our investment in Carriage, The low churn and growing top-down approach. In many despite buying at a higher price member and waitlist numbers ways, SCI has its own than when we initiated, as we reflect the high value that the compounding capability, but have become more club provides to its members. we found Carriage’s comfortable with the business, management team to really the industry, and the We think we have a variant understand their advantage and management team. We believe view from many fixed income utilize it to attract the best Carriage is a better business investors who look at trailing assets. than the market perceives. financials that reflect a business that is approximately 7x To return to the question “The great investors are levered. The company is about developing a research performing very well and in a edge, our research on Carriage the ones who have the major growth phase, having focused first on understanding recently opened a number of the core business and ability to be new houses, so the growth- management team, and second, independent in their related expenses understate on understanding the M&A the company’s true earnings opportunity and how much thought.” power. We believe on value that could create. It took normalized earnings, the us a lot of time to do the company is actually levered diligence and get comfortable Carriage trades at a price that under 4x, and the current yield around both of these points. does not reflect its solid core of approximately 8% is business and strong industry attractive given the short The CEO of Carriage is tailwinds. This, coupled with its duration and high quality of the unconventional in a way that excellent management team, business. As I mentioned, could put some investors off, unique decentralized we’ve found that the public so understanding his mindset consolidation strategy, and debt of private companies is a was very important. He disciplined approach to capital good source of opportunities founded the company in 1991 allocation, provides us as they can often trade at and owns 10% of the conviction we will compound more attractive yields since Company, which is a majority our capital for years to come. their financials are not as easily of his wealth, so we feel well- accessible to all investors. aligned as shareholders. As we G&D: Is there a fixed income spent considerable time doing idea you could briefly share G&D: Any advice for students diligence on the CEO, we with us? interested in getting involved in concluded that he is investment management? misunderstood and is in fact an JF: Sure. One of our excellent CEO. He has a great investments that we believe JF: I would start off with vision, he is a strong leader, offers a compelling risk- something necessary for a and he is a disciplined capital adjusted return is the senior newcomer’s personal allocator. secured 2018 bonds of Soho development. The amount of House, a private British group think—the influence that On the M&A side, after company that operates people have on each other’s spending a lot of time talking member clubs across the beliefs—in this industry is quite to people in the industry, you world primarily for people in surprising to me. I have been start to understand what it creative industries. Members disappointed by the lack of means to have a quality funeral pay a monthly fee and pay to independent thought. It's noisy home versus an average one. use the club’s amenities— and you've got to find ways to You start to understand the restaurants, bars, and meeting block out that noise. reputation Carriage has, why it rooms. The clubs have attracts quality assets, and why approximately 66,000 To a newcomer, I would say they're able to buy quality members and a waitlist of that you should do whatever it (Continued on page 50) Page 50 Jared Friedberg

takes to develop your own personal philosophy. It should be something you really can underwrite to and have a high level of confidence with. It should be a philosophy that is evolved enough to block out noise that doesn't make sense to you, but let in things that are helpful to you. The great investors are the ones who have the psychological ability to be independent in their thought. We believe many MBA students underappreciate this.

Related to my private equity background, I believe it is beneficial to have the opportunity to analyze hundreds of businesses and watch how those situations play out. It is central to building your own authentic ideas on how to make money and compound capital over time. I would not be put off by going to a smaller asset management firm where it's an intellectually honest environment and you're going to have the opportunity to wear multiple hats and take on more responsibility.

One of my business school professors told me “culture really, really matters, a culture of mutual respect and intellectually honesty.” These are the sorts of things you don't necessarily think about. You may be more focused on the analytics, but you want to work with decent people who you respect and who respect you. I think there is greater opportunity to flourish in an environment like that.

G&D: Thank you very much.

Page 51 Studness Capital Management (Continued from page 1) economics and finance at a portfolio because they generalist but tended to work Baruch College. He then respond in opposite in a couple of different worked at the Federal directions to changes in industries, including Reserve in New York long-term interest rates. community banks and utilities. before working at several Moreover, stocks of Over the years, I'd talked often Wall Street brokerage companies in each industry about investments with my firms as an equity research tend to do well in different dad, who has a deep Roy Studness ’06 analyst covering airlines economic environments, background in the utility and utilities. In 1979, he so between the two world. founded Studness industries there are usually Research, conducting attractive areas for Charles Studness (CS): research on the electric investment. The bank and After receiving my PhD in utility industry. In 1984, utility stocks they target economics from Columbia I Charles began managing are evaluated on a worked for the Federal portfolios invested commingled basis that is Reserve and then began work exclusively in the electric grounded in a five-year as an equity research analyst utility industry and since forecast for all of the for several brokerage firms then compiled an annual companies. Their fund, covering utilities. Eventually I total return of 16.7% per Studness Capital decided to set up Studness year through 2015 Management, generated a Research which provided (compared to the S&P 500 return of 65.7% in 2016. research on the electric utility Charles Studness at 11.1% and the utility industry to institutional PhD ’63 index at 10.7% during the Graham & Doddsville investors and managed money same period). Charles (G&D): Thank you for taking for clients exclusively in utility received BA and MA the time to speak with us stocks. degrees from the today. Could you tell us a little University of Minnesota bit about yourselves and what G&D: What came from the and a PhD in economics brought you to investing? conversations between the from . two of you? Roy Studness (RS): I Roy began his investment graduated from Columbia RS: We realized how well career at First Manhattan Business School in 2006 and banks and utilities actually fit Co. after graduating from was a member of the Value together in an integrated Columbia Business School Investing Program. Before portfolio. A lot of it is driven in 2006. Roy analyzed a business school, I spent a by how the two industries variety of industries, couple of years as a respond differently to changes including banks and bankruptcy lawyer. Practicing in interest rates. utilities, during his time at law, I found myself more the firm. Roy received his interested in the investment There is a very high negative BA from Wesleyan side of the cases I was working correlation between the University, JD from on. Also, growing up with my changes in bank and utility Vanderbilt University, and dad in the investment business stock prices in response to the MBA from Columbia certainly added to my interest 30-year treasury yield. Often, University. in investing. So, I decided to when one industry is pursue my interest in investing attractive, the other tends not In 2016, Roy joined and Columbia seemed like a to be. If you go into a period Charles, adding his great place to do that. After of low interest rates, where expertise in the banking graduating in 2006, I went to net interest margins for banks industry to Charles’s long work at First Manhattan are compressed, bank track record of successfully Company, a long-only profitability is reduced and managing money in the investment management firm in valuations suffer. At the same electric utility industry, New York. They primarily time, with low interest rates, and banks were added to cater to high-net-worth people seek out yield and they the portfolios. The two individuals with a long-term treat utilities as a bond proxy. industries work together in investment horizon. I was a They're not necessarily (Continued on page 52) Page 52 Studness Capital Management

investing based on the What we've done is put the money center banks like J.P. fundamentals of the utilities at two industries together. You Morgan and Citigroup. We that time; they're more trading can value them on similar look for mid-sized banks that on yield. In the more recent metrics, so we have built a have high returns and are period – before the recent lengthy database for both growing. rally – banks were trading at industries. We went back a low levels and utilities were at number of years to get a sense We create a five-year forecast their highest valuation in 50 of what the trends are. We for all of the stocks in our years. built models and ultimately got universe and we then run to a point where we are valuations screens, including We said to ourselves, "Hey, valuing banks and utilities on an P/E, total return, dividend this is a real opportunity. integrated basis. We put the discount model, etc. for the These two industries work two industries together in forecast period. This results in really well together." My dad January 2016 and produced a a ranking of our stock universe was investing in utilities and total return of approximately for each metric. We then had a very good track record, 65% in 2016. We are using the combine these individual but at the same time, the same methodology that metric rankings into a volatility was increasing due to produced a 13.4% total annual composite ranking based on all the persistently low interest return from 1991-2015 which of the metrics used. Now that rate environment. You could compares to the S&P at 9.6% we have the stocks ranked in outperform the S&P one year and the utility index at 8.9% order of attractiveness, that and underperform the during that period. tells you where you want to be following. If you're only in that focusing your attention. one industry, you don't have anywhere else to go when “We realized how well The rankings aren’t fully risk- things get unattractive without adjusted so you can start with shorting or going to cash. If banks and utilities number one and say, "Okay, is you have another area to actually fit together in there a risk here? Are there invest with a high negative aspects to this company that correlation to interest rates, an integrated portfolio. mean you don't want to own it that could provide an for some reason? Is the loan opportunity for better returns. A lot of it is driven by portfolio too risky or are they It reduces the risk in the how the two industries doing other things that you're portfolio as well. not comfortable with?” If so, respond differently to then you could cross that Both banks and utilities are name off and move on to your changes in interest highly regulated industries in next one. which there is a large amount rates.” of publicly available data. Both Ultimately this leads to a provide very critical services. portfolio of about twelve to Power and financial systems thirteen stocks which results in are necessary for businesses to G&D: How do you select the concentrated positions. We operate properly. These aren’t best opportunities within these don't want to be an index and discretionary businesses. two industries? we want to make sure we're Utilities are regulated outperforming. In the utility monopolies, so that's a unique RS: Essentially, we view our space, if there's only 30 names dynamic. It's a rate case universe as about 100 stocks. and you own seventeen of mechanism that sets returns. There are about 30 electric them, you're going to be that By contrast, competition is utilities – the industry has industry index anyway and it's what determines bank consolidated over the years, so going to be hard to outcomes. Banks are regulated, there are not so many of them outperform. That's why we but competition determines left. The other 70 are banks, stay more concentrated. winners and losers in that and we focus on those that industry. have a track record of high G&D: How do you manage performance. We exclude the the mix of these two industries (Continued on page 53) Page 53 Studness Capital Management

in the portfolio? not as strong in those years may own a brokerage firm and but still negative. Obviously, are very complicated. The RS: We believe in focusing on that's a rather unique period of ones that we want are single- your most attractive time. If you went back further, service and much simpler in opportunities where we have you’ll see another strong that regard. the most conviction. We correlation before the financial invest in whichever stocks are crisis. In general, there is a high RS: As far as the banking the most attractive at a negative correlation over the universe, we're looking at 70 particular point in time. If longer period. of them. There are over 5,000 numbers one through 30 are banks in the United States. all banks, then our portfolio is Many of them are small and going to be all banks. The same “Investing in the two private. Liquidity is an issue for goes for utilities. If we're at a industries can provide a some of them. It's a point where it's a mix, then the consolidating industry. If you portfolio would reflect that. natural hedge on interest went back to the early 2000s, The construction of the there were over 8,000 banks. portfolio is really driven by the rate changes.” The consolidation will continue forecasts for all of the stocks and there's going to be fewer and the valuation screens. banks five to ten years from G&D: You mentioned you're now than there are today. The Interest rates are important not looking to make calls on government has to grant you a because they can create rates, but a lot of the charter to form a bank. movement in the stocks we economics for a bank are Normally, there would be this own. We're not trying to driven by rates. How do you consolidation but there would forecast interest rates because address this? also be new banks being we think that's not something formed. A management team one can do. We're not making RS: At the base level, you could sell to a large regional any direct forecasts of interest want to start with the industry bank at a big multiple and then rates, we don’t say "interest fundamentals and understand they could go across the street rates are going to go up 50 the dynamics there. Once you and set up their own bank. basis points next year." We have a sense of where the They'd attract clients back and have our forecast for all of the industry is and what the do it all over again. But that companies in our universe. fundamentals are, then you hasn't really been happening There can be an indirect proceed to the most attractive over the last nine years forecast of interest rates stocks within that industry. because only a handful of new within those forecasts but charters have been granted. we're not trying to make a big We are focused on traditional The result has been macro call on the interest banks, where the primary accelerated consolidation since rates. Investing in the two driver is net interest income. the financial crisis. industries can provide a natural There are banks out there, hedge on interest rate changes. especially the money center G&D: How does the ongoing banks, where they have an trend of consolidation affect G&D: Are there periods of investment bank or trading your investing outlook? Do time where the relationship arm and there's lots of other you view M&A as a beneficial did not hold? Were there moving parts. It's a little hard driver for banks? abnormalities where that to understand what's going on benefit of negative correlation or what the real drivers are. RS: It's a consolidating did not exist? We try to focus on banks that industry so there's been lots of derive most of their earnings M&A and there's going to be RS: It stands up over time but from net interest income. more M&A. One might rather the strength of the negative own the seller than the buyer correlation can change. It's CS: These are largely single- because the premium would been strong for the last five service companies, much like accrue to the seller. The banks years. If you went back before the utilities. Once you get into that we're looking at are that, to the financial crisis, it is the money center banks, they performing at the high end of (Continued on page 54) Page 54 Studness Capital Management

the industry so they tend not commodities? something that inherently has to be the target or receive a changed about the business shareholder activist letter RS: For the banks, that might prevent this? Banks requesting a bank be sold. competition determines that have high returns and Some of them are better off on returns and profitability, and grow are usually not going to their own because they're ultimately the winners and be the cheapest banks—but going to generate a better losers. We're trying to focus this can vary with size and return over several years than on those that have a track liquidity of a bank stock as if someone gives them an record of high performance. well. immediate premium. Up until Since it's a competitive recently, a lot of people didn't landscape, loans and deposits Usually, an abnormal event have the resources to provide are really just commodities. makes a bank suddenly move an adequate premium for the We could get some capital, we up toward the top of our higher performing banks. could attract some deposits, rankings sheet. Maybe a bank and then make some loans. has a very good track record For banks we target, M&A can That by itself is not that hard. of performing and growing; also be a part of their strategy. Those that have the ability to but, for whatever reason, the If they have the capital and a consistently generate double- market is focusing on a short- sufficient stock currency, they digit ROEs—over 1% ROAs— term issue and this is impacting can make the transactions there's usually something the stock price. Then you have accretive. But you want to unique about the business, to determine if what the look at what's happening to there’s often a niche there. market is focused on is tangible book value per share. There's something about their transitory. Is this something Are we still compounding that? business that makes the that is leading to a Is that still going up? There are returns durable, that makes it disappointing quarter but is banks out there who do these so those returns aren't easily not necessarily impacting the transactions and they become competed away by the long-term model? Over the bigger, but the tangible book thousands of other banks that next year or two, is everything value over three or four years are out there. going to rectify itself and is exactly the same. It hasn't return the bank to high gone anywhere. You just look “Management is critical performance? Or is the issue around and ask, “Are we any an impairment of the business? better off?" in the banking industry G&D: How do you consider You want to look at who is because over time the and judge the quality of acquiring effectively. That's the industry hasn’t had large management? Specifically for appeal of looking at those banks, where does that skill banks that are compounding barriers to entry. If manifest itself? book value. Maybe M&A is not a primary strategy but it can be you’ve got some capital, RS: Management is critical in something that a strong bank you can get some loans the banking industry because considers to accentuate the over time the industry hasn't growth opportunities. For and deposits. That by had large barriers to entry. If every management decision, I you've got some capital, you would ask, "If I really just boil it itself isn’t going to lead can get some loans and down to one share, is my one to good returns.” deposits. That by itself isn't share more profitable after going to lead to great returns. they do that? Are we compounding that per share Part of the process is trying to The niches are really important value or not?" I would look at understand: do I have and they can really vary. Part M&A within that prism as well. confidence that the factors of it is based on the market on that led to the returns over which you focus. There are G&D: How do you find these the past six to seven years are some banks that focus on an high quality banks when most likely to persist for the next ethnic market. It could also be banking services seem to be four to five years? Is there a focus on a particular end- (Continued on page 55) Page 55 Studness Capital Management

market. A large bank called intensive business and the that regulators want solved. Silicon Valley Bank has a niche utility needs access to the Increasingly, regulators are catered towards the venture capital markets to be able to viewing the utilities as a part of capital and private equity fund ongoing capital the solution, which is different markets. If we were just expenditures needed to than in prior eras in which the putting together our bank and maintain the infrastructure to relationships were more making loans and deposits, have a reliable power grid. adversarial in nature. Utilities those are areas that are a little have a lot of capex projects to harder to penetrate. We Over time that is going to address this issue and couldn't just go out and get result in certain valuations for customers can really see the into those markets. That utilities based on access to the benefits, as opposed to prior requires expertise. capital markets. If a utility's capex projects, such as trading around book value, installing a scrubber on a coal Part of a niche can also be they don't have very good plant, in which the project is product-driven. For example, access to the capital markets. If large but at the same time it is some banks focus on making they're trading at 1.8-1.9x harder for the customer to commercial real estate loans tangible book value, then they feel or see the benefit. The and can do it better than other clearly do have good access to projects now tend to be banks. So you've got this capital markets. That might smaller, more granular, so expertise that you develop that cause some issues, such as a there is lower regulatory risk. is very hard to replicate. Some rate decision that might not be Together you've got a banks are more responsive. as favorable. That's a dynamic backdrop of positive Other deliver on execution. that's at play that's unique to a fundamentals. Obviously, Some players provide deal regulated monopoly. prices are high for utility certainty that others cannot. stocks at the moment which has been driven by low There are different ways that a “Regulation is becoming interest rates, but the bank can establish a niche. You fundamentals for the industry more of a partnership as look at it over time and it are good. proves itself out through the climate change is a durability of the returns. At For banks, the fundamentals the end of the day, common problem that have been challenged for management is going to be several years since the financial regulators want solved.” critical in identifying, crisis. The challenge that they cultivating, maintaining, face is persistently low interest broadening, and protecting rates and compressed margins. those niches. G&D: How do you view the Since the financial crisis, Dodd- current fundamentals of each Frank was passed and that’s led G&D: What would you say is industry? to more regulation, which has the biggest difference between added a lot of additional costs utilities and banks, from an RS: The fundamentals for to the industry. On top of that, investor’s point-of-view? utilities are very strong. That's the recovery, while it's been separate from the stock price lengthy, has been rather slow. RS: Utilities are different in valuations, but just the Banks can do well in a growing the sense that they are business fundamentals are very economy as the growth fuels regulated businesses; they are positive. They're state- more loan demand. monopolies. The returns are regulated businesses and a lot not determined by competition of states are dealing with We'll see what happens in with other utilities – they are climate change. A lot of them 2017, but the market seems to largely determined through a are setting renewable be anticipating change. Some of regulatory process. This is an standards, and that is having an those headwinds may dissipate essential service so regulators impact on the business. or you may see tailwinds. With want to make sure that Regulation is becoming more the election, there's been a electric power stays on for the of a partnership as climate sharp rally in bank stocks with customers. It is a capital- change is a common problem people expecting some (Continued on page 56) Page 56 Studness Capital Management

regulatory reform or that really need rather than new at? burdens will be reduced in projects. That could lead to a some way. There's been talk of better rate case as they file the G&D: Utility rates are driven fiscal stimulus, so perhaps you next one, leading to better by the government and they would have a more robust returns and an improvement in can ignore economic reality for economy. If that picks up, that valuation from 1.0x book value periods of time before they Nicholas Turchetta ’17, would be something that could to maybe 1.5x book value. In have to come back to the William Hinman ’17, and be a positive on the this type of a case, I don't think underlying fundamentals. How Charles Wu ’17 celebrate fundamentals for the banks as you're necessarily making an do you handle this dynamic? the end of the semester at well. With interest rates, there explicit forecast or prediction. the Value Investing Holiday was the increase by the Fed in It's more your reaction to CS: We look mainly at Party December 2016 and we'll see opportunities that are coming regulation. When regulators if that leads to continued about based on rate cases and make rate decisions that are action. Some of the past how the market responds to very unfavorable, this sets off a challenges may disappear or be them. chain of events: pressure on reduced going forward. the utility and pressure on the CS: As Roy noted, the stock price. We look at that G&D: With both industries regulation of the utility is and how far the regulations being driven by regulation, primarily at the state level. You can go, which can be more how do you try to assess have a different set of forces telling than how far the industry prospects? How does and dynamics than you have company can go. At a certain heavy regulation influence your with bank regulations at the point, the regulator's going to process? federal level. In California, they have to come to terms with have their own renewable economic reality. It's not the RS: We're not making a bet program. As far as the change utilities coming to terms with on whether reform is going to in federal rules, the movement that but more on the happen. Partly because at this away from coal burning is not regulatory side. point, it's hard to really know. driven by regulation, it's driven Taking the utility side first, by the market. Gas is cheaper G&D: Would you like to talk you've got rate cases and it’s a than coal to generate power. through a couple of recent process, so you see how it Bank regulation is a different investments you've made or plays out over time. Access to animal and is dominated at the ideas that you find compelling? the capital markets is federal level. important as that's going to RS: We've been invested influence those rate cases RS: For the banks, we're not exclusively in banks since going forward. It can create making any type of prediction February 2016. The most opportunity if a utility has a on what type of reform is attractive stocks between the bad rate decision, leading to a going to happen. You want to two industries were clearly decline in the stock price. All understand the industry on the banks in our rankings. When of a sudden, it may be trading macro level, but the drivers for they sold off in the beginning of at a value that one would stock selection are the 2016, the banks were just too question what type of access forecasts for the all of the cheap. That was the starting to the capital markets they individual stocks in the point. You have the headwinds have. That's a situation where universe. That's where you we talked about and banks you're going to see a good really focus on the micro were not very popular. Now investment opportunity if it is rather than trying to make after the election, there's been managed properly. broader interest rate or a lot of anticipation or reform calls. We break it discussion of how some of You say to yourself, "Oh, they down for each specific these headwinds might go can't go out and raise equity to company and ask, what's the away. do the various projects and company-specific outlook? maybe they need to cut back How does that outlook and I think people all of a sudden on the capex." So what does valuation compare with the forgot how profitable the that do? Maybe they're only outlook for the other ones in industry was before the going to do the minimum they the universe that we're looking financial crisis, before the (Continued on page 57) Page 57 Studness Capital Management

regulation changed, and with market and this differentiates it issues. One, there was concern higher interest rates. If you from other banks. The bank on the Chinese economy and went back in time to 2003 to can provide a level of service how that was going to grow. 2006, for a group of these competitors cannot or do not Two, EWBC had a regulatory midsize, high-quality banks, provide. It does not only help issue with Bank Secrecy Act you're looking at ROEs of 15%. them get business directly (BSA) compliance. Regulators People have forgotten that was related to China or Chinese examined the bank and said, really achievable. Dodd-Frank companies entering the U.S., it "We don't think your came and people thought also helps them get non- procedures to monitor Bank "We're not going to go back to related business because some Secrecy Act compliance are that world.” might want the option to sufficient enough and we're access this expertise at some going to require you to beef I think the election may have point, even if it is not needed that up." caused some people to re- immediately. I think that's examine that assumption. something that can help them This was the first time they'd ROEs don't necessarily have to elsewhere outside of that gotten any type of regulatory get back to 15%, but if that targeted Chinese-U.S. business. order in their history. The 15% went to 9% from 2007- CEO has been at the helm for 2011 that's a big drop. All of a In addition, while EWBC has a over twenty years and it's been sudden it goes during 2012- strong record of financial the same management for 2015 up to 10.5%; that's a little performance, the mix of its some time. Those two issues better but you're not back to loans and deposits has changed made the stock sell off and 15%. It frames the issue as far over the past ten years to become quite attractive. Our as where we were and where make the bank more attractive. analysis was: first, was the we are. Specifically, EWBC used to be stock attractively valued? Since a bank focused on commercial the valuation was attractive, Back to the micro level, banks real estate loans that were we moved on to a second that we like are the high- funded by high-cost CDs— step: are the issues causing this quality ones that have a track both of which are transactional high-quality bank to become record of growing. One I can in nature rather than based on attractively valued transitory? think of off-hand is the largest a relationship. This mix has Is there an impairment of the Chinese-American bank, East shifted as EWBC has business going forward? West Bank (EWBC). The bank diversified its loan portfolio to has a very good track record. also include more home On the BSA issue, we got A lot of these high-quality mortgages and commercial confidence that this was banks we view as business loans while isolated. This isn't a bank that's “compounders.” You look at significantly reducing its perpetually in and out of tangible book value, they just percentage of deposits regulatory problems, and they have good compound growth comprised of CDs and had a clear plan to deal with it. year in and year out. They're increasing its core deposits. So, They laid out the parameters putting up double-digit ROEs these have made the bank and the course of action. and the bank is growing. more of a “relationship” bank Throughout 2016, one could rather than a “transactional” track and see how that was For EWBC, their niche is their bank which, all else equal, going. We got comfortable expertise in facilitating business makes the bank more valuable. that this was not an between Chinese and In addition, EWBC is a very impairment of the business. American businesses. EWBC asset-sensitive bank with lots There are implications if you brands itself as a “bridge” of variable rate loans which have an order like that. It does between the two markets and position the bank well for have some restrictions on they can help facilitate higher interest rates. management and capital relationships in either allocation, but those are direction. There are other Why is it attractive? EWBC primarily related to M&A and Chinese-American banks out became very attractive opening new branches. It can there – but it is the largest. towards the end of 2015 and it take a bank a year or eighteen EWBC has expertise in that remains so. EWBC faced two months to get out of this type (Continued on page 58) Page 58 Studness Capital Management

of order. That didn't seem mainland China, but they have current idea in the utilities overly onerous to us and the presence there and that's space? wouldn’t change the thesis or solidifying the expertise they the quality of the opportunity. have. RS: Since we do not own any We got comfortable that these utilities at the moment, a past were transitory issues. In Those are things that gave us utility investment may be addition, EWBC has spent the comfort that the shorter worth discussing. Ameren significantly on non-recurring term issues aren't impairments (AEE) exemplified some of the consulting costs to improve its of the business model. This issues that we've talked about BSA systems and these costs bank has a long track record of and is a great case study. should reduce significantly high returns and good quality They're a utility in Missouri (around $15 million) in 2017 assets and one can reasonably and Illinois. They have a history which can provide an expect that to continue over of good returns. They're additional benefit to earnings. the next few years. When we primarily a regulated utility but look at our five year forecast they also had some merchant G&D: Don’t the remaining and the valuation screens we power plants in Illinois, which concerns regarding the health run on that, even now it still were deregulated. AEE of the Chinese economy looks very attractive to us. operated them very well and represent a substantial and had good performance. Then possibly unknowable risk for G&D: Does the company get power prices went down and this investment? an advantage in attracting and the returns in the merchant retaining low-cost deposits business went down. RS: We're not experts on the with its focus on China and Chinese economy and can’t Chinese-Americans? When the financial crisis hit, provide any unique insight on they decided to cut their it, but we're not looking to RS: They're not unique in the dividend. When a utility cuts trade for a particular quarter. sense that they're a Chinese- its dividend, it can have a very We're trying to take a longer American bank. There are out-sized negative impact on term view and make an numerous others as well. I the stock because that's why a investment that is going to don't want to create the lot of people own the stock. work out over the longer impression that they're unique Maybe management thought term. We think that the in that sense. Where their other utilities were going to interconnectedness of the uniqueness comes from is cut their dividends as well. But world’s two largest economies higher up the food chain. It is only one other utility did so will continue to increase over in the expertise and the during the crisis, so AEE stood time and that there will be a sophistication that they can out even more. The stock sold growing need for expertise for provide. On the sophistication off sharply. It began trading a facilitating business between level, these other Chinese- little bit below tangible book these economies. The increase American banks can provide value. There was a change in may not be linear but the access to or knowledge of the management and a bad rate direction is up. Chinese market, but they're case decision as well. The issue small and do not have the was "How are we going to deal If you looked at Chinese expertise or product offerings with this? What is the plan to investment in the U.S. over the of EWBC. In addition, they bring the returns up?" last several years, it's been don't have the balance sheet to steadily increasing. In fact, the access certain parts of the RS: The new management’s Chinese direct investment in market. For those larger banks, plan after they got the bad rate the U.S. surged in 2016 Chase is going to have a desk decision was that it would only to about $50B up from a few to deal with China or Korea. undertake absolutely essential billion five years ago. China is a They're going to have those capex. That would result in very large market, and we people that are dedicated fewer jobs, so the unions all of think the expertise of EWBC is towards that market, but they a sudden joined the side of the hard to replicate. EWBC has don't provide the service. utility because they don't want ten offices in China. They're to see the job cuts. That sent a not making many loans in G&D: How about a past or clear message to the regulator (Continued on page 59) Page 59 Studness Capital Management

to get a better rate decision value. The cloud hanging over another one later on. It can because clearly the company this company represented only help you get a feel for how doesn’t have access to the 10% to 15% of the earnings different each industry can be capital markets at that low and it should not have been and what the drivers are. I just valuation. part of the story. think about banks and utilities. A lot of people wouldn't CS: New management was Eventually AEE sold the initially think that they would actually a promotion from merchant business, which go together. The person who's within, so it was not a new made it a much cleaner story. covering the banks is generally executive from outside. They became a pure regulated not covering utilities. I don't utility focused on the right think they are paired together RS: It showed a lot of issues, notably the rate cases. at all in that sense. Initially they discipline. If they'd just kept Over time, it's worked out seem very different but as you going with the plans as if very well, beginning around see, over time, the drivers of nothing had happened and 2010. From 2010-2014, one industry can drive another were still going to spend Ameren produced a very good industry, and reactions can be money on capex, then that's annual return of approximately very different. That can create on the shareholder. The 14% with low risk. unique opportunities in shareholder's subsidizing unexpected areas. everything and they're the G&D: Did they have any ones taking the hit. In that problems servicing their debt Five years ago, I wouldn't have case, the customers and during the crisis? thought that these two regulators aren't taking a hit industries together would have for the poor rate decision. It RS: They cut the dividend but this great fit. Being open- was important to see how the they didn't need to cut it. We minded about those things and utility management was going thought they were being overly looking at relationships that to handle the situation. cautious by cutting. In our aren't presented by Wall view, they were doing Street is valuable. Remain open “I would recommend something that they didn't -minded about investing. need to do. Obviously it initially getting as much created a significant CS: Being open-minded is not a matter of finding glamorous exposure as you can in opportunity as a result. industries. Utilities are usually many industries. I think CS: They absolutely didn't thought of as a rather dull need to cut the dividend. It industry, but I think you can that can help you even if was important in that it led to see from what we've done that the management change. There you can make very good you focus on another were some other things returns in an industry like this. one later on.” happening at that time that The important thing is not to showed a lack of leadership in start excluding anything. As management and that got Roy said, be very open. The other thing in the changed. background was the merchant RS: Sometimes investors have power business, which was a RS: The merchant business preconceived notions on what small part of the business, but had some debt as well, but is possible from certain it started to dominate the they had that ring-fenced. industries. Sometimes you'll story. The merchant power want to look at the facts and business was only 10% to 15% G&D: Do you have any advice the numbers, and not of earnings, but people really for current students? necessarily listen to people's focused on it all of a sudden. preconceived notions. That This shouldn't have been a big RS: I would recommend can lead to more negative. You could back out initially getting as much opportunities. the value of the rest of the exposure as you can in many business and the merchant industries. I think that can help G&D: On that point, do you business had a negative implied you even if you focus on have any particular view (Continued on page 60) Page 60 Studness Capital Management

regarding specialization versus remaining a generalist?

RS: I've narrowed over time on what I've focused on. It's worthwhile to have the broader experience to provide more context then maybe focus on particular industries. At a Graham & Dodd Breakfast, Bruce Greenwald was talking about specialization and how he was a proponent of it, suggesting that this was one feature that could lead to high performance. We would probably agree with part of that. The problem is, to us it's not just knowing the stock – it's knowing the industry. It's knowing what drives economics for that industry. It's harder to gain that expertise in a short period of time and be actionable on a stock. Not that it can't be done, but from our point of view, it seems a little more challenging. That's how I would think about specialization, but there's not a wrong way.

G&D: Thank you again for the time. Get Involved:

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Contact Us: [email protected] Graham & Doddsville Editors 2016-2017 [email protected] [email protected] Eric Laidlow, CFA ’17

Eric is a second-year MBA student and member of the Heilbrunn Center’s Value Investing Program. During the summer, Eric worked for Franklin Templeton Investments. Prior to Columbia, he was an equity research analyst at Autonomous Research and a senior port- folio analyst at Fannie Mae. Eric graduated from James Madison University with BBAs in Finance and Financial Economics. He is also a CFA Charterholder. He can be reached at [email protected]

Benjamin Ostrow ’17

Ben is a second-year MBA student and a member of the Heilbrunn Center’s Value Invest- ing Program. During the summer, Ben worked for Owl Creek Asset Management. Prior to Columbia, he worked as an investment analyst at Stadium Capital Management. Ben gradu- ated from the University of Virginia with a BS in Commerce (Finance & Marketing). He can be reached at [email protected]

John Pollock, CFA ’17

John is a second-year MBA student. During the summer, John worked for Spear Street Capital. Prior to Columbia, he worked at HarbourVest Partners and Cambridge Associ- ates. John graduated from Boston College with a BS in Finance and Accounting. He is also a CFA Charterholder. He can be reached at [email protected]