Compilation of GD Newsletters PDF

Graham & Doddsville Investment
Newsletter
Compilation of newsletters published by “Graham
and Doddsville”. They publish 2-3 newsletter a
year. Contains many interviews of famous
investors.
No editing to the original content has been done.
Source:
https://www8.gsb.columbia.edu/valueinvesting/resources/new
sletters
Compiled by Venkatesh Jayaraman

J, Venkatesh
4/18/2018
@VenkateshJayar2
THIS PAGE IS INTENTIONALLY BLANK
Graham and Doddsville
An investment newsletter from the students of Columbia Business School
Volume 1, Issue 1 December 2006

Inside this issue:
Graham and Dodd 3

Breakfast with
An Interview with Richard Pzena
Thomas A. Russo
We recently had the oppor- sort of problem which issue that caused the drop in
Tracking the 9 tunity to sit with Rich Pzena, causes the price of the price is temporary or perma-
Superinvestors nent.
head of Pzena Investment
International Coal 12 Management. Founded in
A typical scenario will see a
Group 1996 after heading the US
company’s earnings and busi-
Equities group at Sanford C.
ness chugging along, and then
Strattec Security 14 Bernstein, Pzena Investment
Corp. get hit with a problem. It
Management’s Value fund has
isn’t always clear, says Pzena,
compiled an annualized com-
What’s Happening 21 if a downturn is cyclical or
pounded return of 16.3%
on Campus secular in nature. He cites
since inception, compared to
Kodak and the newspaper
a compounded annualized
industry as examples where
return of 9.3% for the S&P
Editors: he passes on trying to under-
500.
stand how their core busi-
Joseph Esposito Pzena’s investment approach
nesses are going to unfold in
MBA 2007 the years ahead. By con-
is very straightforward: he Richard Pzena, Founder and
Co-Chief investment Officer trast, housing and auto part
purchases shares in good
Abigail Corcoran of Pzenal Asset Management companies are clear exam-
MBA 2008 businesses that are selling at
ples of firms experiencing
a low price. He understands
shares to drop. The ques- cyclical downturns.
David Kessler that it is often unrealistic to
MBA 2008 expect such opportunities to tion Pzena and his team try
(Continued on page 2)
be available absent some to answer is whether the
Contact us at: Welcome to “Graham and Doddsville”

newsletter@grahamanddodd.com
We couldn’t be more forum for exchanging ideas provide a truly remarkable
Visit us at:
www.grahamanddodd.com
pleased to present the first and keeping abreast of what interview. Luciano Ferre-
edition of Graham and is happening at Columbia – ria and David Bernfeld,
www0.gsb.columbia.edu/students/
Doddsville, Columbia Business the longtime home of value leaders of the school’s Best
organizations/cima/
School’s student-led invest- investing. We aim to pro- Ideas Club, helped coordi-
ment newsletter. Co- vide readers with content nate the inclusion of our
sponsored by the Heilbrunn whose insight is timeless, student write-ups on Inter-
Center for Graham & Dodd alongside specific investment national Coal Group (ICO)
Investing and the Columbia ideas that are relevant today. and Strattec Secuirty Corp
Investment Management (STRT). And, of course,
Association, our goal is to Our thanks go first to Rich special thanks go out to the
provide students, alumni, and Pzena, who sat down with us staff of the Heilbrunn Center
the investment community a for an extended period to (Continued on page 2)
Page 2
Welcome to Graham And Doddsville (continued from page 1)
for Graham & Dodd Invest-

ing, and to Burak Alici and
Kevin H. Byun, Co-
Presidents of CIMA for their
support and constructive
feedback throughout the
process of putting all the
pieces together.
Please feel free to contact us

if you have comments or
ideas about the newsletter,
as we continue to refine this Students at Columbia Business School have the un-
publication for future edi- paralleled advantage of learning from value investing
tions. luminaries including Joel Greenblatt of Gotham Capi-
tal and Bruce Greenwald
Enjoy! -G&Dsville
Richard Pzena (continued from page 1)
Asked to provide an example industry average that the firm it in both places I’ll cut the
“...you have to listen of when his team misread an had about $2/share in normal- price.” Because that’s the only
impaired business’ problems as ized earnings power. way you’re going to incent
for things which are
temporary rather than perma- them to do it: somebody has a
going to tell you that nent, he offered the example of Pzena: Here’s a good exam- business relationship here and
Tenet Healthcare. ple. A company says, “We they have a different business
the senior have local expertise and local relationship here and you’re
management thinks “Tenet Healthcare was a busi- presence but we’re now going saying “I can offer you one-stop
ness whose margin structure to go national or global and shopping.” Well, what do I
the margin structure went from being the best to we’re going to have a sales want one-stop shopping for
the worst in the industry” for force dedicated to calling on unless there’s something in it
of the industry in the
several reasons, explains Pzena, national accounts.” The only for me, like a lower price?
future is lower than including a government lawsuit thing that can mean is that
and a management team in you’re lowering the price. So you have to listen for things
it was in the past.” turmoil due to alleged Medi- which are going to tell you that
care insurance fraud. It really is the only thing that the senior management thinks
can mean because you’re either the margin structure of the
Pzena and his team reasoned going to bundle things together industry in the future is lower
that there was no structural and lower the price or you’re than it was in the past. And
reason why Tenet’s margins going to say “If you have my either assess whether it’s still
should remain the lowest in the business in California you cheap or not, or decide to
industry, and projected that if should have it in New York pass.
margins simply reverted to the also, and to incent you to have (Continued on page 4)
Volume 1, Issue 1 Page 3
A Value Approach to Global Equity Investing

Graham and Dodd Breakfast was also encouraged to think or to make value-destroying
with Thomas A. Russo globally by Jack McDonald, the acquisitions.
On October 27th hundreds of legendary professor of finance.
private investors, alumni, and Warren Buffett came to But be careful which family you
investment management pro- McDonald’s class to talk to get into bed with. Asked how
fessionals converged on the students, and told them to an investor can distinguish fami-
Marriott Marquis to attend the think about the tax break the lies that are running public
16th annual Graham & Dodd government allows investors by companies for the benefit of all
allowing them to defer taxes shareholders, from those who Keynote Speaker Tho-
Breakfast. Organized by
mas A. Russo, Partner,
school’s Heilbrunn Center for on their gains until they sell. view the assets of the compa-
Gardner Russo &
Graham & Dodd Investing, the Buffett also advised the stu- nies they control as their own Gardner
crowd included a veritable dents to “find people you can private piggy bank, Russo re-
“Who’s Who” of value invest- to do business with.” plied that the family’s ability to
ing greats, including Mario attract and maintain Russo advised
Gabelli (’67), Jean-Marie high-quality manage-
Eveillard, Walter Schloss, ment is an important young investors
William von Mueffling indicator. He also
suggested focusing on
starting out to
(’95), David Winters,
potential conflicts of
Curtis Jensen, and keynote
interest, providing the
think and act
speaker Thomas Russo.
example of the Rigas’
globally, remain
The topic of this year’s gath- family ownership of
ering was Global Value Equity cable systems outside generalists, and
Investing, an activity Russo of the holdings of Adel-
Dean Glenn Hubbard and Professor
has been engaged in for years, Bruce Greenwald
phia as a situation that to concentrate
much to the benefit of his cli- raises a red flag.
ents. Since December 31st Clearly Russo absorbed both their portfolios.
1992 through September 30th lessons. Not only is his invest- Russo advised young investors
2006, his Semper Vic Partners ment style characterized by a starting out to think and act
LP has generated a 16.3% com- long-time horizon and low globally, remain generalists, and
pounded annualized return on portfolio turnover, he has also to concentrate their portfolios.
its equity holdings, compared taken positions in several fam- He also told the audience of
to a 10.5% and 12% return, ily-run businesses over the students, alumni and other
respectively, for the S&P 500 years. He observed that fam- investors to stay mindful of the
and Down Jones Industrials. ily-run businesses didn’t seem fact that, even for value inves-
to get the same valuation as tors, growth is required for
similar franchises, yet reasoned good returns. Walter Schloss and Ben Gra-
Russo’s global perspective was ham Jr. at this years Graham
shaped early in life. He de- that family-run businesses
The Graham & Dodd breakfast, and Dodd Breakfast
scribed how as a child his might actually be less prone to
a long standing tradition at the
mother thought it would be a engage in foolish behavior.
school attracted over 300 in-
good idea for him to subscribe Russo felt that if a family was
vestors in New York and was
to newspapers from around truly focused on running the
telecast to London to an audi-
the world (despite the fact that business to maximize long-term
ence of about 50 people,
he couldn’t read them). While gains that they would be less
hosted by GAMCO Investors
pursuing his joint MBA/JD at apt to grant large option grants
at the Dorchester Hotel.
Stanford in the early 80’s, he that would dilute their equity,
-G&Dville
Page 4
Introducing The CBS Best Ideas Club

The Best Ideas Club at Columbia Business School had its first meeting on September 19, 2006. The
group was organized last year by Matthew Hultquist (’06) to help students discuss and receive
feedback from experienced professionals as members prepare to enter the field of Investment Man-
agement. Each member must submit a write-up of one compelling investment idea to gain admission
to each bi-monthly meeting.
One reason the BIC has been extremely successful is due to the alumni who volunteer to work with
students helping them become better analysts and investors. The group also helps to create an ex-
cellent network between current students and alumni who share a passion for investing. Members of
the BIC are especially grateful to Jennifer Wallace (’94), Ciara Burnham (’93), and Grange Johnson
(’93) for their time and guidance.
The introduction of Graham and Doddsville will now allow students a forum to distribute their ideas.
At each BIC meeting several ideas are chosen from those presented. Students whose ideas are se-
lected may choose to have them published in each edition of the newsletter. We are pleased to pre-
sent the first two ideas in our inaugural issue (begins on page 12).
If you are interested in joining the alumni panel please contact the group’s current leaders: Luciano
Ferreira (lferreira07@gsb.columbia.edu) or David Bernfeld (dbernfeld07@gsb.columbia.edu).
-G&Dsville

Question: When you talk take a paper company that on low normal ROE you want to
about ranking companies average has produced a 6% adjust your view of value
from top-to-bottom based return on equity through its downward. So you need to
on the ratio of their cur- history, and take Microsoft, have a cheaper P/E to buy a
rent price to what you pro- which has produced a 50% lower quality company. And
ject their EPS will be in 5 return on its equity through its that’s the way we adjust.
years, do you adjust for history. One unit of growth or Take Microsoft: we adjust our
industries that always seem one percent of growth at Mi- view of its normal earnings
to trade at a discount to crosoft is worth way more power upward because of its
the market, like financials? than one percent of growth in high ROE. We actually go out
a paper company. and project another 5 years to
Pzena: I don’t think financials figure out year 10 earnings, and
always trade at discounts to So the way we adjust is to because Microsoft earns a 47%
the market. Certain industries make the assumption that the return on equity the cash that
like insurance companies might, high return nature, or the low this business is generating, even
but that’s because their return return nature of the business if it grows slowly, is in excess
on equity is below the market’s will continue for some period of the needs of the business.
return on equity based on their of time. Therefore when And so because that excess
profit structure. you’re extrapolating the future cash is available for share buy-
earnings power of this business backs, the earnings of the com-
The answer is that we adjust a company with a high ROE pany will actually grow faster
based on the business quality you want to adjust your view than the growth rate of the
rather then on how they’ve of value upward. I’m talking company.
traded in the past. So for ex- about normal ROE, rather than
ample let’s take 2 extremes: current ROE. And one with a (Continued on page 5)

And if I compare that to a pa- year. Just read the research: or investing in dead money,”
per company, it’s a downward “We’re changing the buy to a we promise them we’re going
adjustment but it’s the same sell because we’re expecting to do that too. If I knew which
concept. It’s extrapolating the the quarter to be weak.” one was going to be value trap
earnings and saying if the busi- There’s a lot of that going on in advance I would avoid it!
ness grows 5% a year, the earn- out there. People are overly But how do you know in ad-
ings will actually grow slower sensitive to short-term results. vance?
than that because I’m not gen-
erating enough internal cash to It’s not just the sell-side, it’s I think the attempt to avoid
Arthur Samberg (‘67) and
fund that growth. So I’ll have also the hedge fund community. value traps is what keeps peo-
Professor Bruce Greenwald
to either issue equity or raise ple from being real value inves-
debt. tors, because for something to Columbia Business
“Just read the
be real value, you can’t know School is a leading re-
The growth rate is somewhat research: “We’re whether it’s a value trap or source for investment
deceiving. If you have two not. If it was obvious, if it was management profession-
companies, one that has a 5%
changing the buy labeled that this one was a als and the only Ivy
League business school
ROE and is growing 10% a to a sell because value trap and that one was
in New York City. The
year, and another that has 30% not, they wouldn’t sell for the
School, where value
ROE and is growing 2% a year we’re expecting the same price. So you have to be investing originated, is
(top-line growth), and the mar- willing to accept that some of
quarter to be consistently ranked
gins are going stay the same, the stuff you invest in is going among the top programs
the earnings per share increase weak.” There’s a to go wrong. for finance in the world.
on the 2% grower could be
higher than on the 10% grower.
lot of that going on That’s how I define value trap:
That’s simply because the 10% out there. People you buy something and your
grower is not self-sustaining thesis is wrong. You thought it
because it only has 5% ROE so are overly sensitive was value but it wasn’t value.
whatever capital it requires it’s But you just don’t know.
to short-term
going to have to raise, while Sometimes maybe you could
the other one can buyback results.” have known, and I’ll call that a
stock. research mistake (like Tenet).
If you’re running a business Others you couldn’t have
Question: Do you think where if you have a bad year known. You make a judgment
one of the reasons your half of your business will go based on probabilities, it turns
methodology has proved away, you’d be very focused on out not to be what you ex-
successful is because you the short-term, even if you’re a pected, and you lose money.
look at earnings 5 years long-term oriented kind of We expect to lose money in
out, while other investors person. It’s hard not to be. about 40% of the stocks we
or sell-side analysts are Better to run a business where invest in. And I think that’s
looking at earnings and you promise your clients how you win: by not being
earnings revisions over a 2- you’re going to have bad years, afraid to lose.
3 year period? which is what we do, we prom-
ise them. So long as you can understand
Pzena: Shorter than that. I how much you’re going to lose.
think they’re looking over a 1-2 If they ever ask us, “What If you think there’s some prob-
year period, or even less than 1 about investing in value traps (Continued on page 6)
Page 6
ability that the company is go- reward trade-off. nobody else can do that so
ing to be wiped out, then that’s they have a low capital require-
another story. But making the Take Fannie Mae and Freddie ment and earn a high return on
judgment that the margin struc- Mac: nobody would touch equity.
ture for the hospital industry these stocks. Why? There
should be about 15%, you’re was potentially bad accounting, So if you invested in that fund,
not going to be that far off, and and the government could have let’s say it was a fund instead of
Dean Glenn Hubbard and
Mario Gabelli (‘67) even if you’re wrong and it pulled the plug because of the a stock, if you invested in that
turns out to be 11 or 12% bad accounting. Did anybody fund it would have returned
you’re not going to lose a ever sit there and say, “Does 20-25% per year after-tax for
whole lot of money. the accounting matter in this the last 20 years. Pretty good
business.” I mean how many business.
Take a situation like Tenet people looked at this and said,
where you completely blew it, “You can’t use generally ac- Now along comes somebody
and you still can get out at the cepted accounting principles and says, “You know what, I’d
same price you bought in on. for this business.” like to understand the results
It’s because you bought at a of your fund on GAAP. Forget
low enough price because eve- You can’t. The fact that any- how much money you’ve made
rybody else was looking at this body is even looking at GAAP for me, just give me your
and saying, “Oh my God, look earnings is ludicrous, including GAAP statements.” And the
at this mess. Their customers Congress by the way, because person scratches their head
are pissed off at them, the gov- it’s a hedge fund. What are and says, “Ok, but GAAP tells
ernment’s going to sue them, Fannie and Freddie? They’re a me I have to mark-to-market
the management is in turmoil, small number of people sitting the asset side of the balance
you don’t know what’s going to in Washington DC who buy sheet, but not the liability side
happen,” and people therefore mortgages and fund them with of the balance sheet. So I’m
avoid it. And because they do debt. And the reason they going to have unbelievable
you’re buying at such a low make more money than any- crazy results on GAAP, so I
price that even if it turns out to body else doing this is because better do something about it if
be a value trap you don’t lose a their status allows them to somebody’s going to analyze
whole lot of money, and if it borrow long-term, and no me on GAAP.” So I try and
turns out to not be a value trap financial institution can borrow qualify for the exemptions to
you make a lot. long-term. Not even Citibank. the asset/liability separation,
I think most smart investors, if If you look at Citibank’s bal- and that’s hedge accounting.
you have a 50% chance of dou- ance sheet there’s not a lot of Under hedge accounting you
bling your money, and a 50% long-term debt on it. Fannie can net the two. So I’m going
chance of losing a quarter of it, and Freddie’s long-term debt is to engage in all kinds of stuff to
you would just take that invest- callable debt, so they can pretty net the two, and then I report
ment any day of the week. But much match the duration of my financials.
when it comes to the stock the asset and the liability side
market people say, “Oh my and take very little interest rate By the way, I’m still reporting
god, I might lose 25% of my risk. Nobody else can do that what I earned on the portfolio
money I’m not going to touch so they make a spread. The in real terms, the mark-to-
it,” and they don’t do the risk- regulators understand that market valuation of the whole

portfolio. Even though it’s not ment will pull the plug or they timed it exactly: sell the value
generally accepted accounting won’t. I would bet they won’t, stocks and buy the NASDAQ,
principles to do that, it’s the but I don’t really know. But I right at the peak.
right way of doing it. know if they don’t I’m making a
lot of money. And by the way And you know we were a
And now a regulator comes they’re still making that 20-25% young firm, so we didn’t have a
along and says, “You didn’t do while we’re sitting here waiting. long track record to fall back
that right, and you cheated They didn’t stop investing in on. From 1/1/96 to 2/28/2000,
because you wanted to make their mortgage portfolio, so the so about 4 years, we were
your bonus.” And so they liquidation value is actually 6000 basis points behind the
blow the whole thing up. Con- accreting over time, so it’s an S&P 500 (since our inception).
gress gets all upset and says even better investment. This is And here you are trying to run “My favorite story
“I’m going to pull the plug on without knowing what the an investment management
is I sat down across
Fannie and Freddie because outcomes going to be, without firm trying to beat the S&P, and
they’re out of control.” This is knowing if it’s a value trap. what are the odds that you the table from
effectively what’s happened, could ever in your life make up
right? And the stock gets Question: What was it like 6000 basis points? It’s pretty somebody who said
killed. So where does it go? It to be a value manager in depressing. I’ve got to tell you to me, “My
actually trades below the liqui- the late 90’s? it’s pretty depressing.
dation of their portfolio. For- grandmother’s a
get accounting, I could stop the Pzena: It was not fun. You 12/31 of 2000, 9 months later,
business and earn a profit. And had 2 things going on. One is we were ahead of the S&P 500
better investor than
people are saying, “Oh my god, you saw all these great things cumulatively because the mar- you. This is very
the business is going to stop. I you wanted to buy, and you ket collapsed, and our stuff
don’t want to own the stock.” saw how much everything else went up. I think we were up easy. She gets it,
But it’s already selling for be- was valued at, but then you 40% or something like that in
you don’t. All you
low what it’s worth if the busi- talked to your clients. My fa- 2000, and the market was
ness stops. And if doesn’t stop, vorite story is I sat down down 30. And all of a sudden have to do is buy
you’re making a fortune. across the table from some- you’re now ahead of the S&P,
body who said to me, “My which is where we’ve been Cisco. How come
Now can I tell you I know grandmother’s a better inves- ever since. But believe me it’s you won’t buy
what’s going to happen? How tor than you. This is very easy. not fun. It’s not fun thinking
could anybody know what’s She gets it, you don’t. All you that I’ve started a business and Cisco? How does
going to happen, if it’s going to have to do is buy Cisco. How it’s going to fail. I’ve hired a
stop or not stop? But I would come you won’t buy Cisco? whole staff and they’re going to
my grandmother
still make that bet every day of How does my grandmother lose their jobs. You’ve let know this, and not
the year. And they’re now know this, and not you?” down your clients. You’re
going through the process of questioning yourself, although I you?”
coming up with new financials, That was the kind of conversa- never totally did, because I
and they’re going to be just as tion we were having, so it was never could understand it. My
crappy as the old ones. And not fun. And just as everything response to the grandmother
anybody that relies on them you ever read about cycles will comment was, “Can I just walk
should be shot because it’s a tell you, right at the peak, I’m you through some arithmetic,
stupid way of looking at the talking about February of 2000, because Cisco has a $500 bil-
earnings power of that busi- that’s when we had the biggest lion market cap. Let’s say
ness. And either the govern- outflows of money. They you’re going to buy the whole
Page 8

company. You’re rich and so you can take it a little bet- whole lot of money. But if I
you’re going to write a check ter. And you just defend it and can buy a liquid portfolio at
for $500 billion, and you want say, “This is why I don’t own book value, then I can say I
to make a 15% return on your energy, this is the logic.” And have some downside protec-
investment. That’s $75 billion; after the clients or your staff tion. That’s an easy example.
they have to make $75 billion hear it for 18 months then it
every year. They’re making $1 starts to get old, and they say Take a tougher example, one
billion! I mean something’s “Well now you’re just wrong. that nobody would have
wrong, isn’t it?” And they You’ve missed it and you’re viewed had downside protec-
would just look back and say, just wrong.” That’s why having tion, Computer Associates.
“You just don’t get it.” And I that ranking, having that disci- They’re a software company
would agree, “Obviously I don’t pline is so important. Because that had some accounting is-
get it.” I’ll pull up Exxon on the screen sues, some management issues,
and the stock went from 79 to
and say, “What do I have to
Question: How do you deal 8. I bought it at around 15,
believe for this to be a cheap
with the emotional ups and thinking that at 15 I didn’t have
stock?” I’ll plug it in and then
downs where your invest- a whole lot of downside. And
I’ll say, “I just can’t believe this.
ment results can vary so it did go to 8 but I still was
It’s too fanciful to believe that
dramatically, and for such right, it went to 8 for a short
this is what could happen.”
an extended period of period of time.
And you try and stay anchored
time, from the quality of
in the facts as much as possible.
your investment process? Here was a business that had a
customer base. They sold
Question: You’ve already
Pzena: Well, first of all that software that ran the back
talked about using margin
was a very unusual environ- office systems tools for large-
structure to think about
ment. It was 2 and a half years scale data centers. So it was
how much downside an
of being completely out-to- job processing, network ad-
investment could have. In
lunch relative to what was ministration, security and those
addition to margin struc-
going on in the world. It’s not kinds of tasks in a large data
ture, can you talk about
normal that you have to go center. They had one real
how you wrap your arms
through that. competitor in the world, which
around how much you can
is IBM, and what’s interesting
lose in an investment?
We just went through a mini- about that business is that the
version of it this past year with switching costs are astronomi-
Pzena: Sometimes it’s easy, as
the energy stocks being so cally high. What are the odds
it’s just the underlying value of
strong, and us not being in- that you’re going to shut your
the assets of the company. The
volved in them, and looking at system down and replace the
assets have some value outside
it and saying “This doesn’t tools? That’s like saying I don’t
of the business. Take a life
make any sense.” That’s more like Con Ed doing my lights, I’m
insurance company, simple
normal: when you get it wrong, going to try some start-up
example. It’s a bond portfolio.
you’re getting it wrong for 12 company to supply electricity.
How much below book value
months, 18 months, and you Nobody even thinks about it, is
can a bond portfolio go, unless
trail the benchmarks by 4 or 5 the point. Nobody ever thinks
they totally screw it up?
percentage points. It’s not 2 that we should change the job
Probably not much. It doesn’t
and a half years at 60 percent- processing software: it’s not of
mean I’m going to make a
age points. It’s a big difference, (Continued on page 9)

strategic importance, it’s a business and I say “Let’s sign a negative, and the stock went
utility. So they have a renewal 3-year contract” and you give down. The cash flow per share
rate on their contracts in the me a 3-year contract and I did not move by even a dollar.
90’s. book $280. Next year I go to It’s such a steady business. The
this other guy and say “Can we customers never cancel, they
Now this is an accounting ir- sign a 4-year contract?” So I just keep sending you a check.
regularity concept, but when sign a 4-year contract with him This is the greatest business in
you sell a software license un- and book $360 in revenues, the world: I collect checks and Edwin and Walter
der GAAP, if it’s a multi-year and then I report 30% revenue put them in the bank. And you Schloss
software license you still book growth. And they did that for can see the bank account.
all the revenues in the first year a decade, extending the aver- That’s one thing it’s hard to Columbia Business
because you have no on-going age life of their contracts and screw up on an audited finan- School would like to
obligation. If I give you a disc, reporting earnings in excess of cial statement, is what the cash wish longtime friend
and you promise to pay me their cash flow. Now because balance is, because I think that’s Walter Schloss a Happy
$100 a year for 3 years and it’s not a growing business, it’s one thing the auditors have 90th Birthday. Walter,
then send me back the disc, I all a renewal business, you’ve figured out how to check. a former colleague of
book the present value of the now renewed all of your cus- Benjamin Graham, was
$300, I book $280 of revenue, tomers to one of these long- So you’ve got this business recently honored by
and that’s it. term contracts, now there’s producing $2.50/share of cur- New York Society of
nothing to do. So you’re done, rent cash flow, as it had each Securities Analysts.
So the way I can manipulate my and all of a sudden your earn- year for the prior 5, and then
results in that environment is, ings collapse. The earnings you talk to the customers and Visit the public section
let’s say I have a $100/year in went from $3/share to zero, or (Continued on page 10) of the Schloss Archives
for Value Investing to
read the 2003 Bottom
Tracking the Superinvestors Line interview with
Walter and Edwin
As the academic center for the philosophy and principles of value investing, Columbia Business School
Schloss by Eli Rabi-
has built a strong network within the investment community. Beginning with Benjamin Graham and
nowich (‘04).
David Dodd, continuing with Roger Murray, and with Bruce Greenwald continuing this tradition,
Columbia Business School continues to attract inspiring
investors who seek to learn the disciplined philosophy of Value
Investing.
Columbia students are known for searching the universe of

stocks to discover undervalued stocks. As taught by Professor
Greenwald, the first step in discovering undervalued securities
is to develop an appropriate search strategy. One resource
that students have found to be fertile soil for ideas are the SEC
Form 13Fs that are published quarterly by money managers Lee Cooperman (’67) Founder and
with $100 million or more under management. Chairman of Omega Advisors speaks
with a CBS student
Each issue of “Graham and Doddsville” will highlight recent investment decisions of successful alumni,
professors, and other prominent investors who are admired by Columbia Students and adhere to a
value-oriented philosophy. (See page 18 for the investors highlighted in this issue.) -G&Dsville
Page 10
Richard Pzena (contnued from page 9)
they all tell you they’re going to

DGX - 1 Year
renew their contracts because
they have no choice. 65
They’re very clear about it: 60

they don’t like Computer As-
sociates, but there’s nothing 55
they can do about it. And you

50
have the history of the contract
renewal. 45
11/21/2005 2/19/2006 5/20/2006 8/18/2006 11/16/2006

So I say, here’s $2.50/share of
cash flow that’s going to go on
forever, and the stock is 15. Quest Diagnostics Inc. (DGX - NYSE)
Do I have downside protec- Price: 52.26 (12/16/06) Market Cap: 9.99 billion
tion? I think so. So when the 52 Week Range: 48.09 – 64.69 Sector: Healthcare
stock goes to $8, we double-
checked to make sure we did- We have that ranking system, And the same thing is true
n’t get the $2.50 wrong, and in large cap there’s 500 stocks, when you blow it. We use the
we didn’t get it wrong. We and if it gets ranked 250 or same ranking system, but in-
bought a 2% position at 15, so below we have to sell it. Pe- stead of the stock price going
at 8 it’s a 1% position (that’s riod. That discipline is so im- up to get to a higher P/E ratio
what happens), and we quintu- portant, because otherwise the we cut the earnings estimates
pled up (5% is the maximum emotions rule and you say, “I and decide we just got this
we hold, so we took it up to a think I’m going to ride this for wrong. Tenet didn’t have $2/
5% position). The stock went another week because it’s got share of earnings power, it had
all the way back up to 20- great momentum, I love the $1/share of earnings power, so
something. management team, this guy at $15 we thought it was cheap
from Goldman Sachs is about but now we think it’s fully
I think that’s downside protec- to publish a positive report.” priced, so we got out.
tion. Did I know what was This is the kind of stuff that
going to happen? I didn’t have goes on in people’s head, and Question: Can you discuss
to believe anything other than we just take that out of the the best investment you’ve
that most of the people would process. So once it’s at fair made in your career, and
renew their contracts every value, ranked 250 out of 500, whether you realized the
year. I didn’t even have to it’s a sell. And we’ll start to upside potential at the
believe that all of them would trim it as it gets close to that if time you made it?
renew it. we have something more at-
tractive to put the money into. Pzena: The best in terms of
Question: When do you Because if you’ve got all your percentage terms was one
start considering when to money invested and you come where I didn’t realize the up-
trim or eliminate a posi- up with another idea, you have side. But I think the best and
tion? to sell something. So we sell the worst are rare. For me,
whatever is getting close to making 10 times my money is
Pzena: Eliminating a position that fair value point. rare, and losing all of my
is a straight, simple rule for us. (Continued on page 11)

money is rare, but that would test in Teterboro and the cost went out with the story, and
be the best and the worst. for processing the same test in the stock went up even with-
Chicago. It cost $3 in Teter- out them selling anything to the
The best was Quest Diagnos- boro and $27 in Chicago. They drug companies. So that was a
tics. A simple business that said, “We’re just going to figure huge home run, totally unantici-
takes your blood and sends you out what we do right in Teter- pated. It was anticipated that it
results of your blood tests boro and do it in Chicago.” would be a success, that we
back. They were owned by That was exaggerating, but would double our money, but
Corning, who spun them off. there were massive differences. not that it would be a huge
They went into this massive The guy said “Here’s our busi- home run. “I offer this advice
roll-up of all these labs across ness strategy. We did this whether you’re
the country, and they just let whole roll-up, and then we The worst investment of my going into
them run the way they were never employed the best prac- life was Fruit of the Loom.
i n v e s t m e n t
being run. And Medicare tices. So I’m going to system- Great business, temporary
shook things up. They went atically go and adopt the best problems, or so we thought. management or
public right before Medicare practices, and I think we can The underwear business is a not. Find
things shook things up, so get the margins higher.” great business, particularly something that you
Corning got out ok, but then mens and boys through the
really like doing
Medicare came in and said, So we bought into that, figuring discount channel, because
“We don’t need all these blood that they must know how to that’s where 70% of underwear because, if you’re
tests that you’re doing. You do it. And we really explored is bought. There are 2 players, forcing yourself to
know a doctor wants one and what gave rise to $3 here ver- Hanes and Fruit of the Loom. go into something
you do 12 and bill us for 12. sus $20 there, and there was They each have about half the
that you’re really
Well we’re only paying for 1.” nothing structurally different market, and they both make a
It killed the business, and then about those two markets. lot of money because they have not turned on by
the HMO’s all went along and Nothing. But you used to not cost structures that nobody then it’s not going
said “We’re not paying for all care when you sold the blood else can compete with due to to work, even if
these blood tests either.” test for $50, but when you sell of their volume and their
it for $20 you care, or you sell sourcing and manufacturing
you get paid a lot
The stock got killed, the earn- it for $18 and you’re actually operations. They print money. of money or it’s
ings got killed, and we went losing money in Chicago you prestigious.”
and started researching it. We care. On top of that they have a
watched the HMO pricing sta- commodity fleece and t-shirt
bilize, watched the Medicare So they actually pulled it off. I business for screen printers.
pricing stabilize, and asked the became very friendly with the They had warm weather in the
company what they were going guy who was running it over winter, and got stuck with a lot
to do. “You used to make 25% the course of 2 years that we of excess fleece inventory.
margins, now you’re making 3% owned it. Then they started They marked it down, and shut
margins, and you have this saying, “Look what we’ve got down their factories (which
price that you’re never going to here. We have all this data on were big fixed cost operations)
be able to raise, so what are people’s blood tests. I bet you to work off the inventory. The
you going to do?” And they we can sell this to the drug earnings got killed, the stock
showed us unbelievable data. companies.” That never oc- got killed, went from like $45
One of their big labs is in curred to me when we made to $14. We bought it at $14
Teterboro, and they showed us the investment. Never oc- thinking there was about $3 of
the cost for processing a blood curred to me at all. Then they (Continued on page 16)
Page 12
International Coal Group

Rookie Slump Masks Homerun Potential
Jonathon Luft
jluft08@gsb.columbia.edu
At $4.20, International Coal (ICO:N) is significantly undervalued based on the value of the company’s
reserves, and superior production growth profile. The value of the equity has declined from $14 at a
year ago, due to consecutive quarters of lowered guidance caused by technical problems with some
of their assets, higher raw materials and extraction costs, and the tragedy at the Sago Mine in early
January. As investors have sold the stock based on these near term factors an opportunity has been
International Coal Grp created for those with a longer time horizon to own these assets at a ridiculously cheap valuation.
(ICO - NYSE) Furthermore, as the company builds up their mining capabilities, operating cash flow should ramp up
accordingly and based on my 2008 EBITDA estimates, ICO trades at 3.3x EV/EBITDA. At current
Price: 4.20
S/O: 152m levels, an investment in ICO offers investors both a margin of safety and significant upside potential.
Market Cap: $642m
Net Debt: $108m Company Profile
ICO was formed in May 2004 by WL Ross with the purpose of restructuring
and consolidating key coal assets in Appalachia and the Illinois Basin. The com-
pany purchased select assets from Horizon in September 2004 through a bank-
ruptcy auction, and then added Anker and Coalquest assets in November 2005.
These assets were all union-free organizations with limited legacy liabilities.
Combined, these assets have 918m proven tons of reserves, and using 2006
estimated production of 17m equals 54 years of production capability. Further-
more, of these reserves, the company’s Central Appalachian coal is a premium
product (due to higher heat and lower sulfur content) and 65% of their reserve
life is steam coal (used by utilities), with the remaining high priced metallurgical
coal (used in the production of steel). Lastly, industry dynamics for coal produc-
ers going forward look positive, as the EIA estimates scrubber installations will
nearly triple this decade increasing NAPP and CAPP coal pricing.
Valuation
In evaluating ICO, I first attempted to look at the value of the reserves to determine the margin of
safety. To do so, I looked at other publicly traded Eastern Appalachian competitors to determine
what the market is paying for current reserves and found the weighted average price/ton to be $1.85.
Understanding that the market is skeptical of the quality of the company’s reserves (given the prob-
lems at their Sago Mine and high capital expenditure required to bring them up to speed), I think it is
appropriate to discount this average by 1/3 to determine a reasonable margin of safety, which equates
to $1.20/ton or $6.53/share. At the current valuation, this is about a 50% premium to the current
share price.
The second valuation I looked at was to model the company’s increased production capabilities going
forward and their shift towards higher priced met coal. Going forward I have priced in an average
future price/ton of $47 in 2007, and $49 in 2008 with cash costs of $42, for an operating margin of
$5/ton and $7/ton. In determining average future realized price/ton, I use the EIA CAPP 2007 and
2008 average monthly futures price. To determine EBITDA, I estimate 2007 production at 20m, and
2008 at 23m which represents the Beckley complex coming online (2007), and Tygart coming online
(2008). Depreciation is constant at 67m/year, or ½ of CAPEX. This results in 2007 EBITDA of 167m,
and 2008 EBITDA 228m or an EV/EBITDA of 4.5x and 3.3x. To compare that to its peers historically,
coal companies from 2002-2005 have traded from 4.1x-7.4x forward EV/EBITDA which equates to an
ICO price of between $3.80 and $7.42.
An important element in this valuation is that the company has the second longest reserve life in the
industry, is transitioning towards higher priced met coal, has no significant pension and union liabilities,
and has several potential mines and opportunities for production growth. The company, behind the back-
ing of WL Ross has committed to invest approximately $850m (following the Q3 call this was scaled back
down to $665m) in capex over the next four years, which is greater than the entire current market capi-
talization of the company. With WL Ross (owns 16% of the s/o) as chairman I believe this capex adds a
free call value in the sense that given his financial acumen investors can have confidence that the present
value of these projects are greater than repurchasing shares at this level (and thus creating opportunities At current prices,
for current investors).
ICO offers
Risks
As with any commodity product, the risk is in future coal pricing and concurrently the high raw material investors a
costs (such as diesel fuel, excavation equipment) that have compressed margins this past summer. Fur-
thermore, the company has significant unpriced production (45% compared to peers between 20%) for significant margin
2007, and a concentrated customer base (with 65% of production going to the top five customers). As
well, the company has had production problems including the tragedy at the Sago mine in January of safety based on
(determined to be due to natural causes which cost the company $15m), and the fire at the Vindex mine
in Illinois. Lastly, from a financial markets perspective Wall Street has no faith in current management due the value of its
to the consecutive downgrades in future guidance. As WL Ross is the chairman and current equity prices
are near his purchase price, I believe he will provide appropriate stewardship to realize significant capital reserve base,
appreciation for shareholders.
which I estimate
Summary
At current prices, ICO offers investors a significant margin of safety based on the value of its reserve to be worth at
base, which I estimate to be worth at least $6.50/share. Looking forward, I think that the delta of produc-
tion growth will be on the upside, as the company spends $650m in capex to build out its existing re- least $6.50/share.
serve base and transitions towards producing higher priced met coal (the company estimates 2010 pro-
duction to be about 4m tons of met coal compared to 100K in 2006). As the company executes its pro-
duction plan I believe it is reasonable to project 2008 EBITDA at 228m, which represents a current
valuation of 3.3x EV/EBITDA.
The catalyst going forward to recognize this value is twofold: first is simple execution, as Wall Street
regains confidence in the company and quality of its reserves the equity should be valued in line with
peers. Secondly, with the Beckley and Tagart mines producing, tons sold per year should increase sub-
stantially from 17m to 20m and 23m, which will more than double EBITDA.
Q3 Follow-Up
Following the third quarter earnings report, ICO equity increased to approximately $5/share as the com-
pany was able to meet EBITDA estimates and boost fourth quarter guidance by 5m. Furthermore, the
company announced reduced capex plans for the next four years from approximately $850 to $650m by
deferring investments in some higher cost mines. My sense is that investors simply rewarded the com-
pany for meeting their target and applauded the company’s prudence in investing in higher margin pro-
jects going forward. Lastly, natural gas prices have moved upwards in the past two months (from the mid
Eastern Coal Producers Reserves
Company Price Market Cap Enterprise Value NAPP CAPP Other Total EV/Reserves 2007 EV/EBITDA
Massey $ 21.7 $ 1,781. $ 2,608. 0 100 0 2,25 1.16x $ 47 5.5x
Alpha Natural Re- $ 15.3 $ 1,059. $ 1,539. 19 81 0 49 3.14x $ 37 4.1x
James River Coal $ 13.1 $ 394. $ 660. 0 75 25 24 2.73x $ 8 8.3x
0
International $ 4.2 $ 641. $ 750. 60 32 8 91 0.82x $ 16 4.5x

Note: EBITDA Estimates are from FirstCall, ICO estimates proprietary WAV 1.85x 5.3x
Page 14
Strattec Security Corp. (NasdaqNM: STRT) BUY at $42
Luciano Ferreira
LFerreira07@gsb.columbia.edu
Summary Thesis
Strattec Security Corp. (STRT) is a great business in an out of favor industry. Concerns over declin-
ing sales; dependence on the big 3 U.S. auto manufacturers; bankruptcy of an important customer;
increasing raw materials cost; and unfavorable industry dynamics have driven down the stock price,
creating an attractive buying opportunity for long-term investors. STRT is trading at less than 7x
ESTIMATED VALUE depressed LTM operating income and at 1.4x tangible book value. In very difficult times, STRT is still
PER SHARE: $58 quite profitable (LTM EPS equals ~70% of peak earnings); generates $15-$20 mm in cash per year
(+40%) (12% LTM FCF yield); and produces high returns on capital (32% ROTC and 20% ROIC, LTM). The
Company has a solid balance sheet with no debt and $64 mm in cash (~40% of current market cap).
There is a clear turnaround strategy, which is starting to present results. STRT has repurchased 49%
Price: $46.69 of issued shares and patient investors will be rewarded once the business recovers. Should my con-
servative assumptions materialize, and STRT continue to use its cash wisely, the stock could trade
Market Cap: $166 million or $58 three years from now, yielding a 12% annual return.
(as of 12/15/06)
Background
STRT was spun off from Briggs & Stratton in 1995. Its traditional products are mechanical and elec-
tronic locks and keys for cars and light trucks. STRT also produces ignition lock housings (mating
part for ignition locks and typically part of the steering column), and markets latches made by Witte,
a German parts supplier. These latches are used in several car parts: trunk, liftgate, tailgate, hood
and side doors. The Company’s main customers are DaimlerChrysler (32% of FY 2006 sales), GM
(18%), Ford (15%), and Delphi (15%). Export sales (primarily to auto manufacturing plants in Canada
and Mexico) represent ~20% of total revenues.
STRT has been one of the world’s largest producers of automotive locks and keys since the late
1920s, and currently has a 46% share of the North American market. In FY 2006, STRT supplied
93% of DaimlerChrysler’s production, 52% of GM’s and 66% of Ford’s. Direct competitors include
Huf North America, Ushin-Ortech, Tokai-Rika, Alpha-Tech Valeo, Methode, Shin Chang, and Pollak.
STRT’s main manufacturing facility and headquarters is located in Milwaukee, Wisconsin. Finishing
and assembly take place at the Company’s other two plants, located in Juarez, Mexico. Detailed
Thesis
The key issues are:
1) Will STRT be able to replace lost revenues and sustain current businesses?
2) Can the Company adjust prices to offset increases in raw materials cost?
3) What is STRT going to do with the cash?
These are my answers:

1) JVs, new products, new contracts, and geographical diversification can offset the two causes of
revenue decline: Big 3 market share losses; and de-contenting (lower number of locks per car)
VAST China can generate ~$18 mm in additional revenue: STRT teamed up with Witte and ADAC
Plastics to create VAST (Vehicle Access Systems Technology). This partnership is the only true
global one-stop shop for lock products (Ushin and Methode do not have a presence in Latin
America; Tokai does not offer latches nor handles). Automakers are looking increasingly to buy
parts from fewer, larger suppliers that are capable of shipping components to factories any-
where in the world. The alliance enables companies to bundle together locks and keys made by
Strattec, latches made by Witte, door handles made by ADAC and a keyless entry system de-
veloped by STRT and Witte. The partnership can support global automakers from 11 locations
around the world. Strattec and Witte each own a 40% stake in the alliance, while ADAC holds
the remaining 20%. See pages 10 and 11 of STRT’s 2006 annual report for details on the part-
nership’s structure. VAST JVs in China yielded ~$12 mm of business in 2006 (year-to-date)
with Volkswagen, GM and Ford. Management expects VAST China sales to exceed $30 mm by
2009.
Strattec Security Corp. (Continued from page 14)

10-yr avg. 5-yr avg. LTM 2009
ASDM is expected to contribute ~$12 mm in new businesses: Effective October
Revenue from new businesses:
2006, a new JV (ADAC Strattec de Mexico – ASDM) was formed between VAST China 4.3 (1)
ADAC and STRT. The JV will conduct injection molding and assembly opera- ASDM 6.3 (1)
tions, primarily for door handles. STRT is the majority owner, at 50.1%. The Competitors' lockset business 9.9
Total 20.4
JV has already been awarded contracts for parts of the Ford Fusion and % Considered 50.0%
Dodge midsize crossover, starting July and December 2007, respectively. Adjusted total new businesses 10.2
Expected annual sales for the 2008-2010 period are $5.4 mm; $12.5 mm; and Revenue from re-codeable locks:
Total Master Lock sales 250.0
$14.2 mm. Re-codeable % 10.0%
STRT % 20.0%
Take over of competitor’s lockset business can bring ~$10mm in additional sales Re-codeable locks 5.0
volume: In October 2006, STRT announced that it is actively engaged in dis- Revenue from current businesses 174.5
cussions to takeover $10 mm worth of competitors’ lockset business, start- Total revenue 194.8 194.3 174.5 189.7
EBIT margin 11.5% 11.6% 7.7% 9.0%
ing January 2007. The contracts involve supplying locksets for 11 branded EBIT 22.5 22.6 13.4 17.1
models (5 vehicle platforms), mostly passenger cars. Pricing for these con- Tax rate 36.2% 34.7% 29.3% 37.5%
tracts already includes readjustments for increased raw materials cost. Sev- NOPAT 14.3 14.7 9.5 10.7
Earnings Power at 10x 106.7
eral automotive suppliers are in financial distress and some have been forced (+) Net cash per share 109.4 (2)
into filing for bankruptcy protection. Since STRT is one of the few companies Intrinsic value 216.1
in the industry that still have a solid balance sheet and strong cash genera- Shares outstanding, fully diluted 3.7
tion, the Company is in a good position to quote takeover business from Intrinsic value per share 58.7
Implied upside 41%
both distressed and bankrupt suppliers. Implied average annual return 12%
Notes:
STRT recently became the exclusive supplier of re-codeable locks to Master Lock: (1) Adjusted for STRT's stake (24% and 50.1%, respectively)
(2) Current balance of $64.4 mm + $15 mm per year
Also in October 2006, STRT and Master Lock Company announced the
introduction of re-codeable lock technology developed by STRT in some of
Master Lock products. Re-codeable technology allows the consumer to have one single key for a vari-
ety of lockable items. This type of lock codes the first key inserted and turned in the lock. STRT has
patented this technology and is the exclusive manufacturer of re-codeable lock cylinders for Master
Lock applications. This product also gives STRT an opportunity to diversify beyond its core automo-
tive OEM market. (See http://graphics.jsonline.com/graphics/bym/img/nov06/onekey24g.jpg for more
details.) Master Lock is a subsidiary of Fortune Brands (NYSE:FO), has annual sales of $250 mm and is
the # 1 padlock worldwide.
STRT has production facilities in low cost countries and is one of the most innovative companies in the industry:
STRT has 2 plants in Mexico and, through VAST Alliance, the Company also controls 2 production
facilities in China and 1 in Brazil. Therefore, there is no risk of losing business or suffering price pres-
sure because of imports from China or India. STRT is also moving its Milwaukee service assembly op-
erations to Mexico, where labor costs are ~50% lower than in the US. This move is expected to gen-
erate cost savings starting in January, 2007. STRT and Witte have developed a keyless (non-cylinder)
door opening system. Non-cylinder locks are being used in many of the new vehicles. STRT also ex-
pects to generate future businesses from residual magnetics, a device that prevents undesirable motion
in ferrous objects (applications encompass various industries, from automotive to medical equipment).
Even the most pessimistic investors would probably agree that the Big 3 will not cut production forever: They
are starting to fix their cost structures, but need to address the product side. GM, Ford and Daimler-
Chrysler still have strong brands. A restructuring will occur, but there will always be a need for some
type of automotive lock system. Over the last 36 years, the U.S. light truck industry has only experi-
enced 8 years of declining sales, with no consecutive declining 4-year period ever. STRT is also striv-
ing to win businesses from the Japanese OEMS. A sales and engineering branch office in Tokyo, estab-
lished with VAST Alliance partners, will become operational in January, 2007.
2) Alternative raw materials, and contract renewals will facilitate cost reduction and price readjust-
ments, respectively
There are lower cost alternatives to current zinc and brass components: A significant part of STRT’s prod-
ucts could be manufactured in magnesium, aluminum, plastic, steel, etc. Since zinc and brass have more
than doubled in cost during the past year, both OEMs and suppliers are working together to find viable
alternatives.

Page 16
Strattec Security Corp. (Continued from page 15)

Customers are starting to accept potential raw material adjustments going forward: Many of the new contracts being awarded already include
pricing adjustments for changes in raw materials cost, but it will take most of FY 2007 to make an impact on STRT’s results.
3) STRT will use its cash balance to buy-back shares at attractive prices and opportunistically seek an acquisition
a. STRT has repurchased 3.3 mm shares (49% of issued shares) at an average cost of $37
b. The Company has never paid dividends and there is no clear indication of any change in this policy
c. Based on a conversation with the CFO, STRT will pursue a conservative acquisition policy: will only consider a business
that is smaller than STRT, at a cheap price; target has to make similar products, to maximize use of existing distribution
channels and benefit from STRT’s engineering experience; use low leverage (if any).
Valuation
Management’s expectations should always be taken with a grain of salt. Therefore,let’s assume that only 50% of management’s fore-
casted new businesses materialize. Moreover, let’s consider that Master Lock’s $250 mm revenue base stays unchanged until 2009.
The details of STRT’s supply contract with Master Lock arenot public. Based on Master Lock’s price list, the average price for a re-
codeable padlock is $30. According to my independent research, the average price for a lock cylinder is $10. Let’s suppose that STRT’s
receives 1/5 of every $1 the worth of recodeable products sold by Master Lock, although my research supports a higher percentage.
The re-codeable locks seem to have good market potential. However, let’s conservatively assume that, 3 years from now, only 10% of
Master Lock’s revenue will come from this type of product. STRT’s LTM revenue was $175 mm. Let’s assume no growth in this reve-
nue base for 3 years. The sum of these 3 revenue streams results in $190 mm of sales by 2009. Despite STRT’s efforts, it is unlikely
that margins will recover to historical levels. However, on-going initiatives (alternative raw materials, price readjustment, increased
production in low cost countries) should generate some improvement in margins. Let’s assume a 9% normalized EBIT margin and con-
sider maintenance capex equal to depreciation. On a revenue base of $190 mm, this yields an EBIT of $17 mm. Assuming a 37.5% tax
rate, which does not give full credit to STRT’s foreign sales tax benefit, NOPAT is $11 mm. STRT currently generates about $20 mm
per year of FCF and has $64 mm in net cash. Let’s consider that over the next 3 years, STRT will accumulate an additional $45 mm in
cash. Applying a reasonable multiple of 10x and adding the estimated cash balance results in a $58 stock, representing ~40% upside to
the current share price of $41.
Investment Catalysts
Reasonable results from new businesses; take over of competitors’ business; cost reduction and price readjustments; share repur-
chases; improved industry conditions.
Risks
Management does not have much “skin in the game” (~5% collective ownership); loss or financial distress of important clients
(Mitsubishi, ~2% of sales, will no longer be a client as of 2007); expanding presence of non-client OEMs; fluctuations in the price of

earnings power there. What could be between sweatshirt and t-shirt seasons. manufacturing budget by something like
more temporary than the weather? When they went to start-up for t-shirt $200 million. The banks pulled the
season it was all screwed up, and they plug.
Then they proceeded to muck up the were about 8 weeks delayed. But they
manufacturing during the period that had all these delivery commitments to We got out before it went bankrupt,
the factories were down. A company the Wal- Marts of the world for t- but not before we lost most of our
with a 100-year reputation as a brand shirts, so they decided to go out on the money. Then Warren Buffett bought it.
and as one of the best manufacturers spot market to try and acquire spot He got a much better deal than we did,
in the industry, decides to re-jigger cotton fabric. But they caused the mar- but I think he saw the same quality busi-
their logistics to try and lower their ket price to go through the roof be- ness in the mens and boys underwear
manufacturing costs. They started cause they were the biggest cotton business that we saw.
moving equipment around during the spinner in America. They had quality
down period while they were working problems and logistics problems, and
off this excess inventory, which was they wound up over-running their (Continued on page 17)
commodities (e.g. zinc, brass); bad uses of cash (e.g. acquisitions).

Question: What advice would a portfolio manager or running a
you offer an MBA student hedge fund, even if that might happen.
going into investment man- I think you should go into this business
agement? saying, “I like figuring things out. I
want to be an analyst.” Because if you
Pzena: I offer this advice decide your whole life you’re going to
whether you’re going into invest- be an analyst, no matter what job you
ment management or not. Find actually have that’s what this business
something that you really like is all about: figuring things out. Sitting
doing because, if you’re forcing around while other people figure
yourself to go into something that things out and you just decide, without Jean Marie Evilliard and Walter Schloss are among
the legendary investors who attend the Heilbrunn
you’re really not turned on by engaging yourself in that process, I Center’s Annual Graham and Dodd Breakfast (above)
then it’s not going to work, even think you fail. So you better like that
if you get paid a lot of money or part of it.
it’s prestigious.
Thank You. -G&Dsville
You’ve got to really be turned on

in investment management by The Value Investing Program at Co-
figuring this stuff out. And I think lumbia gives second year MBA stu-
you should not go into this busi- dents the opportunity to interact
with the world’s top investors such
ness thinking that you want to be
as Mario Gabelli (’67) (right)
10th Annual
Columbia Investment Management Conference
Confirmed Speakers include: Bill Miller, Lee
Cooperman, David Winters, Professor Bruce
Greenwald, and more…
Details and updates will be posted on our website
When: Friday, February 2, 2007
Where: Columbia University

Alfred Lerner Hall
New York, NY
For additional information contact: Ahmar Ahmad (AAhmad07@gsb.columbia.edu) or

Andrew Ewert (AEwert07@gsb.columbia.edu)
For the most recent agenda and updated information please visit our website at:
www0.gsb.columbia.edu/students/organizations/cima/ (click on 2007 Columbia Investment Management Conference)
Page 18
William Von Mueffling (’95)

Cantillon Capital Management
Cantillon Capital Management was founded in September of 2003. Prior to Cantillon,
Mr. Von Mueffling was with Lazard Asset Management where he was best known for
the European Opportunities Fund he began in 1998. Starting with roughly $600 million,
Cantillon has grown to over $9 billion in its 3 years in operation. William Von Mueffling
graduated from Columbia Business School in 1995 and is an adjunct professor teaching
a very popular Seminar in Applied Value Investing class.
Top Buys 52 week

Company Shares Value Last Hi Lo
ABERCROMBIE & FITCH CO 798,352 $56,914,515 $71.29 $79.42 $49.98
PT TELEKOMUNIKASI INDONESIA 1,169,492 $48,779,510 $41.71 $42.26 $20.46
SYMANTEC CORP COM STK 2,019,559 $41,643,308 $20.62 $22.19 $14.78
PETROLEO BRASILEIRO SA ADR 399,160 $35,433,432 $88.77 $107.45 $64.04
GOODRICH CORP COM STK 767,005 $34,400,173 $44.85 $47.45 $37.15
AFFILIATED COMPUTER SVC 563,500 $28,344,050 $50.30 $63.66 $46.50
ACCENTURE LTD HAMILTON 770,100 $26,560,749 $34.49 $35.17 $25.68
ZIMMER HOLDINGS INC COM STK 307,700 $22,680,567 $73.71 $75.36 $52.20
LONE STAR TECHNOLOGI ES 378,300 $18,771,246 $49.62 $63.96 $42.23
Top Sells 52 week

BECKMAN COULTER INC COM 1,258,910 $75,433,885 $59.92 $62.14 $49.73
TELKOM PT ADR RPRSNTNG 20 1,160,300 $48,396,112 $41.71 $42.26 $20.46
LG PHILIP LCD CO LTD ADR 2,715,500 $43,991,102 $16.20 $24.49 $14.67
FANNIE MAE COM STK 726,000 $42,057,180 $57.93 $62.37 $46.17
PHILIPPINE LONG DIST TEL C 688,360 $34,418,000 $50.00 $51.90 $31.54
CAREMARK RX COMMON STOCK 673,930 $31,337,745 $46.50 $59.89 $42.40
THE TIMBERLAND COMPANY 681,400 $21,668,519 $31.80 $37.61 $24.80
BALL CORP COM 307,700 $13,028,018 $42.34 $45.00 $34.16
Top Holdings 52 week Share

Company Shares Value Last Hi Lo Change
RENAISSANCERE HOLDIN GS LTD 2,944,485 $165,421,168 $56.18 $57.71 $40.56 939,720
JOHNSON & JOHNSON COM 2,069,386 $138,669,560 $67.01 $69.41 $56.65 349,418
TELEFONOS DE MEXICO SA 4,791,278 $126,106,435 $26.32 $27.52 $17.61 939,720
NIKE INC CL B COM ST 1,258,115 $121,206,794 $96.34 $96.49 $75.52 700,765
MOBILE TELESYSTEMS SP ADR 2,624,621 $115,220,866 $43.90 $45.18 $26.00 88,435
WELLPOINT HEALTH NET WORKS 1,493,433 $107,586,915 $72.04 $80.39 $65.49 112,833
INGERSOLL RAND CO-A 2,805,540 $107,508,292 $38.32 $49.00 $34.95 311,848
INTL BUSINESS MACHS COM 1,074,154 $100,164,861 $93.25 $94.05 $72.73 650,954
MERCK & CO INC COM STK 2,039,217 $90,887,901 $44.57 $46.37 $27.99 154,033
DAVITA INC COM STK 1,602,518 $84,869,352 $52.96 $60.70 $46.70 164,028
Data obtained from SEC Form 13F filed for period ending 6/30/06
Pricing Information as of 11/21/06 13F filings include only U.S. holdings
David Einhorn
Greenlight Capital, Inc.
Greenlight Capital is a “value oriented, research driven” asset management firm founded in 1996 by David
Einhorn. The company focuses on US corporate debt and equities, both long and short. Prior to found-
ing Greenlight Capital, Mr. Einhorn worked as an investment analyst at Siegler, Collery & Co. and as an
analyst in the Investment Banking Group of Donaldson, Lufkin & Jenrette. Mr. Einhorn received his Bache-
lor of Arts in Government from Cornell University.
Top Buys 52 week

FIRST DATA CORP 740,000 $18,433,400 $24.91 $48.88 $21.93
RESEARCH IN MOTION LTD 1,200,000 $0
Top Sells 52 week

APPLICA INC 655,200 $3,734,640 $5.70 $5.95 $1.24
STANDARD MICROSYSTEMS CORP 236,269 $7,730,722 $32.72 $34.97 $20.36
MEDICAL PPTYS TRUST INC 1,418,200 $19,911,528 $14.04 $15.25 $8.75
Top Holdings Change

Company Shares Value Last (shares)
FREESCALE SEMI CLB 11,130,350 $443,210,534 $39.82 -3,383,191
FREESCALE SEM CL A 9,830,409 $391,545,208 $39.83 3,301,791
AMERIPRISE FINL INC 6,400,000 $346,687,988 $54.17 -750,000
MICROSOFT CORP 8,900,000 $266,020,995 $29.89 0
M D C HLDGS INC 4,221,550 $228,343,640 $54.09 -208,450
MI DEVS INC 4,730,000 $200,788,500 $42.45 0
HOSPIRA INC 5,971,200 $192,451,773 $32.23 879,400
WASHINGTON GROUP INTL INC 2,762,000 $161,245,563 $58.38 0
NEW CENTURY FINANCIAL 3,494,700 $127,906,015 $36.60 0
CF INDS HLDGS INC 5,137,400 $116,207,992 $22.62 0
D R HORTON INC 3,000,000 $73,980,000 $24.66 1,000,000
AMERICAN HOME MTG INVT CORP 1,920,000 $67,680,000 $35.25 0
FLAMEL TECHNOLOGIES SA 1,547,045 $44,570,366 $28.81 0
GENWORTH FINL INC 2,576,900 $25,872,076 $10.04 -200,000
MERCER INTL INC 1,894,830 $20,521,009 $10.83 0
FIELDSTONE INVT CORP 2,402,250 $13,260,420 $5.52 0
INTERNATIONAL COAL GRP INC N 2,668,361 $12,674,715 $4.75 0
Pricing Information as of 11/21/06
13F filings include only U.S. holdings
Page 20
Stephen Mandel, Jr.

Lone Pine Capital, LLC
Lone Pine Capital is a long/short equity money manager founded by Stephen Mandel
1997. Prior to founding LPC, Mr. Mandel was senior managing director and consumer
analyst at Tiger Management Corporation (1990-1997), mass-market retailing analyst at
Goldman, Sachs (1984-1990) and senior consultant at Mars and Company (1982-1984).
Mr. Mandel graduated from Philips Exeter Academy (1974), Dartmouth College (1978)
and Harvard Business School (1982). He is also a founder and board member of the
Lone Pine Foundation, whose mission is to help children and families in the greater
New York City area.
Top Buys 52 week
BAIDU COM INC ADR 1,224,839 $134,989,505 $110.21 $111.85 $44.44
BED BATH & BEYOND INC 3,586,238 $142,875,722 $39.84 $44.10 $30.92
GRUPO TELEVISA SA DE CV ADR 2,227,600 $54,999,445 $24.69 $25.43 $16.13
ITT EDUCATIONAL SERVICES INC 94,100 $6,592,646 $70.06 $70.98 $55.70
LAS VEGAS SANDS CORP 619,700 $55,711,031 $89.90 $92.90 $38.07
MARRIOTT INTL INC NEW 3,153,688 $144,060,469 $45.68 $45.74 $31.62
SCHLUMBERGER LTD 5,773,099 $365,148,512 $63.25 $74.75 $46.77
SOUTHWESTERN ENERGY CO 8,218,512 $314,522,458 $38.27 $44.28 $23.66
STARBUCKS CORP 2,257,702 $82,970,549 $36.75 $40.01 $28.72
VULCAN MATLS CO 978,600 $86,860,538 $88.76 $93.85 $65.76
Top Sells 52 week

Company Value Last Hi Lo
CIA VALE DO RIO DOCE-ADR 11,158,000 $290,554,330 $26.04 $29.10 $19.16
COGNIZANT TECH SOLUTIONS CR 619,846 $49,637,269 $80.08 $80.76 $47.73
COPART INC 1,250,520 $37,252,992 $29.79 $30.39 $21.14
FIRST DATA CORP 2,465,900 $61,425,569 $24.91 $48.88 $21.93
FORD 719,300 $6,236,331 $8.67 $9.48 $6.06
HONGKONG LAND HOLDINGS LTD 1,309,000 $5,157,460 $3.94 $3.98 $3.92
RESEARCH IN MOTION 2,342,351 $321,862,459 $137.41 $138.90 $59.16
VERTEX PHARMA 495,800 $22,370,495 $45.12 $45.34 $24.55
Top Holdings Change

Company Value Last (shares)
BROOKFIELD ASSET MGMT INC 11629148 $630,648,696 $54.23 796,153
GOOGLE INC 1,118,149 $553,539,649 $495.05 -340,101
COMCAST CORP NEW 11764631 $479,879,309 $40.79 4,714,176
QUALCOMM INC 11501753 $427,290,142 $37.15 1,701,766
AMERICA MOVIL S A DE C V 9310989 $419,739,401 $45.08 -4,379,800
SCHLUMBERGER LTD 5,773,099 $365,148,512 $63.25 5,773,099
SLM CORP 6348375 $299,643,305 $47.20 -935,800
APPLE COMPUTER INC 3723286 $321,952,545 $86.47 1,801,979
ADVANCE AUTO PARTS INC 7874612 $298,841,531 $37.95 -2,166,669
Pricing Information as of 11/21/06 13F filings include only U.S. holdings
What’s Happening at CBS

Upcoming Events
1/23/2007 Stock Pitch 301
2/2/070.-2.0. 10th Annual CIMA Conference – watch for a list of speakers on the CIMA website
Additional Upcoming Events (see website for updated dates and times)
January Distressed Investing Panel
Hedge Fund Panel
Party to welcome incoming J-Term students
February Mutual Fund Panel

Private Wealth Management Panel
March VP Elections
Semester In Review
9/12/06: CIMA Kick Off for 2006 – 2007
First year students were introduced to the many opportunities of being a CIMA member
9/14/06: Panel Discussion: “An Overview of Various Hedge Fund Strategies.”

Jonathon Fox (’03) of Lehman Brothers, David Lichtman (’01) of SAC Capital and David Schwartz (’05) of Ar-
gonaut Capital Management, and Jason Jones who is starting his own firm shared their thoughts on current hedge fund
strategies and answered questions from CIMA members.
10/10/06: Stock Pitch 101

Second year students Ahmar Ahmad (’07) and Matthew Robinson (’07) helped eager first years to get an early
start on preparing their stock pitches.
10/12/06: Mutual Fund Panel

Sott Winters (’05) an analyst with Oppenheimer Capital, Kathryn Mak (’05) an analyst with UBS Global Asset Man-
agement and Milu Komer a vice president with Lehman Brothers Investment Management shared their thoughts and
answered questions about the industry as well as how to be successful in the recruiting process.
10/27/06 16th Annual Graham and Dodd Breakfast

Featuring Thomas A. Russo, Partner, Gardner, Russo & Gardner
10/27/06 Golf Outing

CIMA teamed up with the CBS Golf Club to enjoy a round at Great George Country Club
11/2/06 Fidelity Investments Stock Game

Sammy Simnegar (’98), Ben Hesse (’05) and Vincent Montemaggiore (’05) flew in from Boston to guide and
challenge CIMA members in preparing a stock pitch.
11/3/06 Mutual Fund Trek

Twelve members of CIMA traveled to Boston together. Organized by Matt Loesch (’08), the group spent the morn-
ing with investment professionals from Wellington Management (including Jeffrey Kripke (’95)), and met with invest-
ment professionals from Fidelity Investments (including Peter Saperstone (’95), and Sammy Simnegar (’98)) in
the afternoon.
11/7/06 Stock Pitch 201

Gregory Monahan (’05), Vice President of Crescendo Partners gave first year students more advice on preparing
stock pitches.
11/9/06 Distressed Investing Panel

Marc Sole, Head of Distressed Research at D. E. Shaw, Robert Stark, Partner in the bankruptcy practice at Brown
Rudnick Berlack Israels LLP, Dan Krueger (’02), Adjunct Professor Seminar Distressed Value Investing and Head of
Distressed debt at Owl Creek Asset Management, Steven R. Strom, Managing Director of Recapitalization and Re-
structuring Group, Jefferies & Company shared their views on the distressed markets.
Please visit http://www0.gsb.columbia.edu/students/organizations/cima/ for details and updates

Get Involved:
To hire a Columbia MBA for an internship or full-time position, contact Bruce Lloyd,
assistant director, outreach services, in the Office of MBA Career Services at (212) 854-
8687 or valueinvesting@columbia.edu . Available positions also may be posted directly on
the Columbia Web site at www.gsb.columbia.edu/jobpost.
The Heilbrunn Center for Graham & Alumni

Dodd Investing Alumni should sign up via the Alumni Web site. Click here to log in,
Columbia Business School (www6.gsb.columbia.edu/alumni/emailList/showCategories.do), then go to the Cen-
Uris Hall, Suite 325c
3022 Broadway ters and Institutes category on the E-mail Lists page.
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Please also share with us any suggestions for future issues of Graham and Doddsville:

Columbia Business School
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Volume I, Issue 2 Summer 2007

Inside this issue:
Sitting Down with

Warren Buffett
p. 3
Global Treasure Hunter: David Winters
For the second issue of Gra- Q: You’ve described yourself
2007 CIMA p. 4 ham and Doddsville we are as being on a global treasure
Conference hunt. What’s the checklist
pleased to share an interview
with David Winters, Foun- of characteristics that a
Footstar p. 12 der and Chief Investment situation has to have before
Officer of The Wintergreen you invest?
Fund. Prior to founding
Ainsworth Lumber p. 14 Wintergreen Advisors in DW: I don’t know if there’s
Co. 2005, Mr. Winters was Chief an exact checklist. There’s
Investment Officer of Frank- no magic formula because
Tracking the Super- p. 18
lin Mutual Advisors and Port- every situation is a little dif- David Winters, Founder and
Investors
folio manager of the Franklin ferent. But if you’re talking Chief investment Officer of
Mutual Discovery Fund. Mr. about what my ideal invest- The Wintergreen Fund
Editors: Winters joined Mutual Series ment is, first of all I want a
in 1987, one year before the good underlying business. A the same direction as the
Joseph Esposito death of legendary investor business that is, hopefully, rest of the shareholders.
MBA 2007 getting better over time, so I think you want to have
Max Heine. He would spend
the next decade working time is your friend. Then I both those factors plus an
Abigail Corcoran
side-by-side with another really need to have manage- undervalued security price.
MBA 2008
investing legend Michael ment who are committed to When you have those 3
David Kessler Price. doing the right thing, who I things, then you have a
MBA 2008 sometimes describe as being trifecta. And you want a
in the boat pulling the oars in trifecta.
Contact us at: Welcome Back to Graham and Doddsville

We are pleased to present for an extended, insightful aim to provide specific in-
Visit us at: you with the second edition conversation describing his vestment ideas that are rele-
of Graham and Doddsville, approach to investment man- vant today. Inside are two
www0.gsb.columbia.edu/students/ Columbia Business School’s agement. He and his col- student investment recom-
organizations/cima/ student-led investment leagues at Wintergreen Ad- mendations, including the
newsletter co-sponsored by visers have truly embarked first short to appear in the
the Heilbrunn Center for upon, as Mr. Winters calls it, pages of Graham and
Graham & Dodd Investing a “global treasure hunt.” Doddsville.
and the Columbia Invest- We hope and trust you will
ment Management Associa- learn as much from reading it In April students of Profes-
tion. as we have. sor Greenwald’s Value In-
vesting class made their an-
This edition’s feature inter- Along with providing our nual pilgrimage to the offices
view is with David Winters, readers with insightful and of Berkshire Hathaway in
who graciously sat with us timeless contents, we also (Continued on page 2)
Page 2

(Continued from page 1)
Omaha Nebraska. Close to
100 students spent the bet-
ter part of a day with War-
ren Buffett ‘51. In addition,
three students were selected
to sit down with Mr. Buffet
to learn his thoughts on lead-
ership and ethics. We are
lucky to have one of those
students share his experience
sitting down with the Oracle
of Omaha.

if you have comments or Students at Columbia Business School have the un-
ideas about the newsletter, paralleled advantage of learning from value investing
as we continue to refine this luminaries including Joel Greenblatt of Gotham Capi-
publication for future edi- tal and Bruce Greenwald
tions. Enjoy!
David Winters (continued from page 1)

“We’ve found over Q: Are there additional items the great currencies of the where the barnacles on the
that you look at when you’re world. shells hide the underlying
the years that in investing in non-US companies?
How do you assess things like beauty underneath. Where
the best investment how solid the currency is, or There are other currencies does the search start for you?
how reliable the legal systems where it’s very hard to know.
situations, the more or the accounting standards In those situations we might be DW: The new 52 week low list
are? inclined to hedge out the risk if
you dig at them the is a great place to look. And
DW: They’re all good ques- it made sense. But we like the sometimes it isn’t just individual
more good stuff you tions, and there are no exact really hard currencies. names, but a sector may be out
answers. Some countries have of favor. Other times it’s com-
find.” With the legal system you’ve
wonderful underlying curren- plexity that really distorts
cies. For example, Norway, got to figure out if the rule of something that’s wonderful,
where you have all this oil and law is important to the way the because most people don’t like
gas. You have 4.5 million peo- society is run. In a country like complexity. This business is
ple, and you have approxi- Switzerland or the UK, there is about people basically being
mately 300 billion dollars rule of law. That doesn’t mean spoon-fed, and if you have a
(derived from oil taxes) sitting
there aren’t going to be legal conglomerate that requires a
in a government fund for the
surprises, but there are clearly lot of work and more than one
betterment of society. So
long-standing legal systems to sector, that really turns people
you’ve got millions of dollars in
cash and securities behind protect owner’s rights. off.
every Norwegian citizen. You
can see why I think the Norwe- Q: You’ve talked about con-
gian Krona is probably one of structing a portfolio of pearls, (Continued on page 4)
Volume I, Issue 2 Page 3
One on One with a Legend - A Personal Meeting

with Warren Buffett
Burak Alici, MBA 2007 argue whether Berkshire is the tremendous resources and
simply a statistical outlier. Co- opportunities we’ve enjoyed,
Marc Schaeffer, Mike Assenza lumbia’s value investing infused it’s our responsibility to help “(Buffett) also
and I were quite tense as we students religiously (try to) others that have not had this
walked into 1440 Kiewit Plaza follow Warren’s and his part- chance. We often witness that stated that we
for a school interview with ner Charlie Munger’s philoso- success in the world of invest-
Warren Buffett on Leadership phy. Warren mentioned that ing often comes with an ego
and Ethics. Although we had what he learned from Dave attached to it and many Wall at Columbia
seen him at the class visit the Dodd and Ben Graham Street champions would proba-
day before, the realization hit changed his life – and he still bly have a problem acknowl- are very lucky
us that we were about to sit truly appreciates the chance he edging that their wealth was
and have a heavy conversation had to be their student and due to other factors rather to have access
with the wisest man alive. friend. He also stated that we than their own “rock star” type
at Columbia are very lucky to abilities. While this is easier
Stepping out of the elevator, have access to such resources said than done, I hope the suc- to such
we were surprised at how plain and a great investing program. cessful ones among us will have
the hallway was. We actually the conscience to give resources and
had difficulty finding the main when the time comes.
door, and by mistake walked a great
in through the back door - After our conversation,
the office almost felt vacated. we were lucky enough
Contrary to many Wall Street to enjoy an office tour investing
firms, Berkshire does not rely by Warren himself.
on a large army of profession- Interestingly, the best program.”
als to operate – the ‘rational’ part of the office was
investment approach saves the hallway. The walls
the hassle. We recalled War- are full of highly inter-
ren telling that they probably esting memorabilia in-
never built a spreadsheet in cluding the first share
the history of Berkshire. The Burak Alici, Mike Assenza, Warren registry of his early part-
miraculous four-decades-long Buffett, Marc Schaffer nership, the letter sent to
investment record is obvious take over LTCM, an origi-
evidence that a few ‘clear’ To the statement that “we bet nal American Express stock
thinking individuals can be su- our careers that markets are certificate signed by founders
perior to hundreds that follow not efficient”, his response was: Wells and Fargo, a trading
an ‘unclear’ thought process. “Let the other guys bet their ticket at Tweedy Browne & Co
career on the other side. of Berkshire shares (including
Margaret, Warren’s personal There’s nothing like being on a Warren’s first purchase at $7
assistant, greeted us, and bridge table when the other 3/8), an exact half-scale model
thankfully chatted with us to guy believes he shouldn’t be of the robot sent to Mars, and
alleviate the stress (she also Warren Buffett (’51) posed
looking at his cards.” many more.
showed the courtesy to drive with students outside of
us to the airport later on). As Our conversation was focused Warren is referred to by many Gorat’s Steak House
we sat in the office and enjoyed on leadership and ethics. As as the ‘Oracle of Omaha’. On
our ice cold Cokes, Warren every one of his sentences is the contrary, he has made his
soon showed up with some worth a life lesson, I think success not by predicting fu-
newspapers and a McDonalds quoting them untouched is the ture events, but by benefiting
bag in his hand. The hamburger best way to pass on the wis- from his rational thought proc-
along with a glass of Cherry dom in its purest form. The ess. Hence, the referral ‘the
Coke is part of the daily diet. quotes under different topics Sage of Omaha’ is probably
When his doctor asked him to are listed below. more appropriate. As laid out
make a choice between cutting in the quotes below, it’s truly
down on the burgers or having In essence, Warren asked us to amazing how Warren uses his
to exercise every day, Warren acknowledge how lucky we are framework – not only in invest-
chose to exercise. in this world and to give ing – but also in every other
thought on how to give back complex issue in life. Not every
Let market efficiency cohorts our winnings to society. Given (Continued on page 16)
Page 4
The 2007 CIMA Conference

On Friday, February 2, 2007 Ahmad (’07) and Andrew foundation for an investment
over 500 students, alumni, Ewert (’07) assembled a group philosophy and marked the
investment professionals and of panelists that might be called beginning of a rich tradition
members of the press gathered the “Dream Team” of value that sets Columbia Business
for what has become an annual investors. School apart from its academic
pilgrimage to Columbia’s Morn- brethren. As Dean Glenn Hub-
ingside Campus for the 10th If you ask 10 investors to de- bard noted in his opening re-
Annual Columbia Investment fine the term “value investing” marks, Columbia is one of the
Management Conference. The you will probably receive 10 few Business Schools that
CIMA conference, which is co- different answers. Each an- bridges theory and practice by
sponsored by the Heilbrunn swer, however, will share one teaching the investment princi-
Center for Graham and Dodd common element. They will all ples and methodologies that
Investing, has grown over the be based on the principles have proven to work in the
past 10 years from an after- originally developed by Colum- real world.
noon event held on the third bia Business School professors
floor of Uris Hall into being Benjamin Graham and David Columbia alumnus and Board
one of the most anticipated Dodd in what many consider to of Overseers member, Lee
annual events for followers of be the most influential book on Cooperman (CBS ’67), Chair-
the value investment philoso- investing: “Security Analysis”. man and CEO of Omega Advi-
phy. Rising to the challenge, Originally published in 1934,
conference co-chairs Ahmar “Security Analysis” formed the (Continued on page 16)

(Continued from page 2) loss of your capital. In almost If you’re in a business like that,
We’ve found over the years any business other than an you’ve got a problem.
that in the best investment asset play, risk and reward are
situations, the more you dig at evaluated on the basis of how The other thing to consider is
them the more good stuff you much cash you can generate whether there has there been a
find. And in the bad invest- over time. You must be aware fundamental change in the un-
ments, the more you dig the of Ben Graham’s margin of derlying economics. For exam-
more you find additional skele- safety and look at what the ple, for many years the newspa-
tons in the closet (e.g., toxic company is really worth. What per business was a virtual li-
liabilities that aren’t on the is the relationship between the cense to print money. If you
balance sheet). company’s worth and its cur- owned the newspaper you
rent market price? Does the were one of the richest people
Often you can figure out pretty company have the ability to in town. Now that is no longer
quickly if an investment is one raise prices? There are many the case because you’ve got
where the assets are under- businesses that are so brutally classified and display advertising
stated, or is it one where the competitive that they don’t going to the internet. Newspa-
liabilities are understated. You have any ability to raise their pers have lost pricing power
want lots of assets for free, or prices. Then you have to look and they’re losing revenue. So
the potential for free. at what their competitive posi- I think you really have to pay
tion is in the world. Do they attention to whether there is a
Q: How do you evaluate down- have an edge? And are they game change, and that’s not
side risk in a security? making a product that can be always apparent in the valua-
easily duplicated somewhere tion or in the annual report.
DW: The ultimate downside else, in a fairly undifferentiated
risk in a security is permanent manner, at a much lower price. (Continued on page 5)

(Continued from page 4) think of DCF as garbage-in, tomorrow for free. Somebody
Q: You’re a long-term investor, garbage-out. Conceptually it’s showed me a DCF model last
but when do you sell? right, but the ability of anybody week and I looked at it and I
to make accurate estimates is was pretty skeptical. They had
DW: There are a couple of low. During the many years I a terminal growth rate of 2%,
reasons why you should sell. worked for him, one of the and I asked, “What happens if it
One is if you made a mistake. I becomes 5%?” The value went
think one of things we all have “Even when an up by 100%.
to do is to be intellectually
investment is great, James Tisch at the 2005
honest. Were you wrong in So I share Michael’s skepticism CIMA Conference
your analysis? Did something if it trades at full about DCF. I think it’s an
Columbia Business
change? Or did you learn a over-rated tool. Think about
new piece of incremental infor-
and fair value, at the bubble years, when people
School is a leading re-
source for investment
mation that changes your view? best it’s dead were extrapolating things far management profession-
Instead of being an ostrich into the future that ended up als and the only Ivy
about investing, sticking your money. And in all being preposterous, while at League business school
head in the sand and hoping the same time you could buy in New York City. The
likelihood there is a
things improve, often the best real companies like Brown- School, where value
thing to do is to realize you’ve better use for the Forman, that distills Jack investing originated, is
made a mistake and to sell. Daniels. At the height of the consistently ranked
money elsewhere. bubble Brown-Forman dropped among the top programs
for finance in the world.
The other big reason to sell is So you have to to a valuation that was proba-
if the valuation gets out of bly half of what an arm’s-length
whack. When you own some- have the discipline transaction would take place at.
thing wonderful, if it ap- People were buying DCFs be-
to say, “The
proaches or becomes fully cause they wanted get-rich-
valued, it often makes sense to company has done quick schemes. Brown-Forman
sell. Even when an investment had no debt, net cash on the
is great, if it trades at full and
its heavy lifting for balance sheet and a LIFO re-
fair value, at best it’s dead me. I’ll pay the tax serve. And getting back to Jack
money. And in all likelihood Daniels…it holds a place of
there is a better use for the and move on.” honor in my heart near the
money elsewhere. So you have American flag.
to have the discipline to say, lessons I learned from Michael
“The company has done its was not to be so dependent on Q: What was it like to be a
heavy lifting for me. I’ll pay the earnings. Wall Street is so value manager in the late 90’s?
tax and move on.” obsessed with, “Did they beat
by a penny? Did they miss by a DW: There was a lot of stuff
Q: Michael Price visited our penny?” If you’re investing in going on. Not only being a
class, and he did not have very securities that are so contin- value manager, but I was pro-
good things to say about utiliz- gent on that, the possibility moted to running Mutual
ing DCFs. Do you employ increases that you’re going to Shares, and basically I came in
them at all? get beat. almost at the bottom of the
whole thing.
DW: I probably inherited Mi- Our approach is to try to buy
chael’s skepticism for DCF. I today at a discount and get (Continued on page 6)
Page 6

(Continued from page 5) Everything on TV was negative. DW: I like to dissect where a
It was very hard because suc- There was one day where we company got its earnings: Was
cess demanded being both were buyers of almost every it gains? Was it from opera-
really disciplined and confident security we had in the portfo- tions? I think organic growth is
in your work as well as your lio. And here we are 2 months a really important measure.
ability. At the same time you later, markets have rallied, And was organic growth
had to realize that the world everything on TV is positive, achieved through sales and/or
had sort of taken leave of its and nothing’s really changed. I margin?
Dean Glenn Hubbard and
senses. There were relatively think that’s really one of the big
Mario Gabelli (‘67)
few of us who maintained the lessons of value investing, that A lot of this business is based
core belief in value investing at you’ve got to do the work, and on judgment, and one of the
the bottom. There was a lady realize as Ben Graham wrote things we’ve barely touched on
who wrote me a hand written that Mr. Market is often irra- is the importance of manage-
letter complaining that I was a tional, and you’ve got to take ment. That’s one lesson I’ve
dinosaur, and she said that I advantage of market fluctuation learned: the importance of the
There was a lady
didn’t get hot investment re- rather than be a victim of it. people you hand your wallet
who wrote me a sults because I didn’t own to. Obviously you want a good
Cisco Systems. She wasn’t But it’s hard. You really have company you can invest in, or
hand written letter alone in that opinion. There to have the right temperament that has good assets, but you
complaining that I was tremendous pressure from and discipline to do this, and I also really must have people
multiple directions to capitu- don’t think most people do. who are going to make that
was a dinosaur, late, and I refused to capitulate. It’s very hard. company work for you.
The thing that I found so amaz-
and she said that I
ing was that there were won- Q: Do you think some people It’s just like if you have a great
didn’t get hot in- derful companies you could buy are just born with the right professor, and you enjoy the
that I had drooled over for temperament? Has your tem- class, then you’ll get an A.
vestment results years, but could never own perament evolved over time?
because I didn’t because they were always trad- If you have a professor you
ing at big multiples. So we DW: I started the David Win- don’t like, who comes to class
own Cisco Systems. were able to buy some very ters investment account when I and turns his back to the stu-
compelling things. It wasn’t an was 5, so I definitely had some dents, then you’re not going to
easy period, but I learned a lot, of the DNA, but I’ve certainly do as well.
and it ended up being wildly learned a lot over the years.
profitable for our fund inves- I’ve been doing this a long time Q: How do you figure out
tors. now, and I try to learn every- what makes a management
day, watching the way people team tick?
And there’s a lesson in all of participate in markets. Part of
this. In February of this year, the reason we set up Winter- DW: The world has gotten in
people were so concerned green was so we could try to some respects easier and in
when we had this sell-off in capitalize on all this stuff that other respects harder to deci-
China one night. “Oh no, goes on in the world, and not pher. You can find out a lot
China’s coming to an end. The be part of the daily fray. about people today. Not all
sky is falling and the world is prior management behavior is a
coming to an end.” Stock mar- Q: Do you have any favorite predictor of the future, but you
kets all round the world went measures of earnings quality? have to figure out if manage-
down for a couple of weeks. (Continued on page 7)

(Continued from page 6) principles they learned from
ment is motivated to just make Q: Is it harder to try and wrap Columbia, and apply them at
a bunch of money and go to your arms around the share- home. A lot of those folks are
the beach, or if they love the holder orientation of non-US going to kick some serious
business they are in and want managements? butt. So part of what we’re “The thing that’s
to achieve long term success? finding is that the next genera-
How do they think? Are they tion of managers were edu- wild today is if
interested in taking short cuts, DW: You know I’ve been cated in the US or the UK, and
you think about
or are they more interested in fortunate since I was a little kid then they take a lot of the best
taking the longer road and to travel all over the world. I of the Anglo-Saxon principles how many of your
doing things properly? keep having to add pages to my and they modify them to fit
passport. their own cultures.
colleagues at
Then you’ve also got to try to Columbia are
figure out if the management is People and cultures are differ- I think this is an exciting time in
risk-averse. We’re very risk- ent, and their behavior is differ- the world, despite all the things from overseas.
averse here, and we want to do ent. One of the things that as we get could obsess about that
Some large
really well, but we don’t want an American you have to be we know aren’t good. But
to take a lot of risks to get very careful about is that every- there are more wonderful percentage of
there. body doesn’t play by our rules things to look at. There is
or our expectations, nor do tremendous wealth creation,
them are going go
You also have to try and figure they necessarily respond well and you have all this free move- back to wherever
out how people are wired. to some of our behavior pat- ment of ideas, and free move-
When you see that certain terns. So sometimes it is very ment of people. You have all they came from,
people must have all the accou- challenging to figure out what’s these young people who are
take all the
trements of success, and if that really going on, but again some- doing all kinds of amazing think-
becomes an obsession on their times you just observe what ing and work all over the principles they
part as opposed to living in the they do, not what they say. If planet, so while it is not easy,
same house forever. That is you see a management team our view is there are good
learned from
one of the telling signs. behaving in a rational manner, people in every culture and in Columbia, and
that’s a really good clue. If you every country, and the idea is
There’s a lot you can learn. It’s see them doing really bizarre to just go find those folks. And apply them at
not an exact science, but every things, or things where you you just ask around, “Are they
home. A lot of
now and then you have what I scratch your head and say, good, or are they not good?
call the “ah-ha moment.” “why would they do this,” then Are they smart? Are they hard those folks are
Other times you look at it, and it doesn’t matter what they say. working? Are they honest?
you have an “oh-no moment.” Are they nice, or are they not going to kick some
You go, “Oh-no, I don’t think Then occasionally you’ll find a nice?” serious butt. ”
so. This is not going to be a company that is very straight-
situation where we’re going to forward and open about what Q: How do you recognize, and
be comfortable.” Sometimes they’re trying to do, and they avoid, value traps?
there are managements that execute. The thing that’s wild
stay up late at night and try to today is if you think about how I’ve been involved in some
figure out how they’re going to many of your colleagues at value traps over the years, and
benefit themselves at the ex- Columbia are from overseas. I’ve learned a lot about their
pense of shareholders. Those Some large percentage of them characteristics. There was one
are the folks you don’t want to are going go back to wherever that we owned years and years
be involved with. they came from, take all the (Continued on page 8)
Page 8
(Continued from page 7) that we really try to focus on

ago where the stock price the things where we actually One of my heroes was a guy
never went up, and eventually add value by doing research. named Phil Carret, who passed
got taken out. You have to try away a couple of years ago.
to figure out if the business is There are a tremendous num- And Phil was over 100 years
any good, and whether the ber of things that are unknow- old when he died, and was just
people are any good, but you able. Think about how much incredible. He was so sharp,
know if you find something time people spend obsessing and over a full life I think he
that’s a value trap, time is your about what the next move by probably became an even bet-
enemy. You really want time the Fed will be. I don’t know ter investor.
to be your friend. You want to what it will be, and it really
go to sleep at night knowing shouldn’t matter if you’re mak- Q: We heard you in one of
that you’re incrementally get- ing good long-term invest- your interviews talk about how
ting a little wealthier, even if ments. Unless you’re doing you’re really focused on build-
the stock price or the bond DCFs where everything is so ing wealth over the next 40
price does not reflect it. You finely priced, a 25 basis point years.
have to recognize the impact of movement in interest rates
time on your investment. shouldn’t change your world Yeah, it’s true! This is fun.
view. We’re just trying to
Take HSBC. Though we don’t focus on what matters, and to In our view the investment
own it anymore, we loved the not pay attention to a lot of the business has gotten bifurcated
idea that somewhere around nonsense. All we have is time, into an index-hugging model
the world, somebody was going and once you spend the time it that most of the large com-
to an ATM, borrowing money, is gone, so we just really try to plexes are doing. Being over-
or making an investment. It’s focus our energy on what we weight or underweight some
kind of a neat thing to own a think can make a difference. index by ten basis points is not
piece of a business where 24 investing. At the other ex-
hours a day they’re working It’s experience, too, and judg- treme are highly leveraged
hard for you. We love those ment. Judgment is such an compensation models. They
situations. important element in this capture a large amount of the
whole business. performance fee carry as fast as
Q: On a day-to-day basis, how possible.
do you filter out the noise? The beauty of the investment
business actually is that it’s The investment community
Part of it is that we’ve really cumulative, and oftentimes the offers many more choices and
tried to create a very rational, best people in the investment ways for people to participate
fun, long-term environment. business are not the 22 year- in the market than it did
We’ve eliminated a lot of the olds who are often the champi- twenty years ago when I was in
distractions. We kind of oper- ons in professional sports, but school. One of the most com-
ate as a think tank here. It’s a the 72 year olds. As long as mon is the so-called hedge
fun place where there is room they keep learning and they fund. These investment vehi-
for both independence and love the business, it’s all about cles offer every imaginable
collaboration of thought, and thinking and implementing and form of diversity, risk and lock
we do a tremendous amount of change. That’s why I think it’s ups. With literally thousands
reading. There is so much the greatest business in the
nonsense outside of the office world. You can do it forever.
(Continued from page 8) risk (by risk I mean permanent amounts of free cash flow is a
of people operating these loss of capital, not quotation wonderful thing.
funds, it stands to reason that risk), and to be in a position so
there would be a wide range of that when people do panic, I have a friend of mine named
portfolio managers. I encour- which they seem to do once Andrew, he’s been a friend of
age you to carefully research every three months or so, that mine since I’ve been a kid. And
the reputation and history of we’re there to pick up the I started managing Andrew’s
those you trust with your pieces. money years ago, and it was a
money or your career. relatively small pile. It’s a much Joel Greenblatt
Cash is great, we love cash. bigger pile now, thankfully, and
Members of the Applied
All around the world, when we And today you get paid 5% to Andrew’s attitude is that he
Value Investing Program
study who’s done really well in hold onto cash while you wait looks at his statement twice a
at Columbia University
business, it’s taken long periods for the investment you want to year, and generally if there’s
have had the unique op-
of time. It most frequently has be available at the price you more than there was the last
portunity of taking a se-
been done by ownership of like. Cash is a beautiful thing, time he looked at the state-
mester long seminar
pieces or all of a business that not only us having cash, but we ment, he’s happy. Part of the
taught by Joel Green-
have been held for very long love companies that have cash. reason we did a mutual fund,
blatt. In addition to
periods. It has not been done Because as long as they have even though our whole genera-
teaching at Columbia,
by hyperactive trading or deals. the right management they can tion went in the opposite di-
be opportunistic on buying rection, is that the mutual fund Joel Greenblatt is the
And so that’s what we’re really back stock, doing deals, paying business is being dominated by Founder and Managing
trying to do, to create long- dividends, etc. Increasing this index-hugging model, Partner of Gotham Capi-
term wealth without a lot of tal and a best selling au-
thor of The Little book
That Beats The Market
Tracking the Superinvestors and You Can Be a Stock

Market Genius.
As the academic center for the philosophy and principles of value investing, Columbia Business School
has built a strong network within the investment community. Beginning with Benjamin Graham and Mr. Greenblatt is not
David Dodd, continuing with Roger Murray, and now with Bruce Greenwald continuing this tradition, only known for his in-
Columbia Business School attracts inspiring investors who seek to learn the disciplined philosophy of vestment success but also
Value Investing. for his philanthropic ac-
tivities. This past April,
Columbia students are known for searching the universe of stocks to Mr. Greenblatt and his
discover undervalued stocks. As taught by Professor Greenwald, the first
partner Robert Goldstein
step in discovering undervalued securities is to develop an appropriate
announced the establish-
search strategy. One resource that students have found to be fertile soil
ment of an annual $1
for ideas are the SEC Form 13Fs that are published quarterly by money
million Gotham Prize for
managers with $100 million or more under management.
Cancer Research to en-
Stephen Mandel, Founder and courage new and innova-
Each issue of “Graham and Doddsville” will highlight recent investment President of Lone Pine Capital
tive approaches to cancer
decisions of successful alumni, professors, and other prominent addresses CBS Students.
research and to foster
investors who are admired by Columbia Students and adhere to a
collaboration among top
value-oriented philosophy. (See page 18 for the investors highlighted in this issue.) -G&Dsville
thinkers in the field..
Page 10
Im perial Tobacco 1 Year Q: What is the market missing issued stock when they needed
on Japan Tobacco? to. They’re just great capital
$110 allocators, and they never let
$100 DW: JT is a very complicated all of this go to their heads.
$90
company. It’s a Japanese com- They’re really pretty humble
$80
$70 pany and they’re doing a great people, yet they have one of
$60 job. They’ve just closed on the best records of any corpo-
$50 buying Gallaher in the UK, and rate management I’ve ever
we think it’s a very, very smart seen. We’re Imperial fans.
06
07
07
07
06
20
20
20
20
20
acquisition. They had 6 billion

3/
3/
3/
3/
/
/3
7/
1/
4/
7/
10
dollars in cash, give or take, Q: What’s the best investment

earning 1%, and by doing this that you’ve ever made, and did
Imperial Tobacco Group plc (ITY- NYSE) deal they not only increased you realize the upside at the
the size of the company, I think time of purchase?
Price: 91.93 (7/19/06) Market Cap: 31.01 billion their cost of financing, pre-tax,
(Continued from page 9) is going to be 3 and a half per- DW: One of the best ones has
cent. It’s very lucrative. to be Berkshire Hathaway. It’s
which we don’t buy into, and just been such a great long-
the public in general doesn’t We don’t advocate smoking, term investment. One of the
know what to do with its but we do think the economics things that‘s neat about Berk-
money. of the business are good. shire is that it has become a
better company than it was.
And we set it up so that our Q: Can you talk about Imperial
money is side by side with our Tobacco, and the management The annual reports are great
investors. My business partner there? because they make you think.
Liz Cohernour and I started That’s not only been an excel-
out basically with all friends and DW: Imperial is an amazing lent financial investment, but
family, now it’s extended company. The Imperial To- it’s been a great intellectual
friends and family, but you bacco management, as we put investment. Berkshire has
know whether it be my parents in our last annual report share- provided not only direct finan-
or my friends, many of them holder letter, is we think one cial benefits, but there have
don’t know what to do with of the best managed companies been ancillary benefits because
their money, and they don’t in the world. They came out of studying that company has
really want to obsess about it Hanson. Lord White and Lord improved how I think.
either. They want to put it Hanson built a conglomerate in
somewhere, where it will be the ‘60s, and it was dismantled Q: Almost every investor who
more when they need it. in the ‘90s. Hanson was always comes to speak on campus
That’s what we do, and then a very cost conscious, high extols the benefits of concen-
we try to write to everybody integrity kind of a place. tration. They’re all very suc-
twice a year and explain what cessful, though it’s interesting
we’re up to. In the last letter Imperial comes out of that that they define a concentrated
we used Mark Twain quotes to culture. They have the largest portfolio differently. For some
try to explain that human na- market share in the UK, and it’s 4 or 5 stocks, for others it’s
ture hasn’t changed very much they’ve done a series of very 50 or 60. You have about 30
over the years. smart acquisitions. They’ve
bought back stock; they’ve (Continued on page 11)
(Continued from page 10) as you’ve done the work, in all end of the bubble where peo-
positions. Why does that num- likelihood you’ll have better ple were just capitulating for
ber sit right with you? results. We don’t want to run get-rich-quick schemes. They
Noah’s Ark (2 of everything). couldn’t stand the fact that
DW: We’re a mutual fund, I’ve seen that, and you might as their neighbors were getting
regulated by the Investment well go buy an ETF or an index rich in zippidy-do-da.com, and
Company Act of 1940. There- fund. We’re comfortable they would sell the Brown
fore it has to be diversified and somewhere in between. We Forman. In retrospect many
meet certain specific diversifi- don’t want to put it all on black people now realize they were “Just be true to
cation requirements. Most of with leverage. That’s not our following a fad rather than true
yourself, and try to
the guys who are running 4 or style. style.
5 stocks are in a partnership find something
Q: What advice would you give
format, and usually are getting We also want to be in a posi-
annual fees of 1 or 2 percent tion where if there’s an unex-
MBA students? that you love. I
plus 20% of the profit. We pected event, that we can react think that so many
DW: Just be true to yourself,
have a partnership that’s got to it. I’ll give you an example.
and try to find something that
the same management fee as In 2002 there was a series of people get
you love. I think that so many
the mutual fund. It is more corporate scandals. Enron,
people get obsessed with trying obsessed with
concentrated, so it will have a Adelphia, and all this stuff hap-
to do what they think will get
lumpier performance, but it is pened. There was a gap down-
them to a certain point, but if trying to do what
not as small as 4 securities or 5 ward in the high yield market,
you enjoy the passage of time, they think will get
securities. and then there was another
the likelihood that you’re going
very sickening drop, because them to a certain
to be happy, healthy, and suc-
I think that if you can find 4 or after the initial scandals there
cessful increases.
5 great investments and ride were a whole series of other point, but if you
them, it’s probably going to be ones. So for what now, in You’ve got to find something
enjoy the passage
a lumpier way to investment retrospect, looks like a very you’re passionate about, that
nirvana, but it works. For us, short period of time, it was really makes you want to go of time, the
we have a couple of very large almost complete disarray in the the extra mile, because often
positions. We call our invest- fixed income market. But if times that’s what differentiates likelihood that
ments the major leagues, the you didn’t have the money, you success in business. Sometimes you’re going to be
minor leagues, and the farm wouldn’t have been able to buy it’s just luck, like the Beverly
team. Some of them are on all this great debt cheaply. So Hillbillies where you miss the happy, healthy,
their way up, some are on their we don’t agree with the idea of turkey and you hit the oil well,
way down, and some of them always being fully invested, and
and successful
but a lot of it is just that you’re
you just couldn’t get enough of that every great idea is always so excited about how you increases. ”
because it was not available at going to be apparent at that work and what you do that you
the price you want to pay. time. can’t wait to do that extra little
incremental thing. That has got
I think you want to be diversi- One of things about this busi- to come from love, not greed.
fied on some level, in case a ness is that sometimes you just Most of the people that are
satellite hits the company, or have to be patient and wait for really, really successful, I don’t
something terrible happens that the fat pitch. Going back to think it was only money that
you don’t expect. But the the bubble period, the bubble motivated them.
more you can have in your went on for quite sometime,
highest conviction ideas, as long and it was really almost at the Thank you Mr. Winters.
Page 12
Footstar, Inc. Buy

Jonathan Salinas June 2007
JSalinas08@gsb.columbia.edu
Introduction
Under reorganization, Footstar sold 349 Footaction stores to Footlocker for $225 million in cash. Ad-
ditionally, the company sold or closed other underperforming stores and exited operations in 44 Gord-
man stores and 87 Federated department stores. Company facilities in California and South Carolina
were also sold to raise cash. All cash proceeds were used to pay off creditors during the reorganization
process. During bankruptcy, Footstar and Kmart engaged in a series of legal battles in which Kmart
Footstar, Inc. tried to terminate the original Master Agreement for Meldisco (originally scheduled to last until 2012.)
(OTC: FTAR) Eventually, the parties agreed to a new deal with the following terms: Footstar gained 100% control of
Meldisco (previously Footstar shared ownership 51/49 with Kmart) and agreed to pay 14.625% of
Price: $4.56 monthly gross sales to Kmart. Footstar pays a “rental fee” of $23,500 to Kmart for each store in which
(7/30/07) it operates. In turn, Kmart pays Footstar a fixed fee for each store it closes. The amended agreement is
Market Cap: $95.97m scheduled to end December 31, 2008, at which time Kmart is required to purchase Footstar’s out-
EV: $4 standing inventory at book value. Footstar, Inc. emerged from bankruptcy in February 2006 with a
large cash balance and no outstanding debt, having paid its creditors in full.
Investment Thesis and Valuation Assumptions

Adjusted Present Value
On the asset side of the balance sheet, I reduce net re-
ceivables by 15% to yield a conservative estimate given
potential problems collecting on accounts during liquida-
tion. In addition, I discount all intangible values to 0 (for
actual value of brands see “Brand Value” section). I do
not make any adjustment to inventory, given Kmart’s
agreement to purchase outstanding inventory at book
value. On the liability side, I reduce the long-term pen-
sion liabilities (booked as “other long term pension li-
abilities”) by $25m. The company’s disclosure statement
from December 2005 explains that the company values
liabilities at $28m, however, if Footstar were to elimi-
nate this benefit, its liabilities would be approximately
$3m in total. Conversations with CFO Mike Lynch con-
firmed that retirement liabilities can be cancelled at the
company’s discretion, and are valued in filings under the
assumption that the company operates as a going con-
cern. If the company is forced to liquidate, it will likely
negate these obligations and not be responsible for pay-
ment of these claims. Finally, I discount adjusted book
value of approximately $117m by 10% over two years to
derive $96m present value for the net worth of the com-
pany under a liquidation scenario.
Brand Value
In my calculation of adjusted net worth, I assume that all stated intangibles are reduced to 0. However,
under a liquidation scenario, Footstar can license or sell its proprietary brands and trademarks, most
notably, Thom McAn. I confirmed the company’s proprietary ownership of Thom McAn and also
discussed estimates of brand worth with management. CFO Mike Lynch explained that the most re-
cent estimate of brand value, derived by a third-party consulting firm, is $15-$30 million dollars. Ap-
proximately $200m in sales can be attributed to Thom McAn products, and management believes such
brands typically are valued based upon a 5x multiple of revenue to brand value, implying a high-end
estimate of $40m. That being said, to be conservative, I value the brand at the low-end of the range,
$15m, for my SOTP estimate.
Earnings Estimates
For my calculation of discounted cash flow, I assume the company
operates with approximately 5-6% decline in revenue for 2007 and
an almost 7-8% decline in revenue in 2008. I utilize realistic worst
case margins to arrive at EBITDA and EBIT, and discount EBIT
at 10%.
NOL Value
Footstar presently possess net operating loss carry forwards for
approximately $150m. This NOL asset is understated on the bal-
ance sheet and offers an attractive tax shield for an acquirer. Per
Rule 382, the value of an NOL to an acquirer is defined as fol-
lows:
Fair market value of company prior to acquisition * Adjusted

federal rate at time of acquisition = Amount of write-off per year
The annual write-off amount can be used for a 20 year carry for-
ward period. I utilize the current equity market value, the January
2007 IRC 382 Rate, and assume a 40% corporate tax rate to de-
rive: Value of NOL = 134 * 4.15% * 40% = 2.2
I discounted the 2.2 at 10% over a 20 year period and arrived at a

present value of the NOL equal to ~ $19m.
Business Description
Footstar, Inc. licenses and wholesales discounted footwear through its main subsidiary, Meldisco. Known
for its Thom McAn brand, the company sells footwear in approximately 1,400 Kmart stores and 850 Rite
Aid stores. Previously, the company supplied footwear to Walmart, Federated and other retailers. Wal-
mart continues to purchase products for its Puerto Rico stores and sources FTAR footwear to sell under a
proprietary brand on a case by case basis. Footstar’s products are manufactured in China and logistics are
handled by third-party vendors.
Catalysts
Potential catalysts include:
• Acquisitions – Management has made it clear to me that they are actively pursuing acquisitions or new
business agreements to try to continue the business past 2008. Additionally, another discount retailer can
potentially acquire Footstar for its brands and NOL at a premium to the current price.
• Dividend or Stock Buyback – Footstar possesses a large cash balance that should be used to buy back
stock or issue a dividend (or a combination of the two). Management has intimated that it will begin to
return cash to shareholders if it can not find an appropriate acquisition to continue the business.
• New or Extended Sales Agreement – If Footstar can extend its contract with Kmart past 2008, or de-
velop new business relationships, there is significant upside potential for the stock. Right now, it seems the
market is pricing the company for liquidation at the end of 2008, but if new agreements can extend the life
of the company past 2008, then there is significant upside potential.
Risks
Footstar faces numerous potential risks including:
• Possible early termination of the sales agreement with Kmart – The current sales agreement between
Footstar and Kmart can be terminated prior to December 31, 2008 if annual sales fall below $550 million
dollars. Additionally, Footstar has the right to terminate the deal if sales fall below $450 million dollars in
any four consecutive quarters.
• Outstanding Wells notice from SEC – The SEC has filed a Wells notice related to the accounting ir-
regularities discovered in 2002. Possible fines related to this Wells notice could materially impact that
value of Footstar.
• Risk of damages from ongoing litigation with Adidas and NAFTA Traders – Footstar faces ongoing
litigation with Adidas related to a copyright suit. Adidas claims a four-stripe sneaker Footstar sells in
Kmart locations infringes on Adidas’s three-stripe patent. The suit seeks unspecified damages.
Management believes the suit has no merit. Additionally, NAFTA Traders, a salvage company who did
business with Footaction, is seeking damages for $9 million dollars. The company plans to object and
defend against this claim, and does not believe any loss in excess of previously recorded amounts is likely.
Page 14
Ainsworth Lumber Co. Ltd. Short ($7.70) Short
David Bernfeld June 11, 2007

DBernfeld07@gsb.columbia.edu
Company Description
Ainsworth Lumber Co. Ltd. (“Ainsworth”, or the “Company”) is a manufacturer of oriented
strand board (“OSB”) and other engineered wood products with facilities in Alberta, British
Columbia, Ontario, and Minnesota. The Company is the fourth-largest manufacturer of OSB
Ainsworth Lumber Co. Ltd. in North America and sells 87% of its product into the United States, principally in the West-
(ANS - TSX) ern and Central regions. OSB is a structural panel used in building applications, primarily as
residential roof, wall, and floor sheathing. Since OSB constitutes nearly 90% of Company
sales, this analysis focuses on the OSB market and the Company’s position within that mar-
Price: 7.50
ket.
(7/19/07)
Investment Thesis
$20.00
Ainsworth operates in a highly cyclical industry that faced sub-
$16.00
stantial overcapacity, additional capacity coming on line, and
deteriorating demand prospects. As a high-cost producer in a
$12.00 commodity industry, the Company suffers from competitive disad-
vantages. As of June 8, 2007, Ainsworth has an estimated
$8.00 $1,070 mm of debt, $159 mm of cash, and $60 mm in availability
under its credit facility. At the Company’s current run rate, Ains-
$4.00
worth consumes $40 to $50 mm per quarter to fund operations
$0.00
and to service debt. The Company will burn through its cash and
7/ 20/ 2006 10/ 20/ 200 1/ 20/ 2007 4/ 20/ 2007 7/ 20/ 2007
availability in approximately one and one-half years unless OSB
pricing conditions dramatically improve.
Industry Overcapacity
• Total North American OSB capacity of 28.2 billion square feet (‘bsf”). At Q1 07 run rate,
estimated annualized industry
capacity utilization is 76% and seasonally adjusted capacity utilization is 80-85% (see graph
3).
• Based on announced and funded projects, industry capacity is estimated to reach 32 bsf
by end of 2008.
OSB Demand Driven by Housing Starts and Product Substitution Trend

• Single family housing starts are the largest determinant of OSB demand.
o Single family housing starts are confronting substantial headwinds.
• Substitution trend of OSB for plywood by builders (see graph 2).
o Trend has slowed in past five years, with OSB on the average taking less than 1%
market share from plywood.
Substantial Gap between Capacity and Demand

• The home building industry would need to experience 15% demand growth/year for
two years for seasonally adjusted capacity
utilization to reach 90%. This unlikely scenario would require:
o Single family housing starts to return to peak 2005 levels.
o OSB to gain from plywood an additional 1.8%/year share of panel market for two
consecutive years (i.e., 2x 5-yr avg).
High Cost Producer

• Ainsworth manufacturing costs are 6-7% higher than Louisiana Pacific, the Company’s
largest competitor.
• Given low marginal cost of production and current market overcapacity, firms have in-
centive to sell at prices approaching marginal costs.
Ainsworth Lumber Co. Ltd. (Continued from page 14)
Cash Burn
• The Company will burn through its cash and availability in approximately one and one-half
years unless OSB pricing conditions dramatically improve.
Exchange Rate
• Should the Canadian dollar remain at current high levels, the recent strength of the Cana- “Ainsworth oper-
dian dollar will accelerate Ainsworth’s problems.
o Since the end of first quarter 2007, the CAD/USD exchange rate has increased by ates in a highly
$0.09. If the rate remains at this level, the Company’s cost disadvantage will deepen,
resulting in an annualized reduction of $36 mm to EBITDA. cyclical industry
Competitive Outlook
that faced sub-
Continued Downward Pressure on New Housing Starts
stantial overca-
• Housing stock has been growing faster than population for the past six years.
• The unprecedented extension of credit to marginal borrowers from 1999 through 2005 pacity, additional
supported the longest continuous growth in new single family housing starts since 1960
(see graph 4). capacity coming
• Facilitated by arm, option arm, negative amortization and teaser rates mortgages.
• The diminished availability of credit to such borrowers has contributed to a significant re- on line, and dete-
duction in demand for new housing.
• Recent high levels of sub prime mortgage defaults have led to foreclosures and reintro- riorating demand
ducing significant housing supply to the market.
o Sub prime mortgage defaults should continue to grow as increasing numbers of prospects. As a
five and seven year arm mortgages readjust from 2008 through 2010.
o As expectations of home price appreciation are not realized, marginal borrowers
high-cost pro-
will not be able to refinance mortgages coming off low “teaser” rates.
ducer in a com-
No Pricing Relief in Sight
modity industry,
• Additional capacity coming online.
• Incentive to sell below cost during times of industry overcapacity because incremental the Company
cost of production is approximately 30% lower than average cost of production.
o Variable costs of OSB production include wood (32%), glue/wax (28%), labor suffers from
(24%), supplies (10%), and energy (6%). Most labor and energy costs and some sup-
ply costs become sunk costs in the short run. competitive dis-
Investment Catalysts advantages.”
• The Company is using excessive amounts of cash to fund operations and to service debt.
• Potential liquidity crisis leading to insolvency.
• Monthly announcement of housing start levels could provide downward pressure on Ains-
worth securities if levels are below expectation.
Risks
• On May 31 2007, secured lenders issued a $115 million term loan to the Company. These
lenders would have access to material non-public information and chose to extend addi-
tional credit to the Company. This decision could suggest that results for the second may
show an improvement over first quarter results.
• Lenders could extend additional credit to Ainsworth.
• Recent high plywood prices may spur increased use of OSB as substitute for plywood.
• Interest rates could return to historic lows, resulting in reduced mortgage default and in-
creased new housing starts.
• Special Canadian insolvency law arrangements if any.
• Takeover by private equity buyer.
Page 16
2007 CIMA Conference (Continued from page 15)
(Continued from page 4) tion continues to increase from the sufficient difference between a
sors, Inc. opened this year’s confer- funds flow into the industry or if we stock’s current market price and
ence by sharing some were to enter a prolonged one-way the price that an investor believes
of the lessons he learned during his bull market. Addressing current MBA to be its true value, or “intrinsic
40+ year career. Mr. Cooperman students, Mr. Cooperman believes that value”. This difference provides a
began by explaining his positive out- they will benefit from the trend on cushion that will minimize losses if
look for the markets in 2007 and Wall Street of reducing research dean investment does not perform as
provided insight into the research his partments, causing a need for hedge expected and ensures that no mat-
firm performs to reach their conclu- funds to hire more talented analysts. ter how good a company looks,
sions. “Bull markets don’t die from the stock will only be purchased
old age, they die from excess – and The first panel discussion was on the when it is selling at a price lower
we don’t see this type of excess at topic of “Margin of Safety”, one of the than its true value. While this may
this time.” underlying principles defined by Gra- seem like common sense, very few
ham and Dodd. Warren Buffet once investors adhere to this discipline
Mr. Cooperman also weighed in on commented that the three most im- in practice. Each panelist, which
the topic of the hedge fund industry, portant words of investing are “margin included Stephen Bepler (CBS ’66)
as did many panelists throughout the of safety”. Before making an invest- (Capital Research Company), Ste-
day. Cooperman reminded us that, ment, a value investor will demand a (Continued on page 17)
by definition most investment pro-
fessional do not beat the market - so Save the Date:
charging "2 and 20" will not be sus- 11th Annual
tainable over the long term for most Columbia Investment Management Association
money managers. To underscore his
point, he went into his files and Conference
pulled some figures from a 1970's Columbia University Morningside Campus, Alfred Learner Hall
article on the hedge fund industry. A
majority of the largest hedge funds in February 1, 2008
December of 1968 were down well
over 50% to 100% by September of Past speakers have included: William Ackman, Bruce Berkowitz, Jim Chanos,
1970, and many are no longer in Leon Cooperman, Stephen Mandel, Bill Miller, Michael Mauboussin, Thomas
business. Cooperman noted that a Russo, Marty Whitman, and David Winters
hedge fund meltdown was possible in
the current environment if competi- Get your tickets early! The conference has sold out for the past 3 years.
Warren Buffett (continued from page 11)

(Continued from page 3) “Munger sitting with a gorgeous Ethics & Reputation
one of us will grow into becoming such a woman – she asked ‘if you had to boil “We can afford to lose money – even
successful investor some day, but his down the reason for your success into a lot of money. We cannot afford to
advice on living a better life can be one word what would it be?’, he said lose reputation – even a shred of
followed by everyone. He lays out his ‘Rationality’. You should have a good reputation.”
wisdom quite clearly – all we have to reason for doing things.”
do is grasp it. “We must measure every act against
“It wasn’t as personally satisfying to not only what is legal but also what we
Career Advice & Tips for Success buy and sell things all the time as I would be happy to have written about
“Go work for whomever you admire found it to be to build a business over on the front page of a national news-
the most – I tried to get there very time, and build long-term associa- paper in an article written by an un-
quickly. I admired my dad and Ben tions.” friendly but intelligent reporter.”
Graham – my first two jobs after
school were with my dad and Ben “Everyone else is doing it” – are the
Graham.” (Continued on page 21)
ven Galbraith (Maverick Capital), the CEO… That is not what was hap- learned from Bill Miller is not to
John Gunn (Dodge & Cox) and Alex- pening…” and the recent wave of cor- become trapped in the
ander Roepers (Atlantic Investment porate scandals was a direct result. “traditional” value box. A com-
Management), described their indi- During the Q&A the panel was asked mon factor mentioned by each of
vidual application of the principles of how current activist investors differ the panelists was the importance
value investing to determine whether from the corporate raiders of the of only investing in companies with
a margin of safety exists. The panel- 1980’s. Eric Rosenfeld replied that the a strong management team. When
ists also discussed the keys to main difference is the raiders, for the asked about past mistakes, each
achieving long term success in the most part, were only looking out for investor spoke of a time when
industry. Among the traits men- themselves, while current activist in- they momentarily drifted away
tioned were having a narrow focus, vestors are creating value for all of the from their discipline.
avoiding all types of idiosyncratic company’s shareholders.
risk, building a team of industry spe- Closing the conference was an-
cialists, avoiding “style drift”, and The final panel provided the audience other Columbia alumnus, Mark
most of all maintaining strict disci- with a firsthand look into the invest- Kingdon (CC ’71) who is the
pline. ment strategies of some of the world’s President and Founder of Kingdon
most highly regarded investors, includ- Capital Management. In a fitting
After lunch, the topic of “activist ing Bruce Berkowitz (Fairholme Capital change of pace, Mr. Kingdon
investing” was addressed. Investors Management), David Greenspan (CBS shared with the audience his set of
have been increasingly proactive in ’00)(Blue Ridge Capital), Bill Miller investment principles which fo-
helping, or sometimes forcing man- (Legg Mason), and David Winters cused more on managing people
agement to maximize shareholder (Wintergreen Advisors). Each member than on managing money. Included
value. While the panelists, which of the panel shared their outlook for among these principles were the
included James Mitarotonda the investment landscape, offered some value of a strong work ethic, the
(Barington Capital Group), Kevin specific stock ideas and explained the importance of taking time to go to
Richardson II (Prides Capital Part- reasons behind their selections. Lead- the gym, the necessity of maintain-
ners), Eric Rosenfeld (Crescender ing the panel was Professor Bruce ing focus within a long term con-
Partners), and Roy Katzovics Greenwald who began by asking each text, and the priority that should
(Pershing Square Capital), repre- investor to describe their process for be given to family. He also men-
sented funds that are generally con- finding actionable investment ideas. tioned rules such as: “You can
sidered “activist funds”, they warned Mr. Berkowitz immediately answered turn a portfolio manager into
not to lose sight of the fact that only that the first thing he looks at and the mentsch”, “You can’t always turn
a small percentage of each fund is “only thing you can count on at the a mentsch into a good portfolio
invested in positions where an activ- end of the day” is cash. Mr. Greenspan manager”, and “become passion-
ist role is pursued. The panel was in described his process of searching in ately involved in a charity.”
agreement that the most important places where people are slow to react
factor driving investment decisions to current events. These are usually The conference attracted a record
are the principles underlying funda- found by looking at industries in the attendance (with over 60 people
mental research and valuation. Ac- midst of change. He also looks for unable to get off the wait-list).
tivism is only used as a tool in the places where hate or anger are influ- After spending the day learning
event that management is unwilling encing the stock price, using the exam- from those who are recognized as
or unable to unlock shareholder ple of when CNBC showed a con- the best at what they do, everyone
value. Mr. Mitarotonda pointed out sumer taking a chainsaw to a Dell com- walked away with valuable advice
that the recent increase in activist puter. Bill Miller and his team receive and a multitude of ideas on how to
investing has forced the board of daily alerts of any company that has a become a better investor.
directors of many public companies large one day sell-off, or shows up on
to reassess their roles. To illustrate the 52-week, 5-year and 20-year low Look out for details, speakers, and
his point, he asked the audience to list. He also stressed the importance ticket purchasing information for
imagine if the president, not the peo- of not treating every industry the same. the 2008 CIMA Conference which
ple, appointed the majority of con- As for Mr. Winters, many of his ideas will be held on February 1, 2008.
gressional representatives. “It is the are found by doing a tremendous Updates will be posted on both
same thing in corporate America. amount of reading while viewing each the CIMA and Heilbrunn Center
The board of directors works for situation from many different angles. websites, as well as in the next
the owners of the company, not for Another important lesson that he edition of Graham and Doddsville..
Page 18
Meryl Witmer
Witmer Asset Management
Meryl Witmer is a former vice president of Mutual Series Funds where she worked under Michael
Price. In 1989 she teamed up with Donald Parker and formed Emerald Partners, a research-intensive
hedge fund. Mrs. Witmer spent 2 years as an analyst with Dean Witter Realty and holds a finance
degree from the University of Virginia’s McIntire School of Commerce. Meryl Witmer is currently a
general partner at Witmer Asset Management in New York City.
Top Buys
Company Shares Value
Top Sells
NAVISTAR INTL CORP 885,400 $40,507
Top Holdings Change

Company Shares Value (shares)
TEXAS INDS INC COM 801,300 $62,830 0
KAISER ALUMINUM CORP COM 759,100 $55,323 (311,116)
WHIRLPOOL CORP COM 461,000 $51,263 0
COMCAST CORP NEW Cl A 1,382,700 $38,660 258,600
CROWN HOLDINGS INC COM 1,261,700 $31,505 362,900
MEDIA GEN INC Cl A 887,800 $29,537 0
USA MOBILITY INC COM 1,039,614 $27,820 0
BERKSHIRE HATHAWAY INC DEL Cl A 237 $25,946 0
LIVE NATION INC COM 944,300 $21,133 (75,000)
CHAPARRAL STEEL CO 11,400 $819 (166,892)
Bruce Berkowitz
Fairholme Capital Management
Bruce R. Berkowitz is the Founder and Managing Member of Fairholme Capital Management. He was
previously employed at Lehman Brothers until December 1993 and at Smith Barney Investment Advisers
from December 1993 to October 1997, where he was a Managing Director of Smith Barney Inc.
Mr. Berkowitz also serves as a Trustee of Winthrop Realty Trust, and is a Director of White Mountains
Insurance Group, Ltd. and TAL International Group Inc. He received his Bachelor of Arts in Economics,
cum laude, from the University of Massachusetts at Amherst.
Top Buys
AUGUSTA RES CORP COM NEW 1,147,800 $3,329
XTO ENERGY INC COM 3,226,700 $193,925
Top Sells
MERITOR SVGS BK PA COM 43,645 $196
USA MOBILITY INC 2,374,526 $47,324
WELLSFORD REAL PPTYS COM 10,548 $82
Top Holdings Change

CANADIAN NAT RES LTD 18,671,770 $1,238,872 516,902
BERKSHIRE HATHAWAY INC DEL A 10,553 $1,155,290 731
ECHOSTAR COMMUNICATIONS CORP C 12,716,422 $551,511 (965,354)
PENN WEST ENERGY TR UNIT 11,635,430 $388,274 (769,690)
MOHAWK INDS INC COM 3,341,368 $336,776 (37,400)
LEUCADIA NATL CORP COM 8,886,042 $313,233 120,430
EASTMAN CHEM CO COM 3,975,869 $255,768 (15,999)
BERKSHIRE HATHAWAY INC DEL B 51,293 $184,911 1,138
USG CORP NEW COM 3,670,336 $179,993 146,100
SEARS HLDGS CORPCOM 987,589 $167,396 (2,000)
MUELLER WTR PRODS INC COM SER 9,523,800 $142,857 (700)
TAL INTERNATIONAL GROUP INC 2,760,997 $82,029 0
IDT CORP CL B 6,547,200 $67,567 0

Page 20
Chuck Akre
Akre Capital Management
Chuck Akre is the founder of Akre Capital Management and Portfolio Manager of the
Friedman Billings Ramsey Small Cap Fund. After graduating from American University,
Mr. Akre became a stockbroker with Johnston, Lemon & Co. He eventually become
Johnston, Lemon & Co.’s Director of Research and CEO of its Investment Manage-
ment Division. He opened Akre Capital Management in 1989 and began managing the
FBR Small Cap Fund in 1997.
Top Buys
Alimentation Couche-Tard SVS C 1,350,913 $27,861
Burke & Herbert Bank/bhrb 1,744 $2,590
Peyto Energy Trust/peyuf 900,000 $15,407.00
Top Sells
Enstar Group Ltd./esgr 2,350 $232
Global Imaging Systems/gisx 1,085,400 $21,165
Top Holdings Change

Penn National Gaming/penn 7,458,289 $448,169 62,600
American Tower A/amt 8,255,000 $346,710 77,480
Markel Corporation/mkl 414,034 $200,624 2,712
CarMax Inc./kmx 4,441,071 $113,247 32,187
99 Cent Stores/ndn 6,996,231 $91,721 83,214
Americredit/acf 3,273,834 $86,920 50,297
Bally Technologies/byi 2,395,432 $63,287 22,485
Pool Corp./pool 1,597,620 $62,355 709,913
Pinnacle Entertainment Inc./pn 2,055,825 $57,871 11,125
O'Reilly Automotive/orly 1,352,311 $49,427 28,782
Monarch Casinos/mcri 1,656,090 $44,466 (140,908)
Simpson Manufacturing/ssd 1,301,929 $43,927 (78,196)
AES Inc./aes 1,611,534 $35,260 18,710
Isle of Capri Casinos/isle 1,132,609 $27,137 22,998
Warren Buffett (continued from page 16)

(Continued from page 16) that I was born elsewhere. On top
most five dangerous words in of that, I was wired for capital allo-
business. The rationale used for cation in a world where capital
an action that otherwise you’d allocation had become incredibly
have trouble justifying.” important. We had a market sys-
[To his managers] “If you see tem that rewarded far out of pro-
anything whose propriety or le- portion to nurses, teachers, any- Paul Sonkin ’95, William von Mueffling '95,
gality causes you to hesitate, be thing else, you name it. I had two Warren Buffett ’51, and Glenn Greenberg ’73
sure to give me a call. However, parents that educated me.”
it’s very likely that if a given ful life and it should go back to society.”
course of action produces such “My friend Gates says if I come up
hesitation, it’s too close to the wired for capital allocation in Af- [The Gates Foundation] “will measure the
line and should be abandoned. rica 1000 years ago, I’d be some $1.5 billion by ‘does it improve more lives
There’s plenty of money to be animal’s lunch. I can’t run fast, I than any other course of action than they
made in the center of the court. can’t climb trees. I can say ‘I allo- could take?’ - every human life being equal”
If it’s questionable whether some cate capital’, and the animal would
action is close to the line, just say ‘those are the guys that taste [Idea of specialization of labor by Adam
assume it is outside and forget it.” the best’. It was totally just an acci- Smith] “I wouldn’t cut my own hair. It also
dent.” applies to philanthropy.”
“We have no directors’ and offi-
cers’ liability insurance – I tell “We are the luckiest people in the
them “if the ship goes down, world operating in the United Corporate Governance and Board Gov-
you’re going to ground”. States in year 2007. During the ernance
20th century, the real standard of [About Board of Directors’ selection]
[If an event that threatens the living went up to 7 from 1 for “How would you fire yourself from a
reputation of the organization Americans – this never happened $200k per year job on a directorship -
happens] “1) Jump on it quickly, in history of the world. There are especially when you’re living off a $100k a
2) Get the facts out as fast as you centuries with no gain. Here we
year pension?”
can and try to correct it - and of are lucky. Drop us down to Af-
course you apologize.” ghanistan or wherever it may be, [About Board of Directors’ compensation]
all this wonderful talent won’t ac- “Have them get rich if shareholders get
“People pick up the ethics sur- complish anything. We are lucky rich, have them get poorer if shareholders
rounding them. You will behave enough to accumulate more than
get poorer.”
better if you marry a woman anybody else in this world to pass
that’s better than you are.” it on to our kids.” [About Management Compensation] “We
do not have a stock option plan. We have
[Graham’s market analogy of a “What do you do with that luck – a range with numbers that relate to things
voting/weighing machine] “applies and what obligations do you have? under their control and relate to profit-
to individuals as well as busi- That is a question to be answered ability. (An) option is like a goody – once
nesses. In the long-term you only by the government via their tax
you get it you don’t like to give it back.”
have your reputation. When you system etc.”
get to be 75 you get the one you [About Management stock ownership
deserve. You can get away with through options] “I don’t like it, but it’s
things in the short-run, but life Philanthropy part of the game. I would be really cau-
sorts you out.” “You need a market system to tious to get in with a management that
keep pushing the lucky ones to overreaches.”
Role of Luck and Success help the society to help somebody
“I won the ovarian lottery when I who did not win the lottery.” Burak Alici graduated with an MBA from Co-
was born. In 1930, there was one lumbia Business School in May 2007. Burak was
chance in 50 roughly that I was “Why should a kid just get more a member of the Applied Value Investing pro-
born in the US, and the chances because his family was rich? Soci- gram and was the President of CIMA for 2006 -
were much higher, by 49 times, ety gave it to me, I lived a wonder- 2007.
Get Involved:

New York, NY 10027
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E-mail Address: _____________________________
Business Phone: _____________________________

Contact us at:

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Volume II, Issue I Winter 2007/2008

Inside this issue:
Graham and Dodd

Breakfast
p. 3 Staying Power: Jean-Marie Eveillard
Jean-Marie Eveillard is a leg- Jean-Marie Eveillard’s strict
D.R. Horton, Inc. p. 14
end in the world of value investment discipline and
Macy’s p. 16 investing. Widely recognized outstanding investment re-
as the first truly global value turns earned him a Morning-
investor, Jean-Marie achieved star Lifetime Achievement
Netflix p. 18
his status by adhering to the Award in 2003.
Industry p. 20 investment principles of Gra-
Networking Night ham and Dodd, and ex- On March 26, 2007 First
panded upon by Warren Eagle Funds and its invest-
Value Investing in p. 22 Buffett. ment advisor, Arnhold and S.
India Bleichroeder Advisors, offi-
Jean-Marie began his career cially announced that Jean-
in 1962 with Societe Gener- Marie would resume portfo- Jean-Marie Eveillard, Portfolio
Editors: ale and became portfolio lio management responsibili- Manager - First Eagle Funds.
manager of what is now the ties for the First Eagle
David Kessler First Eagle Global Fund in Global, Overseas, Gold, you tell us your story?
MBA 2008 Overseas Variable and U.S.
1979. Prior to his brief re-
tirement in 2004, Jean-Marie Value Funds. JME: I had been working
Charles Murphy since the early 1960’s with a
MBA 2009 led the First Eagle Global
Q: It seems that every value French bank doing securities
Fund to a 15.8% average analysis in Paris. The French
investor has their own story
David Silverman annual return - compared to bank sent me to New York
about how they stumbled
MBA 2009 13.7% for the S&P 500 upon value investing. Can presumably for a year or
(according to Morningtar).

As we enter our second value investor Jean-Marie and The Heilbrunn Center.
Visit us at: year, we are pleased to pro- Eveillard of First Eagle Funds. Inside you will find coverage
vide you with the third edi- Mr. Eveillard was gracious of the 17th Annual Graham
www.gsb.columbia.edu/students/ t ion of Gr ah a m and enough to sit down with us and Dodd Breakfast featuring
organizations/cima/ Doddsville, Columbia Business and share the wisdom he has David Einhorn of Greenlight
School’s student-led invest- gained during a distinguished Capital; lessons from the
ment new slette r, co- career that has spanned over Industry Networking Night
sponsored by the Heilbrunn three decades. featuring William von Muef-
Center for Graham & Dodd fling (’95) of Cantillon Capital
Investing and the Columbia We also hope to give you a Management and David
Investment Management taste of some of the extraor- Greenspan (’00) of Blue
Association. dinary events sponsored by Ridge Capital; and you will
Columbia Business School, travel to India with Professor
This edition features an in- the Columbia Investment Bruce Greenwald and mem-
terview with legendary global Management Association, (Continued on page 2)
Page 2

bers of The Heilbrunn Cen-
ter to discuss value investing,
globalization, corporate so-
cial responsibility, and com-
petitive strategy.
As always, we also feature

investment ideas from the
students of Columbia Busi-
ness School.

as we continue to refine this Legendary investors Martin Whitman and Edwin Schloss at
publication for future edi- the 17th Annual Graham & Dodd Breakfast on October
tions. Enjoy! 19, 2007. The annual breakfast is organized by The Heil-
brunn Center for Graham and Dodd Investing.
-G&Dsville
Jean-Marie Eveillard (continued from page 1)
two. I got to New York There is a story in France approach – trading the big
City for the first time in about a famous French poet stocks. Neither in New
“To me, value January of 1968. I didn’t named Paul Claudel who York, nor when I went back
know many people, but I had not believed in God. to Paris for a few years,
investing is a knew a few people in the One day, he was standing by could I convince anybody to
French community, and I a pillar at a Cathedral near look at value investing. Still
got to meet two French Paris and he said: “I was today to my knowledge, the
big tent that students attending Columbia illuminated by faith.” In a French banks and institu-
Business School whose in- sense, I was illuminated not tions do not have value in-
accommodates terests were not investing – by faith, but all of a sudden, vesting. Societe Generale
their interest was market- it seemed to me that Ben sold our operation to Arn-
ing. During that summer, Graham simply made sense. hold and S. Bleichroeder at
many different we bicycled together on The idea of margin of safety, the end of 1999, and I’ve
weekends in Central Park. the idea of intrinsic value, kept in touch with some of
people.” They knew that I was in the the idea of Mr. Market, the the people there. I have
field of investments, and very humble idea that the tried to convince them over
they had heard of Ben Gra- future is uncertain - it made the past seven years that
ham. Investments were not sense to me. I stayed in they should make some
their interest, but they men- New York for another few room somewhere in a little
tioned Ben Graham to me. years, but I could not con- corner for value investing,
So, I went to a bookstore vince Paris headquarters but they are not into it.
and bought The Intelligent because their whole ap-
Investor and Securities Analy- proach was completely dif- Today in Paris there are a
sis. The Intelligent Investor in ferent. Their approach, in a few people practicing value
particular sort of struck me. sense, was more of a trading (Continued on page 4)
Volume II, Issue 1 Page 3
Fooling Some of the People All of the Time

Graham and Dodd Breakfast
with David Einhorn
On the morning of October

19th, close to 400 investors
gathered at The University “The crisis
Club in Manhattan for the
17th Annual Graham & came because
Dodd Breakfast. This year’s
keynote speaker was David we have a lot
Einhorn, President of
Greenlight Capital. Under of bad
the title “Fooling Some of
the People All of the Time,” practices and a
Mr. Einhorn addressed the
current state of the capital practices and a lot of bad This includes not only the
markets and shared his ideas.” The result is that sub-prime market but also
lot of bad
thoughts on ways to remedy lenders were “induced to all areas of residential real
the current situation in the take imprudent risks and estate, commercial real es-
ideas.”
credit markets. make imprudent loans, tate and the corporate lend-
which of course led to ing markets and has applied
Mr. Einhorn, introduced by losses.” One practice ad- equally to borrowers
Professor Bruce Greenwald monished by Mr. Einhorn is whether they are an average
as an investor with a crea- the current system of dele- American trying to purchase
tive mind, a powerful intelli- gating the assessment of a house or a private equity
gence, and a sound instinct credit risk to credit rating firm pursuing an LBO.
for value, is a graduate of agencies that are paid by
Cornell University. He be- bond issuers rather than Why have borrowers en-
gan his career in the Invest- bond buyers. joyed such low rates? Ac-
ment Banking Group of cording to Mr. Einhorn, the
Donaldson, Lufkin & Jen- While the media might lead answer lies in how this risk
rette. After 2 years with one to believe that sub- of structured financial prod-
DLJ, Mr. Einhorn left to take prime loans are at the root ucts are assessed. Rating
a job as an analyst with a of the current capital mar- agencies perform their
hedge fund. In January 1996 ket disarray, Mr. Einhorn analysis free from the re-
he co-founded Greenlight asserts that that sub-prime strictions of “Reg FD”.
Capital. Starting with less loans have become a con- Without access to the same CBS alumni reconnect at the
Graham & Dodd Breakfast
than $1 million in capital, venient excuse for a much information as the credit
Mr. Einhorn built Greenlight larger problem. The real agencies, investors are not
into one of the most suc- issue is that lenders of all able to decide whether they
cessful hedge funds in the sorts lent too much money agree or disagree with the
industry. Greenlight, which and did not demand enough rating. “Without enough
has grown to over $4 bil- interest to compensate information in the market
lion, boasts returns which their risk. “There has been other than the credit rating,
are reported to be 27% a colossal undercharging for it is hard for buyers and
annualized. credit across the board,” sellers to decide what to do
Einhorn stated. Loans were once the credit rating
In speaking about the credit issued based on the bor- comes into doubt.” Einhorn
markets, Mr. Einhorn de- rower’s ability to refinance believes that one solution to
clared “the crisis came be- rather than the borrowers this problem is to make all
cause we have a lot of bad ability to repay the loan. (Continued on page 4)
Page 4
17th Annual Graham and Dodd Breakfast

(Continued from page 3) an enormous systemic risk David Einhorn concluded his
information as these entities are able to remarks by reading an ex-
shared with maintain access to cheap cerpt from his forthcoming
rating agen- credit while over extending book due on bookshelves
cies available themselves beyond pru- next spring. Among the
to the entire dence.” guests at the breakfast were
market. three generations of value
In describing his own invest- investors including Walter
Einhorn sug- ment philosophy, Mr. Ein- and Edwin Schloss, Marty
gested that horn said that the idea is to Whitman, Mario Gabelli,
“the rating preserve capital on an in- Jean Marie Eveillard, and
agencies ve st men t-b y-in ve st ment Tom Russo. The breakfast,
Mario Gabelli (’67) and
have lost their ability to basis. His goal is to put which is organized by The
Walter Schloss catch up
at the Graham and Dodd impose discipline on the together a portfolio of indi- Heilbrunn Center for Gra-
balance sheets of the broker vidual ideas that are set up ham and Dodd Investing,
Breakfast
dealers, the financial guaran- to preserve capital if he is was simulcast to London
tee companies, enablers of wrong, and will achieve a and webcast to an audience
structured finance that bring good return if he is some- around the world.
so much business to the thing other than wrong.
rating agencies. This creates -G&Dsville

(Continued from page 2) about value investing. They best book that has ever
investing. Twenty years said: “Hey – we have a small been written about invest-
ago, there was nobody to fund in New York - $15 ing.
my knowledge, but I think million – why don’t you go
today there are a few inde- back to NY and run it?” Over the past almost 30
pendent shops that tend to Because it was small and years, we (First Eagle) have
do value investing. And, because I was across the sort of floated between Ben
indeed, there are two young ocean, they basically let me Graham and Buffett. We
Italian men three or four run it the way I wanted. began with the Graham ap-
years ago who went to the Within a few months of proach which is somewhat
same business school I went when I came back to New static and less potentially
to in Paris. They looked up York in late 1978, I also rewarding then the Buffett
my name in the alumni book came across the annual re- approach, but less time con-
and called me and came to ports of Berkshire Hatha- suming. So as we staffed up,
see me because they had way. To me, value investing we moved more to the Buf-
just started a small value is a big tent that accommo- fett approach, although not
shop in Paris. I became a dates many different people. without trepidation because
minority shareholder in At one end of the tent the Buffett approach – yes,
their advisory firm. there is Ben Graham, and at you can get the numbers
the other end of the tent right, but there is also a
So in any case, I came there is Warren Buffett, major qualitative side to the
across The Intelligent Investor who worked with Graham Buffett approach. We, or at
in 1968 and, then, had to and then went out on his least I, surely do not have
wait a little more than 10 own and made adjustments the extraordinary skills of
years until late 1978 when to the teachings of Ben Gra- Buffett, so one has to be
Paris headquarters was get- ham. Still today, Buffett says very careful when one
ting tired of hearing me talk The Intelligent Investor is the (Continued on page 5)

(Continued from page 4) So there are not a great there are two characteris-
moves to the Buffett ap- number of value shops, al- tics to borrowing. Number
proach. Today, we have though I must confess that one: borrowing works both
Bruce Greenwald as direc- there are quite a few value ways. So you are compro-
tor of research, and there shops on the hedge fund mising the idea of margin of
are nine in-house analysts. I side. Usually they are long safety if you borrow. Num-
think Bruce will take that only. They have the ability ber two: borrowing reduces
number up to something to borrow, the ability to your staying power. As I Professor Bruce Greenwald and
like twelve within the next short, but there are very said, if you are a value inves- Dean Glenn Hubbard
few months. few value investors that get tor, you are a long term
involved in shorting because investor, so you want to Columbia Business School is
So this is how I came across have staying power. a leading resource for invest-
Ben Graham and then 10 ment management profession-
years later, just in time, the I’m not familiar with many als and the only Ivy League
Buffett approach. “There are very of the value shops on the business school in New York
long only hedge fund side, City. The School, where value
Q: You have been managing few value investors but if you look at the mutual investing originated, is consis-
the First Eagle Global fund fund world, you don’t have tently ranked among the top
that get involved in
since 1979, and you spoke that many value shops. You programs for finance in the
about how your philosophy shorting because if have Marty Whitman’s world.
has shifted over time. How Third Avenue, you have
have you seen the philoso- you are a value Mason Hawkins at South-
phy of Value Investing in east, you have Oakmark in
general evolve over that investor, you are a Chicago, you have Tweedy
time? Browne, and a few others,
long term investor. but you don’t have that
JME: I think today, to some If you are a long many.
extent because of the ex-
treme popularity of Warren term investor, you Q: You were probably one
Buffett, there is more com- of the first recognized global
petition. If you think of the don’t have to worry value investors. How has
previous generation of true global investing, in general,
value investors – individuals about market changed over the past 30
like Walter Schloss and the years?
like - they were truly very psychology.”
close to the Graham ap- JME: It has changed in the
proach. And I think today sense that it has also be-
when you look at the vari- if you are a value investor, come more competitive
ous value shops in the U.S. - you are a long term inves- because there are more
keeping in mind what the tor. If you are a long term American value investors
late Bill Ruane tried to fig- investor, you don’t have to who invest on a global basis,
ure out six or seven years worry about market psy- and because there is a little
ago, and it is probably true chology. As Ben Graham bit more competition from
today - there was really no said: “Short term - the stock the locals, there are more
more than 5% of profession- market is a voting machine; people outside the U.S.
ally managed money in the long term - it is a weighing looking for value investment
U.S. that was invested on a machine.” But it is very ideas. Let me give you an
value basis, broadly speak- hard to get involved in example: In the 80’s and up
ing. And there was much shorting without taking mar- until the early 90’s, there
less than that outside the ket psychology into account. were many companies in
U.S. Of course, by definition, (Continued on page 6)
Page 6
that if we decide to look For instance in the early

into a particular investment 1970’s, Buffett figured out
idea we have to do most of that the major characteris-
the work in-house, hence tics of the newspaper busi-
the extreme importance of ness had to do with the fact
the in house research de- that many newspapers had a
partment. This is because quasi-monopoly. Buffett
sell-side research is directed determined that what was
towards the 95% or so of important was not the fact
professional investors who that already in the 1970’s
are not value investors, so circulation was not growing
their time horizon is usually much, if at all, but that the
more along the lines of six local department store
to twelve months as op- automatically advertised in
Jean-Marie Eveillard, Xavier (Continued from page 5) posed to five or more years the local newspaper. On
De Romana (‘02), Walter for us. top of that, it was not a
Schloss Europe that had very con- capital intensive business. It
servative accounting. The The work, of course, starts was a service business with
locals did not pay attention with public information – higher margins, not that
to how conservative the running numbers. Some- they could charge any price,
“Every chief finan- accounting could be. This is times, we make adjustments but they were the advertis-
no longer true. to the reported numbers, ing instrument of choice for
cial officer in this which is particularly impor- local businesses. Wall
country, and even Q: What are the character- tant today because every Street was entirely focused
istics that draw you to an chief financial officer in this on the fact that they were
some outside the investment and how do you country, and even some not growth companies, pre-
go about finding new ideas? outside the U.S., seems to sumably because circulation
U.S., seems to be be trying to show the high- was not going up.
JME: Well, in terms of est possible reported earn-
trying to show his hunting grounds, in general, ings without going to jail. In This fits in with Buffett’s
we don’t do screens be- order to do so, they have to idea that value investors are
or her highest pos- cause we like to check the make sure that they observe not hostile to growth. Buf-
sible reported accounting carefully and the letter of the regulation, fett says that value and
make our own adjustments. but they don’t hesitate to growth are joined at the hip
earnings without To take an extreme exam- betray the spirit of the regu- – value investors just want
ple, take a look at an Ameri- lations. So, we run the profitable growth and they
going to jail.” can forest products com- numbers coming from public don’t want to pay outra-
pany. If they still own tim- information, and it’s not a geous prices for future
berland, as is the case of matter of having fifteen growth because, as Graham
Weyerhaeuser, which they pages of numbers. I like the said, the future is uncertain.
acquired about a century idea that the important And also, what is probably
ago, they continue to carry numbers have more or less more important from Buf-
it on the balance sheet for to fit on a single page or fett’s point of view is to
about $1 an acre. Today, it two pages at the most. identify the extremely small
is more like $1,000 an acre number of businesses
or more in the south and Then, there is the qualitative where, after doing a lot of
$2,000 an acre in the Pacific side, which is of course homework and exercising
Northwest. So a screen judgmental and has a lot to judgment, you come to the
would not help you in any do with trying to figure out conclusion that the odds are
way in that respect. the three, four or five major good that the business has a
The way we go about it is characteristics of a business. (Continued on page 7)
Volume I,
II,Issue
Issue21 Page 7

(Continued from page 6) details, so sometimes the rassed because she didn’t
‘moat’, the business has a analyst investigates an idea know. And so that evening,
competitive advantage, and for a few days or for a few when I came home, she
that business will be as prof- weeks and comes back to asked “What do you do at
itable five or ten years down me and says “Sorry, but this the office?” I thought,
the road as it is today. This is not a very a good idea rather than trying to explain
is opposed to simply ex- and here are the reasons what money management is
trapolating 20% or 25% an- why.” This is fine with me. to a six year old, I said, “I
nual growth observed over Third, we always make sure spend half of my time read-
the past three years. There the analysts have enough ing and half of my time talk-
“For value
is a very limited number of time left to initiate and de- ing with my colleagues.” My
businesses that can continue velop their own investment daughter said: “Reading? investors, the edge
that type of growth. In any ideas. They come to me Talking? That’s not work!”
case, Buffett never insisted first, but it is very rare for But in fact, that is what I do! is seldom in
on 20% - 25% growth. I me to tell them that I think I spend a considerable
think he even said some- they are barking up the amount of time talking with unusual
thing to the effect that a wrong tree, wasting their the analysts, looking with
profitable business that is time for such and such rea- them at the various angles, information which
not growing is not a business sons. It very seldom hap- trying to make sure that
the rest of the
that has no value. A busi- pens. they have properly esti-
ness can have value even if it mated the strengths and the market doesn’t
is not growing. In that So the analysts go out, run weaknesses of the business
sense, value investors tend the numbers according to – then they go back and have. There is a
to think like private equity public information, and investigate further.
investors – we are looking make the adjustments to the fine line between
for stable and profitable numbers as necessary. For We invest, if in the end, we
businesses - sometimes in instance, for quite a while, agree with them from an unusual
what appears to be mun- we had to make the adjust- analytical point of view. In information being
dane areas. ments for the issuance of other words, we think we
stock options because there understand the business, we obtained by
The analysts here keep were many companies that think we like the business,
track of what we own but in until they were forced to do and we think investors are regular means or
our case, most of the work it, just didn’t do it. mis-pricing the business.
is done before we start buy- For value investors, the by ‘not so regular’
ing a stock. Afterwards, it is The analysts try to figure edge is seldom in unusual
just a matter of updating the 3 – 5 major characteris- information which the rest means. It is more
and we don’t spend any tics of the business. I don’t of the market doesn’t have. in the
time trying to figure out the ask them to write about There is a fine line between
next quarter. So our nine this, but it comes in the unusual information being interpretation of
analysts keep track of the conversation that we have obtained by regular means
securities we own, they after we look at the num- or by ‘not so regular’ the information.”
investigate the ideas that the bers. Then there is the means. It is more in the
portfolio manager may have back and forth between me interpretation of the infor-
which, at least in my case, and the analyst. mation. It is more figuring
usually comes from reading out the major characteris-
newspapers or flipping Many years ago, when our tics of a business. Buffett
through some sell-side re- younger daughter was six or didn’t know more than Wall
search and saying “hmmm, seven years old, somebody Street knew about the
maybe we should look at at school must have asked newspaper business. He
this.” Of course, for a value her, “What does your fa- just decided that looking at
investor the devil is in the ther do?” She was embar- (Continued on page 8)
Page 8
(Continued from page 7) Only after the analysts have you are a long-term inves-
the advertising power of the already done a lot of work tor, you accept in advance
newspaper was more im- will they go and meet man- that you are making no ef-
portant that the flat circula- agement, because manage- fort whatsoever to keep up
tion numbers. ment figures out very early with your benchmark or
in the conversation whether your peers on a short term
Q: You said that occasion- we already know a lot about basis. So you know in ad-
ally you will tell an analyst their business, so they are vance that every now and
they are barking up the less likely to lie. I am exag- then you will lag. We
wrong tree. Are there any gerating here, but some- lagged sometimes in the
recurring traps that inves- times there are instances 1980’s, in the early 1990’s
“Sometimes, there
tors with less experience where either they tell you we lagged as well, but then
are non-value inves- might fall into? nothing, or they tell you lies, in the late 1990’s we lagged
or they tell you things that terribly for several years.
tors who tell me, JME: It might be the impres- they shouldn’t tell you in We were still producing
sion I might have had be- the first place. We have to absolute returns, but rela-
well, I would love to cause maybe I looked at the be very careful, not because tive to our benchmark and
businesses six or eight years management deliberately to our peers we were lag-
do what you do, but before, and I was under the tries to give us inside infor- ging terribly because I had
impression that manage- mation, but sometimes, par- declined to participate in
if I did it and start
ment was intellectually dis- ticularly if we own 10% - technology, media and tele-
lagging, either my honest. In terms of man- 15% of a business, we are com, together with many
agement, of course there is the second largest holder other value investors.
boss or my share- the Buffett quip that when after a family that controls
rowing a boat - what mat- the business and we’ve held In less than 3 years, be-
holders will fire me. ters less is how strong your the stock for 7 or 10 years, tween the fall of 1997 and
arms are, what matters so management truly looks the spring of 2000, our
Of course, the an- more is whether the boat is Global Fund, which I had
at us as long term partners.
leaking. This is, of course, a run since early 1979 and
swer is you have the
metaphor for the fact that had a long term record, lost
wrong boss or Wall Street tends to pay a Q: You have often been seven out of ten sharehold-
great deal of attention to quoted as saying you have a ers. One has to live with
wrong shareholders how good the management five-year time horizon vs. that because a mutual fund
is, but Buffett has also said Wall Street’s six-to-twelve is open to subscriptions and
or both!” that he wants to buy into month time horizon – redemptions every day.
businesses that even an idiot When do you think about You don’t get to choose
could run. It is the quality, selling a stock? Especially your investors. You take
or lack thereof, of a particu- given that your performance whoever is sending the
lar business. is measured against other check. You try in your sales
mutual funds, how do you effort to explain very clearly
I could think, again because I have the staying power to what you are trying to do,
came across the stock be- remain disciplined? so that you don’t get the
fore, this is a business wrong type of investors.
where the accounting is But there are many inves-
dubious, or I could be under JME: That is a key question tors who will either not
the impression that there is – to answer the second understand what we’re try-
a major weakness to the question first – if you are a ing to do or will understand
business that may not be value investor - you are a what we’re trying to do, but
apparent immediately. long-term investor. Warren if we lag for a year or two,
Buffett did not become very they will forget about it.
rich trading securities. If (Continued on page 9)

(Continued from page 8) me. Of course, the answer ment had done much worse
There is impatience among is you have the wrong boss than Peter Lynch’s record
investors. Ideally, if you run or wrong shareholders or because they usually bought
money professionally on a both! into the fund after Peter Professor Bruce
long-term basis, you would Lynch had really hit the ball Greenwald
want shareholders in your Q: You must have experi- and then they would leave if
fund to be long-term inves- enced that, especially early for six or nine months if he Bruce C. N. Greenwald
tors, but that’s not always in your career when you was doing less well or if the holds the Robert Heil-
what happens. were with Societe Gener- market went down during brunn Professorship of
ale? that period. I hesitate Finance and Asset Man-
Incidentally, not only does whenever I meet with finan- agement at Columbia
value investing make sense, cial planners or brokers, Business School and is
at least to me, but it works. JME: That is why very early, who are our real constitu- the academic Director of
In that respect, you are late 1997, after only a few ency, because they are the the Heilbrunn Center
probably familiar with the months of net redemptions, ones who decide to choose for Graham & Dodd
piece written by Buffett – they made the decision of which mutual fund to invest Investing. Described by
“The Superinvestors of Gra- selling our investment advi- in for their own clients. I the New York Times as
ham and Doddsville” – and sory firm. They were exam reluctant to try to tell “a guru to Wall Street’s
then 20 years later, the tremely impatient. One them how to run their busi- gurus,” Greenwald is an
piece written by Louis thing is that if I look back, nesses, but it seems to me authority on value in-
Lowenstein (“Searching for we ran a total of $6 billion that they are much too vesting with additional
Rationality in a Perfect in the fall of 1997. Even worried about asset alloca- expertise in productivity
Storm”). Buffett himself though we continued to tion, they should be trying and the economics of
considered another nine make money for sharehold- to find three, four or five
information.
value investors. So then the ers, funds were down to good value managers and
question arises - why are $2.5 billion in the spring of just stay with them. Maybe
there so few value investors 2000. Today we manage they are worried that if they
if it makes sense, if the ap- close to $35 billion. So (Continued on page 10)
proach makes sense and it what I am saying here is that
works? I think the answer it seems to me that it goes
is truly psychological, and to show that if you do what
that is what I was referring you think is right for the
to when I said that if you shareholders, even if they
are a value investor, you don’t seem to agree them-
have to accept in advance selves, if you think you do
that you will lag. And if you what is right for the share-
lag, you suffer. Yes, you say holders, in the end, it bene-
to yourself, I’m a long-term fits your business from a
investor so my day will long-term point of view
come, but if it goes on too because $35 billion is not
long, it is not only the only a lot more than $2.5
doubt, but there is a genu- billion, it is also a lot more
ine suffering associated with than $6 billion. It goes back
lagging, and human nature to when Peter Lynch was
shrinks from pain. Some- running the Fidelity Magellan
times, there are non-value fund. Lynch had a superior
investors who tell me, well I long-term track record, but
would love to do what you he discovered to his dismay
do, but, if I did it and start that the great majority of Jean-Marie Eveillard answering questions after delivering the
lagging, either my boss or shareholders of the Magel- keynote address at the 15th Graham & Dodd Breakfast on Oc-
my shareholders will fire lan Fund during his manage- tober 18, 2005
Page 10
(Continued from page 9) JME: Yes, but if you look at or two or three of very
pick three, four or five value the U.S. equity market, we difficult economic and finan-
managers and stick with are in the midst of what cial circumstances, because
them, after two or three appears to be a major and if that were the case, those
years the clients will say worldwide credit crisis. In intrinsic values would be at
“What am I paying you for?” August, the crisis was identi- least temporarily too high,
fied as a sub-prime housing and accordingly, the risks
David Einhorn with his
parents at the Graham
Q: I recently read that American problem. Today, associated with our equity
Tweedy Browne opened four months later, it appears portfolio would be bigger
& Dodd Breakfast
their Global Value Fund, to be a worldwide credit than I think they are. So, to
Third Avenue International crisis, and yet the American the extent that we consider
is opening their fund, Long- stock market is 5% off its the top-down we look from
leaf is opening their Partners high at the end of the fifth a negative standpoint. What
Fund, and you just opened year of a Bull market. Ex- could screw up, from the
your Global and Overseas cept for the Tokyo stock top-down, the investments
funds. Does this mean that market, which I think is we make with a bottom-up
investment opportunities about 20% off its high, mar- approach?
are beginning to appear on kets in the U.S. and Europe
the horizon? and most emerging markets In another respect, we’ve
are very close to their high. been in a twenty-five year
JME: That is right - I saw the Combined with the fact that credit boom, since the early
press release from Third we are in the midst of a 1980’s, interrupted painfully
Avenue and I also saw the major financial crisis, it but briefly in 1990. I say
press release from Longleaf. seems to indicate that inves- painfully because at the end
Longleaf is saying “We see tors, and for all I know they of 1990 you can point to
opportunities today.” Third may be right, believe that Rupert Murdoch’s News
Avenue and we are saying we’ll get out of the crisis Corp. almost going bank-
much more that the market reasonably soon. Other- rupt until the banks, and we
is very turbulent. To para- wise, markets would be - although I made the mis-
phrase Ben Graham, Mr. much lower than they are take of buying the bonds
Market seems to be moving today. So that is why, instead of buying the stock -
from fear to greed and back. speaking very generally, we and a few others under-
Both Third Avenue and we don’t find a tremendous stood that what they had
are saying that maybe there amount of investment op- was a liquidity problem, but
will be opportunities if the portunities right now. not an insolvency problem.
turbulence continues, but Even on a conservative ba-
neither one of us is saying You know value investors sis, the sum of the parts of
we see an opportunity right are bottom-up investors, the assets was quite a bit in
today. I believe Mason but I do pay some attention excess of the debt. They
Hawkins is saying that there to the top-down. First, it simply had a temporary cash
are currently opportunities cannot be completely ig- flow problem. Also in 1990
and for all I know, he may nored. Second, the intrinsic is when Sam Zell’s real es-
be right. values we establish for the tate empire almost col-
businesses we are invested lapsed. So, we have been in
Q: Your answer leads me to in or that we consider in- a twenty-five year credit
believe that you would cur- vesting in do not assume boom with one interrup-
rently be looking at some of eternal prosperity. They tion, which is a truly long
the most turbulent areas of assume that the world mud- credit boom.
the market right now? Is dles through, which is usu-
that true and where might ally what the world does. We seem to be facing a
that be? They do not assume a year (Continued on page 11)
(Continued from page 10) investors that if I go down sense my baby. I didn’t
worldwide credit crisis. the drain, well it is o.k. as want to just leave it. In
The central banks are pedal- long as everyone else is view of the size of assets
ing as fast as they can to going down the drain with under management, it was
mitigate the damage. This is me. I think that with the odd in a way that there was
crisis number six or seven. hedge fund business, at least only one portfolio manager.
You had October 1987, you so far, the regulators have I mean myself for twenty-six
had 1990, you had the late been careful enough to basi- years and Charles De Vaulx
1994 Mexican crisis, you cally prevent the middle for two years. Of course if
had the 1997 Asian crisis, in class from getting involved you have a single portfolio “You know value
1998 the Russian crisis and with hedge funds. But in the manager and he leaves or is investors are
the Long Term Capital Man- mutual fund business, we run over by a bus, what is
agement collapse. You had have almost one-million left is a big void. Although it bottom-up
the bursting of the technol- shareholders in our funds is true that value investors,
ogy/media/telecom bubble and while we have some at least in our case, it does- investors, but I do
and now the sub-prime institutional accounts and n’t matter who has the big-
housing crisis. The odds are some very wealthy individu- gest battalions. What I pay some
pretty good that crisis num- als, the great majority of the mean is if I had forty-five
ber six or seven in twenty one-million are middle class analysts, we wouldn’t be attention to the
years will be gone in a few people. If I screw up, I can doing any better than nine top-down. First, it
months, but maybe it will make daily lives difficult. or ten, but I think it is the
take longer or maybe the Financial planners have told kind of approach where we cannot be
financial system is truly fray- stories about individuals want as many people on the
ing at the edges. who did not have a great in-house research staff and completely
nest egg, but thought they as few people as possible on
I think it is Peter Bernstein had enough of a nest egg to the portfolio management ignored. Second,
who said sometimes what retire. They invested the side.
matters is not how low the money with conventional the intrinsic values
odds are that something money managers who pro- Q: You spoke about risk we establish for
truly negative happens - and ceeded to lose 30% to 40% being the consequence, not
the odds are pretty low that between the spring of 2000 necessarily the odds. How the businesses we
the system blows up - and the spring of 2003. does this thinking come into
sometimes what matters is These people had to go your investment process? are invested in or
what the consequences back to work, or sell the
would be if it happened. boat. JME: Risk to us goes back that we consider
For example, if I tell you if to not paying attention to
you do this, the odds are I remember the day after I how one does in the short
investing in do not
one-in-ten that you will lose retired, which was January term. If you go back to assume eternal
$50, no big deal. If I tell you 1, 2005, I got up late, took a Berkshire Hathaway’s an-
the odds are one-in-one stroll in Central Park and I nual report page that has prosperity.”
hundred, even better odds felt lighter than air. The the forty-plus year record
in the sense that the risk of responsibility was off my of Buffett, on a cumulative
losing is minute, that you shoulders. That is why I basis the record is extraor-
die, then the consequences wasn’t particularly eager to dinarily better than the S&P
are so drastic that even the come back, but I had been 500, but you can spot four
odds as low as one-in-one treated very well here at or five years, I think there is
hundred are just not good Arnhold and S. Bleichroe- one year where he is 1,500
enough. der, and also there was a basis points behind the S&P
side to it where particularly 500. So he too accepts the
I think there is a mindset the old fund, which I have fact that every now and
among many professional run since 1979, was in a (Continued on page 12)
Page 12
probably an opportunity to suffer because you will lag.

buy more of the stock. The It goes back to what Buffett
key distinction is what was saying when he said
Marty calls permanent im- something to the effect that
pairment of capital, which are investing does not require
fancy words for “Damn it, I high intelligence, but it re-
made a mistake.” Not a quires some temperament.
mistake because I bought a
stock at $35 and now it is at Q: On the topic of tempera-
$27. I made a mistake be- ment - Buffett has said that
cause either my original he is “wired” a certain way.
analysis of the business was Do you think temperament
wrong or because after I is something you are born
started buying the stock, I with or a trait that can be
Jean-Marie Eveillard and (Continued from page 11) failed to observe that the learned?
David Winters at a past business model was chang-
then you will underperform.
Graham & Dodd Breakfast ing for the worse. In this JME: One way to view it is
Risk to us is absolutely not case you have to acknowl- in the U.S. and also now in
volatility. We always have edge your mistake, sell at a Europe, some people go too
this discussion with financial loss, and move on. easily to the psychiatrist,
consultants - it is not volatil- because if they do so, it
ity. Marty Whitman is un- If you think it is a temporary shows that there is an ex-
usual in a sense that there unrealized capital loss, if you pectation that they should
are not many value inves- bought a stock at $35 and be happy every day. Of
tors who were very good two or three years later it is course, it is true at the
practitioners and also could at $27, it becomes painful other extreme. You have
write from a theoretical and the great majority of people who tend to believe
point of view. Marty, in one money managers get very too easily that life is a valley
of his books, makes a key upset. But you have to ask of tears and that one can
distinction between what he yourself, “Did I miss some- only be happy in the eternal.
calls temporary unrealized thing?” If the answer is, “I The truth is in between, one
capital loss, which is you buy don’t think so,” then you has to accept the fact that
a stock at $35 and, after a have to accept that fact. one is not happy every day.
year or two or three, it is at For example, if you buy a One is not entitled to be
$25 or $30. If you think stock for $25 and four years happy every day and I think
you have done your original later it is still at $25 and in that as an investor it is the
homework before you the fifth year it goes to $50, same idea that we don’t
bought the stock in a I don’t think in terms of I need to win every day. We
proper manner, if you kept wasted my time for four just need to win over time.
reasonably close to the years or it was what some Maybe the people who say,
situation as the business investors call stale money well, I cannot afford to be a
evolves over time, and if for four years, I say hey, I value investor because my
you believe that nothing doubled my money in five boss or shareholders will
major has changed for the years and that is 15% annu- fire me, maybe they are
worse since you started alized a year and that is fine. right. But I think there is
buying the stock, that is also the idea that I just don’t
what Marty calls temporary Going back to what I was want to suffer. I remember
unrealized capital loss, saying, not that value inves- there was a movie about
which is nothing to worry tors are masochists, but that baseball called “A League of
about. If anything, it is accepting in advance that (Continued on page 13)
every now and then you will
(Continued from page 12) said there were at least 20 fund field, most of which are
analysts there. The truth is long only. Also, keep in
Their Own” where at some they do distressed investing mind that in the words of
point a woman says to Tom and you need specialized Paul Isaac, hedge funds are a
Hanks, who plays the coach, people for that. Marty has compensation scheme and “Join a value shop.
“Baseball is too hard.” Tom also decided to become that indeed a reasonably
Hanks replies something to more of an activist, which good value mutual fund is, in Keep in mind …
the effect of “Of course it’s we have done very rarely, the end, from the point of
hard. If it was not hard then takes a lot of time and en- view of the shareholder of that indeed a
everybody would be doing ergy. the funds, a very cheap
it.” It is the idea that every- hedge fund, because all value reasonably good
thing in life that is worth- Number two, and most investors, whether they are
value mutual fund
while comes hard. importantly, in the value with hedge funds or with
tent, Bruce is definitely on mutual funds, shoot for ab- is, in the end, from
Q: You recently hired Co- the Buffett side although he solute returns. If you
lumbia Professor Bruce is very tolerant. Some peo- achieve absolute returns the point of view
Greenwald as the Director ple on the Graham side are and compound at a reason-
of Research. He is one rea- intolerant of the Buffett side able rate over the years the of the shareholder
son that many of us choose and vice-versa. You know, difference between you and
to pursue an MBA at Co- Buffett has called the pure a long only hedge fund is of the funds, a very
lumbia. How do you think Graham style “Cigar Butt” that you are charging 1.25%
cheap hedge fund,
he will enhance the team investing, which is not very overall expense ratio as
you have in place at First flattering, although I remem- opposed to two-and- because all value
Eagle? ber Walter Schloss chuck- twenty. You should also
ling that he himself thought approach professors who investors, whether
JME: Bruce is sixty-one he got more than one good are also practitioners to get
years old, and I first met puff every now and then. their opinions on which they are with
him several years ago. His However, Bruce has also firms would be good for you
entire professional career introduced some refine- to join.
hedge funds or
has been in the academic ments of his own to the
with mutual funds,
world, and he was willing to Buffett side and that will be Thank you, Mr. Eveillard.
go into the real world, so to very helpful to the analysts shoot for absolute
speak, as opposed to the here. Although the in-
academic world. He was house staff here does not returns.”
intrigued by the idea of be- need to be energized, you
ing director of research and, know that Bruce is an ener-
in that respect, I think he gizing personality. So, we
will do at least two things. are looking forward to his
Number one, although of joining the team. To me, he
lesser importance, he will is the ideal director of re-
help us beef up the research search.
department because he
knows a lot of people who Q: What advice would you
graduated from Columbia offer an MBA student aspir-
Business School and were ing to enter the field of in-
enrolled in the Value Invest- vestment management?
ing Program. I never
thought I was understaffed JME: Join a value shop.
until I recently met with Keep in mind there are
David Barse who is the value shops in the mutual
CEO of Third Avenue. He fund field and the hedge
Page 14
D.R. Horton, Inc. (SHORT)

Joshua Chekofsky November 2007
JChekofsky08@gsb.columbia.edu
Investment Thesis
I advocate a short position in the common stock of D.R. Horton, Inc. (“D.R. Horton” or the Company), as
I believe the stock has an intrinsic value today of $7.25 (representing a margin of safety of approximately
40%, against today’s price of $11.86), based upon a Price / Adjusted Book Value analysis; yet, there is
risk of 15% upside ($13.75). A six-month timeframe, across which the Company will report its next three
fiscal quarters of performance, should be ample for the Company’s homebuilding fundamentals to dete-
riorate further and for management to make additional impairment announcements. The Company is
poorly positioned in the current homebuilding environment. It has significant exposure to the weakest
D.R. Horton, Inc. (DHI)
geographic housing markets, and owns some of the youngest land supply in the industry, which is at
Price: $15.43
greatest risk of loss. Sales orders have fallen dramatically, while cancellations are at abysmal levels. As
(Jan. 25, 2008)
management pursues aggressive sales to generate free cash flow to pay down its significant debt load,
operating margins will deteriorate further. With adjustable-rate mortgages continuing to re-set, the Com-
pany’s core first-time buyers will be considerably affected. D.R. Horton will be required to take exten-
sive further impairments on its inventory (homes, land and options). Housing market conditions will
continue to be challenging and the timing of a recovery is unclear. The industry is currently mired in a
deep cyclical trough, which will likely persist for the foreseeable future. There will be continued margin
pressure from increased price reductions and sales incentives, continued high levels of new and existing
homes available for sale, weak demand for new home as potential buyers continue to see home prices
adjust downward, increased sales cancellations, continued weak housing affordability, and a decline in
the availability of mortgages due to further credit tightening. The formerly hottest housing markets are
now reeling, a growing number of foreclosed homes will be returning to the market, a sizable level of
mortgage loans will continue to default, and it will now take an elongated timeframe for the average
home buyer to receive a mortgage. The primary valuation was based upon a Price / Book Value method-
ology, in which book value was adjusted for anticipated substantial further asset impairments. A 0.75x
multiple (given investors’ weak confidence and the turmoil in the industry) was allocated.
Supporting Points / Catalysts

• Any further negative economic and industry performance releases will lead to a de-
crease in the Company’s stock price.
• The Company recently reported that cancellations increased to 48% in the 9/30/07
quarter, which is dramatically higher than the 30% to 40% in prior quarters. The Com-
pany’s backlog no longer provides accurate visibility on future revenues. Cancellations
should continue to remain at heightened levels.
• D.R. Horton has significant exposure to the weakest geographic housing markets in-
cluding California, Arizona, Nevada and Florida. Moreover, the Company maintains a
very young land supply, relative to other home builders. This land which was purchased
in 2005 and 2006 in formerly hot markets is at significant risk of impairment.
• D.R. Horton has a heavy debt load. Any further deterioration in performance could
lead to debt downgrades, and extensive impairments will reduce the borrowing base.
This leads to broken financial covenants and lower liquidity.
• D.R. Horton’s target customer base has been greatly affected by tightening in the mortgage market, as
the Company’s focus is on first-time buyers and first time move-up buyers (with most homes priced
below $250,000).
D.R. Horton is the largest homebuilding company in the country based on homes closed during the 12
months ended 6/30/07. The Company constructs and sells homes through its operating divisions in 27
states and 83 metropolitan markets. Homebuilding operations include the construction and sale of single-
family homes with sales prices generally ranging from $90,000 to $900,000, with an average closing
price of $261,600 during the nine months ended 6/30/07. Approximately 80% of home sales revenues
were generated from the sale of single-family detached homes in the 9 months ended 6/30/07, with the
remainder from the sale of attached homes. DHI Mortgage, a wholly-owned subsidiary, provides mort-
gage financing services to purchasers of homes it builds and sells.
Historical and Projected Performance

The Company’s performance has deteriorated over the last several quarters. Sales and operating margins
for the homebuilding operations have dropped precipitously, and results for the financial services busi-
D.R. Horton, Inc. (Continued from previous page)

ness have followed in concert. The Company has aggressively moved towards selling its inventory, to work “Sales orders
down the glut of supply, which has lowered its average selling price and operating margins. The fall-out
from the exuberant rise in homebuilding activities will take time to work its way through the system. Until have fallen dra-
the demand/supply imbalance is corrected and selling prices stabilize, performance will continue to be de-
pressed. Further compounding the problem, the Company will very likely have to recognize significant matically, while
additional impairments on its inventory (homes, land and options), as management realizes that losses will
be worse than expected. It is assumed that industry fundamentals will remain weak across Q4 2007 and FY cancellations are
2008, and that the situation won’t stabilize until 2009. Revenue and margins are projected to improve in
2009, towards the levels reached in the earlier part of this decade. at abysmal lev-
Valuation els.”
Given the weak recent EBIT growth, poor pre-tax
ROTC, and heavy debt load, the EV/EBIT valua-
tions produce low intrinsic values. The historical
EV/EBIT analysis produces a value of $5.45 to
$9.30. The Projected EV/EBIT analysis produces a
value of $6.20 to $8.60. A more robust approach for
this inventory-intensive business is a Price / Ad-
justed Book Value analysis, which produces a target
price of $7.25. Impairments on homes is driven by
the perception that 20% of the 6/30/07 homes inven-
tory book value is at risk, as D.R. Horton has ag-
gressively moved towards price slashing, which
may create a price-cutting war. The Company’s core
first-time buyers are seriously affected by the recent
credit crisis. The estimate for the decline in homes
inventory is estimated to be negative 20%. The level
of impairments on the land (held for development,
under development, and in development) is assumed to be triple this dollar amount, as land prices change at
three times the price of homes, given that the Company prices land on a residual basis, after development
and construction costs. Options on land/lots are assumed to be worthless, as these contracts were entered
into at the peak of the real estate boom. The impairments are tax-effected at a discount to the 37.5% tax rate, “A more robust
given the risk and elongated timeframe to reap the deferred tax asset benefits. With the current turmoil in
the housing sector and the lack of investor confidence, it is assumed that the market will allocate a 0.75x approach for this
multiple. An upside risk scenario is also calculated.
inventory-
Risks to Thesis: The prices of homebuilder stocks have fallen substantially already this year, and any posi-
tive national economic activity news, housing industry news, or peer earnings releases could spur an upward intensive busi-
bounce in stock prices. The level of housing starts (i.e., new construction activity) has already decreased
significantly from levels in previous years as homebuilders have shifted focus towards working through the ness is a Price /
excess supply of inventory on the market. Although the Company has high leverage, the majority of the debt
does not mature for a few years, and D.R. Horton has been generating strong cash flows from operations Adjusted Book
recently, albeit through very aggressive pricing and weak gross margins. A significant decline in long-term
interest rates (and correspondingly in mortgage rates) would increase housing affordability, as well as lead Value analysis,
to inventory burn and a return to price appreciation.
which produces
a target price of
$7.25.”
Page 16
Macy’s, Inc. (NYSE: M) Long

Del Anderson, CFA
DAnderson08@gsb.columbia.edu
Current Price (1/25/2007): $22.47

Intrinsic Valuation Range: $37.00 ($34.00 - $45.00)
Margin of Safety: +60% (base case)
Thesis Summary: Macy’s is a long because of:
Horizon mismatch: Macy’s shares have been punished due to slow sales growth at rebranded May stores; however, the
near-term focus of many analyst models fails to capture a “sweet spot” in which sales growth normalizes at these stores
throughout 2008 and beyond, improving returns and turnover.
Impact: True demand in new markets is presently undervalued
Downside Protection: Recent investments in revenue optimization systems and “service culture” will improve margins in
the event of a full-blown downturn, while Macy’s ownership of most of its stores provides a tangible floor of $14 for the
stock price. Additionally, middle-market retailers (including Macy’s) have outperformed both lower- and higher-end peers
significantly during each of the past three Fed easing cycles.
Impact: Sensitivity to downturn low relative to peers
Total Enterprise Value Calculation
Stock buyback: Macy’s repurchased 22% of shares outstanding Share Price (01/25/08) $22.47
in 2007 out of strong free cash flow, and has made a commit- x Shares Out. 433.0
ment to maintain its investment grade rating while repurchasing = Market Capitalization ($MM) $9,729
~5% of shares during the coming year. In retrospect, Macy’s + Net Debt 10,456
could have purchased some shares at lower rates, but it still = Total Enterprise Value (TEV) 20,185
represents a long-term positive for equity holders given that
EV/EBITDA 5.6x
shares were purchased well-below my intrinsic valuation.
Impact: EPS to be amplified 5%+ as share count contracts 52-Week High $46.51
52-Week Low $21.31
Bottom line: Macy’s may decline modestly with retail peers in the
near term, but this represents a buying opportunity. Over two-year Forecast & Consensus
horizon, Macy’s will be a strong outperformer from current levels. EPS P/E Concensus
Current* $2.18 10.3x $2.19
Background:
FY' 2009 $2.41 9.3x $2.37
In late 2005, Federated Department Stores (now Macy’s) acquired
FY' 2010 $2.72 8.3x $2.62
a key competitor, the May Company, doubling its store count in
largely untapped markets and adding 15 new states to its territory, FY' 2011 $3.03 7.4x $2.90
making it a truly national brand. Subsequently, the firm has real- *Current (FY' 2008) ends on 1/31/2008
ized administrative synergies in excess of initial plan but sales Valuation Methodologies
growth at rebranded stores has lagged. Free Cash Flow to Equity (base case) $37.00
Private Market / Reproduction Value >>$35.00
Market Misperception:
Comparable Multiples (14x Fwd P/E) $34.00
Macy’s shares declined throughout 2007 on recession fears and
concerns about poor performance at acquired stores. In one sali- Liquidation Value $15.00
ent example, former Marshall Field’s shoppers in Chicago began Upside FCFE: $45.00 +100.3%
boycotting rebranded Macy’s stores; however, I believe it won’t be Downside FCFE: $18.00 -19.9%
long before these protesters trade their picket signs for Macy’s Upside / Downside Risk Ratio 5.0x
cards. At present, sales at “new Macy’s” stores are lagging be- Retail Malaise & Post-Merger Comps Hurt Macy's in 2007
cause shoppers are not used to Macy’s promotional style (no 20%
coupons), sales associates are unaccustomed to Macy’s brands 10%
and regional merchants have not fully adapted Macy’s product 0% Retail Peer Group
lines to local consumer tastes. All of these issues are temporary.
-10%
On the operational front (gross margin, SG&A expense, systems
integration), Macy’s has delivered as promised by the merger. -20%
Thus, I believe that the first evidence of a sales revival at the -30% -32%
new stores will be a strong positive catalyst for the company. -40%
Macy's, Inc. -37%
-50%
Nov 2007
Jan 2007
Jun 2007
Jul 2007
Jan 2008
Feb 2007
Mar 2007
Apr 2007
Aug 2007
Sep 2007
Dec 2007
May 2007
Oct 2007
Macy’s, Inc. (Continued from previous page)

To test the impact of the current sales drag, I modeled sales by region and store type based on growth projections using
pre-merger sales data. Assuming a conservative -10% sales drag at the rebranded stores, Macy’s revenues will be impaired
by $1.1 billion during 2007. However, this bodes well for the future, since it means that current sales numbers are temporar-
ily suppressed. As customers adapt to Macy’s strategy, the sales drag will narrow and total sales will increase rapidly in
2008 and beyond. The table below forecasts sales for Macy’s major divisions, with an estimate of the gap between new
and legacy stores. The sales growth estimates for legacy divisions are conservative and well-below Macy’s historic organic
growth rate of 4.3% over the past seven years.
Sources of Macy's Sales Growth CY
(Legacy v. May stores) 2006 (A) Growth (%) 2007 (E) Growth (%) 2008 (E) Growth (%) 2009 (E) Growth (%) 2010 (E)
Bloomingdales 2,317 6.0% 2,456 3.0% 2,530 4.0% 2,631 3.5% 2,723
Macy's East 7,193 2.5% 7,373 2.0% 7,520 2.0% 7,671 2.5% 7,862
Macy's West 6,002 3.0% 6,182 2.0% 6,306 2.0% 6,432 2.5% 6,593
Macy's South & Florida 5,564 -5.0% 5,286 -1.5% 5,207 2.0% 5,311 2.5% 5,443
Macy's Central & Midwest 5,444 -2.0% 5,335 0.0% 5,335 2.0% 5,442 1.0% 5,496
Macy's.com 450 50.0% 675 25.0% 844 20.0% 1,013 15.0% 1,164
Less: Lag from legacy May Stores* 11,601 -11.4% (1,105) -5.6% (416) -4.4% (217) -3.7% (147)
Total Revenue Projection 26,970 -1.5% 26,564 3.4% 27,471 3.4% 28,392 2.9% 29,135
* Sales growth lag relative to growth rates at legacy stores.
Scuttlebutt Research Support:

Interviews with buyers at Macy’s and Bloomingdales, visits to rebranded stores and some entertaining hours online reading
blog posts and online consumer chatter about Macy’s brand yielded several key insights:
1) According to buyers, sales at rebranded stores are lagging legacy stores by ~10% overall and up to 20% in some re-
gions, although sales of exclusive brands (inc. Martha Stewart) were strong companywide. Over the holidays, the gap
between legacy and rebranded stores declined.
2) Rebranded stores have the potential to deliver results on-par with legacy Macy’s stores. Longtime May employees be-
lieve that their customers are no different from Macy’s target customers, so localization strategy should yield results.
3) Consumers’ online sentiments are getting better. One enlightened poster even noted that “My rage at the Marshall
Field's takeover diminished when I visited Macy's…. To my surprise, they retained many MF touches. I’ve seen nothing
but improvement in the store.”
Industry Analysis:
Retail stocks are out-of-fashion at the moment, creating a buying opportunity for the shares of several companies (Macy’s,
Nordstrom, JCP); however Macy’s is particularly well-suited to outperform given that its stores are less-concentrated in the
bubbliest housing markets and that under 15% of sales come from home essentials. As a purveyor of reasonably-priced
quality brands, Macy’s stands to benefit in a downturn relative to higher-end peers (i.e., pinched Saks/Nordstrom shoppers
would feel comfortable being seen at Macy’s).
As of 1/25/2007 Volume Valuation Leverage Operating & DuPont Metrics
Enterprise Total Sales Price/Earnings EV / Price / FCF Dividend Debt/ Interest S&P Gross Oper. Sales Asset Equity
Company Name Value Sales Growth Current Forward EBITDA Book Yield Yield Assets Coverage Rating Margin Margin ROE Margin Turnover Leverage
Macy's Inc. (M) 21,973 26,878 (1.8) 12.0 10.8 5.6 1.2 4.5 1.9 36.2 4.7x BBB 40.2 8.3 10.2 = 3.3 1.0 3.1
Peer Summary Analysis % x x x x % % % x % % % x x x
Median 13,248 17,336 6.7 16.3 14.3 7.9 2.5 -3.4 0.9 25.0 6.6x - 32.2 7.37 20.5 4.2 1.6 2.7
Target Corp. (TGT) 57,380 63,207 11.4 15.7 14.2 9.0 2.8 -0.1 0.9 32.7 4.2x A+ 30.2 8.5 19.0 = 2.2 1.6 2.7
Sears Holdings Corp. (SHLD) 20,322 51,777 (2.0) 19.8 23.2 6.0 1.3 6.9 0.0 13.6 8.9x BB 26.3 4.1 10.9 = 0.9 1.7 2.8
Kohl's Corp. (KSS) 15,560 16,417 10.9 12.6 11.6 6.8 2.6 -3.2 0.0 20.0 10.9x BBB+ 34.2 11.6 20.4 = 3.7 1.6 1.9
TJX Cos. (TJX) 14,371 18,256 7.5 17.0 14.9 9.6 6.5 5.0 1.1 12.4 25.5x A 24.1 6.2 26.6 = 7.1 2.8 3.2
J.C. Penney Co. Inc. (JCP) 12,124 20,134 3.6 9.7 9.9 5.5 2.2 -3.5 2.3 27.3 4.2x BBB- 37.1 9.5 33.1 = 4.7 1.5 3.1
Nordstrom Inc. (JWN) 10,842 8,945 8.7 13.5 12.3 7.3 6.8 -4.6 1.3 38.1 15.9x A- 37.6 10.7 45.0 = 2.3 1.8 4.2
Saks Inc. (SKS) 3,169 3,238 15.5 40.9 30.2 14.4 2.3 -27.8 0.0 24.6 1.5x B+ 36.2 2.2 2.8 = 5.8 1.2 2.2
Dillard's Inc. (DDS) 2,940 7,441 (1.8) 28.1 54.2 5.6 0.6 -7.1 0.8 25.5 1.1x BB 29.5 0.6 6.6 = 8.2 1.2 2.4
Source : FactSet Daily Prices, Capital IQ, Reuters Global Fundamentals, First Call Estimates
History also suggests that the freefall of retail stocks may be nearing its nadir. During the
past two consumer downturns (1990, 2001), general retail stocks fell ~40% from peak-to-
trough and they reached bottom within a month of the official start of the recession. Macy’s
shares hit a cyclical low three months before the 2001 recession after falling 50% during
the preceding year. Such statistics are meaningless from a fundamental perspective, but
they do suggest that the majority of the losses associated with a recession may be re-
flected in Macy’s share price already.
Page 18
Short Netflix (NFLX) at 21.75 — Price target $16
Avram Drori November 2007

ADrori09@gsb.columbia.edu
Netflix (NFLX)
Price: 21.75
(Jan. 25, 2008)
Investment Thesis:
Simply put there is no reason for Netflix to exist. The business model is fundamentally anachronistic
and the company is destined to become a marginal player within the medium term. Cable, satellite
and telcos have achieved penetration rates of advanced video on demand services in ~75% of their
cumulative territory, implying ~65% of American Households can watch video on demand (VOD).
VOD has incremental costs of essentially nil and the immediate gratification provided by the model is
superior to Netflix’s 1 day turnaround. Additionally, the company has been late to recognize this and
continues to spend money to attract new customers. The economics of new customer growth are ex-
“Simply put tremely unattractive and as customer usage of the service declines, there will be a self-selection proc-
ess whereby only the heaviest users of the service (and therefor the most costly to the company) will
there is no rea- maintain their service. Due to stagnating growth and shrinking margins, I have assigned a price target
of $16, representing ~30% downside from current levels. However, because of the high short position
son for Netflix to (~24% of float) and the relatively volatile nature of the stock (beta=2.2) there is a meaningful risk of
short term trading losses due to potential short squeezing and the stock could trade up to $25 (15%),
exist. ” but given the poor fundamentals, I expect any uptick in the stock to be a temporary trading move, not
a fundamental revaluation with the ultimate downward catalyst coming when they announce Q4 num-
bers and the damaging impact of their new marketing strategy and unattractive incremental sub eco-
nomics flows through to their financials.
Company Overview:
Netflix provides online subscription ser-
vices for DVD’s. Customers log on to
their website and select movies or TV
shows they would like to watch and the
company ships out the DVD’s to the cus-
tomers via US Postal Service. There are
no late fees and the company has several
pricing plans and fee structures but their
most popular allows for unlimited rental
per month, with up to 3 DVD’s at a given
time for $16.99/mo. No pricing plan
charges late fees.
Investment Thesis:
*The company has already experienced
their strongest growth phase. The initial
ramp is rolling off and revenue should peak in ’08. Management is seeking to initiate a second stage
of growth where they will attempt to distribute videos online. The company will not be successful in
this endeavor because they have no competitive advantage (and importantly, unlike MSO’s and tel-
cos, they don’t own the pipes into consumers homes and ISP’s can prioritize their traffic over NFLX
downloads). Additionally, the company lacks sufficient scale with content producers to negotiate
favorable on-line distribution terms.
*The subscriber economics are becoming increasingly unattractive. Because the company
continues to spend aggressively on both attracting new customers (SAC continues to rise and
Netflix (Continued from previous page)
even if management gets it under

control, the levels are unsustain-
able) and continued churn
make per sub economics dilutive
to the overall company. Manage-
ment could throttle back on
SAC and milk the company for
cash flow and possibly generate
meaningful cash flows, but they
have given no indication of their
willingness to do this.
*The eventual emergence of a “Based on the

new DVD technology will in-
crease the costs associated with fundamentals of
meeting customer needs. For the
medium term (until a winner in the HD-DVD/Blu-Ray format conflict emerges) the company will have the company and
to purchase both formats, as well as traditional DVD formats. This will squeeze margins and I estimate
an incremental 300 bps of margin compression from this dynamic. deteriorating
subscriber eco-
Valuation:
*A $15 price target is based on a (generous) 8x multiple off ’08 EBITDA-an analysis of variation nomics the long
around multiples demonstrates the potential conservatism of this estimate
term prospects
*Based on the fundamentals of the company and deteriorating subscriber economics the long term
prospects of the company are poor. From a trading perspective the stock is volatile and the of the company
position could see upward pressure, but long-term downward catalysts should come when
damaging impact of the company’s marketing efforts flow through in Q4 numbers. Additionally, are poor.”
continued price wars with Blockbuster and Wal-Mart will provide an inevitable downward
catalyst (these price announcements have occurred every few months for the past two years).
* My $15 price target is based off an ’08 P/E of 18 (weighted 40%), an ’08 EBITDA multiple of 8x
(weighted 40%) and potential for near term trading up to $25 (weighted 20%) to achieve the $16
level.
Page 20
“Innovations in Investing” — Industry Networking Night and Panel

Industry Networking Series Greenwald, who is the observation is that “the big
with Professor Bruce Robert Heilbrunn Professor are getting bigger.” As an
Greenwald, William Von Muef- of Finance and Asset Man- example, he observed that
fling (’95), and David Green- agement at Columbia Busi- hedge fund firm Citadel cur-
“There is no
span (‘00) ness School and Director of rently has 86 investment
‘hedge fund’ indus- the Heilbrunn Center for professionals on the ground
On October 30th, over two Graham and Dodd Invest- in Asia. The next five of von
try that exists hundred students, alumni, ing. Mueffling’s observations
and faculty filled every spare included:
separately from square inch of the large hall Mr. von Mueffling kicked off
at the Columbia University the discussion with a Letter- • Given the explosive
the ‘money man- Club of New York on West man-style list of observa- growth of alternative asset
43rd Street for a night of tions on major changes in classes, investment manag-
agement’ indus-
learning and networking. the investment industry. ers must employ more
try.” sophisticated risk manage-
Professor Bruce Greenwald He began with a question: ment processes.
—William von opened the panel discussion Which asset class do you • Pensions and endowments
by contrasting the evening’s think has grown the most in are now among the largest
Mueffling enthusiastic crowd with a the last three years? People investors in hedge funds.
somewhat different audi- shouted out answers, which • Some alternative invest-
ence. “No one sat in the ranged from index, interna- ment strategies are al-
front row,” he observed, “at tional, and various hedge ready obsolete, such as
my executive seminar at fund strategies. The answer convertible arbitrage, sta-
Harvard Business School.” was a strategy he termed tistical arbitrage, and
Indeed, it was standing “low octane alpha”— macro.
quantitative investing strate- • Long/short equity is large
gies that deliver roughly a and growing but offers a
few hundred basis points of lot of market correlation,
excess return over a market whereas some firms
benchmark. (including Cantillon) offer
their clients “pure alpha.”
Next, on a related note, von • John Paulson’s success in
Mueffling pointed out that shorting the sub-prime
clients are more sophisti- mortgage market demon-
cated than in the recent strates that securitization
past. “The customer base (and other forms of finan-
knows the difference be- cial innovation) creates
tween alpha and beta, which
opportunities for alpha.
is an important change.” • Investors’ return expecta-
Third, Mr. von Mueffling tions are out of touch
David Einhorn and Whitney room only to hear a panel advised that the distinction with the reality of today’s
Tilson discussion on innovations in between hedge funds and market. Underscoring this
investing, featuring former traditional buy-side firms point, Mr. von Mueffling
students William von Muef- may no longer be valid. observed that equities
fling (’95), founder, Presi- “There is no ‘hedge fund’ have returned an average
dent and CIO of Cantillon industry that exists sepa- of just 3.5% per year since
Capital and David Green- rately from the ‘money 1998 (excluding divi-
span (’00), Managing Direc- management’ industry—
tor at Blue Ridge Capital. dends).
they are one in the same.”
The panel was moderated
by Professor Bruce Mr. von Mueffling’s next (Continued on page 21)
“Innovations in Investing” (continued from page 18)

(Continued from page 20) or bad fundamentals, the
Mr. Von Mueffling closed his more likely you are to dis-
remarks with some advice cover an instance of hard
for MBAs aspiring to a ca- wiring.”
reer in investment manage-
ment. “Don’t ask about
compensation—prove your- Second, Greenspan dis-
self first.” Asking about cussed the virtues of ex-
compensation, he quipped, ploring investment opportu-
“is an immediate disquali- nities in nontraditional ar-
fier.” eas, such as in developing
countries or asset-backed
Next, David Greenspan securities. Regardless of the
shared his thoughts on terrain or subject area,
t h r e e c o m m o n Greenspan advised the audi- particularly important for Jean-Marie Eveillard and Pro-
“ingredients” in his most ence to “think about unique realizing investment oppor- fessor Bruce Greenwald
successful investment ideas: elements that you can bring tunities.
to the table.” He also ob-
1. Identifying Instances of served that nontraditional First, intangible assets.
“Profit levels around the “Opportunities are
“Investor Hard Wiring” areas often involve com-
2. Exploring Nontradi- plexity, which can create world are higher than ever, local in nature.
tional Areas opportunities for investors.
but are they sustainable?” Recognize that,
3. Elongating the Search Professor Greenwald sug-
Finally, Greenspan suggested
Process that he has benefited by gested that one cannot an- and fetch informa-
lengthening his search proc- swer this important ques-
Mr. Greenspan summarized tion without first under- tion that is un-
the first ingredient by point- ess for uncovering new in-
vestment ideas. “I am con- standing the intangible as-
ing out that, “When inves- sets, such as organizational available to most
tors stop thinking, it creates stantly filtering the world,
looking for signposts of in- capital, that are associated investors.”
opportunities to make with service-based indus-
money.” For example, in vestor hard wiring or com-
plex—and therefore poten- tries. According to —Prof. Bruce
2004, Greenspan and his Greenwald, the world is not
colleagues noticed that Fiat tially misunderstood—
situations.” Ultimately, yet sophisticated in judging Greenwald
was one of the least recom- the worth of intangible as-
mended stocks in Europe. In Greenspan’s goal is to find
opportunities with a lack of sets, which creates opportu-
general, the automotive nities for investors.
sector had fallen out of fa- economically motivated
vor, and investors com- buyers and sellers.
Second, franchise value.
plained that Fiat’s balance “Opportunities are local in
sheet was in disarray. In Professor Bruce Greenwald
wrapped up the panel dis- nature. Recognize that, and
2005, the company hired a fetch information that is
new CEO who embarked cussion with a series of
comments on ways inves- unavailable to most inves-
on a series of positive re- tors.”
structuring efforts. How- tors can generate alpha in
ever, at the time, investors today’s market. His com-
ments were united by a Third, growth. “Investors
failed to appreciate these frequently misjudge the
developments, which cre- common theme: know
(exactly) what you are buy- value of growth—it is simply
ated an opportunity for done wrong.”
Greenspan. In summary, ing. In particular, Professor
Greenspan noted, “The Greenwald outlined three
types of knowledge that are -G&Dsville
longer the period of good
I, Issue
Volume II, Issue21 Page 22
The Heilbrunn Center Goes to India

spent two weeks in January
traveling across India to discuss
Value Investing, Globalization,
Corporate Social Responsibility,
and Competitive Strategy with a
number of Indian business
audiences. Professor Greenwald
began his tour of India speaking
at the Corporate Governance
and Social Responsibility
Conference organized by The
Chazen Institute of International
Business at Columbia Business gave a talk on Globalization to
School. approximate 50 professionals at
the Ahmedabad Management
The discussions focusing on Association. Greenwald then
value investing began in earnest traveled to New Delhi, where
before a room of over 170 he was a panelist at an investing
individual and institutional forum sponsored by Reliance
investors in Mumbai. The Mutual Funds, a large mutual
seminar was organized by local fund company in India. There,
investors Chetan Parikh of he discussed the importance of
Jeetay Investments, Sanjay Bakshi local/regional economies of scale
of Tactica Capital Management in building defensible business
and Dhananjay Lodha. models and encouraged Indian
Greenwald conveyed Columbia’s companies to pursue regional
modern view on Graham and strategies that can leverage the
Dodd Investing – speaking to the economics of large fixed cost
audience about valuing growth in infrastructures. Throughout the
terms of return potential and trip, Professor Greenwald met
not paying for growth in with several Indian companies,
businesses where franchises do including pharmaceutical
not exist. He pointed to companies, retail companies
commodities such as steel or textile manufacturers, financial
cement as examples of such services institutions, private
businesses. We hope that the investors, real estate
late January decline of the Indian development firms and noted
stock markets is uncorrelated to that he was impressed by the
Professor Greenwald’s January quality of management within
8th remarks about not the companies and enjoyed their
overpaying for non-franchises discussions about strategy.
and that exercising valuation -G&Dsville
discipline is as important in India
as in any other global market.
The Heilbrunn Center for Graham & Dodd Investing is a
During his next stop, Professor If you have questions or ideas premier knowledge center for the practice and theory of
Gre e n w al d t au gh t Va lu e about other international activities, investing. Building on Columbia Business School’s re-
Investing at the Indian Institute please contact the Heilbrunn nowned history in value investing and finance, the center
furthers new developments in investing and imparts the
of Management- Ahmedabad to Center at: original principles of Security Analysis authors Benjamin
approximately 40 students and valueinvesting@columbia.edu. Graham and David Dodd.
Get Involved:

New York, NY 10027
Name: _____________________________

http://www.gsb.columbia.edu/
E-mail Address: _____________________________
Business Phone: _____________________________

Contact us at:

3022 Broadway
New York, NY 10027
Volume II, Issue 2 Summer / Fall 2008

Inside this issue:
Joel Greenblatt p. 9 Making Heads and Tails of Mohnish Pabrai

Visiting the Oracle p. 10 Mohnish Pabrai launched Pabrai by the Indian approach called
Funds in 1999. Less than a dec- Dhandho. When asked about
Pershing Square p. 14 ade later, Mr. Pabrai’s name is his investment philosophy, he
Challenge often mentioned in the same often repeats the mantra
breath as legendary value inves- “Heads I win, tails I don’t lose
tors who have been in the busi- that much.” Graham and
The Winning Pitch: p. 16 Doddsville was lucky enough to
ness for decades. The Pabrai
NutriSystem sit down and delve deeper into
Funds annual shareholder meet-
ing has become a stop on a Mohnish Pabrai’s investment
11th Annual CIMA p. 18 value investing tour that in- philosophy.
Conference cludes the annual meetings of
Berkshire Hathaway, Wesco, Question: How did you get
Advice from The p. 21 and The Sequoia Fund. He is started with value investing?
Oracle also a frequent guest of
Bloomberg, CNBC, and The Mohnish Pabrai—Pabrai Funds Until I was 30 years old, frankly,
Value Investing Congress. I had never heard of Mr. Buffett.
spent the afternoon of July 25 I had never heard of value in-
Editors:
In 2007, Mr. Pabrai published his with their mentor. vesting. This was 1994 and I
second book, The Dhandho In- was vacationing in London with
David Kessler vestor, which is quickly becoming In April, Mohnish made his first my wife. I was looking for
MBA 2008 a ‘must read’ for all value inves- appearance at Columbia Busi- something to read on the flight
tors. Last year, along with Guy ness School where he appeared back to Chicago, and I picked up
Charles Murphy Spier, manager of Aquamarine as the guest lecturer in Profes- one of Peter Lynch’s books. I
Fund, Mr. Pabrai was the highest sor Bruce Greenwald’s Value am an engineer by training, so
MBA 2009
bidder in an eBay auction for Investing Seminar. Mr. Pabrai’s this was a different field for me.
lunch with Warren Buffett. investment style has not only I read that book on the flight
David Silverman With his daughters sitting on been influenced by Benjamin and I loved it. It made all the
MBA 2009 either side of Buffett, Mr. Pabrai, Graham, Warren Buffett, and sense in the world to me, in
Mr. Spier and their families other value investors, but also (Continued on page 2)
Contact us at:
Graham and Doddsville Celebrates the 75th
Visit us at:
Anniversary of Graham and Dodd’s Classic
Welcome back to Graham and cation of the sixth edition of eration of investors who follow
www.gsb.columbia.edu/students/ Doddsville! The summer has Security Analysis. This edition the framework set forth by
organizations/cima/ come to an end, and a new comes as we celebrate the 75th Graham and Dodd. This issue
school year has begun amidst anniversary of the first edition, is no exception, and we are
the largest shake-up on Wall published in 1934. Professor especially pleased to present an
Street since the Great Depres- Bruce Greenwald continues interview with Mohnish Pabrai
sion. While the times have Columbia’s rich tradition of of Pabrai Funds.
changed, the original tenets of value investing as co-editor of
Columbia Business School Pro- the new edition along with Jim Inside you will learn from inves-
fessors Benjamin Graham and Grant and Seth Klarman. tors such as Warren Buffett,
David Dodd remain the same. Joel Greenblatt, Bill Ackman,
Graham and Doddsville strives Rich Pzena, Daniel Loeb, and
Along with the new school year, to bring you insight and infor- many others. We are also
September also marks the publi- mation from the current gen- (Continued on page 2)
Page 2
Graham And Doddsville Celebrates… (continued from page 1)

proud to feature Shilpa Marda’s
winning pitch from The First
Annual Pershing Square Chal-
lenge.
This year promises to be an

exciting one for all investors.
We will continue to bring you
insights from some of the most
prominent citizens of Graham
and Doddsville. If you have any
comments or suggestions, e-mail
us at:
newsletter@grahamanddodd.com.
Go online to find this and past

issues of Graham and
Doddsville, as well as other
resources from CIMA: Erin Bellissimo, co-director of the Heilbrunn Center, and
professor Dan Kruger, Professor of Distressed Value In-
http://www0.gsb.columbia.edu/ vesting catch up at the 11th Annual CIMA Conference
students/organizations/cima
Mohnish Pabrai (continued from page 1)

terms of how to and how not The thing that I found very ‘winging it’. That is how I saw
“The thing that I to invest. I thought this was an strange was that if there is such mutual funds work – they were
interesting area and I wanted a thing as the laws of investing, just winging it, or they come up
found very strange to know more about it, so I Warren Buffett has pretty with any nuance or ‘flavor of
found that Peter Lynch had much laid them out. What I the day’ they want to pursue. I
was that if there is another book and I read that couldn’t understand was that had a thought that if novices
one too. I wanted to learn when I looked at the entire like me simply adopted Buffett’s
such a thing as the even more, but I ran out of mutual fund industry at the approach and invested in the
Peter Lynch books to read. I time, which were the profes- equity markets with a concen-
laws of investing, remembered that in one of the sional managers that I had ex- trated portfolio, etc. that I was
books, Peter Lynch mentioned posure to, I saw that these guys likely to do better than most of
Warren Buffett has Warren Buffett and told a not only did not follow the the industry professionals. So I
story of how Buffett had called fundamental laws of investing, said it was worth testing this
pretty much laid him to get his permission to but most of them didn’t even hypothesis out. I was lucky at
use a quote. This was the first know what they were. At the the time in 1994; I had about
them out.” time I had ever heard of War- same time, their results re- $1 million in cash. I had just
ren Buffett. I figured since flected sub-par performance. sold some assets of my busi-
Lynch was talking to Buffett, I So I thought there must be a ness and I decided to go ahead
should learn more about who correlation between these guys and manage that in a Buffett-
Buffett is. I looked around, and not following the rules and style concentrated portfolio,
found the first two biographies having poor performance. buying things I understood, etc.
that had just been published: That is how I got into value
Lowenstein’s The Making of an The second thing I found very investing.
American Capitalist and Hag- strange was how you can have
strom’s The Warren Buffett an entire industry which does Question: You have man-
Way. I read those books and I not function with a solid frame- aged Pabrai Funds since
just had an epiphany. They work. To me, it is like people 1999. That must have
resonated strongly with me. doing brain surgery by just (Continued on page 3)
(Continued from page 2) Question: Where do you is in fact a good invest-

been quite a time to open a hunt for your ideas? ment?
value fund.
“What I couldn’t
When I look for ideas, I look in After I identify an interesting
Actually, 1999 was very inter- places like the 52-week-low company, I begin to drill down understand was
esting. I think it was a great list, Value Line, as well as stocks reading the 10K’s and 10Q’s.
time to start as a value investor with low P/E ratios, low P/B When I first come across a that when I looked
because the market in 1999 ratios, or large discount-to- business, I generally ask myself
and 2000 had segregated. As a book value. Now I have Joel within the first few minutes: Is at the entire mutual
matter of fact, on the day that Greenblatt’s Magic Formula; I this something I understand
the NASDAQ hit its peak, look at that on a daily basis as well? Is this a relatively fund industry at the
Berkshire hit its 52-week low. well. I also subscribe to Portfo- straight-forward business to
What happened is that a lot of lio Reports, published by Out- understand? If I am not getting time… I saw that
money had gone into these standing Investor Digest, which a clear idea in my head of how
frothy dot-com type stocks, gives a listing of all the buying the business works and how it these guys not only
but effectively it had come out of major value investors every makes money, then I will gen-
of brick-and-mortar, normal few weeks. I also look at 13F erally stop and move on to the did not follow the
businesses. A lot of brick-and- filings of the usual suspects next business. In fact, I often
mortar, real-world businesses such as the Fairholme Fund, move on if I can’t answer that fundamental laws
were trading really cheap. So it Marty Whitman, Einhorn, and question right way. So the first
was actually a great time to go all of those folks. That is basi- question you have to ask your- of investing, but
into the equity markets as long cally where I go fishing. self is: In general, is this a busi-
as you didn’t drink the same ness I can understand? I made most of them didn’t
Kool Aid that everyone else Question: What are char- an investment in 2001 in a
was drinking. In fact, after acteristics of the compa- company called Stewart Enter- even know what
Pabrai Funds’ first year, in June nies that attract you? prises which is in the funeral
2000, we were up approxi- services business. I can under- they were. At the
mately 38% after fees. Then In general, I look for industries stand that business. You bury
the second year we were up by with a slow rate of change, people, cremate them, you get same time, their
mid- 30% after fees. We did companies with some type of paid, etc. Then you can start
really well in the year when moat, and companies with hard to think about understanding results reflected
everything crashed and burned, assets. I look to buy businesses the finer points, such as the
for that reason. where I can rest my hat on the brand, and what people think s u b - p a r
hard assets of the business. about the community of funeral
Question: Over the past Other times, I look at busi- service providers. It is not a performance. So I
10 years, how have you nesses that have more of a business where a competitor
seen the value investing franchise value, so the intrinsic can open up overnight with thought there must
landscape change? value is made up more of intan- cheaper pricing and just take
gibles such as brand, etc. Basi- your business away. Then, be a correlation
There isn’t much of a change. cally, what I’m trying to do is there is the fact that it is rare
The good news is that there is find businesses that I can buy for someone to aspire to go between these guys
now more of a community with well below what they are into the funeral business. In
things like Whitney’s newslet- worth. I usually try to make general, it is not an attractive not following the
ter (Value Investor Insight), one bet per industry, and I business for a 25-year-old to
conferences, and the Columbia typically put 10% of the fund’s think about entering, so it rules and having
Value Investing Program. assets into each idea. An ideal keeps the number of new en-
Clearly there is now more portfolio would be comprised trants down. Finally, all hu- poor performance.”
interest. However, if you look of 10 positions from 10 differ- mans eventually die. They may
at all of the people involved ent industries all priced at a live longer, but eventually we
with investing in the equity discount to what they are die, so you also have a steady
markets worldwide, the per- worth. In terms of what ex- stream of customers coming in.
centage of them that focus on actly I focus on is determined
true value investing is still a by what is on sale. So these are the kinds of things
very, very miniscule percent- to think about when you start
age. I think that, in general, the Question: Once you iden- thinking about a business. If
opportunity to do value invest- tify a potential investment they all make sense, then you
ing is almost as good as it was idea, what is your process can begin to look further into
10, 20 or even 30 years ago. for determining whether it (Continued on page 4)
Page 4

(Continued from page 3) the most important tenets that Question: As a value inves-
the business at things like value, Ben Graham talked about. You tor, you have mentioned
why it is trading where it’s always want to ask yourself you look out over the 3- to
trading, what it is really worth “What is my downside?” You 5-year period. Wall Street
and so forth and so on. also want to get some comfort obviously has a much
that you have some protection. shorter horizon. How do
Question: You have often In some cases, you can get that you maintain the tempera-
said that you look for dollar comfort from liquidation value ment to hold a security the
bills that are selling for or hard assets minus liabilities. time it takes to realize its
much less than a dollar, In other cases, you may get value?
then you need to have the comfort from somewhere else.
strength to be patient and For example, if you look at a I’m very blessed with the inves-
wait for the rest of the tors I have at Pabrai Funds. I
In 2007, Mohnish world to realize it is worth have about 400 families across
Pabrai published his
second book, The
a dollar. As MBA students, “I have always the five funds I manage at
we are often asked for Pabrai Funds with over $550
Dhandho Investor stock ideas when we inter- million in assets and on a typi-
view for summer intern- felt that value is cal day, I never hear from any
ships or full-time positions. of them. I have an annual
The first question that we its own catalyst shareholder meeting that many
are often asked is “what is of my investors show up to. It
the catalyst for your idea and that is a great group of investors.
to reach its intrinsic Even recently, with the market
value?” How do you think turmoil, I really haven’t had
about catalysts when you eventually the many e-mails or calls. I love to
are making an investment? partner up with these types of
stock market folks. So I don’t really face
I don’t focus on catalysts. I much pressure from the inves-
have always felt that value is its becomes a tor base.
own catalyst and that eventu-
ally the stock market becomes Second, I generally don’t dis-
a weighing machine and will w e i g h i n g cuss the existing portfolio posi-
weigh stocks correctly. I re- tions. That keeps a lot of the
cently bought into a European machine and noise down. Third, I think the
company that trades at about temperament or patience
1/3 of its hard asset liquidation will weigh stocks comes in part from the way we
value. I can’t see any real cata- are wired or the way we can
lyst in that business. I couldn’t learn, or not learn, from Ben
tell you when or what event correctly.” Graham, Warren Buffett, etc.
will make that value converge, You know, Warren Buffett has
but if something is trading at company like Moody’s or said many times that people
1/3 of what it’s worth, I think American Express, you couldn’t either get value investing in five
that if you are just patient for a invest in these based on liquida- minutes or they won’t get it in
few years, it is highly likely that tion value. If their brands were five years. So, there is some-
you will make money and it is permanently impaired, you thing in the human wiring of
highly unlikely that you will lose would probably be losing our brain that, for some of us,
money. money. However, as long as makes all the difference in the
the brand continues to grow in world right away and the pa-
Question: How do you value, you can end up making a tience that it requires is part of
think about downside risk? lot of money. When you are that wiring process. For oth-
looking at the margin of safety ers, they may buy into the con-
At Pabrai Funds, I have made you can look at it in terms of cept completely, but they tem-
several mistakes in the past and hard assets like Ben Graham peramentally just don’t have
I’m sure I’ll make several more used to, or you can look at it in the patience.
in the future. You always need terms of more intangible assets
to protect the downside risk. I which can be very valuable. Question: When do you
think margin of safety is one of (Continued on page 5)

(Continued from page 4) Question: Several value- go up in value. So the starting
think about selling an in- oriented hedge fund man- point of a short bet is to have
vestment? agers that have spoken to head-winds against you. That is
our class this year talked the first problem.
I typically try to buy things for about the advantage they
fifty cents or less and I start to have to go both long and The second issue is that the
think about selling them when short the market. I know maximum you can make if you
they get to be worth ninety that you have different short a stock and it goes to
cents or more. When things opinions about shorting zero is double your money. Professor Bruce Greenwald and
are above ninety percent of stocks. The maximum you can lose is Dean Glenn Hubbard
intrinsic value, they become infinite, because a stock can
candidates to be sold. Of I think that Charlie Munger keep going up, but can only go Columbia Business School is
course I factor into the deci- expressed it really well at this down to zero, so you don’t a leading resource for invest-
sion things such as long-term have a symmetrical risk-reward ment management profession-
vs. short-term gains or what relationship. The maximum
als and the only Ivy League
other opportunities there are “I think the you can make is two times
business school in New York
for the money. When things your investment; the maximum
go to one hundred percent of you can lose is everything. It is City. The School, where value
intrinsic value, I would be look- temperament or a poor bet to have those types investing originated, is consis-
ing hard for replacements or of odds on any bet you are tently ranked among the top
thinking about going to cash. patience comes making. programs for finance in the
world.
Question: In the past, in part from the Third, I think it is so much
what were some of the easier temperamentally to go
signs that made you realize long on a business. If you short
you had made a mistake?
way we are a business, you either have to
put up stop-losses, or end up
At all times, you have to be wired or the way on a leash glued to a monitor
asking yourself the question all hours the market is open. I
“What is the business worth?” we can learn, or don’t believe that is a very
and “What is the intrinsic value productive way to live your life.
of the business?” A couple of I’m usually drooling on my
things can happen. First, you not learn, from pillow on the West Coast
could have made a mistake on when the markets are opening.
what you thought the business Ben Graham, So it certainly wouldn’t work
was worth and you could later for me since I generally don’t
have realized that it isn’t worth Warren Buffett, look at the market until several
what you thought it was. In hours of the trading day have
this case, you should look at passed.
the current stock price. The etc.”
algorithm I use is to ask Question: I know you are a
whether the current worth of big proponent of Charlie
the business is less than the year’s Berkshire Hathaway Munger’s Latticework of
current stock price. If the Annual Meeting when he said Mental Models approach.
answer is yes, there is no ques- that they made most of their How have you applied this
tion that the stock ought to be money going long on a few thought process to invest-
sold. On the other hand, even great businesses. Buffett has ing?
if I made a mistake, but the ventured into all kinds of de-
current value of the business is rivatives or pair trades, or Well, I think that Munger’s
still above the current stock shorting, etc., but clearly he has mental models approach is a
price, then I will typically wait made most of his money by very powerful construct. First
for two or three years from being long on great businesses. of all, he talks about the notion
the time I bought before I I think that the math on short- of worldly wisdom. He en-
would think about selling. I’ll ing is very bad. courages folks to read and
give the market some time to learn about things that are
try to close that gap. First of all, in general, over very outside of the theme of value
long periods of time, markets (Continued on page 6)
Page 6

(Continued from page 5) tion, but you don’t have much Let’s say you go to see a movie
investing or might not seem to of an upside either. Both ways and you pay $10 to buy a
have a connection to value you are a loser. Most of the ticket. Every seat in the thea-
investing, but I think it is very times that I see people pitching ter is occupied – the house is
Professor Bruce
useful to know the way the an idea, I usually see them talk- full. Suddenly, the smoke alarm
Greenwald world works. Reading books ing about 65 – 75 cent dollars goes off in the middle of the
on science, economics, or and I think that those ideas movie and as smoke begins to
Bruce C. N. Greenwald other different disciplines and tend to be lacking on two fill the theater, people run for
holds the Robert Heil- to have a basic understanding fronts: There isn’t enough of a the exit. Now, this movie
brunn Professorship of of all of these different disci- margin of safety and there isn’t theater has special rules, and
Finance and Asset Man- plines is useful to the investing enough of an upside. the rule is that you can only
agement at Columbia process. I think investing in leave the theater as long as you
Business School and is general is one of the broadest “Many times, when I find someone from outside the
the academic Director of disciplines that one can go into, theater who will take your
the Heilbrunn Center
because any stock you look at hear about a stock ticket and seat. You must en-
is affected by so many different ter into some type of transac-
for Graham & Dodd variables. Many of these vari- idea from another tion where that person pays
Investing. Described by ables touch on subjects that are you for your ticket. So the
the New York Times as outside of investing and finance. investor, the idea be- question that comes up is at
“a guru to Wall Street’s So it is very useful to have a what price will that $10 ticket
gurus,” Greenwald is an broad set of frameworks and ing presented does sell for now that there is this
authority on value in- tools to draw on. I think it is alarm and smoke in the thea-
vesting with additional very useful to basically become not seem to have the ter, and the answer is that it
expertise in productivity a person who is strong on probably doesn’t sell for very
and the economics of worldly wisdom. margin of safety ten- much, or you might have to
give it away for free, or you
information. Question: You are a fre- ets. I generally find may even have to pay the guy
quent speaker at many to take it off of your hands.
events, such as the Value margin of safety to That theater is the New York
Investing Congress, where Stock Exchange, because on
you get to hear many in- be the weakest part the stock exchange every share
vestors pitch their favorite of any business is owned by
ideas. What are some of of most ideas. ” someone at all times. If there
the biggest mistakes you is an event which is a distress-
see investors, especially ing event for a company which
younger investors, making? leads people to say I no longer
Question: We were fortu- want to own the stock, that is
Many times, when I hear about nate to have heard you like the smoke in the theater
a stock idea from another in- speak in Professor and people wanting to exit the
vestor, the idea being pre- Greenwald’s Value Invest- theater. The person who you
sented does not seem to have ing Seminar, where you want to sell the stock to, which
the margin of safety tenets. I used an analogy about is the person who wants to
generally find margin of safety smoke-filled theaters and enter the theater, has access to
to be the weakest part of most spectacular waterfalls. Can the exact same information
ideas. There is a very impor- you discuss this concept? that you do. He also knows
tant thing about Ben Graham’s there is smoke in the theater.
idea of margin of safety which I was recently discussing this Therefore, for him to still be
is that the higher the margin of concept with a bunch of value willing to buy it, the price at
safety, the lower the risk, investors and they all said they which the transaction takes
which is obvious. The second never heard Buffett use this place, is likely to be a significant
tenet is that the higher the analogy, but I could swear that discount at what the stock was
margin of safety, the greater I heard it from Buffett. So for trading at before the smoke. If
the return. If you are buying now, I will continue to say that you enter selected smoke-filled
something that is a 70 cent I got it from Warren Buffett. theaters, and you later find that
dollar, not only do you not the smoke is really nothing to
have much downside protec- Here is the basic concept. (Continued on page 7)
Volume II, Issue 2 Page 7 7
Page

(Continued from page 6) is no data other than news of
worry about, or it has been put the 200 agents. That is clearly The real world usually is not
out, then there is a chance you a theater with an alarm going that accommodating. You may
have gotten a great investment off, with all kinds of smoke in it. have to look at situations, like
and you can do quite well with The people sitting watching the Ben Graham did, where he
it. movie had signed up for this focused more on the hard as-
high-growth, high-momentum sets, and not much on manage- “As a value
The second part of this is when stock, and they had signed up ment, etc. So, I have had some
you have smoke in theaters, to see a certain kind of movie. very successful investments in investor, you don’t
you are going to have these When the federal agents businesses where the bet was
huge collapses in stock prices. showed up, they could clearly based on hard liquidation value, want to enter every
If you look at the stock’s chart, see that this is not the kind of and I did not spend a lot of
these will look like a waterfall. movie they want to see. They time assessing the quality of smoke-filled
So what this means is that don’t want to be hanging management, other than that
smoke-filled theaters are likely around with all the smoke and they were competent. theater. What you
to lead to spectacular water- they want to leave. When they
falls. As a value investor, you try to leave the theater, they There are other businesses want to do is
don’t want to enter every needed to sell those tickets to where the quality of manage-
smoke-filled theater. What someone else and the clearing ment is more critical, because carefully analyze
you want to do is carefully price that they exchanged their of the nature of the business. I
analyze these smoke-filled thea- Wellcare tickets for was $20 a was recently looking at the these smoke-filled
ters to try to find one where share. This was 50% of just the stocks I’ve held the longest at
the smoke is not real, or the cash on their balance sheet. Pabrai Funds. There are some theaters to try to
fire alarm is not real, it went off Forget about the business, the stocks that I have held now for
for no reason, and then buy earnings engine, and everything 5 or 6 years. I looked at these find one where the
those tickets at hugely dis- else; people were not even stocks and I asked what about
counted prices, then sit back willing to pay for the hard as- these companies has kept me in smoke is not real, or
and watch the rest of the sets of the business at that these businesses for so long. In
movie. point – not even the liquid many cases they are up two, the fire alarm is not
assets of the business at that three, or even four times
I think this is a good way to point. So you got a very spec- where I bought them and I still real, it went off for
summarize the framework. tacular, real-world case of logic believe they are undervalued,
One example I spoke about at going out the window, just and still hold onto them. The no reason, and then
Columbia was Wellcare (NYSE: because of the stampede out of reason is, universally, because
WCG). I generally don’t talk the theater. of the quality of management. buy those tickets at
about stocks that I own, but I
felt that Wellcare was such a Question: What impor- What I have learned to appre- hugely discounted
pure textbook example. I tance do you place on as- ciate, when I looked back at
couldn’t come up with a better sessing management when that nuance - historically, I have prices, then sit back
example, even looking at the you make an investment? not paid that much attention to
history of stocks. I also think the jockey. But I have learned, and watch the rest
people learn a lot more with The jockeys are very impor- sometimes very painfully, that
Ben Graham’s technique of tant. It depends on the situa- jockeys are much more impor- of the movie.”
talking about current stocks tion. I think that the ideal tant than I had given them
since they can relate better. situation is to have a business credit for in the past. So going
Here is an event that is still that is a great business, which is forward I care a lot more
playing out; there is still some going to grow a lot in the fu- about jockeys. I’m not always
smoke in the theater. ture and not require much able to find great jockeys along
capital. The best example of with great businesses that are
Wellcare is a situation where something like that is Moody’s also undervalued, but I have
you have a company that is – a great business, growing a learned to appreciate the im-
trading at over $120 a share lot, that you can buy at a very portance of jockeys.
when 200 federal agents show cheap price – well below its
up at their doorstep, unan- worth and run by a spectacular One thing I would say is that if
nounced, holding search war- manager. That is utopia, and you take a look at three classic
rants. The stock is halted and that is what you always want to value managers: Longleaf Part-
when it resumes trading, there try and look for. (Continued on page 8)
Page 8
I think that the best thing to do

is to actually set up a small
portfolio of your own and start
making real investment bets.
Don’t run these virtual portfo-
lios – take real money that you
actually have, and invest it like
you would invest a $5 million
portfolio. Be rigorous about it
because I think you learn when
you make mistakes that actually
cost you money. From my
point of view, that is the best
way to learn.
Going to Columbia is a great

idea! If you are already at Co-
lumbia, follow Buffett’s advice
and try to find a shop that is
run by people you admire and
have principles you believe in,
and try to convince them to
Mohnish Pabrai, Warren (Continued from page 7) about jockey bets. Most of bring you on board without
Buffett (’51), and Guy Spier ners, Third Avenue, and Fair- their portfolio is invested in focusing on compensation.
holme - all three are value people who are great jockeys.
managers, but all three have They have large positions in Thank you, Mr. Pabrai.
very different styles. Marty Leucadia, Berkshire Hathaway,
Whitman of Third Avenue and Canadian Natural Re- -G&Dsville
cares very much about hard sources. If you start to look at
assets and he doesn’t care as why they bought these busi-
much about things like fran- nesses, it is all about the
chise value, or moats or even jockey.
management. He cares the
most about hard assets. If you When I look at Pabrai Funds, I
look at someone like Longleaf, think of it as a blend of the
they care a lot about the fran- three, because I have made
chise. They focus on the en- many investments which are
during moat, franchise, etc. very much Third Avenue-type
One time they mentioned that bets – pure hard-asset plays. I
they thought that Coke bot- have also made investments
tlers were a great business, and where it is about the franchise
they went looking around the value, moats, brands and so on
world making a list of every – a Longleaf play. I have also
Coke bottler on the planet, made several jockey bets, like
trying to see which ones they Fairholme. I would say that
could invest in at decent prices. over the past 12 months, I have
In general, they focus on the learned to appreciate and
business and the valuation, but spend more time analyzing the
not as much on the manage- jockeys and put more weight
ment. Their focus is more on on it.
moats and franchise value,
which is what you will see if Question: What advice
you look at Longleaf’s portfolio. would you give to MBA
Then, if you look at someone students who aspire to a
like Fairholme, they are all career in investing?
Annual Alumni Reunion with Joel Greenblatt

On April 28, 2008, current multiple does that lead you to?
students and alumni of the What multiple does a company
Value Investing Program were deserve in normal times and
invited to the annual spring what kind of a discount does
reunion at the Columbia Club that mean a stock is currently
in Manhattan. In his introduc- at?” Greenblatt’s bet is that a
tion, Professor Bruce turn in the market will come,
Greenwald proclaimed that he just doesn’t know when. By
speaker Joel Greenblatt has focusing on normal earnings, an
achieved “the trifecta: he is a investor can create what Bill
terrific investor, he has written Miller calls Time-Horizon Arbi-
terrific books, and he is a terri- trage. “There are guys who
fic teacher in the Value Invest- can trade short-term, and bang
ing Program.“ out huge returns every month,
Professor Bruce Greenwald moderates a Q&A with Pro-
but (a) I’m not one of them;
After reading his first book, You and (b) you are likely not one fessor Joel Greenblatt at the Columbia Club.
Can be a Stock Market Genius, of them either!” quipped
one might naturally wonder if Greenblatt. Greenblatt, the concepts of
things were different when value investing aren’t very com-
Professor Greenblatt began as Professor Greenblatt suggests plicated; however, they are
a professional investor. “Was that investors focus on finding difficult to put into practice. It
it more of the Wild West 25 areas that are ripe for mispric- is imperative that one maintain
years ago?” asked Greenblatt. ing. When economic forecasts discipline in the face of every-
“Now we keep producing all are bleak, people worry, and in thing going on. Assumptions
these smart guys out of MBA turn, misprice securities. may have been too optimistic
schools who are doing all this “Their outlook may be right,” over the past few years, but
research and maybe those effi- says Greenblatt, “but this isn’t investors need to adjust their “The concepts of
cient market guys were right. where I focus when investing. I valuations based on what they
There are no opportunities focus on normal earnings think normalized is now. value investing
left…” However, Professor power and a long-term normal
Greenblatt pointed out several environment.” According to Professor Greenblatt suggested aren’t very
reasons to be optimistic. First, Greenblatt there are a lot of that “…the best thing to differ-
the internet bubble wasn’t so opportunities right now. entiate yourself in the process complicated;
long ago. Second, in 2002 – is not just by doing the good
2003 there were some of the Next, investors should be try- work, but by having the disci- however, they are
best bargains in the market that ing to figure out what the com- pline to not buy something just
he had seen in many years. panies they are looking at are because you did the good difficult to put into
Third, credit markets, which likely to earn in a normal envi- work.” Investors need the
are much bigger than the stock ronment. Whether that nor- discipline to recognize when a practice…”
market, were insane just about mal environment returns next company they have been work-
a year ago. All this points to a year, or a few years from now ing on is not selling for the
market that is not efficient. is unknown; but investors need same discount as they have
to make sure that whatever seen in the past and pass even
The longer Greenblatt has they are buying is at a big dis- if it is just a ‘little bit’ cheap. “If
been in the business, the more count to that value. But how you are extremely disciplined,
institutionalized he has seen it should an investor think about only buy when you have a large
become. “Money managers normalizing earnings, on a long margin of safety, and are willing
have different directives – and term basis going forward, when to stick it out for two or three
now people only care how you the last 8 years or so of back- years - then I think you have
did last month. If you beat the ward data for many industries the right process.”
benchmark this month or next might be inflated? One thing to
month, and more people be- look for is whether margins “I wait for easy ones,” admitted
come focused on that, then less were higher over the past few Greenblatt. “I wait for ones
people can focus on what nor- years than they were on a long- where I say ‘hey, if someone
mal earnings power should be term basis. That analysis would would have looked at it this
in a normal environment two go into your normalized num- way, it is clearly cheap’.” This
to three years out, and what ber. According to Professor (Continued on page 15)
Page 10
Annual Pilgrimage: CBS Students Meet With The Oracle Of Omaha

generation of his family to run Financial weapons of mass
the company, which was destruction
founded by Rose Blumkin in
1937. The purchase of Ne- Although he has been warning
braska Furniture Mart is the the markets about the dangers
stuff of Berkshire legend. And of derivatives and structured
though Nebraska Furniture products for years, Mr. Buffett
may not contribute as much as appeared to experience no joy
Geico to the bottom line, there in his recent vindication. He
is no question that this business noted that his primary con-
is a quintessential WEB invest- cerns about derivatives involve
ment. It is a business that is run the leverage they allow partici-
by honest, hardworking people pants to employ, and the
who could quit at any time, but opaqueness around their true
don’t because they love their value.
jobs.
On the plus side, Mr. Buffett
By noon, we had taken the full noted that there are often
CIMA Co-Presidents Del “This is a difficult market. Re- tour of Nebraska Furniture and significant mispricings in deriva-
Anderson (’08) and Matt cently I heard the story of an were ready to pepper Mr. Buf- tives which create opportuni-
Loesch (’08) pose with investment banker who had to fett with as many questions as ties to profit. On the minus
Mr. Buffett tell his wife that there would he’d let us ask. The Q&A ses- side, “derivatives present big
be no bonus this year. He says, sion lasted for over two hours opportunities for financial mis-
‘We’re going to have to cut and began with a question chief. When we purchased Gen
back. If you could learn to about Mr. Buffett’s thoughts on Re, there were 24,000 con-
cook, then we could fire our derivates. tracts on the books. One con-
chef.’ To which she replied, ‘If tract went out 100 years!” said
you could learn to make love, Buffett.
then we could fire the gar-
dener!’”
And so began Warren Buffett’s

opening remarks to a group of
students from Columbia Busi-
ness School and the University
of Texas A&M on March 21st at
the Omaha Field Club in
Omaha, Nebraska.
The trek to see the Oracle

began early the night before
with nearly 120 of Professor
Greenwald’s students meeting
at 116th and Broadway at 3:30
am. From there, two buses
arrived and brought us to JFK
airport, where we boarded a
chartered Jet Blue plane at 6
am.
The group arrived in Omaha at

9 am and proceeded to a Berk-
shire-owned subsidiary, the
Nebraska Furniture Mart,
where we were greeted by Bob Adam Lindsay (’09) listens as Warren Buffett (’51) answers
Batt. Mr. Batt, the CEO of questions posed by students of Professor Greenwald’s Value
Nebraska Furniture, is the third (Continued on page 11)
Investing Seminar
Annual Pilgrimage: (continued from page 10)
(Continued from page 10) ceedingly favorable terms in the

It was in this context that he deal. Buffett countered this
remarked “the CEO should point with the following obser-
also be the head of risk man- vation: Just as stocks often pop
agement for any major financial when people find that Berk-
institution. I personally handle shire is buying, they also fall
all of our derivative contracts. when Berkshire is selling.
However, it is now obvious to Would you buy a stock that
all of us that most banks, insur- Mr. Buffett didn’t want? To
ance companies, and asset man- make up for the discount Berk-
agers are not run this way. shire receives when selling—
Back when we were running and to compensate for the
Salomon, my partner Charlie long-term commitment it
found a large number of mis- makes—Berkshire often needs
takes in one of the derivatives to demand excellent terms to
contracts. We paid Arthur justify a deal. It is also worth
Andersen millions of dollars to noting that Mr. Buffett received
review the contracts for us, a salary of $1 and is widely without someone asking how Columbia Business School
and yet they had missed it. credited for keeping Salomon he values a company. This visit
Professors Michael Johan-
These things are designed to out of bankruptcy. As he said, would be no different – but the
fool. They fooled the account- “I think they got their money’s question focused on the valua-
nes and Tano Santos
ants, but they didn’t fool Char- worth.” tion of international companies along with Mr. Buffett
lie!” in particular. The Oracle com-
U.S. trade deficit pared the valuation of compa-
Salomon Brothers nies to how he used to handi-
Mr. Buffett described our trade cap horses. “At the race track,
Mr. Buffett’s discussion of de- deficit as the U.S. force feeding the first thing you want to do ,
rivatives at Salomon Brothers the world $2 billion in U.S. all things equal, is determine
provided a nice segue for a paper every day. “It is kind of each horse’s chance of winning
question about the famous deal like eating an extra roll for the race. Then you figure out
in which Berkshire purchased dinner every night – it’s not which one has the best odds
$700 million of preferred con- like you get up from the table relative to its chance of win-
vertible stock. The question, and suddenly people say, ‘Oh ning.” This is the exact ap-
akin to asking a chess grand- my god, you’ve gotten fat!’ But proach he took to valuing Pet-
master what moves he would over time, of course, it has roChina. Mr. Buffett remarked
use on himself, asked whether consequences.” that when he first looked at the
he would have done the deal company he thought it was
had he been in Salomon’s He also noted that accompany- worth about $100 billion. But it
shoes. Mr. Buffett’s answer ing our deficit are some policy was only selling for $35 billion
highlighted the benefits and decisions that could prove in the market at the time. As
pitfalls that he experiences as a problematic. China has accu- he said: “That got my atten-
long-term investor, and as one mulated foreign exchange re- tion.” While he freely acknowl-
considered by many to be the serves of $1.5 trillion. Yet edged that investing in China is
greatest of all time. when they tried to take some not quite like investing in the
of those funds and purchase a U.S., Buffett maintained that
Initially, Buffett explained, third-tier oil company, Unocal, PetroChina seemed to be trad-
Ronald Perelman had indicated “Congress went ape.” Forcing ing at a “significant discount for
interest in buying Salomon – other countries to take our one of the world’s largest oil
but John Gutfreund was un- money and then not allowing companies.” In such a way,
happy with the prospect of them to spend it as they wish Berkshire was able to scoop up
selling to someone with a repu- does not seem sustainable, shares of PetroChina with a
tation for financial engineering. Buffett claimed. significant margin of safety. In
Berkshire clearly had no inter- general, Mr. Buffett explained
est in buying it, levering it up, Valuation of international that he takes the same ap-
and selling – so the firm be- companies proach to evaluating foreign
came a very attractive candi- companies as he does domestic
date. Second, it has been ar- A Q&A session with Mr. Buf- ones, but he requires an extra
gued that Buffett received ex- fett would not be complete (Continued on page 12)
Page 12
(Continued from page 11) even an MBA could under- to Korea. Management could
measure of undervaluation to stand, Mr. Buffett described the be crooks for all I know, but if
compensate him for potential financial crisis in the following you buy 10 or 20 of these com-
unknowns. way: “Banks got into trouble by panies, you can’t lose money.
passing around this toxic Kool - You can find these investments
Of course, as any value inves- Aid, like Jim Jones. And then today, but you may have to
tor will tell you, a huge compo- they drank a couple of gallons look in places like Korea.”
nent of valuation is understand- themselves.”
ing competitive advantage. Lesson from past crises
When asked about how he Other people’s money
assesses a company’s competi- On the topic of managing
tive advantage, Mr. Buffett One CBS student displayed an money, a student asked about
Students present Mr. Buf- walked us through numerous interest in starting his own firm Mr. Buffett’s thoughts on les-
fett with a Yankees Jersey examples including See’s one day and asked Mr. Buffett sons learned from past crises
bearing the year he gradu- Candy, Coca Cola, and Snick- how he knew he was ready to such as 1973-1974 and 1989-
ated from Columbia Busi- ers. This discussion can be manage other people’s money 1990. Mr. Buffett reminded us
ness School summarized succinctly with at such a young age. Mr. Buffett that the “stock market is there
Buffett’s first eight words: “If it recalled that he left Columbia to serve you, not to instruct
isn’t obvious, I don’t buy it.” when he was 20 years old and you. The volatility in a stock is
became a stock broker in your best friend! I love it when
Banks and the financial Omaha. His first call was to his companies’ prices jump up by
crisis Aunt Alice, to whom he sold 100 percent or down by 50
100 shares of Geico. Buffett percent in the same year. Vola-
“Banks got into Not surprisingly, the current remarked that some of the tility in stocks is what has made
turmoil in the financial markets other calls weren’t so easy. “I me rich!” He further instructed
trouble by spurred one student to ask Mr. was always comfortable doing us to be “detached from the
Buffett his thoughts on Citi- things with my own money – market emotionally, but pay
group and the other money- that was never a problem. But I attention to opportunities as
passing around center banks. Acknowledging was bothered when others they arise.”
all of our concerns, he re- bristled at the price action on a
this toxic Kool- marked that “Citi will be stock or investment I had rec- A turnabout on turn-
around in the future. You have ommended. It was difficult for arounds
Aid, like Jim to think that when the Fed me. People would worry if
steps in to save number five Geico lost 50 percent, but I Some of us in the audience
Bear Stearns, they will print would just buy more.” apparently are not patient
Jones. And then money if they have to in order enough to wait around for the
to get the big banks through.” Acknowledging Ben Graham’s market to throw them a “fat
they drank a More interesting, perhaps, was influence on him, he said that pitch.” One student asked
how Mr. Buffett betrayed his “after I met Graham, I felt 100 about Mr. Buffett’s thoughts on
couple of financial sophistication when percent confident that I was turnaround situations and
discussing the possibility of doing the right thing. So the noted that Buffett had been
bankruptcy in the financial mar- key was getting my investors to involved in quite a few when he
gallons kets. Although decrying the agree to the partnership rules, was younger. Mr. Buffett ex-
abuse of derivatives, Mr. Buffett and they did.” Mr. Buffett went pressed a different sentiment
themselves.” is unquestionably savvy and will on to describe how he used to now perhaps because of Berk-
look just about anywhere for comb through the giant securi- shire’s current size or because
mispricings. “It is interesting if ties manuals published by of the evolution in his invest-
you look at the credit default Moody’s or Standard & Poor’s ment philosophy. “If you are
swap market, which is essen- looking for value. Recently he good at turnarounds,” he said,
tially the cost of insurance tried a similar tact when he “you are probably just a good
against Citigroup defaulting on bought a manual for securities manager. Go join a good busi-
its bond obligations, it is imply- and companies in Korea where ness and you will probably do a
ing a 3.4% likelihood of default. he quickly found dozens of lot better. Why try to swim
I think that is wrong.” companies selling for two and against the tide? If you want to
three times earnings: “I had build a good reputation, buy a
Showcasing his knack for never heard of any of these good business. I can’t think of
evocative analogies and imagery companies, and had never been (Continued on page 13)

one person who has been re-
peatedly successful at turn-
arounds. Capitalism can be
brutal when you are up against
competition that has some
advantage over you.”
Students, managers, and

investors
The conversation took its final

turn toward three constituen-
cies in which Mr. Buffett has a
lot of interest: students, manag-
ers, and investors. Commenting
first on his advice for students,
Mr. Buffett highlighted the culti-
vation of accounting and com-
munication skills. “Get as
much accounting as you can,”
he explained, ”it is the language
of business.” In addition to
accounting, he stressed the you can sell to a private equity
has the best track record. You Professor Bruce Greenwald
importance of written and shop, which is like selling to a
need to spot great investors and Warren Buffett (’51)
verbal skills and pointed out porn shop. They will buy the
when they are young and un-
that “the only diploma I have company and they will want to
known.” Nevertheless, as great
hanging up in my office is from adjust a few things, make the
as it is to find investors before
the Dale Carnegie School for boobs bigger, and so forth… It
they are famous, he reminded
public speaking. I joined 30 will sit on the shelf for a couple
us of the difficulties in managing
people every week to work on of months, and then some guy
large sums of money. Although
public speaking. It changed the in a trench coat will come
he thinks funds like Sequoia and
course of my life. Also, I think along and buy it from them.” Baupost will do better than
writing is extremely important.
average, these funds will strug-
If you can get ideas across to Once the laughter in the crowd
gle to do as well as they did
other people, you will stand settled down, we left Buffett
with a final question: “which when they were smaller.
out anywhere you go.”
investors would you recom-
Although he discussed what he mend today?” Although he was Striking a pose
looks for in a manager in some able to tick off a few names,
such as Greg Alexander at After a few concluding re-
detail, it boils down to one
Ruane, Cunniff & Goldfarb and marks, Mr. Buffett accompanied
word: “passion – they’ve got to
Seth Klarman at Baupost, Mr. us outside where we partook
want to do the job.” In perhaps
Buffett focused more on how in yet another Buffett trip tradi-
his most colorful analogy of the
we should think about finding tion: pictures with the Oracle
day, Mr. Buffett described the
these great investors. When he himself! It is quite a sight to
type of managers he’d buy a
closed his partnership in 1969, behold to see 120 professional
business from: “We don’t do
he recommended Sandy Got- and successful adults swarm
auctions. Owners who auction
tesman and Bill Ruane. He around Mr. Buffett like so many
their business don’t care about
knew them well, knew their fifteen-year-old girls at a Justin
what happens to them. They
temperaments, and knew they Timberlake concert. But War-
don’t think of it like a painting.
would pursue sound strategies ren took it all in stride and
When you sell your business,
(for more on this topic, see patiently took photos until
you have two options. Sell to
Buffett’s article: “The Superin- every camera had run out of
Berkshire and it is like selling
your painting to the Metropoli- vestors of Graham and Dod- memory
tan Museum of Art. We will desville). He also noted that, “I
put up a wing for it. Otherwise wouldn’t pick the person who -G&Dsville
Page 14
Squaring Off Against a Hedge Fund Master

charitable giving. As an manageable level. The judges
added incentive, Ack- pressed further: “Do they own
man pledged to donate or lease their stores? How
$25,000 to Columbia much do they pay in rent?” In
Business School on each case, Chen responded
behalf of the student calmly with an impressive com-
with the most promis- mand of the facts, and the pan-
ing investment thesis. elists offered suggestions for
how she could improve her
Students spent months thesis.
preparing for the con-
test. After a series of Next, Vikas Jain shared his
five training sessions views on database marketing
spanning February to firm Acxiom Corporation,
April, students submit- which he believed is “a good
Judges of the 2008 Announcing the 2nd Annual Per- ted two-page summaries of business run badly.” Jain pre-
Pe rsh in g Sq u are shing Square Value Investing and their investment ideas to a sented a series of steps man-
Challenge included (l Philanthropy Challenge selection committee, which agement could take to increase
to r): Professor consisted of recent graduates the firm’s stock price. Again,
Bruce Greenwald, For many investment profes- from Columbia’s Applied Value the judges asked questions to
Danilo Santiago, Bill sionals, making money in the Investing program. Five finalists better understand the risks and
Ackman, Ali Namvar, stock and bond markets is the – ‘09ers Amy Chen, Vikas Jain, assumptions behind Jain’s the-
ultimate challenge. For those Adam Lindsay, Shilpa Marda, sis, inquiring about whether
and Ken Shubin-Stein who succeed, an additional and Stephen Walker – were their technology was proprie-
(arguably no less formidable) selected to present their ideas tary and about the presence of
challenge can be finding mean- to a star-studded panel of a competitive advantage.
ingful and effective philan- judges:
thropic activities. Bill Ackman, Adam Lindsay continued the
Founder of Pershing Square • Bill Ackman – Founder challenge by advocating a long
Capital Management, noted this and Portfolio Manager, Per- position in used car retailer
“high-class problem” in his CARMAX. His comments dem-
introductory remarks for the shing Square onstrated a thorough under-
first annual Pershing Square • Ali Namvar – Senior Ana- standing of the business, em-
Value Investing and Philan- lyst, Pershing Square phasizing its strong competitive
thropy Challenge, which took • Danilo Santiago – Founder position and potential expan-
place in Uris Hall on April 25th and Portfolio Manager, Rational sion opportunities. In the Q&A
2008. portion, the panelists asked a
Asset Management
series of detailed questions
Ackman’s own experience with • Prof. Bruce Greenwald - about the company’s financing
business school, he reflected, Robert Heilbrunn Professor of business and receivables. One
was “a lesson in due diligence.” Finance and Asset Management judge suggested that a sensitiv-
He followed in his father’s • Ken Shubin-Stein - Value ity analysis of customer default
footsteps and attended Har- Investing Program Adjunct rates would be helpful. The
vard Business School, which – Professor judges also inquired about po-
much to his chagrin – did not tential threats from nontradi-
offer classes in investment The final presentations began tional competitors, such as
management. To provide addi- on Friday morning, April 25th. eBay.
tional training opportunities for First, Amy Chen presented her
students of investing, Ackman thesis on retailer Limited Shilpa Marda made a compelling
worked with Columbia’s Heil- Brands. After a brisk five- case for NutriSystem, the
brunn Center to create the minute presentation, the judges weight management system.
Pershing Square Challenge, began peppering Chen with Her pitch included primary
which has two objectives: to questions, starting with the research on potential competi-
teach students how to develop balance sheet. Chen explained tive threats and a sensitivity
and pitch investment ideas, and that the Limited had recently analysis of the firm’s marketing
to give students exposure to restructured; debt was at a (Continued on page 15)
Squaring Off... (continued from page 14)
tions focused on a number of

spending. One of the judges key issues from regulatory
complimented her research on pressure that could arise in a
competitors but pushed for tough economy, competition
more detail on the company’s from the trucking industry, and
track record of returning cash a potential shift away from coal
to shareholders. Marda re- given a new presidential ad-
sponded with an easy com- ministration’s emphasis on new
mand of the relevant facts. energy sources.
Another panelist observed that
Marda’s valuation was very After these spirited discussions,
conservative—she could go the panel adjourned for several
slightly higher and remain con- minutes to debate the merits of
servative. In response to one each idea and select a winner.
judge’s question on the impact In the end, the judges selected
of a consumer recession, Ack- Shilpa Marda’s NutriSystem
man interjected, “it costs $10 pitch. At a lunch reception that
per day – that’s less than followed, Ackman presented Amy Wu, David Krasne, and Stephen Walker, members
McDonalds! You can save the check for $25,000 to Co- of the Class of 2009, enjoyed the after reception where
money and fit in your old lumbia Business School on
Marda’s behalf and lingered in
the winner of the 2008 Pershing Square Challenge was
clothes.”
announced. See Shilpa Marda’s winning pitch on the
order to chat with students.
Finally, Stephen Walker pitched next page.
CSX, a provider of rail-based Attention future hedge fund
transportation services. In his impresarios: do not miss this McDonald (smcdonald09@
opening remarks, Walker year’s Pershing Square Value gsb.columbia.edu) or Priyanka
pointed out that CSX benefits Investing and Philanthropy Agnihotri (pagnihotri09@
from a combination of growing Challenge! The first training gsb.columbia.edu), VPs of edu-
demand and tight capacity for event – Competition Analysis cation and mentoring for the
coal, which “has to go by rail.” and Valuation I – begins on Columbia Investment Manage-
As a former employee, Walker September 26th at 10:00am in ment Association.
displayed a wealth of knowl- Uris 301. For more informa- -G&Dsville
edge about the business. Ques- tion, please contact Sean
Joel Greenblatt (continued from page 9)

(Continued from page 9) some of the smaller situations. Addressing the 2009 graduates
way, Greenblatt does not have This is where younger inves- of the Value Investing Program,
to make much in the way of tors can excel. One piece of Professor Greenblatt agreed
predictions or have to base his advice he would give to inves- that for those who have not
whole thesis on normalized tors who are just starting out, yet found a job, the economic
earnings. “I look for something especially if they are starting situation sounds like bad news;
any idiot would buy if they their own fund, is to avoid “but you don’t really want to
were looking at it in the same investing “like you are running start working at a time when
way that I was.” $20 billion if you are running things are at all-time highs,”
$20 million… Look at some of Greenblatt asserts. This is
Professor Greenblatt thinks the situations that some of the actually a much better environ-
young managers will always bigger guys aren’t looking at. ment, if you can find a job., he
have an advantage in the busi- Do your own work. You don’t says, concluding that “it is a
ness, whether it is value or have to be as smart as guys harder time to find a job and a
special situations, because the that have been doing this for better time to get one!”
investors who have success in twenty years, because there
these areas make a lot of are situations the older guys -G&Dsville
money and become too big for just can’t look at anymore.”
Page 16
The Winning Pitch: NutriSystem Inc.

Shilpa Marda The following section includes a reproduction of Shilpa Marda’s winning investment pitch from the Pershing
smarda09@gsb.columbia.edu Square Philanthropy and Investment Challenge. Please note this information is dated.
NutriSystem Inc. Investment Thesis

NutriSystem Inc. is a provider of a weight management system based on a portion-controlled, prepared-
(NASDAQ: NTRI)
meal program. NutriSystem utilizes a direct-to-consumer sales and distribution approach and out-
sources the bulk of production and distribution of its meals. This results in a business model with low
Price: $18.93
capital requirements, high financial returns (ROA 53%), solid free cash flow, and high margins (gross
Shrs Out: 29.56M
margin 53% and operating margin 21%). Sales have experienced tremendous growth in the past few
Market Cap: 559.60M
years: 68% in 2004, 459% in 2005, 167% in 2006 and 37% in 2007. NutriSystem is primarily a sales and
marketing organization with a highly scaleable business (revenue per employee increased from $268k in
PE: 9.14 2002 to $836k in 2006). Since July 2007, the stock price has fallen from about $72 to $20 per share
Yield: 3.7% (current) due to a 3rd quarter and 4th quarter earnings miss and new competitive threat from Alli, which
52wk Hi: $50.33 is the first FDA approved OTC weight-loss drug, introduced in June 2007. However, this competitive
52wk Lo: $12.55 threat has been misunderstood by the market and I believe NutriSystem will maintain its pricing power
(implemented 15%, 3%, 4%, 2% price increases between 2003-2006) and benefit from a growing indus-
try, proven product efficacy, untapped markets and a strong fundamental business model.
52 Week Chart:
Investment Catalysts
• Impact of Alli – Introduced by GlaxoSmithKline, Alli restricts the
absorption of fat in the body, and has severe side-effects including increased
bowel movement and oily spotting. Alli had 2M customers in 2007 since its
introduction, resulting in NTRI falling short of new customer acquisitions by
40K in Q3. However, I believe this is a short-term shift in the competitive
landscape, as Alli is not sustainable. Initially many people tried it, but did
not continue to use it due to severe side effects, and weight gains after they
stopped using the product. Alli sales according to GlaxoSmithKline (in
British Pounds) were 76M in Q2 (with just 2-weeks of being on the market)
34M in Q3, 40M in Q4 and 9M Q1 2008, indicating the ‘faddish’ nature of
this new drug. Before Alli was introduced, NTRI was trading at a P/E of
30X around June 2007.
• Growth in Market Share – NTRI is positioned for growth in a number of areas: a) Men’s Diet
(data as of 09/25/2008) Market – Implemented in July 2006 and represented 30% of the business at the end of 2006. NTRI
provides a simple and private weight-loss solution, ideal for the men’s market. b) International mar-
ket – Business model facilitates easy expansion through local partners/distribution. Canada
launched in Q1 2008 and Japan, Australia, Germany and UK expected to launch in 2009. c) Seniors
– Launched NutriSystem Silver in December 2006. Provides a simple solution to seniors with
minimum hassle. d) Domestic – Only represented 1.9% share of diet market in 2007. Innovative
product launches such as NutriSystem Advanced in 2008 (omega 3’s and heart-healthy meal pro-
gram) will help increase share.
• Stable Business with a Scaleable Model – As NTRI's client base increases, customer reactiva-
tions (purchases made outside of the 9-month initial diet cycle) have gone up and in 2007 are ex-
pected to represent over 12% of sales. Reactivations yield a net profit margin of 31% vs. new cus-
tomers, who yield 15%. In 2007, new customers yielded gross margins of $373/customer and CAC
of $173, yielding a profit margin per customer of $200.
• Management buyback of stock and Acquisition Target – Management has board approval
to buy back up to $200M of stock. Management also alluded to receiving calls from potential ac-
quirers.
Industry Landscape and Competitive Advantage

• In 2006, there were 62M dieters in the U.S. divided into the commercial weight loss market
(approximately 10%) and self-directed (79%). This is expected to grow to 81M dieters in 2010
(30% increase).
• The international diet market is on the rise with the spread of fast-food chains, increase in wealth
and shift to less physically intensive work. According to WHO, in 2005, 1.1B people were over-
weight.
NutriSystem Inc. (Continued from previous page)

• Increasingly busy lifestyles and growing use of the internet are condu-
cive to NTRI’s model of a convenient web-based weight loss solution.
• Also, in addition to diet due to health risks, U.S. consumers are prone
to images in media, fashion, and entertainment that depict thin as the
ideal body type.
• Main competitors are WeightWatchers (center-based), Medifast, Jenny
Craig (center and direct), eDiets.com (direct – caters to a less price
sensitive customer), and self-administered products such as Atkins and
South Beach diet and medically-supervised programs.
• NTRI targets the price-sensitive consumer who wants a simple-to-use
weight-loss program, but is also used by customers that would not be
considered price-sensitive. This is a large market as the majority of
overweight people are in the less affluent segment of society.
• While barriers to entry appear to be low, it is interesting to note that
other entrants into the online diet market have not been successful.
This indicates that NTRI does enjoy barriers to entry, including cus-
tomer captivity and cost efficiencies.
Primary Research
• Surveyed doctors and pharmacists as a potential Alli consumer. 80%
told me they would not recommend the drug, and 20% were neutral,
focusing more on the medical aspects. They said the side-effects are
very extreme and involve changing your lifestyle to adapt to them.
They also said the “results are not that good anyways, if you read the
small print.” One pharmacy had to send back their stock of Alli as inventory levels were too high due Bill Ackman and Shilpa
to weak demand.
• Spoke with people in healthcare field about weight-loss drugs and found out that typically there is an Marda (’09)
initial hype with weight-loss drugs, and then demand tailors off as side-effects occur and weight comes
back.
• After reading internet diet blogs and surveying people who had actually used or tasted NTRI, I got
very positive feedback. People thought it was an extremely simple system that works. They liked the
taste of most of the foods and enjoyed the variety. The major drawback was that people wanted to
eat out occasionally and other similarly minor issues.
Valuation
• Average P/E of peer group is approximately 14x earnings. In my base case scenario, I have assumed
multiple expansion to 13X and an EPS of $3.41 (NTRI repurchased 10% of shares O/S in Q1 2008)
(15% YoY growth). This results in a price target of $45.
• A discounted cash flow analysis with conservative sales growth estimates and terminal growth of 3%
and WACC of 13% also yields an intrinsic value of close to $45.
• Employing an Earning Power Value approach, and adjusting for normalized 2007 earnings, depreciation
and capex with no growth, yields a price of $28, which represents an estimate of downside risk.
NTRI requires very few assets to generate revenue. I came up with a net balance sheet reproduction
value for NTRI, including marketing expenses incurred over the past few years as though they were
capitalized at $365M. This indicates the existence of a franchise, as the normalized EPV of the firm is
$895M. I believe NTRI enjoys barriers to entry and will be able to grow profitably within its franchise
over the next few years.
Risks
• NutriSystem may be subject to fluctuations in demand due to the diet industry’s vulnerability to
changing fads
• Increasing customer acquisition costs and weak consumer discretionary environment
• Extended impact of Alli due to strong marketing efforts by GlaxoSmithKline
Page 18
The 11th Annual CIMA Conference

avoid such down periods, but
remarked that “you can really
only do this with a computer.”
Combining momentum and
value requires bargain hunters
to “ride the wave” – something
that is hard for them to do.
Pzena’s solution: Instead of
avoiding these periods – prom-
ise them! If your investors
don’t like it, they can find
someone else to manage their
money.
Commenting on market volatil-

ity and his investment frame-
work, Pzena made the observa-
tion that volatility occurs when
investors pay attention to the
marginal news instead of un-
derstanding the entire fran-
Panelists (l to r) Profes- On February 1, 2008, the Co- the bad periods?” chise. He went on to describe
sor Bruce Greenwald, lumbia Investment Management his rigorous investment proc-
Association, in conjunction He discussed three types of ess. The process, which
Bill Miller (Legg Mason),
with The Heilbrunn Center for investors: momentum investors stresses a formal valuation
Lisa Hess (Lowes Corp) Graham & Dodd Investing, framework, looks at stocks on
(who “ride the wave”), value
and David Winters sponsored the 11th annual Co- a normalized price-to-earnings
investors (who exploit emo-
(Wintergreen Fund) lumbia Investment Management tions), and savants (who pre- basis and focuses on the long-
Conference. With students, dict the emotions). Mr. Pzena run underlying earnings power
faculty, alumni, investors, and presented data going back to of the business.
press in a packed Lerner Hall 1968 which suggested that a
Auditorium, the conference did simple value strategy, based Concluding his remarks, Mr.
not disappoint. solely on low price-to-book Pzena gave some insights on
companies, and a simple mo- what it takes to be a value
Dean Hubbard opened the mentum strategy, based on the investor: 1) A value investor
conference with a few remarks. nine-month return, outper- has to be willing to invest when
He first noted that “great informed the market. He noted, the outcome is uncertain; 2) If
vesting is important for dy- however, that if you had used you need to know what’s going
namic economies” and ex- the value strategy during this to happen, you’re not a value
pressed his conviction that 40-year stretch, there were investor; 3) The only reason
Columbia Business School is at eight years when you would stock prices get really low is
the vanguard of the next gen- have lost 20%. In the grand because of uncertainty – al-
eration of great investors. Fi- scheme, he remarked, these though you don’t know what’s
nally, he was sure to thank the are blips – but did comment going to happen, you can try to
conference organizers Jon that “when you’re losing 20%, size the risk/reward trade-off.
Salinas, Qie Zhang, and Puneet it doesn’t feel very good. Cli-
Kakar. ents begin to question you. Following Mr. Pzena’s speech
You begin to question yourself. was the Real Estate Panel with
Richard Pzena, founder of the And investors ask: ‘Wasn’t it Columbia Business School Pro-
highly regarded Pzena Invest- obvious this was going to hap- fessor Chris Mayer, Pershing
ment Management, which was pen?’” Square founder Bill Ackman,
recently taken public, delivered and Pennant Capital founder
the morning’s keynote address. He then posed the question: Alan Fournier. Professor Mayer
His speech was directed to- “Can you avoid the 20% down began the comments by de-
ward the question all value periods? Should you?” Mr. scribing the situation through-
investors will have to deal with: Pzena noted the temptation to out the country and remarking
“How do you make it through combine various strategies to (Continued on page 19)
CIMA Conference (continued from page 18)

(Continued from page 18) banks -- and potentially good singling out Nestle.
that “in some parts of the for foreign relations as well.
country there are unheard-of Mr. Ackman said, “They’re not On assessing foreign manage-
going to shoot us if they have ment, Weiss stressed the need
vacancy rates.” for humility and the need to
money in our banks.” Ackman
expressed worries that foreign demand higher return require-
Addressing liquidity, Mr. Ack-
investors will be disappointed if ments as well as “big boy” cor-
man suggested that he “used to
ultimately they lose money in porate governance. Jean-Marie
think the Fed controlled the
Eveillard conveyed a skeptical The Heilbrunn Center for
supply of money – the rating those bank investments. attitude towards management, Graham & Dodd Investing is a
agencies do it now by endors-
noting that he never meets premier knowledge center for
ing structured products.” Mr. The second panel of the day
with management until he has the practice and theory of
Fournier added that the futures covered the topic of interna-
done a lot of work because investing. Building on Colum-
markets are implying lower tional value investing and in-
then they need to be straight bia Business School’s re-
home prices over the next cluded Andrew Weiss, founder
with him. On a lighter note, nowned history in value in-
several years – bringing us back of Scout Capital, Jean-Marie
Mr. Eveillard made the com- vesting and finance, the center
to trend. Eveillard, portfolio manager of
ment that Wall Street’s furthers new developments in
the First Eagle International
“optimized balance sheets” investing and imparts the
The panelists continued to Value Fund, and Jeff Lee, a part-
discuss the role of the rating aren’t so ‘optimal’.” original principles of Security
ner at Owl Creek.
agencies, the banks, and the Analysis authors Benjamin
Paraphrasing Warren Buffett, Graham and David Dodd.
individuals in creating the sub- Responding to where the over-
Jean-Marie Eveillard under-
prime mess. Professor Mayer looked pockets of value might
scored the importance of un- Pictured Above: Roger
contrasted credit card securiti- be, Weiss suggested non-bank
derstanding companies and Murray and Robert Heilbrunn
zations with asset backed secu- financials, exchanges, and credit
their managements: “When
rities, noting the incentives are card processors. Eveillard com-
rowing a boat, what matters is
more cleanly aligned in the mented that there are world
not how strong your muscles
former. Mr. Fournier declared class industrial companies in
are, but whether the boat is
that “structured finance is Japan. And Mr. Lee suggested
leaking.” For example, he ex-
dead” and Mr. Ackman sug- Japan, China, and India with the
plained, “stupid acquisitions
gested that the rating process caveat that one needs to focus
bother me more than excess
be restructured so that the on management because you
buyers of credits pay for the need to focus on how to close cash on the balance sheet.”
ratings instead of the issuers. the discount gap. In the U.S.
there are mechanisms for this, In the next panel, Bill Miller,
in Japan there aren’t. Mr. Russo Lisa Hess, and David Winters
The panelists agreed that, over-
noted that there are many discussed their best ideas and
all, the presence of sovereign
excellent European companies, offered advice to students pur-
wealth funds will be good for
suing careers in investment
management. Mr. Miller started
with the point that often the
best places to look are the
areas that have done the worst
– housing, financials, and con-
sumer discretionary. He also
pointed out that, historically,
recessions happen 5% of the
time and that if the Fed can’t
predict them, there’s no point
for us to try to predict them.
Lisa Hess suggested that the

U.S. could offer some good
opportunities and remarked
that it used to be the emerging
markets. Hess noted she espe-
cially likes “financials with
Professor Artie Williams (EMBA ’02), Jennifer Wallace (Continued on page 20)
(MBA ’94), and Professor Bruce Greenwald catch up at the
11th Annual CIMA Conference
I, Issue
CIMA Conference (continued from page 19)

who do best are the ones who management. “Value investing”
know themselves best.” And isn’t buying the cheap stocks of
David Winters echoed: “Who bad businesses.
gets rich? People who do solid
fundamental work, have stable Mr. Loeb also offered the audi-
emotions, and are long-term ence a look into the various
investors.” Lastly, Bill Miller strategies Third Point employs –
quoted Keynes: “it is the duty of including special situations, risk
the long-term investor to en- arbitrage, and distressed debt.
dure great loses with equanim- He walked us through his past
ity.” investment in Dade Behring, a
great but misunderstood busi-
The conference concluded with ness. On the topic of special
the Keynote address of Daniel situations and event investing, he
Loeb, the founder of Third Point stressed the point that the stu-
Capital Management. He began dents in the room should take
his speech describing his early Joel Greenblatt’s course at Co-
Bill Miller and Thomas forays into investing during col- lumbia – or at the very least
Russo catch up at the lege. Despite a quick and lever- read his book “You Can Be a
11th Annual CIMA moats around them and retail.” aged start, he ended up $7,000 Stock Market Genius (Even If
In contrast, David Winters is in debt to his father. He didn’t You’re Not Too Smart).” He
Conference
focused outside North America pay this off until he was 29. also pointed out that although
where he says you can get both Third Point does engage in activ-
growth and value. He said he has Mr. Loeb then described the ism from time to time, it really is
also taken an interest in the founding of Third Point with just a small portion of his port-
stocks of luxury goods compa- $3,000,000, mostly from friends folio.
nies – companies whose stocks and family. He suggested this
have gotten “smashed.” Ms. was his best career move since Finally, Mr. Loeb left us with his
Hess was generous enough to he was “unemployable” due to insightful comments on risk
offer her “walk away from the his varied and eclectic back- management. He underscored
markets for five years and sleep ground. “Luckily,” he observed the difference between net and
well at night” portfolio to the dryly, “I was there to give myself gross exposure and – alluding to
audience. a job.” Mr. Loeb stressed the the phrase, “love means never
point that there is more to run- having to say you’re sorry” –
Describing the types of compa- ning a hedge fund than just in- suggested that, “good risk man-
nies he looks for, David Winters vesting. It is also managing a agement means never having to
said he likes good businesses business and requires one to sell something you really like.’”
with pricing power at a low think deeply about retaining, -G&Dsville
price – he called this the attracting, and moti-
“trifecta.” An added bonus is vating the best em-
when management is “pulling the ployees. He urged
oar in the right direction – that’s those considering a
a beautiful thing – that’s how similar path to “give
you get rich!” it some thought.”
Finally, the panelists were good Offering his

enough to offer their career thoughts on invest-
advice to the students in the ing, he said that
room. Bill Miller told the eager value investing isn’t
students that they “need an just analyzing num-
edge” and need to know them- bers – there are a
selves. He said the biggest ten- number of pitfalls
dency he sees is that people get you have to be
“very emotional.” He stressed aware of: value traps, liquidity Legendary value investor Jean-
that the “environment where traps, catalysts, proper assess- Marie Eveillard answers questions
you operate is very important.” ment of the business climate,
from conference attendees
Lisa Hess added that the “ones portfolio construction, and risk
MBA Advice from the Oracle of Omaha

By David Kessler (MBA ’08) would last, he replied, “I don’t attention to salary. “Who you
know. I have never made work for is extremely impor-
money on macro calls.” Buffett tant, so choose carefully,” he
On March 21 I flew to Omaha
said that even if he had per- counseled, adding that the
— along with 150 of my class-
fectly predicted macro condi- most important decision of his
mates — to meet Warren
tions in 1973–74, he would not own career was going to work
Buffett, MS ’51, a man I have
have bought See’s Candies in for Benjamin Graham.
admired (some friends would
1972 going into a recession and
say fanatically idolized) for
would have missed out on a As MBA students, we are be-
close to 15 years. company that he has referred ginning our careers in an age
to as “the prototype of a where the image of a corporate David Kessler (’08) and Warren
After a tour of the Berkshire dream business.” Buffett (’51)
executive has been bruised.
Hathaway-owned Nebraska
Spending time with Warren
Furniture Mart, we were
After joking that our gradua- Buffett — an astute business-
brought to a room at the
tion was not perfectly timed, man, a legendary investor, a
Omaha Field Club. Warren
Buffett warned that we should rational and disciplined person
Buffett stood at the front —
not be discouraged from pursu- and a generous philanthropist
two of his five daily cans of
ing a career in finance. Finance — afforded us the opportunity
Cherry Coke nearby — and for
is only going to become more to learn much more than just
the next two and a half hours,
important as time goes on, he how to pick stocks.
answered our questions. said, and it is a field where one
can truly stand out and be rec- Before the trip, I was certain
The questions covered a wide ognized. that no one could ever live up
range of issues, including what
to the sincere, humble and
he looks for in a business, the
He advised MBA students to generous image depicted of him
current financial situation, re-
learn as much about accounting in books, shareholder letters
cent events at Bear Stearns,
as possible, adding that, and TV interviews. I was
ethics, emerging markets, com-
“accounting is the language of wrong. Even that lofty image
modities, his relationship with
business.” He also said that did not hold a candle to the
Benjamin Graham and his typi-
writing and verbal communica- man I was lucky enough to
cal day. His answers were a
tion are extremely important in spend half the day with in
powerful reminder of his
the business world and that Omaha.
unique ability to distill complex
students should seek out ways
issues down to their bare es-
to improve these skills every Originally posted to Columbia
sence. Business School ‘s Blog, “Public
chance they get.
Offering”
When asked about how long http://www4.gsb.columbia.edu/
Buffett urged students looking publicoffering
the current financial crisis
for jobs not to pay too much
SAVE THE DATE

The 12th Annual CIMA Conference
February 13, 2009
Columbia University - Lerner Hall
Past speakers have included: Jean-Marie Eveillard, Marty Whitman, Leon
Cooperman, Steve Mandel, Daniel Loeb, Thomas Russo, Bruce Berkowitz,
Rich Pzena, James Tisch, David Winters, Bill Ackman, and more...
The conference will sell out, so get your tickets early!

Get Involved:

New York, NY 10027
Name: _____________________________

E-mail Address: _____________________________
Business Phone: _____________________________

Contact us at:

3022 Broadway
New York, NY 10027
Volume II, Issue I Winter 2007/2008

Inside this issue:
Graham and Dodd

Breakfast
p. 3 Staying Power: Jean-Marie Eveillard
Jean-Marie Eveillard is a leg- Jean-Marie Eveillard’s strict
D.R. Horton, Inc. p. 14
end in the world of value investment discipline and
Macy’s p. 16 investing. Widely recognized outstanding investment re-
as the first truly global value turns earned him a Morning-
investor, Jean-Marie achieved star Lifetime Achievement
Netflix p. 18
his status by adhering to the Award in 2003.
Industry p. 20 investment principles of Gra-
Networking Night ham and Dodd, and ex- On March 26, 2007 First
panded upon by Warren Eagle Funds and its invest-
Value Investing in p. 22 Buffett. ment advisor, Arnhold and S.
India Bleichroeder Advisors, offi-
Jean-Marie began his career cially announced that Jean-
in 1962 with Societe Gener- Marie would resume portfo- Jean-Marie Eveillard, Portfolio
Editors: ale and became portfolio lio management responsibili- Manager - First Eagle Funds.
manager of what is now the ties for the First Eagle
David Kessler First Eagle Global Fund in Global, Overseas, Gold, you tell us your story?
MBA 2008 Overseas Variable and U.S.
1979. Prior to his brief re-
tirement in 2004, Jean-Marie Value Funds. JME: I had been working
Charles Murphy since the early 1960’s with a
MBA 2009 led the First Eagle Global
Q: It seems that every value French bank doing securities
Fund to a 15.8% average analysis in Paris. The French
investor has their own story
David Silverman annual return - compared to bank sent me to New York
about how they stumbled
MBA 2009 13.7% for the S&P 500 upon value investing. Can presumably for a year or
(according to Morningtar).

As we enter our second value investor Jean-Marie and The Heilbrunn Center.
Visit us at: year, we are pleased to pro- Eveillard of First Eagle Funds. Inside you will find coverage
vide you with the third edi- Mr. Eveillard was gracious of the 17th Annual Graham
www.gsb.columbia.edu/students/ t ion of Gr ah a m and enough to sit down with us and Dodd Breakfast featuring
organizations/cima/ Doddsville, Columbia Business and share the wisdom he has David Einhorn of Greenlight
School’s student-led invest- gained during a distinguished Capital; lessons from the
ment new slette r, co- career that has spanned over Industry Networking Night
sponsored by the Heilbrunn three decades. featuring William von Muef-
Center for Graham & Dodd fling (’95) of Cantillon Capital
Investing and the Columbia We also hope to give you a Management and David
Investment Management taste of some of the extraor- Greenspan (’00) of Blue
Association. dinary events sponsored by Ridge Capital; and you will
Columbia Business School, travel to India with Professor
This edition features an in- the Columbia Investment Bruce Greenwald and mem-
terview with legendary global Management Association, (Continued on page 2)
Page 2

bers of The Heilbrunn Cen-
ter to discuss value investing,
globalization, corporate so-
cial responsibility, and com-
petitive strategy.
As always, we also feature

investment ideas from the
students of Columbia Busi-
ness School.

as we continue to refine this Legendary investors Martin Whitman and Edwin Schloss at
publication for future edi- the 17th Annual Graham & Dodd Breakfast on October
tions. Enjoy! 19, 2007. The annual breakfast is organized by The Heil-
brunn Center for Graham and Dodd Investing.
-G&Dsville
two. I got to New York There is a story in France approach – trading the big
City for the first time in about a famous French poet stocks. Neither in New
“To me, value January of 1968. I didn’t named Paul Claudel who York, nor when I went back
know many people, but I had not believed in God. to Paris for a few years,
investing is a knew a few people in the One day, he was standing by could I convince anybody to
French community, and I a pillar at a Cathedral near look at value investing. Still
got to meet two French Paris and he said: “I was today to my knowledge, the
big tent that students attending Columbia illuminated by faith.” In a French banks and institu-
Business School whose in- sense, I was illuminated not tions do not have value in-
accommodates terests were not investing – by faith, but all of a sudden, vesting. Societe Generale
their interest was market- it seemed to me that Ben sold our operation to Arn-
ing. During that summer, Graham simply made sense. hold and S. Bleichroeder at
many different we bicycled together on The idea of margin of safety, the end of 1999, and I’ve
weekends in Central Park. the idea of intrinsic value, kept in touch with some of
people.” They knew that I was in the the idea of Mr. Market, the the people there. I have
field of investments, and very humble idea that the tried to convince them over
they had heard of Ben Gra- future is uncertain - it made the past seven years that
ham. Investments were not sense to me. I stayed in they should make some
their interest, but they men- New York for another few room somewhere in a little
tioned Ben Graham to me. years, but I could not con- corner for value investing,
So, I went to a bookstore vince Paris headquarters but they are not into it.
and bought The Intelligent because their whole ap-
Investor and Securities Analy- proach was completely dif- Today in Paris there are a
sis. The Intelligent Investor in ferent. Their approach, in a few people practicing value
particular sort of struck me. sense, was more of a trading (Continued on page 4)
Fooling Some of the People All of the Time

Graham and Dodd Breakfast
with David Einhorn
On the morning of October

19th, close to 400 investors
gathered at The University “The crisis
Club in Manhattan for the
17th Annual Graham & came because
Dodd Breakfast. This year’s
keynote speaker was David we have a lot
Einhorn, President of
Greenlight Capital. Under of bad
the title “Fooling Some of
the People All of the Time,” practices and a
Mr. Einhorn addressed the
current state of the capital practices and a lot of bad This includes not only the
markets and shared his ideas.” The result is that sub-prime market but also
lot of bad
thoughts on ways to remedy lenders were “induced to all areas of residential real
the current situation in the take imprudent risks and estate, commercial real es-
ideas.”
credit markets. make imprudent loans, tate and the corporate lend-
which of course led to ing markets and has applied
Mr. Einhorn, introduced by losses.” One practice ad- equally to borrowers
Professor Bruce Greenwald monished by Mr. Einhorn is whether they are an average
as an investor with a crea- the current system of dele- American trying to purchase
tive mind, a powerful intelli- gating the assessment of a house or a private equity
gence, and a sound instinct credit risk to credit rating firm pursuing an LBO.
for value, is a graduate of agencies that are paid by
Cornell University. He be- bond issuers rather than Why have borrowers en-
gan his career in the Invest- bond buyers. joyed such low rates? Ac-
ment Banking Group of cording to Mr. Einhorn, the
Donaldson, Lufkin & Jen- While the media might lead answer lies in how this risk
rette. After 2 years with one to believe that sub- of structured financial prod-
DLJ, Mr. Einhorn left to take prime loans are at the root ucts are assessed. Rating
a job as an analyst with a of the current capital mar- agencies perform their
hedge fund. In January 1996 ket disarray, Mr. Einhorn analysis free from the re-
he co-founded Greenlight asserts that that sub-prime strictions of “Reg FD”.
Capital. Starting with less loans have become a con- Without access to the same CBS alumni reconnect at the
than $1 million in capital, venient excuse for a much information as the credit
Mr. Einhorn built Greenlight larger problem. The real agencies, investors are not
into one of the most suc- issue is that lenders of all able to decide whether they
cessful hedge funds in the sorts lent too much money agree or disagree with the
industry. Greenlight, which and did not demand enough rating. “Without enough
has grown to over $4 bil- interest to compensate information in the market
lion, boasts returns which their risk. “There has been other than the credit rating,
are reported to be 27% a colossal undercharging for it is hard for buyers and
annualized. credit across the board,” sellers to decide what to do
Einhorn stated. Loans were once the credit rating
In speaking about the credit issued based on the bor- comes into doubt.” Einhorn
markets, Mr. Einhorn de- rower’s ability to refinance believes that one solution to
clared “the crisis came be- rather than the borrowers this problem is to make all
cause we have a lot of bad ability to repay the loan. (Continued on page 4)
Page 4
17th Annual Graham and Dodd Breakfast

(Continued from page 3) an enormous systemic risk David Einhorn concluded his
information as these entities are able to remarks by reading an ex-
shared with maintain access to cheap cerpt from his forthcoming
rating agen- credit while over extending book due on bookshelves
cies available themselves beyond pru- next spring. Among the
to the entire dence.” guests at the breakfast were
market. three generations of value
In describing his own invest- investors including Walter
Einhorn sug- ment philosophy, Mr. Ein- and Edwin Schloss, Marty
gested that horn said that the idea is to Whitman, Mario Gabelli,
“the rating preserve capital on an in- Jean Marie Eveillard, and
agencies ve st men t-b y-in ve st ment Tom Russo. The breakfast,
Mario Gabelli (’67) and
have lost their ability to basis. His goal is to put which is organized by The
Walter Schloss catch up
at the Graham and Dodd impose discipline on the together a portfolio of indi- Heilbrunn Center for Gra-
balance sheets of the broker vidual ideas that are set up ham and Dodd Investing,
Breakfast
dealers, the financial guaran- to preserve capital if he is was simulcast to London
tee companies, enablers of wrong, and will achieve a and webcast to an audience
structured finance that bring good return if he is some- around the world.
so much business to the thing other than wrong.
rating agencies. This creates -G&Dsville

(Continued from page 2) about value investing. They best book that has ever
investing. Twenty years said: “Hey – we have a small been written about invest-
ago, there was nobody to fund in New York - $15 ing.
my knowledge, but I think million – why don’t you go
today there are a few inde- back to NY and run it?” Over the past almost 30
pendent shops that tend to Because it was small and years, we (First Eagle) have
do value investing. And, because I was across the sort of floated between Ben
indeed, there are two young ocean, they basically let me Graham and Buffett. We
Italian men three or four run it the way I wanted. began with the Graham ap-
years ago who went to the Within a few months of proach which is somewhat
same business school I went when I came back to New static and less potentially
to in Paris. They looked up York in late 1978, I also rewarding then the Buffett
my name in the alumni book came across the annual re- approach, but less time con-
and called me and came to ports of Berkshire Hatha- suming. So as we staffed up,
see me because they had way. To me, value investing we moved more to the Buf-
just started a small value is a big tent that accommo- fett approach, although not
shop in Paris. I became a dates many different people. without trepidation because
minority shareholder in At one end of the tent the Buffett approach – yes,
their advisory firm. there is Ben Graham, and at you can get the numbers
the other end of the tent right, but there is also a
So in any case, I came there is Warren Buffett, major qualitative side to the
across The Intelligent Investor who worked with Graham Buffett approach. We, or at
in 1968 and, then, had to and then went out on his least I, surely do not have
wait a little more than 10 own and made adjustments the extraordinary skills of
years until late 1978 when to the teachings of Ben Gra- Buffett, so one has to be
Paris headquarters was get- ham. Still today, Buffett says very careful when one
ting tired of hearing me talk The Intelligent Investor is the (Continued on page 5)

(Continued from page 4) So there are not a great there are two characteris-
moves to the Buffett ap- number of value shops, al- tics to borrowing. Number
proach. Today, we have though I must confess that one: borrowing works both
Bruce Greenwald as direc- there are quite a few value ways. So you are compro-
tor of research, and there shops on the hedge fund mising the idea of margin of
are nine in-house analysts. I side. Usually they are long safety if you borrow. Num-
think Bruce will take that only. They have the ability ber two: borrowing reduces
number up to something to borrow, the ability to your staying power. As I Professor Bruce Greenwald and
like twelve within the next short, but there are very said, if you are a value inves- Dean Glenn Hubbard
few months. few value investors that get tor, you are a long term
involved in shorting because investor, so you want to Columbia Business School is
So this is how I came across have staying power. a leading resource for invest-
Ben Graham and then 10 ment management profession-
years later, just in time, the I’m not familiar with many als and the only Ivy League
Buffett approach. “There are very of the value shops on the business school in New York
long only hedge fund side, City. The School, where value
Q: You have been managing few value investors but if you look at the mutual investing originated, is consis-
the First Eagle Global fund fund world, you don’t have tently ranked among the top
that get involved in
since 1979, and you spoke that many value shops. You programs for finance in the
about how your philosophy shorting because if have Marty Whitman’s world.
has shifted over time. How Third Avenue, you have
have you seen the philoso- you are a value Mason Hawkins at South-
phy of Value Investing in east, you have Oakmark in
general evolve over that investor, you are a Chicago, you have Tweedy
time? Browne, and a few others,
long term investor. but you don’t have that
JME: I think today, to some If you are a long many.
extent because of the ex-
treme popularity of Warren term investor, you Q: You were probably one
Buffett, there is more com- of the first recognized global
petition. If you think of the don’t have to worry value investors. How has
previous generation of true global investing, in general,
value investors – individuals about market changed over the past 30
like Walter Schloss and the years?
like - they were truly very psychology.”
close to the Graham ap- JME: It has changed in the
proach. And I think today sense that it has also be-
when you look at the vari- if you are a value investor, come more competitive
ous value shops in the U.S. - you are a long term inves- because there are more
keeping in mind what the tor. If you are a long term American value investors
late Bill Ruane tried to fig- investor, you don’t have to who invest on a global basis,
ure out six or seven years worry about market psy- and because there is a little
ago, and it is probably true chology. As Ben Graham bit more competition from
today - there was really no said: “Short term - the stock the locals, there are more
more than 5% of profession- market is a voting machine; people outside the U.S.
ally managed money in the long term - it is a weighing looking for value investment
U.S. that was invested on a machine.” But it is very ideas. Let me give you an
value basis, broadly speak- hard to get involved in example: In the 80’s and up
ing. And there was much shorting without taking mar- until the early 90’s, there
less than that outside the ket psychology into account. were many companies in
U.S. Of course, by definition, (Continued on page 6)
Page 6
that if we decide to look For instance in the early

into a particular investment 1970’s, Buffett figured out
idea we have to do most of that the major characteris-
the work in-house, hence tics of the newspaper busi-
the extreme importance of ness had to do with the fact
the in house research de- that many newspapers had a
partment. This is because quasi-monopoly. Buffett
sell-side research is directed determined that what was
towards the 95% or so of important was not the fact
professional investors who that already in the 1970’s
are not value investors, so circulation was not growing
their time horizon is usually much, if at all, but that the
more along the lines of six local department store
to twelve months as op- automatically advertised in
Jean-Marie Eveillard, Xavier (Continued from page 5) posed to five or more years the local newspaper. On
De Romana (‘02), Walter for us. top of that, it was not a
Schloss Europe that had very con- capital intensive business. It
servative accounting. The The work, of course, starts was a service business with
locals did not pay attention with public information – higher margins, not that
to how conservative the running numbers. Some- they could charge any price,
“Every chief finan- accounting could be. This is times, we make adjustments but they were the advertis-
no longer true. to the reported numbers, ing instrument of choice for
cial officer in this which is particularly impor- local businesses. Wall
country, and even Q: What are the character- tant today because every Street was entirely focused
istics that draw you to an chief financial officer in this on the fact that they were
some outside the investment and how do you country, and even some not growth companies, pre-
go about finding new ideas? outside the U.S., seems to sumably because circulation
U.S., seems to be be trying to show the high- was not going up.
JME: Well, in terms of est possible reported earn-
trying to show his hunting grounds, in general, ings without going to jail. In This fits in with Buffett’s
we don’t do screens be- order to do so, they have to idea that value investors are
or her highest pos- cause we like to check the make sure that they observe not hostile to growth. Buf-
sible reported accounting carefully and the letter of the regulation, fett says that value and
make our own adjustments. but they don’t hesitate to growth are joined at the hip
earnings without To take an extreme exam- betray the spirit of the regu- – value investors just want
ple, take a look at an Ameri- lations. So, we run the profitable growth and they
going to jail.” can forest products com- numbers coming from public don’t want to pay outra-
pany. If they still own tim- information, and it’s not a geous prices for future
berland, as is the case of matter of having fifteen growth because, as Graham
Weyerhaeuser, which they pages of numbers. I like the said, the future is uncertain.
acquired about a century idea that the important And also, what is probably
ago, they continue to carry numbers have more or less more important from Buf-
it on the balance sheet for to fit on a single page or fett’s point of view is to
about $1 an acre. Today, it two pages at the most. identify the extremely small
is more like $1,000 an acre number of businesses
or more in the south and Then, there is the qualitative where, after doing a lot of
$2,000 an acre in the Pacific side, which is of course homework and exercising
Northwest. So a screen judgmental and has a lot to judgment, you come to the
would not help you in any do with trying to figure out conclusion that the odds are
way in that respect. the three, four or five major good that the business has a
The way we go about it is characteristics of a business. (Continued on page 7)
Volume I,
II,Issue
Issue21 Page 7

(Continued from page 6) details, so sometimes the rassed because she didn’t
‘moat’, the business has a analyst investigates an idea know. And so that evening,
competitive advantage, and for a few days or for a few when I came home, she
that business will be as prof- weeks and comes back to asked “What do you do at
itable five or ten years down me and says “Sorry, but this the office?” I thought,
the road as it is today. This is not a very a good idea rather than trying to explain
is opposed to simply ex- and here are the reasons what money management is
trapolating 20% or 25% an- why.” This is fine with me. to a six year old, I said, “I
nual growth observed over Third, we always make sure spend half of my time read-
the past three years. There the analysts have enough ing and half of my time talk-
“For value
is a very limited number of time left to initiate and de- ing with my colleagues.” My
businesses that can continue velop their own investment daughter said: “Reading? investors, the edge
that type of growth. In any ideas. They come to me Talking? That’s not work!”
case, Buffett never insisted first, but it is very rare for But in fact, that is what I do! is seldom in
on 20% - 25% growth. I me to tell them that I think I spend a considerable
think he even said some- they are barking up the amount of time talking with unusual
thing to the effect that a wrong tree, wasting their the analysts, looking with
profitable business that is time for such and such rea- them at the various angles, information which
not growing is not a business sons. It very seldom hap- trying to make sure that
the rest of the
that has no value. A busi- pens. they have properly esti-
ness can have value even if it mated the strengths and the market doesn’t
is not growing. In that So the analysts go out, run weaknesses of the business
sense, value investors tend the numbers according to – then they go back and have. There is a
to think like private equity public information, and investigate further.
investors – we are looking make the adjustments to the fine line between
for stable and profitable numbers as necessary. For We invest, if in the end, we
businesses - sometimes in instance, for quite a while, agree with them from an unusual
what appears to be mun- we had to make the adjust- analytical point of view. In information being
dane areas. ments for the issuance of other words, we think we
stock options because there understand the business, we obtained by
The analysts here keep were many companies that think we like the business,
track of what we own but in until they were forced to do and we think investors are regular means or
our case, most of the work it, just didn’t do it. mis-pricing the business.
is done before we start buy- For value investors, the by ‘not so regular’
ing a stock. Afterwards, it is The analysts try to figure edge is seldom in unusual
just a matter of updating the 3 – 5 major characteris- information which the rest means. It is more
and we don’t spend any tics of the business. I don’t of the market doesn’t have. in the
time trying to figure out the ask them to write about There is a fine line between
next quarter. So our nine this, but it comes in the unusual information being interpretation of
analysts keep track of the conversation that we have obtained by regular means
securities we own, they after we look at the num- or by ‘not so regular’ the information.”
investigate the ideas that the bers. Then there is the means. It is more in the
portfolio manager may have back and forth between me interpretation of the infor-
which, at least in my case, and the analyst. mation. It is more figuring
usually comes from reading out the major characteris-
newspapers or flipping Many years ago, when our tics of a business. Buffett
through some sell-side re- younger daughter was six or didn’t know more than Wall
search and saying “hmmm, seven years old, somebody Street knew about the
maybe we should look at at school must have asked newspaper business. He
this.” Of course, for a value her, “What does your fa- just decided that looking at
investor the devil is in the ther do?” She was embar- (Continued on page 8)
Page 8
(Continued from page 7) Only after the analysts have you are a long-term inves-
the advertising power of the already done a lot of work tor, you accept in advance
newspaper was more im- will they go and meet man- that you are making no ef-
portant that the flat circula- agement, because manage- fort whatsoever to keep up
tion numbers. ment figures out very early with your benchmark or
in the conversation whether your peers on a short term
Q: You said that occasion- we already know a lot about basis. So you know in ad-
ally you will tell an analyst their business, so they are vance that every now and
they are barking up the less likely to lie. I am exag- then you will lag. We
wrong tree. Are there any gerating here, but some- lagged sometimes in the
recurring traps that inves- times there are instances 1980’s, in the early 1990’s
“Sometimes, there
tors with less experience where either they tell you we lagged as well, but then
are non-value inves- might fall into? nothing, or they tell you lies, in the late 1990’s we lagged
or they tell you things that terribly for several years.
tors who tell me, JME: It might be the impres- they shouldn’t tell you in We were still producing
sion I might have had be- the first place. We have to absolute returns, but rela-
well, I would love to cause maybe I looked at the be very careful, not because tive to our benchmark and
businesses six or eight years management deliberately to our peers we were lag-
do what you do, but before, and I was under the tries to give us inside infor- ging terribly because I had
impression that manage- mation, but sometimes, par- declined to participate in
if I did it and start
ment was intellectually dis- ticularly if we own 10% - technology, media and tele-
lagging, either my honest. In terms of man- 15% of a business, we are com, together with many
agement, of course there is the second largest holder other value investors.
boss or my share- the Buffett quip that when after a family that controls
rowing a boat - what mat- the business and we’ve held In less than 3 years, be-
holders will fire me. ters less is how strong your the stock for 7 or 10 years, tween the fall of 1997 and
arms are, what matters so management truly looks the spring of 2000, our
Of course, the an- more is whether the boat is Global Fund, which I had
at us as long term partners.
leaking. This is, of course, a run since early 1979 and
swer is you have the
metaphor for the fact that had a long term record, lost
wrong boss or Wall Street tends to pay a Q: You have often been seven out of ten sharehold-
great deal of attention to quoted as saying you have a ers. One has to live with
wrong shareholders how good the management five-year time horizon vs. that because a mutual fund
is, but Buffett has also said Wall Street’s six-to-twelve is open to subscriptions and
or both!” that he wants to buy into month time horizon – redemptions every day.
businesses that even an idiot When do you think about You don’t get to choose
could run. It is the quality, selling a stock? Especially your investors. You take
or lack thereof, of a particu- given that your performance whoever is sending the
lar business. is measured against other check. You try in your sales
mutual funds, how do you effort to explain very clearly
I could think, again because I have the staying power to what you are trying to do,
came across the stock be- remain disciplined? so that you don’t get the
fore, this is a business wrong type of investors.
where the accounting is But there are many inves-
dubious, or I could be under JME: That is a key question tors who will either not
the impression that there is – to answer the second understand what we’re try-
a major weakness to the question first – if you are a ing to do or will understand
business that may not be value investor - you are a what we’re trying to do, but
apparent immediately. long-term investor. Warren if we lag for a year or two,
Buffett did not become very they will forget about it.
rich trading securities. If (Continued on page 9)

(Continued from page 8) me. Of course, the answer ment had done much worse
There is impatience among is you have the wrong boss than Peter Lynch’s record
investors. Ideally, if you run or wrong shareholders or because they usually bought
money professionally on a both! into the fund after Peter Professor Bruce
long-term basis, you would Lynch had really hit the ball Greenwald
want shareholders in your Q: You must have experi- and then they would leave if
fund to be long-term inves- enced that, especially early for six or nine months if he Bruce C. N. Greenwald
tors, but that’s not always in your career when you was doing less well or if the holds the Robert Heil-
what happens. were with Societe Gener- market went down during brunn Professorship of
ale? that period. I hesitate Finance and Asset Man-
Incidentally, not only does whenever I meet with finan- agement at Columbia
value investing make sense, cial planners or brokers, Business School and is
at least to me, but it works. JME: That is why very early, who are our real constitu- the academic Director of
In that respect, you are late 1997, after only a few ency, because they are the the Heilbrunn Center
probably familiar with the months of net redemptions, ones who decide to choose for Graham & Dodd
piece written by Buffett – they made the decision of which mutual fund to invest Investing. Described by
“The Superinvestors of Gra- selling our investment advi- in for their own clients. I the New York Times as
ham and Doddsville” – and sory firm. They were exam reluctant to try to tell “a guru to Wall Street’s
then 20 years later, the tremely impatient. One them how to run their busi- gurus,” Greenwald is an
piece written by Louis thing is that if I look back, nesses, but it seems to me authority on value in-
Lowenstein (“Searching for we ran a total of $6 billion that they are much too vesting with additional
Rationality in a Perfect in the fall of 1997. Even worried about asset alloca- expertise in productivity
Storm”). Buffett himself though we continued to tion, they should be trying and the economics of
considered another nine make money for sharehold- to find three, four or five
information.
value investors. So then the ers, funds were down to good value managers and
question arises - why are $2.5 billion in the spring of just stay with them. Maybe
there so few value investors 2000. Today we manage they are worried that if they
if it makes sense, if the ap- close to $35 billion. So (Continued on page 10)
proach makes sense and it what I am saying here is that
works? I think the answer it seems to me that it goes
is truly psychological, and to show that if you do what
that is what I was referring you think is right for the
to when I said that if you shareholders, even if they
are a value investor, you don’t seem to agree them-
have to accept in advance selves, if you think you do
that you will lag. And if you what is right for the share-
lag, you suffer. Yes, you say holders, in the end, it bene-
to yourself, I’m a long-term fits your business from a
investor so my day will long-term point of view
come, but if it goes on too because $35 billion is not
long, it is not only the only a lot more than $2.5
doubt, but there is a genu- billion, it is also a lot more
ine suffering associated with than $6 billion. It goes back
lagging, and human nature to when Peter Lynch was
shrinks from pain. Some- running the Fidelity Magellan
times, there are non-value fund. Lynch had a superior
investors who tell me, well I long-term track record, but
would love to do what you he discovered to his dismay
do, but, if I did it and start that the great majority of Jean-Marie Eveillard answering questions after delivering the
lagging, either my boss or shareholders of the Magel- keynote address at the 15th Graham & Dodd Breakfast on Oc-
my shareholders will fire lan Fund during his manage- tober 18, 2005
Page 10
(Continued from page 9) JME: Yes, but if you look at or two or three of very
pick three, four or five value the U.S. equity market, we difficult economic and finan-
managers and stick with are in the midst of what cial circumstances, because
them, after two or three appears to be a major and if that were the case, those
years the clients will say worldwide credit crisis. In intrinsic values would be at
“What am I paying you for?” August, the crisis was identi- least temporarily too high,
fied as a sub-prime housing and accordingly, the risks
David Einhorn with his
parents at the Graham
Q: I recently read that American problem. Today, associated with our equity
Tweedy Browne opened four months later, it appears portfolio would be bigger
& Dodd Breakfast
their Global Value Fund, to be a worldwide credit than I think they are. So, to
Third Avenue International crisis, and yet the American the extent that we consider
is opening their fund, Long- stock market is 5% off its the top-down we look from
leaf is opening their Partners high at the end of the fifth a negative standpoint. What
Fund, and you just opened year of a Bull market. Ex- could screw up, from the
your Global and Overseas cept for the Tokyo stock top-down, the investments
funds. Does this mean that market, which I think is we make with a bottom-up
investment opportunities about 20% off its high, mar- approach?
are beginning to appear on kets in the U.S. and Europe
the horizon? and most emerging markets In another respect, we’ve
are very close to their high. been in a twenty-five year
JME: That is right - I saw the Combined with the fact that credit boom, since the early
press release from Third we are in the midst of a 1980’s, interrupted painfully
Avenue and I also saw the major financial crisis, it but briefly in 1990. I say
press release from Longleaf. seems to indicate that inves- painfully because at the end
Longleaf is saying “We see tors, and for all I know they of 1990 you can point to
opportunities today.” Third may be right, believe that Rupert Murdoch’s News
Avenue and we are saying we’ll get out of the crisis Corp. almost going bank-
much more that the market reasonably soon. Other- rupt until the banks, and we
is very turbulent. To para- wise, markets would be - although I made the mis-
phrase Ben Graham, Mr. much lower than they are take of buying the bonds
Market seems to be moving today. So that is why, instead of buying the stock -
from fear to greed and back. speaking very generally, we and a few others under-
Both Third Avenue and we don’t find a tremendous stood that what they had
are saying that maybe there amount of investment op- was a liquidity problem, but
will be opportunities if the portunities right now. not an insolvency problem.
turbulence continues, but Even on a conservative ba-
neither one of us is saying You know value investors sis, the sum of the parts of
we see an opportunity right are bottom-up investors, the assets was quite a bit in
today. I believe Mason but I do pay some attention excess of the debt. They
Hawkins is saying that there to the top-down. First, it simply had a temporary cash
are currently opportunities cannot be completely ig- flow problem. Also in 1990
and for all I know, he may nored. Second, the intrinsic is when Sam Zell’s real es-
be right. values we establish for the tate empire almost col-
businesses we are invested lapsed. So, we have been in
Q: Your answer leads me to in or that we consider in- a twenty-five year credit
believe that you would cur- vesting in do not assume boom with one interrup-
rently be looking at some of eternal prosperity. They tion, which is a truly long
the most turbulent areas of assume that the world mud- credit boom.
the market right now? Is dles through, which is usu-
that true and where might ally what the world does. We seem to be facing a
that be? They do not assume a year (Continued on page 11)
(Continued from page 10) investors that if I go down sense my baby. I didn’t
worldwide credit crisis. the drain, well it is o.k. as want to just leave it. In
The central banks are pedal- long as everyone else is view of the size of assets
ing as fast as they can to going down the drain with under management, it was
mitigate the damage. This is me. I think that with the odd in a way that there was
crisis number six or seven. hedge fund business, at least only one portfolio manager.
You had October 1987, you so far, the regulators have I mean myself for twenty-six
had 1990, you had the late been careful enough to basi- years and Charles De Vaulx
1994 Mexican crisis, you cally prevent the middle for two years. Of course if
had the 1997 Asian crisis, in class from getting involved you have a single portfolio “You know value
1998 the Russian crisis and with hedge funds. But in the manager and he leaves or is investors are
the Long Term Capital Man- mutual fund business, we run over by a bus, what is
agement collapse. You had have almost one-million left is a big void. Although it bottom-up
the bursting of the technol- shareholders in our funds is true that value investors,
ogy/media/telecom bubble and while we have some at least in our case, it does- investors, but I do
and now the sub-prime institutional accounts and n’t matter who has the big-
housing crisis. The odds are some very wealthy individu- gest battalions. What I pay some
pretty good that crisis num- als, the great majority of the mean is if I had forty-five
ber six or seven in twenty one-million are middle class analysts, we wouldn’t be attention to the
years will be gone in a few people. If I screw up, I can doing any better than nine top-down. First, it
months, but maybe it will make daily lives difficult. or ten, but I think it is the
take longer or maybe the Financial planners have told kind of approach where we cannot be
financial system is truly fray- stories about individuals want as many people on the
ing at the edges. who did not have a great in-house research staff and completely
nest egg, but thought they as few people as possible on
I think it is Peter Bernstein had enough of a nest egg to the portfolio management ignored. Second,
who said sometimes what retire. They invested the side.
matters is not how low the money with conventional the intrinsic values
odds are that something money managers who pro- Q: You spoke about risk we establish for
truly negative happens - and ceeded to lose 30% to 40% being the consequence, not
the odds are pretty low that between the spring of 2000 necessarily the odds. How the businesses we
the system blows up - and the spring of 2003. does this thinking come into
sometimes what matters is These people had to go your investment process? are invested in or
what the consequences back to work, or sell the
would be if it happened. boat. JME: Risk to us goes back that we consider
For example, if I tell you if to not paying attention to
you do this, the odds are I remember the day after I how one does in the short
investing in do not
one-in-ten that you will lose retired, which was January term. If you go back to assume eternal
$50, no big deal. If I tell you 1, 2005, I got up late, took a Berkshire Hathaway’s an-
the odds are one-in-one stroll in Central Park and I nual report page that has prosperity.”
hundred, even better odds felt lighter than air. The the forty-plus year record
in the sense that the risk of responsibility was off my of Buffett, on a cumulative
losing is minute, that you shoulders. That is why I basis the record is extraor-
die, then the consequences wasn’t particularly eager to dinarily better than the S&P
are so drastic that even the come back, but I had been 500, but you can spot four
odds as low as one-in-one treated very well here at or five years, I think there is
hundred are just not good Arnhold and S. Bleichroe- one year where he is 1,500
enough. der, and also there was a basis points behind the S&P
side to it where particularly 500. So he too accepts the
I think there is a mindset the old fund, which I have fact that every now and
among many professional run since 1979, was in a (Continued on page 12)
Page 12
probably an opportunity to suffer because you will lag.

buy more of the stock. The It goes back to what Buffett
key distinction is what was saying when he said
Marty calls permanent im- something to the effect that
pairment of capital, which are investing does not require
fancy words for “Damn it, I high intelligence, but it re-
made a mistake.” Not a quires some temperament.
mistake because I bought a
stock at $35 and now it is at Q: On the topic of tempera-
$27. I made a mistake be- ment - Buffett has said that
cause either my original he is “wired” a certain way.
analysis of the business was Do you think temperament
wrong or because after I is something you are born
started buying the stock, I with or a trait that can be
Jean-Marie Eveillard and (Continued from page 11) failed to observe that the learned?
David Winters at a past business model was chang-
then you will underperform.
Graham & Dodd Breakfast ing for the worse. In this JME: One way to view it is
Risk to us is absolutely not case you have to acknowl- in the U.S. and also now in
volatility. We always have edge your mistake, sell at a Europe, some people go too
this discussion with financial loss, and move on. easily to the psychiatrist,
consultants - it is not volatil- because if they do so, it
ity. Marty Whitman is un- If you think it is a temporary shows that there is an ex-
usual in a sense that there unrealized capital loss, if you pectation that they should
are not many value inves- bought a stock at $35 and be happy every day. Of
tors who were very good two or three years later it is course, it is true at the
practitioners and also could at $27, it becomes painful other extreme. You have
write from a theoretical and the great majority of people who tend to believe
point of view. Marty, in one money managers get very too easily that life is a valley
of his books, makes a key upset. But you have to ask of tears and that one can
distinction between what he yourself, “Did I miss some- only be happy in the eternal.
calls temporary unrealized thing?” If the answer is, “I The truth is in between, one
capital loss, which is you buy don’t think so,” then you has to accept the fact that
a stock at $35 and, after a have to accept that fact. one is not happy every day.
year or two or three, it is at For example, if you buy a One is not entitled to be
$25 or $30. If you think stock for $25 and four years happy every day and I think
you have done your original later it is still at $25 and in that as an investor it is the
homework before you the fifth year it goes to $50, same idea that we don’t
bought the stock in a I don’t think in terms of I need to win every day. We
proper manner, if you kept wasted my time for four just need to win over time.
reasonably close to the years or it was what some Maybe the people who say,
situation as the business investors call stale money well, I cannot afford to be a
evolves over time, and if for four years, I say hey, I value investor because my
you believe that nothing doubled my money in five boss or shareholders will
major has changed for the years and that is 15% annu- fire me, maybe they are
worse since you started alized a year and that is fine. right. But I think there is
buying the stock, that is also the idea that I just don’t
what Marty calls temporary Going back to what I was want to suffer. I remember
unrealized capital loss, saying, not that value inves- there was a movie about
which is nothing to worry tors are masochists, but that baseball called “A League of
about. If anything, it is accepting in advance that (Continued on page 13)
every now and then you will
(Continued from page 12) said there were at least 20 fund field, most of which are
analysts there. The truth is long only. Also, keep in
Their Own” where at some they do distressed investing mind that in the words of
point a woman says to Tom and you need specialized Paul Isaac, hedge funds are a
Hanks, who plays the coach, people for that. Marty has compensation scheme and “Join a value shop.
“Baseball is too hard.” Tom also decided to become that indeed a reasonably
Hanks replies something to more of an activist, which good value mutual fund is, in Keep in mind …
the effect of “Of course it’s we have done very rarely, the end, from the point of
hard. If it was not hard then takes a lot of time and en- view of the shareholder of that indeed a
everybody would be doing ergy. the funds, a very cheap
it.” It is the idea that every- hedge fund, because all value reasonably good
thing in life that is worth- Number two, and most investors, whether they are
value mutual fund
while comes hard. importantly, in the value with hedge funds or with
tent, Bruce is definitely on mutual funds, shoot for ab- is, in the end, from
Q: You recently hired Co- the Buffett side although he solute returns. If you
lumbia Professor Bruce is very tolerant. Some peo- achieve absolute returns the point of view
Greenwald as the Director ple on the Graham side are and compound at a reason-
of Research. He is one rea- intolerant of the Buffett side able rate over the years the of the shareholder
son that many of us choose and vice-versa. You know, difference between you and
to pursue an MBA at Co- Buffett has called the pure a long only hedge fund is of the funds, a very
lumbia. How do you think Graham style “Cigar Butt” that you are charging 1.25%
cheap hedge fund,
he will enhance the team investing, which is not very overall expense ratio as
you have in place at First flattering, although I remem- opposed to two-and- because all value
Eagle? ber Walter Schloss chuck- twenty. You should also
ling that he himself thought approach professors who investors, whether
JME: Bruce is sixty-one he got more than one good are also practitioners to get
years old, and I first met puff every now and then. their opinions on which they are with
him several years ago. His However, Bruce has also firms would be good for you
entire professional career introduced some refine- to join.
hedge funds or
has been in the academic ments of his own to the
with mutual funds,
world, and he was willing to Buffett side and that will be Thank you, Mr. Eveillard.
go into the real world, so to very helpful to the analysts shoot for absolute
speak, as opposed to the here. Although the in-
academic world. He was house staff here does not returns.”
intrigued by the idea of be- need to be energized, you
ing director of research and, know that Bruce is an ener-
in that respect, I think he gizing personality. So, we
will do at least two things. are looking forward to his
Number one, although of joining the team. To me, he
lesser importance, he will is the ideal director of re-
help us beef up the research search.
department because he
knows a lot of people who Q: What advice would you
graduated from Columbia offer an MBA student aspir-
Business School and were ing to enter the field of in-
enrolled in the Value Invest- vestment management?
ing Program. I never
thought I was understaffed JME: Join a value shop.
until I recently met with Keep in mind there are
David Barse who is the value shops in the mutual
CEO of Third Avenue. He fund field and the hedge
Page 14
D.R. Horton, Inc. (SHORT)

Joshua Chekofsky November 2007
JChekofsky08@gsb.columbia.edu
Investment Thesis
I advocate a short position in the common stock of D.R. Horton, Inc. (“D.R. Horton” or the Company), as
I believe the stock has an intrinsic value today of $7.25 (representing a margin of safety of approximately
40%, against today’s price of $11.86), based upon a Price / Adjusted Book Value analysis; yet, there is
risk of 15% upside ($13.75). A six-month timeframe, across which the Company will report its next three
fiscal quarters of performance, should be ample for the Company’s homebuilding fundamentals to dete-
riorate further and for management to make additional impairment announcements. The Company is
poorly positioned in the current homebuilding environment. It has significant exposure to the weakest
D.R. Horton, Inc. (DHI)
geographic housing markets, and owns some of the youngest land supply in the industry, which is at
Price: $15.43
greatest risk of loss. Sales orders have fallen dramatically, while cancellations are at abysmal levels. As
(Jan. 25, 2008)
management pursues aggressive sales to generate free cash flow to pay down its significant debt load,
operating margins will deteriorate further. With adjustable-rate mortgages continuing to re-set, the Com-
pany’s core first-time buyers will be considerably affected. D.R. Horton will be required to take exten-
sive further impairments on its inventory (homes, land and options). Housing market conditions will
continue to be challenging and the timing of a recovery is unclear. The industry is currently mired in a
deep cyclical trough, which will likely persist for the foreseeable future. There will be continued margin
pressure from increased price reductions and sales incentives, continued high levels of new and existing
homes available for sale, weak demand for new home as potential buyers continue to see home prices
adjust downward, increased sales cancellations, continued weak housing affordability, and a decline in
the availability of mortgages due to further credit tightening. The formerly hottest housing markets are
now reeling, a growing number of foreclosed homes will be returning to the market, a sizable level of
mortgage loans will continue to default, and it will now take an elongated timeframe for the average
home buyer to receive a mortgage. The primary valuation was based upon a Price / Book Value method-
ology, in which book value was adjusted for anticipated substantial further asset impairments. A 0.75x
multiple (given investors’ weak confidence and the turmoil in the industry) was allocated.
Supporting Points / Catalysts

• Any further negative economic and industry performance releases will lead to a de-
crease in the Company’s stock price.
• The Company recently reported that cancellations increased to 48% in the 9/30/07
quarter, which is dramatically higher than the 30% to 40% in prior quarters. The Com-
pany’s backlog no longer provides accurate visibility on future revenues. Cancellations
should continue to remain at heightened levels.
• D.R. Horton has significant exposure to the weakest geographic housing markets in-
cluding California, Arizona, Nevada and Florida. Moreover, the Company maintains a
very young land supply, relative to other home builders. This land which was purchased
in 2005 and 2006 in formerly hot markets is at significant risk of impairment.
• D.R. Horton has a heavy debt load. Any further deterioration in performance could
lead to debt downgrades, and extensive impairments will reduce the borrowing base.
This leads to broken financial covenants and lower liquidity.
• D.R. Horton’s target customer base has been greatly affected by tightening in the mortgage market, as
the Company’s focus is on first-time buyers and first time move-up buyers (with most homes priced
below $250,000).
D.R. Horton is the largest homebuilding company in the country based on homes closed during the 12
months ended 6/30/07. The Company constructs and sells homes through its operating divisions in 27
states and 83 metropolitan markets. Homebuilding operations include the construction and sale of single-
family homes with sales prices generally ranging from $90,000 to $900,000, with an average closing
price of $261,600 during the nine months ended 6/30/07. Approximately 80% of home sales revenues
were generated from the sale of single-family detached homes in the 9 months ended 6/30/07, with the
remainder from the sale of attached homes. DHI Mortgage, a wholly-owned subsidiary, provides mort-
gage financing services to purchasers of homes it builds and sells.
Historical and Projected Performance

The Company’s performance has deteriorated over the last several quarters. Sales and operating margins
for the homebuilding operations have dropped precipitously, and results for the financial services busi-
D.R. Horton, Inc. (Continued from previous page)

ness have followed in concert. The Company has aggressively moved towards selling its inventory, to work “Sales orders
down the glut of supply, which has lowered its average selling price and operating margins. The fall-out
from the exuberant rise in homebuilding activities will take time to work its way through the system. Until have fallen dra-
the demand/supply imbalance is corrected and selling prices stabilize, performance will continue to be de-
pressed. Further compounding the problem, the Company will very likely have to recognize significant matically, while
additional impairments on its inventory (homes, land and options), as management realizes that losses will
be worse than expected. It is assumed that industry fundamentals will remain weak across Q4 2007 and FY cancellations are
2008, and that the situation won’t stabilize until 2009. Revenue and margins are projected to improve in
2009, towards the levels reached in the earlier part of this decade. at abysmal lev-
Valuation els.”
Given the weak recent EBIT growth, poor pre-tax
ROTC, and heavy debt load, the EV/EBIT valua-
tions produce low intrinsic values. The historical
EV/EBIT analysis produces a value of $5.45 to
$9.30. The Projected EV/EBIT analysis produces a
value of $6.20 to $8.60. A more robust approach for
this inventory-intensive business is a Price / Ad-
justed Book Value analysis, which produces a target
price of $7.25. Impairments on homes is driven by
the perception that 20% of the 6/30/07 homes inven-
tory book value is at risk, as D.R. Horton has ag-
gressively moved towards price slashing, which
may create a price-cutting war. The Company’s core
first-time buyers are seriously affected by the recent
credit crisis. The estimate for the decline in homes
inventory is estimated to be negative 20%. The level
of impairments on the land (held for development,
under development, and in development) is assumed to be triple this dollar amount, as land prices change at
three times the price of homes, given that the Company prices land on a residual basis, after development
and construction costs. Options on land/lots are assumed to be worthless, as these contracts were entered
into at the peak of the real estate boom. The impairments are tax-effected at a discount to the 37.5% tax rate, “A more robust
given the risk and elongated timeframe to reap the deferred tax asset benefits. With the current turmoil in
the housing sector and the lack of investor confidence, it is assumed that the market will allocate a 0.75x approach for this
multiple. An upside risk scenario is also calculated.
inventory-
Risks to Thesis: The prices of homebuilder stocks have fallen substantially already this year, and any posi-
tive national economic activity news, housing industry news, or peer earnings releases could spur an upward intensive busi-
bounce in stock prices. The level of housing starts (i.e., new construction activity) has already decreased
significantly from levels in previous years as homebuilders have shifted focus towards working through the ness is a Price /
excess supply of inventory on the market. Although the Company has high leverage, the majority of the debt
does not mature for a few years, and D.R. Horton has been generating strong cash flows from operations Adjusted Book
recently, albeit through very aggressive pricing and weak gross margins. A significant decline in long-term
interest rates (and correspondingly in mortgage rates) would increase housing affordability, as well as lead Value analysis,
to inventory burn and a return to price appreciation.
which produces
a target price of
$7.25.”
Page 16
Macy’s, Inc. (NYSE: M) Long

Del Anderson, CFA
DAnderson08@gsb.columbia.edu
Current Price (1/25/2007): $22.47

Intrinsic Valuation Range: $37.00 ($34.00 - $45.00)
Margin of Safety: +60% (base case)
Thesis Summary: Macy’s is a long because of:
Horizon mismatch: Macy’s shares have been punished due to slow sales growth at rebranded May stores; however, the
near-term focus of many analyst models fails to capture a “sweet spot” in which sales growth normalizes at these stores
throughout 2008 and beyond, improving returns and turnover.
Impact: True demand in new markets is presently undervalued
Downside Protection: Recent investments in revenue optimization systems and “service culture” will improve margins in
the event of a full-blown downturn, while Macy’s ownership of most of its stores provides a tangible floor of $14 for the
stock price. Additionally, middle-market retailers (including Macy’s) have outperformed both lower- and higher-end peers
significantly during each of the past three Fed easing cycles.
Impact: Sensitivity to downturn low relative to peers
Total Enterprise Value Calculation
Stock buyback: Macy’s repurchased 22% of shares outstanding Share Price (01/25/08) $22.47
in 2007 out of strong free cash flow, and has made a commit- x Shares Out. 433.0
ment to maintain its investment grade rating while repurchasing = Market Capitalization ($MM) $9,729
~5% of shares during the coming year. In retrospect, Macy’s + Net Debt 10,456
could have purchased some shares at lower rates, but it still = Total Enterprise Value (TEV) 20,185
represents a long-term positive for equity holders given that
EV/EBITDA 5.6x
shares were purchased well-below my intrinsic valuation.
Impact: EPS to be amplified 5%+ as share count contracts 52-Week High $46.51
52-Week Low $21.31
Bottom line: Macy’s may decline modestly with retail peers in the
near term, but this represents a buying opportunity. Over two-year Forecast & Consensus
horizon, Macy’s will be a strong outperformer from current levels. EPS P/E Concensus
Current* $2.18 10.3x $2.19
Background:
FY' 2009 $2.41 9.3x $2.37
In late 2005, Federated Department Stores (now Macy’s) acquired
FY' 2010 $2.72 8.3x $2.62
a key competitor, the May Company, doubling its store count in
largely untapped markets and adding 15 new states to its territory, FY' 2011 $3.03 7.4x $2.90
making it a truly national brand. Subsequently, the firm has real- *Current (FY' 2008) ends on 1/31/2008
ized administrative synergies in excess of initial plan but sales Valuation Methodologies
growth at rebranded stores has lagged. Free Cash Flow to Equity (base case) $37.00
Private Market / Reproduction Value >>$35.00
Market Misperception:
Comparable Multiples (14x Fwd P/E) $34.00
Macy’s shares declined throughout 2007 on recession fears and
concerns about poor performance at acquired stores. In one sali- Liquidation Value $15.00
ent example, former Marshall Field’s shoppers in Chicago began Upside FCFE: $45.00 +100.3%
boycotting rebranded Macy’s stores; however, I believe it won’t be Downside FCFE: $18.00 -19.9%
long before these protesters trade their picket signs for Macy’s Upside / Downside Risk Ratio 5.0x
cards. At present, sales at “new Macy’s” stores are lagging be- Retail Malaise & Post-Merger Comps Hurt Macy's in 2007
cause shoppers are not used to Macy’s promotional style (no 20%
coupons), sales associates are unaccustomed to Macy’s brands 10%
and regional merchants have not fully adapted Macy’s product 0% Retail Peer Group
lines to local consumer tastes. All of these issues are temporary.
-10%
On the operational front (gross margin, SG&A expense, systems
integration), Macy’s has delivered as promised by the merger. -20%
Thus, I believe that the first evidence of a sales revival at the -30% -32%
new stores will be a strong positive catalyst for the company. -40%
Macy's, Inc. -37%
-50%
Nov 2007
Jan 2007
Jun 2007
Jul 2007
Jan 2008
Feb 2007
Mar 2007
Apr 2007
Aug 2007
Sep 2007
Dec 2007
May 2007
Oct 2007
Macy’s, Inc. (Continued from previous page)

To test the impact of the current sales drag, I modeled sales by region and store type based on growth projections using
pre-merger sales data. Assuming a conservative -10% sales drag at the rebranded stores, Macy’s revenues will be impaired
by $1.1 billion during 2007. However, this bodes well for the future, since it means that current sales numbers are temporar-
ily suppressed. As customers adapt to Macy’s strategy, the sales drag will narrow and total sales will increase rapidly in
2008 and beyond. The table below forecasts sales for Macy’s major divisions, with an estimate of the gap between new
and legacy stores. The sales growth estimates for legacy divisions are conservative and well-below Macy’s historic organic
growth rate of 4.3% over the past seven years.
Sources of Macy's Sales Growth CY
(Legacy v. May stores) 2006 (A) Growth (%) 2007 (E) Growth (%) 2008 (E) Growth (%) 2009 (E) Growth (%) 2010 (E)
Bloomingdales 2,317 6.0% 2,456 3.0% 2,530 4.0% 2,631 3.5% 2,723
Macy's East 7,193 2.5% 7,373 2.0% 7,520 2.0% 7,671 2.5% 7,862
Macy's West 6,002 3.0% 6,182 2.0% 6,306 2.0% 6,432 2.5% 6,593
Macy's South & Florida 5,564 -5.0% 5,286 -1.5% 5,207 2.0% 5,311 2.5% 5,443
Macy's Central & Midwest 5,444 -2.0% 5,335 0.0% 5,335 2.0% 5,442 1.0% 5,496
Macy's.com 450 50.0% 675 25.0% 844 20.0% 1,013 15.0% 1,164
Less: Lag from legacy May Stores* 11,601 -11.4% (1,105) -5.6% (416) -4.4% (217) -3.7% (147)
Total Revenue Projection 26,970 -1.5% 26,564 3.4% 27,471 3.4% 28,392 2.9% 29,135
* Sales growth lag relative to growth rates at legacy stores.
Scuttlebutt Research Support:

Interviews with buyers at Macy’s and Bloomingdales, visits to rebranded stores and some entertaining hours online reading
blog posts and online consumer chatter about Macy’s brand yielded several key insights:
1) According to buyers, sales at rebranded stores are lagging legacy stores by ~10% overall and up to 20% in some re-
gions, although sales of exclusive brands (inc. Martha Stewart) were strong companywide. Over the holidays, the gap
between legacy and rebranded stores declined.
2) Rebranded stores have the potential to deliver results on-par with legacy Macy’s stores. Longtime May employees be-
lieve that their customers are no different from Macy’s target customers, so localization strategy should yield results.
3) Consumers’ online sentiments are getting better. One enlightened poster even noted that “My rage at the Marshall
Field's takeover diminished when I visited Macy's…. To my surprise, they retained many MF touches. I’ve seen nothing
but improvement in the store.”
Industry Analysis:
Retail stocks are out-of-fashion at the moment, creating a buying opportunity for the shares of several companies (Macy’s,
Nordstrom, JCP); however Macy’s is particularly well-suited to outperform given that its stores are less-concentrated in the
bubbliest housing markets and that under 15% of sales come from home essentials. As a purveyor of reasonably-priced
quality brands, Macy’s stands to benefit in a downturn relative to higher-end peers (i.e., pinched Saks/Nordstrom shoppers
would feel comfortable being seen at Macy’s).
As of 1/25/2007 Volume Valuation Leverage Operating & DuPont Metrics
Enterprise Total Sales Price/Earnings EV / Price / FCF Dividend Debt/ Interest S&P Gross Oper. Sales Asset Equity
Company Name Value Sales Growth Current Forward EBITDA Book Yield Yield Assets Coverage Rating Margin Margin ROE Margin Turnover Leverage
Macy's Inc. (M) 21,973 26,878 (1.8) 12.0 10.8 5.6 1.2 4.5 1.9 36.2 4.7x BBB 40.2 8.3 10.2 = 3.3 1.0 3.1
Peer Summary Analysis % x x x x % % % x % % % x x x
Median 13,248 17,336 6.7 16.3 14.3 7.9 2.5 -3.4 0.9 25.0 6.6x - 32.2 7.37 20.5 4.2 1.6 2.7
Target Corp. (TGT) 57,380 63,207 11.4 15.7 14.2 9.0 2.8 -0.1 0.9 32.7 4.2x A+ 30.2 8.5 19.0 = 2.2 1.6 2.7
Sears Holdings Corp. (SHLD) 20,322 51,777 (2.0) 19.8 23.2 6.0 1.3 6.9 0.0 13.6 8.9x BB 26.3 4.1 10.9 = 0.9 1.7 2.8
Kohl's Corp. (KSS) 15,560 16,417 10.9 12.6 11.6 6.8 2.6 -3.2 0.0 20.0 10.9x BBB+ 34.2 11.6 20.4 = 3.7 1.6 1.9
TJX Cos. (TJX) 14,371 18,256 7.5 17.0 14.9 9.6 6.5 5.0 1.1 12.4 25.5x A 24.1 6.2 26.6 = 7.1 2.8 3.2
J.C. Penney Co. Inc. (JCP) 12,124 20,134 3.6 9.7 9.9 5.5 2.2 -3.5 2.3 27.3 4.2x BBB- 37.1 9.5 33.1 = 4.7 1.5 3.1
Nordstrom Inc. (JWN) 10,842 8,945 8.7 13.5 12.3 7.3 6.8 -4.6 1.3 38.1 15.9x A- 37.6 10.7 45.0 = 2.3 1.8 4.2
Saks Inc. (SKS) 3,169 3,238 15.5 40.9 30.2 14.4 2.3 -27.8 0.0 24.6 1.5x B+ 36.2 2.2 2.8 = 5.8 1.2 2.2
Dillard's Inc. (DDS) 2,940 7,441 (1.8) 28.1 54.2 5.6 0.6 -7.1 0.8 25.5 1.1x BB 29.5 0.6 6.6 = 8.2 1.2 2.4
Source : FactSet Daily Prices, Capital IQ, Reuters Global Fundamentals, First Call Estimates
History also suggests that the freefall of retail stocks may be nearing its nadir. During the
past two consumer downturns (1990, 2001), general retail stocks fell ~40% from peak-to-
trough and they reached bottom within a month of the official start of the recession. Macy’s
shares hit a cyclical low three months before the 2001 recession after falling 50% during
the preceding year. Such statistics are meaningless from a fundamental perspective, but
they do suggest that the majority of the losses associated with a recession may be re-
flected in Macy’s share price already.
Page 18
Short Netflix (NFLX) at 21.75 — Price target $16

Netflix (NFLX)
Price: 21.75
(Jan. 25, 2008)
Investment Thesis:
Simply put there is no reason for Netflix to exist. The business model is fundamentally anachronistic
and the company is destined to become a marginal player within the medium term. Cable, satellite
and telcos have achieved penetration rates of advanced video on demand services in ~75% of their
cumulative territory, implying ~65% of American Households can watch video on demand (VOD).
VOD has incremental costs of essentially nil and the immediate gratification provided by the model is
superior to Netflix’s 1 day turnaround. Additionally, the company has been late to recognize this and
continues to spend money to attract new customers. The economics of new customer growth are ex-
“Simply put tremely unattractive and as customer usage of the service declines, there will be a self-selection proc-
ess whereby only the heaviest users of the service (and therefor the most costly to the company) will
there is no rea- maintain their service. Due to stagnating growth and shrinking margins, I have assigned a price target
of $16, representing ~30% downside from current levels. However, because of the high short position
son for Netflix to (~24% of float) and the relatively volatile nature of the stock (beta=2.2) there is a meaningful risk of
short term trading losses due to potential short squeezing and the stock could trade up to $25 (15%),
exist. ” but given the poor fundamentals, I expect any uptick in the stock to be a temporary trading move, not
a fundamental revaluation with the ultimate downward catalyst coming when they announce Q4 num-
bers and the damaging impact of their new marketing strategy and unattractive incremental sub eco-
nomics flows through to their financials.
Company Overview:
Netflix provides online subscription ser-
vices for DVD’s. Customers log on to
their website and select movies or TV
shows they would like to watch and the
company ships out the DVD’s to the cus-
tomers via US Postal Service. There are
no late fees and the company has several
pricing plans and fee structures but their
most popular allows for unlimited rental
per month, with up to 3 DVD’s at a given
time for $16.99/mo. No pricing plan
charges late fees.
Investment Thesis:
*The company has already experienced
their strongest growth phase. The initial
ramp is rolling off and revenue should peak in ’08. Management is seeking to initiate a second stage
of growth where they will attempt to distribute videos online. The company will not be successful in
this endeavor because they have no competitive advantage (and importantly, unlike MSO’s and tel-
cos, they don’t own the pipes into consumers homes and ISP’s can prioritize their traffic over NFLX
downloads). Additionally, the company lacks sufficient scale with content producers to negotiate
favorable on-line distribution terms.
*The subscriber economics are becoming increasingly unattractive. Because the company
continues to spend aggressively on both attracting new customers (SAC continues to rise and
Netflix (Continued from previous page)
even if management gets it under

control, the levels are unsustain-
able) and continued churn
make per sub economics dilutive
to the overall company. Manage-
ment could throttle back on
SAC and milk the company for
cash flow and possibly generate
meaningful cash flows, but they
have given no indication of their
willingness to do this.
*The eventual emergence of a “Based on the

new DVD technology will in-
crease the costs associated with fundamentals of
meeting customer needs. For the
medium term (until a winner in the HD-DVD/Blu-Ray format conflict emerges) the company will have the company and
to purchase both formats, as well as traditional DVD formats. This will squeeze margins and I estimate
an incremental 300 bps of margin compression from this dynamic. deteriorating
subscriber eco-
Valuation:
*A $15 price target is based on a (generous) 8x multiple off ’08 EBITDA-an analysis of variation nomics the long
around multiples demonstrates the potential conservatism of this estimate
term prospects
*Based on the fundamentals of the company and deteriorating subscriber economics the long term
prospects of the company are poor. From a trading perspective the stock is volatile and the of the company
position could see upward pressure, but long-term downward catalysts should come when
damaging impact of the company’s marketing efforts flow through in Q4 numbers. Additionally, are poor.”
continued price wars with Blockbuster and Wal-Mart will provide an inevitable downward
catalyst (these price announcements have occurred every few months for the past two years).
* My $15 price target is based off an ’08 P/E of 18 (weighted 40%), an ’08 EBITDA multiple of 8x
(weighted 40%) and potential for near term trading up to $25 (weighted 20%) to achieve the $16
level.
Page 20
“Innovations in Investing” — Industry Networking Night and Panel

Industry Networking Series Greenwald, who is the observation is that “the big
with Professor Bruce Robert Heilbrunn Professor are getting bigger.” As an
Greenwald, William Von Muef- of Finance and Asset Man- example, he observed that
fling (’95), and David Green- agement at Columbia Busi- hedge fund firm Citadel cur-
“There is no
span (‘00) ness School and Director of rently has 86 investment
‘hedge fund’ indus- the Heilbrunn Center for professionals on the ground
On October 30th, over two Graham and Dodd Invest- in Asia. The next five of von
try that exists hundred students, alumni, ing. Mueffling’s observations
and faculty filled every spare included:
separately from square inch of the large hall Mr. von Mueffling kicked off
at the Columbia University the discussion with a Letter- • Given the explosive
the ‘money man- Club of New York on West man-style list of observa- growth of alternative asset
43rd Street for a night of tions on major changes in classes, investment manag-
agement’ indus-
learning and networking. the investment industry. ers must employ more
try.” sophisticated risk manage-
Professor Bruce Greenwald He began with a question: ment processes.
—William von opened the panel discussion Which asset class do you • Pensions and endowments
by contrasting the evening’s think has grown the most in are now among the largest
Mueffling enthusiastic crowd with a the last three years? People investors in hedge funds.
somewhat different audi- shouted out answers, which • Some alternative invest-
ence. “No one sat in the ranged from index, interna- ment strategies are al-
front row,” he observed, “at tional, and various hedge ready obsolete, such as
my executive seminar at fund strategies. The answer convertible arbitrage, sta-
Harvard Business School.” was a strategy he termed tistical arbitrage, and
Indeed, it was standing “low octane alpha”— macro.
quantitative investing strate- • Long/short equity is large
gies that deliver roughly a and growing but offers a
few hundred basis points of lot of market correlation,
excess return over a market whereas some firms
benchmark. (including Cantillon) offer
their clients “pure alpha.”
Next, on a related note, von • John Paulson’s success in
Mueffling pointed out that shorting the sub-prime
clients are more sophisti- mortgage market demon-
cated than in the recent strates that securitization
past. “The customer base (and other forms of finan-
knows the difference be- cial innovation) creates
tween alpha and beta, which
opportunities for alpha.
is an important change.” • Investors’ return expecta-
Third, Mr. von Mueffling tions are out of touch
David Einhorn and Whitney room only to hear a panel advised that the distinction with the reality of today’s
Tilson discussion on innovations in between hedge funds and market. Underscoring this
investing, featuring former traditional buy-side firms point, Mr. von Mueffling
students William von Muef- may no longer be valid. observed that equities
fling (’95), founder, Presi- “There is no ‘hedge fund’ have returned an average
dent and CIO of Cantillon industry that exists sepa- of just 3.5% per year since
Capital and David Green- rately from the ‘money 1998 (excluding divi-
span (’00), Managing Direc- management’ industry—
tor at Blue Ridge Capital. dends).
they are one in the same.”
The panel was moderated
by Professor Bruce Mr. von Mueffling’s next (Continued on page 21)
“Innovations in Investing” (continued from page 18)

(Continued from page 20) or bad fundamentals, the
Mr. Von Mueffling closed his more likely you are to dis-
remarks with some advice cover an instance of hard
for MBAs aspiring to a ca- wiring.”
reer in investment manage-
ment. “Don’t ask about
compensation—prove your- Second, Greenspan dis-
self first.” Asking about cussed the virtues of ex-
compensation, he quipped, ploring investment opportu-
“is an immediate disquali- nities in nontraditional ar-
fier.” eas, such as in developing
countries or asset-backed
Next, David Greenspan securities. Regardless of the
shared his thoughts on terrain or subject area,
t h r e e c o m m o n Greenspan advised the audi- particularly important for Jean-Marie Eveillard and Pro-
“ingredients” in his most ence to “think about unique realizing investment oppor- fessor Bruce Greenwald
successful investment ideas: elements that you can bring tunities.
to the table.” He also ob-
1. Identifying Instances of served that nontraditional First, intangible assets.
“Profit levels around the “Opportunities are
“Investor Hard Wiring” areas often involve com-
2. Exploring Nontradi- plexity, which can create world are higher than ever, local in nature.
tional Areas opportunities for investors.
but are they sustainable?” Recognize that,
3. Elongating the Search Professor Greenwald sug-
Finally, Greenspan suggested
Process that he has benefited by gested that one cannot an- and fetch informa-
lengthening his search proc- swer this important ques-
Mr. Greenspan summarized tion without first under- tion that is un-
the first ingredient by point- ess for uncovering new in-
vestment ideas. “I am con- standing the intangible as-
ing out that, “When inves- sets, such as organizational available to most
tors stop thinking, it creates stantly filtering the world,
looking for signposts of in- capital, that are associated investors.”
opportunities to make with service-based indus-
money.” For example, in vestor hard wiring or com-
plex—and therefore poten- tries. According to —Prof. Bruce
2004, Greenspan and his Greenwald, the world is not
colleagues noticed that Fiat tially misunderstood—
situations.” Ultimately, yet sophisticated in judging Greenwald
was one of the least recom- the worth of intangible as-
mended stocks in Europe. In Greenspan’s goal is to find
opportunities with a lack of sets, which creates opportu-
general, the automotive nities for investors.
sector had fallen out of fa- economically motivated
vor, and investors com- buyers and sellers.
Second, franchise value.
plained that Fiat’s balance “Opportunities are local in
sheet was in disarray. In Professor Bruce Greenwald
wrapped up the panel dis- nature. Recognize that, and
2005, the company hired a fetch information that is
new CEO who embarked cussion with a series of
comments on ways inves- unavailable to most inves-
on a series of positive re- tors.”
structuring efforts. How- tors can generate alpha in
ever, at the time, investors today’s market. His com-
ments were united by a Third, growth. “Investors
failed to appreciate these frequently misjudge the
developments, which cre- common theme: know
(exactly) what you are buy- value of growth—it is simply
ated an opportunity for done wrong.”
Greenspan. In summary, ing. In particular, Professor
Greenspan noted, “The Greenwald outlined three
types of knowledge that are -G&Dsville
longer the period of good
I, Issue
The Heilbrunn Center Goes to India

spent two weeks in January
traveling across India to discuss
Value Investing, Globalization,
Corporate Social Responsibility,
and Competitive Strategy with a
number of Indian business
audiences. Professor Greenwald
began his tour of India speaking
at the Corporate Governance
and Social Responsibility
Conference organized by The
Chazen Institute of International
Business at Columbia Business gave a talk on Globalization to
School. approximate 50 professionals at
the Ahmedabad Management
The discussions focusing on Association. Greenwald then
value investing began in earnest traveled to New Delhi, where
before a room of over 170 he was a panelist at an investing
individual and institutional forum sponsored by Reliance
investors in Mumbai. The Mutual Funds, a large mutual
seminar was organized by local fund company in India. There,
investors Chetan Parikh of he discussed the importance of
Jeetay Investments, Sanjay Bakshi local/regional economies of scale
of Tactica Capital Management in building defensible business
and Dhananjay Lodha. models and encouraged Indian
Greenwald conveyed Columbia’s companies to pursue regional
modern view on Graham and strategies that can leverage the
Dodd Investing – speaking to the economics of large fixed cost
audience about valuing growth in infrastructures. Throughout the
terms of return potential and trip, Professor Greenwald met
not paying for growth in with several Indian companies,
businesses where franchises do including pharmaceutical
not exist. He pointed to companies, retail companies
commodities such as steel or textile manufacturers, financial
cement as examples of such services institutions, private
businesses. We hope that the investors, real estate
late January decline of the Indian development firms and noted
stock markets is uncorrelated to that he was impressed by the
Professor Greenwald’s January quality of management within
8th remarks about not the companies and enjoyed their
overpaying for non-franchises discussions about strategy.
and that exercising valuation -G&Dsville
discipline is as important in India
as in any other global market.
The Heilbrunn Center for Graham & Dodd Investing is a
During his next stop, Professor If you have questions or ideas premier knowledge center for the practice and theory of
Gre e n w al d t au gh t Va lu e about other international activities, investing. Building on Columbia Business School’s re-
Investing at the Indian Institute please contact the Heilbrunn nowned history in value investing and finance, the center
furthers new developments in investing and imparts the
of Management- Ahmedabad to Center at: original principles of Security Analysis authors Benjamin
approximately 40 students and valueinvesting@columbia.edu. Graham and David Dodd.
Get Involved:

New York, NY 10027
Name: _____________________________

E-mail Address: _____________________________
Business Phone: _____________________________

Contact us at:

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Volume III, Issue I Winter2009

Inside this issue:
Pershing Square p. 3
Challenge Launch
“If Not Now, When?” — Bruce Berkowitz
Despite never having attended which professional investors
Graham & Dodd p. 14 Columbia Business School, increasingly aim for specific
Breakfast Bruce R. Berkowitz has become style boxes. How did you
one of the most highly re- develop and refine the ap-
garded value investors of his proach to investing you em-
Michael Mauboussin p. 20
generation. He is the Founder ploy at Fairholme Capital?
and Managing Member of
Fairholme Capital Management BB: Well, there are many
Security Analysis p. 29 where he has trounced the elements. If you are going to
Symposium market averages and devel- manage other people’s
oped a loyal following. Prior to money and do it well, you
Bruce Greenwald p. 31 founding Fairholme, Mr. Berko- have to put yourself on the
witz worked at Lehman Broth- same level, the same playing
ers until 1993 and at Smith field as your investors. The
Barney from 1993 to 1997, only way to do that is by Bruce Berkowitz, Portfolio
Editors: being one of your own inves- Manager - Fairholme Capital.
where he was a Managing
Charles Murphy Director. He graduated from tors. In order to make as
MBA 2009 the University of Massachusetts few mistakes as possible, I own money as I possibly can
David Silverman at Amherst with a Bachelor of assume that investors have in the fund. So, we are trying
MBA 2009 Arts in Economics, cum laude. entrusted me with all of their to create level playing fields. I
money, and then I try to am constantly trying to put
Megan Johnston
Knight-Bagehot Fellow 2009 G&D: You’ve said that you understand the implications myself in the shoes of our
manage the portfolio as if of that. Essentially, it means shareholders and our inves-
Matthew Martinek we can’t lose. The only way tors. So, “don’t lose” is al-
MBA 2010
shareholders have 100% of
their money in your fund, to fully understand that is for ways going to be rule num-
Clayton Williams which is unique in a world in me to put as much of my (Continued on page 2)
MBA 2010
Welcome Back to Graham and Doddsville

Contact us at:
newsletter@grahamanddodd.com The Heilbrunn Center for Despite our best efforts to In our feature interview with
Visit us at: Graham and Dodd Investing follow the value investor’s Bruce Berkowitz of Fair-
www.grahamanddodd.com and the Columbia Invest- creed and remain strictly holme capital, you will not
ment Management Associa- rational – we confess to have only learn how he thinks
organizations/cima/ tion is proud to present the gotten somewhat carried about “killing” companies but
fifth edition of the Graham away. In the spirit of excess, also which musical instru-
and Doddsville newsletter. this edition of G&D is 50% ment he plays in his spare
With the tumult in the finan- bigger than past issues. And time (hint: it’s not a clarinet).
cial markets and economy at while we certainly agree that Michael Mauboussin dis-
large, we at G&D have found quality is far more important cusses how understanding
ourselves more excited than than quantity, we think you investor behavior and expec-
ever to report on the theory will find the extra time spent tations is a key component
and practice of Value Invest- reading to be well worth the to any well designed invest-
ing – which we believe to be effort. ment strategy. And Profes-
more relevant than ever. (Continued on page 2)
Page 2

sor Bruce Greenwald walks
us through his analysis of
financial services firms, his
thoughts on the new edition
of Security Analysis as well as
the three characteristics it
takes to be a great investor.
We hope you enjoy reading

this as much as we enjoyed
putting it together – and be
sure to keep an eye out for
the next issue of Graham and
Doddsville coming out this Bruce Greenwald, Seth Klarman, and Jim Grant speaking at
spring. the Graham & Dodd Breakfast on October 8, 2008. The
annual breakfast is organized by the Heilbrunn Center for
—Graham & Doddsville Graham and Dodd Investing.
Bruce Berkowitz (continued from page 1)
(Continued from page 1) book” shape your evolution huge margin of safety so
ber one because no one as an investor? that the odds are in your
wants go back and start favor.
again. And again, that is BB: The business of making
“So, ‘don’t lose’ easy to say and easy to think odds goes back a long way The other element of grow-
about, but until you put and is the concept of trying ing up in a book-making
yourself in the situation to figure out what you give environment—a Las Vegas-
is always going where if you did lose, you and what you get. That’s type of environment—is
would have to start all over pretty much the same as the that you do develop an in-
to be rule again, then you can’t fully business of investing. You tuitive understanding of
comprehend it. are constantly trying to un- what I call a perverse psy-
derstand the cash you are chology. So at a very young
number one.” G&D: At the Graham & going to have to pay and age, I received my first edu-
Dodd Symposium this fall, what you’re going to have cation in behavioral finance
you talked about working as to give up. Then you try to before the term was coined.
a bookie growing up. Of figure out—over the life of
course, a lot of other great the investment, from the G&D: It is interesting be-
value investors have had day that you make it to the cause, in a sense, gambling
early experiences that in- day the investment ends— implies risk-seeking behav-
volved gambling. For in- how much you are going to ior, while many value inves-
stance, Warren Buffett make. So you have to come tors describe themselves as
handicapped horses as a kid. up with some kind of odds. being very risk-averse.
How do you think those Also, if you are smart and
skills relate to value invest- you know what you are BB: It depends. If you are
ing and how did “making a doing, then you build in a (Continued on page 4)
Volume III, Issue 1 Page 3
Second Annual Pershing Square Challenge

December 4, 2008—Bill your chances of success.” when Gotham Partners be-
Ackman, founder of hedge Ackman reflected on advice gan investing in new strate-
fund Pershing Square Capital he received while in busi- gies and asset classes, which “Mr. Ackman
Management, visited Colum- ness school from CBS alum he humorously claimed had
bia Business School to kick- Warren Buffet who sug- a “low return on invested said he created
off the Pershing Square gested that if you want to brain damage.” He also
Challenge, a stock pitch be like Michael Jordan, ge- remarked that it is very im- the competition
competition for CIMA netics play a big role. But if portant to stay disciplined
members. The visit was you want to be a successful as an investor and to never to encourage
both insightful and enter- person, whatever you need, reduce your standards of
taining, as Mr. Ackman in- you can have. Ackman sug- value just because the world and teach the
terjected a bit of humor gested many of the attrib- is not offering many inter-
along with his thoughts and utes that lead to success are esting opportunities. Finally, next generation
guidance. relatively simple, such as in a nod to the value invest-
returning phone calls ing curriculum at Columbia of value
The Pershing Square Chal- promptly, treating others Business School, Ackman
lenge, which will commence appropriately, being diligent, noted that despite the re- investors as
in March, is sponsored by and having good character. cent market turmoil, the
Pershing Square Capital principles of value investing well as to
Management in conjunction Confidence and humility are will continue to endure and
with CIMA. The contest is the two psychological traits they continue to underlie
structured as a team event Ackman pointed to as es- the investment strategy of
engrain the
in which one second-year sential to a successful in- Pershing Square Capital
student will partner with vesting career. In his mind,
virtues of
Management.
two first-year students to with respect to investing,
pitch an investment idea to confidence is “believing you Given the state of the finan-
charitable
Mr. Ackman and a panel of are right and sticking with it cial markets, Ackman also
judges. The winner of the when everyone else thinks offe re d some t ime ly
giving. “
event will be presented with you are wrong.” Ackman thoughts on how we got
a $25,000 award, which will commented that investors into this difficult environ-
then be gifted back to Co- need the confidence to “pull ment. Contrary to what has
lumbia Business School at the trigger,” because every been written in the popular
the discretion of the win- investment has a flaw. The press, Ackman does not
ning team. During the pres- key is to make sure the believe the majority of our
entation, Mr. Ackman said price adjusts for the prob- problems can be blamed on
he created the competition ability of the flaw. On the a lack of regulation. Rather,
to encourage and teach the other hand, the humility to he pointed out that many of
next generation of value admit when you are wrong the high profile failures have
investors as well as to en- is equally, if not more, im- occurred at some of the Bill Ackman spoke on cam-
grain the virtues of charita- portant. most heavily regulated insti- pus in December to promote
ble giving. Despite being a tutions in the US, namely the Pershing Square Chal-
Harvard Business School Ackman also offered some AIG, Fannie Mae and lenge.
graduate, he enjoys working advice drawn on experi- Freddie Mac, and Lehman
with Columbia and holds its ences and lessons he has Brothers. By comparison,
Applied Value Investing pro- learned during his career. Ackman pointed to the
gram in high regard. For example, he referred to lightly-regulated hedge fund
his first hedge fund, Gotham industry, which he believes
Ackman’s advice for stu- Partners, when suggesting outperformed virtually
dents centered around the that investors are wise to every other asset class in
idea that, “high-quality per- stick to what they know. 2008.
son meaningfully increases Ackman learned this lesson (Continued on page 4)
Page 4
Pershing Square Launch (continued from page 3)

(Continued from page 3) ture, such as energy and
When asked transportation-related in-
what he thought
Ackman vestments. Ackman also
should be done encouraged the proposed a restructuring of
to help shore Fannie Mae and Freddie
up the econ- SEC to publicly Mac, which would include
omy, Ackman promise to “never recapitalizing and merging
had some the two institutions. Finally,
thoughtful ad- again change the referring to short-selling
vice for the
rules of the game.” regulations, Ackman en-
incoming ad- couraged the SEC to publi-
is celebrating the 75th ministration. First, he sug- cally promise to “never
anniversary of Graham’s gested a tax holiday may that could be invested at again change the rules of the
Securities Analysis. encourage the repatriation home. Next, Ackman be- game.”
of a portion of the massive lieves that a stimulus pack-
amount of corporate cash age is important, particularly —Graham & Doddsville
sitting idle overseas; cash if it is focused on infrastruc-
Interview with Bruce Berkowitz (continued from page 2)

(Continued from page 2) all there. cash flow—even in stressful
the house it is risk-taking. If environments—in relation-
you are the gambler, it is G&D: In your introduction ship to the price that you
risk-seeking. I always en- to Part IV, you wrote about paid is the most important
joyed being the house. I the importance of evaluating factor. Bad management or
was never a gambler. companies’ free cash flow. a bad person can really
If free cash flow is the pri- screw up a good company
G&D: I know that Security mary metric, then manage- so the management factor
Analysis had a big impact on ment is critical because you has become more and more
your approach. How signifi- have to trust that they are a part of how to kill a busi-
cant was it for you to be going to do something good ness. Once you ascertain
asked to write an introduc- with that cash flow. How the free cash flow of a com-
tion to Part IV of the 6th do you evaluate manage- pany, one of the ways that
edition of that influential ments? you can try to kill a business
text? is through poor capital allo-
BB: The management fac- cation.
BB: It was a huge honor. I tor is important, but the
was really quite stunned ability of a company to in- More and more I think it is
that I was asked to do it. trinsically generate cash is going to be important to
To be asked to write an probably more important. study the paper trail of ex-
introduction to an impor- It is always nice to own a isting management. You
tant section of Graham & company that your idiot have to understand how a
Dodd’s work was quite an relative could run. Great manager behaves and how
honor, and I don’t know managers have failed at that manager has behaved in
what more I can say. Fun- lousy businesses, so really past situations. In general,
damental analysis, margin of the nature of the business you have to understand the
safety, behavioral finance— and its ability to generate history of that person’s be-
the building blocks are just reasonable amounts of free (Continued on page 5)

(Continued from page 4) Sears. Is it fair to say that would take to destroy or
havior to get an idea of you were able to assess impair a company’s ability to
what the future is going to Eddie Lampert’s background generate cash flow. How do
look like. While very smart from what he had done in you go about killing a com-
people and good managers previous stressful situations? pany you are considering
don’t all of a sudden get investing in? I guess each
bad, it is possible. I think BB: Yes, we examined his case might be different, but
the Madoff affair shows that. career – how he behaved, maybe you could walk us Professor Bruce Greenwald and
I am stunned by the people his performance, and what through an example with Dean Glenn Hubbard
who seem to have fallen kind of person he is. Is his the HMOs and how you
into some kind of trap, hero in fact Warren Buffett? thought about killing those Columbia Business School is
which I just never would businesses. a leading resource for invest-
have expected. It also ment management profession-
shows that one bad thirty- BB: To kill the HMOs, als and the only Ivy League
second decision could possi- you just have to answer the business school in New York
“It is always nice to
bly destroy a lifetime’s following question: Who City. The School, where value
worth of work. own a company would do what they’re do- investing originated, is consis-
ing if they weren’t doing it?” tently ranked among the top
The management factor is that your idiot The big issue with HMOs is programs for finance in the
extremely important when a a radical restructuring of the world.
manager can kill the busi- relative could run. healthcare system and
ness. We don’t try to, or whether or not someone
we’ve never made very Great managers else can do what they are
good money trying to pre- doing, or whether they can
have failed at lousy
dict the future. It is impos- be forced to do it at much
sible for me to do that. My businesses.” lower prices. By studying
crystal ball has never the industry and the partici-
worked well and our per- pants, you can come to the
formance last year showed conclusion that the only
that. Therefore, we tend to Does he take to heart the thing the government can
react in response to the tenets of Buffett, Benjamin do is cut a check. And
environment. We feel it is Graham, Phil Fisher, and every time they’ve tried to
important to try to under- Charlie Munger? That helps run a healthcare system by
stand how managers have us think about how he is cutting checks, such as with
reacted in the past and not going to behave in the fu- Medicare, the costs just
focus as much on the un- ture. The man is not as escalate. The HMOs have
known of the future. It is smart and he’s not the mes- become gatekeepers and
important to understand a siah that he was made out they do it for reasonable
company’s strategy and a to be at one point, but he’s prices. There is no other
manager’s strategy, the phi- definitely a very sharp guy. organization or other indus-
losophy going forward, and And he’s nowhere near as try that we believe is a com-
where the company will be bad as he is being portrayed petitive threat, and there
five or ten years from now. right now. All of a sudden, are no other people that
But it is more important to people think that he is over have the scale or skills by
understand past actions. the hill—in the same way, which to carry forth the
people once thought that future healthcare system,
G&D: You mentioned on a Buffett was over the hill. whether it is universal
public shareholder confer- health or corporate health-
ence call last fall that you G&D: In your earlier com- care policies. So when we
hadn’t actually spoken with ments, you referenced this are trying to kill an HMO,
Eddie Lampert before mak- idea of “killing the com- the first question that we
ing your investment in pany”—figuring out what it (Continued on page 6)
Page 6

scribed it before as a role- company will be able to
playing exercise. maintain a set level of cash
flow, you get to more and
BB: I think killing a busi- more questions about a
ness is the research process. company and an industry
We tend to start off looking and an environment. You
at industry sectors and busi- just keep going. The proc-
nesses that are under stress. ess is continuous.
And by stress, I mean that
their stock prices and their G&D: When you think
market values have fallen off about how much a business
a cliff. Then we try to un- can earn in a normal envi-
derstand the current free ronment, how do you think
Berkowitz and Glen Green- cash flows of those busi- about what a normal envi-
berg (‘73) share a laugh at nesses and try to under- ronment will look like? Has
the Security Analysis Sym- address is the obvious issue stand how much free cash your view on that changed
posium. of how they can be pushed flow can be maintained. Or in recent months?
aside, and our answer is that if it can’t, what level can be
we can’t find any way to kill maintained assuming that BB: We’ve gone further
them from a competitive or they will be able to maintain than that now. We no
regulatory threat. the business at some level. longer think about a normal
Also, how are those free environment, we think
Once you get to that, then cash flows going to get to about an abnormal environ-
“We tend to start you can say that these com- the owner? After all, they ment. We focus on a diffi-
panies have had really poor are owner earnings as Ben- cult and continuing environ-
off looking at in- capital allocation policies in jamin Graham would say. ment where credit markets
the past. They have spent Are we going to see divi- are still rigid. They’re just
dustry sectors and
billions of dollars buying dends or buybacks or is the not working. If the current
businesses that are their stock back at two money going to be funneled difficulties keep going for
times or three times cur- back into the business for another year or two years
under stress. And rent prices. The only con- growth? Or is it going to be, or more, I want to under-
clusion that we can come to as Peter Lynch used to call stand whether or not a
by stress, I mean there is that it wouldn’t be a it, “de-worsification”? Are company can survive. Just
mistake for them to do that the executives going to piss look at what is going on
that their stock today. Most likely they are away the money? We had a with the banks and the bro-
all buying their stock back. company called WellCare in kers. For years, we could
prices and their
So if the HMOs—United which—for reasons beyond not understand what they
market values have Health, WellPoint, and oth- my understanding—a past owned and what they owed.
ers—are not going to man- CEO decided not to report It was nearly impossible for
fallen off a cliff.” age the healthcare system, an overbilling. the insurance companies or
then who is? And I can’t any financial institution that
find an answer to that. I Then it goes into a more had a large or not-so-large
can’t find an alternative. macro environment. What derivatives book. Today it’s
happens if a small, dirty nu- not even clear to me who
G&D: Is killing the com- clear bomb goes off in the owns them. I can’t tell you
pany a mindset that you New York port? You go who owns Citigroup. My
employ when you analyze a through crazy, man-made default answer would be
business, or is it a separate and natural catastrophes that the government owns
process you take on after such as going into a deep Citigroup. It is pretty obvi-
you have analyzed a busi- recession. And then, after ous with the auto compa-
ness or when you are talk- asking all the questions and nies that some combination
ing to experts? You’ve de- testing your thesis that a (Continued on page 7)
Volume I,
III,Issue
Issue2 1 Page 7

(Continued from page 6) It is when you’re not think- have to throttle back down
of bondholders and retirees ing about it that you get because the credit markets
have owned the big three hurt. It is when you pay will not allow them to do
auto companies for quite a that optimistic price. It has the kind of volumes that
long time, so the stock always paid to be very they are capable of doing.
prices of GM and Ford greedy when everybody else I am a director of
never made sense to me. It is quite fearful of the envi- AmeriCredit now so I can’t
just seemed to be a fallacy. ronment, because that fear spend time talking about the
And we are going that way factor is priced in. You tend company, but if you take a
now with our large banks. to get a relatively decent look back and see—before I
margin of safety based on was a director—a deal
The amazing thing is that the price you are paying for where we had AmeriCredit
people just don’t seem to a given level of free cash securitize auto loans. We
learn from history. Difficult flow. That is where we are were able to get our share-
times correct problems. today. What better time is holders a significantly over-
Companies are tightening there? If not now, when? capitalized 18% yield-to-
up, losing the fat, becoming Was it a better time to in- maturity with a cash cushion
“They are learning
more efficient, learning very vest three years ago? Six and a significant corporate that you should
tough lessons about lever- years ago? And the answer guarantee behind it. It was
age, and relearning about is no. What is happening a great deal for our share- not play Russian
the sanctity of the balance today, as in most bear mar- holders, and it also helped
sheet. They are learning kets, is that people either AmeriCredit securitize roulette even if the
that you should not play don’t have the cash or they loans that were in their
Russian roulette even if the don’t have the stomach— warehouse facility. Fair- gun may have a
gun may have a thousand hence the low valuations. holme would love to do
more of that. Today you
thousand chambers
chambers and only one bul-
let because if you hit that G&D: You’ve received a can be at senior levels of a and only one bullet
bullet, you are dead. Much lot of kudos for avoiding company’s credit structure
of the probability and statis- financials in the last year or or in a position where you because if you hit
tics work—for instance, so. Is there anything that have significant collateral
Monte Carlo simulations— would make financials more and still get an equity re- that bullet, you are
are based upon thousands attractive to you going for- turn.
and thousands of spins of ward? Do you envision dead.”
the wheel. But if you kill them becoming an invest- G&D: So you believe that
yourself that one time, you ment opportunity again at the dislocations at the top
can’t spin again. I don’t any point? end of the financial system
know where that is ad- are creating some poten-
dressed in the statistical BB: I think that there are tially attractive valuations at
courses. Now we know it. many financials out there the lower end among
Now we have books about where they haven’t put smaller, more transparent
black swans and fat tails, and themselves into a death financials. Do you think this
we understand that a bad spiral. Some are just in a is an attractive area for
thing can happen more of- tough position because of a value investors to prospect?
ten than you think. lack of credit. Once the
credit markets open up, BB: Yes. The news is fo-
In life as in investing, what they will be absolutely fine. cused on the top dozen
kills you is what you don’t To some extent, some of financial institutions, but
know about and what these trite sayings are actu- there are good companies
you’re not thinking about. ally quite true: whatever out there. If you can actu-
Today investors are focused doesn’t kill you only makes ally read their reports to
on most of the ways in you stronger. They will the SEC and they make
which you can die, which is come out of this bigger and sense to you, that’s great.
a great signal for the future. better. They just currently (Continued on page 8)
Page 8
(Continued from page 7) AAA rating. It is the same not going out there and
When you read the report idea with off-balance sheet acquiring a whole bunch of
of AIG half a dozen years financing. Even if you could competitors at stupid
ago, the section on deriva- do it, if you had an off- bal- prices. The company is
tives was one paragraph. ance sheet company blow learning that it doesn’t have
How could you know? And up, you’ve lost your reputa- to be fat to be happy, and
“What better time today it is page upon page tion. Reputation is critical there is tremendous cost-
upon page and you still even if it’s not part of the cutting going on. The com-
is there? If not don’t know. How do you Qs and Ks of a company. pany has the largest global
know the ultimate counter- distribution capabilities in
now, when? Was it party? So that is a form of G&D: What types of in- the industry and realizes
killing a business. You end vestments are you looking that everything doesn’t have
a better time to up saying, “I can’t figure this at right now that you find to be created at the com-
out. It’s too tough. Move most interesting in the cur- pany, but that it has the
invest three years distribution, the cash, and
on.” rent environment?
ago? Six years the know-how to be a great
G&D: We’ve seen the BB: We are driving less partner with any other
ago? And the an- financial sector as a percent and we need more health- pharmaceutical company—
of the S&P rise from 5% in care as we get older, so we especially in phase three
swer is no. What is the early 1980s to above have made a significant drugs.
20% a couple of years ago. move away from oil and gas
happening today Do you think that the finan- to healthcare companies It faces Lipitor going off
cial economy has driven too such as pharmaceuticals or patent in a couple of years,
as in most bear much of the productive ca- and everyone’s perception
markets is that pacity of the country? Is Pfizer Inc. Stock Chart is that it is
this the beginning of a re- going to kill
people either don’t versal of that trend? Can the them. What
productive sectors of the no one real-
have the cash or economy absorb the slack izes yet is
from the shrinking financial that Pfizer is
they don’t have sector of the economy? the sixth or
seventh
the stomach— largest ge-
BB: Oh, I think you’ve got
hence the low it right. Yeah, I think you neric drug
pretty much have it exactly manufac-
valuations.” right. Wall Street was the the HMOs. Our largest turer now. It most likely
biggest casino, and it just position today is Pfizer will continue to increase
doesn’t make sense for so which we think we have a sales of generics that every-
many people to be doing better handle on than most. one is worried about. It is
what they were doing. It It has a AAA-rated balance interesting that people will
had to end. What happens sheet, a 7%-plus dividend spend more time thinking
is that the worst possible yield, trading at seven to about the kind of chocolate
results usually happen when eight times free cash flow, they eat than the kind of
you take a good idea to and generating about $17 medicine they’re swallowing.
some kind of illogical ex- billion in free cash, which People just blindly accept
treme. It is a crazy idea that works out to be $2 to chemical compounds with-
you can take a whole bunch $2.50 per share of free cash out realizing that generics
of crap and chop it, dice it, flow. The stock is trading are not exactly the real deal.
mix it, shake it up and then below $20 per share. Pfizer They may be as effective,
paste it back together again has a great new CEO that but then again they may not
and all of a sudden it gets a everyone hates because he’s (Continued on page 9)

(Continued from page 8) So we started to look at the
be as effective. The big G&D: Here is a hypotheti- credit structures and the
pharmaceutical companies cal for you: If you had to put bonds of companies that
have historically just given all of your money in one had covenants that insisted Professor Bruce
that business away, but stock right now, what upon paying them in full Greenwald
they’re not giving it away would that stock be? upon change of control.
anymore. There is nothing From there we started to Bruce C. N. Greenwald
wrong with the profit mar- BB: It would be a holding look at all of the covenants holds the Robert Heil-
gins of mature products, so company with a diversified and indentures such as brunn Professorship of
you are going to see big group of business like Berk- cross defaults, rankings and Finance and Asset Man-
pharma move more and shire Hathaway or Leucadia, repayments during defaults. agement at Columbia
more toward mature prod- where you have smart, There are a lot of bonds out Business School and is
ucts and think about com- bright, and talented people there yielding 20% to 30% the academic Director of
peting in that space. who think that not losing is that had to be as good as the Heilbrunn Center
much more important than the equity—maybe even for Graham & Dodd
So we like the company, we making a fortune. You better—given that you had Investing. Described by
like the strategy, we like the know that they have a bal- to see something improve in the New York Times as
paper trail of the chief ex- anced portfolio of busi- that credit structure before “a guru to Wall Street’s
ecutive, and we love the nesses where no one com- you would start to see the gurus,” Greenwald is an
amount of free cash flow pany can kill the portfolio. equity of that company im- authority on value in-
the company is generating. That doesn’t mean that they prove. If your bond is yield- vesting with additional
The only reason that it has have to have dozens. It is ing 30%, the market thinks expertise in productivity
such a high free cash flow like the central limit theo- there is a real risk that and the economics of
yield is because the price of rem in math—you don’t you’re not going to make it.
information.
the stock has fallen off a need that many to approach However, if the bonds start
cliff. Many of the companies diversification. You do need to improve and the yields go
that are very interesting to have a strong assessment down dramatically it would
right now are interesting of the management with a be an indication that the
because their price has de- long, successful paper trail. equity structure is stronger
clined in relationship to A trail of not making a lot of than most thought. So by
their earnings. Pfizer was a bad decisions, especially if marrying the two together,
company that a decade ago the idea is that you can only we thought that each part
people were willing to buy pick one company and have made the package stronger.
at 40 times or 50 times to live with it for a decade.
earnings, and today it is G&D: And you are plan-
trading at seven to eight G&D: Earlier you touched ning on doing more of that
times earnings. This is a on your strategy of marry- in the future?
level that I can’t find the last ing debt with equity. When
time that the company ever did you begin employing this BB: We can. If the oppor-
traded at. So again it goes strategy in the portfolio? tunity is there, it makes per-
back to the old days as a fect sense to me—especially
bookmaker or at the corner BB: It germinated based on when you can get excess
grocery shop I grew up in, our role-playing activities equity returns with fixed
watching the register and regarding how we could income instruments.
the money go in and out. I lose money. The idea that
learned a lot about the per- we buy a company cheap G&D: Regarding short-
verse psychology of the doesn’t mean that we’ll live selling, in the past you have
human condition. It all adds to see it do really well if said that you have no prob-
up to what Munger calls companies are taken over, lem with shorts. In fact,
these lollapalooza effects and taken over cheaply as you’ve pointed out that
that exist today. has happened in the past. (Continued on page 10)
Page 10
(Continued from page 9) formance? generating a 5%-plus cash

shorts are sometimes bene- return on cash. I don’t
ficial because they may cre- BB: I don’t know if it has know how you can call that
ate opportunities for you to to do with the size. My past a bad asset. And our insight
buy stocks cheaper. But you successes have usually been from trying to kill Wells
don’t do any shorting your- due to a kind of informa- Fargo was enough to make a
self. Why not? tional arbitrage or insight very big investment in Wells
that existed—for example, if Fargo.
BB: Because I am not ge- a company has done quite
netically engineered for well, but the market does G&D: If you were running
shorting. If you are long and not expect it to continue to 50 million dollars instead of
you are wrong, you go to do so well or even expects the amount that you are
zero. If you are short and it to do poorly. This re- running today, would you be
you are wrong, you may minds me of the story of doing anything differently?
face death. The mania of Warren Buffett when he
markets can last quite a long invested in American Ex- BB: Obviously, the size
time, and when you take press. He knew that the would enable you to look at
into account mark to mar- salad oil scandal was a one- smaller companies, which
ket and the collateral time bump that had nothing would make a difference.
needed, it doesn’t appeal to to do with their basic credit But what I think a lot of
me. It frankly does not ap- card operation. So he people don’t fully compre-
peal to me to bet against asked, “Will people stop hend is that with these small
the company, and the man- using the card?” Then he companies also comes illiq-
agers, and the shareholders. would go in his favorite res- uidity. So say you find a
taurants and watch whether nice portfolio of small and
G&D: In a sense, shorting people would use their medium-sized companies,
seems to fit quite well with American express card, or and then the world changes
your philosophy of trying to their MasterCard, or Visa, as it did in November of last
kill the company. If you find and came to the conclusion year, and all of a sudden
a company that you can kill, that the scandal was not there are other great small
wouldn’t it make a good going to kill American Ex- and medium- sized compa-
short? press, nies to invest in. What do
you do? Your companies
BB: Do you want to beat it Also, in the early 1990s I are down and by the nature
up or kill it? That involves a was a big investor in Wells of small companies, they are
certain amount of mud Fargo when it was being very illiquid. So you’ve put
wrestling that I think life is shorted heavily and consid- yourself in a corner, and
too short for. ered by many to be a bank- then you start to have re-
rupt bank because of the demptions, and then you
G&D: With regards to huge reserves they were have to sell that which is
capitalization, some value taking on in their real estate illiquid. So the moral of the
investors prefer to target portfolio. But the bottom story is that Fairholme is
less efficient areas of the line was that the reserves agnostic about size. There
market—for example, in were being forced by the is good and bad to all levels
small and mid-cap stocks. government agencies be- of capital structure size, and
What has enabled your out- cause of all of the disasters we will go wherever it
performance in large-caps? that they were facing taking makes the most sense to go.
Does it have something to over banks. Their so-called At any given time that may
do with the fact that they bad assets for which they be large-cap or small-cap.
are large-caps, or do other had to reserve billions and What we do is multi-cap
factors explain your outper- billions of dollars were also (Continued on page 11)

(Continued from page 10) life is about not dying. It is tremely humbled and im-
value investing. Even if all avoiding those places where pressed by our shareholder
these great small cap ideas you can die. That’s why I’m base. Our shareholders
existed, it could potentially not a really big fan of para- have really stuck with us. If
be a suicidal strategy just to chuting. we had a gigantic partner-
invest in those companies. ship structure at one-and-
The lesson of the past few G&D: The current envi- twenty, I don’t know if that
months is that cheap has ronment showcases the would be the case. We
become cheaper. Never frustrations inherent in run- have engineered Fairholme
before have I sold so much ning a public fund. What such that I would be happy
of that which is cheap to made you structure the fund if I were the client. As a
buy that which is cheaper. as it currently exists rather client, I like the concept of a
You can do it in large caps, than as a hedge fund or in- 1% flat fee. I like the trans-
but it is difficult when the vest ment p artnership? parency of the fund. I like
trading in a security trickles Would you make the same the public reporting and “Once a person
toward zero. decision now? How does auditing. I like the safety
the structure of the fund and the separate custodian- has an idea, we
G&D: Shifting gears to impact the way you invest? ship and independent ap-
your interaction with your praisal. Mutual funds have a then start
analyst team: How does an BB: We restructured the system of checks and bal-
analyst convince you that he fund somewhat in the past ances that I feel very com- whacking at it. We
or she really understands year. We’ve redone our fortable with.
foundation documents such
invert the concept.
the business?
that we have a lot of flexibil- G&D: Do you think that Instead of trying to
BB: It is based on this ity. We have as much flexi- hedge fund fees—and man-
process of trying to kill the bility as you can have under ager compensation—are prove a person’s
business. Once a person the 1940 Investment Com- going to come down?
has an idea, we then start pany Act, and I believe that idea, we try to kill
whacking at it. We invert the fund can do much of BB: I don’t know. At the
the concept. Instead of what a partnership can do. end of the day the fees it, and if we can’t
trying to prove a person’s It is done in a more regu- should not matter. What
idea, we try to kill it, and if lated fashion, which I think should matter is the after-
kill it then the
we can’t kill it then the per- is good for my shareholders. fee, after-tax return of the person is onto
son is onto something. And I don’t have a problem fund, and with an assess-
Whether it is my own idea that we charge a flat 1% fee. ment of how that return something.”
or someone else’s idea, that With the scale that we have was generated. If it was
is the process we go now, we have the ability to generated through a medio-
through. We will then talk pay, achieve, hire, and do cre return leveraged up,
to experts with 20 or 30 whatever we need to do. then you have a problem.
years of industry knowledge, I think that the fact that we Very smart, talented people
and we will try to attack it are a mutual fund with a low deserve to make a lot of
from every way that we fee structure also attracts a money. Mediocre people
know how. After a period certain type of shareholder. shouldn’t be making any-
of time as we go through We’ve tried very hard to where near the money that
our checklist and we’ve attract the right sharehold- they are making. I don’t
been through all the ways ers that understand our know where this issue will
that we can kill an institu- philosophy, our strategy and go, but I know that I per-
tion, we decide that maybe the long term nature of our sonally think that lower fees
we can make some money. investments. Investing is make a lot of sense. It takes
Much of investing is about not that much different than away a lot of the perverse
not losing just as much of business. I have been ex- (Continued on page 12)
Page 12
(Continued from page 11) formance of the fund due to So given the rules of engage-
psychology. A one-and- taking up one’s time doing ment and putting myself in
twenty structure allows interviews on one side and the shoes of my sharehold-
someone to go for the effectively communicating ers, I have made the deci-
gusto, knowing that you with our 200,000 sharehold- sion that it makes sense to
only need a couple of years ers on the other side. You do an interview or go on
of great success to achieve can speak openly in a public CNBC for 13 nanoseconds
the same as a decade of forum in a way that you or do a one hour confer-
hard work. That can cause cannot openly speak one-on ence call. Would I do this
some serious problems. -one. For example, that when we get to a more nor-
But once again, the idea isn’t which I say in a webcast mal time? The answer is no.
bad—it has just been taken becomes public. That which It would not be an effective
to an illogical extreme. I I say to an individual inves- use of my time. I have
think that a lower fee structor may not become public. saved up this time for when
ture without leverage—and If I want to tell our share- the environment is difficult.
holders how I feel and That is the time you have to
where we’re going, it is best communicate with your
for me to do that in a public shareholders more than
format. ever. I don’t think there is a
real need for intense, con-
It is done to keep our stant communication all the
shareholders informed in time. In normal environ-
this environment. The big ments, there is no need for
danger for a shareholder in frequent communication
our fund is that other share- because strategies don’t
holders sell at the worst change.
possible time. I don’t know
how you can talk to 200,000 G&D: On a recent confer-
shareholders and give them ence call, you commented
your views and let them ask that—if it turns out that you
questions and give them made the wrong decision by
Bruce Berkowitz an investment process that answers. I try to accumu- going on offense in the fall
(Center) on a panel with is fairly simple—is probably late the toughest questions I and buying into the mar-
Greenwald, Greenberg a better way to go through can find and even come up ket—you don’t deserve to
(‘73), and Russo at the life. with some of my own, and be in business. That is a
Security Analysis then go through them on pretty strong statement.
Symposium. G&D: You are considered public conference calls. At
to be a contrarian investor. the same time, I don’t think BB: The point I made is
Other contrarian investors I’m giving away the candy that, if this isn’t the time to
prefer to stay under the store talking to them. I more aggressively buy public
radar, but you have commit- could talk to you about equities in recent years,
ted yourself to continued Pfizer until I am blue in the then I think that is correct.
media interviews and public face. But in this environ- I have always suffered from
calls with your shareholders. ment, there is not much you what I call premature accu-
How do you think about can do about it. It is not as mulation, because that is
communicating with the if I have a strong desire to just part and parcel of not
public and with your share- invest much more of the having a crystal ball and the
holders? fund’s money in these fact that cheap can become
names due to concentration cheaper. If you don’t step
BB: The balance is be- rules. up to the plate when you
tween not hurting the per- (Continued on page 13)

(Continued from page 12) ance record will tell you ing market for investing?
can find high quality compa- that. We have great share-
nies at mid-to-high single holders and smart share- BB: I think this is the time.
digit multiples, then when holders and I am not going I can’t think of a better time
are you going to do it? If to be the only one to come
to be getting out of business
performance suffers from to that conclusion. It is
mistakes, then I don’t de- harsh to judge yourself that school than in the next year.
serve to be in business. I’ll way, but that is the way it However, the world is so
be the first one to pull the should be. In the long term competitive; you have to do
plug. if you’re not good at what what you like. There is no
you do, then you’re not way you can go out for eight
G&D: By that logic, a lot of doing anyone a favor, in- to 10 hours a day, five to
people who are considered cluding yourself. seven days a week other-
great investors today should
G&D: A lot of great inves- wise. It is impossible.
also not be in business.
tors read voraciously and You’d just kill yourself. It is
BB: I don’t judge. I’ll talk are very curious thinkers. If also important to find a de-
about sins, but I won’t talk you weren’t a professional cent, successful person to
about sinners. I must admit money manager, what mentor you. If you work “Nothing makes
that I have enough of my would you see yourself do- with the right people and do
own mistakes to focus on ing instead? me happier than
what you like to do, then
than to look at others so I
can’t comment. Let me put BB: It is interesting that you’ve got it made. The when my youngest
it in the words of Buffett. I you say that—voracious work has to be in the cate-
comes running out
know that I was swimming readers. I must admit that I gory of a hobby. You would
partially naked last year with have been reading less lately want to do it even if you of her room asking
a lot of other great people, because I just don’t want to weren’t getting paid for it.
but that is no excuse. We get persuaded by mass sen-
If you are lucky enough to
me to turn down
don’t want to be naked. timent right now. If you are
You can’t control the mania talking about the great find something, whatever it the volume on the
of the markets. The trick is books and classics, I think is, you should do it, because
to not let the mania nega- you will eventually achieve amp.”
that is correct.
tively influence you. The what you want to. The best
markets are made to be And I don’t know what I plumber in the world proba-
taken advantage of, not to would be doing. You need bly ends up owning the larg-
be persuaded by. That is some kind of diversion. I
est plumbing company in the
Ben Graham’s Mr. Market. tried golf, and it didn’t
The market in the short work. These days, believe it world after just being a
term is a voting machine or not, it has been music. I good plumber for a while.
and in the long term it is a am trying to play the guitar. Those are the only two
weighing machine. The vot- Nothing makes me happier points I have been able to
ing is quite pessimistic right than when my youngest figure out so far. Also, it is
now and it should be some- comes running out of her important whom you marry.
thing to take advantage of. room asking me to turn
The right person will be
If I have dramatically mis- down the volume on the
judged the free cash flows of beyond-words helpful and
amp.
companies or the safety of the wrong person will de-
their balance sheets and G&D: What advice do you stroy everything in your life.
businesses, then I shouldn’t have for MBA students
be in business. Over the heading into a difficult job G&D: Thank you, Mr. Ber-
long term, your perform- market but a very interest- kowitz.
Page 14
Highlights from the Graham & Dodd Breakfast

October 8, 2008— Graham had lost 70 percent overvalued levels.” He
Inaugurated in of his partnership’s net asset stated that “at some point,
1988, the Graham value, as he suffered losses being too early feels indis-
& Dodd Breakfast of 20 percent in 1929, 50 tinguishable from being
exemplifies eight percent in 1930, and 16 wrong,” which is a signifi-
decades of Gra- percent in 1931. cant risk for “value-starved”
ham and Dodd investors. Despite this risk,
tradition at Co- Wearied by the market tur- Klarman shunned attempts
lumbia Business moil and his dismal record at market timing and sug-
School. Held in the prior decade, Graham gested that value investors
New York City wrote at the end of the should be buying stocks
every fall, the 1940 edition of Security when they are cheap and
breakfast brings Analysis that institutional offer a sufficient margin of
together alumni, investors should buy bonds, safety, instead of waiting for
students, scholars which were yielding 2-3 them to fall further.
and practitioners percent, and avoid stocks
for a forum on despite their superior yield Klarman recalled “the wis-
current insights of 6-8 percent. The irony, dom of Graham and Dodd”
and approaches to according to Grant, is that and advised that Security
investing. This Graham added this com- Analysis is a “remarkable
highly successful mentary after writing 750 roadmap carried on the
Seth Klarman speaking at and invigorating event at- pages on the virtues of fun- most successful investment
the Graham & Dodd
tracts some of the most damental common stock journeys the past 70 years.”
Breakfast.
prominent figures in the analysis. It seems that even Klarman also recounted that
investing community. the “father of modern secu- as Graham and Dodd were
rity analysis” had difficult writing Security Analysis in
Jim Grant, the breakfast’s days at the office and sec- 1934, they had to “combat a
first speaker, expounded on ond-guessed his approach at widespread conviction that
Benjamin Graham’s histori- times. However, Graham financial debacle was to be
cal returns and his human remained “determined and the permanent order.”
fallibility as an investor dur- undefeated,” according to Klarman later reminded the
ing the Great Depression. Grant, and he prospered audience that “you can only
Grant claims that Graham after the Great Depression. control your process and
occasionally “outsmarted Grant emphasized his admi- your approach” and echoed
himself” and “got caught up ration of Graham’s analytical Warren Buffett’s advice that
in the times in which he powers and good heart. you should only hold invest-
lived,” enjoying the equiva- ments that you would be
lent of today’s “Greenwich Seth Klarman followed Jim comfortable with even if
lifestyle.” Grant with his own per- “the market could be closed
spective of Security Analysis for the next five years.”
Graham entered 1929 with as a practitioner. The ad-
$2 million of capital in long dress was an inspirational Following Seth Klarman’s
positions, hedged with $2 appeal for the audience to speech, Professor Bruce
million in short positions. maintain a disciplined and Greenwald spoke about his
Despite this apparent con- rigorous approach as value re-reading of Security Analy-
servatism, his partnership investors. Klarman spoke sis, his deep admiration for
also had $4 million in lev- with impressive candor as Graham and Dodd’s quality
ered long positions, which he discussed his greatest of thought. Prof. Greenwald
he considered to be worth fear as an investor of explained to the audience
more than their market “buying too soon on the that no one knew what a
price. However, by 1932, way down from often very (Continued on page 15)
Graham & Dodd Breakfast (continued from page 14)
(Continued from page 14) sheet. He also praised Gra- the world with dollars”
discounted cash flow analy- ham and Dodd’s prescience t h rou gh e x p an s ion ar y
sis was in 1934; it wasn’t on the value of active secu- monetary and fiscal policy.
taught at Harvard Business rity analysis, while keeping
School until 1949. Addi- in mind that the perform- - Seth Klarman’s comment
tionally, fundamental analysis ance of the average profes- that, until today’s unprece-
was also not widely prac- sional investor is, well, the dented buying opportunities
ticed at the time and was market average. To con- due to market dislocations
typically restricted to bonds. clude, Professor Greenwald and forced sales from re-
demptions, he had not been
extremely active in the U.S.
equity markets since 1992.
Over the past 15 years,
Klarman had moved to less “Klarman also
liquid, less public invest-
ments as he took advantage recounted that as
of opportunities in the real
estate market following the Graham and Dodd
S&L collapse. In previous
environments, he noted that were writing
you had to compete against
many smart people and cor-
Security Analysis in
porate insiders; whereas 1934, they had to
today, you have sellers who
have not carefully analyzed ‘combat a
the positions. ”What a great
Greenwald, Grant, and Klarman at the breakfast. time to be a value investor,” widespread
offered these encouraging he said.
In hindsight, Greenwald was words: “There are no bad conviction that
also impressed by Graham days in the market; when it - Bruce Greenwald’s en-
and Dodd’s diligence and goes down, [there are] bar- couraging view that unem-
financial debacle
research process of looking gains; when it goes up, no ployment was 14% in 1940 was to be the
at all available facts, from bargains, but you’re rich!” and that there are large
reports to the controller of institutional differences be- permanent order.’”
the currency for banks to Following the three tween now and the Great
industry publications. speeches, Grant, Klarman Depression, after which he
Greenwald remarked, “If and Greenwald sat together offered the advice, “People
people did this today, there as a panel to answer ques- should take a deep breath
would be a lot more suc- tions in a Q&A format. and put it in perspective.”
cesses in this tradition,” and Some highlights:
perhaps many fewer invest- This article was contributed by
ment mistakes and frauds. - In a reply to a question Eric Beardsley, MBA ‘09.
about gold as an inflation
Professor Greenwald then hedge, Jim Grant said, “Gold
further espoused the virtues is the value investor’s guilty
of Graham and Dodd’s asset pleasure. It yields nothing,
-based approach to valua- earns nothing; no manage-
tion, suggesting that inves- ment to talk to, which is a
tors should start their analy- good thing…” Nonetheless,
sis with the most reliable he saw gold prices going
information—the balance higher as the U.S. “carpets
Page 16
Marvel Entertainment, Inc. (SHORT)

Thesis:
I advocate a short on Marvel Entertainment (NYSE: MVL) at $30 as I believe the stock is meaningfully
overvalued and has substantial downside due to unconventional financing and accounting as well as
slowing long term demand. I believe fair value is $18, representing ~40% downside from current lev-
els. The company’s core business-production of films based on a stable of proprietary characters-has
proven successful in the past, but now they are working with 2nd and 3rd tier characters who lack
the installed audience base of earlier characters which will lead to declining box office revenues. Ad-
Marvel Entertainment (MVL)
ditionally, a declining economy will crimp discretionary spending and movie receipts will likely be
Price: $26.67
negatively impacted by this in general. Declining box office receipts will lead to declining merchandise
(Feb. 6, 2009)
sales and related ancillary revenue. Finally, and perhaps most importantly, the company has employed
a particularly unconventional financing and accounting format which means GAAP earnings are not at
all reflective of true cash flow accruing to equity. This presents the potential for a serious negative
catalyst if top line performance doesn’t meet bullish expectations.
Background:
In 2006 Marvel moved from a licensing based model, whereby they were essentially an intellectual
properties company, to a more traditional film production company. They are now producing a slate
of movies which is a riskier model since they assume significant production costs but it also implies
potentially larger payoffs. To finance this the company contributed ten characters (Ant Man, Black
Panther, Captain America, Cloak & Dagger, Doctor Strange, Hawkeye, Iron Man, Nick Fury, Power
Pack, Shang-Chi, The Avengers and The Incredible Hulk) to an LLC as collateral on an otherwise non-
recourse $525MM revolving credit facility. The company draws down on this revolver to finance film
production and then as profits from the films come in, these flow to the LLC and remain there until
there is a net cash balance of $350MM, at which time funds can be dividended out to the company.
Investment Overview/Catalysts:
• Based on conversations with management and entertainment industry sources, Marvel needs to
generate ~$150MM in domestic box office revenues to break even on their films (as per illustrative
model below). Excluding outlier franchises (e.g., Spiderman and X-Men) the company has generated
an average domestic box office (DBO) of $122MM across 15 films since 1998. This, combined with
the fact that the films in the LLC are generally 2nd and 3rd tier properties, suggests this is probably a
fair number to assume going forward. Even assuming a significantly more generous domestic box
office take of $175MM, the company still does not generate significant value.
• Due to the LLC structure, assuming $175MM average DBO, the company cannot
access cash at the LLC until 2011 at the earliest. If their movies perform more in-line
with how they have performed in the past (the $122MM average DBO of non-outlier
films), they will never be able to access this cash and residual value to shareholders
will be minimal.
• Another wrinkle of the LLC structure is that the company, when valued off EBIT or
net income multiples, may seem reasonably priced, but because that cash is trapped,
income statement multiples are inappropriate and a DCF (representing ultimate cash
flow to equity) is probably the best way to value this company. Based on a DCF of
CF’s to equity, fair equity value for the company is ~$18 (see sensitivity analysis be-
low). Again, this is based on a possibly generous $175MM average DBO; a lower
DBO suggests no value for the LLC equity and a residual common equity value <$10.
• Note this financing model which leaves cash trapped at an LLC creates a disconnect
between net income and cash flow. Cash flow is essentially zero for the next few years while net
income will be significantly higher as it will represent net income to the LLC. If the company never
exceeds the minimum cash balance at the LLC this money will never be available to the equity.
• The second-tier nature of the LLC properties suggests that DBO will likely be weak relative to past
blockbusters. While the company will continue to generate licensing revenue from previously li-
censed properties (Spiderman, X-Men etc) their self produced films will see softer built-in demand.
Additionally, it is reasonable to assume that eventually people get “superhero fatigue.” In addition to
Marvel characters, there are several other superhero type characters (e.g., Batman, Superman,
Transformers, Green Hornet, Conan, Hellboy) which will dilute the genre.
• Management has changed significantly over the past two years. This company has a turbulent back-
ground with a robust history of lawsuits and bankruptcy. The person generally credited for reviving
Marvel Entertainment, Inc. (Continued from previous page)
the franchise, CEO Avi Arad, left the company in

’06 in what seems to have been a pretty good deal
for him (and a much less good deal for the com-
pany). He convinced the company it was necessary
to self-produce movies to avoid the problems they
had with Sony over Spiderman, but also convinced
them to allow him to leave the company and be-
come the producer for all their self-produced films.
He is credited with creating the vision behind the
company so it is somewhat unclear how well posi-
tioned current management is to run the operations.
Risk to thesis:
• Risks to my short thesis include box office performance significantly better than what I anticipate. Still, I
believe the base case scenario of a $175MM DBO average is, if anything, generous for the company
considering the weak character roster they present.
• A related risk is my film financing model may not accurately reflect their costs since it is based on an
“average” film. The company may be able to adjust costs to lower their break-even DBO.
“Marvel needs to
• Also, the market may not care about the unconventional financing structure. I think this risk is signifi-
cantly mitigated (if not entirely reversed) by the fact that the market generally may not be aware of the
generate $150MM
LLC structure. I believe investors will care that the “cash” generated by their company isn’t really
theirs, but I could be wrong. The company has a large retail ownership based (only ~62% of shares
in DBO revenues
owned by institutions) which is due to Marvel Comics fans buying stock in a company they like. They
to break
may not be the most sophisticated investors and may not even know about the LLC structure.
Assumptions
Domestic Box Office $150.00
even...Excluding
Negative Cost ($140.00) range of $135m to $165m
P&A Spend ($105.00) range of $100-120MMGross Film Revenue
Amount After Reserve
Notes
outlier fran-
98.00%
International box office pct per MVL est Domestic
Theatrical Rental Revenue
Domestic 55.00% traditional split
Theatrical
Home Vid
$82.5
$117.0
$82.5
$117.0 chises...the com-
International 43.00% PPV $7.5 $7.5
Pay TV $17.5 $17.5
Reserved Territories Free TV $14.9 $14.9 pany has gener-
Min guarantees 33.00% traditional split
Pct of Int'l Ultimate 40.00% International
Theatrical $63.2 $37.9 ated an average
Home Video Home Vid $64.4 $38.6 reflects intl non-reserved
Domestic 78.00% historical avg Pay TV $20.9 $12.5 territories where they sold
International 55.00% Free TV $30.0 $18.0 rights to distribute DBO of $122MM.”
TV Cap Min Guarantees $46.2
Domestic (contractual) Total Gross Revenue $392.6
PPV 12.50% $7.50
Pay 45.00% $17.50
Free 18.00% $40.00 Film Costs
International Amount Notes
Pay 33.00% $30.00 Distribution Fee ($33.2)
Free 50.00% $30.00
Domestic Costs
P&A Margin est P&A ($70.0) assume ~2/3 of WW P&A
Home Video Costs -37.5% 62.5% Home Video Costs ($43.9) spent dom. (consistent with
TV Costs -5.00% Standard Total ($113.9) old film model)
Residuals International Costs

Home Video -11.00% -13.0% P&A ($35.0)
TV -9.00% Standard Home Video Costs ($14.5)
Total ($49.5)
Participations
Marvel Producer Fees -5.00% Contractual TV Costs ($3.5)
3rd Parties -2.50% MVL est
Residuals
Home Vid ($17.1)
Distribution Fee -10.00% 10-12% typical distribution fees TV ($5.7)
Total ($22.8)
Participations
Marvel Producer Fees ($16.6)
Third Parties ($9.8)
Total ($26.4)
Total Film Opex ($249.2)
Negative Cost ($140.0)

Capitalized Interest ($15.4)
Film Profit ($12.0)

Marvel Production fee $16.6
Operating Income $4.6
2 Page 18
Horsehead Holding Corp. (LONG)
Grant W. Bowman November 2008

GBowman10@gsb.columbia.edu
Horsehead Holding (ZINC)

Price: $4.46
(Feb. 6, 2009)
Summary: ZINC is the lowest cost producer of specialty zinc and zinc-based products as a result
of their refining process which uses EAF dust, a byproduct of the steel mini-mill production process
which the mills pay ZINC to dispose of. While zinc prices have fallen precipitously in the past few
months, the long term fundamental outlook has improved due to the cancellation or closure of sev-
eral new and existing zinc refining and/or production facilities. In addition, ZINC has no debt, a cash
balance that makes up 70% of their market capitalization, hedged production through 2009, and an
activist shareholder who is pushing the company to return capital to stockholders.
Valuation: ZINC is currently trading at approximately 40% of book value, and 70% of the value of
current assets minus all liabilities not including the value of their in the
money zinc put options. The company purchased zinc put options at $1.00
per pound with expirations during 2008 and 2009 early in 2008. On its re-
cent conference call the company stated they sold their 2009 put options at
$0.54 a pound, which will result in $64.5 million and $30.6 million in cash
income and earnings in the fourth quarter, respectively. The company still
holds the 2008 options which at current prices are valued at approximately
$20 million. Therefore, the after tax value of the options ($55 million) plus
their current cash balance equals $135 million, compared to their current $112 million market cap.
Business: ZINC is among the lowest cost producers of zinc products because of their negative cost
to acquire the majority of their feedstock (through being paid to dispose of the EAF dust) compared
“The current to the majority of zinc refiners whose feedstock is purchased or mined. ZINC currently recycles
more than half of all EAF dust created in the US and is the only zinc smelter in North America who
valuation is be- can refine zinc using 100% recycled feedstock. As a result, the majority of their feedstock is not
subject to fluctuations in LME zinc market prices.
low liquidation
EAF dust also contains a significant iron by-product, but until recently the company had not had the
value.” technology needed to recover it. ZINC is currently in trials with a customer to test the quality of
iron made from the by-product. ZINC estimates they can recover 350,000 tons of iron from their
current process, which would translate into almost $8 million in additional revenue per year at the
current depressed price of $22.50 a ton, the majority of which should flow straight to the bottom
line.
The company is also taking aggressive steps to reduce their cost structure by implementing a $35
million cost savings program which garnered $5.5 million in savings during the September quarter,
idling its recycling facilities for the last week of 2008, reducing its salaried workforce, and revising
the construction strategy for its new South Carolina facility.
Zinc Prices and Hedging: ZINC prices have recently plummeted to around $0.50 per pound
from around $2.00 per pound at the beginning of 2007. ZINC hedges its production output in two
ways. If they enter into a contract with a customer to sell ZINC at a fixed price, they also enter into
a fixed-to-variable swap contract and therefore do not carry any fixed price contract risk. The com-
pany has also purchased additional put options with a $0.50 strike to cover any additional downside.
3
Horsehead Holding Corp. (Continued from previous page)
Customers and Suppliers: ZINC has

supplied eight out of their 10 largest cus-
tomers for over a decade, despite going
through a bankruptcy during that time. In
addition, the company believes they are the
sole supplier of zinc to the majority of their
customers. The company has long term
contracts with its EAF dust suppliers that
have a weighted average length of approxi-
mately three years.
Shareholders: Cobalt Capital currently

owns about 5% of their shares and is push-
ing the company to use their excess cash to
buy back shares, and to shut down their
higher cost operations. The company re-
sponded by idling their highest cost operat-
ing furnace in Pennsylvania during October,
one of six they have at the location. In
addition, the company stated on their 3Q08
conference call on November 7th that “the
stock is an attractive investment ... as a
company we need to take a closer look at
it and we will be discussing it with the
board at our upcoming board meeting.” In addition, Mohnish Pabrai filed a 13G disclosing a 5.1% stake
in ZINC on December 4th.
ZINC has no
Balance Sheet: As noted, ZINC previously has no debt on its balance sheet. This is the result of the
CEO choosing to retire all outstanding debt with their IPO proceeds. In addition, ZINC has an un- debt, a cash bal-
drawn $75mm revolver under which they currently have approximately $60mm in availability (due to
letters of credit). ance that makes
Cancelled Zinc Projects: Due to the decrease in zinc prices, a significant amount of zinc produc- up 70% of their
tion has been cancelled or closed. For example, Strategic Resources Corp (SRZ) recently announced it
would shut down one of its mines and cancelled two other zinc mines scheduled to go into produc- market capitali-
tion. Lundin Mining’s (LMC) announced its zinc mine in Ireland will enter a three-year phased shut-
down, Hudbay Minerals announced it will be shutting down one of its zinc mines in upstate New York zation, hedged
in August, and Teck Cominco (TCK) said it will be closing down one of its zinc mines in Australia.
production
Why is the stock so cheap?: The primary reason is because zinc prices, which have fallen signifi-
cantly. Additionally, there appear to be some technical factors. 1) The company has only been public through 2009,
since August of 2007, so some of the holders were likely betting on the continuing commodities bull
market and have dumped it as prices have declined. 2) The company has large hedge fund ownership and an activist
including some who have been rumored to have had poor performance. 3) The company has commit-
ted to an $80 million capex program to build a new EAF facility in South Carolina which worries some shareholder.
investors because of the size of the cash outlay. The new facility will allow ZINC to run its refining
with a higher EAF dust input which will lower costs. Note that if you subtract the entire capex pro-
gram out of their cash balance and add back the value of their zinc hedges they are still trading below
net current asset value. In addition, the company is delaying its South Carolina project in order rein in
capex spending levels.
Conclusion: ZINC is a low risk stock due to their cheap valuation and rock solid balance sheet. In
addition, there is a possibility of significant upside because of (a) shareholder friendly activities, (b) the
positioning as their industry’s low-cost producer with a cost base that will decrease further when their
South Carolina facility is open, and (c) an improved outlook due to the cancellation or closure of sev-
eral significant supply sources. While a fall in their stock was warranted given the fall in zinc prices, I
believe the current valuation is below liquidation value, and is likely the result of forced or irrational
selling rather than fundamental analysis.
4 Page 20
A Marriage of a Contrarian Streak and a Calculator

Michael Mauboussin, Legg camp most finance profes-
Mason’s Chief Investment sors are in—is the idea that
Strategist and adjunct profes- there are no arbitrage op-
sor at Columbia, recently dis- portunities. That is when
cussed his current market two assets become mis-
views with Graham & priced relative to one an-
Doddsville. other, an arbitrageur will
come in and buy one, sell
G&D: You’ve written a the other, and close the
great deal about investor aberrant price gap. Under
behavior and how that con- normal circumstances the
tributes to market prices. idea that there are no $100
“The real-world What’s your take on inves- bills lying on the street is a
tor behavior right now in reasonable one. No arbi-
results depart the current market? More trage is also a very plank in trageurs. Second, these
specifically, what changes finance theory. For example, theories fall short when we
meaningfully from have you seen recently in the Modigliani and Miller test them empirically. For
the way that investors be- capital structure invariance example, most mean vari-
normal have, and in your view, does propositions from the late ance models assume normal
the recent behavior that 1950s are based on an arbi- or log-normal price changes.
distributions. And you’re seeing reinforce or trage argument. And of But we know that the distri-
historically when depart from historical course the most famous bution of asset price
norms? application of arbitrage is changes is fat-tailed. The
there have been the Black-Scholes option- real-world results depart
MM: To answer that I want pricing model. meaningfully from normal
the greatest to take one step back and distributions. And histori-
talk the theories of how The third way to get effi- cally when there have been
arbitrage market efficiency comes ciency is what is colloquially the greatest arbitrage op-
about. We’ll first ask, how called the “wisdom of portunities of all—and we
opportunities of and why do markets get to crowds.” More formally, it is may be in that situation to-
all—and we may efficiency? And then from viewing markets as a day—arbitrageurs have
there we can figure out why “complex adaptive system.” failed to show up. Research-
be in that situation they become inefficient. The simple story is that ers documented this pretty
under certain conditions, well for Long Term Capital
today— There are three classical when a diverse group of Management in 1998. I think
ways to explain market effi- agents get together to solve it very much characterizes
arbitrageurs have ciency. The first is mean- a problem, they tend to today’s market, but only
variance efficiency, which is come up with the right solu- time will tell.
failed to show up.” what we teach in business tion even when any individ-
school. Here, investors ual agent doesn’t know very So let me turn to the
understand their utility func- much. Dumb agents and “wisdom of crowds” argu-
tions and how to trade off collective smarts. ment. For the wisdom of
risk and reward. A lot of crowds to work, you need
models in finance are based The first two approaches, to have three conditions in
on mean variance efficiency, mean variance and no arbi- place. Condition number
including the capital asset trage, pose some problems. one is agent diversity—that
pricing model and most of First, both make assump- is, the decision rules or ap-
portfolio theory. tions about the mechanism. proaches that the individual
That is, we have to assume investors use have to be
The second way to get the existence of rational diverse. Long-term ori-
there—and I think it’s the agents or well-financed arbi- (Continued on page 5)
5 Page 21
Interview with Michael Mauboussin (continued from page 20)

(Continued from page 4) of very poor asset price the market is mispricing the
ented, short-term oriented, returns; if you take 10-year security. Baupost’s Seth
fundamental, technical— rolling real returns, the S&P Klarman nailed it at the
whatever you want to say— 500 today is similar to the Graham & Dodd Sympo-
but they have to have very 1970s, the 1930s, and the sium in October when he
different perspectives. Sec- mid-1800s. So for people said: “Value investing is a
ond, we need a properly- with long memories—or marriage of a contrarian
functioning aggregation large databases—this is not streak and a calculator.”
mechanism—some way to unprecedented. But for The first part is to ask what
bring that disparate informa- most of us this is first time your edge is. And your edge
tion into one place. Ex- we’ve seen something of must mean you have a view
changes obviously do this this magnitude in our invest- that’s different from that of
effectively. And the third ment careers. the market. Often, that is
thing is properly-functioning because the market is suf-
incentives, effectively re- G&D: Would you say that fering from a diversity
wards for being right and the things you’ve just ob- breakdown. So to me diver-
penalties for being wrong. served—the types of mis- sity breakdowns are a really
pricings due to lack of agent good starting place to think
If you apply those three diversity and so forth— about where you might be
conditions to humans, diver- reinforce the investment able to gain an edge.
sity is by far the most likely process that you employ at
condition to be violated. Legg Mason Capital Manage- But being a contrarian is not
And when you lose diversity ment? Or does it imply that enough. In fact, the market
in markets—that is, when there are certain changes is actually often right. What
people become uniformly that you guys should be you then have to incorpo-
euphoric and uniformly de- thinking about? rate is Klarman’s calcula-
spondent—you tend to get tor—you have to determine
vast inefficiencies. To come MM: It’s a great question, the gap between price and
back to your original ques- and I think in large part the value. The way I like to do
tion, I think we are now in a answer is a function of your this the best—and I think
period of substantial ineffi- time horizon. Short-term it’s actually very applicable
ciency sparked by a diversity oriented investors have to in today’s environment—is
breakdown. In this case be dialed in to sentiment to reverse engineer. So you
unlike the late 1990s, when and try to play off of it to take the current asset
it was very bullish, this is some degree. But that is price—stock price specifi-
very bearish. And leverage really what Ben Graham cally for equities—and you
has played a meaningful role called speculation. There’s ask what kind of financial
in this as well, as it has in nothing wrong with it, as performance is required in
past downdrafts. long as you acknowledge it order to achieve that stock
for what it is. For long-term price. In a lot of instances
I will say is that it’s hard to oriented investors, this is an today, despite that the cur-
know what is normal in ideal type of an environ- rent economic environment
markets. But I do believe ment. These kinds of mis- will be very challenging for
that the period we’re going pricings are fundamentally the foreseeable future, ex-
through today is not that what you’re looking for. pectations for long-term
unique. Obviously all of cash flows are relatively
these periods are unique on Once I was asked to give a modest.
some level, but in some talk about what it is to be a
ways it is not unique. We’ve contrarian investor. I sug- G&D: It sounds like you
seen elevated periods of gested there are two es- use the behavioral phe-
volatility like we’re seeing sential components to this: nomenon as a search strat-
today; we saw it in the be prepared to go against egy to look for areas and
1930s. We’ve seen periods the crowd but make sure (Continued on page 6)
6 Page 22

(Continued from page 5) Let me make a separate a specific score.
then you do the classic point and underscore it as
valuation analysis. To play strongly as I can. I would G&D: In that framework,
devil’s advocate and ques- argue that the single most isn’t it risky to use market
tion the purpose of the be- common error in the invest- expectations as a baseline
havioral phenomenon to ment industry is a failure to for your own opinion on a
begin with, at what point distinguish between funda- stock—particularly in situa-
could you just value an as- mentals and expectations. tions where the market
set, and if it’s trading below And those are two very might not be pricing effi-
its value then you should distinct things that you have ciently? How do you man-
buy it, regardless of what’s to think about separately. age that risk?
happening in the market? Fundamentals are about
value while expectations are MM: I think it is essential to
MM: You’re obviously the price. What happens think probabilistically. So
looking for some sort of typically is when fundamen- whereas we all have a view,
evidence of mispricing in tals are good, people want or a most-likely outcome, it
your search strategy. Let me to buy. And when funda- is really crucial to consider
“I would argue reiterate the obvious: it is mentals are bad, people if/then scenarios. What I like
very difficult for active man- want to sell. It’s a very hu- to do is to take a current
that the single agers to beat the market. man reaction. But the goal is stock price and reverse-
most common We know for sure they to be very explicit in sepa- engineer the current expec-
don’t do it in aggregate be- rating those two things. tations—which I think is a
error in the cause of fees. We also know reflection of the current
it’s very difficult for anybody For example, let’s say you consensus. That gives me
investment to do it on a sustainable went to the race track and I some sense of the baseline.
basis. So this is not a trivial told you the [most prob- And I then consider various
industry is a failure task. So step one is to figure able] winner of every race if/then scenarios. This an-
out your search strategy. in advance. That’s not really swers questions like: if
to distinguish We look for diversity the information you want. things are better—for ex-
between breakdowns as the headline, What matters is not so ample, revenues are really
and there can be all sorts of much which horse is going going to come in higher or
fundamentals and indicators of a breakdown. to win, but what odds are margins come in better—
Examples include statistically priced in. So you’re not just what does it mean for value?
expectations.” cheap stocks, for example looking at fundamentals— And likewise, if things come
high dividend yields and low how fast the horse can in worse, what happens to
price-to-earnings or low run—you’re looking at rela- value?
price-to-book ratios. Or it tionship between fundamen-
can be changes in manage- tals and expectations. And Whenever I think about an
ment—so a new manage- it’s the difference between investment I like to think
ment comes in, reallocating those two things that is so about the range of possible
capital in a new way—or a essential. That’s why I’m value outcomes and the
change in industry struc- such an advocate for the associated probabilities of
ture—for instance, the in- reverse-engineering expec- those outcomes. The ex-
dustry’s consolidating, or tations investing approach. pected value is the product
expanding geographically, or Often it is easier to say of those probabilities and
cutting capacity. So there what is built into the price, outcomes. Of course, you
could be a host of items and I think the fundamentals need to compare that ex-
that might be a source of an are going to be better or pected value to the current
edge and encourage you to worse. It’s more like betting price. So while people may
investigate it further. on the over/under in a foot- look at something and think
ball game, versus betting on (Continued on page 7)
7 Page 23

(Continued from page 6) flected a wider distribution the same time also rely on
that it’s cheap, they often of price changes than the access to capital and access
don’t think enough about analysts had. So this exer- to leverage. When we go
the range of possible out- cise allows for a way to re- through deleveraging phases
comes, or the probabilities calibrate yourself, using like today the ability of arbs
of those outcomes coming market-based prices. to operate is severely lim-
to pass. ited.
It’s also important to be
G&D: So in your process at explicit. It’s a really good What typically happens in
Legg Mason Capital Manage- idea to keep these distribu- these cycles is at the top of
ment, how explicit are you tions in a file so you can the market, volatility tends
in setting these outcomes revisit them periodically. to be low, access to capital
and probabilities? Is it more This allows you to effec- tends to be very easy, rates
of an overarching frame- tively look back on how you tend to be attractive, and
work that you take into were thinking about the we get over-levered. And
account, or do you explicitly situation at a given time, then there’s a big transition,
set out your distributions and keeps you from falling where volatility goes back
and expected values? for hindsight bias. By the up, leverage goes down, and
way, Warren Buffett and
MM: We set them out ex- Charlie Munger say very
plicitly. I’ll make one link to explicitly that it’s about
one of the behavioral fi- probabilities and outcomes.
nance biases that we all tend I have a great Buffett quote
to bump into: overconfi- to that effect. He’s also said
dence. Specifically, we tend that it’s an imperfect proc-
to think we know what to- ess, but it’s the way you
morrow’s world is going to have to think about the
look like. One of the mani- world.
festations of overconfidence
is projecting ranges of out- G&D: Getting back to the
comes that are vastly too agent diversity point earlier,
narrow. So I’ll give you an you mentioned that there’s
example of how you might been a lack of bullishly-
combat that bias. inclined investors recently
and a preponderance of
One thing you can do is go bears. What other agents
to the options market and are missing from today’s
look at long-dated options. market? obviously asset prices suffer. Michael Mauboussin talking
You need options that trade Eventually, almost no one with Paul Johnson at this
fall’s Security Analysis Sym-
reasonably well—not some- MM: I wrote a piece earlier has access to capital. One
thing illiquid. If you look at a this year called, “The Failure of the key things missing posium.
series of long-dated options, of Arbitrage.” [See http:// today is an active commu-
both puts and calls, you can www.lmcm.com/podcast/ nity of arbitrageurs. And
construct the distribution TheFailureofArbitrage.htm.] that’s going to take some
of prices that are based on The arbitrage idea is a plau- time to repair. We’re seeing
put and call spreads. I’m not sible one and I think, on the a number of new funds step
saying the options market first order, is really correct. in—bankruptcy or dis-
has the absolute right an- So there clearly are arbitra- tressed funds—and they will
swer—certainly it’s the geurs that cruise markets eventually move the assets
market’s answer—but what and—of course in more back in the right direction.
we found almost inevitably normal conditions—keep But today there is an ab-
that in doing that exercise, things reasonably efficient. sence of arbitrage.
the options market re- But those arbitrageurs at (Continued on page 8)
8 Page 24

(Continued from page 7) that enthusiasm? Or are you $50s, maybe less. But the
concerned about some of idea is to take a steady-state
By the way, this is nothing the contextual factors that level of earning and capital-
new. Roger Lowenstein’s might skew those metrics, ize it. So you’re only paying
book, When Genius Failed, like inflation, taxes, compo- for the steady-state, not for
Books by Michael starts off with the story of sition of assets, and so the present value of growth
Mauboussin: John Eckstein, an arbitrageur forth? opportunities.
working in the late 1970s.
Eckstein had put on a clas- MM: If you adopt a longer- The third level is calculating
sic arbitrage position with term perspective—say three a franchise value, where
leverage. But the position to five years, which to me is you’re paying for future
worked against him, and a pretty reasonable time to value creation. There are a
because he was leveraged, consider—and take a prob- fair number of businesses
he ran out of capital. So he abilistic view of things, I out there that you can buy
had to shop his position, think the preponderance of today without paying much,
and the guy who took it evidence suggests that re- if anything, for franchise
over was John Meriwether, turns will be satisfactory and value. Bruce’s approach is
then at Salomon Brothers. maybe even really good. very reasonable in all envi-
And then it turned out al- ronments, but especially
most 20 years later Meri- I’d add a couple of points. applicable today.
wether found himself in the First, this is an ideal time to
exact same position as Eck- use some of the valuation The second comment re-
stein when Long-Term techniques Bruce lates to volatility. Volatility is
Capital Management’s port- Greenwald has popularized. a broad proxy for the cost
folio started to bleed badly. You can go back to the Gra- of capital. Clearly credit
By the way, Meriwether, ham and Dodd roots. Bruce spreads—both high-grade
and hence Salomon, made a has articulated value on and high-yield credit
lot of money on Eckstein’s three levels. The first is ba- spreads—have really blown
position as it worked out. sic old-fashioned asset value, out. High-yield spreads, for
But unlike Eckstein, Meri- where you literally go down example, in the high teens
wether couldn’t find anyone the balance sheet item by suggests very elevated ex-
to assume his positions. item, and mark things to pectations for risk and re-
What we’re seeing today is where you think they are ward. And then you can
an absence of arbitrage. reasonable today. I think if look at the VIX, which is the
While the government may you go through that exer- one-year implied volatility
try to step in and be the cise—an intrinsic value for the S&P 500. The VIX
buyer of last resort, it’d be based on pure asset value— was at a ridiculous level,
better to see these proc- you can find a lot of things close to 90, in the fall. But
esses work out organically. that are pretty attractive now it’s still in the mid-40s.
even in today’s environ- If you’re looking at the capi-
G&D: Earlier you talked ment. tal market line over time, a
about metrics that investors 40 or 45 volatility is consis-
use to try to find the areas If that doesn’t get you any- tent with returns in the high
of the market that are where, then you step up to -teens to low-20s. So in
priced inefficiently, such as second level—earnings summary you have below
price-to-book or price-to- power. Earnings power to- trend earnings and above
earnings ratios. A lot of in- day is probably below trend perceived risk. As
vestors, particularly value trendline. Trendline earn- both of those normalize
investors, are excited about ings are probably in the $70 over time, equity markets
the statistical cheapness of -$80 range for the S&P 500, can do okay.
stocks today. Do you share and for 2009 it will be in the (Continued on page 9)
9 Page 25

(Continued from page 8) tion games. So those games value investing tradition
must be largely skill. Then from Columbia Business
G&D: You’ve written a lot there are some games that School. A focus on process
about investor skill, includ- are in the middle, like back- asks: Are we doing things
ing a piece in More than You gammon or poker, where that are economically
Know in which you com- you can make a bad move sound, that are repeatable,
pared Bill Miller’s streak to and still win the hand or a and that are disciplined?
that of a free-throw good move and still lose the When the answers are af-
shooter. The idea being hand, so there is skill com- firmative, you are likely to
that the greater the skill of bined with an element of see satisfactory results over
the investor, the more likely chance. time.
the streak is to be longer. If
you look at a lot of the So here’s how you might G&D: Speaking of long and
great investors more reapply this to investing. Ask short portfolios: Do you
cently, a lot of them have a person to create two think there is an inherent
been pummeled pretty portfolios: one they believe behavioral bias for long-only
badly. How do you assess would be beat the market managers who, because they
investor skill given that it’s and one they believe would are not looking for shorts,
hard to look at investor’s underform the market. If tend to miss negative indica-
returns in the short term? you did that experiment for tors in stocks they might
a large sample of people, have otherwise been willing
MM: I actually have a new what would result? My gut to short?
book coming out this fall is that the returns on the
with a whole chapter dedi- long portfolio and the short MM: First of all, in equities
cated to this issue. Let me portfolio wouldn’t be all there is inherent bias to-
start by saying that when- that different. In investing, ward the long side because
ever you have a prolonged it’s hard to win on purpose, stock values should increase
streak, either in investing or but it’s also hard to lose on over time. Why else would
in sports, you are assured a purpose. you defer current consump-
component of skill. A tion to invest? To compen-
streak is by definition a lot So in investing—and I do sate for deferred consump-
of luck and skill combined. believe there is skill in in- tion, you expect a rate of
That said, the interesting vesting—the edge conferred return—really the ability to
thing about investing is how by skill can be swamped by consume more in the fu-
much of the results you see luck in the short term. So ture. So stocks should go
are skill and how much are it’s virtually impossible to up over time, which of
luck. make any judgments about course they have. That
someone’s skill in the in- doesn’t mean they go up
One of the best indicators vesting over short periods every year or even every
as to whether there is skill of time. A year or a couple ten years. But over the long
in a domain is to the answer of years is vastly too short. haul equities have delivered
to a simple question: can real rates of return in the 6-
you lose on purpose? For The problem is that the 7% range.
example, if you play the longer you have to wait to
roulette wheel or the slot decide whether an investor Further, going long and go-
machines, can you lose on is skillful, the greater chance ing short are very different
purpose? The answer is no. the investor will suffer hor- psychologically. To state
That means the game is all rible returns in the mean- the obvious, if you go long a
luck. With other games like time. What I recommend stock and it does poorly, it
chess or checkers, can you people do is rather than becomes less consequential
lose on purpose? The an- focus on outcomes, focus in your portfolio. If you go
swer is of course yes be- on the investing process. short a stock and it goes up,
cause they are full informa- This is at the core of the (Continued on page 10)
10 Page 26

(Continued from page 9) the housing start numbers years haven’t been a fat tail
it becomes more conse- are down dramatically. The and we should actually be at
quential. So there are a homebuilders have been in a $45 of S&P earnings?
very different set of tools full-blown depression for a
for the longs and shorts. It couple of years. On the MM: You need to think
is true that if you are long- demand side, the govern- about the type of system
only you are looking for ment has taken a lot of ini- you’re dealing with. Some
different signs than if you tiative to try to get financing systems are going to be
are also looking for shorts. costs down. Obviously, much more predictable, and
But there are a whole host housing affordability should sticky, than others. Take,
of other factors that make also improve from home for example, the path of
shorting very difficult. prices coming down. But growth in GDP—you don’t
“Your need to even with less new home get fat tails in GDP num-
G&D: We talked earlier supply and greater afforda- bers. The economy doesn’t
think about the about mispricings and bear- bility, it will take some time grow 70% in one year and
ish sentiment. Do you see for housing prices to stabi- decline 70% the next year.
type of system any fundamental signals lize. So there are some systems
you’re dealing coming out of all the noise that are a little more sta-
and volatility in the markets I also like to look at wealth tionary. I believe the earn-
with. Some systems that worry you going for- effects. The numbers are ings outlook is something
ward? For example, are you almost incomprehensible— along those lines.
are going to be looking at demographic the net worth of the U.S.
changes or other fundamen- consumer is down about $7 Let’s take corporate reve-
much more tal indicators that you think -$8 trillion year-over-year. nue in the U.S.—that num-
are a legitimate cause for If you apply a 5% wealth ber is going to grow at
predictable, and bearishness right now? effect to that number, you some number that approxi-
sticky, than others. have about $400 billion of mates GDP over time and
MM: There are clearly evaporated purchasing then there is going to be
Take, for example, many reasons to be con- power. Fortunately, that’s some kind of corporate
cerned in the short term. being offset in part by lower profitability level—
the path of growth We will likely continue to gasoline prices. But if we measured in margins or
see substantial increases in see more difficult equity return on invested capital.
in GDP—you don’t U.S. unemployment or if markets and falling home It turns out that we have
deflationary pressures con- prices, the U.S. consumer been in a steady 20-25 year
get fat tails in GDP tinue. The one area that I will continue to be very trend of rising returns on
numbers.” would try to keep a close strapped. The U.S. con- capital. In fact, going into
eye on is the housing mar- sumer represents something this market dislocation, re-
ket. It’s not an exaggeration like 17-18% of global GDP, turns on capital were among
to say that the roll over in so that’s a really important the highest they’ve ever
housing has led to the cur- engine that’s sputtering in been. So clearly returns are
rent set of problems we are the global economy. coming down and may even
facing. Likewise, finding go back to where they were
some footing in the housing G&D: Nassim Taleb has in the 1970s. But I suspect
market may provide an indi- written a lot about non- that because of the compo-
cator as to when we come normal and non-stationary sition of corporate Amer-
out of this downturn. environments. When you ica—that the mix between
Clearly, from a supply- mentioned that trendline the manufacturing busi-
demand perspective, we’ve earnings for the S&P are nesses, service businesses,
seen pretty meaningful $70-$80, how confident are and knowledge businesses—
changes on both sides. you in that level? How do I’m more sanguine and
From a supply perspective, you know that the last 20 (Continued on page 11)
11 Page 27

(Continued from page 10) related securities or any- they represented up to 30-
don’t see a full retracement thing related to the housing 40% of the trading volume.
in returns. market. I think you could So they really had punching
probably move into some of power above their weight.
Those kinds of trends— these investments with rela- Clearly, there will be a role
GDP growth, earnings tively low risk and relatively for hedge funds going for-
growth, margin structures— low leverage and get a rate ward.
those are the things that of return that has been very
don’t so much lend them- attractive on a historical There was recently a great
selves to the extreme basis. Even in the fixed in- interview with David Swen-
events as do asset price come markets, whenever sen of Yale, which is worth
changes or other natural you see fixed income re- reading. You had a lot peo-
things where that would turns that are competitive ple who saw the perform-
come into play— with long-term equity re- ance of alternative asset
earthquakes, power failures, turns, that’s almost always a management strategies, and
and so forth. The point I good time to get involved. decided to model them-
want to make is that there I’ve seen reports saying selves after the Harvard or
is a continuum of distribu- what’s priced into high- Yale endowment. They
tions. Some distributions grade or at least the highest thought it was a road paved “Quite frankly, we
are prone to fat tails and level of high-yield bonds are with gold. In reality, it’s like
others aren’t. rates of bankruptcy and anything in investing—the are heading
recoveries that are worse more people believe in toward a very
G&D: Given the environ- than what we saw in the something, the less attrac-
ment, are there certain ar- Great Depression. Could tive it becomes. attractive mergers
eas in the market that you we see something like the
think are more interesting great depression? I person- A lot of money that moved and acquisitions
than others? You men- ally don’t think that’s a huge into hedge funds in recent
tioned housing, but would probability. years was not too sophisti- environment, in my
you say that because of the cated. Much of it was
uncertainty there, it is a G&D: For the asset man- working through funds-of- opinion, for both
good place to look. agement industry in general, funds or consultants with- financial and
do you have any thoughts as out a full understanding of
MM: I gave a talk in Decem- to how it’s developing? what was going on. That strategic buyers.”
ber about what I call the Also, with the quasi- led to significant asset
“paradox of risk”—which is institutionalization of hedge growth, but when things
to say that sometimes the funds and other investment turned sour, investors
assets that appear to be the vehicles, do you find turned tail. The estimates
least risky are actually the changes in investor behavior call for something like $300-
riskiest and, on the other or do you find that it’s fairly $400 billion of net outflows
hand, assets that seem risky stationary? from hedge funds on an
are sometimes the least asset base of $1.5-1.6 tril-
risky. Of course, the way MM: I actually wrote a lot lion. Clearly, there will be a
the paradox is reconciled is about this earlier this year hedge fund industry, includ-
through expectations. To in a piece called “The Soci- ing quantitative strategies,
me, the area that seems to ology of Markets,” where I but there has to be some
be overcrowded on the long tried to address this ques- sort of a healing process
side is Treasuries. I can tion. To state the obvious, first.
certainly understand why, hedge funds up through a
but I think that fact makes year ago had been an impor- Private equity too, is an-
Treasuries unexciting. tant factor and were coming other area under stress.
on really strong. They did- Access to capital tends to
On the flip side, I believe an n’t control a ton of the as- be very cyclical. Two years
attractive area is mortgage- sets under management, but (Continued on page 12)
12 Page 28

(Continued from page 11) intersection between valua- can point to that is explana-
ago the PE firms had access tion work and competitive tory or causal for high or
to financing at very attrac- analysis. For example, if you consistent returns. In other
tive rates. Now they can’t take a competitive strategy words, the return patterns
get a loan. Of course, there course, you will learn a lot are not much different than
will be a time again when PE of really cool things about what chance would dictate,
firms will have access to industry life cycles, five So there’s an interesting
capital. Quite frankly, we forces, value chains, disrup- intersection between strat-
are heading toward a very tive innovation, and game egy and finance—we don’t
attractive mergers and ac- theory—all these things that know enough about it yet.
quisitions environment, in lead to high returns on capi-
my opinion, for both finan- tal for businesses. Then you G&D: Final question. It
cial and strategic buyers. I take a finance course and wouldn’t be an appropriate
don’t know who will be the learn the valuation stuff. interview if we didn’t ask for
first to dip their toes into But they are treated as dis- your advice on pursuing a
the water, but we are set- tinct disciplines. What I career in investment man-
ting up for a very attractive would really love to see is agement, especially in the
M&A market, maybe in the some way to combine these current environment.
latter part of 2009 and 2010 two disciplines. For exam-
-2011. ple, companies with better MM: It’s clearly a very
strategic positions should be tough environment. The
G&D: Is that something accorded higher valuations one thing I would say is that
you can try to capitalize on? and poor companies should it’s very important to find an
get low multiples. The mar- organization that you are
MM: It is something we try ket sorts this out pretty intellectually compatible
to capitalize on. We’re well, but to me that’s one of with. It’s important to en-
thinking about, as part of the really exciting areas joy and respect the people
our investment considera- where we can get more there, but most important is
tion, the probability of rigorous. the work they’re doing and
stocks that we own becom- that the approach fits well
ing takeover candidates. About a year ago I published with your personality. Being
We are thinking about a piece about mean rever- somewhere with which you
which industries are most sion and return on invested are philosophically aligned is
likely to undergo consolida- capital. It showed a very really important. Some
tion. Clearly, financial ser- simple, economically intui- people feel more comfort-
vices are still high on the list tive conclusion, which is able in short-term, trading
for a lot of obvious reasons. that high-return companies oriented organizations.
We are thinking about tend to see their return on Others feel comfortable in a
which industries are ripe for invested capitals move long-term, patient type of an
it and which companies are down toward the cost of organization. The key is to
positioned well, both as capital over time. Likewise, do a really honest self-
sellers and buyers. for firms that earn a very assessment and do good job
low return on capital see of matching up your person-
G&D: Is there a certain their returns drift up to- ality and temperament with
direction you are looking to ward the cost of capital. It’s an appropriate organization.
pursue research or anything very much what you would
else over the next five expect. G&D: Thank you, Mr.
years? Mauboussin.
The problem is that when
MM: One area that I think you peel back the onion,
is exciting right now is the there is nothing that you
13 Page 29
Security Analysis Symposium

Investors celebrate the of the mortgage bailout bill,
risk management as another
75th anniversary of Gra- which would face a House factor that has fed the cur-
ham’s Security Analysis vote the following day. rent financial crisis. In his
view, most investors and
On Thursday, October 2nd, All three panelists criticized financial institutions have
some of the world’s most the prevalence of leverage operated with a seriously
distinguished investors gath- within the investment indus- misguided view of risk. He
ered at Columbia to cele- try. When describing his said that his first tenet of
brate the 75th investing is to
anniversary of control risk and
Security Analysis, never suffer per-
the book hailed manent capital
as the founding losses. He was
docu ment of very critical of
value investing. statistical ap-
The symposium proaches to risk
was organized as management,
a series of forums such as using
with the ten con- concepts like
tributing editors value-at-risk and
of the recently Howard Marx speaking on a panel with Seth Klarman and historical esti-
revised and rere- David Abrams. mates of volatility.
leased 6th edition. “Risk cannot be
Security Analysis was pub- investment philosophy, Klar- measured in numbers,” he
lished in 1934 by famed Co- man stated, “We don’t lev- said. “The business about
lumbia University professors erage the funds, ever. Lev- volatility being risk is a con
Benjamin Graham and David erage is the enemy of a long job.” He stated that risk
Dodd. The book was mod- -term approach.” Effec- managers who knew every-
eled after the course that tively, leverage can over- thing about statistics but
Graham taught at Columbia whelm otherwise sensible nothing about investments
for almost thirty years. investment decisions by substantially contributed
subjecting them to unpre- to the problems on Wall
The first panel, entitled dictable short-term fluctua- Street.
Value Investing Today, was tions in the market. Klar-
comprised of value investing man noted that extreme All three panelists were
titans Seth Klarman, presi- market conditions offer the upbeat about the attrac-
dent of The Baupost Group, greatest investment oppor- tive opportunities that
David Abrams, founder of tunities and emphasized that the market dislocation
Abrams Capital, and How- in order to capitalize on was uncovering. Abrams
ard Marks, chairman of these periods, investors said that the availability of
Oaktree Capital. The panel should not be afraid to hold attractive investments in
as a group oversees the large cash positions when the current environment Artie Williams (EMBA ‘02)
management of $77 billion. there are few attractive was “eye-popping.” He is and Beth Lilly.
These speakers dealt with alternatives in the market. approaching the current
the application of value in- By avoiding leverage and market in the same way that
vesting principles in today’s maintaining financial flexibil- he always approaches the
tumultuous financial mar- ity, savvy investors are able market – by looking for
kets. Even as members of to find bargains while other good businesses with attrac-
the panel were speaking, the market participants are tive margins of safety. With
S&P 500 was in the midst of forced to sell attractive as- this perspective, he believes
a 4% decline as the market sets at distressed prices. that it is currently one of
grappled with uncertainty the best times in his career
over the second incarnation Howard Marks highlighted (Continued on page 14)
14 Page 30
Security Analysis Symposium (continued from page 29)
(Continued from page 13) The panel was more divided ing policy responses on easy
to be a value investor. To on the topic of specializa- money, low interest rates
successfully capitalize on tion versus generalization in and malleable accounting.
these opportunities, how- the investment process. He feared that these actions
ever, he thought it was criti- Greenwald proposed that might ultimately forestall the
cal for investment managers increasing complexity in setting of asset prices at
to have a client base with a corporate structures and market-clearing levels.
long-term time horizon who investment alternatives ne- Merkin, citing the lessons
would allow them to make cessitated a greater degree learned from Japan’s decade
courageous decisions against of specialization among in- -long economic stagnation in
the flow of the market. vestment analysts. Russo, the 1990s, agreed that hous-
who focuses primarily on ing prices should not be
The second panel, entitled media and branded con- supported at unnaturally
Post Security Analysis: Devel- sumer goods companies, high levels, but defended the
opments in Value Investing, agreed. Gardner Russo’s bailout package, arguing that
was moderated analysts typically cover a “parts of the system are
by Columbia’s single industry or a small set genuinely broken.” In his
own Bruce of industries, he said, allow- view a government-led bail-
Greenwald and ing them to offer a greater out was necessary to permit
was comprised of depth of knowledge in their the offloading of securities
Bruce Berkowitz analysis. However, both from leveraged balance
of Fairholme Greenberg and Berkowitz sheets and to avoid the
Capital, Glenn strongly defended the gen- downward spiral of a garden
Greenberg of eralist model because it variety recession into a de-
Chieftain Capital, offers greater flexibility to pression.
and Thomas pursue attractive investment
David Kessler (‘08) and Russo of Gardner Russo & opportunities wherever Taking a historical perspec-
Bobby Buckley (‘09). Gardner. Greenwald kicked they arise. All of the panel- tive, Lowenstein said that
off the panel with a discus- ists agreed, though, that it the market has never really
sion of the market’s attitude was perhaps impossible for changed, from the “go-go”
toward risk, arguing that an outside analyst to truly stocks to the “nifty-fifty” to
euphoria and complacency understand the risk expo- the dotcom bubble. He be-
had led to its global under- sures on the large banks’ lieves that the locus of
pricing. At the peak of the balance sheets. speculation and excessive
market, he noted that an enthusiasm may change, but
investor could have pur- The final panel, Security that the underlying market
chased CDS, or insurance Analysis and the Evolution of dynamic remains the same.
against default, on Dubai’s Investment Philosophy, was mod- Merkin concurred; how-
government bonds for only erated by James Grant, the ever, he added that “the
4 basis points. Greenwald editor of Grant’s Interest world always thinks that
believes that it works in Rate Observer, and included cycles get repealed only at
investors’ favor that insur- noted financial author Roger the top,” but that it holds
ance is always the cheapest Lowenstein and J. Ezra true for the bottom as well,
when it is the most desir- Merkin of Gabriel Capital. ending the symposium on
able, and that investors the positive note that this
should seek out high quality Grant offered a cautious crisis too shall pass.
assets with insurance-like assessment of the govern-
characteristics when every- ment’s bailout package, ex- —Graham & Doddsville
one else is completely un- pressing concern that Con-
concerned with risk. gress might be “using the
cause as the cure” by focus-
15 Page 31
A Conversation with Bruce Greenwald

On September 15, Graham & ever. But
Doddsville had the opportunity first you
to sit down with the “Guru to understand
Wall Street’s Gurus,” Professor the operat-
Bruce Greenwald. Over lunch at ing business.
Camille’s on Amsterdam, we
discussed everything from finan- Then you
cial services firms, to the new look at the
Security Analysis book, to balance
Greenwald’s winding journey sheet. You
from Bell Labs to the Heillbrunn need to
Center. Known for his cutting look and
insights and broad circle of see what it’s
competence, we gladly listened investing in.
as he pulled few punches and Often the
told us exactly what he thinks. s e c o n d
business is a
In this environment, lunch does- big money loser. So you say, $12 billion in normal- Bruce Greenwald talking
n’t begin with appetizers—it have an operating business ized earnings. At an 8x mul- with Berkowitz and Russo.
begins with a discussion of fi- (where you can look at tiple that gives you a $96
nancial services firms. In his Earnings Power Value) and billion valuation. But the
characteristic clear thinking and then you have a write-up or book is $50b so already
concise analysis, Professor write-down based on the that’s suspicious. But fine,
Greenwald began discussing balance sheet. And looking let’s assume there’s a fran-
how he looks at financial ser- at the balance sheet will give chise there. What fraction is
vices: you an idea of where the $96 billion of $1.7 trillion
vulnerabilities are. [Citi’s total assets]—about
BG: You’ll always have at 6%? And let’s say that $500
least two businesses. One Many value investors get billion of those assets are
will usually be a local retail into trouble with financials. completely safe. Well, all it
business. And there you’re Take Fannie and Freddie, for takes is a 10% write-down
looking for local economies example. Everyone said of $1.2 trillion and the eq-
of scale either in product they’re great franchises. And uity is completely wiped
space or geography. There here you could evaluate the out. How much is left? It’s
are local banks that dominate franchise—you could do a all gone. With a 5% write-
and there are local banks reasonable analysis of the down, maybe $36 billion is
that are spread all over. Na- earnings power – this wasn’t left. Forget about it—it’s a
tional indemnity is an exam- too hard to analyze. But no brainer!
ple of an insurance company then you need to do a vul-
that is very specialized in a nerability assessment. They And this is all before we
product space. So the first started to lever up and even look at their competi-
thing you do is look at the started investing in risky tive position. Citi doesn’t
underlying profitability of that assets. Freddie has $750 have a retail franchise.
operation. When they throw billion in mortgages. So let’s Where do they dominate?
off excess funds you adjust write down the portfolio by Not in New York, that’s JP
how much credit you give 6%—this completely wipes Morgan. How are Citi’s re-
them depending on the qual- out the earnings power tail franchises going to com-
ity of the business and rein- value. Look historically at pete profitably against JP
vestment opportunities. the write-downs relative to Morgan? What about credit
There will be an operating the declines in housing cards? Are they dominant
business there—financial prices. there? No! We’re doing a
management, insurance, asset quick and dirty here, but
management, banking, what- Or take Citi—it’s got, let’s (Continued on page 16)
16 Page 32
Bruce Greenwald (continued from page 31)

(Continued from page 15) comes down to is that that’s not pertinent? So
you get the point pretty you’re speculating when you you’re looking at the bal-
quickly. So I don’t know don’t know what you are ance sheet because that’s
what to say to you – with buying. And you never want the best information. And
Citi, you have no idea what to do that. Don’t you think you have a better model to
you’re buying. Surely that’s that’s what is happening in understand franchises and
the first value investing prin- this market? That even where profitability comes
ciple—know what you’re though a lot of investors did from—and that’s the part
buying! But you want to their analysis and looked at he didn’t really under-
look in places where there the balance sheet—they stand—then that’s going to
has been pain and carnage didn’t take into account the give you an advantage. And I
and death and suffering— full range of outcomes. So think it’s absolutely perti-
that’s definitely where you that’s the first thing—to nent to financials—how
should look. That’s where understand the discipline of many of these people really
the opportunities are going knowing what you’re buying. tried to look at the balance
to be. But if you can’t say sheets of these companies?
what’s going on with the The second thing—which he
“With Citi, you company … that’s not in- really understood as early as And there’s even another
vesting—that’s speculating. the 1940 edition – is the issue about looking at the
have no idea what essence of efficient markets. balance sheet. There are
Compare Citi to American And there’s overwhelming two ways in which you can
you’re buying. Express. AXP has much evidence that markets aren’t get in trouble with a balance
better growth prospects. efficient in the traditional sheet. One is that you go
Surely that’s the AXP dominates many mar- sense. On the other hand, bankrupt. You go under and
kets. And AXP has high re- there is this inescapable that’s the end. And some-
first principle of turns on pretax invested sense in which markets are times you get in trouble
value investing— capital! [Editor’s note: AXP efficient—the average re- when you shouldn’t—that if
has outperformed Citi by turn before fees of all inves- you could hold these to
know what you’re 50% since September 15]. tors has to be the return of maturity you’d be fine – but
the market. So everybody you can’t. But the second
buying!” Security Analysis can’t outperform the mar- way to get in trouble is if
ket. Another way of saying you have to go out and raise
In light of the publication of that is that every time you capital where you are doing
the newly updated version of buy or sell something it on very unfavorable
Security Analysis, no conversa- there’s someone on the terms. So when you look at
tion with Professor Greenwald other side of the trade. And the balance sheet you really
would be complete without one of you is wrong. And he need to forecast how it’s
asking his thoughts on Ben literally talked about that. going to evolve.
Graham and the evolution of Then he talks briefly about
the great text. technical analysis … do you Skills of Great Investors
think if you’re doing techni-
BG: The extraordinary cal analysis you’re better We also asked Professor
thing about the book is how informed than the other Greenwald for his view on—
prescient and right he was person on the other side of other than circle of compe-
about so many things. One the trade? tence—what really separates
of the first things he writes the great investors from the
about, which is absolutely The third thing he says also-rans.
pertinent today, is this – he which is absolutely true
talks about the difference today is that almost no one BG: There are three things
between investing and bothers to look at the bal- that Buffett is good at—and
speculating. And what it ance sheet. Do you think (Continued on page 17)
17 Page 33

(Continued from page 16) between when there’s a any—that’s only a 9% re-
if anyone is good at two of moat and when there’s not. turn. And these are busi-
the three, they do ex- nesses that are shrinking at
tremely well. And then you’ve got to be 5% a year and not throwing
good at valuation. And that’s off much capital. So you
First, and it’s something part of understanding the take five away from nine and
that, interesting enough, economics. You’ve got to you get a 4% return. And he
Graham wasn’t that good at, understand the economics said a while back when we
because you have to be in- and understand what you’re took the class out – that if
credibly disciplined—but buying. Use all the informa- he weren’t emotionally at-
you can’t take a flyer and tion. Be very disciplined. tached he would have sold
say, well, isn’t this an op- Have a thorough knowl- all of his newspapers. But he
tion? If you don’t know, edge. And it usually makes a certainly wasn’t buying
then you’ve got to have the big difference if you’re an them!
discipline not to do it. And industry specialist. Buffett
that’s probably where Seth has three to four industries So one—be very disciplined.
[Klarman] is the best person he knows really well— Two—really understand the
in the world at it. It’s really consumer non-durables like businesses and the valuation
what protected [First Ea- Coca-Cola and See’s Can- implications. And three— “When you guys go
gle’s] clients—because Jean- dies. He’s made a ton of you need to be a good judge
Marie [Eveillard] didn’t money in insurance. And of managers. You have to out to work—it’s
know—so he didn’t do any then media and communica- know who are clowns and one of the things
financials. You have to be tions. who aren’t. So you have to
incredibly disciplined—and be good at judging people. to focus on—risk
most people aren’t. Most The classic case is newspa- So Seth [Klarman] is proba-
people fall in love with com- pers. But what Buffett un- bly good at this, but he’s management. And
panies and deceive them- derstands is that when a exceptionally good at the
selves about things. franchise grows, it’s earning other two. forgetting this has
above the cost of capital.
Second, it seems to me that When a franchise shrinks gotten a lot of
Applied Value Investing
you have to be really good it’s earning below the cost people into
at this—and it’s something of capital so it destroys Finally, we asked Professor
that’s developed but most value. They’re great busi- Greenwald for his take on the trouble.”
people still aren’t good at it nesses—everyone says they evolution of Columbia’s Ap-
except for you guys [in the used to be such great busi- plied Value Investing program.
Applied Value Investing pro- nesses. But what they didn’t
gram]. It’s understanding understand is that a growing BG: Oh, I think it’s the right
what a franchise is. You good business is phenome- way to do things. I think the
need to understand what a nal. But a shrinking good way we do valuation is
moat is versus an intangible business is a disaster in heads and shoulders better
asset. Where there’s real terms of the multiple it can than what you’re taught in
earnings power and no one get. traditional corporate finance
is going to enter and erode courses. Doing DCFs and
it away. Most people just So people were talking excel models is crazy com-
don’t understand this – they about 14-15x after tax op- pared to what we know
don’t understand local erating earnings for newspa- how to do. And there are
economies. So the second pers historically. So when very smart people in the
thing is that you really have the papers traded down to program. I really think we’re
to understand the econom- 11x, people thought, how going to turn out the best
ics of the business. And Buf- exciting! But what Buffett investors in the world.
fett is just exceptionally understands is that at 11x— We’ve had huge success so
good at that. He really un- and even if they return all of far without the full program.
derstands the difference the cash without wasting (Continued on page 18)
18 Page 34

should be looking for. then he builds a portfolio
And lastly you’ll take that will do under those
Value Investing where circumstances and assets
we’ll talk about integrat- that will be reasonably resis-
ing valuation and the tant and that have high re-
search process – and turns. But it’s a balanced
listen to great investors. portfolio—and that was a
really important lesson to
And all of you want to be learn. But even with diversi-
a portfolio manager. And fication—he has an under-
portfolio management is standing of what the risks
risk management. That’s are across the portfolio.
what you’ll learn in Value And when you guys go out
Investing. It’s a skill that’s to work—it’s one of the
required of a PM but is things you want to focus
very hard for us to train. on—risk management. And
But you ought to listen forgetting this has gotten a
Professor Bruce Greenwald (Continued from page 17) very carefully to the portfo- lot of people into trouble.
posing for a photo at the And you guys are doing lio managers that come in. And I don’t get the feeling
Security Analysis really well. The top part of It’s risk management—that’s that a lot of investors were
Symposium. the class just does phe- what they do. And that’s carefully constructing their
nomenal. Do you think what Jean-Marie is superb portfolios from a risk per-
you’ll have a better under- at. And I never really spective.
standing of a franchise than thought about—but what he
at other schools? Do you has is a good intuitive sense —Graham & Doddsville
think you’ll have a better of what could undermine
understanding of the eco- individual stocks. What sort
nomics? When you take the of economic or financial
Advanced Investment Re- environment could under-
search course, you’ll learn mine the portfolio. And
how to define the questions
based on the financials and *****************************************
knowledge of the industry
so you don’t just run out VALUE INVESTING CONGRESS
there and do indiscriminate
research. You’ll do very
focused research on specific May 5th and 6th
issues.
Pasadena, CA
So you’ll take seven courses:
Security Analysis, Applied
Value Investing, Economics October 19th and 20th
of Strategic Behavior, Spe-
cial Situations with Joel New York, NY
Greenblatt, Distressed
Value Investing, and then
Advanced Investment Re- Register at:
search where you’ll put all
these techniques to work so www.valueinvestingcongress.com/register
that before you out to work
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Inside this issue:
Berkshire Annual p. 3 Volume III, Issue II Summer 2009
Meeting & Heilbrunn
Center Reception
“Fish Deeper, Fish Alone”—Paul Sonkin
The Mother of Dis- p. 11
tressed Cycles-Steve Paul Sonkin is managing mem- because people expect it, I
Moyer ber of the Hummingbird Value think it’s not going to hap-
Fund. He has worked at the pen. An example that I was
Precision Castparts p. 16 talking about the other day is
SEC, Goldman Sachs, Royce
Apollo Group p. 18 Funds, and First Manhattan 9/11. I think that there are a
Company. He holds an MBA lot of commonalities be-
Focused on Essentials- p. 20 from Columbia, where he tween Lehman and 9/11.
Brown Brothers teaches courses on applied Basically, what happened is
Harriman that Lehman set off a chain
value investing.
reaction – sort of a negative
A Quant Among Us- p. 26 feedback loop. I think it was
GD: What is your take on
Jim Scott the market right now? There a Thursday morning, Octo-
seems to be some diver- ber 11th when the Reserve
Michael van Biema at p. 36
gence of opinion among in- Fund announced that they
NYSSA had a lot of exposure and Paul Sonkin - Managing Mem-
vestors currently about
they broke the buck. I re- ber, Hummingbird Value
Pershing Square P. 34 where we are in the cycle.
member that we were think- Fund.
Challenge
PS: What’s going on now is ing, “Our cash may not be
Editors: that many of the people I am safe.” Wachovia had failed happened after 9/11 – al-
talking to – many smart, and you were having these though, I think that was
Charles Murphy
MBA 2009 savvy investors – think that huge bank failures and the more psychologically driven.
the second and third shoe is world became a very, very You had this huge exogenous
David Silverman event, which introduced a
going to drop. For that rea- scary place. Everybody
MBA 2009 huge amount of uncertainty
son, I think there is a tre- pulled back. The country
Matthew Martinek mendous amount of money just shut down for a quarter, in both cases.
MBA 2010 which is very similar to what Continued on page 2
sitting on the sidelines. And,
Clayton Williams
MBA2010
Welcome Back to Graham & Doddsville
Contact us at:
newsletter@grahamanddodd.com We are pleased to present investment philosophy, and value investing professor at
you with the third edition of at Graham & Doddsville, we Columbia. Paul gives us his
Visit us at: Graham & Doddsville, Colum- believe that there is no bet- thoughts on the current
www.grahamanddodd.com bia Business School’s student ter way to study investing market environment and
-led investment newsletter than directly from successful applying Graham & Dodd
co-sponsored by the Heil- industry practitioners. With principles to a microcap
brunn Center for Graham & this objective, our current strategy.
Dodd Investing and the Co- issue contains four inter-
lumbia Investment Manage- views with leading invest- Since the application of value
ment Association. ment professionals. investing goes far beyond
common stocks, Steve
The tumultuous market over First, the issue features an Moyer, author of Distressed
the last year has only further interview with Paul Sonkin, Debt Investing, sits down
reinforced the merits of a managing member of Hum- with us to discuss opportuni-
sound, long-term oriented mingbird Value Fund and (Continued on page 2)
Page 2
Welcome to Graham & Doddsville (continued from page 1)
(Continued from page 1) Director of General Mo- winner of the second annual
ties in the current dis- tors Asset Management Pershing Square Challenge.
tressed cycle, and their im- and a former Columbia
plications for value inves- Business School professor. Finally, this issue contains
tors. articles detailing the numer-
Along with providing our ous opportunities in invest-
Next, Timothy Hartch and readers with insightful and ment education available to
Michael Keller of Brown timeless content, we also CBS students, including this
Brothers Harriman Core aim to provide specific year’s trip to the Berkshire
Select Fund discuss their investment ideas that are Hathaway Annual Meeting
philosophy of focusing on relevant today. Inside are and the Second Annual Per-
essential services in a value two condensed student shing Square Challenge.
framework. investment recommenda-
tions. The first recom- Please feel free to contact us
Finally, we talk with Jim mendation is Precision if you have comments or
Scott, director of research Castparts (PCP), winner of ideas about the newsletter,
at the Heilbrunn Center, this year’s Sonkin Prize. as we continue to refine this
about applying quantitative The second recommenda- publication for future edi-
tools to value investing. Mr. tion is the short-sale of tions. Enjoy!
Scott is also a Managing Apollo Group (APOL),
Paul Sonkin (continued from page 1)
When people are faced with money when they need to caviar. They’re not going to
“When people uncertainty, they really go from one extreme to
spend money.
don’t know how to react so another. You have intelli-
are faced with whatever they are doing, What we are seeing with a gent people making intelli-
they just stop. They go into lot of our companies is that gent decisions about spend-
uncertainty, they conservation mode. I am a people are making necessary ing and there are companies
big proponent of evolution- expenditures, but they are that are going to be benefi-
really don’t know ary psychology. It is sort of revisiting all of their other ciaries of that.
like the fight or flight reflex. expenses. You are still go-
how to react so If you are faced with a huge ing to go out to dinner, but Getting back to the 9/11
shock, you get this huge maybe you go out to the analogy, the “next 9/11” is
whatever they adrenaline bump and it is less fancy place. In our not going to be as much of a
kind of like an automatic portfolio companies, I think shock. If you have another
are doing, they response. I think that is that one big beneficiary of horrific incident where
what happened in the fourth that is a company called 2,000 people were killed in
just stop.” quarter. What I am starting Avantair that does fractional say, San Francisco, the
to see now in the press and planes at basically half the country would just react
in anecdotal evidence com- cost of NetJets. It has actu- differently because it has
ing out of these companies ally been taking a lot of already happened once, and
on a grass roots level is that share from NetJets. I think I think that when it happens
people are starting to spend this happens at every level. the first time there is this
money again. They aren’t People want to downsize a huge reaction. When it
going to spend as frivolously little bit, but they don’t happens the second time,
as they did in the past, but want to be eating cat food people become desensitized
they are going to spend when they’ve been eating (Continued on page 4)
Volume III, Issue II Page 3
Berkshire Annual Meeting

I could have sworn I was at generations. The grand- what he intended to do af-
a rock show, not an annual mother’s father had been ter the sale, and then to
meeting. Yet there I stood approached by Warren Buf- send over three years of
outside the Qwest Stadium fett in the 1950s to contrib- financial reports and a brief
in Omaha, Nebraska on a ute $10,000 to his original history of the company. “There is no
Saturday morning at 6am partnership and had de- Within three days, Bill had a
with 35,000 other excited clined the offer. The family response. The offer was
fans waiting in anticipation we were visiting had a simi- significantly lower than the
‘hedge fund’
for the doors to open for lar story. Her father was $200 million he had been
the 2009 Berkshire Hatha- approached by Warren Buf- offered by investment bank- industry that
way Annual Meeting. fett too. He told Warren ers and other furniture re-
to come back when he was tailers, but ultimately Bill exists
This year, the annual meet- driving a nicer car than him. accepted Warren’s lower
ing had a cowboy theme, The irony is that Warren is offer. I was amazed that it separately
which couldn’t have been probably still driving a worse took Buffett only three days
more appropriate. Our car (he drove a Lincoln to feel comfortable purchas- from the
tickets branded us as Town Car until 2001, and ing this company.
“partners,” not sharehold- then replaced it with a ‘money
ers. And when the doors Cadillac DTS). I wondered Waking up the next morn-
finally opened, the stampede how many others had simi- ing at 5am was remarkably management’
for the best seats in the lar stories. easy. I jumped out of bed
stadium began. Never did I like a kid on Christmas industry.”
anticipate that I’d be com- After the Borsheim’s recep- morning. We arrived out-
peting in a foot race against tion, we ventured over to side the Qwest stadium by
agile seniors at 7am on a the local Dairy Queen (also 6am. After claiming our
Saturday morning for a owned by Berkshire). It seats, we decided to go ex-
chance to listen to a pair of was hosting a book-signing plore the exhibition hall.
octogenarians speak for 6 with authors who had writ- Two friends stayed behind
hours. ten books on Warren Buf- to guard our prized seats.
fett. A BBC film crew was
Fortunately, I was traveling there filming a documentary. The hall was filled with com-
with another student who After indulging my child- panies Berkshire owned,
had attended before. He hood sweet-tooth with my including Borsheim’s, Fruit
led the way as we weaved favorite DQ Blizzard, I sat of the Loom, Dairy Queen,
our way through the crowd down and spoke with Bill NetJets, Justin Boots, See’s
into seats 10 rows off the Child about his book: Candy and more. We had Ajit Jain, Adam Weiss ‘96,
left side of the stage; a per- “How to build a business our pictures taken with the and Bruce Greenwald at the
fect line of sight for the Warren Buffett would buy.” Fruit of the Loom “fruit” Heilbrunn Reception in
Oracle. It was 7:15am. Bill Child built RC Willey and the Dairy Queen mas- Omaha following the
into Utah’s largest furniture cot. Add in a “Wall St.” Berkshire Annual Meeting
The night before, we at- store and sold the company roller-coaster ride to par-
tended a shareholders re- to Berkshire for $175 mil- ody the ups and downs of
ception at Borsheim’s, one lion in 1995 after being in- “Mr. Market” and the annual
of North America’s largest troduced to Buffett by the meeting would have been a
jewelers which Berkshire owners of the Nebraska cross between a Disney
purchased in 1989. The Furniture mart (as you can Land for investors and a
store overflowed with part- guess, also owned by Berk- Star Trek convention, ex-
ners proudly bearing their shire). cept instead of speaking in
shareholder passes around Klingon, people used words
their necks. I asked Bill how Warren had like “margin of safety,”
assessed his company. “intrinsic value,” and
At the reception, I met a Warren asked him why he “moats.”
family represented by three was selling the company, (Continued on page 4)
Page 4
Berkshire Annual Meeting (continued from page 3)

(Continued from page 3) We returned to our seats answer format. Questions
eager to finally hear him alternated between audi-
Then I noticed a press circle speak. The morning began ence members and ques-
moving toward us. Before I with a one-hour video col- tions submitted in advance
knew it, Warren Buffett was lage of commercials for to three journalists from
walking directly toward me. companies Berkshire owns Fortune, CNBC and the
In fact, I was in his way. I and small satiric skits. In New York Times. The
came face-to-face with my one clip, Warren pretended questions covered every
idol and completely froze to be Tiger Wood’s caddie. topic, from improving finan-
like a deer in headlights. In another, Warren sold a cial literacy, Berkshire’s ex-
Would security jump on me mattress called the Nervous posure to derivatives, Buf-
if I said hello and reached Nellie to a customer in the fett’s view on the govern-
out to shake his hand? I Nebraska Furniture Mart. ment bail-out, the threat of
decided to smile and politely The mattress had a com- inflation, and Berkshire’s
step aside. “Those dilly bars partment to store money, investment in a Chinese
look good,” he said pointing Berkshire shares, and old battery maker (BYD). The
to another member of the magazines. entire time Warren and his
crowd as he walked by, “I partner, Charlie Munger,
should get one.” The rest of the meeting drank coke, ate See’s fudge
followed a question and (Continued on page 15)

(Continued from page 2) same view now. You have two really intelligent guys.
to it. Mauboussin talks these widely differing views, We were just kind of chat-
about is what’s called and because you have these ting and I said, “What do
“robust consensus.” You differing views there is a lot you think? Do you think
have manias and panics of cash sitting on the side- that it is a head fake or the
when you don’t have a ro- lines and one of those two beginning of a new rally?”
bust consensus. If you are constituencies is going to be And one of them said it was
in a boat and everybody is right. There is either going a head fake and the other
sitting in the middle, you’re to be another shoe to drop said it was the beginning of a
fine. If everybody goes to or not. But I think a lot of recovery, and they said it at
the bow then it’s going to that other shoe dropping the same time.
sink. If you have a robust has already been priced into
consensus and people’s ex- stocks such that you have GD: Some have speculated
pectations are evenly dis- companies that are trading that the recent “robust con-
tributed then you’ll have an as if they are going bank- sensus” is more shorts cov-
equilibrium, but if everyone rupt. I think it was back in ering their positions and
expects the same thing then February when GE was buying back shares in decent
you will have disequilibrium. $5.80. It was trading as size.
So what happened in the though it was going to go
bubbles is that you had this bankrupt, and Citi was trad- PS: Yeah, but we are also
disequilibrium and then you ing as if it was going to go hearing that people are
had this shock to the system bankrupt. There were a lot starting to put capital to
that brought it back to equi- of other companies. Those work again and that stocks
librium. companies have rallied off of look cheap. Prices are
their lows, but still you have clearly made on the margin
What you have now is more a lot of people who still and the volume would not
of a robust consensus. Eve- believe it. I was on the be indicative of short cover-
rybody doesn’t have the phone the other day with (Continued on page 5)
(Continued from page 4) is going to perform in a re- have gotten killed. I think
ing per se. covery, but it will still per- that there are some people
form. Or a company like that call these things and
GD: Playing devil’s advo- Fortress International, there are some people who
cate, very few people pre- which we own, or a lot of are ahead of the curve and
dicted this would happen or these other companies will they are lauded as geniuses.
that it would be this bad. be able to perform quite A former student of mine
But if you didn’t catch it the well, irrespective really of has a $2 million fund and Professor Bruce Greenwald and
last time, what makes you what the overall economy was up 40% last year be- Dean Glenn Hubbard
think you can predict the does. cause he had one long that
macro environment today? As a microcap investor, did really well and one short Columbia Business School is
that did really well out of a leading resource for invest-
PS: I don’t. I don’t think only five positions. Statisti- ment management profession-
that anybody can. What cally you are going to have a als and the only Ivy League
you will see is that guys with few of those. Wayne Gar- business school in New York
very small funds don’t think zarelli called the 1987 crash. City. The School, where value
a lot about the macro envi- John Paulson called the sub- investing originated, is consis-
ronment. I could talk about prime crash and made a ton tently ranked among the top
the macro environment, just
“As a microcap of money. You can’t look at programs for finance in the
like I could talk about the those guys. You have to world.
Yankee game or whatever investor, what look at the Seth Klarmans
the topic du jour is. But who have consistently been
when you have a large cap you are looking able to sidestep these disas-
fund or a large fund com- ters. You can’t really look
plex, you have to really be for is something at the one-offs.
able to opine intelligently on
where the macro economic where it can We had a horrific year last
situation is going because year. We were down 40%,
you are the market. If you grow against the just like everybody else.
have $20 billion under man- What I find very surprising
agement, you are the mar- industry” is that people said for a mi-
ket. If you have $20 billion crocap fund, if you were
under management, you only down 40%, that was
either have a huge position pretty good. The Russell
in a lot of tiny companies, in 2000 was down around
which case you are fairly 33%. What killed us was
exposed to the overall mar- illiquidity. Usually, we are
ket or you have concen- what you are looking for is long illiquid names. That
trated positions in large cap something where it can usually works out well over
companies in which case grow against the industry the long-term as long as you
you are really exposed to returns or grow against don’t have any major panics.
the macroeconomic envi- negative economic trends. If you want to sell a house
ronment. But if you have a What we have experienced today, it is a very illiquid
small portfolio with little is that when you have a cri- asset, but if you want to sell
companies, you are not as sis, everything is correlated. a house over six months
exposed. You don’t really Since June 2007 and until then it is more liquid, de-
need to have a view. We very recently, there was pending on the price. It is
could get down in a granular nowhere to hide. The only the same way with our
way and say that even in a place where you would have stocks. In the short term
severe recession that Avan- been safe was short-term they are illiquid, but in the
tair is going to perform rela- treasuries. If you were in longer term, they are very
tively well – not as well as it equities then you would (Continued on page 6)
Page 6
(Continued from page 5) picking through our names. growth in the space. Plus,
“Our investors liquid. What we are seeing is you get a great management
that—name by name—they team. We have companies
want us to play at GD: You mentioned Klar- are starting to get picked like this in our portfolio
a specific table and man as a positive example. over and the stocks are which are just incredibly
Are there any things that starting to perk up. Essex cheap.
we tell them that it you are doing to emulate his Crane (HYDQ) got down
risk management? to $3 per share and now it Another company that we
is going to be vola- is at $5.40 bid and $6.40 own, just to give you a
PS: It is not really what we offer, but still down from really extreme example, is a
tile. It doesn’t do. There are funds that $8. They put out good re- company called TNR Tech-
sults and things look good nical (TNRK). They distrib-
work all the time, have very open charters and
funds that have relatively going forward – great funda- ute batteries. The stock is
but over very long close charters. We have a mentals with a great man- at $8.50. They have
very narrow niche that we agement team. 306,000 shares outstanding
periods of time it seek to dominate and oper- One of our other names so the market value of
ate in. For Seth Klarman, it that we are extremely bull- shares outstanding is $2.6
works.” is like the book Bringing ish on is Fortress Interna- million. They have $2.55
Down the House. These guys tional. They basically per- million in cash so you can
had six different tables and form a lot of technical con- buy the entire business for
whichever table that was sulting, construction man- $47,000 dollars and in the
hot, they would play at that agement, and server farm last 12 months they have
table. Klarman just wants facility maintenance. This is generated $700,000 in oper-
to have as many different a huge growth industry. ating income with no debt.
tables as possible to play at They have had some prob- It is an $8.50 stock price
and plays where the best lems in the past but they with $8.35 in cash – a 15
opportunity is. Our inves- have identified what those cent enterprise value and in
tors want us to play at a were and are fixing them. the last 12 months they
specific table and we tell We ran some numbers. earned $1.55. We have
them that it is going to be The stock is at $1 per share been sitting on the bid and
volatile. It doesn’t work all with 12.8 million shares whenever anyone comes in
the time, but over very long outstanding with $12.5 mil- to sell, we buy stock. It is a
periods of time it works. lion in cash. They have $6 $22 offer so at the offer it
Over a ten year period, we million in debt, giving them looks quite different. At
are up over 50% while the an enterprise value of about that price, it has a $6 million
markets are at 12 year lows. $6.3 million. You can buy enterprise value – just 10x
Over the long-term, we the whole business at $6.3 earnings. They had a large
expect that we will have million. This is a business dividend a couple of years
pretty good returns. If you that will do $80 to $100 ago so they distribute cash
look forward ten years from million in sales and they and buy back stock.
now, I think the returns are could easily do 5% EBITDA You are able to find these
going to be absolutely ex- margins – probably closer to things if you just know
traordinary because stocks 10% over time. However, where to look.
are just so cheap and the over the last six months,
luxury we get is that you’ll they have done $2 to $2.3 GD: So how to do you find
see the significant rally in million in EBITDA so you your ideas?
the broader market but it figure, even if they do
takes a while to trickle $500,000 in each of the PS: I have known TNR for
down to our names. So we next two quarters, they are years and years. I have a
are able to get some confir- trading at 2x EBTIDA. You database in my head of
mation and then we will get all the growth for free – thousands of companies that
start seeing some people margin expansion and their (Continued on page 7)

(Continued from page 6) else is. We fish deeper and friend, so clearly your inves-
I have been looking at over we fish alone, and I think tor base is important. How
the last 20 years. I started that’s really it. We are do you communicate that
out smiling and dialing at a looking for companies that issue with your clients?
regional office of a wire- are unloved, there is no
house, Dean Witter Rey- institutional sponsorship, PS: You need to manage
nolds in 1986 so I have been there’s no analyst coverage, your investor’s expectations
in this business for 23 years. where there’s very little very carefully. What we try “We fish deeper
I have always loved micro liquidity, and where manage- to do is write very honest, and we fish alone,
and nanocap stocks. We ment is pretty quiet – they sober letters and we tell
don’t really do small cap if have been sort of “run si- our investors that we are and I think that’s
you define small cap as $1 lent, run deep.” not the place to put all of
to $2 billion. We really your money. You ideally really it. We are
specialize at the sub-$100 So you go from unloved, no want to have less than 5% of
million, which is the smallest institutional sponsorship, no your net worth with us be- looking for
of the small. We are traf- analyst coverage, little li- cause it is a very risky strat-
ficking in the smallest 40 quidity, and quiet manage- egy. Of course, we don’t companies that
basis points of the U.S. mar- ment, to – these stocks be- feel it’s all that risky. are unloved, there
ket where there are still come loved, they get the
8,000 companies. So there institutional sponsorship, GD: I guess that’s a matter is no institutional
is still tremendous opportu- the analyst coverage, more of how you define risk.
nity. liquidity, and management sponsorship,
starts selling the story. PS: Right, the risk of a per-
GD: How much capacity is manent capital loss. So, in there’s no analyst
there to manage against that GD: Given the segment of terms of risk, it’s the perma-
the market in which you nent capital loss versus vola- coverage, where
kind of benchmark?
operate, do have a higher tility. We think our perma- there’s very little
PS: Chuck Royce has had hurdle rate for the type of nent capital loss risk is low,
very good performance return you are looking for? but volatility risk is high. liquidity, and
managing $1.5 billion in mi- Unfortunately, what we’ve
crocaps. Their microcap PS: Clearly, we are always had over the past 18 where
fund has a geometric aver- looking for a stock that can months is continually falling
age of $200 million and return a multiple on our stock prices. But that cre- management is
$600 million under manage- money. We look for situa- ates the opportunity. The
ment in just that one fund. tions where the stock could issue is that investors who pretty quiet –
So you can run a lot of easily double. With these have just lost money just they have been
money. But I think $100 small companies, we’ve seen want the pain to go away.
million is a good level for us. stocks go private at double That’s why they sell at the sort of “run silent,
We peaked out at $130 where they were trading. bottom. And when things
million and now we have We had one that went pri- are going well, it’s like they run deep.”
about $50 million. We will vate at 7x and one that just don’t want the juice
get back to about $100 mil- went private at 10x, so we taken away. People just
lion and then we will start see those from time to don’t want to sell when
to give money back. time. Usually, when you see things are going up and
these really ridiculous that’s why investors tend to
GD: It seems like your moves, the insiders have a sell at the bottom and buy
search process is a large controlling interest, so at the top. It’s just human
part of where you think you unless the buyer is willing to nature. Look at Fidelity
get an edge over the mar- pay up, management isn’t Magellan, it has com-
ket. Is that fair to say? willing to sell. pounded at whatever rates
it has, but if you look at the
PS: Where we get an edge GD: With your strategy, it rates of what investors have
is by being where nobody sounds like time is your (Continued on page 8)
Page 8
(Continued from page 7) Our arbitrage investments Smith Investment Company

made, it is half because peo- turn over and convert to for stock. For every share
ple get in and out at the cash constantly, so our of Smith, you’re going to get
wrong times. portfolio generates cash 2.84 shares of AO Smith, so
flow that we can redeploy its kind of a spin-off in that
GD: So clearly, illiquidity is into such situations. We sense. However, Smith
Paul Sonkin ‘95, Dan Loeb, a particular challenge in have a situation now that Investment Company also
and Craig Effron at the managing your portfolio. we’ve been waiting on for a has two or three other busi-
Pershing Square Challenge You mentioned earlier that year and we are going to get nesses, which they spun-off
you embrace diversification a huge slug of cash from it; into a liquidating LLC. We
by holding a relatively large we are going to go from actually made money be-
number of stocks. But how cause we were able to cre-
do you deal with particular ate Spinco at a negative
stocks getting cheaper and “So, with a lot of valuation. And we have a
not being liquid enough to spread on the arbitrage
these companies,
take advantage? which will collapse.
PS: A lot of investors will

the spread GD: How much work do
sell something cheap to buy you put into a name like
between the price
something cheaper. I don’t that?
really see a lot of that be- and the intrinsic
cause when something goes PS: It was a big position, so
wrong, it’s priced into the value gets wider we put a lot of work into it.
stock in this kind of envi- Typically, you start out with
ronment. What I see hap- as the business a small position and you put
pening in this kind of envi- a little bit of work into it.
ronment is, let’s say a stock deteriorates be- As you start to build on the
is trading at $8 and has an position, you do more and
intrinsic value of $12. Let’s cause investors more work. Eventually,
say that, later, the intrinsic your biggest positions are
value falls to $6. In this just don’t want to the ones you’ve put the
environment, the stock will most work into.
go to $2 from $8. So, with own it.”
a lot of these companies, GD: Do you think of your
the spread between the fund as two different portfo-
price and the intrinsic value 10% cash to 20% cash pretty lios – arbitrage opportuni-
gets wider as the business quickly. ties and general value op-
deteriorates because inves- portunities?
tors just don’t want to own GD: What kind of situation
it. is it – merger, spin-off, PS: It’s all one portfolio, but
SPAC? liquidations are the best
GD: So, even if you have places to be. Totally not
the opportunity to do that, PS: Actually, it’s a merger/ followed by the market and
a lot of times you might not spin-off/liquidation – a little you are doing a pure liquida-
because the names are so bit of everything. There’s tion analysis. We’ve been in
illiquid? this company called Smith business for ten years and
Investment Company that we’ve had just one down
PS: Well, one thing we do has always owned a control- quarter in our liquidation
is hold cash to redeploy. ling interest in another com- portfolio. But the beauty of
That’s one of the advantages pany called AO Smith. arbitrage is that they are not
of our arbitrage portfolio. Now, AO Smith is buying (Continued on page 9)
(Continued from page 8) have pricing power, it must

as correlated to the market. GD: You made the com- be in a very specific niche
However, it can become ment about having a disci- industry.
correlated, like in the cur- pline and sticking to it and Professor Bruce
rent environment, when about not deviating. A lot PS: For example, a battery Greenwald
credit is scarce and deals of guys that have come to distributer we own. I have
are broken. So you will get Bruce Greenwald’s seminar seen this business model Bruce C. N. Greenwald
some correlation to the class have talked about try- many times in the past. holds the Robert Heil-
market in the tails, but arbi- ing to make some tweaks to They carry a lot of SKUs in brunn Professorship of
trage is a wonderful place to what they have done in the inventory. If you need three Finance and Asset Man-
be. past because of the huge of some kind of battery and agement at Columbia
volatility in the market. The you need it tomorrow, you Business School and is
GD: A lot of value inves- most popular comment has can get it from these guys. the academic Director of
tors have been creamed been, “We’re going to pay a The only other option is to the Heilbrunn Center
lately, but that doesn’t mean lot more attention to macro order 2,000 from China for Graham & Dodd
they aren’t good investors. now.” Would that send you with a six month lead time. Investing. Described by
If you can’t judge a manager running to the hills as an I’ve seen this model many the New York Times as
based on recent perform- investor? times; they have a low “a guru to Wall Street’s
ance, what should you look ROA, because of all the gurus,” Greenwald is an
at to evaluate an investor? PS: It’s like closing the barn inventory, usually about authority on value in-
How would you want to be doors after the horse has three years worth. They do vesting with additional
assessed? gotten out. Everybody saw it because they are able expertise in productivity
the signs, but you just didn’t earn high margins. When and the economics of
PS: I think you need to look think there would be this you speak with them, once
information.
at the process and relate huge catastrophe. There they showed me an invoice
the process to what has and are a few guys that had in- where they bought the
hasn’t worked historically. surance against a huge catas- product for a nickel and
We have tried to determine trophe and a few guys that sold it thirty-five cents.
what works, which part of thought there would be a They’ve generated 10% op-
the market is the richest huge catastrophe. But I erating margins as a distri-
pond to fish in. Then we’ve think it was just a very low bution company. When
tried to identify which bait is probability scenario that have you heard of a distri-
the best to use – we fish actually played out. So bution company with 10%
deep and we fish alone. If would I do anything differ- operating margins? Their
you stick to your discipline, ently? I make mistakes every customers are paying for
then you won’t get into too day and I try to learn from the convenience. That is
much trouble. We stuck to those mistakes. Everybody the type of businesses
our discipline and we are makes mistakes, but the fact model that we really look
still down 50%, so people that so many people are for and they are out
have asked us if we are will paying attention to macro there—and they’re cheap.
change our discipline – I said economics…it’s not going
absolutely not. I lot of the to be there because that’s GD: You have some ex-
damage has already taken where everyone expects it. perience working for the
place. Again, it’s this issue SEC. How has that influ-
of people just wanting the GD: So with the companies enced the way that you
pain to go away, they just you are looking at, you must think about the regulatory
don’t want to look at it any- be looking for companies environment?
more. Now, we are proba- that can dominate the very
bly in the best time in a gen- specific niche industries in PS: In the class that I
eration to be investing in which they participate. For taught, I used to bring in an
these kinds of companies. these small companies to (Continued on page 10)
Page 10
(Continued from page 9) five different Buffetts. My you go to work, you’re

SEC lawyer to talk about Buffett would be Buffett #1 probably going to need to
insider trading and compli- from the Buffett partner- learn to do it in an eighth
ance issues. The most in- ship. There’s Buffett the way. Arguing with your
teresting thing from that value investor with Berk- boss is just not a good idea.
perspective is that every- shire. The third incarnation
thing is a grey area. What I is Buffett the rock star. The GD: On that note, maybe
James Walsh ‘10 and would try to press upon the fourth incarnation is Buffett you could talk about some
Christof Pfeiffer ‘10 students is that one bad that buys and holds busi- of the mistakes you have
prepare for their pres- decision could affect the nesses. The fifth incarnation
entation after coaching
made personally.
rest of your career. Before is Buffett the philanthropist.
from Paul Sonkin you make any decision, I just So I identify most with the PS: Well, recently, we were
want you to hesitate for an first and a little bit with the in cash for so long that as
instant and think about what second. soon as we saw opportuni-
you are about to do. ties present themselves, we
GD: We were hoping to pounced on them. We
GD: OK, ground rule: you talk a little bit about your should have waited a little
can’t pick Buffett. Who’s involvement with the Per- longer and husbanded the
your favorite investor? shing Square Challenge cash a little bit more.
[Editors note: Sonkin taught
PS: Oh, I wouldn’t have a master class this year at GD: Was that a market
picked Buffett. Seth Klar- CBS in connection with the direction issue – mark-to-
man. Pershing Square Stock Pitch market – or is it that you
and Philanthropy Challenge.] didn’t realize how much the
GD: Why do you say Klar- First of all, what did you businesses would deterio-
man? You mentioned ear- think of the final output? rate?
lier that he is a very differ-
ent investor than you are. PS: The quality of the work PS: I think it’s more a mark-
What about him – is it his was really excellent. I was to-market issue. There are
record? very pleased with the effort some companies we own
that most of the students where their business models
PS: It’s not the record. It’s put in. have fallen apart, but you’re
more the quality and clarity just going to have those,
of thought, the discipline, GD: Where do you think particularly in a portfolio of
and the creativity. Another students make the most microcap companies. But
investor I have a lot of re- mistakes? for the most part, stock
spect for is Walter Schloss. prices have really been irra-
He kept it really simple, he PS: The most common mis- tional. Stocks are just trad-
kept it small, and he has take that students make is ing way below cash on the
tremendous discipline. He when a boss, for example, balance sheet or replace-
also had a long, consistent asks him for a red umbrella ment value. It’s staggering.
track record. I think he had and then he comes back
the longest unbroken track with a blue one and an ex- GD: Thank you, Mr. Sonkin.
record, I think it was about planation for how it’s going
45 or 46 years. It was to keep him dry. If you
about 500 basis points for have seven different teach-
45 or 46 years. And he just ers, you might need to learn
kept it really simple; buy how to do something seven
cheap stocks. If you ask me different ways. Then you
who I admire, I guess it’s can just absorb it and decide
Buffett, but I think there are what suits you. Then when (Continued on page 11)
The Mother of Distressed Cycles—Steve Moyer
the current cycle coming investing in the unsecured

For over 20 years Steve Moyer well before it arrived. If we and perhaps even the sec-
has become both a leading look only at the increase in ond lien debt of companies
practitioner of distressed debt leverage over the last five with a lot of first lien debt
investing and a teacher of its years it was foreseeable that potentially very risky. So as
methodology and value to there would be a large num- always the issue will come
investing strategy. His book, ber of distressed companies down to price relative to
Distressed Debt Analy- once we entered into a revaluation. While it’s really
sis, serves as the fundamental cession. Of course, as with hard to generalize, unse-
handbook for understanding most other investors, ana- cured paper may need to
the particular factors and ap- lysts did not necessarily get cheaper before it pre-
proaches that differentiate predict the severity of the sents an attractive risk/
distressed investing. His distin- downturn and that led to reward tradeoff. However,
guished career has encom- many funds making invest- the complexity of capital
passed both buy- and sell-side ments too early in the cycle structures and existence of
positions at Tennenbuam and suffering losses as a CDS should present some
Capital Partners, Imperial result. potentially attractive capital
Capital, Banc of America Secu- structure arbitrage opportu-
“While it’s really
rities, Kemper Securities, This cycle will be much nities.
Drexel Burnham Lambert and broader than previous ones.
hard to
First Boston. He graduated It will have a large number GD: Is it a fair statement,
then, to say that the fulcrum
generalize,
with honors from Grinnell Col- of “fallen angels” like GM
lege with a Bachelor of Arts and Chrysler and could in- security today lies some-
where within secured debt?
unsecured paper
degree in Economics, holds a clude much more participa-
Juris Doctorate from the Stan- tion by the financial sector. may need to get
ford University School of Law, The lack of capital market SM: Again it’s hard to gener-
a Masters in Business Admini- liquidity will drive a lot of alize, but yes, I think to the cheaper before it
stration from the University of restructurings and liquida- extent secured creditors
Chicago School of Business tions will become more want a restructuring (as presents an
and is a holder of the Char- common if financing for opposed to attempting to
tered Financial Analyst desig- reorganizations remains force a sale) they will likely attractive risk/
nation. Mr. Moyer recently sat limited. This cycle may also receive a significant if not
down with Graham & be more litigious as capital controlling stake in the reward tradeoff.”
Doddsville to discuss the structures have become debtor’s equity more so
current distressed cycle, its more complex and credi- than in the past. Given the
implications and potential tors fight over recoveries. proportionately large
opportunities for value inves- amount of secured debt
tors. GD: Comparing the lower today and the low market
volatility approach of invest- valuations of firms, it’s prob-
GD: Distressed investors ing in secured debt vs. the able that secured debt will
were touting the arrival of potentially asymmetric re- often be the fulcrum secu-
the next cycle as early as turns of buying bonds how rity.
2006 but to what degree did do you think of value and
they expect it to take the rates of recovery in today’s GD: As for the ease of ac-
shape we see today and distressed capital struc- cess to capital during the
how have the rules of en- tures? bubble what kind of changes
gagement changed when do you expect going for-
compared to previous dis- SM: There is proportion- ward?
tressed cycles? ately more secured debt in
many capital structures in SM: I don’t think I’d be going
SM: Investors definitely saw this cycle. That will make (Continued on page 12)
Page 12
Steve Moyer (continued from page 11)
(Continued from page 11) ten used diversified posi- times having more experi-
much out on a limb to pre- tions throughout the capital enced parties leads to more
dict there will be less debt structure as a way to man- rational solutions, it can also
in capital structures for the age the upside/downside inject a lot of contention
foreseeable future. Among tradeoff. Given the severity into the process. So, while
other reasons, CDO’s will of the sell-off that’s hap- the exact effect the litigation
either disappear or become pened in many investment will have on returns is un-
much less viable which will markets generally, a lot of clear, I do expect more in-
reduce an important inves- investors are willing to leave ternecine warfare among
tor class that contributed to some money on the table in creditor classes given the
the last bubble. In addition, favor of lower volatility and incremental complexity in
the underwriting pendulum are looking for investment capital structures. Also, as
will swing back and leverage styles that they perceive as we get to the recovery
ratios, covenants and other offering an “increased mar- phase of the recession,
underwriting criteria will gin of safety”. Time will tell more junior creditors may
tighten significantly. whether that is a permanent view it as in their best inter-
shift in investor psychology est to delay the process
GD: How do you think or whether they become hoping that the economic
about the margin of safety more absolute return fo- outlook for the debtor will
on a distressed investment? cused. improve leading to higher
valuations and recoveries.
SM: Generally speaking the GD: Intense litigation seems
margin of safety in dis- to be a major theme of this GD: The increased competi-
tressed investing can be cycle as well. Will this have tion you reference is per-
difficult to quantify. Dis- any impact on returns from haps a reflection of the size
tressed investing can be as distressed investments? of the opportunity in this
much art as science since distressed cycle. How do
returns often depend on SM: First to comment on you envision the near-term
unquantifiable variables in the phenomenon [of in- growth and success of the
the bankruptcy process. creased litigation], part of distressed fund industry?
Looking back at the 1990’s the reason you might see
and in 2000, the concept of that more is that we have a SM: There’s a growing con-
“margin of safety” was not significantly larger group of sensus that there’s going to
nearly as important as it is investors that are savvy be a lot of opportunity in
today for a lot of institu- about the bankruptcy/ the distressed market.
tional investors. The advent restructuring dynamic. In Wilbur Ross’ prediction that
of VAR [value at risk] analy- the 1990’s there weren’t as this would be the “mother
sis and the focus on return many people that under- of all distressed cycles” is
correlation and volatility has stood the bankruptcy proc- probably right. But that
to a certain extent changed ess. In the 2000 cycle, many doesn’t mean outsize re-
the vocabulary of distressed of the investors of the 90’s turns will be either easy or
managers. had left the game, so we certain. Many investors
were again left with a rela- have already been burned
In past cycles, the combina- tively small number of ex- because they were early and
tion of less secured debt, perienced workout inves- the opportunities to reor-
structural inefficiencies in tors. ganize are limited due to the
the distressed market and limited market for DIP fi-
economic conditions re- This time around, we have a nancing. In addition, much
sulted in the fulcrum class lot of players that know more dedicated distressed
being lower in the capital how to play the game and
structure and investors of- play it well. While some- (Continued on page 13)
Steve Moyer (continued from page 12)
(Continued from page 12) wouldn’t get so bogged that is increasingly difficult.
capital has been raised this down in second-guessing a So, it’s no surprise that a
cycle so the market may not manager’s strategy and its good number of DIP loans
get as technically oversold effectiveness as opposed to we’ve seen have been from
as it did at the peak of some focusing on choosing the the existing secured credi-
of the previous distressed manager with great experi- tor constituency and have
cycles. That may limit over- ence and a proven track used roll-ups of existing
all returns as a class and put record. debt as an inducement to
an even greater premium on commit more capital. I sus-
the specific manager. Going GD: How do you approach pect that trend will continue
back to the big picture, the search process for gen- unless asset valuations in-
though, if the recession is erating investment ideas? crease.
prolonged and capital for
HY companies to refinance SM: I’ve had the benefit of GD: Aside from your book
remains restricted, there watching an incredible what would you consider as
will be a lot of distressed “Wilbur Ross’
change in technology over required reading for today’s
paper and that usually leads distressed value investor?
to opportunity.
my twenty year career. We prediction that
have so much access to in-
formation and data, it’s fairly SM: I think there’s a lot of this would be the
GD: Are there any specific easy to run quantitative substantive literature com-
strategies that will return screens as a starting point ing out of bankruptcy law “mother of all
more than others or garner for idea generation. But, of firms that is very helpful/
more attention from poten- course, that’s just the begin- useful. There are many distressed cycles”
tial capital? ning of the process. The more law firms trying to
depth and quality of work establish a presence in the is probably right.
SM: There are so many as- required today relative to reorganization field and one
set classes from which to the industry norm back in of their chief marketing But that doesn’t
choose as an investor in this 1990 is night and day. I also tools is to publish analyses
cycle. One driver of returns think utilizing one’s network of legal developments in the mean outsize
among these classes may be is critically important. Being field. It’s critical to pay close
whether it’s a class that has able to talk to a bunch of attention to changes in returns will be
yet to attract a lot of the different people in the in- bankruptcy law and under-
capital and thus have a dustry allows for great idea stand any potential impacts either easy or
greater chance of getting flow back and forth. on the process. On the ana-
oversold. Take, for example, lytical side, there’s some certain.”
mortgage securities. There good analyses published by
has never been this much GD: DIP (Debtor in Posses- the research departments at
distressed mortgage paper sion) financing has made a the different [Wall Street]
before. Although some slow re-entry into the mar- firms. Even if there isn’t one
dedicated distressed mort- kets. What has to happen on every situation of inter-
gage capital has been raised, before DIP loans become est, they can do a good job
it’s small relative to the lit- readily available to firms of laying out the issues and
erally trillions of potential filing Chapter 11? the analytical approach.
supply. That’s why you see
the government getting in- SM: Well, if you’re a pro- GD: Finally, if you were a
volved in trying to attract spective DIP lender you young analyst graduating
more capital to the area. As have to have adequate from business school today,
for which strategies will be credit support for your what would you look for in
effective for fundraising – I loan. But with so much a firm when recruiting?
think if institutional inves- secured debt in place in
tors were smart, they today’s capital structures, (Continued on page 14)
Page 14
Moyer (continued from page 13) || Heilbrunn Reception
(Continued from page 13) lumbia Business School with national franchises.
alumni headed across N However, exactly how
SM: Well my view has 10th Street to the Omaha Wells Fargo is different, he
changed over the last two Hilton, where the Heilbrunn left unsaid. Greenwald pro-
years but one obvious an- Center hosted an alumni vided his own supposition
swer in this cycle is you reception and speaker that the difference lies in
want to go to a fund with panel. After digesting the Wells Fargo’s decision to
locked up capital. There are day’s events and reconnect- manage the company as a
a lot of funds with great ing with former classmates, collection of regional banks,
analysts that are closing CBS alumni were treated to which provides lower cost
their doors due to redemp- an exceptionally thoughtful deposits and better risk
tions and there’s nothing panel of speakers that in- management compared to a
you can do about that. Being cluded Professor Bruce single national bank model.
able to take the long-term Greenwald, Thomas Russo
view is critical and locked of Semper Vic Partners, and After Greenwald concluded
up capital permits that. You Adam Weiss (CBS ’96) of his remarks, Russo spoke
“Many shall be should also try and get a Scout Capital. on the search for value in
good understanding of the global markets, and then
restored that now investment process at a firm Topics discussed covered a Weiss delivered a compel-
– something you may only wide range of subjects from ling speech on the relevance
are fallen, and gain from the junior guys if the day’s events and the of Security Analysis 75 years
you can find one that will be legacy of Benjamin Graham after its first publication. In
many shall fall candid about the reality and David Dodd’s Security addition to highlighting Gra-
versus the party line: is it in Analysis, to the pitfalls of ham & Dodd’s warnings
that now are in reality one primary decision investing in bank stocks against investing in banking
maker, how political is the based only on projections of stocks saddled with nonper-
honor.” - Horace process, can you get stuck normalized earnings and the forming mortgages from
in an out of favor sector, search for value in global another era, Weiss brought
those sorts of issues. Of markets. Greenwald kicked up a quotation he once
course, you want to find a off the panel by pointing out heard that had resonated
firm that agrees with your that although Buffett gener- with him so much that he
investment style and ap- ously shares a great deal of decided to have it framed
proach. Ultimately, you the insight and reasoning and displayed prominently in
should find good people that underlie his investment his office: “Many shall be
with whom you think you decisions, at times it is what restored that now are fallen,
would enjoy working and Buffett does not share that and many shall fall that now
can learn from because accounts for his success. As are in honor.” Upon reread-
there’s no substitute for an example, Greenwald re- ing Security Analysis after
that basic element. ferred back to earlier in the many years, Weiss was sur-
day, when Buffett told those prised to find that very
GD: Thank you very much, in attendance how he was same quotation staring back
Mr. Moyer. prompted by a visiting class at him. Even though the
of Chicago MBAs in March practice of value investing
to declare that he would has evolved greatly since the
Berkshire Annual
have put his entire net publishing of Security Analy-
Meeting & Heilbrunn worth into Wells Fargo that sis, Weiss’ story provided a
Center Reception day at under $9 a share. striking example of just how
Buffett went on to explain much we have all been influ-
On May 2, 2009, after War- that this confidence was enced by Graham & Dodd.
ren Buffett concluded the because Wells Fargo is dif- This article was contributed by
Berkshire Hathaway Annual ferent than other banks Matt Gordon, MBA ‘10.
Shareholders Meeting, Co-
Berkshire Annual Meeting (continued from page 4)
(Continued from page 4) these two men could sit Tom Russo of Gardner
and looked happier than there for so long in such Russo Gardner, and Adam
two kids in a sandbox. The comfort with no break. At Weiss of Scout Capital
Q&A period broke for a ½ 3:30pm, the Q&A period shared their thoughts on
hour lunch and then re- ended and the formal annual the meeting and the endur-
sumed. meeting began, whereupon ing relevance of Benjamin
the board of directors were Graham and David Dodd’s
The most intriguing ques- reelected by majority vote. 1934 Security Analysis. Illus-
tions were those Warren Interestingly, a shareholder trating its ongoing rele-
didn’t really answer. Who had put forth a motion re- vance, Adam Weiss cited
was in line to replace him as questing Berkshire to pro- passages from Security Analy-
CEO and head investor? duce a sustainability report. sis that warned against over-
There were three candi- This was my first exposure levered institutions. Tom “Our model is a
dates for CEO and four for to criticisms against some of Russo explained how his
Berkshire’s subsidiaries.
seamless web of
CIO, he said, but he didn’t best investments had come
give any names. Why did he According to the share- from companies that had trust that’s
hold Wells Fargo stock? If holder’s representative, grown in value and bene-
he could only invest in one there were allegations of fited not only when the deserved on both
company, he replied, it labor violations at a Russell market recognized its intrin-
would be Wells Fargo. Of Athletics factory in Hondu- sic value, but when the sides. That’s what
course, he never said why. ras. Several Ivey league company grew and its multi-
schools had discontinued we’re aiming for.
ple expanded.
How did he evaluate and their use of Russell Athletics
because of these allegations.
The Hollywood
incentivize managers? That Professor Greenwald shared
was a great question, he The representative then his perspective on Buffett’s model where
responded. “We don’t passed the microphone to a incomplete answers. Why
want relationships that are worker from the Russell was Wells Fargo different everyone has a
based on contracts,” he factory in Honduras. She from most other banks?
said. Charlie Munger added: spoke for 10 minutes in Because it focused on local contract and no
“Our model is a seamless Spanish about the cramped economies of scale, he said.
web of trust that’s deserved workspace, long hours with Unlike other banks, Wells trust is deserved on
on both sides. That’s what few breaks, and anti-union Fargo had concentrated its
activity. Following her testi-
either side is not
we’re aiming for. The Holly- growth in the west, not
wood model where every- mony, Warren asked the across the entire country, as what we want at
one has a contract and no CEO of Russell Athletics to did See’s Candy. What
trust is deserved on either respond. He outlined the made Buffett’s contracts all.” - Charlie
side is not what we want at actions they had taken to unique? They incentivized
all.” Then Warren cited improve conditions, and managers to not only pur- Munger
Peter Kiewit’s contracts how a non-partisan labor sue growth, but to achieve
(who founded Omaha’s larg- rights group had been in- profitability. Following the
est construction company) vited to monitor and evalu- reception, we drove to the
as an example, without ate the conditions. The Nebraska Furniture Mart
specifying what those con- motion was then put to a for a western BBQ cook-
tracts entailed. vote and defeated. out. I was expecting a large
warehouse like Costco and
By 2pm, we were all getting Following the meeting, Co- was shocked when we ar-
fidgety. I didn’t want to lumbia Business School held rived. At 77 acres, the Ne-
miss a word, but my legs a reception hosted by the braska Furniture Mart was
were beginning to cramp. I Heilbrunn Center for Gra- not only larger than eight
had to get up and walk ham and Dodd Investing. Costco warehouses laid side
around. I couldn’t believe Professor Bruce Greenwald, (Continued on page 33)
Page 16
Precision Castparts Corp. (Winner of the 2009 Sonkin Prize)

Chuck Murphy March 2009
CMurphy09@gsb.columbia.edu
Company Description: Precision Castparts Corporation (PCP) manufactures specialized metal
components for original equipment manufacturers in aerospace (53% sales), power generation (27%
sales), and other industrial (20% sales) markets. While these end-markets are cyclical, a substantial
portion (roughly 30-40%) of PCP’s business relies on maintenance and repair-based sales. PCP is or-
ganized by product type, including investment castings (33% sales), forged products (44% sales) and
fastener (23% sales).
Thesis Summary: PCP’s business is misunderstood for two reasons. First, PCP will continue to
benefit from the secular shift to high performance materials, such as titanium. This represents an
Precision Castparts (PCP)
organic growth opportunity of 5-10% per annum, which will at least partially offset cyclical declines.
Price: $63.85
Second, a substantial portion of PCP’s sales includes content required by its customers to properly
(March 2, 2009)
maintain their capital base. Moreover, PCP has dominant market share in its core product areas—
FV Target: $90
e.g., as much as ~90% in large-diameter structural castings—and generates 22% returns on invested
capital, which have risen with its increasing size. In addition to excellent management, it is likely to
sustain these returns on capital due to three structural advantages. (i) Scale and (product) scope
economies. Scale enables PCP to offer lower prices than competitors in exchange for four or five-
year contracts, which in turn creates higher customer switching costs. (ii) Captive customers. Most
parts are custom-designed for specific, precise end-products; OEMs (or ultimate owners) cannot
replace them with “generic” substitutes. Front-end collaboration forges trusted relationships. (iii)
Proprietary manufacturing processes. PCP’s know-how is a function of unique manufacturing proc-
esses, engineering expertise, and custom-tailored equipment and tools. It is difficult to replicate.
Valuation: PCP’s current price of $64 implies an extreme bear-case scenario, including (i) a severe
downturn followed by no meaningful recovery and (ii) relatively poor sales and margin execution by
management. (See reverse-engineered DCF analysis on opposite page). It is unlikely that both of
these conditions will present themselves simultaneously in the next cycle, particularly given manage-
ment’s stellar execution in the last recession. Assuming a severe downturn with a modest recovery
and solid execution, I arrive at a cash flow-based intrinsic value of ~$90 per share. Risks to the upside
include (i) consolidation opportunities and (ii) escalating 787 build rates.
Risks: A deepening recession would certainly adversely affect PCP’s business but it would not impair
long-term cash generation. Moreover, passenger miles flown and demand for electricity have been
remarkably stable in prior recessions. Due to its strong competitive positioning, PCP is able to “pass
through” commodity price fluctuations directly to its customers, thereby insulating itself from infla-
tionary pressures.
Catalysts: One of the difficulties of investing in PCP now is that there are no immediately obvious
events that will unlock value in the next ~12 months. At the same time, it is possible that EOMs
could “push out” or cancel orders, which would probably cause the stock price to fall further in the
short term sales prospects. The following is a brief list of potential events that could improve short-
term valuation: Competitor has a liquidity problem. Of the available options, Alcoa would be the
most likely candidate given that it recently implemented a large dividend cut in order to preserve
cash. Regulatory change in the U.S. and/or U.K.. New fuel efficiency requirements for aircraft or
other industrial products could cause increased demand for PCP’s products. Fundamental perform-
ance beats expectations. Over the medium and long-term, PCP’s fundamental performance should be
a catalyst for the stock, as outlined in my valuation analysis above. Assuming no short term catalysts
and a difficult industry recession lasting through 2012, investors may have to wait until 2012 or 2013
in order for the market to recognize PCP’s long-term value. In this scenario, the IRR on investing in
PCP today would be ~23% (assuming value is realized by 2012) and ~17% (assuming 2013).
Growth Drivers: PCP’s growth has been higher than that of its end-markets. The Air Transporta-
tion Authority expects global commercial airline capacity to grow at ~3% annually through 2025;
similarly, the International Energy Agency expects that world demand for electricity will grow by
~2.5% per year through 2030. By contrast, specialty metal component manufacturers to the aero-
space and energy markets have grown at a 10% CAGR over the last 10 years. PCP has gained share,
growing at a 20% CAGR—roughly twice as fast as its market peers—over the same period. Back-of-
the-envelope analysis suggests PCP’s historical CAGR comes from the following sources: Aerospace/
energy end-market growth: 2-3% per year; Acquisitions: 10-12% per year; Shift to high-performance
material: 5-8% per year. Driver #1: OEMs are switching from steel and aluminum to lighter weight
composite and titanium parts; this trend is especially pronounced in aerospace. PCP and its peers
have benefited from increasing demand for castings and forgings made from composite metals (e.g.,
titanium alloy) and titanium, which are more difficult to work with and thus require highly-
Precision Castparts Corp (Continued from previous page)
sophisticated manufacturing processes. Fuel efficiency is paramount. Lighter-weight metal components

allow end-users to reduce their total cost of ownership. Fuel represents ~30% of operating costs for an
average commercial jet liner, whereas maintenance materials are roughly 2%. Increasing demand for com-
posite parts feeds on itself. Aluminum corrodes when it is bonded to composite material; thus, by intro-
ducing composites, OEMs must employ titanium (which is corrosion-resistant) or still more composites
in its place. Titanium usage has doubled from ~8% of the airframe weight on the Boeing 747 to ~15% on
the (forthcoming) 787. This has resulted in a 10-fold increase in revenue per ship set for PCP. Driver
#2: Consolidation—since fiscal 1998, PCP has spent ~$3.6 billion on acquisitions; based on a partial list
11 out of 20 transactions, it has paid an average multiple of 0.9x-1.1x sales. This multiple implies that 50-
60% (or $3.4 billion) of PCP’s incremental revenue has come from acquisitions.
Valuation: Price-implied expectations
for PCP are unreasonably low at $60
per share. To produce the current
price, one must assume a downturn 2x
worse than 2001-2003, followed by an
anemic recovery, which results in a top-
line CAGR of -1% over the next 10
years. In addition—this part is more far
fetched—one must assume management
is unable to control costs as well as it
has in the past. E.g., although PCP’s sales
volumes were down ~20% in 2003,
management was able to increase oper-
ating margins by 100 bps in investment
castings and limit declines to 200 bps in
forgings, its most fixed-cost intensive
product line. My $90 fair value estimate
assumes PCP grows at a CAGR of 4-5%
over the next 10-year cycle (versus 20%
in the last cycle). Also, I gave manage-
ment credit for its proven ability to trim capacity and sticky expenses during periods of falling volumes;
still, I assume margins contract modestly during the downturn. Finally, I assume a discount rate of ~10%,
gradual debt repayment, and the current fully diluted share count.
Page 18
Apollo Group - Short (Winner of the 2009 Pershing Square Challenge)

Apollo Group (APOL)
Price: $66.97 Tim Rupert ‘09 (TRupert09@gsb.columbia.edu) April 2009
(July 17, 2009) Grant Bowman ‘10 (GBowman10@gsb.columbia.edu)
John Piermont ‘10 (JPiermont@gsb.columbia.edu)
Apollo group is priced to perfection while the outlook is far from perfect. In order to
maintain its current valuation, APOL must increase its enrollment by more than 70%
which implies an unrealistic share of the total addressable market. They must do this in
the face of increased regulatory scrutiny, more competition and deteriorating student
defaults.
There was a critical inflection point in APOL’s business in 2005. Associate students rep-
resented less than 5% of the total in 2004, but today represent more than 40% of total
enrolled students and more than 50% of new starts. This represents a fundamental de-
terioration in the business, as Associates degree students pay 25% lower tuition, are
30% less likely to graduate and have default rates of 27% vs. 7% for Bachelor degree
students. As a result of rising defaults, APOL stopped enrolling Associate students at its
2-year school and began enrolling them at the University
APOL has traded down to Associate degrees to continue growth of Phoenix in order to conceal them among the larger
bachelor degree student body.
Despite these efforts, our analysis indicates APOL is in
APOL Student Enrollment by Year (000s)
jeopardy of violating its Title IV eligibility requirements
200 171k Assoc. in 2009
after reflecting a new default test and rising defaults for all
150
consumer loans. Even if APOL does not violate its re-
quirements, it will have to scale back Associate enroll-
100 ments in order to manage its cohort default rate (CDR).
The new method for calculating CDRs has extended the
50
default period, which will result in higher CDRs and will
10k Assoc. in 2004
require APOL to track its former students for an another
0
year in order to keep them current on their loans. This
1998
1999
2003
2004
2008
2009
2000
2001
2002
2005
2006
2007
will pressure APOL’s margins. The test for cohort default

Associates Bachelors
rates has increased from a two-year test to a three-year
4
Source: Company reports test. Student lenders estimate this will result in a 40-60%
increase in defaults numbers. Additionally, performance
for similar consumer loans has steadily deteriorated. Losses on credit cards and con-
sumer loans have increased by 50% and 70% respectively.
For-profit education is perceived to be countercyclical. This has not been the case in
past economic downturns. During 2001 to 2003, for-profit education performed well
but that was not the case
during past recessions. The Education has not been countercyclical during past recessions
for-profit education industry
took off in that period due to 30%
a rapid expansion of online 25%
degrees. The overall educa- 20%
tion market did not perform 15%
well during that period. If 10%
APOL is countercyclical: 5%
Why are FAFSA applications 0%
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
down? Why is APOL having ‐5%
to spend more per new ‐10%
start? And why aren’t ‐15%
APOL’s enrollment counsel- For Profit Total Market 2 year institutions

ors becoming more produc- Periods of increase in unemployment or decrease in GDP
6
Source: National Center for Education Statistics, Bureau of Labor Statistics, and the Bureau of Economic Analysis
Apollo Group (Continued from previous page)
Associate degrees are the educational equivalent of subprime tive?
Public universities pose a threat to APOL
2006 APOL Cohort Default Rate (CDR )Percentages
and the for-profit education industry. Our
Public 2‐Yr 3.4%
primary research with a board member
6.4%
and graduate of one of APOL’s for-profit
3 Year Test 1 Year Test
competitors indicates that public universi-

Public 4‐Yr
7.2%
ties are a real threat. Our contact indi-

APOL 4‐Yr
27.4%
cated that: “You can do everything at

APOL 2‐Yr
the University of Minnesota that you

Est. Pro Forma
35.8%
can do at [For-Profit school]. That

Low
40.2%
wasn’t the case 8-12 twelve years

High
ago. The only reason I didn’t go to U. of

0% 10% 20% 30% 40% 50%
M. was I had a job and didn’t want to lose

5
Source: Department of Education and our estimates
it. There was just no flexibility. Now there

is. U. of M. will take the students back that it
lost to [For-Profit School].”
We’ve spoken to a number of public universities Per student valuation summary
that have online degree programs. In 2002, only
15% of public universities offered online degrees, P er Student Valuation Analysis:
Average Revenue Per Studen t
Comments/Assumptions
$9,500 LTM of $9,448
today that number is above 60%. For-profit com- Average Discount
N et Revenue
(475) LTM discounts of 4.8%
$9,025
petitors are also an increasing threat. The number Instructional Costs

Contribution Margin
(4,000) LTM of $4,013
$5,025
of new for-profit schools has doubled since 2000. % Margin 56%
This manifests in increased pressure for leads. Our

Ann ual Marketing Expenses:
Marketing Cost Per New Start $2,700 LTM of $2,735
primary research with for-profit lead generators

Required Starts 76% Given 55% churn, must start 0.76 students per year to maintain enrol lment
Ann ual Marketing Expenses $2,052
indicates that the typical number of bidders has G &A / Student $600 LTM of $659
greatly increased and that leads prices have in- Pre‐tax CF Per Student
Taxes (@38%)
$2,373
(902)
creased by 50%. A/t CF Per Student $1,471
APOL’s growth has been achieved by rapidly ex- Discount Rate

Implied Valu e Per Head
8.0%
$18,391
10.0%
$14,713
12.0%
$12,261
panding its enrollment staff. We don’t need to get
Note: This assumes APOL maintains 1 student into perpetuity and reflects required annual
into the enrollment tactics, but let’s just say these marketing expenses to offset churn
counselors could sell Mexican timeshares. APOL is 19
vulnerable to competition because it does not pro-

vide attractive value to its customers. An “education” at APOL costs more than at public
universities, yet students receive less support and are far less likely to graduate. The best
evidence of APOL’s customer value proposition is its dismal retention rate, which is the
lowest among all reporting
online colleges. Its reten-
APOL offers dismal customer value proposition tion is also lower than no-
torious high churn indus-
Average tuition
$15,500 tries like diet programs
$10,400
$13,046
and fitness centers. You’re
$6,585
more likely to stay with
Their slogan should be: Jenny Craig than APOL.
$2,402
Pay More. Get Less. Importantly, this results in

APOL 2‐Yr Public 2‐Yr APOL 4‐Yr Public 4‐Yr
Sources: US Department of Education Institute of Education Statistics, College Entrance
NFP 4‐Yr APOL having to continually
replace its student base.
Examination Board and University of Phoenix. Tuition figures are for in‐state enrollments.
Graduation rates Retention rates (new starts)

APOL 4% APOL 28%
For Profit Colleges 25% Online Colleges 56%
Online Collegs 37% U of Arizona 80%
Public Universities 55% Other High‐Churn Industries
U of Arizona 56% Diet Programs 30%

National Average 57% Pre‐paid wireless 50%
Private Colleges, NFP 64% Fitness Centers 60% 10
Source: National Center for Education Statistics and Digest of Education Statistics (Dept. of Education). Source: National Center for Education Statistics and Digest of Education Statistics (Dept. of Education).
Page 20
Focused on Essentials: Hartch & Keller of BBH Core Select

Timothy Hartch and Michael priority is to preserve capi- estimates.
Keller, CFA, are co-managers tal and our second priority
of the BBH Core Select Fund. is to grow it. These dual MK: We use an intrinsic
Mr. Hartch received an A.B. objectives drive our focus value framework. Most of-
from Harvard University, on market leading busi- ten, this means we are using
where he was elected to Phi nesses providing essential a DCF or economic profit
Beta Kappa. He also received products and services. model. We augment these
an M.B.A. and J.D. from the methods with other ap-
University of Michigan. Mr. MK: And, by the way, most proaches such as backward
Keller previously worked for of the $5 billion in equities valuation analyses that use
KeyBanc Capital Markets and that we currently manage is the current price to deter-
earned a B.S.E. from Princeton from our private wealth mine what growth and prof-
University. management business, al- itability assumptions—as
though the mutual fund is well as returns on capital—
growing steadily. are embedded in the stock
GD: You’ve noted in the price. A current example in
past that the BBH Core which we have used this
Select investment criteria approach is Dell. Dell is
grew out of Brown Broth- facing a horrendous hard-
ers Harriman’s successful ware environment and weak
M&A advisory and private “We have a cul- corporate PC spending, but
equity activities. Are there our work suggests the mar-
other ways you are influ- ture that ket is pricing in negative
enced by being part of this growth into perpetu-
firm? emphasizes ity. Essentially, the company
is being valued as though it
Timothy Hatch (top)
and Michael Keller
TH: Yes, several members integrity and is a run-off business, and we
of our equity investment feel that’s unjustified.
(bottom) - co-managers team including me began It’s true that we will look at
of the BBH Core Select our careers here at BBH in
capital preser- comparable private transac-
mutual fund. M&A and private equity and tions, mostly as a sanity
the Fund’s investment strat-
vation. We try check. It is not the primary
egy reflects that heritage. tool. It is just to supple-
Brown Brothers Harriman to keep things ment the DCF valuation to
is also a privately owned make sure we are not arriv-
bank and we have a culture simple, avoid ing at a value that is grossly
that emphasizes integrity inconsistent with actual
and capital preservation. big risks and transaction multiples.
We try to keep things sim-
ple, avoid big risks, and fo- focus on what is GD: That said, given falling
cus on what is important. transaction values in the
The Core Select investment important.” current environment, how
strategy was originally de- have you adjusted your pri-
signed for clients of our vate market value estimates?
private wealth management Are you finding that your
business, many of whom are GD: It seems like there intrinsic value estimates
owners or former owners might also be a link in terms have changed much in the
of private businesses. They of valuation. In addition to last year?
tend to understand and ap- DCF, I’ve read that you also
preciate our criteria and use private market values to MK: As we define it, intrin-
share our goals. Our first arrive at your intrinsic value (Continued on page 21)
Page 21
“BBH Core Select” (continued from page 20)

(Continued from page 20) usually not relevant to how don’t often find ourselves
sic value is not a rapidly much a company is worth needing to screen for new
fluctuating number. It is a today. ideas. Not every company
relatively fixed conception and industry fits the stan-
of value. Valuation models TH: Also, our process is dards we are looking for.
themselves don’t yield any not just about valuation. It’s Some companies are not
certainties – false precision about fundamental analysis going to make the shopping
and overly optimistic as- and due diligence. We don’t list now or ever. Given our
sumptions can undermine spend much time trying to objectives, we like to have
the exercise. Looking at guess about macro factors. reasonable visibility into “As a general
comparable transaction mul- We maintain an exclusive what a company will look
tiples can bring you back focus on our investment like 10 or 15 years down point, we spend
down to earth. Also, it’s criteria, and we try to as- the road. Not many busi-
wise to examine the embed- sess the risks outside of nesses offer that. We are zero time focusing
ded marginal returns on management’s control. It’s investing in tremendous
capital in the forecast period how you would think if you franchises with durable on historical
to make sure you have owned 100% of a business. competitive advantages.
made realistic assumptions.
valuation ranges
We approach public equity
The idea is to stimulate investing with the same long GD: It sounds like your infor companies or
thought and protect against -term strategy. vestment criteria are mostly
some of the common short- qualitative (e.g., loyal cus- industries. How
comings you find with DCF GD: How do you proceed tomers, essential products,
modeling. with due diligence in the etc.). Is that right? the market valued
large cap space? Where do
Complexity in modeling can you think you are getting an TH: I think you are correct a company ten
be the enemy of clear think- edge over other investors? to say that our criteria are
years ago is
ing. We often gain greater Is it more in the valuation largely qualitative. We start
insights from simple models, or the screening process? by figuring out which are usually not rele-
such as one we use that the right businesses. Then
distills our forecasts into an TH: Because we focus on we look closely at manage- vant to how much
IRR calculation showing our large cap public companies, ment to see if they are good
prospective returns from there is only so much addi- allocators of capital. Finally, a company is
today until an exit a few tional information you are we look at price. Price is
years out. We assume that going to get from meeting really the third step, but still worth today.”
the cash flows during the with management. Also, if a critical step, in our proc-
holding period either pay you are doing work on eBay ess.
down debt or are used to or Microsoft, you may not
repurchase shares. Here, have the same kind of ac- MK: Often qualitative fac-
we’re asking the question, cess to senior management tors will get you to the
“If you were buying the that you might find in the quantitative. There is quite
whole business, what sort of small cap space. So we do an overlap between a com-
return could you reasonably as much work as we can pany’s returns on capital and
generate?” The higher the with a company and then its qualitative characteristics,
better – we like to see re- find former executives, cus- such as industry structure
turns at least approaching tomers, competitors, and and competitive position.
the mid teens. other knowledgeable indus-
try participants that can GD: Can you think of a time
As a general point, we provide additional insight. when you have waived one
spend zero time focusing on or more of your criteria and
historical valuation ranges MK: I think it’s important, why?
for companies or industries. too, to understand that our
How the market valued a criteria create a fairly small MK: I wouldn’t say
company ten years ago is set of opportunities, so we (Continued on page 22)
Page 22
(Continued from page 21) companies aside, most of and operations supplies to
“waived.” But as an exam- the others are trading be- industrial and commercial
ple, we own positions in tween 50-70% of intrinsic businesses. Grainger has
two oil and gas compa- value. been the dominant company
nies—XTO and Occidental in its space for decades, yet
Petroleum—despite the fact GD: How does this com- it still has less than 5% share
that their revenues are pare to other companies on of a $140 billion market.
largely determined by com- the shopping list that are We think Grainger has an
modity prices. not in the portfolio? opportunity over many
years to double or even
“Our investment TH: In other words, these TH: There are many busi- triple its market share. Rela-
are companies that might nesses that we follow that tive to its competition, the
decisions don’t just
fall short on our “loyal cus- right now are trading below company has a broad prod-
come down to the tomers” criteria. Their our intrinsic value estimates, uct line, great geographic
products are have-to-have but our investment deci- coverage, and significant
companies but they are commodities. sions don’t just come down scale and purchasing power.
to the companies’ discount
discount to MK: Both XTO and Occi- to intrinsic value. It’s also GD: Does Grainger have a
dental acquire and exploit the quality of the business loyal customer base?
intrinsic value. It’s proven resources rather and the risks. Right now, I
than taking wildcat explora- think we have the opportu- TH: Yes, Grainger has a
also the quality of
tion risks. Nor are they nity to buy some of the best strong customer value
the business and focused on the downstream businesses at very reason- proposition that generates
side of the business where able prices. For example, repeat purchases. From a
the risks. Right margins aren’t very attrac- late last year we purchased customer’s perspective, 40%
tive. Both companies have Dentsply (NASDAQ: of the cost comes from the
now, I think we very low finding and devel- XRAY), which is the leading process of purchasing sup-
opment costs and the ability provider of consumable and plies, rather than from the
have the to increase production sub- other products to dentists. actual cost of the supplies
stantially over the next dec- This company has a power- themselves. Grainger helps
opportunity to buy
ade. And if you pick up ful sales force, strong reduce the process costs.
some of the best Occidental’s annual report brands, and a broad product You can’t take for granted
and read it, you will be very line. Dentistry is also bene- things like the fulfillment of
businesses at very impressed with manage- fiting from very positive purchase orders, which can
ment’s emphasis on return demographic trends, which be a huge headache. If a
reasonable on invested capital. should fuel increased de- customer goes to a local
mand from developed and distributor for a critical part
prices.” GD: How large of a dis- emerging markets. Histori- —and they don’t have it—
count is the current portfo- cally, Dentsply’s share price then that person has to
lio selling at versus your reflected these many posi- spend more time looking
estimate of intrinsic value? tives and traded at lofty around for it. Grainger cov-
multiples. But currently ers 99% of the country and
TH: Of the 30 companies in Dentsply is trading at $26 is able to offer a higher level
the portfolio, there are two or under 14x this year’s of service, including one-day
that have balance sheet is- EPS. Our intrinsic value delivery, which its competi-
sues —those would be Lib- estimate is north of $40. tors can’t match.
erty Media Interactive and Another high quality addi-
Aflac— and they are both tion to the portfolio last GD: Have you ever looked
trading at about 30% of our year was W.W. Grainger. at Pool Corporation
intrinsic value estimates [as They are a leading distribu- (NASDAQ: POOL)? It has a
of March 31st 2009]. Those tor of maintenance, repair (Continued on page 23)
Page 23

(Continued from page 22) rials and Martin Marietta. had problems in its $65 bil-
similar franchise in the pool Again, we like both busi- lion investment portfolio. It
construction and mainte- nesses a lot, but right now holds over $8 billion of jun-
nance supplies distribution we just own Vulcan. ior debentures issued by
business. European financial institu-
MK: We pay almost no tions. Investors have been
TH: We have in our small attention to sector weight- concerned that some of
cap team. As I recall, they ings relative to indices. these financial institutions
also have strong manage- Some over-weightings in might fail.
ment and an enviable com- our portfolio might not be
petitive position. But I’m surprising given our criteria MK: A critical difference
“We have
not sure about the steady- and objectives—for exam- relative to most life insurers
state number of pools in ple, we own a number of is that Aflac’s exposures are purposefully only
this country or the opportu- food and beverage compa- capped. You can have a run
nity for market share gains nies in the consumer staples on a life insurer if customers invested in
over time. Accordingly, sector. But it is not a the- cash in their policies. But
there may not be as much matic call. It’s simply an that can’t happen to Aflac. financial services
certainty about the long outgrowth of applying our Most of their policies, like
term outcome as with investment criteria and in- cancer insurance in Japan companies with
Grainger. sisting on a discount to in- and disability insurance in
strong franchises
trinsic value. the U.S., have a defined pay-
GD: What about the other out for a particular event and balance
130—the “rejects,” if you TH: We are careful about and no surrender
will? concentrations of risk. For value. Aflac knows the sheets. It is
example, right now we have maximum payout at the
MK: Just to clarify, yes, approximately 15% of the origination of each pol- because Aflac
there are roughly 150 com- portfolio invested in insur- icy. The real risk – because
panies on our wish list, in- ance companies, including of the long-lived liabilities started with a
cluding the companies in the three property and casualty and potential for losses in
strong balance
portfolio. As for the 120 companies (Berkshire the investment portfolio – is
that aren’t in our portfolio Hathaway, Chubb, and Pro- that Aflac could fall out of sheet that it
are not, we don’t think of gressive). Since hurricanes line with statutory capital
them as “rejects.” It would and other catastrophes can requirements and need to should be able to
be more accurate to think hurt property and casualty raise additional capital at
of them as our “bench”— companies, we might not exactly the wrong time, survive the current
companies we would like to add a fourth company with which would be dilutive to
own. In a lot of situations, storm.”
that kind of exposure. current shareholders.
the bench companies have a
close counterpart in the GD: The other insurance GD: Why are you comfort-
portfolio. company in your portfolio is able with this risk?
Aflac. As you mentioned
TH: An example is Waste earlier, Aflac is currently TH: When we made our
Management. We really like facing some balance sheet initial investment in Aflac
the long term outlook for challenges. several years ago, it had a
the waste industry. The strong capital position and a
other leader in that industry TH: Aflac is a provider of conservative investment
is Republic Services. At the specialty medical and disabil- strategy of matching assets
moment, we have chosen ity insurance in Japan and with liabilities and purchas-
Waste Management, but the U.S. The core operating ing only highly rated securi-
Republic has capable man- business is performing quite ties. Aflac also did a good
agement and good assets well despite the recession, job of avoiding the sub
too. There is a similar but like many other insur- prime problems that caught
situation with Vulcan Mate- ance companies Aflac has (Continued on page 24)
Page 24
(Continued from page 23) avoid forced sales, but it is restrictions against building
many other companies. not managed to a specific a new landfill. We think of
What Aflac didn’t foresee is minimum, nor would we be them as very real assets—
that so many of the world’s disappointed if the cash bal- both operating assets that
leading banks who are the ance swelled. In 2006, we generate cash for the busi-
issuers of these debentures had over 10% cash at one ness, but also as stores of
would run into serious point, but generally it has value that can be priced well
trouble at the same time. been well below that level. over time. Real estate is
However, because these another asset class that can
banks are so important to GD: On a related note, protect against inflation, but
“If you look at the the world financial system, what do you think about we don’t own any REITs in
governments have rushed to gold? Some value investors our portfolio at this time.
businesses we own, their aid with additional seem to have caught the
capital. Accordingly, most gold bug. What is your view GD: Do you have a view on
you will see of the junior debentures on that thesis? On one inflation?
that Aflac owns probably hand, gold has no intrinsic
companies that
will not default. Aflac’s core value; on the other hand, it MK: We worry about rising
really have out- business also continues to could be an attractive hedge inflation and are aware of
grow rapidly and is ex- against inflation or devalua- the potential for monetary
standing quali- tremely profitable. Manage- tion. debasement, but our equity
ment expects net income of investment team doesn’t
ties—have-to-have over $2 billion in 2009 be- MK: I tend to agree with make specific inflation fore-
fore investment losses. your comment that, first, casts. That’s not part of our
products and ser- That means that Aflac can gold doesn’t have a measur- investment decision making
absorb significant investable intrinsic value and, sec- process.
vices, large cus-
ment losses without having ond, you have to store it
tomer bases, high to raise additional capital, as and insure it. Given the TH: Our view is that a busi-
long as the losses don’t all choice, I think we would ness that provides essential
retention rates, come at once. We have generally prefer other “real” products and services and
purposefully only invested in assets that generate cash has a strong competitive
good returns on financial services companies flow. Think about our two position is a pretty good
with strong franchises and energy names or Vulcan hedge against inflation.
capital, and ample balance sheets. It is because Materials, which has 13 bil- Consider a company like
Aflac started with a strong lion tons of aggregates in Coca-Cola with superior
after tax free cash
balance sheet that it should the ground. These compa- brands, great global distribu-
flows.” be able to survive the cur- nies have assets that can’t tion, and relatively low pri-
rent storm. be duplicated and demand vate label penetration. In an
GD: Turning to portfolio for those assets will grow inflationary environment,
construction, some value over time. Waste Manage- Coca-Cola should be able to
investors have advocated ment is another example. raise prices to offset rising
holding cash in this environ- The company owns 273 input costs. Companies
ment. What is your phi- landfills with an average with weaker competitive
losophy on holding remaining life of 40 years. positions won’t have that
cash? You are currently at People don’t usually think luxury. High inflation is not
6%, is that correct? about it this way, but these good for financial assets in
landfills are not just holes in real terms, but we think our
MK: Our cash right now is the ground. They are portfolio would hold up
below 5%. Cash is an out- unique assets that are diffi- relatively well.
growth of securities selec- cult to replicate. Not sur-
tion. Generally we keep prisingly, there are all kinds MK: The thesis for gold
enough cash in the fund to of zoning and environmental (Continued on page 25)
Page 25

(Continued from page 24) We record in writing our immaterial, but we listen
starts to make sense if you due diligence findings. We with an open mind. You
believe we are heading to- also prepare a detailed writ- guys probably know this
wards hyperinflation. ten investment summary for better than I do from your
each company. The invest- courses, but there is a well-
GD: Names like eBay, Intuit, ment summary describes documented behavioral bias
and Dentsply are not neces- how the business compares towards explaining away
sarily traditional hunting against each of our invest- negative inputs. We want
grounds for value investors. ment criteria. The summary to know the short stories
also identifies the key risks on our companies.
TH: We think our approach for each company and the
is pretty differentiated. Our big variables outside of man- GD: I gather that position “On this subject,
business criteria are differ- agement’s control. We try size is a function of discount
ent from what other value to avoid companies with to intrinsic value but also though, our think-
investors use. If you look at high severity risks, even if something you have called
the businesses we own, you they are low probability “durability of the franchise.” ing is different
will see companies that risks. Putting down our How do you assess the lat-
really have outstanding analysis in writing makes it from many other
ter variable?
qualities—have-to-have easier to recognize when
investors. We see
products and services, large there has been an adverse MK: The primary metric for
customer bases, high reten- development or when our determining position size is margin of safety as
tion rates, good returns on original thesis is not playing margin of safety. On this
capital, and ample after tax out. Also, having clear cri- subject, though, our thinking having two
free cash flows. We are teria is empowering to the is different from many other
proud of the businesses we investment team. It gives investors. We see margin of components —it
own. We think they will junior people more ability safety as having two compo-
to challenge senior people nents —it should be re- should be
thrive over many years.
without making the discus- flected, first, in the business reflected, first, in
MK: We also look for busi- sion personal. You’re abso- and, second, in the price.
nesses with hidden assets lutely right—you don’t want We are not strictly buying the business and,
and “optionality.” You to fall in love with your in- $1 for $0.50. Absolutely, we
mentioned Intuit. Intuit is a vestments. want that price discount. second, in the
company that is pursuing But we also want a margin
several promising growth Our intrinsic value esti- of safety in the business price.”
initiatives in healthcare, mates also provide objectiv- itself. The durability of the
online banking, and geo- ity. Last year we sold all of franchise refers to the
graphic expansion. The our Western Union shares strength of the competitive
company is spending money based on price. It’s an ex- position and the certainty of
in these areas, but we aren’t cellent company, but the the outcome. For every
giving them any credit for market price rose above investment, we want to be
these investments in our our intrinsic value estimate. certain that our capital is
intrinsic value estimates. It's At the time, Western Un- protected against a perma-
nice to get the upside for ion’s business was flourish- nent loss and we want an
free. ing and its share price didn’t opportunity for significant
look like it was reflecting capital appreciation.
GD: How do you avoid fal- the potential for any cyclical
ling in love with companies or long term challenges. GD: Thank you, Mr, Hartch
that meet your criteria and and Mr, Keller
have performed well? MK: When we come across
negative feedback about one
TH: We try to be very ob- of our companies, we al-
jective with our process. ways investigate. Often the
criticism will prove false or
Page 26
A Quant Among Us—Interview with Jim Scott

Jim Scott is Managing Director at the Heilbrunn Center. It’s on a lot of different compa-
for General Motors Asset been wonderful. He is a nies. So the best way to
Management. Previously, Mr. great guy to work with. take advantage of that is
Scott was President of Quanti- diversify and to control risks
tative Management Associates, GD: Which finance courses or the factors you are not
a subsidiary of Prudential Fi- did you teach at Columbia? predicting. So a lot of it is,
nancial, where he managed a “what can I predict, what
team overseeing $45 billion in JS: Corporate finance, secu- can I not predict?” And you
enhanced equity index, value, rity analysis, an M&A semi- protect yourself against the
balanced, and long-short nar, PhD seminars—this, stuff you can’t predict. It’s
funds. Mr. Scott is a graduate that and the other. just a very useful discipline
of Rice University and holds an and it is not one that is
M.S. and Ph.D. in Economics GD: The Heilbrunn Center widely appreciated in the
from Carnegie Mellon Univer- takes a different approach non-quant community.
“As a quant … you sity to efficient markets than
traditional corporate fi- Although it’s increasingly so.
are dealing with a nance. Since you’ve seen We’ve got a good manager
GD: Can you describe your both sides, I wonder what is in the UK, who is purely a
lot of low quality background and your role in your perspective on that? fundamental guy. 20 stocks,
the Heilbrunn Center? OK? Or 30 stocks. He
information. So JS: I believe there is money comes in every morning and
JS: Let me start off earlier. I to be made by active man- pulls up a screen and he
the best way to didn’t always have the title agement. I prefer a fairly looks at the marginal contri-
take advantage of of professor, but I taught for disciplined approach, a bution to tracking error on
about 20 years. I started as quantitative type of ap- every stock in his portfolio.
that is diversify grad student and visited at proach. But certainly since So he knows where he is
Stanford and then came to I’ve come here, I’ve come to taking his big bets relative to
and to control Columbia. I left in 1987. better appreciate fundamen- what he believes the market
Not that I was off the pay- tal approaches, value ap- is judging him against. And
risks or the factors roll but I was off the tenure proaches. I think there are he will trim his position if he
track. Then I was working at strong growth managers thinks his confidence is not
you are not Prudential in their asset too. It’s a different disci- in line with that marginal
predicting...And allocation group. That even- pline. contribution to tracking
tually grew into a quantita- error. So you are seeing
you protect tive equity shop with some When I was teaching corpo- much more quantitative
asset allocation. I was Presi- rate finance at Columbia, tools being used by funda-
yourself against dent of that, we formed a most of it was based on mental guys. And by value
subsidiary. And then, when I valuation theory. Everything guys as well.
the stuff you can’t retired from that, my wife had to do with the valuation
said, “You have insufficient of a company. I was heavily At the same time, what you
predict.” interests.” And so I asked influenced by that. So when are seeing is the quants are
my buddy Tony who needed I came back to develop a becoming more and more
somebody to do equity quantitative strategy, initially fundamental. Doing more
here, that was about three it was value-based. Net pre- industry analysis, sector
years ago, and I started do- sent value, book value— analysis, trying to dig inside
ing that. stuff like that. As a quant … income statements, and
I guess I should make a things like that. There are
Before that, when I was point here. You are dealing always going to be people
retired, I talked to Bruce with a lot of low quality on either extreme but you
Greenwald. And he said, information. Because you’ve are seeing a bit of a conver-
come be research director got not much information (Continued on page 27)
Page 27
“Jim Scott” (continued from page 26)

(Continued from page 26) manager. In a way, you short-term oriented for self-
gence. And I’m trying to could see how that could preservation. Which is not
manage money and make encourage less risk taking. to say you can’t utilize the
money, what are the tools same skills, but you have to
at my disposal, how can I JS: No, this is a very aggres- be much more careful about
make the best use of what- sive manager. He has had a portfolio construction if
ever information I can gen- stellar track record. He has your ideas have longer pay-
erate. So you are seeing that won all sorts of awards for outs. So I think they are
sort of thing. high returns which you both consistent and the
don’t get by not taking risk. notion that, “hey this is a
GD: Talk about risk metrics He just wants to know cheap asset, I’m going to
“What you are
you’re looking at. Do you where they are and how buy it and I’m going to make
tend to use industry Stan- heavily he is exposed on a lot of money one of these seeing is the
dard BARRA risk factors or individual names. Because he days,” is very appealing and I
do you have your own risk looks at his portfolio in think right. It’s just that to- quants are
models that you use? terms of individual names. It day today’s institutional
makes sense. If you are tak- marketplace, and to some becoming more
JS: At my former shop, we ing three times as much risk extent the mutual fund mar-
had used BARRA risk fac- on this one stock, which ketplace, it is somewhat and more
tors initially. We moved you are no more confident more difficult to actually
fundamental.
away from BARRA’s be- in than this other stock, use.
cause we thought they were then you want to straighten Doing more
universally used. We didn’t things out. GD: Knowing that, have you
know what kind of factor tried to construct time arbi- industry analysis,
exposures they were giving GD: A lot of value investors trage portfolios? Do you
us. We moved to much will say things like, “market talk to your clients and say, sector analysis,
more explicit consideration risk isn’t price risk, that’s here is an opportunity three
of risk where we knew ex- not the real risk,” and years out, here is the model trying to dig inside
actly what we were control- “volatility is your friend.” that will help us generate
income
ling. We controlled for in- But if you plot that against alpha in the long term, but
dustry, sector, size of posi- BARRA risk factors, it just in the short term you might statements, and
tion, growth rate, etc. We looks like you are taking on not like the way it looks?
knew that if we got far away more risk. Whereas they things like that.”
from our benchmark on would claim they are not. JS: Three years is a little
those dimensions, one, we How do you reconcile short for some of these
weren’t sure how good our those viewpoints? strategies. It is a hard ques-
alpha was, how well we tion to answer. Most institu-
could predict, and so we JS: Both things are correct. tions say they have long
decided to focus the alpha To a large degree, it is mat- time horizons. But at the
by controlling those things ter of time horizon: how end of the day, you had bet-
where we felt we had pre- long do you as a manager ter keep performing.
dictive ability. The way I do have to produce good re-
risk control is, “how do I turns? If you have the luxury GD: What about this insti-
best focus my portfolio to wait five to seven years tution? How long would you
where my skill is? How do I for a big payoff, then the say is the time horizon
control those things that I way you view risk is differ- here? Are you managing
know can hurt me and ently than if you are report- primarily on behalf of Gen-
where I don’t have a lot of ing to institutions that get eral Motors’ pensioners?
confidence in those predic- really upset if your three
tions?” year track record slips. As JS: And for a lot of other
the markets have become clients as well. I don’t want
GD: Interesting what you more institutionalized, man- to get into it, but I will tell
said earlier about the UK agers have become more (Continued on page 28)
Page 28
(Continued from page 27) least considering industry- panies like that, you can
you personally they have a type models or super indus- focus on their normalized
very long horizon. Although try type models. To an ex- earnings are, what their
maybe it is getting shorter. tent, industry models have assets are, stuff you can see
When times get tough, hori- been in place for a long time pretty well today. What
zons get shorter. because many value factors Graham would say—or
“To an extent, work best within industries what Greenwald would
GD: Any reactions to the or within sectors than say—is pretty good infor-
industry models recent Dave Swensen inter- across them if you are look- mation. Because it is near-
have been in place view in the WSJ? The re- ing for shorter-term or term and it is more tangible.
porter asked him if endow- even medium term payoffs.
for a long time ments should change their But there have been explicit OK so in that part of the
portfolios to be less volatile models of different indus- market, you use value met-
because many in the short run. Swensen tries. rics more because that
was fairly adamant that— makes more sense. When
value factors work regardless of current mar- Backing up—first generation you get out here to the high
ket conditions—the horizon quant was, you run a regres- growth rates—that is sort
best within indus- hasn’t changed, therefore sion, you figure out what of hopes and dreams. Price
tries or within the portfolios shouldn’t. So the coefficients are, and that to earnings ratios, or price
that is the ideal, right? tells you what you should to book ratios, can be very
sectors than across be using to generate alpha. high and yet you can make
JS: To a degree—to the Second generation gets money by buying those
them if you are degree that it is really imple- much more complex and stocks. So it is more of a
mentable. I mean, every- starts dealing with different Buffett notion that you are
looking for shorter body faces pressures. Fortu- ways of looking at different willing to pay for growth.
nately, we didn’t have those types of stocks. Third gen- The way we implemented it
-term or even kinds of problems. Not by a eration I guess is, within a is—we called it the news
medium term long shot. quant portfolio, forming factor. We’re looking for
what might be … sort of news of a fundamental na-
payoffs.” GD: When you’re con- robotic industry analysts. ture that should affect the
structing models. You men- So, you’ve got your model present value of future cash
tioned quant moving more for a particular industry. flows for growth companies.
in a fundamental direction. OK? And that was the main
Do you have very specific What I have tended to favor thing we focused on. So the
models for different indus- and actually we perhaps question is, what’s news,
tries, or subsectors, or do pioneered this—we cer- and how does it evolve over
you use low price to book tainly thought we did at the time if government rules
which tends to work across time and most of our clients change, or whisper esti-
industries so you’ll use that, thought it was unique—is mates go out of style be-
or do you look at different we just started out from a cause …
variables for industries ver- basic PV formula. And said,
sus chemicals or pharma OK, if you look at this for- GD: Reg FD.
you might look at different mula … think of a Gordon
things? Dividend Discount Model. JS: Yeah, that sort of stuff.
You’ve got dividend divided So it’s a question of what’s
JS: Let me talk about the by discount rate minus the news. And so, in that part of
industry in general, and then growth rate. If the growth the market, you still have
I will turn to my approach. rate is zero, it is just divi- some value metrics, but you
What you are seeing in the dend or earnings divided by focus more on news met-
industry is that more people the discount rate. So what rics. You are more like a
are either moving to or at that’s telling you is, for com- (Continued on page 29)
Page 29

(Continued from page 28) the price. And conversely, I know the name and I know
growth stock investor. You they leave the party for it is what they try to do. It
want to know what’s driving some of these stocks that is typically your long-run
those hopes and dreams. are subsequently going to fundamental, your value
And in the middle, it turns have hard times. So they sell investors and your good
out you need a little of those and they drive prices growth investors. And there
both. The way we ap- down a little bit. When we are a lot of investors who
proached it was very much started looking at it though don’t fit either of those clas-
finance based and econom- that lens, it is pretty clear— sifications neatly. They just
ics based and how do we at least it is clear to us, it is look for stuff they think is
build in ways to measure not clear to some of the cheap. They are looking at “Momentum is
what theory is telling us academics yet. Momentum balance sheets, they are
neither over-
should matter. It still works. is neither overlooking at industries and
extrapolation of past results how industries are moving, extrapolation of
GD: And you found a good nor is it under-reaction to and they may be in stocks
way to quantify the news news—it is smart people an index provider might past results nor is
based information? moving prices before others classify value or might clas-
figure it out. sify growth, but they are it under-reaction
JS: Some of it is real simple, really looking for fundamen-
such as analyst earnings esti- In my work here, as I talk to tal economic value. And to news—it is
mates. This relates to some a lot of these managers, I sometimes they don’t fit
smart people
of the work I’ve done with initially tried to talk to them some of these metrics. And
the Heilbrunn Center. I in those terms. Some of I’m a little hesitant to name moving prices
started out trying to test them got it. It is clear that individual managers just
whatever behavioral theo- that is what a lot of them given my position here. before others fig-
ries were really important. are doing. And that’s the
Were people over- reason they are successful. But they are out there and I ure it out.”
extrapolating past results or A really good fundamental like some of them a lot.
were they slow to act? guy is really trying to look One of the interesting
Were they too conservative out as far as they can into things I’ve discovered here
… what was going on? I had the future. I think some of is how some of these guys
a great grad student who them have better insights aren’t looking at individual
worked on this with me, a than get into their portfo- companies they’re looking
PhD student, Jorge Murillo. lios. Because sometimes the at industries, and they’re
portfolios don’t control for looking at capital flowing
We were looking at mo- these uncontrollable or un- into and out of industries,
mentum, which you can predictable risks. And so and they’re doing a lot of
either explain as overreac- their good ideas are may be industry dynamics, and tak-
tion or under-reaction to influencing market prices ing advantage of that in in-
news. And that under- and driving momentum but teresting ways. One of the
reaction to news came out they may not be capturing things I’d like to do if I could
of something like prospect the full advantage of that. ever get the time enough to
theory or something. And do it is to figure out how
we finally found that actually GD: What types of inves- quantitatively how to ap-
neither one of those is what tors are these? Could you proach some of those things
is going on. There are some put a face on who these because I think quants can
smart investors out there momentum guys or smart learn a lot from savvy funda-
who are six months, 12 guys are? Are these like the mental guys.
months or 18 months ahead Tiger Managements or tiger
of the market. And they see cubs of this world? GD: Have you noticed a
that this stock is going to common intellectual thread
outperform significantly, JS: Yes, exactly. I’m not you seen in good fundamen-
they buy-in, and they affect really familiar with them but (Continued on page 30)
Page 30
(Continued from page 29) So there are different ways The fundamental guys are
tal managers and good to intelligently look at risk more difficult. And the most
quant managers? If you and build a portfolio. But difficult are the guys who
knew nothing about their generally I am looking for are pretty good but can’t
portfolios but only knew someone who has some of explain what they are doing.
how they described them- that—some intelligence in Those are tough. You push
“You can still get selves and their process— that respect. And if you just for transparency but some
what do you look for? let things fall out as they of the times it is very diffi-
yourself in trouble may, then I would certainly cult to obtain.
if you overweight JS: What I look for is a sen- argue for a smaller alloca-
sible economic story and tion to that manager no GD: There are investors
one factor way intelligent use of data. As matter how good they are. who have seven to 10
you know, data is very im- If you put too much of your stocks in the portfolios. Is
beyond all bounds portant for fundamental money with that manager, that just unacceptable to
guys and quant guys. If they you can get your head your framework?
of what you can are looking at shipping in handed to you.
and out of Los Angeles or JS: There are lots of ways to
predict. And some the West Coast ports— GD: How much transpar- make money in this world
people still do well, that’s interesting. Par- ency do you require of your and that is too few for my
ticularly if you see they do managers? taste. By a long shot. How
that. They claim that right and make money do I know if they are smart
in the process. So the first JS: Equities are relatively or lucky? You just can’t tell
they are just two things are a sensible easy. I mean, we know eve- as an outsider.
economic story and good rything they hold all the
picking bottom up use of data. time. We can see their per- GD: Specific quantitative
formance hourly if we so approaches. What do you
stocks and these And I tend to still be inter- want! But, you know, we think about the magic for-
exposures just fall ested in portfolio construc- have other things to do. mula?
tion because I think you can
out—but still get yourself in trouble if Transparency of process is JS: Well I think it is very
you overweight one factor something you always want. simple. Certainly institution-
sometimes they do way beyond all bounds of With quants, the tugging ally that would not fly. Be-
what you can predict. And match is a little more clear cause people believe there
too.” some people still do that. because the quant isn’t go- is more at work than that.
They claim they are just ing to turn over the com- They may be wrong, but
picking bottom up stocks puter code to you. That is generally people want multi-
and these exposures just fall not fair to ask. But you do ple metrics to value. As far
out—but sometimes they want to know, what is the as profitability is concerned,
do too. It’s a problem. So I intelligence being brought you need information about
like to see some risk con- in? How do the risk con- stability and predictability of
trol. Quants typically controls work? What are the future profitability as well. In
trol industry, sector, size— alpha signals? How do you today’s environment, one of
stuff like that. The good construct them? What is the major mistakes some
fundamental guys, they con- most important? How do value guys have made is
trol some things differently. they evolve over time? Just insufficient concern about
They may be concerned a whole series of issues that corporate liabilities. And in
about macroeconomic risk, you can ask without asking part, that is due to lack of
about a recession or expan- them to divulge some im- transparency in the account-
sion, or about commodity portant trade secret. ing data, which has really
prices risk. badly served investors.
Page 31

(Continued from page 30) security. Transactions cost And there are a lot of differ-
are very important, espe- ent tools out there. And
GD: What goes into a great cially if you have a risk con- some of the players are
quantitative investment trol product. Because the deciding they can use sev-
process? Is it model building lower your tracking error— eral tools.
to capture alpha? Portfolio for example, 5 bps or
construction? Risk Manage- 10bps—it can make the GD: Getting back to the
ment? Trading and imple- difference between huge Heilbrunn center, are there
mentation? commercial success or not. directions you’d be inter-
So you need to really focus ested in seeing it go? Obvi-
“A lot of large
JS: It’s a good question. And on what’s the best and most ously we don’t do a lot with managers use net
the answer is: everything effective way to trade. It’s a quantitative approaches.
matters. You need some continual battle. Your approach is very dif- present value
fundamental insights on how ferent than a lot of the
you are going to capture GD: What are your things they teach us in the techniques, but
alpha. And then once you thoughts on applying quanti- Value Investing Program.
have that, you build a proc- tative approaches to funda- you don’t want to
ess around that. And it can mental value approaches? JS: Yeah, and I think the
either be a high tracking Value Investing Program has
over rely on that
error process or a low JS: Some are moving more been tremendously success- because you don’t
tracking error process. But towards that. And I see ful. The kind of insights peo-
it ought to be dependent on more moving towards that ple can generate coming out want to neglect
where you’re trying to gain every year. And does it limit of there are extraordinarily
your alpha. For example, returns? Well, arguably not. valuable. I’m going to be the balance
that model I laid out earlier Because arguably you’re just teaching some lectures at
about growth rates is a limiting risks that you don’t Columbia soon—they’re sheet—
process that is really a core know how to predict. I not actually in the Value
process to both growth and think it makes sense to do Investing program but
particularly the
value stocks, so what that it. But do I think it makes they’re going to be about liabilities.”
argues is a fairly risk con- sense to do it in as explicit a portfolio construction—and
trolled process. way as a quant? No, I don’t I think some of those ideas
think so. I think it’s useful in could be powerfully intro-
Given that, everything you the way that some of these duced to some of the stu-
said matters. You want the managers have quantitative dents in the program.
best sources of alpha you tools that tell them when
can get. First, you want the they’re wandering away And you’re starting to see
best source of alpha. Sec- from the market in some value managers using a vari-
ond, given your source of sense. That’s useful—and ety of quantitative tools,
alpha, how do I best pack- they should pay attention to particularly the larger ones.
age it? What can I predict that. A lot of large managers use
and what can I not predict? net present value tech-
And how do I control those GD: Why hasn’t it happened niques, but you don’t want
things I can’t predict? So it’s sooner—that fundamental to over rely on that because
all portfolio construction. and quantitative investors you don’t want to neglect
And then there’s turnover. are comparing notes more? the balance sheet—
How frequently should I particularly the liabilities.
turn this portfolio over? JS: I think it is happening. I We’ve seen financial institu-
Well, turnover depends on think it’s happening more tion after financial institution
the decay rate of your alpha. and more. And I don’t think imploded. Certainly they
And it also depends on your it’s going to stop. You are all—or a lot of them—
transactions cost. And all of know, because it’s a com- use screens of various kinds,
those things determine how petitive game and the ques- using the types of value
long you are going to hold a tion is—how do you win? (Continued on page 32)
Page 32
(Continued from page 31) back into more cyclical ing stock prices. So that’s
metrics that have worked in names. And the jury is out one of my areas of interest.
the past. And there are two on that one. It’s a very diffi-
views on that. Some think cult time. It’s a very uncer- GD: What’s your philoso-
they are very helpful be- tain time. So far, the govern- phy on sharing research?
cause they help you focus ment actions have stabilized Let’s say you come up with
on things that may be useful. the bond market to a de- a fresh insight about what
But they may also leave out gree and some large finan- drives momentum, for ex-
“So far, the gov- some things that may be cial firms. But we have not ample. It’s nice to publish it
important. Some fundamen- moved much beyond that. – but it’s also nice to cap-
ernment actions tal value managers actually And the problem now is the ture it yourself.
use optimizers. And they real economy. If you look at
have stabilized the may not follow them, but some of the really dis- JS: Well, I think you can use
they look and see what tressed fixed-income— it both ways. It’s a general
bond market to a they’re suggesting. And they some of the stuff that looks rule—particularly if you are
degree and some might tweak their portfolios like it has some life—it was starting an investment
to get closer to the bench- a great buy in October but shop—it’s very useful to
large financial marks they’re being judged it’s not so good now. publish. It gives you a lot of
against. And really I’m talk- credibility and if it’s an ac-
firms. But we have ing more about from an GD: Let’s talk about your cepted piece, it’s a good
institutional perspective role here at General Motors marketing tool. Secondly, if
not moved much because that’s the world I’ve Asset Management. you publish, aren’t people
lived in. going to steal your ideas?
beyond that. And JS: I’m the Equity Guy. We To a degree, yes. But could
the problem now GD: What about the types manage equities for a num- they copy your investment
of things you think look ber of different pension process? No. I mean, you
is the real econ- really interesting? programs and we also do could have a quant come in
derivatives of various types here and tell you exactly
omy.” JS: Well, I agree with Bill – futures, swaps, options, what he was doing and you
Gross – that TIPS look ex- etc. We use external man- wouldn’t do it. Because if
traordinarily underpriced agers and manage three you’re good enough to du-
right now. The inflation pro- different strategies in our plicate it, you wouldn’t.
tection is essentially just offices here. They’re all Because you’d have your
being given away. Although largely quantitative because own ideas about how you’d
I’ve noticed that since he we haven’t got a huge staff change it and tweak it. And
came out with that state- of analysts. So that’s the way so people try to keep these
ment the spread between to go in that situation. ideas proprietary but most
10 year TIPS and treasuries of them are pretty much
has widened. Some people GD: Can you talk about out there in the public do-
may have followed his sug- some of the research you’re main anyways. So, can you
gestion. So that’s pretty currently interested in? give your research away? A
obvious. A bet that a num- little bit, but not too much.
ber of people have made JS: I’m still really interested If you’ve done the re-
recently is on quality—solid in this momentum idea. Be- search—you wouldn’t pub-
companies with good fran- cause as far as I can tell, lish all of it anyways—and
chises and strong balance nobody has come up with a are there things in there
sheets that look kind of good notion of what drives you can use to make
bullet proof relative to the momentum. And so I’m still money? Generally, yes. Also,
recession. Those stocks looking at that—and what I you’ll know more about
have gotten bid up. People think it is good value guys how to take advantage of
are wondering when to go and good growth guys push- (Continued on page 33)
Page 33
“Jim Scott” (continued from page 32) || “Berkshire” (continued from page 15)
(Continued from page 32) Berkshire Annual Meeting It helped me realize that if
these insights than other (Continued from page 15) there was one underlying
people. So it’s also useful in -by-side, it probably had its theme to the weekend, it
developing and changing own zip code. Talk about was the value of trust. The
your process. economies of scale! original partners trusted
Buffett with their hard-
GD: Any advice you’d have On the way to the airport earned money, and Buffett
for us as we’re starting out? the next day, we drove by in turn held that level of
Buffett’s house and Kiewit trust in the managers of
JS: It’s a tough time—it’s a every company he has ever
very tough time. Starting owned. He trusted Russell
your own firm is difficult. Athletic’s management to
You need that first inves- “Trust is not make the right decisions in
tor—and then not only that, Honduras. He trusted Bill
but you need to grow something that Child to continue to run RC
pretty quickly. As I say, one Willey exactly the same way
of the surest ways to do it appears explicitly in after he bought the com-
in “quant land” is to publish. pany. He trusted all of his
If you look back at a lot of a p/e ratio or a dis- managers and that trust
these large successful quant manifested itself as stable,
funds, a lot of them were count rate. It’s not predictable cash flows.
started in exactly that way.
You need some way to es- something you can But trust is not something
tablish credibility. So work- that appears explicitly in a p/
ing for another firm is a model in an excel e ratio or a discount rate.
good way to do it, but it’s a It’s not something you can
longer trip to getting there. spreadsheet. And model in an excel spread-
I think this is a difficult busi- sheet. And it’s certainly not
ness to break into although it’s certainly not something that can be quan-
the Applied Value Investing tified in a contract; which
program seems to have something that can presents amateur investors
done pretty well relative to like me with a challenge. If
most because it is a very be quantified in a trust is so important, how
small community. I think this do we identify and value it?
is a great business, though. contract.” I suppose that is the art of
You have so much fun. investing, and why “value”
There’s always something to investing is a bit of a misno-
learn. And it’s really hard— Plaza – about a 10 minute mer. After all, Benjamin
you’re gonna lose a lot. And drive apart. You could eas- Graham didn’t title his book
everybody knows that. Your ily imagine Warren skipping “the value investor,” he
peers know that. And your into work. He had a gor- called it The Intelligent Inves-
clients know that. geous brown house with a tor.
barn-style roof, but it was
GD: Thank you, Mr. Scott. certainly not the type of This article was contributed by
palace you would expect Brandt Blimkie, MBA ‘10.
one of the world’s richest
men to own. What
shocked me the most was
the lack of a visible security
presence. No fence. No
moat. He obviously trusted
his neighbors.
Page 34
Second Annual Pershing Square Challenge

mented that the idea was
The five teams selected as “extremely well re-
finalists presented their in- searched.”
vestment recommendations
to a distinguished panel of Next, Matt Gordon, Renata
hedge fund portfolio manag- Motta, and Carlos Medeiros
ers, including: Bill Ackman presented First American
and Paul Hilal of Pershing Title Company (FAF). The
Square, Craig Effron of team argued that the core
Scoggin Capital Manage- title insurance operation
ment, John Griffin of Blue was depressed due to the
Ridge Capital, Douglas sharp decline in home sales.
Hirsch of Seneca Capital, However, the team noted
Dahlia Loeb of Reveille that even following the de-
Capital, and Daniel Loeb of cline, sales were at the same
2009 Pershing Square Winners: John Piermont ‘10, Tim Rupert Third Point LLC – as well as level as in the late 1990’s
‘09, and Grant Bowman ‘10 with Pershing Square Founder Bill
Columbia’s own, Professor when they conservatively
Ackman. Bruce Greenwald. Each estimated earnings power of
On April 3, Columbia Busi- group made a ten minute around $155 million (versus
ness School held the finals presentation followed by -$117 million in 2008). The
for the Second Annual Per- fifteen minutes of follow-up team applied an EBT multi-
shing Square Value Investing questions from the panel. ple of 8x to their estimate
& Philanthropy Challenge. of normalized earnings for
The event marked the cul- Ivan Andreev, Eric DeLa- the core business and used
Pershing Square mination of the three- marter, and Richard Tosi the market valuation for the
month competition among made the first presentation publicly traded subsidiary
Challenge Winners 42 teams of first and second of the day, recommending First Advantage (FADV).
year CBS students. Per- the purchase of Lender Under this scenario, the
2008 shing Square founder and Processing Services (LPS) market was valuing the re-
Tim Rupert ‘09 CEO Bill Ackman launched with a target price of $50. maining Information Ser-
the Challenge in 2008 to LPS is the largest mortgage vices segment at only 2.2x
Grant Bowman ‘10 build upon Columbia’s value processor in the U.S., han- its $319 million trailing
investing tradition and instill dling over one-third of all EBITDA. Applying a more
John Piermont ‘10 a deeper commitment to originations, mortgage proc- normal multiple gave the
Philanthropy among the essing, and default services. stock a substantial 20% to
2007 next generation of business The team felt that the stock 70% margin of safety.
leaders. was “unloved, neglected,
Shilpa Marda ‘09 and misunderstood” by ana- The third group recom-
The Challenge grew dra- lysts due to its exposure to mended the short sale of
matically from its first year, the mortgage industry. Apollo Group (APOL), the
involving 124 students in a However, they believed that parent company of the for-
special master class led by the company’s scale gave it profit University of Phoenix.
CBS alums Paul Sonkin and an entrenched competitive The group members, Tim
Caryn Zweig. The class advantage in a favorable Rupert, John Piermont, and
taught a Graham & Dodd industry environment. In Grant Bowman gave a spir-
framework for search and their view, the company was ited argument that the mar-
valuation strategies, and well positioned to make ket’s belief that the stock
students further benefitted money despite, or indeed, was countercyclical was a
from extensive mentoring because of the poor per- fallacy. First, nearly all of
from twenty practicing in- formance of the underlying the company’s recent
dustry professionals. mortgages. Mr. Griffin com- (Continued on page 35)
Page 35
“Pershing Square Challenge” (continued from page 34)

(Continued from page 34) ness traded at a similar mul- and third place were
growth has been in Associ- tiple to Lamar Advertising, awarded to Clear Channel
ate degrees, which now the market value of the ra- and Jack in the Box, respec-
make up 40% of enrollment dio business was only $800 tively. The first place award “Last year we
– up from 5% in 2005. million, despite generating was given to Tim Rupert,
These degrees have lower an estimated $865 million in John Piermont, and Grant
provided angel
tuition and graduation rates 2009 EBITDA. The team Bowman for their analysis of financing. This
and carry a much higher argued that this was far too Apollo Group. The winning
default rate. In fact, the high conservative and that the team received a $25,000 year it is mezza-
default rate (27.4% versus debt had significant asset check from Pershing Square
an average of 6.4% at public protection. After comple- that they could then direct nine. Next year, I
4-year universities) had menting the group’s to an area of their choice at
placed the school’s Title IV “incredibly impressive analy- Columbia Business School. am expecting the
eligibility under review, with sis,” Mr. Ackman said that Mr. Ackman was very
80% of the firm’s revenue at the judges would “have pleased with the growth and
competition to be
risk. The team argued that their own competition to success of the competition like a Berkshire
the competitive situation see who gets to hire the stating, “Last year we pro-
had also worsened with 60% presenters.” vided angel financing. This Hathaway annual
of public universities now year it is mezzanine. Next
offering online degrees and The final presentation by year, I am expecting the meeting.”
more than twice as many Troy Scribner, Meghan competition to be like a
for-profit competitors than Baivier, and Duncan Wel- Berkshire Hathaway annual
in 2000. The group believed stead was the recommenda- meeting.”
that with APOL, both stu- tion of Jack in the Box
dents and investors “paid (JACK) with a target price
more and got less.” Mr. of $30 per share. The team
Ackman commented that believed that the nation’s
the research was “very fifth largest burger chain had
thorough,” but Mr. Griffin strong core restaurant op-
cautioned that the stock erations, significant asset
was very expensive to value, high growth in its
short, with an annual cost of Qdoba chain, and a catalyst
22%. to unlock value as the com-
pany refranchises more
Next, Christof Pfeiffer and company-owned locations.
James Walsh recommended The firm’s real estate was
the purchase of Clear Chan- valued at $15.2 per share
nel senior secured term based on recent transac-
loans that were issued in tions, and an earnings
connection with the com- power valuation of the cur-
Pershing Square Judges: Paul Sonkin, Daniel Loeb, Craig Ef-
pany’s 2008 LBO. The debt rent stand alone restaurant fron, Caryn Zweig, Douglas Hirsch, Dahlia Loeb, Kevin Oro-
was currently trading at operations amounted to Hahn, Paul Hilal, Bill Ackman, Bruce Greenwald, and John
forty cents on the dollar, $13.45 per share. The team Griffin.
implying an enterprise value attributed additional value
of $6.7 billion. However, of $4.5 and $5.1 per share
the team calculated the for refranchising and
firm’s value at a minimum of growth, respectively, and
$12 billion. Under this then subtracted $8.5 per
analysis, the debt offered an share in debt.
IRR of 30% per year over
three to five years. Assum- After a brief consultation
ing that Clear Channel’s the panel of judges returned
outdoor advertising busi- with their verdict. Second
Page 36
Van Beima at NYSSA

Last year was a rough one he said. “If there is a low vantage. Once that arbitrage
for even the top value inves- degree of error and you buy opportunity disappeared, it
tors. On Jan. 27, Michael it at a significant discount, reappeared, and the fund
van Biema, a former Colum- you are an intelligent inves- manager was able to make
bia Business School profes- tor.” money off of the same play
sor and current principal of two more times. “That
“We always think van Biema Value Partners, Another misconception that should not be happening,”
presented his ideas at a value investors have is that said van Biema. But people
of value investors New York Society of Secu- they will always do better are seeing nice returns as a
rity Analysts meeting on than the growth guys. Not result of these arbitrage
as protecting cash, how investors should view so, said van Biema. “We opportunities.”
risk and reward to prevent always think of value inves-
because we buy at making repeat mistakes. The tors as protecting cash, be- van Biema is also looking to
a discount to the title of the talk: “A Snowball cause we buy at a discount Asia for investment ideas; in
in Hell,” after the new War- to the intrinsic value, so we October, the firm started a
intrinsic value, so ren Buffett biography, “The should lose less than the separate Asia fund. van
Snowball.” market. In fact, that couldn’t Biema said that huge oppor-
we should lose less be further from the truth,” tunities are arising due to
Risk and reward is the key he said. In periods of ex- people’s expectations; eve-
than the market. metric upon which invest- treme irrationality, the per- rybody is focused on high
ment professionals evaluate formance of value investors growth companies. They are
In fact, that the quality of investments, can be even worse than the missing out on the relatively
couldn’t be further said van Biema. market’s. But as long as you slower-growth companies,
“Unfortunately, it doesn’t are a patient investor, said which are still growing at an
from the truth.” appear that we have a terri- van Biema, it shouldn’t mat- uninterrupted rate of 12%.
bly good understanding of ter over the long term. van
what that means,” he said. Biema’s fund was down 22% van Biema ended the discus-
“Very brilliant people have last year. That performance sion with the idea that
tried to understand the re- still made it the second-best brighter times are ahead.
lationship between risk and performing value fund, be- Prior to the beginning of
return and have failed horri- hind Jean-Marie Eveillard’s significant market disrup-
bly.” First Eagle Global. tions, van Biema said he
grew wary because he no-
van Biema said that the fail- Another problem is con- ticed that small value man-
ures of late have happened tinuing to believe in the ra- agers were all starting to
in large part because inves- tionality of the markets. Just converge. He looked back
tors don’t properly under- because markets have be- to historical data, and no-
stand risk. Informational come inefficient and mis- ticed that the periods where
risk, in particular, has played priced does not prevent value investors had corre-
a large role in the root of them from becoming more lated predicted significant
the various financial crises irrationally mispriced. “The economic declines. The
over the past 100 years. van fixed income markets dis- good news, however, was
Biema believes that to coun- prove the theory that mar- that after those periods,
teract informational risk, kets behave efficiently,” he returns tended to be very
good value investors should said. But smart investors positive for the next two to
pay attention to the degree can find value in those ineffi- four years. His conclusion:
of error they put on their ciencies. One of van Biema’s “Now is probably a pretty
valuation. “If an investment fund managers discovered good time to start a value
has a large degree of error an arbitrage opportunity in fund.”
in it, you are better off to the fixed income markets,
moving to something else,” of which he then took ad-
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Graham & Doddsville
Issue VII Fall 2009
Inside this issue: “Do an Excellent Job at a Few Things” — Howard Marks
Amedysis Home p. 12 Howard Marks is co- G&D: Can you tell us about
Health Svc. Stock your early career and what
founder and Chairman of
Analysis Oaktree Capital Manage- got you interested in invest-
Care Investment ment. Founded in 1995, ing?
p. 14
Trust Stock Analysis Oaktree manages over
$60 billion of investments HM: Well, I’m not one of
in a variety of less effi- those guys who started buy-
Dave Samra— p. 16 cient arenas, including ing stocks at the age of six.
Artisan Partners High Yield Debt, Dis- The key is that unlike the
tressed Debt, and Private rest of the guys you talk to
Kevin Dreyer— p. 22 Equity, among other as- who liked investing all of
GAMCO Asset set classes. Oaktree’s their lives, I did not. It was
Management excellent long-term track something I discovered late.
record and Mr. Marks’ My dad was an accountant. I
unique investment phi- went to Wharton and Howard Marks, Portfolio
Editors: planned on majoring in Ac- Manager - Oaktree Capital
losophy have resulted in
Matthew Martinek a loyal following of in- counting, but I got more
MBA 2010 vestment professionals. interested in Finance and I had a summer job in the
Clayton Williams Since starting his career changed majors. In those investment research depart-
MBA2010 in 1969, Mr. Marks has days we went straight to ment at First National City
seen a range of ups and grad school, so I went to the Bank (now Citibank) in 1968.
James Dunavant
MBA2011 downs in the financial University of Chicago where When I was getting out of
markets, from the I did major in Accounting to grad school, I had no idea
Garrett Jones compliment my degree in what I wanted to do, so I
MBA 2011
growth of the high yield
bond market to the cur- Finance. interviewed with one large
Dan Kaskawits rent leverage meltdown. (Continued on page 2)
MBA 2011

Contact us at:
newsletter@grahamanddodd.com Oaktree Capital Manage- philosophy. Mr. Samra and
As we enter our fourth year,
Visit us at: ment. His client memos his co-Portfolio Manager
we are pleased to present
www.grahamanddodd.com you with the seventh issue of have become must-reads for Daniel O’Keefe were named
their insightful thoughts and 2008 International-Stock
www0.gsb.columbia.edu/students/ Graham & Doddsville, Colum-
organizations/cima/ entertaining commentary. Fund Manager of the Year by
bia Business School’s student
-led investment newsletter We are privileged to have Morningstar .
him share his investment
co-sponsored by the Heil- Finally, we interview Kevin
brunn Center for Graham & philosophy with us. Dreyer ‘05, a recent alum of
Dodd Investing and the Co- Dave Samra ‘93, a CBS alum the Applied Value Investing
lumbia Investment Manage- and portfolio manager for Program to gain the insight
ment Association. Artisan Partners’ Interna- of a recent alumni whose
This edition features an in- tional Value and Global Value career has spanned a very
funds, provides some unique interesting time in financial
terview with Howard Marks,
insights into his investment
the founder and Chairman of (Continued on page 2)
Page 2
Welcome to Graham & Doddsville (continued from page 1)

markets. Kevin provides an
interesting perspective for
investors and students alike.
Along with providing our
readers with insightful inter-
views, we also aim to offer
specific investment ideas
that are relevant today.
Inside are two student in-
vestment recommendations,
Amedisys (AMED) and Care
Investment Trust (CRE).
Please feel free to contact
us if you have comments or
as we continue to refine this
publication for future edi- Seth Klarman, David Abrams, and Howard Marks at the 2008
tions. Enjoy! Security Analysis 75th anniversary symposium.
Howard Marks (continued from page 1)
(Continued from page 1) took place during this pe- were considered major re-
management consultant, one riod. Citibank was a growth sponsibilities for both
small management consult- investing shop and practiced budget and people, and it
ant, one investment bank, what was called “nifty-fifty” was my job to know two
one public accounting firm, investing. As a result, eve- sentences on three hundred
one corporate treasury op- ryone who was in the non- companies – which I found
eration, one investment growth areas – oil and gas, very unsatisfying. It was a
manager, and in the end, I basic materials and so forth period in which I would say
ended up going back to Citi- – kind of slipped away, and that I was disaffected. One
bank because it had been a by the time the embargo of the great challenges in
good experience. happened, we had no en- investing is captured in the
ergy analyst, forest products saying that an analyst is
So I started off 40 years ago analyst, chemicals analyst, someone who knows a
in September of 1969 as an metals analyst, etc. So I was great deal about a few
equity analyst following con- asked to put together en- things and learns more and
glomerates and office equip- ergy and basic industry re- more about less and less
ment other than computers, search groups, and it was until he knows everything
which meant mostly copiers great to study the cyclical about nothing. And a port-
and facsimile. I did invest- businesses to compliment folio manager knows a little
ment research from 1969 the growth research. bit about a lot of things and
until 1975 when I became learns less and less about
director of research. One In 1975 I became director of more and more until he
of the things that really research and that was a job knows nothing about every-
added to my experience that I sorely disliked. I was thing. That is a dilemma,
was the oil embargo that a 29 year old guy with what (Continued on page 3)

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

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

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

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

ized, niche products and little bit: You have said in
allow the client to handle managers and the past that the third and
portfolio weightings and last stage of a bear market is
allocation. Many investors asset gatherers. when everyone believes that
like the flexibility of moving things are only going to get
to the markets where the We don’t want to worse. Do you think that
opportunities are the best. we’ve had that point and
How do you think about be the latter.” that it happened in March?
that?
HM: When you say March,
HM: That is certainly a you are talking about the
valid discussion point. I can stock market, which is not
think of one investor in par- my main area of operation.
ticular that said, “we aren’t I equate the final stage of
going with you because you of capital so that the clients the bear market with the
have these separate pools know what they are going fourth quarter of 2008,
and we have to decide on a to get and managers don’t when most people thought
fixed allocation between change the composition of that the world was going to
them. That is too rigid for the portfolio without the end and the credit markets
us because you won’t move client’s knowledge and when bottomed. If company XYZ
from A to B if B gets the client doesn’t want it to had been bought by a buy-
cheaper. We like Bob over change. out firm one or two years
there; he can do A, B, and C earlier at $10 billion, you
and he’ll move the money Our approach also lets the could buy a senior claim on
around and so forth.” I say people who work in differ- (Continued on page 7)
Volume I,
III,Issue
Issue2 1 Page 7

(Continued from page 6) saying it today . . . and the ones that they decided not
it through the first-lien bank markets continue upward. to support went bankrupt
debt for $2 or $3 billion We have macro opinions, or were bought out at low
dollars in November of but we don’t base our ac- prices.
2008. That was a bear mar- tions on the assumption
ket blow-off. The funda- that they are correct. So It is very hard to analyze
mental outlook was terrible. we haven’t been selling or financials. They just don’t
The psychology was miser- refusing to buy in the last have analyzability. Earlier
able. The technicals were four or five months. We’ve this year, there was an arti-
horrible, because there was just been increasing our cle in the New York Times
a lot of forced selling from level of scrutiny. Sunday Magazine section
hedge funds getting redemp- about the last weekend of
tions and CLOs getting mar- G&D: Given the rebound in Lehman Brothers. Bank of
gin calls. That is the kind of the markets, are you seeing America and Barclays were
buying opportunity that any investment opportuni- the two primary candidates “We remain fairly
every value investor dreams ties? to buy it. They took a look
of: people assuming that the at it and saw there were allergic to financials
outlook was terrible and HM: I don’t think that there two million interest rate
could only get worse – for- are great opportunities, in swaps. How long would it because financials
ever. terms of whole asset take you to figure out the
classes. You can find great net exposure of two million are very, very hard
G&D: Do you think the individual opportunities, but interest rate swaps, forget-
pendulum has swung too far ting about all of the other
to analyze
not the opportunities you
in the other direction now? see in phase 3 of a bear derivative positions they had compared to
market. We have already on the books? In total they
HM: Well, that is my per- passed that – between Sep- could be very strongly bull- industrials.”
sonal view. The reason we tember 15 and December ish on rates, very strongly
got into this crisis was that 15 of last year in the world bearish on rates, or neutral,
up until the middle of 2007, of credit. but you would have to ana-
everything was priced for lyze them all to know which
perfection. Then of course G&D: During that time, was the case. That is a her-
by the end of 2008, it got there were lots of disloca- culean task if you are inside
priced for the end of the tions in financial institutions. and have access to the data.
world – which so far hasn’t That must have created If you are on the outside,
happened. Now it isn’t some interesting investment then how can you ever fig-
priced for perfection, but it opportunities. Were you ure it out? That is just one
is priced for prosperity. able to capitalize on what example from one part of
Everybody is comfortable was going on in financials the balance sheet.
assuming that there will be a given your historical exper-
recovery and it will be a tise in more industrial areas? We generally consider the
vigorous, normal recovery. analysis of financials incom-
When the expectations that HM: We remain fairly aller- patible with our approach
are factored into prices are gic to financials because to investing. What is a fi-
overwhelmingly sanguine, as financials are very, very hard nancial institution? Number
I think they are today, then to analyze compared to one, it is opaque. Number
the risk is on the side of industrials. Under the con- two, it borrows short to
paying too much. Another ditions of the fourth quar- lend long. Number three, it
important investment adage ter, most financial institu- is subject to a run on the
is “Being too far ahead of tions existed largely at the bank. Number four, it is in
your time is indistinguish- pleasure of the government. the risk assumption busi-
able from being wrong.” The ones that they decided ness. How do you make
We started saying this to support survived and are money doing financing? You
around April and we are still now doing better, and the (Continued on page 8)
Page 8
(Continued from page 7) don’t kill people; people say, “I expect 15%, and if I
put it out at returns that using guns kill people. Lev- double up by borrowing at
exceed your cost of capital. erage kills people if used 5% and investing at 15%,
You borrow at low risk and wrongly. Leverage does not then I’ll get 25%.” But they
lend at high risk. You are a improve investments. It forget that part of their
risk assumption machine. only magnifies gains and probability distribution con-
We rarely get comfortable losses. So when people get sists of losses, and leverage
with that. The things that I silly and think leverage is a will more than double the
say don’t imply that we are good thing and forget to be losses. This is why people
right and others are wrong. risk averse, they take on must remember that maxi-
There are lots of ways to too much leverage. When mizing returns and ensuring
skin a cat, and that’s why you take on too much lev- investment survival are in-
there are so many kinds of erage and things go bad, compatible.
investment firms. then it can be a disaster.
“It is important to I think another important
However, in the fourth I mentioned two adages lesson that has been under-
remember to be quarter of 2008, there were earlier – “what the wise stood at Oaktree for a long
glaring opportunities, even man does in the beginning, time is that the key to in-
skeptical. It is in financials. We bought the fool does in the end,” vesting is not the art called
debt of profitable non-bank and “being too far ahead of portfolio management. The
important to not subsidiaries of banks and your time is indistinguish- key is risk management.
insurance companies. We able from being wrong.” You can’t just buy some US
invest in things you bought debt of holding com- Well, the third important and some foreign, some
don’t understand. panies that had unprofitable adage is “never forget the large and some small, and
bank subsidiaries, because man who was six feet tall some industrial and some
It is important to we thought that there was who drowned crossing the financial and then think
enough value in other as- stream that was five feet you’re safe. You can’t be so
remember that sets. We invested in non- deep on average.” It is not simplistic. You have to
bank finance companies out- sufficient in the investment thoroughly understand the
leverage is not a right. So, there were things world, or any other world, risks in the portfolio.
for us to do in financials, but to survive “on average.”
good thing or a bad You have to get through the G&D: Some say that one
limited in number.
thing.” low points and the bad days. thing that the US needs to
G&D: What lessons do you What leverage does is that do is to reduce consump-
think we should learn from it reduces your ability to tion both at the individual
the crisis and what changes survive the bad day. So you and governmental level and
should be made in re- have to realize that using increase savings. However,
sponse? leverage is a tradeoff. it seems that much of what
the government has done so
HM: I wrote a memo called It’s interesting if you think far has been to avoid that
“The Lessons of 2007.” about it. As investors, we adjustment by spurring
Most of the lessons sur- only enter into investments greater consumption. Do
round risk aversion. It is that have positive expected you think this action might
important to remember to returns, right? If something be setting us up for an even
be skeptical. It is important has a positive expected re- greater correction in the
to not invest in things you turn and you add leverage, future?
don’t understand. It is im- then the expected return
portant to remember that will be even higher. This is HM: This is a great chal-
leverage is not a good thing the trap. All of these things lenge. One example of the
or a bad thing. It is like they are very simple. This is not conundrum is that we want
say with gun control. Guns a complex business. People (Continued on page 9)

(Continued from page 8) thoughts on this trend and G&D: There has been
consumption at the macro its importance to our eco- some finger pointing, argu-
level, but at the micro level, nomic outlook? ing that investment manag-
we need savings. The US ers should have been much
will be a risky place until we HM: That scares the hell more conservative leading
have more savings, but the out of me – on the eco- up to the crisis. However, Professor Bruce
process of creating those nomic side – more than only near-Armageddon sce- Greenwald
savings will be a drag on the anything else. I wrote a narios would have prepared
economy. So what do we memo in August of last year people for what actually Bruce C. N. Greenwald
do about that? That is a called “What Worries Me.” happened. So how do you holds the Robert Heil-
real conundrum. Everybody It’s not that the market is at Oaktree balance being brunn Professorship of
knows that the economy going to decline by a few conservative with remaining Finance and Asset Man-
needs a stimulus, but the percent, or that Oaktree competitive in a more nor- agement at Columbia
stimulus will be designed to will lag by a few percent, or mal environment? Business School and is
support consumption. that some employee will the academic Director of
quit. It is not that bus that HM: The main thing is that the Heilbrunn Center
If I run a business and my everyone asks about – we tell clients that we are for Graham & Dodd
revenues are off because “what happens to Oaktree not high-octane investors. If Investing. Described by
the economy is bad and I when you go under the you want high-octane, there the New York Times as
want to support my profit- bus?” One of the things are managers you can call. “a guru to Wall Street’s
ability, then the best way to that worry me is this: what There are clients who don’t gurus,” Greenwald is an
do that would be to fire a does it mean to have an want to optimize and en- authority on value in-
few folks. That would be economy that doesn’t make sure survival, but we don’t vesting with additional
good for my business and anything? I do your taxes. have any difficulty populating expertise in productivity
bad for the economy. So You do my legal work. our clientele. We say we
the government might cre- Somebody else cuts my hair. give good returns with less
ate a tax credit for every Somebody else flips the bur- than commensurate risk. If
person that I hire. That gers, or drives a taxi. But the market booms, then
would be good for the what supports all of us if somebody else may do bet-
economy and bad for my our economy doesn’t make ter. But if the market col-
business in the long run, anything? I am not smart lapses, we’ll probably lose
because it might cause me enough to know the an- far less. The good news is
to keep employees that I swer, but I worry about that, once we’ve enunciated
otherwise wouldn’t. There that. that position, the people
are no easy answers to who come to us are the
these problems. If you be- In addition, in the industries people who want that.
lieve we need more savings where we are still trying to Then, if we give it to them,
and less consumption, then make things like cars, our they say, “thanks a lot.”
that implies that we are not workers expect the highest
going to have the usual snap wages and highest standard There might be a boom year
back in business, and we of living in the world. How in which we do 25% and
should be cautious at the do you compete in a world somebody else does 30%.
prices at which assets are where everything is fungible I’ll call up the client and say
now selling. and transportable and yet “sorry it wasn’t 30%.” They
your salaries are the highest say, “we got what I ex-
G&D: Over recent dec- in the world? How are you pected.” There is nothing
ades, manufacturing indus- going to be able to compete better for a money manager
tries have been declining in with your higher wages to hear than, “thanks, we
relative economic impor- unless your cars are vastly got what I expected.” It
tance versus service indus- superior? It is not clear. would be great to be able to
tries. What are your (Continued on page 10)
Page 10
(Continued from page 9) You never see a picture of ment tree. Those branches
beat the market when it the manager who had the are subject to cracking un-
does well and fall less when lowest risk, or the best risk- der all that weight. There-
it does poorly, but it is al- adjusted return; just the fore, until conditions
most impossible. What we one with the highest return. change, I suggest something
generally deliver is market People flock to him, and the closer to the ground.”
performance or a bit better next year he drives off of a
in the good times and dis- cliff. It is part of the popu- G&D: That is a great anal-
tinctly above-market per- larization of investing. We ogy.
formance in the bad times. had a long period from 1982
The clients who want that to 2007, with a couple of HM: People forget. That is
come to us, and we give it months of exceptions, why Buffett’s greatest quote
to them. The best formula where investing worked and is, “the less prudence with
in this business is to tell the aggressive investing worked which others conduct their
“The best formula clients what you can and will better. So people tended to affairs, the greater prudence
do, and then do it. If you forget to be scared. But with which we must con-
in this business is to just follow that formula, risk aversion is the most duct our own affairs.”
you’ll avoid 80% of the important element in a ra- When other people are
tell the clients what problems that arise between tional investment market. petrified, then we can be
clients and managers. I’ve aggressive. When other
you can and will do, been in the money manage- You know that in the capital people are aggressive, then
ment business for 40 years, asset pricing model, the line we should be scared stiff.
and then do it. If and I have never had a client slopes up to the right. The People forgot to demand
you just follow that say “that wasn’t what we reason is that people are risk premiums in 2005-07.
expected you to do.” To risk averse and demand The great thing is that risk
formula, you’ll me, if a client says that, it’s higher returns on riskier aversion is observable. You
the kiss of death. That investments. When they can see it in the yield pre-
avoid 80% of the means you mis-advertised forget to be risk averse, mium on high yield bonds.
what you were going to do. then the line flattens out as When people are feeling
problems that arise it did in October 2004, sanguine, high yield bonds
G&D: Why do you think when I wrote my memo yield 250 basis points more
between clients and your clients are so different “Risk and Return Today.” than Treasuries, and when
managers.” from shareholders? If Dick What I said in the memo is: people get terrified, they
Fuld or Chuck Prince had demand 1000 basis points
said something similar, they “Not only is the capital mar- more than Treasuries.
would have been fired. ket line at a low level today That’s an indicator of risk
They would not have lasted, in terms of return, but in aversion. Your relative re-
because they would have addition, a number of fac- turns improve as the risk
been underperforming. tors have conspired to flat- premium at which you buy
ten the line. That is to say increases. That is a simple
HM: Right. To some ex- that the slope of the line is truth which is very impor-
tent there has been a low. Meaning that for each tant.
dumbing down of the main- unit of additional risk as-
stream investment business. sumed, you get little incre- We say we are not market
Too much emphasis on the mental return… The com- timers – we are market
short term, and too much bination of low expected observers. We try to ob-
on return rather than risk returns on safe investments serve the behavior which is
control. It is too easy to and high recent returns on going on in the market and
put the highest returning risky investments is pushing figure out what that means
manager in a given year on investors to dangerously for risk premiums. We try
the cover of a magazine. high branches of the invest- (Continued on page 11)

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

Buy Recommendation—Price Target: $54 (37% upside)
Kenneth Leslie September 2009

KLeslie10@gsb.columbia.edu
Thesis Summary: The current AMED share price
implies little to no revenue growth, presumably due to
margin contraction as a result of potential Medicare
reimbursement reform. I believe that margins will remain
static to expansionary in the near future. These perceived
negatives present an opportunity to buy a best in breed,
regional to national growth story with a reasonable margin
Amedisys (AMED) of safety.
Price: $39.55
(Sept 11, 2009)
Investment Overview:
Underestimated Growth Opportunities: Amedisys
is growing revenues and earnings through acquisitions, a Enterprise Value Calculation
deep pipeline of startup agencies, new services targeting Share Price (09/11/09) $39.55
Ken is a second year MBA preventative medicine, a growing Medicare beneficiary
student and a participant in population and improved operational efficiencies. x Shares Outstanding 27.78
Columbia’s Applied Value Amedisys is capitalizing on the inability of smaller agencies = Market Capitalization ($MM) $1,099
Investing Program. Over to operate efficiently without economies of scale or +Net Debt 240.8
the summer he worked in knowledge of how to navigate changing Medicare = Total Enterprise Value $1,040
the Specialty Pharmaceuti- regulations. Amedisys has ~160 pipeline startup agencies
cals and Generics equity awaiting regulatory clearance, which would grow their 52-Week High $59.24
research team at UBS. agency number by nearly 30%. New startups require
Prior to school, Ken 52-Week Low $25.20
~$300k in investment, and the payback period for these
worked in breast cancer agencies is ~2 years. After 2 years, these agencies contribute more than $250k of EBIT each year. At the
research at the Memorial same time, established locations are growing revenues by treating a sicker patient population and providing
Sloan Kettering Cancer preventative services such as their “Balance for Life” program targeting falls in the elderly. Lastly, large
Center. acquisitions in both 2005 and 2008 hide the true operational efficiencies realized by established Amedisys
locations. As the large 2008 acquisition is fully incorporated, margins should exceed 15%, and may even
Ken is a New York Native
reach 16% in my estimation.
and received a BA in Mo-
lecular Biology from Ken- Information and Infrastructure Advantages: Amedisys has developed a proprietary “Point of Care”
yon College. IT infrastructure which standardizes treatment protocol, documents services performed and provides a
framework in which to remain in full compliance with Medicare standards. Additionally, this system ensures
that physicians can view services rendered to prevent accusations of “up coding” patient conditions. The
result is excellent transparency, superior patient outcomes and expanding operating margins. This system
allows for rapid integration of changing Medicare regulations and faster accretion of acquisition and startup
locations.
Uncertainty is an Opportunity: Uncertainty of the direction of healthcare reform and the reasons for
recent management departures weigh on AMED shares. Home healthcare and hospice represent a cheaper
alternative to traditional inpatient hospital care and represent a solution to the Medicare liability. I expect
any healthcare reform to incorporate proposals by the Government Accountability Office, the
Independence at Home Act of 2009 and the Baucus Bill. Any of these measures would be neutral to
potentially positive to Amedisys. I believe that any Medicare reform will adopt a pay for performance
reimbursement structure. This would also benefit Amedisys, as their care profile displays better outcomes
than the national average in spite of the fact that they treat a higher acuity patient (Amedisys has >10%
Case Mix Acuity Index relative to the industry average; http://www.medicare.gov). Further scrutiny into
compliance and billing practices should not affect Amedisys. Their IT systems lend transparency of billing
and services to the referring physicians and ensure that up-coding and overbilling are avoided.
The previous corporate structure was sufficient for a small to mid cap company. Amedisys is now a billion
dollar company and needs management with experience and an understanding of operations on this scale.
The market sold off 25% (intraday) of the AMED market cap with the announcement of the COO
departure. I feel that this magnitude of drop was in expectation of greater problems in either compliance
or financial manipulation, but neither are on the table.
Background: Medicare pays providers under a prospective payment system for 60 day episodes of
care based on assumptions of the severity of each patient. Episodes of treatment with higher acuity patients
Amedisys Home Health Services (Continued from previous page)

(sicker) are reimbursed at higher rates. Amedisys is one of the largest providers in the highly fragmented home healthcare and
hospice industry with ~7% market share. They have made accretive acquisitions to increase their geographic footprint from a regional
player in the southeast United States to a national enterprise. Revenue growth is fueled by increased admissions, increased patient
acuity and increased recertifications for additional episodes of treatment. New trends in healthcare and proposals by government
officials focus on preventative medicine. Amedisys is in tune with this trend and is rolling out multiple programs, including their
“Balance for Life” program, which focuses on preventing falls among the elderly. This program is reimbursed at higher than average
Medicare rates and has already been introduced to 50% of Amedisys agencies. Non-organic growth is accomplished by acquiring non-
performing, smaller home healthcare and hospice agencies. These agencies are unable to operate efficiently without economies of
scale and an understanding of how to navigate Medicare regulations, yet can be easily integrated into Amedisys’ Point of Care system.
Risks to Thesis: Healthcare reform could induce cuts to Medicare reimbursement rates, lowering operating margins across
the sector. In years past, any cuts have been offset by increases in the market basket (inflationary index). A second risk is that
Amedisys may be unable to successfully integrate future acquisitions. Finally, the recent management departures could have a negative
affect on the efficiency of operations going forward or be an early indication of issues yet to be realized by the public.
Catalysts: Medicare reimbursement for 2010 should be announced in October, and further clarity into healthcare reform
legislation should be forthcoming. The announcement of a succession to the COO/CIO positions would impact AMED shares. The
announcement of additional acquisition targets in more profitable geographic regions, or an illustration of further accretion of past
acquisitions would also benefit shares. Finally, opening of agencies in their startup pipeline would fuel growth in the immediate future.
Industry and Competitive Overview: Home healthcare providers operate at lower costs to the Medicare system
than inpatient hospital care while maximizing patient comfort. There were 9200 home healthcare agencies and 3000 hospice agencies
in the United States as of 2007 and 2006 respectively. The industry is highly fragmented and consolidating. There are few barriers to
entry, although some states require a Certificate of Need (CON) to operate under an agency number. Agency numbers allow
providers to service patients within a 50 mile radius of the agency. Many agencies are single site locations which lack the scale and
ability to navigate a changing Medicare reimbursement landscape. I predict that healthcare reform as it pertains to this sector will
focus on improving transparency, limiting the ability of companies to game the system through overbilling and focusing on reimbursing
providers based on the quality of their care and the outcome of their patients.
Valuation: I approached the valuation of AMED shares in three ways:

1) I acknowledge that forecasting operations into the future is a
difficult exercise. To be conservative, I used an earnings power Earnings Power Valuation
valuation based on expected 2009 revenue and a trailing 2009E Revenue 1484
EBIT margin (TTM) 14.3%
twelve month EBIT margin. I used an 11x multiple for this EBIT 212
calculation. Tax rate 38.7%
2) I utilized a DCF sensitivity analysis with 10% WACC and 2% NOPAT 130
terminal growth rate. My terminal rate is in line with a Earnings Power at 11x 1431
doubling of the number of Medicare beneficiaries over the 2009 EPV Valuation $51.47
next 40 years. A 13% EBIT margin reflects a 2.5% Medicare DCF Sensitivity Analysis (10% WACC; 2% Terminal Growth Rate)
reimbursement rate decrease without a concomitant increase
Forward 5 Year Operating Margin
in the price basket. I see this as a worst case scenario for the
13% 14% 15%
near future. I utilized a 14% margin to reflect the impact of
5 year 10% $46.51 $51.86 $57.22
new acquisitions and pipeline growth opportunities operating
Growth 15% $57.77 $64.32 $70.87
at lower margins. I project that Amedisys will grow at 15%
Rate 20% $71.07 $79.02 $86.97
over the next 5 years due to acquisitions, pipeline startups,
preventative services and a higher acuity population. DCF Valuation $61.05
3) Finally, I used a comparative multiple valuation to value AMED
shares using the industry average forward P/E of 11x based on 11x Industry Earnings Multiple Analysis
2009 estimated earnings. EPS 2009E $4.92
2009E Multiple Valuation $54.12
Levered
Market P/E FCF Gross Op.
Company Price Cap EV LTM P/E For EV/EBITDA P/B Margin Margin Margin ROE ROA
Amedisys $39.50 $1,098.7 $1,340.4 9.6 8.0 6.0 1.7 10% 52.5% 14.6% 19.7% 12.0%
Gentiva Health Services $22.75 $662.3 $797.1 4.0 10.6 6.3 1.2 6.90% 49.1% 8.4% 38.0% 6.6%
LHC Group, Inc $29.53 $544.8 $561.9 13.1 13.4 6.7 2.6 11.30% 50.9% 17.1% 22.6% 21.0%
Almost Family, Inc $28.42 $232.4 $261.9 11.0 10.3 7.1 2.2 5.80% 53.7% 13.6% 22.4% 16.8%
Page 14
Care Investment Trust (LONG)

Eric DeLamarter September 2009
EDeLamarter10@gsb.columbia.edu
Trading Summary (US$ in Millions)
Ticker CRE
CRE - Stock Performance
Stock Price $7.40 13
Book Value per Share $11.79 12
Est. NAV $10.53 11
10
Care Investment Trust Shares Out. (Basic) 20.1
9
(NYSE: CRE) Market Cap $148.4 8
Price: $7.40 Net Debt $28.4 7
(Sept 21, 2009) Enterprise Value $176.9 6
5
Price / Adj. LTM FFO 13.5x 4
3
Price / 2009E FFO 13.7x
Eric is currently a member
08
8
8
8
09
09
09
09
09
09
09
09
09
09
Price / Book Value 0.63x
/0
/0
/0
9/
1/
1/
2/
3/
4/
5/
6/
7/
7/
8/
of the Applied Value Invest-
10
11
12
Price / NAV 0.70x
ing program at Columbia
Business School. This last Thesis:
summer, between his first I propose a long position in the common shares of Care Investment Trust (NYSE: CRE or the Com-
and second year, Eric was a pany) as the stock is meaningfully undervalued on the basis of its assets and near-term catalysts lead-
summer analyst at the long/ ing to value realization are probable.
short hedge fund Stelliam
Investment Management in Background:
New York. At Stelliam he Care Investment Trust is a healthcare focused REIT. Following the evaporation of the securitization
focused on the transports and repo markets the Company has repositioned itself from a finance/ mortgage REIT to an equity
and industrials sectors. REIT focused on direct ownership of property. The Company has a high quality asset base consisting
Prior to Columbia, he spent of $101M in first mortgages to skilled nursing and assisted living facilities with a weighted average LTV
two years as an associate in of 78% and coverage ratio of 1.5x, $106M in wholly-owned, single tenant, triple net leased assisted
private equity and three living facilities and a $61M JV (85% equity interest) in third-party managed class A medical office build-
years an analyst in invest- ings. CRE itself is externally managed by CIT Healthcare, a subsidiary of troubled CIT Group.
ment banking.
Investment Overview & Catalysts:
Eric holds a BA from the • Depressed Stock Value: CRE is an under-followed orphan and mis-priced for the following rea-
University of Michigan. sons: 1) most coverage has been discontinued and interest has been lost as it is no longer classi-
fied as a finance REIT; 2) analysts that do cover CRE value it on FFO, seem to overlook the un-
derlying asset value and likely lack an understanding of the healthcare sector; 3) concerns sur-
rounding the solvency of external manager CIT and; 4) misperceived risks associated with
healthcare reform/ regulation. Consequently, CRE currently trades at 63% of book value and
70% of my estimated NAV.
• Catalysts: CRE is in the process of harvesting assets and returning capital to shareholders. Start-
ing on December 31, 2008, CRE reclassified its mortgages from held-to-maturity to held-for-sale
and has subsequently sold-off $67M or 35% of its mortgage portfolio (representing $101M of its
$268M in real estate related assets at 6/30). The Company has an agreement to put an additional
$80M of mortgages to CIT by September 30, 2009. There is pressure to realize value in the near
-term by: 40% shareholder CIT Group who is facing insolvency and a looming deadline from
regulators to present a capital plan and hedge fund groups (GoldenTree and SAB) holding 35% of
CRE’s shares.
• Strong Balance Sheet & Liquidity Position: Unlike many REITs, CRE has no debt due before 2015,
over $53M in cash and total debt of $83M. Its current fixed charge coverage ratio is 1.5x .
• Dividend: The Company’s dividend yield is 10%. Should a partial or complete liquidation occur,
this would obviously increase meaningfully.
Care Investment Trust (Continued from previous page)
Valuation:
On the basis of conventional FFO, CRE is trading slightly above most of its peers. However, FFO is not
the appropriate metric to use. The most likely scenarios facing the Company over the next 6-months are
an outright sale or liquidation. Assuming a 90% recovery value, the implied value for equity holders is
$9.92 per share, representing an upside of 34%. CRE’s discount to book (which should be a good repre-
sentation of value since mortgage loans are marked-to-market) and estimated net asset value provide
substantial margin of safety should assets sales not materialize or if operating results were to deteriorate.
It should be noted that CRE is one of only several REITs identified that is not facing solvency challenges
and is still trading below book value.
NAV / Portfolio Liquidation Value

(US$ in 000s)
Liquidation - Percent Recovered
Est. NAV 100% 90% 85% 80% 75%
Mortgage Loans 101,199 122,501 110,251 104,126 98,001 91,876
Owned Real Estate 103,116 106,020 95,418 90,117 84,816 79,515
JV Investments 54,758 60,842 54,758 51,716 48,674 45,632
Less: Est. man. Term. fee (15,400) (15,400) (15,400) (15,400) (15,400)
Less: Accrued exp. payable (1,137) (1,137) (1,137) (1,137) (1,137) (1,137)
Plus: Accrued Int. Rec. 557 557 557 557 557 557
Less: AP (6,029) (6,029) (6,029) (6,029) (6,029) (6,029)
Less: Other Liab. (2,803) (2,803) (2,803) (2,803) (2,803) (2,803)
Plus: Cash 53,751 53,751 53,751 53,751 53,751 53,751
Less: Total debt (83,445) (82,183) (82,183) (82,183) (82,183) (82,183)
Net Value 219,968 236,119 207,183 192,715 178,246 163,778
Value Per Share 10.53 11.30 9.92 9.22 8.53 7.84
Premium to current Stock Price 42.3% 52.7% 34.0% 24.6% 15.3% 5.9%
Notes:
Mortgage loans are classified as held-for-sale and listed at book value for NAV calc
Owned RE is undepreciated with 10.2% cap rate applied to NAV calc
JVs almost exclusively consist of interests related to Cambridge Holdings, discounted 10% in NAV calc
Debt for NAV calc is the LTM average
Risks to Thesis:
• CIT Bankruptcy: The original impetus for the CIT-CRE relationship was to enable CIT to take ad-
vantage of REIT tax benefits and concurrently provide CRE with access to CIT’s loan origination
network. Since CRE no longer originates loans, CRE’s reliance on CIT has declined. If CIT Group
were to file for bankruptcy the external manager may need to be replaced at an estimated termina-
tion fee of $15M (3x average annual management fee received during two years). Depending upon
the scope of the bankruptcy and terms of the arrangement, this compensation could potentially be
avoided and even serve as a catalyst for the sale of the Company. CRE also has a mortgage purchase
agreement with CIT whereby it has agreed to buy $80M of CRE’s mortgage loans. CRE’s depend-
ence on this source of liquidity is mitigated by the fact that it could sell these mortgage assets or
simply its entire business in the open market. CRE has already marketed its mortgage portfolio to
83% of cost (ie. taken $23M of valuation allowances), so a sale would likely result in minimal dilution
to book value/ NAV and possible accretion given the recovery in the mortgage market.
Page 16
“Points of Leverage” - Dave Samra

David Samra is the lead class. The project was to the faculty. So we tried to
Portfolio Manager for select a pharmaceutical firm promote value investing
the Artisan Interna- to analyze and I was paired through the Investing Club
tional Value Fund and is up with a guy who picked and we brought in Jim
also a Portfolio Manager Merck. At that time, Merck Rogers, Chuck Royce, Leon
for Artisan’s Global was a growth business that Cooperman, Mario Gabelli,
Value portfolios. Mr. traded at a very high multi- and other investors to
Samra and co-Portfolio ple. I selected a company speak to us about value in-
Manager Daniel O’Keefe named A.H. Robbins; a vesting.
were named 2008 Inter- company I think eventually
national-Stock Fund went bust. They were being Shortly after we left school,
Manager of the Year by sued for problems with one the Robert Heilbrunn seat
Morningstar. From its of their products. But if you for value investing was en-
2002 inception through looked through the litigation dowed and filled by Bruce
Dave Samra—Portfolio 2008, the Artisan Inter- and looked at the valuation Greenwald. Once he got
Manager, Artisan Partners national Value Fund has you were paying for the involved, he turned that
International Value and returned a total of 126% underlying business, it was program into something of
Global Value funds. vs. 43% for the MSCI extremely cheap. For what- much higher quality than
EAFE index. Prior to ever reason, my natural anything we had while we
joining Artisan, Mr. inclination was to look for were there. I think the ad-
Samra was a portfolio cheap equity. ministration eventually real-
manager and a senior ized that there was an un-
analyst at Harris Associ- When I finished under- derlying base of interest in
ates. Mr. Samra holds a graduate school, I started an value investing.
BS from Bentley College investment club with some
and an MBA from Co- friends. Four or five years While I was at Columbia,
lumbia Business School. later, with mainly just ac- the most profound influence
counting experience, I ap- was actually an adjunct in-
G&D: Tell us a little bit plied to Columbia. It was structor named Joel Stern,
about your background, the only school I applied to who was basically an effi-
how you got interested in because of its rich invest- cient markets guy. Joel was
investing, and how your ment history and because mainly a management con-
time at Columbia Business it’s where Benjamin Graham sultant who worked with
School has influenced your taught and Warren Buffett someone named Bennett
investment philosophy. went to school. I spent two Stewart, who wrote a terri-
years there and worked for fic book called The Quest
DS: I first got interested in Gabelli [GAMCO Asset for Value. They coined the
investing when I was an un- Management] on Fridays. I EVA concept that, from a
dergraduate, when I realized also wrote the newsletter financial standpoint, helps
that my finance professors and ran an investment club you to understand the dif-
were, in general, much during that time period. ference between a good
wealthier than my account- When I got out, I took a job business and a bad business.
ing professors. That at- at a place called Montgom- What matters to you as an
tracted me to the finance ery Asset Management. investor is how that differ-
business. ence, compounded over
The interesting part about time, can be very beneficial
It became immediately ap- Columbia while I was there as it accrues to the share-
parent to me which style of is that it was more or less holders of that business.
investing I was interested in an efficient market program. Marrying the concept of
because of the first project Back then, the value invest- investing in a good business
that I had in my finance ing concept had been lost by (Continued on page 17)
Page 17
Dave Samra (continued from page 16)
(Continued from page 16) erage where you have a high multiple should be much
at a cheap valuation is what fixed cost base, so when higher because, longer-term,
has driven my philosophical revenue grows, profitability it’s actually a high quality
approach to investing, both swells and you benefit from business and has the ability
as an analyst and now as a that form of leverage. The to grow and the returns on
portfolio manager. third point of leverage is the business will become
through valuation. very high. That’s what I call
G&D: That’s a great transi- multiple leverage. The last
tion to some questions point of leverage is earnings
about your investment phi- growth on a non-financially
losophy and style. You leveraged basis.
mentioned that you look to
invest in good businesses. As you develop your style
What are some of the char- “Marrying the within investing, you eventu-
acteristics that you most ally pick a point along that
like to see in a business? concept of investing scale. If you are a growth
stock investor, often times
DS: In business school you in a good business you’ll buy a company at a
have to sift through all of fair valuation and look to
the concepts to find what is at a cheap underlying earnings growth
truly valuable. The concept to generate returns as the
of investing in good busi- valuation is what value of the business grows.
nesses is what I gravitated Another style, if you don’t
towards. Once you get out has driven my mind financial leverage, is to
in the real world, identifying buy highly operational and
good businesses using ratios philosophical financially leveraged busi-
is the easy part. Identifying nesses on a highly diversified
a great business by under- approach to basis. Then you just play
standing the reality of the the odds that if you pay low
marketplace in which a investing, both as enough multiples, enough of
company operates and the them will work out, and you
sustainability of that model, an analyst and now will do well overall.
along with how much you
should pay for it, is the art as a portfolio What we have developed
which we exercise on a day over the years is a style that
in and day out basis.
manager.” is much more reliant on
underlying earnings growth
The way to generate re- on a financially unleveraged
turns over and above mar- basis combined with lever-
ket returns over time has to age that we are getting
do with leverage. There are through valuation. So what
a lot of points of leverage in Let’s say you identify a busi- we try to do is to skim off
which to operate in the ness with economics that the top by running a rea-
investing world. The easy would imply a relatively low sonably focused portfolio of
one to identify is financial multiple on earnings, be- companies that fit between
leverage, where if a com- cause in the short-term the the juxtaposition of high
pany has a lot of debt and is business is being hampered, quality and cheap valuation.
growing rapidly, the equity either cyclically or for com- The way we generate our
value of that company will pany specific reasons. How- returns is from growth of
grow in a magnified way. ever, the work you’ve done the underlying value of the
There’s also operating lev- suggests that the valuation (Continued on page 18)
Page 18

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

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

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

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

Kevin Dreyer is an Asso- There are only a handful of important for students to
ciate Portfolio Manager publicly traded firms glob- talk to a lot of people at
of both the Gabelli Asset ally, so it is a pretty small firms for informational in-
Fund and the Gabelli sub-industry, but Mario terviews. Some people I
Healthcare and Well- wants us to dominate the know didn’t find their jobs
ness Fund. Mr. Dreyer knowledge of an industry. It until late in the spring or
received his undergradu- turned out to be an active even until the end of sum-
ate degree from the area since 2005, with Wrig- mer after graduation.
University of Pennsyl- ley being acquired by Mars
vania and holds an MBA last year and Cadbury in the G&D: What was your ex-
from Columbia Business news right now with Kraft perience with the AVI Pro-
School. offering to acquire the com- gram and how did that help
pany. We were involved in prepare you for your cur-
Kevin Dreyer (’05) — both of those companies. rent role?
G&D: Can you tell us a From there, I ended up fol-
Associate Portfolio Man-
little bit about your career lowing a broader section of KD: It helped me get used
ager, GAMCO Asset food and beverage compa-
before business school and to doing full and complete
Management. how you got interested in nies globally. In addition to analysis on companies and
investing? my analyst role, I took on a writing them up and talking
few Associate Portfolio about them. The Applied
KD: After completing my Manager duties – on the Value Investing course that I
undergraduate degree in GAMCO Global Opportuni- took with William von
engineering at the Univer- ties Fund and a sector fund Mueffling was the best
sity of Pennsylvania, I went called the Gabelli Health- course I took in school. I
into investment banking care and Wellness trust. As really learned how to be an
with Bank of America Secu- of last month, I am also an analyst. We were essen-
rities. I worked in M&A Associate PM on the Gabelli tially functioning no differ-
advisory for three years, Asset Fund. ently than if we were work-
which gave me a good intro- ing as analysts following an
duction to finance and un- G&D: What was the job industry, and we met some
derstanding companies. market like coming out of great guest speakers. The
After some time, I decided school? Greenwald value investing
that I wanted to actually use seminar was also terrific. It
that analysis to make invest- KD: There were some op- was interesting to hear the
ment decisions as opposed portunities. In my first year perspective of all of the
to just giving advice. I read at school, the hedge fund great value investors. Eve-
the Intelligent Investor and industry was just starting to ryone has their own flavor
started getting hooked on boom. The big mutual fund of investing and it helps to
the value investing books companies and some hedge crystallize where you want
and applied to Columbia. funds came to campus to to gravitate towards and
Fortunately, the value in- recruit. Investment man- what makes the most sense
vesting program was just agement has always had a to you.
starting to become formal- much different recruiting
ized. I was in the first class process than other business G&D: Is there any investor
to go through the program school career paths like that made a particular im-
in its current form. Follow- banking, trading, and con- pression on you?
ing school, I went to work sulting. A lot of internships
for Gabelli covering food and jobs were secured KD: Well, obviously Mario
and beverage companies. through job postings and Gabelli. The whole notion
The first companies I looked networking rather than for- of Private Market Value with
at were confectioners. mal recruiting. It is really (Continued on page 23)
Page 23
Kevin Dreyer, GAMCO (Continued from page 22)

(Continued from page 22) view being an analyst or a As I mentioned earlier,
a Catalyst was not that portfolio manager very dif- Mario wants us to dominate
much different than the way ferently. It is just that you the knowledge of a particu-
that I had looked at compa- are looking at more compa- lar industry. At school, I
nies as an M&A banker. nies and more industries. initially had this notion that
That was helpful for me in Mario would probably still you just do screens and try
transitioning into investment consider himself an analyst. to find some cheap stocks,
management. Tom Russo We are very stock specific whereas we really want to
was also very interesting. and bottom up. We focus know everything there is to
He follows a lot of the same on what private market val- know about an industry and
companies that I do. I also ues are, particularly if there what the dynamics are and
liked how he took a global is an opportunity to realize how those are going to play
approach. those values through either out over time. We meet
a financial or strategic trans- with management and talk
G&D: Do you still interact action. to competitors, suppliers
closely with the other AVI and customers to get an
students from your class? informed view of what is
going on. Focusing on that,
KD: I do. Right out of regardless of what the mar-
school, a group of us would ket is doing is of critical
try to get together every importance.
few months or so to talk “As an analyst, it
about stocks and how our G&D: Often analysts make
jobs were going. As you get is really easy to recommendations to buy
older, it becomes a bit more what they think are the best
difficult to meet up, but I put your head ideas in the industry and not
definitely still keep in touch buy the worst ideas, but
with quite a few people down and just be they fail to take a step back
from the AVI program. and think about the macro
thinking about position of the industry and
G&D: Are there quite a whether you want to be
your industry. It involved in it at all. How
few AVI alums at Gabelli?
much do you think about
KD: There are a few. We
is always the macro issues when you
recruit at Columbia every are covering an industry?
year so we are always add-
important to step
ing people from Columbia. back.” KD: It depends what you
mean by macro issues. If
G&D: It sounds like you you mean the external fac-
have been pretty successful tors that are going to affect
in your career, progressing an industry and all of the
from being an analyst to companies in an industry, I
having an increasing amount G&D: What have you would say yes. If you are
of portfolio management learned from Mario? talking about short term
responsibilities. Can you fluctuations in stock prices
tell us some more about KD: First, that it is impor- for particular sectors, I
your progression and how tant to define your circle of would say no. In food and
you think about those two competence and stick to beverage we are definitely
different roles? what you know, and to thinking about consolidation
learn something in particular of retailers, input cost infla-
KD: I don’t know that I and know it extremely well. (Continued on page 24)
Page 24
Kevin Dreyer (continued from page 23)

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

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

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

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

(Continued from page 26) roughly in line with a lot of attractive investments as
its food and beverage peers, well.
KD: It’s really a Health and but it has a natural top line
Wellness fund, so my por- growth rate that is 2x to G&D: Any final words for
tion has more of a con- 2.5x as fast. We thought it business school students?
sumer theme. The health- would be an attractive ac-
care portion is managed by quisition candidate, and a KD: Do as much research
someone else. I manage the few years ago Pepsi was as you can and try to come
consumer portion of the looking at them. up with strong stock ideas.
fund. That is how to differentiate
G&D: How do you think yourself– to show that you
G&D: What are some of about international invest- can do the job from day
the names in the consumer ing? one. Try to find your edge,
portion of that portfolio? something that you can do
KD: We follow companies better than someone else.
KD: The largest holding of on an industry basis so to a That is how you can add
mine is Danone, the leading certain extent you have to value to an investment man-
global yogurt manufacturer. agement firm.
They’ve done a reconfigura-
tion of their business; for G&D: What characteristics
example they used to have a should we be looking at in
biscuit business, which they “We follow investment firms that we
sold to Kraft. They bought are targeting for recruiting?
Numico, which is a baby companies on an
food business. It’s a grow- KD: I think the biggest thing
ing category and they pro- industry basis so is investment philosophy.
vide a healthy product. It You guys are in the AVI
has attractive returns, not to a certain program so I am guessing
just for their business, but that is where your interest
also for the retailers as well extent you have is. Within that context,
due to the negative working there are different styles of
capital for both their busi- to be value investing. Some firms
ness and for the retailers as focus on a particular market
well in the fresh dairy cate- international.” cap range. Some are long
gory. There are a lot of only and others are long
reasons why the category is short. Making sure that you
growing. Per capita con- are comfortable with a
sumption is much lower in firm’s particular style is im-
the U.S. and emerging mar- be international. If you are portant. A big part is also
kets than in Western following the spirits indus- personality. If you are going
Europe. From a strategic try, you can’t just follow to work for a portfolio
perspective, they are the Brown Forman and Fortune manager, you have to be
clear leader and can spend Brands. You need to know able to get along. That will
more on R&D than anyone what Diageo is doing and make or break how success-
else, which leads to block- what Pernod and Remy are ful you are.
buster-type products with doing. You have to follow
specific health benefits, such the companies anyway be- G&D: Thank you Mr.
as Activia, which helps with cause they are competitors. Dreyer.
digestion, and Actimel, So from there, it is a natural
which helps immune de- extension to evaluate
fense. The company trades whether these would be
Page 28
AVI Class of 2009
Also Pictured: Mohnish Pabrai, Kevin Oro-Hahn, Bruce Greenwald, and Erin Bellissimo.
Bolaje Adeoye Steven Jung Nick Papanicolaou

Priyanka Agnihotri Adrian Kachmar Priya Patel
Julian Albertini Tarak Kadia Jason Pauley
Walter Amarteifio David Krasne August Petrillo
Ivan Andreev Eric Lee Angelo Rufino
Neal Austria Wei Bing Lee Tim Rupert
David Baron Rob Liebesman Troy Scribner
Eric Beardsley Adam Lindsay Andrea Sharkey
Jonathan Bloom Dhananjay Lodha David Silverman
Robert Buckley Will MacColl Andrew Skatoff
Amy Chen Shilpa Marda Brad Starkweather
Avram Drori Sean McDonald Leeanne Su
Brian Drubetsky Rica Mendoza Scott Van Dusen
Sasha Gentling Jake Miller Stephen Walker
Elson Huang Jonathan Miller Brian Zimmerman
Vikas Jain Shankh Mitra Alex Zuckerman
Brett Janis Charles Murphy
Britt Joyce Eric Nelson
Get Involved:

New York, NY 10027
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Contact us at:
Graham & Doddsville 2009 / 2010 Editors
Matthew Martinek is a second year MBA student and a participant in

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

the Applied Value Investing Program. This summer he interned at
Brandes Investment Partners in San Diego. Prior to Columbia, Clayton
worked for four years in fixed income research and portfolio manage-
ment at Martin & Company, a regional investment management firm in
Knoxville, TN. Clayton received a BS in Finance and Accounting from
the University of Tennessee in 2003.
Graham & Doddsville
Issue VIII Winter 2010
Inside this issue: “Parsimony is Extremely Profitable” — Mason Hawkins

Omaha Trip 2009 p. 2 Mason Hawkins founded tion of Security Analysis. Like
Southeastern Asset Man- most teenagers, investing
agement in 1975, and was not my primary focus,
today the firm manages but I did read the Intelligent
Nexstar Broadcasting p. 10
over $30 billion in value Investor and much of Ben
(NXST)
investments. The firm Graham’s three main tenets
built on its tremendous resonated with me. After
SOHU.com (SOHU) p. 12 high school, I was lucky
track record in 2009,
with its Longleaf Part- enough to have Security
ners Fund posting its Analysis as the core text-
First Annual Moon p. 34 best absolute annual re- book in an undergraduate
Lee Prize turn of nearly 54%. course, in an MBA program
later, as well as in the three
G&D: Could you tell us a CFA courses. I’m grateful Mason Hawkins, Portfolio
little bit about how you de- that the proper foundation Manager - Southeastern Asset
Editors: was established in my early Management
veloped an interest in invest-
Matthew Martinek ing? years. The most significant
MBA 2010 catalyst for me occurred in guide and recorded compa-
Clayton Williams MH: When I was in high the bear market of 1970. nies selling below net-net,
MBA 2010 school, my dad gave me the During my senior year at indentified those selling be-
first edition of the Intelligent University of Florida, I went low their net-cash and
James Dunavant
MBA 2011 Investor and the second edi- through the entire S&P stock (Continued on page 3)
Garrett Jones
MBA 2011 “The Belt & Suspenders Guys” — Tweedy, Browne
Dan Kaskawits
MBA 2011 Tweedy Browne has a G&D: Let’s start with some vestment banking. I joined in
legendary reputation in background for each of you, 1987 on Black Monday – my
value investing, uncover- how you came to Tweedy, first day! I received encour-
Contact us at: ing undervalued securi- and how you got interested aging remarks like the world
newsletter@grahamanddodd.com ties since 1920. The firm in value investing. is coming to an end. What I
Visit us at: provided brokerage ser- learned as an associate at
www.grahamanddodd.com vices to Ben Graham, Thomas Shrager: I went Bear Stearns was how in-
www0.gsb.columbia.edu/students/ Walter Schloss, and to Columbia undergrad at vestment bankers value com-
organizations/cima/ Warren Buffett before the school of International panies. I think that experi-
transitioning to a direct Affairs. I worked myself ence was helpful for me get-
investment management through college – I went to ting a position at Tweedy,
role in the late 1960’s. school full-time and worked because after three years
On February 8th, we in- full-time. After Columbia, I there, I realized I didn’t want
terviewed the four man- joined Arthur B. Little, to be a banker. I wrote a
aging partners of the where I did valuation for letter to Will – a cold letter;
firm, Thomas Shrager, about two years. Subse- he invited me over and I was
Bob Wyckoff, William quent to that, I started offered a job.
Browne, and John working at Bear Stearns
Spears. where I got the bug in in- (Continued on page 14)
Page 2
Welcome to Graham & Doddsville

We are pleased to present tive that he has developed cific investment ideas that
you with the Issue VIII of for over 35 years at South- are relevant today. The cur-
Graham & Doddsville, Co- eastern, giving a unique in- rent issue includes two stu-
lumbia Business School’s sight into the value founda- dent investment ideas, in-
student-led investment tion of the firm’s success. cluding G&D’s first dis-
newsletter co-sponsored by tressed debt investment
the Heilbrunn Center for The issue also features a recommendation. Rich Tosi
Graham & Dodd Investing rare interview with all four presents his thesis for Nex-
and the Columbia Invest- of the Managing Partners at star Broadcasting bonds and
ment Management Associa- Tweedy, Browne Company: Matt Cohen recommends
tion. William Browne, Bob Wy- the purchase of SOHU.com
ckoff, Thomas Shrager, and common stock.
This issue features an inter- John Spears. The partners
view with Mason Hawkins, discuss the evolution of Please feel free to contact
founder and portfolio man- Tweedy’s investment proc- us if you have comments or
ager at Southeastern Asset ess from its Graham & ideas about the newsletter
Management. Mr. Hawkins Dodd roots to a more ho- as we continue to refine this
shares the investment phi- listic business assessment. publication for future edi-
losophy, valuation discipline, tions. Enjoy!
and independent perspec- We also aim to offer spe-
2009 Omaha Trek—Wisdom from the Oracle
The day started off with a

tour of Berkshire Hatha-
way’s Nebraska Furniture
Mart – the largest furniture
store in the United States.
Ater the tour, Mr. Buffett
invited all of the students
back to his office for two
hours of questions and an-
swers to be followed by
lunch at one of his favorite
local restaurants, Piccolo
Pete’s.
The Economy
Columbia’s Omaha group with Mr. Buffett.
“Feel free to ask anything the top floor of Kiewit Plaza With the recent market
you like, except what we’re in Omaha on October 9, turmoil still on most peo-
buying or selling,” was the 2009. Everyone was eager ple’s minds, it was not sur-
only ground rule Warren to ask questions of the prising that one of the first
Buffett offered before openworld’s most successful questioners asked Mr. Buf-
ing the floor to questions investor after a remarkable fett whether the recession
from more than 125 busi- period for the capital mar- had impacted the way in
ness students gathered on kets. (Continued on page 30)
Issue VIII Page 3
Mason Hawkins
(Continued from page 1) and not being swayed by G&D: A lot of people talk
bought a few, literally buying outside factors. One thing about value investing, but
dollars for fifty cents. That that sways a lot of managers what does value investing
experience hooked me for is a desire to minimize ca- mean to you and how does
my career. There were no reer risk by hugging a that differentiate your firm?
computer screens at that benchmark. Your firm takes
point. a completely different view MH: Graham provided the
on that. Could you talk definition in the Intelligent
G&D: That sounds similar about the benchmark you Investor. An investment is Jeremy Grantham deliver-
to what John Templeton use and your attempts to one that promises safety of ing the keynote address
talked about doing in some track that benchmark? principal and an adequate at the 2009 Graham &
emerging markets. Were return. By deduction, those Dodd Breakfast.
there any other influences that don’t are speculators.
on your investing style, in We believe that buying se-
addition to Ben Graham? curities at large discounts to
conservative appraisals pro-
“We clearly vides the best route to
MH: Chronologically, my
Dad, Ben Graham, John remind our above average compound-
Templeton, Warren Buffett ing. We’re focused on nail-
and my partner, Staley associates that ing down our evaluations so
Cates shaped my investment we can use them to make
thinking. you’re right significant long-term invest-
ment commitments when
G&D: When Buffett moved because of your sellers are under duress or
back to Omaha he said that traders are consumed with
escaping the hectic New facts and ephemeral short-term is-
York atmosphere allowed sues.
him to think more clearly. reasoning, not
Do you think that has been G&D: Where do you look
a factor at Southeastern in because to find these ideas?
Memphis?
someone agrees MH: Value Line, new low
MH: Yes. We depend lists around the globe, in-
almost exclusively on our
or disagrees dustry rags, computer
appraisals and our assess- screens, investee manage-
ment of our management
with you.” ments and boards, competi-
partners and their compa- tors of our investees, re-
nies’ competitive positions. spected investors, US and
We clearly remind our as- international “best com-
MH: We try to hug good pany” wish lists, and 35
sociates that you’re right
investments not bench- years of appraisals help pro-
because of your facts and
marks. We’ve established duce our investment ideas.
reasoning, not because
inflation plus 10% as our
someone agrees or dis-
absolute investment goal
agrees with you. And you G&D: Obviously manage-
and that’s been the case for
do eliminate a lot of inter- ment is very important to
our history. There’s not a
ference by being in Memphis you. How do you approach
lot of solace in being down
as opposed to Manhattan. evaluating a management
20% when the market is
team?
down 30%. Investing should
G&D: That’s a very inde- lend itself to risk avoidance.
pendent approach, sticking MH: We strive to know as
to your facts and reasoning (Continued on page 4)
Page 4
Mason Hawkins
(Continued from page 3) those comparable sale yard- that don’t produce any
much as we can about our sticks against our assess- earnings. Burlington North-
prospective CEO-partners. ment of the net-asset or ern in the early 1980’s be-
We want to understand free-cash values and we use came very cheap in relation
their business acumen and the lower of the two. It’s to its land, oil, natural gas,
their personal histories. As important to make sure that gold, timber, and pipeline
others have said, we believe when you record a transac- assets when the company
it’s impossible to do a good tion, you note the interest operated at a loss.
deal with a bad person. rate environment under
which it occurred. If you G&D: What do you think
We endeavor to read eve- recorded a transaction in about Buffett’s decision on
rything that’s available on BNI?
management, but meeting
them in person is critical. MH: I think Mr. Buffett’s a
It’s always important to very, very able investor, if
hear their challenges and not the most talented long-
how they’re addressing term investor, and I think he
them. Business is tough, values highly BNI’s competi-
and the more realistic the
“We’ve made a lot
tive position. I believe they
manager is the more likely have over 95% of the rail
he’ll be successful. We talk
of money in net-
traffic in Montana, for exam-
to their competitors, ex-
employees, board members
asset investing. ple. Burlington Northern is
a call on much higher energy
we’ve known, and commu- There are prices. It is understandable.
nity associates – to name a It has significant operating
few of our checks. companies that leverage coming out of our
economic funk. It will de-
G&D: When you’re setting have significant liver significantly better-than
an appraisal for a business, -treasury returns in my
what process do you follow? asset values that opinion, but we believe it
was a fully-priced acquisi-
MH: We spend a lot of don’t produce any tion.
time on free cash flow gen-
eration after required capex earnings.” G&D: It seems that your
and working capital charges funds are more concen-
and then assess the value of trated than the average mu-
that free cash generation. If tual fund. How do you
the company is not reasona- think about concentration
bly predictable and competi- on an individual name and
tively entrenched, we are sector basis?
very careful about using 1982 when the long treas-
DCFs. We also look at the ury was 15%, you’re going
to see a much lower set of MH: Mathematically, you
net asset or liquidation val- can diversify about 80% of
ues. metrics than if the comp
occurred in 2007 when the your individual company risk
long treasury was under 4%. with a dozen names in dif-
We then compare DCF and ferent industries. You can
net asset values to our com- eliminate some 90% with 18
parable sales database. We’ve made a lot of money
to 20 companies. Beyond
We’ve recorded most M&A, in net-asset investing.
that, there’s very little di-
take-private, or liquidation There are companies that
transactions. We compare have significant asset values (Continued on page 5)
Issue VIII Page 5
Mason Hawkins
(Continued from page 4) we’re buying a company long run, which means our
versification benefit. Ideally, that’s selling below the cash average holding period is
you want to have your on its balance sheet, it can over 5 years. We sell busi-
money in your most attrac- be done quickly. If we’re nesses when they approach
tive quantitative and qualita- buying a normal operating intrinsic value and there’s
tive qualifiers to give you business that has competi- no longer a margin of safety.
the best opportunity for tive challenges, you want to We also might sell a com-
returns. It’s been our long- be able assess it conserva- pany if we can improve our
standing belief that it does tively and explore all the position by 100%.
not make sense to own potential threats. Usually,
Columbia Business School is
your 30th best qualifier when our best ideas are vetted John Templeton called it the
a leading resource for invest-
you can concentrate in your quickly. 100% rule. He wanted a
ment management profession-
top 15. You reduce your 100% improvement in his
return potential as you add position to make a change.
names. It’s mindless to do If a stock was at 80% of ap- business school in New York
so after you’ve achieved praisal, he wanted to buy City. The School, where value
adequate diversification. one that was about 40% of investing originated, is consis-
value to make the switch. tently ranked among the top
That’s because taxable in- programs for finance in the
G&D: What is the dynamic
on your team when evaluat- vestors have to pay taxes, world.
ing new positions?
“You reduce your and you have to be right on
the appraisal of the com-
return potential as pany you’re selling and the
MH: There are 9 and a half
of us - I’m a half. Each ana- company you’re buying.
you add names. Also, in Templeton’s day,
lyst is opportunistically
searching for a terrific in- there were substantial
It’s mindless to do transaction commission
vestment. When somebody
costs, and even today there
finds an idea, they write it so after you’ve are still material market
up. They assess business,
impact costs from buying
people, and price and then achieved and selling.
everybody gets a copy of
the report which attempts adequate
to lay out the relevant facts Another cause for change in
and the investment case. diversification.” our portfolio is deteriora-
Seniority plays no role. We tion in the competitive posi-
are all very mindful that the tion of the company, which
investment succeeds or fails will usually occur quite
based on the facts. Usually, slowly. We’ve had some
if an important question that have been challenged
can’t be addressed ade- more quickly than you might
quately, the idea fails. Fur- expect. Another reason for
thermore, we assign a turnover is that manage-
devil’s advocate to each G&D: Not only are your ment might turn out to be
investment idea. funds more concentrated, less than trustworthy or
they also have a much lower capable and changing them
turnover rate. How often out would be too difficult or
G&D: What is a normal
do you add a new idea to expensive.
gestation period on a new
idea? the portfolio?
G&D: As you’re discussing
MH: We’ve averaged less appraisals and margin of
MH: It can be 5 minutes,
than 20% turnover over the safety, you’ve mentioned
or it can be 5 months. If
Page 6
Mason Hawkins
(Continued from page 5) from stealing a good com- Chesapeake Energy and
investing in net-nets. Do pany. Pioneer Natural Resources
you find margin of safety in are our two major commit-
the quality of the business G&D: What areas of the ments.
or just a cheap price? market do you think are
particularly interesting? G&D: The market’s opinion
MH: Valuable growth is the on the natural gas situation
great eraser if you misprice MH: If we had to cite one, in the US has changed sig-
Jean-Marie Eveillard and
your purchase. Buying good it would be US natural gas. nificantly with shale deposits
Tom Russo at the 2009 Gra-
businesses is critical to prof- and increasing reserves.
ham & Dodd Breakfast.
itable long-term equity in- You used to hear about
vesting. There are three natural gas dependent indus-
components of an equity tries being at a permanent
investment’s return. One is competitive disadvantage in
the discount to intrinsic “Valuable growth the U.S., and now there is a
value. The second is the lot of talk about oversupply
growth in intrinsic value. is the great eraser and lower prices moving
And the third is the rapidity forward. Are you con-
at which the gap between if you misprice cerned about this increase?
price and value closes.
your purchase. MH: We believe demand
Mathematically, we know will rise to that supply, as
that if you buy a business at Buying good busi- you substitute natural gas
half of value, and value ac- for oil and coal and as the
cretes at 12% per annum, nesses is critical industrial use of natural gas
and the price reflects intrin- recovers. Furthermore, we
sic value in the 5th year, you to profitable long believe natural gas directly,
get 29% per annum com- or indirectly via hybrid and
pounding. And you sleep -term equity in- electric power trains, will be
very well at night knowing used in transportation, both
that the value is greater vesting.” in autos and in trucking.
than the price. Clearly, Ben
Graham wrote a lot about G&D: Does your invest-
the margin of safety and ment thesis anticipate any
protecting your principal, government spurred action
but there was less emphasis or is independent of a public
on the benefits to returns policy response?
from buying good busi-
nesses at cheap prices. Natural gas is currently MH: Our appraisals do not
cheaper than other hydro- build in any government
If you bought this example carbons, oil and coal. It is mandates, but we believe
at fair value and it stays at by far the cleanest. It is they’re probable.
fair value, you just get the politically secure. Risk ad-
value accretion, 12%. How- justed, it is most attractive.
ever, if you bought it at half G&D: Another sector that
Lastly, using more of it
of intrinsic value, you pick is garnering a lot of discus-
benefits security, our bal-
up another 17 points per sion is health care, which I
ance of trade and therefore
year of compounding. So, notice has a zero percent
the US dollar. We believe
parsimony is extremely weighting in the partner’s
companies that have grow-
profitable. The less elabo- fund. Is that related to un-
ing reserves and production
rated aspect of value invest- certainty regarding how
of natural gas in this country
ing is the huge plus you get should fare very well. (Continued on page 7)
Volume
Issue VIIII, Issue 2 Page 7
Mason Hawkins
(Continued from page 6) paramount one. Proper racy and accountability.
things will shake out or sim- corporate governance and Nationalization risk is not
ply better opportunities stewardship are others. If one we’ll knowingly take.
elsewhere? there’s not corporate de- Said another way, if you
mocracy, and there’s not a wouldn’t feel comfortable
MH: I was an ethical drug focus on shareholder inter- leaving your money in a
analyst in my first job, and ests, it’s probably not going bank in a country, you cer-
we have partners here that to make it into our portfo- tainly wouldn’t want to own
have explored all aspects of lios. Some countries, the equity of a business in
the health delivery systems. though, protect sharehold- that country.
We have exposure through
Phillips’ medical equipment G&D: So does that put
business, which is its most more of a focus on devel-
valuable division. The rea- oped markets as opposed to
son health care is not a emerging, more volatile
large weighting is because markets?
we haven’t found compelling “We assume an
values. Drug companies MH: It does. There’s an-
have depleting revenue owner-operator other challenge if the cur-
sources that you have to rency is an issue. Many
replenish and there are mentality as you years ago, we found a terri-
price pressures from the fic Coca-Cola bottler in
purchasers of those prod- know. If you work Brazil, but the currency was
ucts, be they individuals or going to cost us 20+% a
third parties. We’d like to for Southeastern, year, and that prevented us
participate in the wonderful from making the investment.
demographic healthcare you have to do all
demand profile of this coun- G&D: You mentioned that
try and that of the world, of your equity labor issues could be a fac-
but we haven’t found a tor on an investment.
company that qualifies busi- investing via the You’ve been an investor in
ness, people, and price. the auto industry in the past
Longleaf Partners — what are your thoughts
G&D: Another area is in- on the sector now?
ternational opportunities. Funds.”
Obviously, you have a lot of MH: We are not inter-
international exposure. Do ested in labor-intensive,
you think about interna- capital-intensive, low-return
tional investing any differ- businesses. Our foray into
ently than domestic invest- GM was predicated on a
ing? Do you have a greater sum of the parts appraisal,
deal of optimism for emerg- ers better than the US. For
example, in South Africa where there was significant
ing market investments? value at the time in their
when we owned DeBeers,
we were able to block a sub investments in DTV, GMAC
MH: Much of the world and some of the separable
-optimal takeover bid with a
outside the United States assets that they had. It was
20% vote and demand ap-
will grow more quickly, and not based on the automo-
praisal rights which got us
as real incomes rise, you’ll bile industry’s economics.
intrinsic value. Thus, we
get pretty rapid demand
spend time looking at gov-
growth in emerging mar- G&D: In that case, you
ernance rules. We want to
kets. However, investment transitioned into converti-
be treated fairly, and we
challenges are numerous.
believe in corporate democ- (Continued on page 8)
High security prices is the
Page 8
Mason Hawkins
(Continued from page 7) know. Another thing that advan-

bles. How do you think tages the Longleaf Partners
about investments in other If you work for Southeast- Funds is our long-term time
areas of the capital struc- ern, you have to do all of horizon. It’s very difficult to
ture? your equity investing via the find a long-term investor
Longleaf Partners Funds. I today, and we believe that’s
MH: Yes, we bought con- believe that benefits us in beneficial to us. The aver-
vertible senior debt, but the two ways. It removes con- age holding period on the
rules for the debt-holder flicts of interest, and it fo- New York Stock Exchange
changed in that particular cuses everyone’s attention has dropped to 6-months
incident. The rule of law on the companies in the from 5 years, 30 years ago.
was threatened. Indentures portfolio. When you see So, there’s a lot of “moving
and contracts were jeopard- about” in the industry and
ized. that average NYSE holding
period dropping is an indica-
G&D: In some ways the tion of just how short-term
auto industry is representa- everybody has become in
tive of the broader U.S. their thinking.
manufacturing industry. Do
you think the U.S. can be “If people are More participants are trad-
competitive in those indus- ers, believing that investing
tries longer-term?
very fearful, you for long-term returns is not
a worthwhile pursuit. We
normally can buy know it is. Growth in cor-
MH: There are major
porate intrinsic value is of-
headwinds, but it is com- in great quantity. ten obfuscated by stock
pany specific and hard to
price movement, which
generalize. But if a business And if people are does not appropriately track
is highly capital and labor
the accretion in business
intensive, they’ll have trou- very greedy, you value. That’s good for all of
ble.
us who are appraisers of
normally can sell businesses, because it means
G&D: You’ve had a long you get more mispricing and
career in investment man- in great quantity.” better opportunity to get a
agement and seen the indus- franchise at a cheap price.
try change over your ca-
reer. What’s your outlook
G&D: You’re also willing to
on the industry going for-
close the funds when they
ward? Do you have any
get too big. Has size been a
thoughts on how the indus-
major detractor as the
try should be changing? your boss in the mirror in firm’s gotten bigger?
the morning, you can assess
MH: We’ve never thought your career risk solely on MH: We had our best ab-
of our business as an indus- your investment results and solute and relative year in
try. We think more about not on politics or relative 2009 when our AUM was
our existence as investors. returns. Our owner- significant. We’ve closed
We believe that if we de- operator culture helps us our funds when the oppor-
liver good returns with low focus on the investments tunity set was small and we
risk for our partners, then and doing the right thing for believed that the investment
the rest takes care of itself. our partners.
We assume an owner- (Continued on page 9)
operator mentality as you
Issue VIII Page 9
Mason Hawkins
(Continued from page 8) average price to values have counted. Only if you com-
prospects were not attrac- been around 68% over our pare them to the extreme
tive. We don’t need to hold funds’ histories and cur- discounts that stocks got to
excessive amounts of cash rently they are still meaning- in the fourth quarter of
and people don’t need to fully below that average, and 2008 and the first quarter of
pay us to buy treasury bills. we’ve delivered good re- 2009 would they seem less
So if our cash is building turns from the average. So compelling.
rapidly and our prospect of if the individual companies
finding good investments is G&D: One final question,
diminished, then we close what advice do you have for
the funds and wait patiently. business school students Professor Bruce
“You want to interested in a career in Greenwald at the 2009
Secondly, the question investing? G&D Breakfast
should be how big is the pursue it for the
qualifying investment uni- MH: You want to pursue it Bruce C. N. Greenwald
verse vis–a-vis the pool of intellectual for the intellectual challenge, holds the Robert Heil-
capital. In a vacuum, the brunn Professorship of
for the reward of being cor-
larger the pool of capital, challenge, for the rect about your investment Finance and Asset Man-
the more difficult it is to decisions, and for the op- agement at Columbia Busi-
manage. But, an intelligent reward of being portunity to help others.
ness School and is the
investor knows there is Those would be the three academic Director of the
great liquidity at each end of correct about your primary reasons I would Heilbrunn Center for Gra-
the psychological barbell. If council you to pursue a ca- ham & Dodd Investing.
people are very fearful, you investment reer in investing. If you Described by the New
normally can buy in great start out just doing it be- York Times as “a guru to
quantity. decisions, and for cause you want to make a Wall Street’s gurus,”
lot of money, I doubt that Greenwald is an authority
And if people are very the opportunity to you’ll be as successful.
on value investing with
greedy, you normally can additional expertise in
sell in great quantity. It’s in help others. Those productivity and the eco-
G&D: Not many managers
between the two extremes talk about investing in terms nomics of information.
that liquidity is a challenge. I would be the
of helping others, but that’s
might add that in the fourth an interesting perspective to
quarter of 2008 to the first
three primary
have.
quarter of 2009, we proba-
bly could have put 10x the
reasons...to pursue
MH: Most of our partners
amount of assets that we
had to work effectively. In
a career in at Southeastern come in
daily for altruistic reasons,
today’s environment, it’s a investing.” not only to help retirees
challenge getting smaller
and college students, but to
sums invested appropriately.
produce the free cash flow
are selling at prices of 62- coupon at Southeastern that
G&D: That’s interesting, can be reinvested to help
because in some ways you 63% of conservative apprais-
als, they’re still attractively those who are less fortu-
seem very optimistic, with nate.
your portfolio price to value offered. If you had landed
below your long-term aver- on this planet today and you
age. were reviewing our long- G&D: That’s a great note
term price to value relation- to end on. Thank you Mr.
ships, you would say that Hawkins.
MH: If you read our annual
they’re adequately dis-
report, you’ll see that our
Page 10
Nexstar Broadcasting, Inc. — Buy 12% Senior Sub PIK Notes

Rich Tosi February 2010
RTosi10@gsb.columbia.edu
Company Overview:
Nexstar Broadcasting, Inc. (“Nexstar”, “NXST” or “the Company”) owns and operates 34
local broadcast television stations. The Company operates, programs or provides other services to an
additional 29 stations, mainly those of Mission Broadcasting, Inc. (“Mission”). The 63 stations are in 34
markets, 22 of which are Nexstar duopolies, and have a reach of 13mm households (11.5% of the US).
NBC, CBS, ABC, and Fox affiliated stations represented approximately 33.0%, 28.1%, 14.7% and 23.7%
Nexstar Broadcasting, Inc. of revenue respectively in 2008. In 75% of Nexstar’s markets they have a #1 or 2 revenue market share.
(NXST) 12% PIK Notes Recommendation:
I recommend buying the Nexstar 12% Senior Subordinated PIK Notes (“12% PIKs”) at 63.
Price: $63.00
(Feb. 17, 2010 - Pricing They are trading 18 points cheap of the 7% Senior Subordinated Notes (“7% Cash-pays”) and 14 points
cheap of the 7% Senior Subordinated PIK Notes (“7% PIKs”) even though they all are pari passu in the
according to Barclays)
Nexstar capital structure. The reason for the disparity seems to be the fact that the 12% PIKs are not
guaranteed by Mission even though the 7% PIKs and 7% Cash-pays are. This guarantee is on a subordi-
Rich is currently a member nated basis to the Mission guarantee of the Nexstar Credit Facility. However, this sub guarantee is
of the Applied Value Invest-
worthless. Using an average of the last two years’ EBITDA, Mission is trading at 10.3x through its
ing program at Columbia $172.9mm of bank debt leaving no recovery for the 7% PIKs and 7% Cash-pays. The YTW is 32% for
Business School. Over the the 12% PIKs versus 12.2% for the 7% PIKs and 13.4% for the 7% Cash-pays. If the 12% PIKs were trad-
summer, Rich was an ing at par, they would have a YTW of 14.8% which is still 140 bps wide of the 7% Cash-pays. This dis-
analyst at the event-driven
credit fund Schultze Asset parity more than compensates for the lack of the guarantee, which really only has option value.
To make a bet solely on the value of this guarantee, one could buy the 12% PIKs and short
Management in New York.
out the 7% PIKs, which do not pay a cash coupon until July 15, 2011 (they pay PIK interest at 0.5%
At Schultze, he was a gen-
through Jan. 15, 2011). One could also buy the 12% PIKs and short the 11.375% Senior Discount Notes
eralist covering a variety of
(“HoldCo Notes”). These HoldCo Notes are structurally subordinated to the 12% PIKs yet they are
bankrupt and distressed
trading at 85 and a YTW of 17.9%. Since the 12% PIKs are the most expensive piece of debt in the capi-
companies. Prior to Colum-
tal structure (accruing at 13% currently which steps up eventually to 15% after Jan. 15, 2012), I believe
bia, he spent two years at
NXST will try to repurchase them before any other note especially now that the 12% PIKs went cash-
an equity long/short fund
pay on Jan. 15, 2010. With NXST’s recently amended leverage ratios that increase to 10.25x total lever-
analyzing special situations
and three years at a law age and 7.5x senior leverage for the June 2010 quarter, there is also very little chance of default.
firm. Rich holds a BA from Investment Overview/Catalysts:
Nexstar operates in many markets as a duopoly. With these arrangements, NXST is able to
Columbia University. spread the high fixed operating, programming and selling costs over a large revenue base. Margins in
Nexstar Broadcasting Group, Inc.
Market Cap/
Nexstar and Mission Corporate Structure Security Ticker Date Price FDS Amount
Common Stock NXST 2/12/2010 $4.80 28.4 136.5
Amount due from Finance Holding 3.1
Cash -
ntee 100%
Guara
Senior
Nexstar Finance Holding Corp.
Outstanding
Security Coupon Maturity Price YTM ($mm)
Senior Discount Notes 11.375% 4/1/2013 80.00% 20.35% 50.0
Due to NBG and NB 4.8
Cash -
100%
Mission Broadcasting Inc. Nexstar Broadcasting, Inc.

Outstanding Senior Spread/ Outstanding
Guara
Spread Maturity Price YTM ($mm) ntee Coupon Maturity Price YTM ($mm)
Security Security <--Operating Assets
Mission Senior Secured Revolver 400 4/1/2012 $91.67 9.45% 7.0 Nexstar Senior Secured Revolver 400 4/1/2012 $97.08 6.50% 78.0
Mission Term Loan B 400 10/1/2012 $91.67 8.63% 165.8 Subor Nexstar Term Loan B 400 10/1/2012 $97.08 6.23% 156.8
Due to NB 13.4 dinate Senior Subordinated Notes 7.00% 1/15/2014 $77.00 15.00% 47.9
d Gua
ra ntee
Cash 1.2 7% Senior Subordinated PIK Notes 0.50% 1/15/2014 $77.00 12.16% 142.7
12% Senior Subordinated PIK Notes 13.00% 1/15/2014 $63.00 32.04% 42.6
Amount due from Finance Holding 1.7
Amount due from Mission 13.4
Cash 18.2
duopoly markets are about 800 bps higher than in other markets. NXST is also such a good operator
that there are many owners that contract with NXST for a fee or revenue split for their services. Mis-
sion Broadcasting is one such company and consolidated for accounting purposes despite 0% ownership.
Television advertising is expected to grow anywhere from 5-10% in 2010 depending on who is
making the forecast. This will be led by political advertising which is expected to be up 31.3% from
2008. One of the main drivers of this increase and may be the impact from the Citizens United Supreme
Court decision. NXST is currently conservatively forecasting that political revenue will be about the
same as it was in 2008 ($33mm). However, with the current acrimonious political atmosphere and ex-
pected Democratic vulnerabilities in atypical states, I expect this target to be easily exceeded. There will
Issue VIII Page 11
Nexstar Broadcasting, Inc. (Continued from previous page)

be 13 gubernatorial races, 15 Senate races and 58 congressional races in markets NXST serves which is the most the Company has
ever had. Also helping in 2010 is the Olympics and NBC changing their late night line-up.
A significant catalyst going forward is revenue from retransmission agreements with cable, telco and satellite pay television to
broadcast NXST’s local stations. Retrans revenue is expected to exceed $32mm in 2009 and YTD has been up 45% over YTD 2008.
This is almost all incremental revenue which flows through at a near 100% cash margin. Since NXST has lead the charge on negotiating
Nexstar Broadcasting Group Inc. Today 2/21/2010 Updated 2/23/2010 Balance sheet date 9/30/2009
Capital structure overview
LIBOR Floor 1.000%
Face Value Create Through
Market Market x LTM x 2010E x LTM x 2010E LIBOR Fixed Current Current
Summary capitalization Maturity Drawn Price Value EBITDA EBITDA EBITDA EBITDA margin Coupon Rate Interest Yield YTW
Commited Net Net Net Net
Nexstar Senior Secured Revolver 82.5 4/1/2012 78.0 97.08% 75.7 400 5.00% 3.9 5.2% 6.50%
Nexstar Term Loan B 10/1/2012 156.8 97.08% 152.2 400 5.00% 7.8 5.2% 6.23%
Total Nexstar secured debt 234.8 227.9 3.4x 2.7x 3.3x 2.7x
3.1x 2.5x 3.0x 2.4x
Mission Senior Secured Revolver 15.0 4/1/2012 7.0 91.67% 6.4 400 5.00% 0.4 5.5% 9.45%
Mission Term Loan B 10/1/2012 165.8 91.67% 152.0 400 5.00% 8.3 5.5% 8.63%
Total secured/guaranteed debt 407.6 386.3 5.9x 4.7x 5.7x 4.6x
5.6x 4.5x 5.4x 4.3x
Total senior debt 407.6 386.3 5.9x 4.7x 5.9x 4.7x

5.6x 4.5x 5.6x 4.5x
7% Senior Subordinated Notes 1/15/2014 47.9 81.00% 38.8 7.00% 7.00% 3.4 8.6% 13.41%
7% Senior Subordinated PIK Notes 1/15/2014 142.7 77.00% 109.9 0.50% 0.50% 0.7 0.6% 12.16%
12% Senior Subordinated PIK Notes 1/15/2014 42.6 63.00% 26.9 13.00% 13.00% 5.5 20.6% 32.04%
Total OpCo debt 640.8 561.8 9.3x 7.5x 8.4x 6.8x
9.0x 7.2x 8.2x 6.6x
11.375% Senior Discount Notes 4/1/2013 50.0 85.00% 42.5 11.38% 11.38% 5.7 13.4% 17.85%
Total debt 690.8 604.3 10.0x 8.0x 9.9x 7.9x 35.7
9.7x 7.8x 9.6x 7.7x
Shares O/S Price
Equity value 28.4 $4.80 136.5 136.5
Cash (19.3) (19.3) 0.7 Less PIK interest
Total capitalization 807.9 721.5 11.7x 9.4x 10.4x 8.4x 35.0 Cash interest
large compensation agreements, the Company is now in its second round of contracts with pay-TV operators which gives them signifi-
cantly more leverage. There is a large amount of upside in retrans and other companies are helping to move the ball down the court
like Chase Carey of Fox who was demanding $5 per sub. Also now that Comcast owns NBC, they have expressed their support for
retransmission contracts. LTM Analysts
Television is not going away as US households Summary financial information 2005 2006 2007 2008 9/30/2009 2009E 2010E
set a new record recently for watching 8 hours 21 min- Revenue 228.9 265.2 266.8 284.9 258.3 247.6 273.7
Growth 15.8% 0.6% 6.8% -13.1% 10.5%
utes of television per day on average. Television is better Gross profit 161.3 193.7 192.7 206.6 181.4
targeted and cheaper than advertising in the local paper at Margin 70.4% 73.0% 72.2% 72.5% 70.2%
~$20 per cpm versus $30-35 per cpm for a newspaper. EBIT 19.9 46.5 38.6 46.6 17.6 14.2 36.0
Local television affiliates’ websites are turning into the Margin 8.7% 17.5% 14.5% 16.4% 6.8% 5.7% 13.2%
place where people now get their local news, video and EBITDA 63.1 88.5 85.1 96.2 69.1 64.2 86.0
Margin 27.6% 33.4% 31.9% 33.8% 26.7% 25.9% 31.4%
sports highlights, displacing the local paper. Nexstar has Leverage 8.3x 5.7x 6.3x 6.2x 6.5x 8.2x 6.1x
been out in front of this trend with well-developed affiliate Leverage Covenant
Senior Leverage
8.5x
6.5x
7.0x
4.6x
7.0x
4.8x
6.5x
4.2x
6.8x
5.3x
8.8x
6.3x
7.8x
4.7x
websites. Revenue from electronic sources grew 100% in Senior Leverage Covenant 5.0x 4.8x 4.8x 5.5x 7.0x 5.5x
2008 and is expected to be over 5% of revenue in 2010. Cash Interest expense

Interest Coverage
44.9
1.4x
38.2
2.3x
40.6
2.1x
39.0
2.5x
31.8
2.2x
34.0
1.9x
35.0
2.5x
The industry has just come out of a significant Interest Coverage Covenant 1.5x 1.5x 1.8x 1.8x 1.8x 2.0x
capital spending cycle because of the digital television con- Maintenance capital expenditures
Capital expenditures 14.0
15.0
24.4
15.0
18.5
15.0
30.8
15.0
27.0
15.0
20.0
15.0
15.0
15.0
version. Now Nexstar can greatly cut back on CapEx. The Cash taxes (0.1) 0.0 0.1 0.2 1.0 1.0 1.0
Free Cash Flow 0.4 30.1 18.5 29.8 2.7 14.2 35.0
Company estimates that spending should come in below
$15mm next year, down nearly 50%. Coupled with all the Mission EBITDA
Leverage Through Mission Bank Debt
10.8
21.8x
19.5
12.1x
17.7
13.2x
20.1
11.7x
16.8
14.0x
cuts the company has made to the operating cost struc-
ture, Nexstar should generate a substantial amount of free cash flow next year. A free option on the upside comes in the form of white
space on the spectrum that they still own that the company could monetize.
Valuation
There are only two analysts that provide estimates for NXST which is another reason that there
may be severe mispricing here. Their estimates seem to be very low considering what the company is saying
about growth compared to 2008 and 2009 and cost cutting measures undertaken in 2009. I am forecasting
revenue of $313mm and EBITDA of $107mm in 2010 versus analysts that are at $274mm in revenue and
$86mm in EBITDA. With $107mm in EBITDA, you can create the company at the Senior Sub level for 5.0x
on a net basis assuming all the Senior Sub Notes trade in line with the 12% PIK Notes at 63. On a LTM basis,
you can buy in at the 12% PIK Notes’ level for 7.8x. But to smooth out the even and odd years it is probably
best to take an average for the last 24 months, in which case you can create the company at 6.4x. LIN TV
has Senior Sub Notes at 7.7x EBITDA yielding 8.8% and Allbritton has Senior Subs at 7.3x yielding 8.3% so
the NXST 12% PIKs are cheap compared to comps and well-.covered in a potential bankruptcy.
Page 12
Sohu.com, Inc. (LONG)

Matthew Cohen February 2010
macohen10@gsb.columbia.edu
Summary Statistics
Sohu Stock Chart
Stock Price (2/23/10) $48.48 $100
X Shares Outstanding 39.0
$80
Market Cap $1,891.3
+Net Debt (cash) ($563.8) $60
EV $1,327.5
$40
Sohu.com, Inc. (SOHU)
Price: $48.48 P / LTM EPS 11.4x $20
(Feb. 23, 2010) (LTM EBITDA - CAPEX) / EV 14.9%
$0
Matt is a second year MBA LTM EBIT / (NWC + NFA) 36.7%
Feb-05 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10
student and a participant in LTM Free Cash Flow Yield 9.2%
Columbia’s Applied Value Thesis:
Investing Program. Over The market questions the sustainability of SOHU’s free-to-play online gaming business model, doesn’t
the summer he worked at like the heavy reliance on a single hit game in a competitive market, and is leery of the recent slow-
Permian Investment down in online brand advertisements. But when you subtract off the value of SOHU’s 66% ownership
Partners and the investment stake in publically traded gaming subsidiary Changyou (CYOU) and the company’s $560mm in cash,
office of NY-Presbyterian we’re paying only $107mm (3.1x 2010E EPS) for all of the company’s popular internet properties,
Hospital. Prior to school, online advertising, and wireless businesses. Thus we can erase the gaming risk and create the internet
Matt spent one year in property stub by shorting out the CYOU exposure. The CYOU subsidiary also appears inherently
investment banking with J.P. cheap, based on a pharma-like runoff analysis of its upcoming games. All in all it seems we’re paying
Morgan and three years in very little for significant upside potential; SOHU is a Chinese growth stock trading at a value price.
private wealth management
Background:
with Goldman Sachs. Sohu.com Inc. (SOHU) is an Internet company that provides news, information, entertainment, online
games, and communication services in China. In addition to the main portal page Sohu.com, the com-
Matt holds a BA from
pany owns a number of other properties: 1.) Chinaren.com, a Facebook-esque school and alumni
Colgate University. social networking site; 2.) 17173.com, China’s largest & most popular online game blogging site; 3.)
focus.cn, a Chinese real estate site; 4.) go2map.com, a Chinese equivalent of Google Maps and 5.)
goodfeel.com, a wireless site that enables ring tone and picture downloads. SOHU’s revenue is com-
prised of 42% advertising, 47% massively multi-player online role-playing games (MMORGs) through
its Changyou subsidiary which it spun off as an independent company in mid-2009, and 11% wireless
services. Founded in 1996, the company is based in Beijing.
Investment Overview/Catalysts:
• Growing advertising opportunity: China’s population is 5x the size of the U.S. with 1.4 bil-
lion people. In 2008 China overtook the U.S. in number of broadband households and has an-
nual online household growth of 35% vs. 13% in the U.S. Despite this, Chinese online penetra-
tion is only 16% vs. 64% in the U.S. There is also a mismatch between the amount of time that
the Chinese consumer spends online (23%) vs. the amount of Chinese advertising spend online
(8%). As broadband penetration increases and the Chinese consumer spends more time online,
online advertising will increase and accrue to popular sites like Sohu. Population aging will also
help this trend, as younger generations are more computer savvy.
• Network effects in online gaming: Tian Long Ba Bu (TLBB) and Blade Online (BO) are two
of the most popular games in China (TLBB is #2). This community is growing rapidly, and be-
comes more valuable as more people join. Near-term switching costs increase as gamers spend
more under the free-to-play model.
• Biggest game is early in lifecycle: Popular online games in the past have delivered positive
growth for over 6 years, and TLBB was launched in 2007. TLBB’s content is updated weekly and
enhanced via expansion packs each quarter. Penetration into lower-tier cities is increasing as a
result of sales force efforts – TLBB and BO are proven concepts which can grow organically as
internet penetration increases.
• Investor friendly & incentivized management team: Unlike many of its Chinese competi-
tors, Sohu has maintained Sarbanes Oxley compliance each year since 2004 and has a share-
holder friendly IR department. The company has also repurchased shares in 5 of the last 6 years
Issue VIII Page 13
Sohu.com, Inc. (Continued from previous page)

and has $130mm remaining on a $150mm buyback. Founder & CEO Charles Zhang owns 19% of
shares outstanding, or $410mm worth.
• Undemanding valuation: Excluding gaming (CYOU) and cash, the remaining business is priced at
a P/E of only 3.1x next year’s earnings, which is a huge discount to all comps. CYOU itself is priced
at a P/E of 10.2x next year’s earnings, and this valuation does not properly reflect the growth op-
portunity from 4 new games that will be introduced in 2010, one of which is a sequel to an existing
popular game that is likely to be a blockbuster.
Valuation: “When you subtract
Using my own assumptions regarding Average Revenue Per User (ARPU) and growth in Active Paying
Accounts (APA) in a pharma-like runoff scenario (not pictured here), I estimate that current games are off the value of
worth 75% of CYOU’s enterprise value. In other words a buyer of CYOU is paying only 25% of EV, or
$400mm, for the value creation from all future games launched after 2010. As a second technique I esti- SOHU’s 66% owner-
mate a sum of the parts valuation for SOHU using downside, base, and bear cases depicted below. Fi-
nally, my DCF analysis suggests a price target of $67. More importantly for a buyer of SOHU that shorts ship stake in publi-
out the gaming exposure, I estimate the stub business to be worth at least twice the current valuation.
cally traded gaming
Sum of the parts valuation
2010E Net Downside Downside Base Upside Upside Case
Segment Profit Multiple Case Value Base Multiple Case Value Multiple Value
subsidiary Changyou
Branded advertising $25.8 9.0x $232.0 15.0 x $386.7 18.0x $464.1
Wireless $8.6 8.0x $68.9 12.0 x $103.3 15.0x $129.1 and the company’s
Gaming (after minority interest) $96.4 10.0x $964.2 18.0 x $1,735.5 21.0x $2,024.8
Subtotal $1,265.1 $2,225.6 $2,618.0 $560mm in cash,
Cash $563.8 $563.8 $563.8
Total equity value $1,828.9 $2,789.4 $3,181.8
Value per share $46.88 $71.50 $81.56
we’re paying only
Upside to current (3.3%) 47.5% 68.2%
$107mm (3.1x 2010E
What multiple is the market assigning to the non-gaming business?
Risk to thesis:
EPS) for all of the
• Borrow may become Q30 9 Sohu total revenu e
Q30 9 gaming revenue
$136.6
$68.7
CYOU Market Cap
Sohu market cap
$1,849.0
$1,891.3 company’s popular
expensive on CYOU Q30 9 non-gaming revenue $67.9 CYOU value at 66 % ownership $1,220.3
short. Currently indi- Sohu cash $563.8 internet properties,
cated at 88bps with Q30 9 Sohu total EBIT margin 38.5% Implied non -gaming market value $107.1
plenty of inventory on Q30 9 gaming EBIT margin 62 .0%

Non-gaming 2010 revenue $284.9
online advertising,
Interactive Brokers. Gaming % Rev 50 .3% Non-gaming 2010 EBIT $41.9
• Ability to profitably rein- Non-gaming % Rev 49 .7% Non-gaming 2010 Net Income $34.4 and wireless
Goal seek to non-gaming margin 14.7% Implied earnings multiple 3.1x
vest large cash balance,
and risk of transforma-
Sohu.com Inc. (NASDAQ: SOHU) businesses.
2009 2010 2011 2012 2013 2014
tive acquisitions. Total Revenue 515.3 606.0 757.5 909.0 1,036.2 1,139.8
• Content regulation from % growth 20.1% 17.6% 25.0% 20.0% 14.0% 10.0%
the Chinese government. EBIT Margins 39.7% 34.0% 32.0% 31.0% 30.0% 30.0%
• A dramatic slowdown in EBIT

Tax Rate
204.4
(14.0%)
206.0
(18.0%)
242.4
(19.0%)
281.8
(20.0%)
310.9
(22.0%)
342.0
(25.0%)
the Chinese economy Tax (28.6) (37.1) (46.1) (56.4) (68.4) (85.5)
will hurt advertising NOPAT 175.8 168.9 196.3 225.4 242.5 256.5
revenues. D&A 20.0 23.5 27.5 30.8 32.7 33.3

• If considering a straight Minority Interest (26.8) (41.7) (49.2) (59.1) (67.4) (74.1)
long of SOHU, consumer CAPEX (20.6) (21.2) (22.7) (27.3) (31.1) (34.2)
preferences can be fickle FCF 148.4 129.5 151.9 169.9 176.7 181.5
and the CYOU subsidi- Discount Rate 11.0% 11.0% 11.0% 11.0% 11.0%
ary may not be able to
PV of FCF 148.4 116.7 123.3 124.2 116.4
maintain the popularity Terminal Value @ 12x 2014 2,177.8
of old games. Barriers to
% of total % of Current EV
entry in online gaming NPV of 2009 and 2010 265.1 13% 20%
are low and the space is NPV of 2011-2013 363.9 18% 27%
NPV of 2014+ 1,434.6 70% 108%
very competitive. Total NPV 2,063.5
Net Debt 563.8
Operating Value 2,627.3
Operating Value/share $67.17
Current Price $48.48
Upside 38.5%
Page 14
“The Belt & Suspenders Guys” - Tweedy, Browne

(Continued from page 1) I think they thought that I to coming here was for a
Bob Wyckoff: I attended was interested in this ap- guy named Jerry Tsai, who
Washington & Lee Univer- proach. As I think with was one of the famous go-
sity and I have a law degree most people who end up go fund managers back in
from the University of Flor- joining Tweedy, if we run the 60’s. He ran the funds
ida. I practiced law for a into people that we think up at Fidelity and made a
few years before getting are interesting and would huge name for himself.
into the investment business make a good addition to the
in 1980. I got my start in firm, we don’t have to be in Afterwards, he went out
the investment business at the middle of a formal em- and started a mutual fund
William Browne has been
Bessimer Trust Company, and raised an absolutely
with Tweedy, Browne
where I was for about five staggering sum of $200 mil-
since 1978. Mr. Browne
years before I moved on to lion. He would run from
received a B.A. from Col-
a couple of other compa- the ticker to the order
gate University and an In Money
nies. When I first got in this room and I would run be-
M.B.A. from Trinity Col-
business in 1980, one of the hind him, jotting down the
lege in Dublin, Ireland. first books I read was Masters, by John justification for what he was
Money Masters by John going to do. I used to come
Train. In the book, there Train, he over to Tweedy at lunch
was a chapter on Ben Gra- time, and I insinuated my
ham and a sub-chapter on described Tweedy way in over here and the
Tweedy Browne where rest is history. To para-
Train referred to Tweedy Browne as “the phrase Buffet, “what you
Browne as the pawn broker need in life is a good idea”
of Wall Street – a place pawn broker of and this firm has a good
where desperate sellers idea.
went to get a bid on stocks.
Wall Street - a
John Spears: I started
His description of Tweedy
place where investing at a very young age
sounded very interesting to – I think about 11 or 12
me. Here was a firm that
desperate sellers years old. I saved up about
owned, at least in those went to get a bid a $1000 mowing lawns and
days, smaller-capitalization selling Christmas cards door
companies. They diversified on stocks.” -to-door. My grandfather
with under-covered, under- introduced me to the finan-
researched issues. I thought cial pages; he taught me
that just sounded right; it what an eighth was. He was
made sense. I little bit later an investor in stocks and I
I read Buffet’s article – the ployment search to take thought this was just an easy
Super Investors of Graham them on. way to make money with-
and Doddsville – and it was out physical effort. So, I
like turning on a light bulb. William Browne: I proba- started investing and I hung
bly have a more checkered around brokerage firms. I
One day I tried to refer a path in terms of experience recall spending a lot of time
client to Tweedy Browne, prior to Tweedy Browne. with the worst performing
and unfortunately, Tweedy Obviously I had been some- salesman – he would spend
didn’t get the client - they what marinated in the value time with me and answer
got me. That was in 1991 investing approach to the my questions. The first few
and I’ve been here ever world by virtue of who my investments that I made
since. I had started talking old man was. One of the worked out pretty well,
to John, Will, and Chris and places where I worked prior (Continued on page 15)
Issue VIII Page 15
Tweedy, Browne
(Continued from page 14) into closed-end funds, sell- Associates, run by the late
even though I didn’t know ing at 60 or 70 cents on the Bill Berger of Berger funds.
what I was doing. My first dollar and just realized I I worked there for three
investment went up 50%. didn’t like selling, I didn’t years and learned about
That was fun, but I had a like the ethics of it. Any- Tweedy Browne from Bill
few losers too. way, I quit, but I probably Ruane, who ran Ruane Cun-
would have been fired if I niff, who I had met through
I started reading Security hadn’t. my job as a junior analyst.
Analysis and taught myself
accounting in high school. I After that, I started up a He asked what I did with my
Thomas Shrager has been
could grasp that it made own money and I men-
with Tweedy, Browne
sense to buy into companies tioned this little partnership
since 1989. Previously,
selling below their net cash I was running and he said,
he worked in M&A at
and you get the business for “you should really meet
Bear Stearns and as a
free. So, I started looking those people at Tweedy
consultant at Arthur D.
around for stocks at $5 or Browne.” And, I said, I see
Little. He received a B.A.
less, trading below net-cash that name all the time in the
and Masters in Interna-
and did pretty well. I felt pink sheets and the blue
tional Affairs from Co-
like a rich-kid in high school “My personal book – they own the same
lumbia University.
and really didn’t want to stocks that I’m interested in.
finish high school, but my point of view is That led to meeting one of
parents insisted on it. I got our retired partners Ed
impatient and bored with it. that you accept Anderson and then I got a
job working for Tweedy
I learned that at the Drexel that investing is Browne in 1974 for maybe
Institute of Technology, you three years. Then, I got the
could design your own cur- not a natural great, great blessing to be-
riculum; you didn’t have to come a partner the follow-
take all the liberal arts science but rather ing year – at the same time
courses – you could just that Chris Browne became
specialize. I set out a cur- a social science.” a partner. It’s really been a
riculum for myself to just blessing and a stroke of
take accounting and finance enormous good luck in my
courses and took each one life.
that they offered. I also
went to some summer G&D: We’ll move to in-
school courses at Wharton vestment approach now.
and at St. Joseph’s night Clearly, Graham & Dodd
school, where I took a little investment partner- have been a huge influence,
course in cost accounting. ship, where I put in $3,000 but I’m sure there have
So, I basically took all the of my own money and other been other influences as
accounting and finance people put in $30,000. I well – Walter Schloss or
courses offered, primarily at drove an airport limousine Warren Buffet. Can you
Drexel. at night to support myself. talk a little bit about your
The fund specialized in Ben investment philosophy and
I didn’t have to go to Viet- Graham type stocks – all how you view value invest-
nam and I took a job as a below net-cash and way ing?
trainee at a New York bro- below net current assets. It
kerage firm. I stayed at it did pretty well and it led to WB: An awful lot of ink
for nine months and I got a a job as a junior analyst at a has been used in order to
few clients, putting them firm called Berger, Kent (Continued on page 16)
Page 16
Tweedy, Browne
(Continued from page 15) ity about being able to pre-
find a multitude of ways to You can look, as we do, at dict the future. It’s not ter-
expand upon what is a sim- comparables and in order to ribly complicated. I think
ple idea that when you in- improve your chances of the more difficult part of it
vest, what you are doing is being right, there are lots of is either you accept it or
buying an interest in the different things that different you don’t.
business. If you accept that people do. One of which,
framework and that lens, from our perspective is G&D: Has your approach
that will drive everything changed over time? You
John D. Spears joined that you do in terms of referred back to Graham’s
Tweedy, Browne in analysis or figuring out what statistical approach.
1974 . He previously the business is worth if you
worked at Berger, Kent accept the simple concept WB: We were net-net
that the value of the invest- “By focusing on a guys. Going back, that’s
Associates, Davic Associ-
ates, and Hornblower & ment is the business and not basically what we did.
the price at which the stock business, I think
Weeks-Hemphill, Noyes
& Co. Mr. Spears studied is marked at on any given JS: In the mid 70’s, we had
day. It’s that concept and that you have a a lot of stocks that were
at the Babson Institute of
Business Administration, that drives everything else two-thirds or less of cur-
you do; you try to analyze a
better chance of rent assets, net of all debt.
Drexel Institute of Tech-
business. There are lots of A lot of those were turning
nology, and the University
good things that flow from
being right – you didn’t have to do
of Pennsylvania—The
that. much analysis of the busi-
Wharton School. because a ness. If the price of inven-
My personal point of view is business, like tory for a bunch of elec-
that you accept that invest- tronic vacuum tubes or la-
ing is not a natural science many other dies dresses, plus the cash
but rather a social science. and the receivables checked
So, it’s never purely empiri- things in the out, you didn’t even need to
cal; what you are trying to make a call to the manage-
do is everything you possi- world, has a ment.
bly can to enhance your
probabilities of being right value.” WB: We had a treasure
more often than being chest of those things that
wrong. had been accumulated over
time. We would go around
By focusing on a business, I and vacuum up all these
think that you have a better cheap stocks. Lo and be-
chance of being right be- avoid highly leveraged busi- hold, in the mid-to-late 70’s
cause a business, like many ness because at points of a lot of guys, and I won’t
other things in the world, strain in an economy, it’s mention their names, who
has a value. Graham origi- the leverage that takes you eventually blossomed into
nally used a statistical ap- down. It all comes from the big leveraged buyout
proach looking at net-nets this basic, simple idea: figure people in the late 70’s and
or a liquidation framework. out what the business is 80’s start showing up at our
Warren Buffet’s approach worth and then see if you door to see if they could go
may have a longer look into can buy into it at a discount. through the files.
the future, but you are es- Be diversified – we accept
sentially trying to buy the the idea of being diversified, JS: We did some consulting
business and figure out what because I think we have a with those people.
the business is worth. very healthy sense of humil- (Continued on page 17)
Issue VIII Page 17
Tweedy, Browne
(Continued from page 16) to it. They were generally value, with almost no debt,
partnerships and a couple of and was around 5x earnings.
WB: John started saying, them would show up; you So, it was maybe 20% return
“what are you guys doing?” would actually be able to sit on debt-free equity and a
Tell us how you do it – there and listen to the two very steady earner. We
what’s going on here; of them go back and forth looked at some deal values
what’s the arithmetic? They with some of our old part- and it looked cheap, so we
sort of laid out the process ners. They would sit there bought into that one.
and how you go about valu-
ing a business as an operat- G&D: So has your invest-
Bob Wyckoff joined
ing entity and the capital ment philosophy and invest-
Tweedy, Browne in 1991.
structure of it. What the ment characteristics evolved
Prior to joining the firm,
income stream is and what over time? Have you gone
he held positions at Bes-
that can support. They from the net-net stocks and
semer Trust, C.J. Law-
walked us through their “Today, a bulk of the net-current assets to
rence, J&W Seligman, and
process – everyone knows focusing more on good
Stillrock Management.
what it is now; it’s basically the assets are at quality companies?
He received a B.A. from
what private equity guys do
good quality, Washington & Lee and a
– it’s very simple. WB: I would say no, not
J.D. from the University
entirely. I’d say that it is still
JS: But, at that time, look- pretty steady some of both. But, today, a of Florida School of Law.
ing at a business in terms of bulk of the assets are at
its whole capital structure, earning, and high good quality, pretty steady
where it’s not just simple- earning, and high return on
minded price/earnings ratio, return on capital capital businesses that do
which is after interest ex- have a tendency to grow a
pense. You could have a businesses that bit.
very, very leveraged com-
pany that would be at a low do have a WB: But, the business has
price/earnings ratio. But, if evolved from simply being
you looked at enterprise tendency to grow more of a statistical process
value, adding in interest- in the late 1970’s/early
bearing debt to the value of a bit.” 1980’s into a somewhat
all the shares – looking at larger view of how you go
that as a multiple of operat- about looking at things.
ing profits after taxes, it
would be a very high multi- TS: It was first that the net
ple. So, the LBO people -nets disappeared and the
and some of these young and debate, asking why second thing, because we
tycoons that we were deal- would you want to own this learned from a number of
ing with were very instruc- piece of junk when this one people how to value these
tive about that. actually earned something businesses that trade at a
on its capital. It was very premium to book or net
WB: The other thing we interesting to sit there and current assets.
had early on in those years, listen to that discussion.
again I won’t mention their WB: And that has resulted
names, were some very JS: I remember Chris in us taking this approach to
successful investors imple- Browne coming up with a global, world-wide model.
menting this idea of buying a Binny & Smith, the crayon
good business using the producer - Crayolas. I think TS: But the framework
business valuation approach it was selling at under book (Continued on page 18)
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Tweedy, Browne
(Continued from page 17) very DCF-type approach, important part of the invest-
stayed the same. There are but then a lot of value inves- ment framework?
two prices to stocks: the tors will then say DCF is
one using the stock market actually very tricky to actu- JS: On average, in my view,
and the one you would get ally implement. looking at screens over the
in a private market transac- years a fair amount, I think
tion. You still want a 30% TS: We don’t use DCF – that leveraged companies
discount from that intrinsic there are too many vari- can be on a total enterprise
valuation. ables. basis, sometimes more ex-
pensive, in addition to being
BW: It’s a mix, and that WB: When you look at riskier. Let’s say you have a
may be one way that we are the multiples people have debt-free value of $100 per
a little bit different from paid for businesses, I’m will- share, but you have debt of
some of our competitors. ing to bet that there has $50 per share. So, you’ve
You will still see net-nets in been, amongst all the analy- got a net value of $50. So,
our portfolio when they are ses these guys do when they let’s say you buy that at two
“The Tweedy available. Today, you can buy a business, there is -thirds of the $50. That’s
buy them in Japan in small- probably a DCF analysis roughly $30, so you’ve got
portfolio tends to cap stocks and you will see floating around in there $20 as your value spread.
some of those in our port- somewhere, which comes But, that’s only 20% of $100
be a few folio. You’ll see very high and backs its way into these total. So, if you have a lev-
quality business like a No- multiples that you are pay- eraged capital structure and
variations on the vartis, J&J or a Nestle, which ing for businesses. But, as you are buying things at a
value theme, but are pretty attractive, high sort of a handy tool, a handy one-third discount after
quality long-term growers, measure of what people subtracting the debt, your
with a deep value and then you’ll see some so- have been paying, you can gross margin of safety on
so businesses in the portfo- look at multiples. the debt-free amount is
orientation lio – sometimes it’s a full- reduced.
blown business appraisal, JS: If an LBO buyer has a
coupled with sort of LBO-type of analysis five-year time horizon, WB: The other thing too
that they’ve been talking they’ll make a guess about is that if you’re in the busi-
diversification.” about. Sometimes it’s a net the terminal number and ness and again, predicting
current assets type of analy- multiple that they expect. the future is always hard,
sis. They will guess that in year but if your business goes
five, EBIT or EBITDA will be limp so to speak and you
Sometimes we are buying “x” and they’ll slap some are not too hopped up,
cyclical companies at a deep sort of a multiple on it and you’ll get through that pe-
discount to book value and there is your blast exit cash riod. If you’re all hopped
letting them go at book. flow. That’s your dis- up, particularly if you are a
The Tweedy portfolio tends counted cash flow model high fixed-cost, low variable-
to be a few variations on and then you’ve got the cost sort of business, we all
the value theme, but with a years in between. How- know where the sharehold-
deep value orientation cou- ever, it’s still human beings ers stack up in terms of the
pled with diversification. doing all this stuff and multi- guys with the claim on the
ples can change in the busi- company and you’ll end up
G&D: You were talking ness acquisition market. with the short end of the
earlier about the LBO stick. So, yes, leverage is
model and you mentioned G&D: I’ve read that you important to us because
learning the tools of an in- focus on buying companies that’s what can lead to real
vestment banker at Bear with good capitalization and problems for you.
Stearns. That is typically a balance sheets. Is that an (Continued on page 19)
Issue VIII Page 19
Tweedy, Browne
(Continued from page 18) running more and more yield on the total purchase
concentrated portfolios and price. Then you can say to
TS: Let me clarify some- we are not doing that. So, yourself, in terms of com-
thing. The fact that we when you think of us, the mon sense, was this really a
learned from people who culture here is extreme great price? Do I want to
are involved in LBO’s, which price sensitive, a cautious slap an after-tax 4% yield on
is part of what we know, approach to valuation, cou- everything? Is that sustain-
doesn’t mean that we like able as a multiple?
leveraged companies.
WB: The ownership arith-
JS: That’s a very critical metic.
point. The margin of safety
idea is very important. You JS: Yes, the ownership
lose 50% on something and arithmetic. So, during the
you’ve got to go up 100% to height of easy credit of
recoup it, and we are in- “What you are 2006/2007 when deal multi-
vesting our own money in ples were expanding at 20-
our portfolios that are com- trying to do when 25% of what they had been
bined with our clients and typically in prior years, if
separate stocks that are you are looking you did some of that
owned by those portfolios. owner’s yield arithmetic,
So, it’s real. at the business is and you knew what was
going on with the lending
BW: I would just add that you are trying to standards and easy money,
when you think of us and easy covenants, all that stuff,
the community of value understand the it makes you a little bit cau-
people, I tend to think of us tious about slapping on
as the belt and suspenders
competitive these new high deal multi-
guys in terms of valuation. ples. You have to look at
We tend to value businesses
advantage.” reality, you have to look at
cautiously. Thus, regardless what the market is. If we
of what we observe being were selling a business, we
paid, if it seems to be esca- would push for the highest
lating and seems unreason- price. You need to use
able, we are going to haircut common sense.
it. In doing our valuation
work, you’ll see the diversi- pled with diversification. TS: So, what that results in
fication that we use, the as a practical method for
avoidance of overleveraged JS: I think you can also say the vast majority of compa-
businesses for the most sometimes that we maintain nies is EBIT multiples be-
part. You don’t see concen- skepticism about acquisition tween 9x and 11x.
tration. valuations. An interesting
exercise is to take a deal G&D: We’ve talked a lot
These days, what seems to multiple of EBIT or EBITDA about valuation, but can we
be more common in the and then convert that to the talk more about how you
investment world and Buf- yield on the total purchase judge the quality of a busi-
fett speaks of it – is putting price. Take the operating ness and what are the char-
your eggs in just a couple of profit or EBIT and then ap- acteristics that you would
baskets and watching them ply a tax rate to it and get like to see if you are willing
very closely. More and your operating profit after- to pay 11x EBIT for, versus
more value investors are tax and look at that as the (Continued on page 20)
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Tweedy, Browne
(Continued from page 19) you two guys were in here TS: We are concerned
9x EBIT or lower? selling copper, from two with whether the reputation
different companies, all I of the business will stay in-
TS: It’s really tough to put care about is who can sell tact. However, this is a
it into neat boxes. But, me copper at a penny a broad spectrum. We make
what you are trying to do pound less. It’s that simple. a point in every single in-
when you are looking at the It’s a crummy, crummy busi- vestment we make, to talk
business is you are trying to ness. You try to think to somebody at the com-
understand the competitive about businesses where pany.
advantage. Who are the there may be some charac-
competitors? Are there any teristics to it that will enable BW: And we try to avoid
disruptive competitors com- you to compete on some getting into bed with people
“But, sitting down ing into the market? What basis, other than you can who we think are going to
is the mix between pricing just bring it to me cheaper hurt us in some way. And
across the table and volume; do you have than the next guy. Whether over the years, we have paid
volume increases, followed there is a concept about it, a lot of attention to pat-
from a media by big price declines – whether there is a habit that terns of insider buying. We
what’s the math there? is embedded in the cus- like to see CEO’s and
trained CEO, who What’s the history of gross tomer; and, of course, CFO’s in particular, buying
is impeccably margin and why has it gone whether you could open the shares right along with us.
up or down? Are these newspaper and read that Those kinds of things inter-
dressed and more things sustainable over long you are out of business es- est us. But, sitting down
periods of time? sentially because someone across the table from a me-
articulate than we has leapfrogged you. dia trained CEO, who is
Then you look at the oper- impeccably dressed and
are. Are we going ating costs and you are try- We like to think that we’ve more articulate than we are.
ing to understand how effi- developed a level of sustain- Are we going to learn a lot
to learn a lot from cient the company is in ability about the business from that?
terms of running the busi- over extended periods of
that?” ness. You are trying to look time. By and large, that kind WB: You are going to
at fixed to variable costs of leads you in one direc- learn what you want to.
ratio. In other words, you tion, versus the other. On
are trying to find out if a 5% average, you would prefer G&D: How often do you
drop in sales would wipe to be in something other consider the macro or secu-
out profitability or whether than a raw commodity. But, lar picture when you are
there is much more flexibil- we’ll buy a raw commodity looking at new investments?
ity in the cost base. In or- if you really think it’s cheap
der to understand all these enough. On the other hand, BW: We read and we are
things, you talk to the com- we prefer things that you aware, but it doesn’t play a
pany, you talk to analysts, burn, smoke, eat, drink; large role in our analysis.
and you sometimes talk to wear out kinds of busi- We tend to start at the
customers and suppliers. nesses. bottom. We tend to start
So, it’s like putting a puzzle with price and relationship
together. G&D: Does management to value. We start with
make a major impact? Are screenings of securities all
WB: Most of our busi- you closer to Graham, or over the globe. It’s rare
nesses are differentiated in are you closer to Buffett on that we come up in our
the mind of the customer management? heads with some macro
and some businesses just theme and decide we are
aren’t differentiated in the BW: Closer to Graham. going to go fish in that pond
mind of the customer. If (Continued on page 21)
Issue VIII Page 21
Tweedy, Browne
(Continued from page 20) no question about it, im- every day – they’ve got as-
because of some idea we pacted to a degree by sets, they’ve got capital,
may have of where the macro developments, de- they’re deploying it, they’re
world is heading or what pending on the severity of making things, they’re selling
this particular innovation them, they aren’t going to things, they’re doing all
might mean for a specific be knocked out of the game sorts of things. To me,
industry. by it. those are very tangible and
hard assets. However, they
WB: We certainly don’t Also, if it’s a pretty good are not inert assets. To me,
build a macro thematic business, maybe there are that’s a much better hard
framework. One, we don’t some guys who are knocked asset than storing away cop-
do that. Two, I suppose at out of it and maybe you’ll per bars or oil in a boat, in
the end of the day, you end up with a slightly better the straits of Malacca.
could probably conclude edge. Now, volatility is “I think that the
that we are optimists. We something that always wears JS: You get a yield on it. If
don’t think that the world is a lot of people down. someone buys Johnny key to being
going to end. I do take a That’s one of the reasons Walker scotch, we make
certain level of comfort in you see markets do what some money on every successful as a
the fact that we invest they do. But, you can’t es- drink. People have to buy
around the world. So, we cape it. insurance every year, and value investor is
are not locked into any par- we own some businesses in
ticular marketplace. Now, I JS: We’re in the macroeco- that field. To me, it’s great this willingness to
think inevitably you are im- nomic boat. If there is going to have things that produce
pacted by the macro world to be inflation, we’re going stuff that people really need accept the near-
to some extent. Businesses to have inflation. If interest every day.
operate in a macro world rates are going to rise, term randomness
and they are impacted. Pre- they’re going to rise. If P/E WB: There may be a cor-
dicting which way it is going ratios are going to come porate CEO, who wakes up that goes on in
to go at any given point in down because interest rates one morning and looks at
time is very difficult. I think are going up, we’re all in his wife and bursts into our markets.”
that in sort of an indirect that. tears and says, “Honey, I
way, we address a lot of just can’t take it!” But most
that by the nature of the WB: I had a friend a while guys are going to wake up
things that we end up in- ago and he was up to his and say, “I’ve got a pile of
vesting in. eyeballs in gold and platinum assets. I’ve got a pile of
and other precious metals capital. I’ve got these assets
We tend to be invested in, and he was really feeling that are earning capital. I
as we said, businesses that good – he had made a lot of have to think about what I
have fairly sustainable de- money. He says, I want to am going to do with them
mand characteristics and own hard assets. But, the to stay ahead of the game.”
have the wherewithal to get fact of the matter is that So, it’s real; it’s organic.
through difficult periods of when you own a business, it
time. And when they come is a fairly hard asset. This is BW: As Will likes to say –
out the other side of it, sort of a silly analogy, but business adapts much more
businesses that will have I’m going to take you over quickly than governments to
prospects that we ex- to corporate headquarters problems that are out in the
pected. We are on average at Diageo and bang your marketplace. He also made
right, more often than we head against the door. I another good statement
are wrong. We understand think you’ll find that to be that I think is important,
the nature of the business. pretty hard. It’s organic. that we are generally opti-
While those businesses are, There are guys waking up (Continued on page 22)
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Tweedy, Browne
(Continued from page 21) not well wired for investing vartis, in one form or an-
mists. I think that the key in many respects – we suffer other, for 20-25 years.
to being successful as a from anchoring on recent We’ve owned J&J for a very,
value investor is this willing- news, confirmation bias, etc. very long period of time.
ness to accept the near- and these all work against Because these businesses
term randomness that goes you in stress periods. are compounding their in-
on in our markets. And to trinsic value, right along
be able to emotionally deal It’s very important to have with their stock price over
with that and accept that an anchor. You’ve got a time. But, if it’s a cyclical
that is something that goes shot at being objective as business like we’ve talked
along with investing. If you opposed to being tossed about, we are typically buy-
are willing to do that and into the panic pot. Then it’s ing it at a big discount to
able to do that and accept all up for grabs – that’s book and then trading it out
“ Emotionally that kind of volatility, then when you are really going to at book. If it’s a net-current
the spreads that we can get it wrong. Whatever it assets stock, we’re buying it
people are drawn make and the kind of invest- is, you’ve got to get a proc- at a discount to net-current
ing that we can do are ess where you can anchor and trading it out at net-
to what they think much, much larger than the your thinking because all of current. But, I’d say if you
spreads these quants are this external stuff grinds made a general statement
they can control trying to make in the short away at your objectivity – about turnover in our port-
run, where they have to use every single day in down folio, its average over time
and that’s a whole lot of leverage for it markets. Up markets, you at about 20% or less.
to make sense. all just walk around thinking
typically
you are smart. But from WB: There is an anomaly
something in the Ultimately, what we are our point of view, you’ve with average mutual fund
doing, I think is a lot safer got to have the objectivity turnover. The highest turn-
short run. and we sleep a lot better at too, because sometimes over is typically found in the
night, knowing that our valuations just get foolish growth fund category, which
Something they whole business is not built and you’ve got to be willing you would think, just as you
upon a foundation of lever- to walk away. go through it logically would
think they can see age. But emotionally, and I be lower because those
think this has been happen- G&D: You mentioned time companies are growing and
an immediate ing over the last 10-15 horizon and how that was wouldn’t need to be traded
years, emotionally people critically important and how out of.
result from.” are drawn to what they it sets you apart from other
think they can control and investors. What is your BW: You’re confusing
that’s typically something in time horizon? growth with momentum!
the short run. Something
they think they can see an BW: I don’t think we WB: No, they don’t say
immediate result from. would put a number on it, anything about that! The
but typically we own stocks ideal stock, if you are in the
WB: But one of the things for three to five years or unenviable position of being
that gives us an edge is that longer. Sometimes stocks a taxpayer, is that you buy a
when we come into the get taken away from us in stock and own it forever.
office in the morning, we takeovers. If it’s a com- Now, I’ll put words in John’s
know what we are going to pounder, one of these bet- mouth - John’s time-horizon
do. We’ve got a frame- ter businesses we’ve talked is his funeral – Buffett’s is
work. A lot of these books about where the intrinsic eternity. But we don’t have
about how we are wired as value is compounding over a time horizon. That goes
creatures are very interest- time, we can own it indefi- back to something I always
ing to read. And people are nitely. We’ve owned No- (Continued on page 23)
Issue VIII Page 23
Tweedy, Browne
(Continued from page 22) through and say which ones people think that if you di-
found interesting. The you like. You can say you versify, you are the market.
problem with a lot of peo- like this coke bottler at 9x So, how do you add value?
ple – individual investors earnings. It’s debt-free, it’s If you look at our portfolios
and I’ve seen it with nieces in Mexico, and they’ve got – despite the fact that we
and nephews and cousins – 85% of the market, and they may own 50 or 60 stocks
is that they’ll own four or have a great delivery system and sometimes even more
five stocks and they’ll have a going to all of the bodegas, depending upon where
stock that sits around there which is hard to compete value is showing up, the
and it doesn’t do anything with. You compare that to portfolios tend to not look
for a year-and-a-half and anything like the market
then they’ll sell it. I’ll ask index. Its multi-cap, and the
why, and they’ll say because weightings and industries
it hasn’t done anything! are vastly different. So just
My friends are making because you are diversified
money in all these other by issue doesn’t mean that
stocks. Regardless of what you have a portfolio that
the considerations were for looks like the market. And
going in and that they have- you can’t simply assume that
n’t changed, this emotional “Don’t confuse because you own a lot of
dimension comes back in. I stocks, you can’t do well.
think one of the nice things diversification by The S&P 500 over long peri-
about being diversified is ods of time has beaten 80-
that we own enough stocks issue with a 85% of professional money
– we have about 67% of the managers. Probably the
portfolio in 25 names and it portfolio that greatest mutual fund inves-
sort of trails off from there. tor we’ve known or heard
You’ve got enough stocks looks like a of over the years is Peter
with stuff going on that you Lynch of the Magellan Fund
don’t have to obsess over market.” and he had 1,000 or 1,500
the ones where nothing is stocks in his fund. So, don’t
going on as long as you confuse diversification by
think the rationale for being issue with a portfolio that
there hasn’t changed. But, looks like a market.
with individuals, it’s very
amusing –“Oh, I’m sick of G&D: We would like to
that stock. I want to get talk a little bit about your
out of it and I’m going to get portfolio. One of the things
out of it right away as soon some cell phone company in we noticed was that you
as it gets up to what I paid a lesser developed country have a lot of capital invested
for it.” where prices go down at a in Consumer Products com-
rapid rate. You’ve got po- panies. Maybe you could
JS: When you have a lot of litical instability and funny talk about one of the names
holdings in your portfolio, insider trading. Which one you own or about the in-
you can compare things to seems simpler? What grabs dustry in general and how
what you already own and you more? You can do that fits the framework that
be reminded of the integrity those sorts of comparative you all find attractive?
of the story and why you judgment exercises.
went into something. Or TS: I think it is much more
when you are considering BW: I would make just important when you look at
something new, you can go one point, though. A lot of (Continued on page 24)
Page 24
Tweedy, Browne
(Continued from page 23) to overcome the same is- And I want to emphasize
consumer products compa- sues with distribution, mar- Tom’s point that they sell
nies, is to understand what keting, packaging – all those products that these aspiring
is attractive. If you are talk- kind of things that are im- middle classes that are com-
ing about food, beverage, portant to those markets. ing up in emerging markets
and personal care compa- A very good example is want to own. Companies
nies, which represent a big Nestle, which gets more like Coca-Cola FEMSA,
part of our portfolio, where than 30% of its income from which is selling coke, water,
you have to look is how developing countries. It has and beer to people in Latin
many billion dollar brands America. Companies like
they have. Because once a Philip Morris International
brand becomes big, it gets that is selling tobacco all
economies of scale. Your over the world. You’ve got
marketing may be less than Novartis selling pharmaceu-
it would otherwise be. You ticals; you’ve got Nestle and
get economies of distribu- Diageo, and if you went
tion. You get a number of right on down the list and
advantages. looked at the percentage of
“People do, I revenues that are coming
Second, you would have to from these faster growing
look at categories. There think, on average parts of the world, it’s sur-
are certain categories that prising. We often like to
grow and ones that don’t want to buy what say that if Nestle wasn’t
grow. You want to have headquartered in Vevey,
your products in those cate- is perceived as a Switzerland, but was head-
gories that grow faster than quartered in Shanghai, it
the market. These food, symbol of a better probably would sell at twice
beverage, and personal care the current multiple. But,
products grow below GDP product. ” interestingly enough, it’s
in the developed world. For benefitting significantly from
example, if you are in pet growth in these emerging
care, that grows much faster markets. So, it’s often a
than GDP. Water, at least cheaper and safer way to
until a year ago, grew much get the benefit of those
faster. And it shows that markets.
things can change within the
categories. Then, things like WB: Generically, if you
ketchup are not growing more than 30 billion dollar think about it, they tend to
faster than GDP. So, the brands, and it is generally in have multiple sources of
categories are very impor- categories that grow a little income, multiple products,
tant. bit faster than the market. and they are constantly
It has tremendous market coming out with iterations
Three, the geography - the share because of those of products to maintain
more emerging market ex- brands in the categories in their market share. Most of
posure you have, where you which it operates. them tend to be big compa-
have a rising middle class, nies, which already have
the better off you are going BW: I might just add that a very strong holds on shelf
to be. Having a strong number of these companies space, which is always a
emerging market exposure are reasonably priced. They hard thing for a new prod-
is not an easy thing to tend to be steadier. Many uct to get. You couldn’t
achieve, because you have of them are underleveraged. (Continued on page 25)
Issue VIII Page 25
Tweedy, Browne
(Continued from page 24) Reynolds, and Axel ness.
come out with Shrager Springer. We are curious In the case of Axel Springer,
ketchup tomorrow and ex- about those types of busi- its main asset is a national
pect to get into A&P or nesses and what has led you newspaper called Bild, which
Kroger. to some investment there. is sort of a tabloid newspa-
per that gets sold all over
BW: Again, they are prod- TS: The Roman Empire Germany with local editions
ucts that are typically less disappeared after the split and they don’t have any
discretionary. And, one of over 1200 years. It split in competition for that. So,
the things we do during 300 AD and then the Byzan- it’s a very unique newspaper
these tough economic times tine Empire disappeared in where the circulation de-
is have endless discussions 1500 AD, which was a rela- clines have been very, very
about trade-downs, and tively long period of exis- moderate for a long period
when people trade down, tence before the time of of time. They can reach a
will they trade back up? decline. You have to look larger audience than the
Sometimes the companies at it company by company. most popular TV program
will come out with various There is no question in my that you have in Germany
price points to sell. But, I’m mind that we held certain by a factor of three or four.
telling you that the trade- media stocks too long. So, advertisers value that.
down/trade-up issue was as Some of them were too So, it’s not the number-four
vibrant in 1976 as it is to- illiquid to get out of. But, I newspaper in a market that
day. People do, I think, on think that we are in rela- is already declining; it’s the
average want to buy what is tively good shape with the number-one with nobody
perceived as a symbol of a media companies that we else behind it, except some
better product. While own now. serious national newspapers
nothing is given, on average that people increasingly
they seem to have, from our I would start with Schibsted don’t read.
point of view, better prob- in Norway. It’s a monopoly
abilities about the future situation where there are a They also have the biggest
than other types of busi- couple of television stations, magazine business and that
nesses. As a group, they but the most important by itself wouldn’t be such a
tend to have better returns thing is that more than 50% good business, but they are
on capital. They are rein- of operating income coming increasing the access of
vesting the capital. They from the internet. So, they their magazines online. For
have, albeit in an uneven have made a transition. example, they have the Auto
fashion, businesses that They have a site that is Bild, which is the car maga-
grow. They grow with the more popular than Google; zine that they have. They
world, they grow with the they have some destination have the Auto Bild site,
population. They find ways sites, including a financial which is the most viewed
to squeeze costs out. website that is extremely automotive site. If someone
There is just a multiplicity of popular in the Nordic coun- wants to buy a car, they are
things that they are tapping tries. They have been able much more likely to go to
on to try and keep the busi- to achieve that because they their site. They have the
ness going. started investing in the mid- second best real estate
1990’s and because people online site, which they de-
G&D: One of the things we in the Nordic countries are veloped from their newspa-
noticed in the portfolio is much more internet savvy per pages. So, they have
that there are a few busi- than other regions of the successfully expanded out-
nesses that are sort of in a world. So, they capitalized side of Germany, where
secular decline that you on that in order to build a they have done very well,
own, such as Philip Morris, very profitable internet busi- (Continued on page 26)
Page 26
Tweedy, Browne
(Continued from page 25) is 55 years old. Thus, as the you are being given another
unlike other companies. population is aging, the de- opportunity to buy these
Overall, it’s a very special mand for medical services pharmaceuticals at attractive
type of situation. and pharmaceutical prod- prices. There are all these
ucts will grow. The ques- patent roll-offs that you
G&D: And, you are com- tion is in what way will the have to pay attention to and
pensated in the form of the government try to limit cost understand, but one of the
price? increases. characteristics of at least
two of the pharmaceuticals
TS: Yes! You are buying at This is a very, very complex that we own is that they
a big discount; these busi- issue because there are so have significant consumer
nesses will generate a lot of many vested interests that products businesses at-
cash, they will pay dividends are trying to protect them- tached with their drug busi-
of 5-6% in some of the in- selves. With rational re- ness. That’s the case with
stances. So, you are getting form, pharma companies J&J and that is becoming the
well compensated. With a should see an impact but case with Novartis. That
“For the dividend of 5%, you need to only a small impact in a part of the business is stead-
compound at just another purely rational environment. ier.
traditional 5% to get double-digit re- However, doctors groups
turns. are very powerful. Nurses TS: But it is a lower margin
portfolio, we want unions are very powerful. business – so you are not
G&D: It also seems that And a number of different getting the 30%-40% margin
at least a 30%- there are a number of phar- interest groups within this that you are getting with
maceutical names in the entire system want their pharmaceuticals.
40% discount off portfolio and that’s certainly little piece of the pie. Union
a space where there is po- companies want their piece G&D: Are there any re-
of our cautious tential governmental inter- and pharma companies want cent investments you would
ference. How much does their slice. How all this like to talk about or an in-
intrinsic value that play into your analysis plays out is going to be investment idea that you are
and what are your thoughts teresting. All I know is that thinking about? It would be
calculation.” around that? the products of these com- great to hear your thoughts
panies will be needed in the on the analytical approach
TS: There has been gov- future and you need to have you use and comments on
ernmental interference a way in which you still give the thesis.
around this industry for- them an incentive to pro-
ever. The question is duce. BW: We have a dividend
whether there will be more fund here. It uses the same
in the future or not. The BW: I would just add that valuation approach that we
election in Massachusetts the death of health care and practice, but we have a
has made it less likely. pharmaceutical companies portfolio that couples our
That’s the only thing I would has been announced many valuation work with stocks
say. On one hand, when times in the past. Thinking that pay above average divi-
you are investing in the back to when the Clintons dends. One of the recent
pharmaceutical or health proposed health care – that stocks we purchased about
care industry, you have the drove down the stock price three months ago was Ex-
wind at your back because of the pharmaceutical com- elon, which is the nuclear
the population is getting panies and we got a chance utility company.
older. For someone who is to buy Johnson & Johnson
85 years old, you are going around 1993 or 1994 at Dave Krasne: It’s the na-
to spend six-or-seven times about 12x earnings, which tion’s largest merchant nu-
more than on someone who was a terrific price. Today, (Continued on page 27)
Issue VIII Page 27
Tweedy, Browne
(Continued from page 26) really attractive yield that is power pricing that they
clear fleet in the country growing over time is suffi- have in the Mid-Atlantic.
and nuclear is among the cient. In this case, Exelon is But, as far as purchasing
large sources of electricity not a traditional deep dis- unencumbered nuclear as-
and the lowest-cost source count, but then Exelon also sets, the value per kwh of
of power. There was a has a kicker associated with assets that you are buying
transaction in December it. are actually at a discount to
2008 with EDF purchasing a what they can spend to Mario Gabelli ‘67 and Bill
50% interest in Constella- DK: If there is any type of uprate the capacity at the Ackman at the 2009 Gra-
tion’s nuclear assets. This a carbon regime, because plants. So what they spend
ham & Dodd Breakfast.
gives a very interesting post nuclear power does not on maintenance capex, and
energy bubble deal multiple have any exposure to car- to some extent growth
– it was an all-cash deal, bon, it would essentially be capex, that increases the
knowledgeable buyer, arms- all additive and go straight capacity of the plant, which
length transaction. They to the bottom line, straight is very economic to them at
bought 49.99% because the to margins. It would in- about $2,500/kwh. The
government won’t let any crease the cost to their current price of Exelon’s
nuclear entity be more than competitors and because of stock – especially now – is
50% owned by a foreign that, the price to consum- at a pretty steep discount to
corporation. ers. The price increases, that. The dividend yield is
The price paid would imply but the costs associated close to 5%. When the
roughly $55 per share for with the new policy would- market looks at it, they see
Exelon’s nuclear assets. Pile n’t increase for Exelon. earnings staying essentially
onto that, Exelon’s two That would potentially add flat for the next several
regulated utility businesses, another $15 per share of years, so from the market’s
which given that they are incremental value if there is standpoint, there is nothing
allowed to earn a regulated some type of carbon regime to get excited about. It’s
rate of return, should be and even if no carbon re- also a utility, which typically
approximately book value. gime gets implemented by has its own investor base.
But if you use a 20% haircut the legislature, the EPA is
to book value, that adds also pursuing its own path BW: We typically don’t
another $11 per share, that would also regulate own a lot of utilities in the
which gets you to $66. It CO2. Thus, even if Con- dividend portfolio, but this
was essentially a more than gress cannot get its act to- was a special situation.
20% discount to intrinsic gether, the EPA can essen-
value on what seemed to be tially do it itself. DK: Power is a commodity
a very conservative and rea- business and generally we
sonable valuation. G&D: Are Exelon’s assets don’t like commodity busi-
similar to the nuclear port- nesses. But, it has a struc-
BW: For the dividend folio that was bought from tural competitive advantage
portfolio, we don’t require Constellation in 2008? as the lowest-cost producer
as deep of a discount as we of that commodity that no
do for the traditional port- DK: You can argue about one else can match.
folio. For the traditional location. Probably about
portfolio, we want at least a 40% of their assets are in G&D: What does Tweedy
30%-40% discount off of our comparable, desirable loca- think about the current
cautious intrinsic value cal- tions, and then there is an- market?
culation. But, for the divi- other 60% of their assets
dend portfolio, something that are in Illinois, which BW: There is no question
that is trading at 15%-20% don’t have the same market that the number of opportu-
off its intrinsic value, with a characteristics in terms of (Continued on page 28)
Page 28
Tweedy, Browne
(Continued from page 27) we bought Conoco Phillips, But when the crisis hit,
nities that we see has Devon Energy, Total in these things came back
slowed pretty dramatically France. We bought some down in price and we had a
over the past several quality growth companies shot to get back in. These
months. We still see op- that we had not been able were companies like Linde,
portunity and we are look- to buy in the past – compa- the German industrial gas
ing at about a half-dozen nies like Henry Schein, company, a company called
things right now. But, if you which is the dental distribu- Kronos, which makes bever-
went back a year-or-so ago, tor and a great company; age equipment for the bev-
there were two-dozen erage and beer industry, a
things in the hopper that we terrific company. So, we
were working on. And, did a lot, but many of those
there have been significant stocks have risen and bar-
changes to the portfolio gain hunting has slowed.
over the last year or year-
and-a-half, but not as many TS: But in the last couple
over the past several of weeks there are more
months with the markets “If you’re ideas coming.
doing what they’ve done.
optimists like we JS: We are doing a few net
We ended up exiting pretty -nets in Japan or Korea
early in a number of in- are, then you most of which are two-
stances in late 2007, early thirds or less of net current
2008 in a number of finan- think the next ten assets and 3x-5x peak earn-
cial stocks that we owned, ings, although earnings are
where as Tom likes to say years have to be depressed. Two of them
“as the onion was being are priced around net-cash.
peeled” and disclosure be- better than the Great balance sheets and
came clearer. Things be- there is tremendous option-
came murkier and we let go
last ten years.” ality in these things. They
of almost all the bank once sold at more than
stocks. We then took that book value and I think if you
money and redeployed it put together a bunch of
and bought some high- them and look out five
quality industrial companies years, I bet you’ll get a
here in the US that we had chance to sell some of them
not had a chance to buy in one of the most recession at book or more.
20 years – companies like resistant businesses ever.
3M or Emerson Electric. We bought some Cintas G&D: Considering your
These stocks have come up and we also own some view that opportunities are
pretty dramatically, but we other uniform businesses. slowing down, what is your
were buying these things in We had a chance at some position on cash?
4Q08 and 1Q09. We Ben Graham statistical type
bought the railroad stocks, bargains, we had a real es- BW: Cash is residual, but
such as Burlington North- tate holding company in we typically have some cash.
ern, Union Pacific, Norfolk Hong Kong, which was trad- We tend to think of our-
Southern. ing below cash. selves as fully invested and
today we are about 95%
For the first time in a long We also bought some Euro- invested today.
time, we bought oil stocks pean companies that we had
as oil prices came down – owned in the past and sold. (Continued on page 29)
Issue VIII Page 29
Tweedy, Browne
(Continued from page 28) businesses, companies that probably stay open here for
TS: We’ve had 20% cash, are globally diversified, that a while.
but it’s not as if we are wak- may have stronger balance
ing up one day in the morn- sheets, that may pay a divi- G&D: Do you have any
ing and saying “we should dend, haven’t participated to parting words for MBA stu-
go into cash.” This is not the same degree as these dents?
what’s happening. If we lower quality businesses.
have more companies that JS: Persevere! Just perse-
reach intrinsic value, then So, we took a look at that vere and realize that when
we sell, and if we have and one of our young fel- you get rejected, it’s not
fewer opportunities to in- lows here took a look at the personal. Many money
vest, then we wind up with S&P 500 for instance and management firms only oc-
more cash. looked at the world index casionally, and very ran-
and took a simple metric – domly, hire people. Our
JS: The great thing about do you pay a dividend or turnover has been so low
these companies that you you don’t pay a dividend. and I couldn’t tell you when
think are going to grow And, in the S&P 500, there we will add to the analyst
while you sleep at night, is were roughly 370 compa- heap.
that when they get up to nies in the S&P 500 that paid
what you thought they were some form of a dividend last BW: We just did! I would
worth, maybe they’ll chug year and 130 that did not. just add that there seem to
along. So you may not have The 370 that paid a dividend be huge headwinds out
another thing to buy when were up, on a weighted- there. The macro picture
you sell it. So, it gives you a average basis, about 27%, looks pretty bleak, but it’s
bit of a luxury, owning some which is pretty attractive been that way in the past
of these things that seem rate of return. The 130 often and we’ve just gone
like they are going to in- companies that didn’t pay a through ten years of flat-to-
crease in value while you dividend were up on aver- negative returns in every
sleep even if they’re not age 82%. For the global market. So, that doesn’t
beautifully and cheaply index, you ended up with happen very often. If you’re
priced. comparable statistics. optimists like we are, then
When you look at your top you think the next ten years
BW: One thing that is 25 holdings at Tweedy, the have to be better than the
characteristic in this market P/E for the top 25 names last ten years. We don’t
is that the bounce that we are anywhere from 14x-16x know that obviously, but I
had since March last year – current run-rate earnings. think if you can get in now,
and I’m being very general in But, at lower multiples, is if you can find your way into
what I’m about to say – all where we think underlying a shop that does something
of the stuff that cratered the earnings power is, even you’re interested in, it’s
worst in 2008 and early though current multiples are probably going to be a de-
2009 are the stocks that higher. So, as John was say- cent future.
came roaring back in late ing, we like what we own
2009. So, to a certain de- and we are comfortable JS: I think small-cap and
gree, when you have a with our holdings. neglect – less liquid – that’s
bounce off of a recession an area of opportunity. As
low like we’ve had, the lev- JS: We liked them better you manage more and more
eraged companies, non- when they were cheaper! money, there tends to be
dividend paying companies, some abandonment of that.
the crummier businesses BW: We closed to new
have gone straight to the business in 2005 and we re- G&D: Thank You.
moon and the higher quality opened in 2008 and we’ll
Page 30

(Continued from page 2) can’t issue bonds denomi- had been performed by long
which he evaluates invest- nated in their own currency, -time business partner
ment opportunities. Natu- and we are headed in that Charlie Munger and Mr.
rally, Mr. Buffett replied that direction. This is not the Munger’s friend, Li Lu (BA/
it had not. While he ex- number one problem right JD/MBA ‘96), Mr. Buffett
plained that any potential now, but it must be ad- explained that Mid-
new laws would be unlikely dressed.” American’s investment was
to prevent future bubbles a strong endorsement of
because of an inability to BYD’s CEO Wang Chan Fu.
legislate human nature, Mr.
Buffett followed up by not- “BYD is a remarkable com-
ing that, “This recession has pany run by a remarkable
changed human nature as guy who started with
much or more than anything $300,000 in 1995 and is
I have seen. When the Re- now the second largest cell
serve money market fund “People get phone battery maker in the
broke the buck, $3.5 trillion world. BYD also has the
was scared very fast. Peo- scared fast and best-selling car in China on
ple get scared fast and to- a monthly basis. [Mid-
gether. They regain their
together. They American Energy CEO]
confidence slowly and one Sokol has never seen a bet-
at a time.”
regain confidence ter manufacturing operation
than BYD. BYD makes eve-
And in case that assessment
slowly and one at rything except the tires and
was not cheery enough, Mr. a time.” glass to maintain quality
Buffett later explained that control.”
the United States current
account deficit means that Not only does Mr. Buffett
we are transferring liabilities see Wang Chan Fu as a re-
against our future output to markable businessman, but
the rest of the world, and also a man of integrity. “It
China now has more than BYD took eleven months for the
two trillion dollars in foreign transaction to be approved.
exchange reserves. Although the price that BYD could have backed out
Berkshire Hathaway subsidi- of the deal terms – the price
“If our bonds retain their ary Mid-American Energy had run up to HKD 40 from
value, we will have to send paid for its stake in BYD HKD 8 – but Wang Chan
over goods at some point in turned out to have been Fu did not. I don’t under-
the future. If the world quite attractive, one student stand the product, so I am
wants goods instead of in- wondered how Mr. Buffett betting on the man.”
terest payments, we won’t justified the purchase of a
be able to consume all of foreign technology company “I’m always interested
our output. This is a prob- in an industry undergoing a when I hear the words,
lem when our children will rapid rate of change, given ‘no one else can do it.’”
only be able to consume Mr. Buffett’s previous aver-
ninety-seven percent versus sion to such investments While Mr. Buffett generally
the current one hundred and preferred holding pe- spends a great deal of time
and two percent. The most riod of ‘forever’. explaining the principles and
likely outcome is printing philosophy behind his in-
more money. Most coun- While acknowledging that vestment process, convinc-
tries that are big spenders most of the due diligence (Continued on page 31)
Issue VIII Page 31

(Continued from page 30) money to learn at businessit.” Customers cannot stock
ing him to divulge much school. Of course, you also
every frame in their shops,
about the practical imple- need to know how long and and all the picture owner
mentation of his strategy is what interest rates, but cares about is getting a nice
notoriously difficult. How- ‘bird in the hand’ is the gen-
frame back fast. Mr. Buffett
ever, that did not stop one eral idea.’ pointed out that it would be
Columbia student from try- almost impossible to create
ing. Mr. Buffett then took the a new competitor to call on
opportunity to describe Larson Juhl’s 18,000 cus-
The topic of the question tomers, so the company will
was Mr. Buffett’s 1995 ac- do very well in its niche,
quisition of R.C. Willey. even if it will never become
Specifically, how was Mr. very big.
Buffett able to agree to a
deal so quickly, and what Another favorite example
did he focus on when re- that Mr. Buffett often cites
viewing the three years of is Coca Cola, which “has
financial history he re- “I’m always share of mind in the world
quested? Without going that cannot be matched.”
into specifics of R.C. Willey, interested when I Rattling off numbers, Mr.
Mr. Buffett outlined four Buffett explained that there
things he considers before hear the words, are 1.6 billion 8-ounce serv-
committing capital to any ings of Coke sold every day,
investment. First, Mr. Buffett ‘no one else can and that number has grown
asks himself whether he can every year since 1886. A
understand what the com-
do it.’” one-penny price increase is
petitive dynamics are likely worth six billion dollars per
to be ten years into the year to the company.
future.
Berkshire owns more than
Second, he seeks to under- 130 million servings, so I
stand what the economics don’t care if you drink it,
of the business are likely to what characteristics he just open the can and pour
be like over ten years. looks for in a business with it on the person next to
Third, Mr. Buffett relates a few examples from Berk- you.” Mr. Buffett also noted
the current price to those shire’s portfolio. that he always asks himself if
economics because, “There he were handed one billion
is no sense in studying When Craig Ponzio called dollars, would he be able to
something for a month only to sell his business to Mr. kill the business, and clearly
to find out the price is too Buffett, he explained, with Coke the answer is a
high.” Finally, Mr. Buffett “Larson Juhl sells custom resounding ‘No.’
asks if he can trust manage- wood frames to 18,000 in-
ment’s ability and integrity. dependent framers, calls on Mr. Buffett then drew the
our customers five times parallel between Coke and
Summing it all up, Mr. Buf- per year, and guarantees Berkshire Hathaway’s See’s
fett explained, “Investing is next-day delivery for any Candies subsidiary. See’s has
laying out money today to order placed before 3pm, raised prices every year
get more money in the fu- and no one else can do it,” since Mr. Buffett acquired
ture. Aesop’s ‘bird in the and Mr. Buffett is always the company in 1972. Ex-
hand is worth two in the interested when hears the plaining why this is possible,
bush’ is what you spend words, “no one else can do (Continued on page 32)
Page 32

(Continued from page 31) anything. Control of impor-
Mr. Buffett pointed out, When he purchased five tant content leads to pricing
“Who wants to hand their percent of Disney for $4 power. Subscribers would
wife or sweetheart a box of million in 1965, Mr. Buffett reach for their pitchforks if
candy and say, ‘I caught the was buying a company with, the cable company tried to
low bid?’ If you only buy “no debt and rights to hun- take away ESPN. I was
something one time per dreds of successful past against buying the remaining
year, you generally don’t movies written down to 20% of ESPN when I was on
know or care what the zero. Constructing the Pi- the board of Cap Cities.
price was last year. You just rate ride for the theme park That decision probably cost
want a happy experience alone cost $17 million at the the company $5 billion.”
because it is an important
gift to a loved one.” Where to look for in-
vestment opportunities
Mr. Buffett then divulged
the company’s highly effec- “You can’t get a As any investor is aware,
tive marketing strategy, making the most efficient
“Women plan ahead, but great price in a use of one’s time spent
men wait until the last min- identifying and researching
ute. That’s why See’s has negotiated deal investments is a critical fac-
their busiest day on the day tor for success. Mr. Buffett
before Valentine’s Day. So, between emphasized this point by
we always have ads on the explaining his approach in
radio making men feel as interested parties, his early years. “I went
guilty as possible.” through all three thousand
but auction pages of the Moody’s man-
Newspapers and Mickey ual, but I didn’t look at any-
Mouse’s Agent markets can lead thing unless it was obvious.
On page one thousand four
The conversation then to crazy prices.” hundred and thirty-three, I
turned to another business found Western Insurance
that Mr. Buffett bought into Securities, which earned
around the same time as twenty-one and twenty-nine
See’s. According to Mr. Buf- dollars in each of the past
fett, when he purchased his time. They recycled Snow two years when it sold be-
initial stake in the Washing- White every seven years at tween three dollars and
ton Post, he was buying a higher price even though thirteen dollars.
$400 million of value for there was no cost the sec-
only $80 million, but today ond time around, and the At that point you just need
he would not choose to Mouse didn’t have an agent! to know if there is anything
own any newspaper busi- ESPN is their big business wrong. You interview
nesses in his personal ac- now and no one can go af- agents and read the state
count, since the moat has ter it. insurance filings. You don’t
disappeared. Although need a 120 IQ. I bought
newspapers have suffered Cable operators hate them, twenty-nine dollars of grow-
from the effects of in- because they charge such a ing earnings for sixteen dol-
creased competition over high price – $4 per sub per lars. I do not want to have
time, Mr. Buffett then took month plus ad sales – even to be smart. Small stocks
the opportunity to describe though they have one fifth sometimes sell at ridiculous
a business where the moat the viewership of CBS and prices. You can’t get a great
has not eroded. NBC, which aren’t worth (Continued on page 33)
Issue VIII Page 33

(Continued from page 32) officer, and he would never broke.
price in a negotiated deal offer any insurance policy or
between interested parties, make any investment that To know that their concept
but auction markets can risks the company. As chief was flawed, you only had to
lead to crazy prices.” risk officer, he dreams up read financial history. Look
scenarios worse than any at the thirty-year on-run, off
“Never start a price other risk manager consid- -run treasury bond trade. In
war, and never lose ers, thinking “like someone 1998 a ten basis-point
one.” that runs a big casino, I care spread was a two-sigma
about the probability that all event, so everyone was in
Beer is a topic near and deals entered into have cor- the trade, but the market
dear to many business stu- relation.” went crazy and the spread
dents’ hearts, and given Mr. went to thirty basis-points.
Buffett’s investment in An- Mr. Buffett then went on to The only way a smart per-
heuser-Busch prior to its recount how Berkshire son can go broke is by using
acquisition by Inbev, it was Hathaway insured the one borrowed money, but tradi-
no surprise that the subject billion dollar Pepsi challenge, tionally, risk analysis has
came up. Mr. Buffett heaped where a lucky contestant been used to determine
praise on the “brilliant” had a one in one thousand how much you can bor-
Jorge Paulo Lemann and chance of winning one bil- row.”
current CEO Carlos Brito, lion dollars of payments
who will “run the company with a present value of two Parting Wisdom
as smart as anyone in the hundred million dollars. A
world.” monkey made the drawing Towards the end of the
as twelve Berkshire Hatha- meeting, Mr. Buffett offered
Mr. Buffett went on to dis- way employees looked on. an explanation of what he
cuss the dynamics of the Originally, Pepsi had wanted has tried to accomplish
beer business, explaining Mr. Buffett to draw the win- through Berkshire Hatha-
that with only a couple of ning number, but he jokingly way. “Ninety-eight point five
big beer companies left, offered to participate only if percent of my net worth is
price behavior is very im- he could bolster his invest- in Berkshire stock, and it’s
portant, given the huge ef- ment in Coca Cola by say- all going to charity. My goal
fect pricing has on profits. ing, “I am only doing this is for my last check written
The most desirable situation because Pepsi can’t be in the world to bounce.
is to have a big company trusted.” Berkshire is my canvas, a
that raises price every year platform for laying out my
and all of the others follow, Bringing the discussion back ideas for how businesses
which is why one rule Mr. to a more serious example, should be run.” As for the
Buffett has for Berkshire Mr. Buffett pointed out the future, Mr. Buffett ex-
Hathaway’s businesses is to history of Long-Term Capi- plained, “I have never had
never start a price war and tal Management, the failed more fun than during 2009.
never lose one. hedge fund that nearly Every day is like a treasure
caused the collapse of Wall hunt. I don’t know about
Managing Risk Street in 1998. “Here was a 2010, but there will be
group of guys that had an something. Having no called
Another Columbia student average IQ of one-seventy, strikes is a huge advantage.”
asked Mr. Buffett about how but they didn’t get it about
he analyzes risk. Mr. Buffett risk – that human beings are This article was contributed by
noted that as the CEO of involved. They operated Matthew Gordon, MBA ‘10.
Berkshire Hathaway, he is with their own money,
also the company’s chief risk worked hard, and still went
Page 34
First Annual Moon Lee Prize for Excellence

Achievement mentoring
program at a local public
high school.
The program grew to 70

students and 60 MBA volun-
teers and impacted numer-
ous lives. Moon loved to
laugh and built strong ties to
so many people. He is sur-
vived by his wife Martine,
his parents, his sisters and
countless devoted friends.
The four finalists, Grant

Bowman, Brad Doppelt,
Sidney Gargiulo, and Mat-
thew Lilling were selected
from a group of 24 contest-
ants. At the reception, each
student presented their
analysis to the judges from
Pictured: Bruce Greenwald, Jon Friedland ‘97, Alex Porter, Aaron Kuperman, Inder Soni, Anurag
Porter Orlin, including Alex
Dhanwantri, Grant Bowman ‘10 (1st Place), Sidney Gargiulo (2nd Place). Porter and Jon Friedland
’97.
cash prizes of $15,000 and
$5,000 and the submissions Following a sequence of
were judged on the quality insightful presentations and
of their research and the vibrant Q&A, the judges
concise presentation of a awarded first place to Grant
strong investment thesis. Bowman for his short rec-
ommendation on Avery
The Moon Koo Lee Prize is Dennison Corp. (AVY) and
given as a tribute to a re- second place to Sidney Gar-
Over 100 alumni of the Ap- spected colleague and a giulo for her long on Interac-
plied Value Investing (AVI) remarkable person. Moon tive Brokers Group (IBKR).
Program gathered on De- worked at Porter Orlin
cember 8, 2009 for a recep- from 2003-2008 and dem- The competition was a suc-
tion and final presentations onstrated a tireless ability to cess for everyone involved
for the first annual Moon identify and analyze deep and as Mr. Porter com-
Lee Prize for Excellence. value opportunities where mented, “All of us at Porter
few could see. Orlin who read the written
The award is given in mem- presentations were greatly
oriam of Moon Lee, a dedi- Moon graduated Magna impressed by the caliber of
cated value investor with Cum Laude from Harvard work submitted. They were
Porter Orlin, LLC. In his College and received his thoughtfully conceived and
honor, his friends at Porter MBA from Harvard Business then presented in an articu-
Orlin initiated this competi- School. During his MBA late way. We are honored
tion for outstanding stu- studies, Moon received the to be part of the process.”
dents in the AVI Program. prestigious Dean's award
The students competed for for co-founding a Junior
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Contact us at:
Matthew Martinek is a second year MBA student and a participant in

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

the Applied Value Investing Program. This summer he interned at
Brandes Investment Partners in San Diego. Prior to Columbia, Clayton
worked for four years in fixed income research and portfolio manage-
ment at Martin & Company, a regional investment management firm in
Knoxville, TN. Clayton received a BS in Finance and Accounting from
the University of Tennessee in 2003.
Graham & Doddsville
Issue X Fall 2010
Inside this issue:

Danilo Santiago and p. 2
Finding Conviction When Others Panic — Steven Romick
Claudio Skilnik —
Rational Asset Mr. Romick, CFA, who enter the investment man-
Management agement industry. Can you
joined FPA in 1996, is the
U.S. Physical Therapy p. 20 Portfolio Manager of the talk about that and what
(USPH) - Ryan Coyle FPA Crescent Fund. Mr. your experience with invest-
‗11 ing was up to that point?
Romick was previously
CoreLogic, Inc. p. 22 Chairman of Crescent
(CLGX) - Alex
Management and con- Steven Romick (SR): I had no
Latushkin ‗11
sulting security analyst experience investing up to
2011 CIMA p. 34 for Kaplan, Nathan & Co. that point. I was on my way
Conference He earned a B.S. in Edu- to law school at USC to get
cation from Northwest- my JD/MBA because I hap- Steven Romick, Portfolio Man-
ern University. pened to have done reasona- ager, FPA Crescent Fund
bly well in school and I didn‘t
Editors:
G&D: You started the Cres- really know what I wanted to tired of unlearning MBA‘s -
Garrett Jones do. I figured I could push off he wanted to teach someone
cent fund in 1993, but let‘s
MBA 2011
go back earlier than that – the real world for a couple from the ground up.
Daniel Kaskawits more years. But, I got a job
you had an interesting op-
MBA 2011
portunity coming out of offer from a friend of my
Anna Baghdasaryan father, who said that he was
Northwestern University to (Continued on page 3)
MBA 2012
Joseph Jaspan
MBA 2012 Low Decile, High Return — Donald G. Smith
Donald G. Smith is the sity of Illinois, an MBA by
CIO of Donald Smith & Harvard University and a
Co. He began his career J.D. from UCLA Law
Contact us at: as an analyst with Capital School and was admitted
newsletter@grahamanddodd.com Research Company and to the Bar Association of
Visit us at: subsequently worked at California.
www.grahamanddodd.com Capital Guardian Trust
www0.gsb.columbia.edu/students/ Co. In 1980, Donald be- G&D: Briefly describe the
organizations/cima/ came the CIO of Home history of your firm and how
Insurance Company, and you got started?
President of Home Port-
folio Advisors, Inc., which DS: Donald Smith & Co. was
he bought in 1983 and founded in 1980 and now
changed the name to has $3.6 billion under man- Donald G. Smith. Donald
Donald Smith & Co., Inc. agement. Over 30 years Smith & Co.
since inception our com-
Mr. Smith was awarded a pounded annualized return is is 12.1% versus −0.4% for
B.S. in Finance and Ac- 15.3%. Over the last 10 the S&P 500. We have
counting by the Univer- years our annualized return (Continued on page 11)
Page 2

We are pleased to present with pricing power. He also focusing on a stable set of
you with Issue X of Graham discusses the fund‘s recent 85 companies.
& Doddsville, Columbia Busi- investment in distressed
ness School‘s student-led mortgages. We also aim to offer spe-
investment newsletter co- cific investment ideas that
sponsored by the Heilbrunn The issue also features an are relevant today. The cur-
Center for Graham & Dodd interview with Donald G. rent issue includes two stu-
Pictured: Bruce Greenwald and Investing and the Columbia Smith, who volunteered for dent investment ideas, in-
Marty Whitman at the Columbia
Investment Management Ben Graham at UCLA. His cluding U.S. Physical Ther-
Investment Management Con-
ference in February. Association. fund concentrates on the apy (USPH), presented by
bottom decile of price to Ryan Coyle ‗11 and Core-
This issue features an inter- tangible book stocks and Logic, Inc. (CLGX) by Alex
view with Steven Romick, has compounded 15% over Latushkin ‗11.
portfolio manager of FPA 30 years.
Crescent Fund. Mr. Romick Please feel free to contact
outlines his free-range capi- We also talk with Danilo us if you have comments or
tal allocation approach and Santiago, CBS ‗01 and Clau- ideas about the newsletter
walks through his prefer- dio Skilnik, CBS ‗02, who as we continue to refine this
ence for large-cap, interna- operate a long-short fund publication for future edi-
tionally exposed companies with a unique strategy of tions. Enjoy!
The Value of Process — Rational Asset Management

Danilo Santiago, CBS
'01 and Claudio Skilnik,
CBS '02 are both engi-
neers who graduated
from the University of
Sao Paulo and co-
founded Rational Asset
Management Co.
("Rational"). Rational is
the Investment Manager
for the Rational Value
Fund ("RVF"), which is a
long-short equity hedge
fund with a well defined Danilo Santiago, CBS ‗01— Claudio Skilnik, CBS ‗02 —
investable base of 85 Rational Asset Management Rational Asset Management
companies that closely
represent the U.S. econ-
omy. Since its inception G&D: Why don‘t you in- School, but we both gradu-
in April 2008, RVF has troduce yourselves and ex- ated from the University of
attained an unlevered plain how you got to know Sao Paulo with engineering
net adjusted alpha in each other and got started degrees. This is important,
excess of 20% when with Rational Asset Manage- because we have a common
compared to the S&P ment? analytical background and a
500 performance. common investment meth-
Danilo Santiago (DS): We odology background. We
met at Columbia Business (Continued on page 24)
Issue X Page 3
Steven Romick
(Continued from page 1) G&D: So what advice hotel down in Laguna Beach
G&D: That was your experi- would you give to young with a guy wearing pajama
ence at Kaplan, Nathan, & men and women looking to bottoms. I‘d never seen
Co.? start their own fund, given anyone wear silk paisley
what you know now? pajamas in the middle of the
SR: It was James Nathan, day before, but it was John
who graduated from Co- SR: I don‘t think it is a mis- Templeton. I got to have
lumbia Business School with take for all young men and dinner with Leon Cooper-
Mario Gabelli and Leon Co- women, but for me it was man, I think when he was
operman sometime in the what I didn‘t know that I running GSAM at the time.
‗60s. I worked with him for taught myself over time. I I got to sit down with these
11 years, and he helped me people and just listen, like a
“Honestly,
start my business during fly on a wall. In Mr. Na-
that time. people shouldn‟t than‘s office I had a desk
pushed up to his and every
G&D: So you started your have given me time he spoke with a com-
own money management pany I listened in on the
money then.
firm in 1990, but the Cres- extension.
cent Fund didn‘t begin until With what I
1993. Can you talk about G&D: Then in 1993, you
those first three years? know now, and started the Crescent Fund.
what I thought I How did you position the
SR: I managed separate ac- fund?
counts. Honestly, people knew then, it‟s
shouldn‘t have given me SR: I felt that most mutual
money then. With what I
such a vast funds were style box con-
know now, and what I difference. strained, and didn‘t take
thought I knew then, it‘s advantage of a deep tool-
such a vast difference. Peo- People took a box. I spent a lot of time
ple took a chance on me, looking at high-yield bonds
chance on me,
and I learned as I went. I‘m and some distressed debt in
better now than I was then. and I learned as I the late 80‘s, and I got a
I think that in the money flavor for it. I didn‘t think
management business, went. I‟m better there were a lot of public
knowledge is cumulative, or now than I was funds out there that in-
rather should be cumulative vested in such diverse asset
rather than repetitive, and then.” classes, but felt that such a
one should improve the vehicle made sense for peo-
longer one is in the busi- put myself in front of a lot ple. For years, I had to fight
ness. I‘m much more com- of people and tried to have the idea that I was a style
fortable wearing the skin of them teach me. I was fortu- box manager.
an investor than I was back nate, because within the
then. I guess I was too ig- first couple of months of
norant to realize that when working for Mr. Nathan I
I was younger. ended up having lunch at a (Continued on page 4)
Page 4
Steven Romick
(Continued from page 3) down, considering what stayed away from financials
G&D: After three years might happen in the world as P/Es on banks expanded
you joined FPA. How did and how we might protect to levels that weren‘t justifi-
that transpire? against certain types of risk. able. I believe that P/Es on
You can protect against any levered business, all
SR: I realized that you can‘t certain types of risk, not things equal, should be less.
wear all the hats well, and I just by hedging your portfo- What‘s more leveraged than
was wearing too many hats. lio, but by choosing to buy a bank? You might have an
I wanted to just focus on certain types of companies 8% capital ratio, so you‘ve
investing. I wanted some- versus others. That might got 12-1 leverage, not in-
one to insulate me from the cluding any off balance sheet
marketing and back office. “We spend a lot of leverage that might exist.
It just took too much time You might have a large de-
away from the portfolio. I time thinking rivatives book, which is a
wanted to partner with peo- black box. We felt the ex-
ple of like-minded nature,
about what can cessive prices being paid
who were value investors happen. At the weren‘t taking the risk into
and had great integrity. account.
They may execute differ- end of the day,
ently, but thought similarly. By the way, when I first
we‟re worry warts.
I had been friends with Bob started out with Mr. Na-
Rodriguez for seven years at As a byproduct of than, I did most of my work
that time, and used to have on banks and thrifts. I was
regular lunches with him to our strategy, we effectively a banking and
talk ideas. At one lunch, I end up with cash thrift analyst back in the mid
asked him if there was a -80‘s, so I was predisposed
place for me at FPA, and he and we end up to analyze and enjoyed own-
said we should talk about it. ing banks. I didn‘t feel it
lagging in up was justified owning those
G&D: You have a unique markets, but companies as a result of our
strategy for a mutual fund, top-down view in the early
in that you can go short as outperforming in part of the last decade. We
well. However, your short wrote about credit default
down markets.”
exposure has never been swaps back in 2002. We
very elevated. How do you spend a lot of time thinking
think about building your mean not owning certain about what can happen. At
portfolio? industry groups or asset the end of the day, we‘re
classes. For years, we didn‘t worry warts. As a byprod-
SR: We think about dis- own financials because we uct of our strategy, we end
crete investments, from the had a lot of concern about up with cash and we end up
bottoms up, which we be- what was happening with lagging in up markets, but
lieve have attractive upside- easy money, poor under- outperforming in down mar-
downside parameters. But, writing standards, excessive kets. It‘s not that we‘re
we also spend a lot of time leverage, and a bubbling targeting such performance
thinking about the top housing market. So we (Continued on page 5)
Issue X Page 5
Steven Romick
(Continued from page 4) nies with excellent track sions end up manifesting
characteristics, but that our records that Wall Street has themselves in volatility,
general sense of unease yet to discover. Is it worth where things are oversold
leads that to be the case. your time looking for these and overbought. Being a
opportunities now that you really good investment man-
G&D: Do you have finan- have $4 billion under manager is equal parts being a
cials in your portfolio today? agement? financial analyst, business
analyst, and psychologist
SR: Now we do. 2008 rolls SR: I think that I was naïve. with conviction to act when Columbia Business School is
around, and we were net What is really undiscov- others are panicking. a leading resource for invest-
short financials, not in a big ered? I think it‘s morphed ment management profession-
way, but short companies from undiscovered to When we screen, we‘re als and the only Ivy League
like Lehman Brothers and unloved or misunderstood. looking for companies with business school in New York
City. The School, where value
certain Spanish banks. Most strong cash flow character-
investing originated, is consis-
of our financial exposure is istics and returns on capital, tently ranked among the top
on the debt side. We were but most of companies
“Being a really programs for finance in the
able to buy loans with very don‘t come from screens. world.
strong collateral, which we good investment What‘s more prominent in
thought we understood our process are monitor
reasonably well, and we manager is equal lists. There are other areas,
stress tested the portfolios parts being a like spin-offs, that we moni-
to determine what our asset tor because we think there
coverage would be in a financial analyst, are more natural sellers
worst case scenario. We than natural buyers. We
ended up buying things like
business analyst, don‘t think spin-offs are
Ford Credit of Europe, CIT, and psychologist terribly inefficient anymore,
American General Finance, but there are other things
and International Lease Fi- with conviction to like that that we follow.
nance. We discounted the
act when others
underlying assets tremen- G&D: How do you think
dously, and in every case we are panicking.” about your goal as a portfo-
didn‘t think we could lose lio manager?
money so we just kept buy-
ing. So our portfolio is not There aren‘t that many un- SR: Beating the market is
long financials on the equity discovered names out there. not our goal. Our goal is to
side to any great degree, but provide, over the long term,
on the debt side. A lot of G&D: How do you go equity-like returns with less
that has been culled back. about looking for ideas risk than the stock market.
The yield on our debt book where there is a gap be- We have beaten the market,
was 23% last year and now tween perception and real- but that‘s incidental. We
it‘s less than 8%. ity? don‘t have this monkey on
our back to outperform
G&D: In your first letter in SR: Fortunately, people are every month, quarter, and
1993, you wrote that you emotional and they make year. If we think the market
often found niche compa- visceral decisions. Such deci- (Continued on page 6)
Page 6
Steven Romick
(Continued from page 5) vested in certain areas of the meds wear off. Half of
is going to return 9% and the market. We don‘t have the people in this country
we can buy a high-yield a crystal ball and don‘t be- are receiving subsidies of
bond that‘s yielding 11.5% lieve that we understand the some sort. What does that
and we‗re confident that the economic picture better mean for GDP? Our econ-
principal will be repaid in than everyone else. At cer- omy is not growing that fast
the next three years, we‘ll tain points though, we feel as it is.
take that. If the market rips that there is enough uncer-
and goes up 30%, we don‘t This is the second deepest
worry about it. We don‘t downturn of the last 100
feel the onus to be buying “We are in one of years and the rebound com-
juice all the time, because ing out of that contraction
that can sometimes turn those periods right has been rather muted.
into disaster. We are abso- There has been some bump
now where we
lute value investors. We – it has been positive – but
take our role as guardians of think the eco- if one used the alphabet
our clients‘ capital quite soup of recovery, it is not a
seriously. If we felt the nomic outlook is ―V‖. It kind of looks like a
need to be fully invested at square root, where it comes
pretty opaque.
all times, then we would up like a ―V‖, but then tails
have to accept more risk The U.S. economy off and does not do much
than I think we need to. I after that. The government
don‘t think our approach is is currently so is doing its best to keep
for everybody, but it works jacked up on ster- things moving with the lat-
for us. I‘d like FPA to be est hope pinned on QE2.
known as respected value oids that you
investors. I‘m very careful G&D: What do you think
in stating ‗value investors‘
can‟t really under- the impact of that poten-
and not ‗value investment stand the data un- tially substantive liquidity
firm‘ because our money is response might be on the
invested alongside our cli- til the meds wear US dollar?
ents.
off.”
SR: The government is do-
G&D: Despite constructing ing its best to destroy the
your portfolio from the tainty that could lead to value of the US dollar. We
bottom-up, your macro either some pretty ugly out- have made efforts to de-
view does play a role in comes or even wonderful dollarize our portfolio, tak-
your analysis. Do you want outcomes. We are in one ing advantage of other parts
to give us an overview of of those periods right now of the world that have bet-
what you are seeing right where we think the eco- ter growth opportunities
now? nomic outlook is pretty than the US with more ex-
opaque. The U.S. economy posure to currencies other
SR: We think it is very im- is currently so jacked up on than our own. We are
portant to have a macro steroids that you can‘t really seeking those companies
backdrop and not be in- understand the data until (Continued on page 7)
Volume
Issue X I, Issue 2 Page 7
Steven Romick
(Continued from page 6) had better earnings for 65% of its revenue from
that are more protected some time and most people outside the US. That will
should inflation be more do not realize it. Admit- drop though because there
than expected in the future. tedly, there are some flaws is a deal closing to buy
Now, we are not calling for with looking at reported Hewitt, a consulting firm.
hyperinflation, but we will earnings, given write-offs Given our knowledge, we
not tell you that it cannot and other noise, and the actually would have pre- Pictured: Glenn Greenberg at the
come – that is something indices are market- ferred that Aon not buy Security Analysis 75th Anniver-
sary Symposium (Fall 2009), with
we view as a real possibility. weighted; but I still find it a Hewitt. But, the gentleman Bruce Berkowitz (left) and Tom
We are looking for compa- who runs Aon has a proven Russo (right).
nies where we feel the pric- track record and we believe
ing power would offset the “We are looking that he will be successful
potential rise in input costs. for companies with the Hewitt transaction.
That leads us to a whole It just would not have been
universe of companies, where we feel the our first choice.
while keeping us away from
others.
pricing power In regards to inflation –
would offset the where are you guys calling
G&D: That seems consis- from?
tent with characteristics of potential rise in
the larger-cap group of G&D: The Columbia Busi-
input costs. That
stocks you discussed earlier. ness School library.
leads us to a whole
SR: Yes, they have better SR: The replacement cost
pricing power, have more universe of of the building you are in
international exposure, and will cost more in an infla-
companies, while
also tend to be less efficient. tionary environment. Aon,
You can improve efficiencies keeping us away which incurs no underwrit-
and take costs out – which ing risk, will be a beneficiary
should lead to better earn- from others.” of increased premiums –
ings. In fact, the large-cap which will rise because of
stock earnings growth has reasonable proxy. replacement valuations.
been stronger than small- But, for Aon to perform
cap stock earnings growth G&D: Can you give us an well, we do not even need
for some time now, which a example of a large-cap stock an inflationary environment.
lot of people find surprising. with pricing power and in- If we just get pricing to sta-
Russell has data showing ternational exposure that bilize, the stock should be a
that 5-year trailing earnings you are looking into? winner. This is a necessary
growth for the Russell 1000 business, it is almost impos-
companies (large-caps) has SR: One name we own is sible to disintermediate, it
been greater than earnings Aon Corp. (AON; $39.46). will improve if the economy
growth for the Russell 2000 They are an insurance bro- improves, it will improve if
companies (small-caps) all kerage firm that does con- inflation comes, and mean-
the way back to 1995. sulting as well. Aon is a
Large-cap companies have business that derives about (Continued on page 8)
Page 8
Steven Romick
(Continued from page 7) SR: Their returns on capital a new CEO, Michael
while it is generating huge are huge. The company was Rouleau, came in and really
amount of free cash flow. built by Pat Ryan, who made drove the business forward
many successful acquisitions as he brought in systems,
G&D: Would potential over a long period of time. took out costs, and at the
inflation also benefit their I would argue it was never same time was able to drive
float? operated as well as it has sales and take advantage of
been since Greg Case came buying power. So, with
SR: Yes, but their float is in. It was a loose collection Aon, Greg has found many
unlike that of a traditional of businesses that were opportunities to improve
insurance company. With a quasi-integrated. We love efficiencies. Return on capi-
broker, the money comes in tal is massive on a tangible
from the client and before it “If you take out book basis. Returns are
is paid to the insurance fantastic for a company that
company it sits on their the intangibles, we think is relatively under-
books and vice versa when leveraged, or at least not at
there actually is
an insurance company has an optimized balance sheet.
to pay a benefit. Unfortu- negative equity – If you take out the intangi-
nately, that cash sits on bles, there actually is nega-
their books earning practi- there is no capital tive equity – there is no
cally nothing today. Thus, for this business. capital for this business.
they will be a beneficiary of The company is comprised
higher short-term interest The company is of people, either brokers or
rates, inflation, a hard mar- consultants and they throw
comprised of
ket in pricing, and their con- off $1 billion of operating
tinued internal restructur- people, either income annually.
ing. We also believe they
will benefit from the Hewitt brokers or G&D: Many investors shy
transaction – we have away from companies that
consultants and
greater belief in it as a finan- were built through acquisi-
cial transaction than as a they throw off $1 tions, but this is a slightly
strategic transaction; al- different view.
though, they believe in both. billion of operating
Plus, Aon has a great bal- income annually.” SR: We shy away from com-
ance sheet. We look at this panies that are serial acquir-
and say it fits those parame- ers until the deals are
ters of being protected in an those types of investments largely behind them and a
inflationary environment where a business was grow- strong operating executive
with a lot of optionality ating through acquisitions for comes to help the company
tached. a number of years, and then realize its potential. An-
they are finally integrated. other example of that is
G&D: How good of a busi- Another example is AGCO, which we have
ness is it other than having Michaels Stores, which we owned for some time.
those characteristics? owned for years. It grew AGCO is a farm equipment
through acquisition and then (Continued on page 9)
Issue X Page 9
Steven Romick
(Continued from page 8) torically and a little bit more on the dollar, of the unpaid
company, which had gone up our alley. We started to principal balance, or roughly
on a binge of acquisitions. work through the idea, and a 65% or so discount to the
After a new management the margin of safety was original estimate of ap-
team came in, they stopped similar to the assets we praised value when the loan
acquiring. We do not mind were buying in 2008/2009, was underwritten.
a company making acquisi- albeit an admittedly lower
tions periodically, we just As an example, let‘s say we
do not want them to have are able to buy a $100,000
an addiction. mortgage at $43,000 and
“We are going to originally that home was
G&D: How do you think different banks valued at $125,000. We
about valuation for Aon? believe we can achieve an
that were appropriate return. If we
SR: We think sustainable knock the appraisal values
originators of sub-
normalized FCF is the rele- that we are getting today
vant indicator of value at prime and Alt-A down by about 10%, then
businesses like AON. So, we figure that we will still
we focus on the normalized loans back in 2005- make an annual return of
level of FCF and are inter- 10%-12%. That also as-
2007 and buying
ested in buying at a reason- sumes 80% foreclosures,
able multiple of normalized these loans at which is not occurring ei-
FCF. On that basis, AON is ther.
trading at 10-11x. roughly forty-three
cents on the dollar, G&D: What happens if you
G&D: Your fund has made can work out a modification
some distressed mortgage of the unpaid on the loan?
investments over the past
12 months – how did you
principal SR: Even better - we get to
come across this opportu- balance...” say to the borrower (who
nity? has a $100,000 mortgage) if
you can qualify for a modifi-
SR: A third-party servicing cation at $65,000, then that
firm that purchased a de- return. For example, if would be beneficial for both
funct sub-prime servicing home prices dropped 10% of us. We will make 50%
platform came in and we were still going to make and you will have a lower
pitched our fixed income money. We think that is a monthly payment and you
team on an opportunity to better risk-reward than the will get to live in your
buy distressed whole loans. stock market. We are going home. That has been our
So, our investment is not in to different banks that were strategy. We would like to
distressed mortgage securi- originators of sub-prime and pick up a lot more of these
ties. This is a little bit out Alt-A loans back in 2005- opportunities and we have
of form for what our fixed 2007 and buying these loans bid on other pools of mort-
income team had done his- at roughly forty-three cents (Continued on page 10)
Page 10
Steven Romick
(Continued from page 9) G&D: You have worked down people who used to
gages; but, we have lost with Bob Rodriguez for work for Aon and get their
more than we have won. many years – what are some phone numbers. We will
With the first pool we pur- of the main lessons that you then have conversations.
chased, we had about 31% learned from him? Or, in certain cases, she will
of principal paid to us over have the conversations for
the initial 10 months and we SR: The biggest lesson I ever us. Other times, she will
made about 24% in that learned from Bob is to pre- act as a data gatherer; for
Professor Bruce period. We do not think pare for the worst and hope instance, insurance market
Greenwald at the 2009 that will be indicative of the for the best. pricing data in a hard-
G&D Breakfast rest of that pool or the market versus a soft-
other pools, but it is still an G&D: We also noticed that market. So, she is an inves-
Bruce C. N. Greenwald
indicator that we are on the you recently hired Elizabeth tigative journalist for us, a
holds the Robert Heil-
brunn Professorship of right track. We have this Douglass, a former business data synthesizer, research
Finance and Asset Man- one mortgage in Detroit, journalist with the LA librarian and just a great
agement at Columbia Busi- which is not in a great area. resource to have.
ness School and is the Our cost of this mortgage is
“As someone
academic Director of the $1,800 and in the last 10 G&D: As MBA students,
Heilbrunn Center for Gra-
interested in an
months, we have received how do you think we should
ham & Dodd Investing. investing career, I
$2,500 in payments and still make the most of our time
Described by the New
York Times as ―a guru to own the mortgage. and squeeze the most out of
think you have to
Wall Street‘s gurus,‖ this program?
Greenwald is an authority G&D: Why do you think patiently wait for
on value investing with such attractive pricing for SR: I appreciate your
additional expertise in these loans exists – is it the opportunity. school‘s program – it is back
productivity and the eco-
similar to a spin-off, where to basics. As someone in-
nomics of information. Also, do enough
you have a pressured seller? terested in an investing ca-
work so that you reer, I think you have to
SR: Sure, banks have added patiently wait for the oppor-
to their reserves and they can take tunity. Also, do enough
are taking losses slowly over advantage of that work so that you can take
time. But, there are not a advantage of that opportu-
lot of natural buyers for opportunity when nity when you see it, either
these assets, so you have a in terms of job prospects or
little bit of a mismatch –
you see it...” an investment proposition.
more capital for sale than Times, which we found in-
there is seeking purchase. If teresting – can you talk G&D: Thank you very much
the housing market goes up about that decision? Mr. Romick – we truly ap-
from here, our returns are preciate you sharing your
going to be terrific. We set SR: We are trying to do due thoughts with our readers.
it up so that we can make a diligence in a deeper way
10% rate of return, even if and get information that
housing prices decline a bit. may not be easily accessible.
For example, with Aon,
Elizabeth will help us track
Issue X Page 11
Donald Smith
(Continued from page 1) earnings were too volatile stocks. Upon graduation I
seven investment profes- to base an investment phi- went to work as a securities
sionals and three of those losophy on. That‘s why I analyst at Capital Research
went through the Value started playing with book in Los Angeles. They had
Investing program at Co- value to develop a better just bought an IBM main-
lumbia. The program has investment approach based frame and had a lot of ex-
been a wonderful hunting on a more stable metric. cess computing capacity.
ground for us to find ana- They had a bright program-
lysts who understand the mer and I asked him to set
value approach. up different screens. So we
backtested many value
Our investment philosophy strategies based on price to
goes back to when I was book, price to earnings,
going to UCLA Law School “I still kept coming price to sales, price to divi-
and Benjamin Graham was dends, growth rates, return
teaching in the UCLA Busi- back to price to on equity, etc. We found
ness School. In one of his that a lot of the value ap-
book. Most of the proaches worked. I guess
lectures he discussed a
Drexel Firestone study backtests we did the moral of the story is
which analyzed the perform- that there is more than one
ance of a portfolio of the showed that price way to skin a cat. But I still
lowest P/E third of the Dow kept coming back to price
Jones (which was the begin- to book would to book. Most of the back-
ning of ―Dogs of the Dow tests we did showed that
30‖). Graham wanted to come out the best price to book would come
update that study but he out the best or close to the
didn‘t have access to a data- or close to the best. I liked the simplicity of
base in those days, so he it. It made common sense
asked for volunteers to best. I liked the to me that stocks should
manually calculate the data. sell in some relationship to
I was curious about this simplicity of it. It their underlying book value.
whole approach so I de- At the time analysts used
made common price to book for utilities,
cided to volunteer. There
was no question that this sense to me that banks and insurance compa-
approach beat the market. nies, but it wasn‘t empha-
However, doing the analysis, stocks should sell sized outside of these indus-
especially by hand, you tries as much as I thought it
could see some of the flaws in some should be. When I joined
in the P/E based approach. Capital I started applying
Based on the system you relationship to price to book more broadly
would buy Chrysler every and I soon became known
time the earnings boomed their underlying as the deep value portfolio
and it was selling at only a manager.
5x P/E, but the next year or book value.”
two they would go into a G&D: Today it‘s a lot easier
down cycle, the P/E would to screen than it probably
expand and you were
was when you started out.
forced to sell it. So in ef-
fect, you were often buying I then went to Harvard Has that made the strategy
high and selling low. So it Business School and spent a more competitive?
dawned on me that P/E and lot of my time analyzing (Continued on page 12)
Page 12
Donald Smith
(Continued from page 11) fers. If we know the tangi- the great franchises of all
ble book value is $10, the time was supposed to be
DS: Screening for tangible liquidation value is $20, and the distribution system and
book value has certainly we can buy the stock for $7, trademark of General Mo-
gotten easier. However, we that‘s ideal. tors. No one could ever
make a lot of adjustments penetrate Chevrolet distri-
that don‘t show up in the G&D: There aren‘t many bution. People paid a lot of
databases. For example, we investors that maintain such money for that ―franchise‖
adjust book value for dilu- a strict focus on tangible and then it disappeared.
tion from options and con- book value, with many seek- Eastman Kodak was one of
vertible debt. We add back ing out franchise businesses. the greatest trademarks in
deferred tax asset valuation the whole world, and then
allowances if there is a likeli- the value of that trademark
hood that they will be used disappeared. There are
to offset taxes in the future. some exceptions - Coca
We also adjust for Cola has managed to keep
―phantom goodwill‖ which its franchise intact. In gen-
can occur when a company “Often when we‟re eral though, franchise value
does acquisitions and writes can disappear on you very
up the assets in the process
buying stocks easily and that‘s how you
so that the purchase pre- below book, there get hurt. Often when we‘re
mium does not show up in buying stocks below book,
goodwill. That is something is some franchise there is some franchise
that most investors don‘t value there that isn‘t on the
do. value there that books: customer relation-
ships, intellectual property,
G&D: The contrast to that isn‟t on the books: etc. We‘ll take it as a free-
might be when tangible bie, but to pay for it, that‘s
book value understates the customer something else.
asset value. Do you tend to
miss out on companies with relationships, G&D: There are plenty of
hidden asset values? studies suggesting that the
intellectual lowest price to book stocks
DS: That can happen, but I outperform. However, only
think it happened more of-
property, etc. 1/10 of 1% of all money
ten years ago. Companies, We‟ll take it as a managers focus on the low-
in the quest for earnings, est decile of price to book
have sold many highly val- freebie, but to pay stocks. Why do you think
ued assets when they had that‘s so, and how do peo-
the opportunity. In our for it, that‟s ple ignore all of this evi-
fundamental research we dig dence?
intensively into the liquida- something else.”
tion value of companies to DS: They haven‘t totally
find instances where that ignored it. There are peri-
value is significantly higher ods of time when quant
than tangible book value. In funds, in particular, use this
that case it‘s just frosting on DS: True. The problem is strategy. However a lot of
the cake. However, we still that franchise value is in the the purely quant funds buy-
like to focus on basic tangi- eye of the beholder. Some- ing low price to book stocks
ble book value because of times it is real, but many have blown up, as was the
the margin of safety it of- times it disappears. One of (Continued on page 13)
Issue X Page 13
Donald Smith
Stocks in the lowest price/tangible book decile have

20.0%
delivered the highest returns over the long-term
15.4%
15.0% 13.7% “In general people
12.5%
11.3% 11.2%
S&P 500 10.5% 10.4% like glamour,
10.7% 10.0% 9.1% 9.2%
8.4%
growth, clean and
5.0%
simple stories. It‟s
also tough to ride
0.0% out our strategy
1 2 3 4 5 6 7 8 9 10
Lowest Highest
P/TBV P/TBV
during hard times.
or so the low price to book try, Rich who knows many

Every ten years or
strategy has a down period. industries, and me. I have
so the low price to
case in the summer of 2007. From a psychological stand- followed many industries
Now not as many funds are point, it can be a difficult over the years and bring a book strategy has
using the approach. Low approach to stick with. macro perspective.
price to book stocks tend a down period.
to be out-of-favor compa- G&D: How is your invest- G&D: What are some of
nies. Often their earnings ment team structured? your key questions for man- From a
are really depressed, and agement?
when earnings are going DS: We all have a sector psychological
down and stock prices are focus. When a new stock DS: The first thing we talk
going down, it‘s a tough sell. hits the watch-list and looks about is the balance sheet. standpoint, it can
Analysts don‘t like to cover interesting, the first work is We want to make sure that
them and they don‘t have an done by the industry ana- tangible book value is accu- be a difficult
easy time pitching them to lyst. If he thinks it‘s worth rately stated, all the assets
portfolio managers. The pursuing, then it goes to are fairly valued and all the
approach to stick
companies are often difficult Rich Greenberg (our Direc- liabilities are stated. We with.”
to understand and have tor of Research). If Rich focus a lot on whether or
many moving parts. Institu- thinks it‘s worth pursuing, not the book value is real.
tional investors don‘t want he comes to me with it, and What‘s the replacement
to have to explain to clients if it looks interesting to me, cost? Is the balance sheet
that their stocks have gone we set up a meeting with sufficient to withstand a
down 50%, that same store management. This really recession for a year or two?
sales are negative, that mar- differentiates us from the We stress test it. That is
ket share is decreasing. In quant shops. We strongly the first of the value traps -
general people like glamour, believe in fundamental re- buying something that ends
growth, clean and simple search. We like the fact up going bankrupt on you.
stories. It‘s also tough to that a stock is being looked The second value trap is
ride out our strategy during at by three people - an ana- buying a cheap asset that
hard times. Every ten years lyst who knows the indus- (Continued on page 14)
Page 14
Donald Smith
(Continued from page 13) I have seen dumb managers DS: We try to make sure
stays cheap forever. That is whose stocks are selling at that when we buy some-
why the second part of our $10, suddenly become gen- thing it‘s so undervalued
meetings with management iuses when their stock goes that natural market forces
is always focused on the to $40. One of the attrac- will cause the stock to go
earnings power of the com- tive things about owning a up. We try not to spend a
pany. We spend time on stock with a low price to lot of time on anything that
where the company is today book ratio is that it often is considered ―active‖. We
and why it is under-earning. attracts good management. might, for example, press
Is it an industry problem? A A good manager at GE for management very hard to
management problem? Is example would rather be- buy back their own stock
underperformance isolated come the CEO of a com- instead of doing an acquisi-
to one struggling division? pany with a stock that‘s at tion that is dilutive to book
Then we come up with an 80% of book than one in the value, but mostly we keep a
estimate of what we think low profile. Generally man-
normalized earnings will be. “We really look for agements tend to just listen
This earnings power is what to you politely and then do
gives us near-term upside, stocks where what they want to do any-
instead of just buying cheap way, unless you have a very
assets and hoping that earnings can turn large position.
someone comes in and buys
them someday. We really around. That‟s G&D: Would you mind talk-
look for stocks where earning about how the composi-
ings can turn around. That‘s
what gives you the tion of that bottom decile
what gives you the doubles, doubles, triples, has changed over time? Is it
triples, quadruples. We put typically composed of firms
that all together and come quadruples. We in particular out of favor
up with 20 to 30 best ideas. industries or companies
put that all dealing with specific issues
G&D: How much impor- unique to them?
tance do you put on a com- together and come
pany‘s management team? DS: The bulk is companies
up with 20 to 30 with specific issues unique
DS: Quite a bit, in the sense to them, but often there is a
that we want a management best ideas.” sector theme. Back in the
team that will do no harm. early 1980‘s small stocks
We don‘t expect a stock same industry selling at 1.8x were all the rage and big
selling at 70% of book to book. We‘ve had compa- slow-growing companies
have Einstein running it. nies with average manage- were very depressed. At
We spend a lot of time ment teams that end up that time we loaded up on a
questioning the manage- with terrific management, lot of these large compa-
ment. Do you plan to do and those companies have nies. Then the KKR‘s of the
acquisitions (we‘re generally become some of our biggest world started buying them
anti acquisition)? Do you winners. because of their stable cash
like your own business? If flow and the stocks went
the stock is selling at 70% of G&D: Have you ever taken up. About six years ago, a
book, why aren‘t you buying an active approach with lot of the energy-related
it back? Ben Graham said managers, for example, stocks were very cheap.
that the opinion people writing letters or campaign- We owned oil shipping, oil
have of management is cor- ing for some sort of services and coal companies
related with the stock price. shakeup of the board? (Continued on page 15)
Issue X Page 15
Donald Smith
(Continued from page 14) back to normal valuations. You now have very strong
trading below book and That was very valuable, and growth in operating rates
liquidation value. When oil primarily precipitated by while fares have also gone
went up they became the bottom-up analysis. It up, so it‘s not uncommon to
darlings of Wall Street. helped us to avoid some see companies with revenue
Over the years we have huge value traps. Some- growth of 13-15%. We
consistently owned electric times it‘s not what you own think the whole industry is
utilities because there al- but what you don‘t own changing as a result of the
ways seem to be stocks that big guys merging. They are
are temporarily depressed going to have more pricing
because of a bad rate deci- power. One company we
sion by the public service like is Republic Airlines
commission. Also, cyclicals (RJET; $8.70). It‘s a low-
have been a staple for us
“We sent a client cost operator with a very
over the years because, by letter out in 2007 good CEO. They recently
definition, they go up and bought Frontier and Mid-
down a lot which gives us saying that housing west out of bankruptcy at
buying opportunities. good prices. At $8.70 the
We‘ve been in and out of prices should go company is trading at 86%
the hotel group, homebuild- of tangible book value and
ers, airlines, and tech down 40% just to we estimate it has approxi-
stocks. mately $1.60 of earnings
get back to normal power, so we‘re paying 5.4x
G&D: Speaking of cyclicals, potential earnings. This
you mentioned your under- valuations. That conservatively assumes EBT
standing of the macro pic- margins of 1.5% for the
ture. How do you overlay was very valuable, Frontier segment and 7.0%
your macro views on top of for the regional jet segment.
your bottom-up perspec-
and primarily The company will not pay
tive? precipitated by taxes for several years due
to tax loss carryforwards.
DS: A lot of times our bottom-up Republic will benefit tre-
macro view is generated by mendously from consolida-
our bottom-up process. analysis.” tion in the industry. South-
For example, we have fol- west is buying Airtran and
lowed homebuilders, banks both of them are big com-
and the mortgage GSEs for petitors of Republic. Fewer
years. When we did a bot- competitors is usually a
tom-up review four years that makes you successful. good thing in this industry.
ago, we saw that these com-
panies were extremely G&D: Would you mind giv- G&D: It‘s interesting, you‘ve
overleveraged and that ing us a few examples of heard very few people say-
housing prices were unsus- your process in action? ing positive things about the
tainable relative to income airline industry. Warren
levels. At the same time, DS: One industry that we Buffett says that each time
down-payments were going like is the airlines. During he thinks about this space,
from 20% to 10% to 5% and 2008/2009, capacity was cut he has a 1-800 number he
then 0%. We sent a client back severely, and while calls to prevent him from
letter out in 2007 saying some is being added now, making an investment in the
that housing prices should it‘s very small compared to industry. What is it that
go down 40% just to get other recoveries in the past. (Continued on page 16)
Page 16
Donald Smith
“The moral of the

story is that no
matter how bad
the industry is, at
the right price and
especially when
the fundamentals
are turning, you
can make a lot of
to easy access to off balance DS: Generally, if anything
money.” (Continued from page 15)
sheet lease financing. It gets to 2x tangible book it‘s
you guys see differently; is it would be a real positive if automatically a sell. The
more a matter of under- airlines had to put all their advantage of this approach
standing the cycles that the leases on balance sheet, of is that if you catch a com-
industry goes through? which there‘s some talk. pany in a real turnaround,
The moral of the story is their book can grow at 20%
DS: People are overly nega- that no matter how bad the a year, and if they have tax
tive on the industry because industry is, at the right price loss carryforwards, even
they have been burned in and especially when the faster than that. In these
the past and because fundamentals are turning, cases the stock price often
―conventional wisdom‖ now you can make a lot of follows the book value
states that you should never money. The steel industry growth but the multiple
buy an airline stock. Yet, was terrible for years, but doesn‘t initially expand so
we think there are a lot of when the fundamentals fi- we stay in the stock. Then
new things going on. Con- nally turned, we made a lot after five years of this, the
solidation has reduced com- of money on AK Steel and growth guys come in and
petition and not as many US Steel. say, this must be a changed
airplanes are being ordered. industry, and then bid the
Companies are being run by G&D: Republic Airways is stock up to 2x book. Then
CFOs that became CEOs so selling at about 86% of tangi- we‘re on our way out. This
they are more focused on ble book right now. At happened with the home-
the bottom line rather than what point do you think builders, when in the early
empire building. Historically about selling? 2000‘s, they were selling at
overcapacity was due in part (Continued on page 17)
Issue X Page 17
Donald Smith
(Continued from page 16) this real estate at $100 a estimates, it‘s based on nor-
less than 50% of book, and square foot is probably a malized earnings looking out
their earnings grew like good deal. two-to-four years. We find
crazy. By the time we finally that it generally takes that
ended up selling at over 2x long for a business to funda-
book, our worst performer, mentally turn around, and
Standard Pacific, had gone that even after it turns
up 7x. Our biggest gainer, around, it takes a while for
Hovnanian, had gone up the Street to pick up on it,
14x. and even longer to attract
“Some academic the momentum investors.
G&D: Do you want to shift Some academic studies sug-
studies suggest that gest that long holding peri-
to another name?
ods for low price to book
long holding
DS: Another name that we stocks are better than short
own is Dillard‘s Department periods for low holding periods. Often our
Stores (DDS; $26.46). This holding period gets cut
is a tough one to get your price to book short because we have a lot
hands around. Management of takeovers. This year we
generally doesn‘t have con- stocks are better have had 8 takeovers out of
ference calls. The Dillard about 60 stocks, and the
family controls the company than short holding premiums have been very
via a dual class share struc- attractive.
ture so there are concerns periods. Often our
about management account- G&D: One of your top
ability. The real story here holding period gets holdings is Yamana Gold –
is tremendous hidden real can we discuss that invest-
estate value. Dillard‘s owns
sped up because
ment?
46 million square feet of we have a lot of
real estate. The stated DS: We were attracted to
book value is $32, but if you takeovers.” Yamana Gold (AUY; $11.63)
assume retail real estate because it was selling at a
value recovers, their real huge discount to tangible
estate could be worth $100 book. We started buying it
a square foot and that at the end of 2008 when it
would add about $20 for an was being dumped during
adjusted book value of $52 the financial crisis. Cur-
(and that‘s after adjusting G&D: This is probably a rently the stock is trading at
for taxes on selling the real good segue to talk about a 25% premium to book but
estate). So you have a stock timing and your average we think it is still attractive
around $27, with a breakup holding period, which is here. At current gold
value of about $52. One of under one year for most prices Yamana has about
the problems with the com- funds. But for a lot of these $1.00 of earnings power.
pany has been their lack of theses to play out, obviously However, the company has
sales growth, and that‘s you‘ll be waiting much significant organic growth
turning around. You have a longer than that. What is potential through the devel-
fundamental turnaround your typical holding period? opment of existing mines
story here, supported by and reserves. Importantly,
tremendous asset value. If DS: We usually hold stocks Yamana has a very strong
you think inflation is a prob- for three-to-four years and balance sheet, with only 7%
lem down the road, owning when we do our earnings (Continued on page 18)
Page 18
Donald Smith
(Continued from page 17) book value, so it makes all which has a big market
debt to capital, so it can the sense in the world for share in mature product
fund expansion through them to buy our tech stocks categories like DRAM and
internally generated cash at book value for cash or NOR flash, and rapidly
flows. Also, in our analysis stock, even paying a pre- growing categories such as
the company can make mium. Some of these com- NAND flash and solid state
money all the way down to panies also have valuable drives. It‘s unlikely that the
$600 gold, so you are get- intellectual property that we company as a whole will
ting production growth and are getting for free. become obsolete. For that
upside leverage to the price reason we generally stay
of gold with limited down- away from single focus tech
side. We think gold stocks companies. Micron has a
are a lot more attractive strong balance sheet and
than the metal itself. trades at 87% of its $8.70
tangible book value. It also
G&D: You have a few tech “...they should buy trades at 6.9x our estimated
stocks in the portfolio, normalized earnings power
which we were surprised to Graham and Dodd of $1.10, which assumes net
find. income margins of about
stocks in their own
11%.
DS: Many small and medium portfolios and see
-size tech companies have G&D: A lot of our readers
been in a bear market since how it works. are MBA students, or re-
the 2000 tech bubble, so cent grads, committed to a
over the last couple of years Hopefully they‟ll value investing approach
we have purchased a lot of based on what they learned
tech stocks at well below make so much from Ben Graham and Secu-
book value. We think all rity Analysis. But as we‘ve
the new gadgets, like smart money that they discussed here, there are
phones and iPads, and the not a lot of disciplined value
corporate replacement cy- can start their own investing firms. What ad-
cle for technology provides vice do you have for some-
good growth prospects for firms.” one who can‘t find the ideal
this industry over the next organization for their first
couple of years. The stocks job?
have sold off recently be-
cause of the fear of a double DS: There are very few
-dip recession. There may G&D: How do you get true Graham and Dodd
be a slowdown in consumer comfortable with the assets style deep value firms, so
spending, but the typical of technology companies, they can send their resumes
smart phone uses 7x the with the fear of obsoles- to us, but other than that
semiconductor content of a cence? it‘s tough. While they‘re
traditional cell phone. Thus, seeking out as many deep
we think revenue growth is DS: We have an analyst value investment firms as
going to be strong for the whose job it is to figure out possible they should buy
enablers of these trends. which products are going to Graham and Dodd stocks in
We think there will be a lot become obsolete, and which their own portfolios and see
of takeovers in this space. aren‘t. But most of our how it works. Hopefully
Many tech companies have a companies are large and they‘ll make so much money
lot of cash, and have stocks diversified, like Micron
trading at big multiples of Technology (MU; $7.60), (Continued on page 19)
Page 19
Donald Smith
(Continued from page 18) stance, companies with G&D: Any parting words of
that they can start their tough union problems can wisdom?
own firms. be a challenge. Another
thing we have learned to DS: The universe of invest-
G&D: You‘ve been in this avoid is companies in secu- ment opportunities is very
industry for over 30 years, lar decline. We always ask large and there is a lot of
which is much longer than ourselves, does this com- analytical noise in the sys-
many people last. Over 30 pany or industry have a cy- tem. When I started at
years of investing, what is clical or secular problem? Capital I realized there were
the most difficult part about Finally, we have learned to a lot of smart people out
a deep value strategy to stay always stress-test our pro- there working 12 hours a
“When I started at disciplined about? jections. For example, what day analyzing every oppor-
happens if oil goes to $150, tunity – how could I possi-
Capital I realized DS: About every 10 years how about $30? With our bly beat them? So I said,
this strategy has a bad pe- airlines, it would not be let‘s just eliminate 90% of
there were a lot of
riod, but those clients that pleasant if oil went to $150. the universe and focus on
smart people out stick with us are usually Yet, they weathered the last the lowest price to book
highly rewarded. After oil spike which gives us decile. To begin with this is
there working 12 these tough periods, our some comfort. If oil goes to a much better pond to fish
stocks have massively out- $30, margins could explode. in. It also gives me a 10 to 1
hours a day performed the S&P. Older focus advantage over the
clients that have experi- G&D: There‘s an active competition. We learn
analyzing every enced these rebounds are debate. A lot of people much more about these
very loyal to us. But with who have thought of them- companies than they can
opportunity – how newer clients, it can be a selves as bottoms-up, are learn about the whole uni-
tough sell. The 2008 down thinking, now in light of the verse. Most importantly,
could I possibly period lasted about 18 past couple of years, we when push comes to shove
months, which is good. If it need to pay more attention and stock prices are falling,
beat them? So I lasts more than two years, to macro. Have your views we have an anchor of solid
patience wears out. Our on that shifted over time? tangible value supporting
said, let‟s just
worst stretch was 1998 and our stocks, so we can confi-
eliminate 90% of 1999. During times of un- DS: It‘s probably true that dently buy at the lows. So I
derperformance there‘s a macro is more important would just say that you need
the universe and lot of pressure to change today because the financial to have a differentiated in-
your stripes, and that‘s what system is much more lever- vestment philosophy. After
focus on the lowest happens at many value firms. aged, and world wide gov- transaction costs, it is a
I‘m convinced that one of ernment intervention is negative-sum game, so not
price to book the main reasons for our having a huge impact on too many people can sub-
superior results is that we interest rates, currencies, stantially beat the market
decile.” take a long-term focus and commodities, etc. Capital over time. You need to
are willing to tough it out flows much more freely have an approach that is
during rough periods. than it did 20 years ago unique.
which can make all asset
G&D: What was the most classes very volatile. I think G&D: Donald, thank you so
instructive mistake you that macro has always been much. We truly appreciate
made in the past? important, but more so now it.
because the whole system is
DS: We have gotten into so leveraged and volatile
trouble in situations where that accidents can and will
the free market isn‘t al- happen.
lowed to work. For in-
Page 20
U.S. Physical Therapy (USPH)

Ryan Coyle
RCoyle11@gsb.columbia.edu
U.S. Physical Therapy USPH Long, Price Target of $24.00 (15.0x 2012E Adj. FCF)
Capitalization Multiples Returns

Price Per Share (10/15/2010) $18.04 LTM LTM Adj. LTM 3-year avg.
Diluted Shares 11.6 TEV/Sales 1.0x -- ROA 15.6% 14.8%
Market Capitalization $209.8 TEV/EBITDA 5.9x 7.7x ROIC 18.0% 17.3%
Plus Debt 4.3 TEV/FCF 8.4x 12.6x ROE 14.6% 13.7%
Plus Non-Controlling Interest (NCI) 8.3 P/B (6/30/2010) 2.2x -- Growth
Less Cash 7.2 EPS P/E LTM 3-year CAGR
Enterprise Value (TEV) $215.3 LTM 6/30/2010 $1.10 16.4x Revenue 5.6% 14.5%
Ryan is a second year MBA Operating Statistics LTM 2010E $1.22 14.8x EBITDA 9.0% 16.0%
student concentrating in Revenue $206.0 2011E $1.33 13.6x Net Income 16.8% 24.2%
Finance & Economics. He EBITDA 36.3 2012E $1.45 12.4x EPS 18.3% 16.0%
spent the summer interning Adjusted EBITDA (ex-NCI) 27.8 Other Corporate Location: Houston, Texas
with a value-focused small- Net Income 13.0 Short Interest 3.4% Clinics: 471, in 41 states
cap fund in New York. Prior FCF (OCF - CapEx) 25.6 Insiders Own 5.9% States with Most Clinics: Tennessee (56),
to enrolling at Columbia Adjusted FCF (OCF - CapEx - NCI) 17.1 Dividend Yield NA Texas (50), Michigan (41), Wisconsin (17)
Business School, he spent
four years covering the Investment Thesis:
consumer sector at a long- I recommend purchasing shares of U.S. Physical Therapy (―the Company‖ or ―USPH‖). USPH is
short hedge fund in New poised to benefit from secular demand growth for physical therapy services. Additionally, the physical
York. therapy business model offers attractive unit economics and solid cash flow, and USPH has a golden
opportunity to gain market share via targeted in-market advertising, selective new partnerships, and
tuck-in acquisitions (taking advantage of an extremely fragmented marketplace). At 12.6x LTM ad-
justed free cash flow to common equity (after cash payments to non-controlling interests, aka clinic
partners), the company is attractively valued in light of the business fundamentals. I believe a combina-
tion of market share growth, demand growth, and operating leverage will enable USPH to grow FCF
at a high single digit rate over the medium term, yielding a value estimate of $24.00 per share, up 33%.
High Demand, Low Supply: The US Bureau of Labor Statistics predicts that the demand for physi-
cal therapy will grow 28% by 2016, or ~4% per annum. A large driver of the demand growth is the
retirement of baby boomers who are pursuing active lifestyles later in life. Further, a recent Business
Week survey indicates that there is an estimated 15% shortage in the supply of physical therapists in
the marketplace. Any individual therapist must complete a three-year graduate degree program, un-
dergo training, and then meet state licensing requirements prior to beginning work in the market-
place. The market demand for physical therapy is brisk, and the industry is healthy.
Selling Therapists Have Limited Options: There are over 16,000 therapy clinics in the USA, and
many of those clinics are locally-owned businesses. In the current competitive landscape, no outpa-
tient physical therapy company has a national market share greater than 6.0%. Indeed, USPH has only
a 2.9% market share. USPH maintains a $50M revolving credit facility and can act quickly and deci-
sively when an opportunity presents itself. Historically, USPH has made acquisitions ranging in size
from one clinic to a regional network of 50 clinics. USPH is in good position to acquire partnerships
as existing therapists/owners seek a partial (or full) liquidity event for their existing enterprise while
still maintaining a minority equity interest in the business. In the wake of the financial crisis, some
clinic owners and therapists are increasingly eager to diversify their personal financial risk away from
their place of business.
Disciplined Buyer: USPH does not undertake an acquisition unless it is immediately accretive to
earnings, and unless the management team is willing to stay on to run the business after the transac-
tion closes. USPH typically extracts immediate synergies as the acquired operations streamline into
the USPH systems. As previously indicated, there are over 13,000 clinics in the universe of potential
domestic acquisitions for USPH, many of which are small operators, and thus it seems reasonable to
assume that USPH can tuck-in or otherwise capture share from these clinics and improve the opera-
tional efficiencies, driving further operating leverage for the company over the medium term.
Management: The USPH management team has industry experience and a record of delivering
shareholder value. The CEO, Chris Reading, is a licensed physical therapist. Prior to joining USPH in
2003, he managed 200 clinics within the HealthSouth outpatient therapy system. Management must
continue to manage the business prudently. To date, they have a good track record of doing so.
Issue X Page 21
U.S. Physical Therapy (Continued from previous page)

Cash Flow: On an enterprise basis, USPH generates substantial free cash flow to equity and is in a net
cash position. Even with substantial non-controlling cash interest expense, the combination of a larger
clinic footprint, operational efficiencies, and an inelastic demand environment for physical therapy ser-
vices will enable the company to grow operating earnings and free cash flow at a high single digit growth
rate over the next 3 years. USPH can redeploy this cash flow into new clinic openings, accretive acquisi-
tions, and/or share repurchases. The company has an existing share repurchase authorization for ap-
proximately 5.9% of the shares outstanding.
Business Description:
USPH is the third-largest provider of outpatient physical and occupational therapy clinics in the United “USPH has a
States and the largest pure-play operator. USPH owns and/or operates 371 clinics in 42 states. A physi-
cal therapy clinic provides rehabilitative exercise services for a variety of physical ailments, including or- golden opportu-
thopedic-related disorders, sports-related injuries, neurological-related disorders, rehabilitation, and
preventative care. Clinics obtain new patients via physician referrals. Services take place on an outpatient nity to gain mar-
basis under the supervision of licensed physical therapists. USPH has historically grown its store base in
the following ways: (1) by partnering with established therapists in select markets to open new centers;
(2) by acquiring ownership interests in existing clinics; and (3) by opening same-market ―satellite‖ loca-
ket share via tar-
tions. Approximately 80% of the current USPH store base was developed organically, with the remainder
coming via acquisition. 80% of revenue comes via non-government sources (Private Insurance and Man-
geted in-market
aged Care 57%, Worker‘s Comp 16%, and Other 7%), with the remaining 20% from Medicare and Medi-
caid. USPH seeks to reduce its exposure to government-funded programs over time because this line of advertising, selec-
reimbursement has recently experienced pricing pressure.
Valuation tive new partner-
USPH is on track to drive Valuation Range
operating leverage in its core Low Mid High ships, and tuck-in
business, and it has a golden TEV (2012E @ 15.0x Adjusted FCF) 255.0 346.7 403.7
opportunity to scale the busi- acquisitions
Equity Value (2012E) 249.6 339.2 395.2
ness further. At current valua-
tion, you are buying a well- Current Value (discounted 2 years @ 10%) $206.2 $280.4 $326.6 (taking advantage
managed business trading at Shares Outstanding 11.63 11.63 11.63
an adjusted FCF yield of 8% Per Share $17.73 $24.10 $28.08 of an extremely
with secular demand tailwinds Upside from Current (1.7%) 33.6% 55.7%
and minimal risk of a serious fragmented mar-
negative change to the underlying business. My midrange valuation assumes USPH adjusted FCF expands
from a normalized base level at a 7.5% CAGR over the next two years, and assumes modest multiple ketplace).”
expansion as the growth trajectory ramps up for this company. This expansion in adjusted FCF comes
alongside growth in the store base and modest operating efficiencies, yielding a midrange value estimate
of around $24.00 per share. Although the current valuation ascribes no potential ―strategic value‖ to this
asset, one could potentially view USPH in this light as large healthcare institutions attempt to diversify
their revenue streams and invest more heavily in preventative and rehabilitative outpatient care. USPH
currently trades at a 65% discount to transaction comps in the space.
Investment Risks/Considerations
Reimbursement Reduction: Many are concerned by the potential for future reductions in govern-
ment reimbursement rates, and they fear that any government reduction will trigger a cascade of reduc-
tions from all other parties. However, I would argue that this risk is less prevalent for USPH because the
company‘s mix of government-paid patients is relatively small (as of 2Q10, 20% of USPH patients are
Medicare/Medicaid). My research indicates that contract negotiations with other payors are more
enlightened as many within the payor community are beginning to embrace the relative cost efficiency
and measurable outcomes of physical therapy (as compared to alternative treatments).
No Moat: Detractors claim that USPH has no ―moat‖ in its business model. This is a fair criticism. How-
ever, I would argue that USPH‘s current scale, the credibility of its management team, and its status as a
pure-play public company with capital markets access give USPH an advantage in executing transactions
quickly. Further, I would argue that the current fragmentation in the market makes it more of a ―land
grab‖ to gain further scale, and that USPH can succeed simply by hitting relatively simple milestones in its
current growth trajectory.
Integration Risk: There is always operational risk to consider. Some are skeptical of this company
because it is a ―roll-up‖ model across disparate geographies, but I would argue that the retained equity
interest in the clinics by the therapist partners keeps the incentives for USPH and its clinicians aligned
and that scale benefits are actually more tangible than detractors believe.
Page 22
CoreLogic, Inc. (NYSE: CLGX) Alex Latushkin—alatushkin11@gsb.columbia.edu

Recommendation: Buy common stock of CoreLogic, Inc. (“CLGX”), which
trades at $18/share and has an intrinsic value of $27/share or ~50% upside.
 CLGX was spun-off from First American (FAF), a title and specialty insurance company
on 6-1-10. Since then, the market has given us the opportunity to invest in a high ROIC
business services/data analytics company with leading niche market share that should
benefit from long-term secular trends of providing useful tools and applications to the
mortgage and financial industry amidst more regulatory oversight and increasing trans-
parency. The stock trades at an attractive 10% free cash flow yield (possibly off cyclical
trough FCF) and is naturally hedged via its default and origination businesses.
 Due to lack of substantial analyst coverage and confusing public financials (Capital IQ
and other financial databases present incorrect pre spin-off financials), CLGX is a be-
Alex is a second year MBA low-the-radar $2.2 billion market cap company.
student and participant in
Columbia‘s Applied Value
 While many of its outsourcing services are demanded irrespective of housing condi-
Investing Program. Prior to tions, the company‘s operations are nonetheless tied to housing and credit and there-
school, Alex Latushkin fore tainted by these currently weak end-markets.
worked in private equity.  Management (having operated together for over 15 years) has been able to grow mar-
Post MBA, Alex would like gins and withstand weak macro conditions despite volumes and sales being tied to
to work at a research- mortgage originations by adding new revenue streams through higher margin product
oriented public equities launches, via incremental market share penetration and by rigorously controlling costs.
investment firm.  With 5 patents, CLGX‘s solutions are used by all top 100 mortgage lenders/
originators, over 500,000 realtors, many hedge funds, broker-dealers, as well as mil-
lions of individual users and government bodies.
 Benefiting from scale, CLGX is the lowest cost provider in the industry, has 50% of its
workforce abroad, carries little debt, and hedges its operations by providing default
services; management is able to sustain a competitive edge in various housing markets.
 Management continues to penetrate growth opportunities by creating new applications
for customers and by entering tangential sectors like telecom, energy and public utili-
ties industries (all need detailed property data and analysis) and international markets.
 In light of the company‘s leading market share (operating in a sector with few major
players), attractive barriers to entry from its heavily invested data analytics and sticky
customer base, the market should value CLGX on a more appropriate mid-cycle FCF.
valuation. Applying 13x free cash flow to a normalized levered FCF of ~$250MM, I
arrive at a target price of $27/share.
Mortgage Originations ($ trillions)
$5.0
$4.5 $4.2
$4.0
$3.5 $3.0
$2.9 $2.7 $2.8
$3.0
$2.2 $2.5
$2.5 $1.9
$2.0 $1.7 $1.6
$1.0 $1.4
$1.5 $1.1
$0.9 $0.8
$1.0 $0.8 $0.8
$0.6 $0.6
$0.5 $0.5
$0.0
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
20
20
MBA Projections (as of 9-10)
$5,000
$4,000
$3,000
$2,000
$1,000
$0
Housing Home Sales M ortgage Purchase Refinancing
Starts Orgn.
2010 2011 2012

Issue X Page 23
CoreLogic, Inc. (Continued from previous page)

 Business and Information Services segment (50% of ‗09 sales; 53% of ‗09 EBITDA) - Mort- “The market has
gage Origination segment provides outsourcing services to mortgage originators, ser-
vicers and default asset managers via tax information from 22k taxing authorities to pro- given us the op-
tect lenders from delinquencies (#1 position/42% share) and via federally mandated flood
zone and geospatial data services to mortgage lenders/insurance companies (#1 posi- portunity to invest
tion/40% share). Default Services & Technology provides for loss mitigation services,
property valuation, default technology, claims management and broker price options (29%
in a high ROIC
market share). Customers include 1MM+ end-users in insurance, real estate, finance, business services/
consumer-direct, and gov‘t sectors. CLGX has grown market share in this segment.
 Data & Analytics segment (35% of 2009 sales; 43% of 2009 EBITDA) - Provides high qual- data analytics
ity data/analytical tools to assist customers in risk management, fraud detection, property
evaluation and consumer credit functions. Specialty Finance provides credit reports, real- company with
tor solutions and compliance services (50% market share); Risk/Fraud provides risk man-
agement (database covers 95% of US properties/135MM non-prime records) to analyze leading niche mar-
mortgage securities/loans. Data & Analytics segment profitability has remained resilient
throughout the recession by introducing higher margin new applications, and via market ket share that
share gains. CLGX has grown market share in this segment.
 I value CLGX on mid-cycle EBITDA/FCF given the cyclical end-markets; 7.5x EBITDA should benefit
or13x FCF given where comps trade, and in light of CLGX‘s leading market share, strong
barriers to entry, high ROIC and secular tailwinds. In a downside case, CLGX is worth
from long-term
$14/share (22% downside) under Bear Case ‗10 EBITDA of $375MM (10% below guid- secular trends of
ance) and at 5x EBITDA. In an upside case of mid-cycle EBITDA of $500MM and 9x
EBITDA multiple, CLGX is worth $37 (105% upside). providing useful
 Risks include a prolonged housing crisis, pressures from bank consolidation, and misuse of
capital. tools and applica-
x 2010 tions to the mort-
Current Capital Structure EBITDA Lev FCF Quick Discounted Cash Flow
Price Per Share (10-15-10)
Shares Outstanding
$18.09
117
WACC
Terminal EBITDA Multiple
10%
7.5x gage and financial
Market Cap $2,117 10.1x PV of Yr 1-5 Unlev FCF's $944
Net Debt
Enterprise Value
$222
$2,339 5.8x
2014 EBITDA
PV of Terminal Value
$506
$2,357
industry amidst
Intrinsic Value Implied Enterprise Value $3,301
Normalized EBITDA & FCF
EBITDA & FCF Multiples
$458
7.5x
$249
13.0x
Implied Price/Share
% upside
$26.32
45%
more regulatory
Implied Price Per Share $27.47 $27.62
($ in millions) LTM Projections (2012 = Normalized) oversight and in-
2007 2008 2009 6-10 2010 2011 2012 2013 2014
Sales
Risk & Fraud Solutions $429 $412 $388 $387 $408 $424 $458 $481 $505 creasing transpar-
Specialty Finance Solutions $355 $320 $301 $294 $263 $273 $295 $313 $328
Data & Analytics
Mortgage Origination Svcs
$784
$562
$732
$430
$689
$565
$681
$528
$671
$510
$697
$530
$753
$573
$794
$601
$833
$632 ency.”
Default & Tech Services $281 $368 $417 $426 $450 $428 $406 $386 $367
Business & Info Services $843 $798 $982 $955 $960 $958 $979 $987 $998
Employer, Legal & Marketing $380 $373 $306 $262 $285 $294 $305 $314 $321
Corporate $31 $9 $14 $6 $0 $0 $0 $0 $0
Total Sales $2,038 $1,912 $1,991 $1,903 $1,916 $1,949 $2,037 $2,095 $2,152
% Growth -6% 4% -4% 2% 5% 3% 3%
EBITDA
Risk & Fraud Solutions $133 $142 $130 $121 $126 $136 $147 $159 $167
Specialty Finance Solutions $62 $61 $71 $65 $58 $63 $70 $78 $82
Data & Analytics $195 $202 $201 $185 $184 $199 $217 $237 $249
Mortgage Origination Svcs $153 $130 $169 $128 $122 $138 $155 $168 $183
Default & Tech Services $42 $53 $76 $84 $95 $90 $81 $77 $70
Business & Info Services $194 $183 $245 $212 $217 $228 $236 $246 $253
Employer, Legal & Marketing $77 $56 $18 $18 $20 $24 $27 $28 $29
Corporate $16 $8 ($1) ($15) ($20) ($21) ($22) ($23) ($24)
Total EBITDA $482 $450 $463 $401 $401 $429 $458 $488 $506
% Margin 23.7% 23.5% 23.3% 21.0% 20.9% 22.0% 22.5% 23.3% 23.5%
Capital Expenditures ($83) ($79) ($81) ($67) ($70) ($75) ($77) ($78) ($80)
Interest Expense ($18) ($18) ($18) ($18) ($15) ($8) ($3) $0 $0
Taxes ($139) ($124) ($130) ($105) ($106) ($119) ($130) ($141) ($148)
Levered FCF $242 $229 $235 $211 $210 $228 $249 $269 $278
Unlevered FCF $260 $247 $253 $229 $225 $236 $252 $269 $278
Page 24
Rational Asset Management

(Continued from page 2) what most people do, is that lio risk control, which is
both had classes with Pro- we have a circular process. very important. Sometimes
fessor Bruce Greenwald, Most funds start with the value investors focus so
which was our real intro- entire universe, screen the much on the individual
“...we remember duction to Value Investing in companies, and then com- analysis that they miss that.
a more practical way and it‘s mence a deep-dive analysis.
that Greenwald fantastic, because it‘s a com- We realized, though, that G&D: It must have taken
frequently mon ground. This consis- this screening process can quite some time to develop
tency is very important for consume a huge amount of your knowledge base.
mentioned the partners. One of the major time and create false leads.
risks when you‘re starting a So what we decided to do Claudio Skilnik (CS): While
concept of „circle fund is to have disagree- was establish our knowledge we were both attending the
ments on your approach. base, which is a group of Seminar in Value Investing,
of competence.‟ We stayed in touch after about 85 solid companies we remember that
Columbia as Claudio went that we don‘t change. With Greenwald frequently men-
This is how we back to work at ABN that knowledge base, we tioned the concept of
AMRO Capital and I went apply the same template and ―circle of competence.‖
designed the fund, to back to McKinsey. Over same process for analyzing This is how we designed the
time we discussed starting a each company. The details fund, in the sense that we
in the sense that fund together, but if not for of the template are highly are truly capable of under-
Columbia, we would not be customized, but we use the standing the industries in
we are truly
partners. same template to give us which we invest and we are
capable of the consistency. The objec- able to understand how
G&D: Was starting the tive is to know each com- those industries evolve.
understanding the fund your first direct invest- pany we cover better than Let‘s take the example of
ment experience? the average investor, given the natural gas industry in
industries in which the amount of time we the United States. To truly
DS: No, I was at a $2 bil- spend performing each understand it, one has to
we invest and we lion hedge fund for almost valuation. follow the industry for at
three years and Claudio was least three to five years.
are able to working with private equity The other component is You have to understand the
after business school. Clau- our portfolio construction importance of drilling in
understand how dio also managed invest- methodology. After you unconventional reserves
ments for family and friends have spent literally hundreds (e.g. shales) as opposed to
those industries before we founded Rational of hours on each one of conventional drilling on-
together. Given our indus- those companies, doing ex- shore and in offshore wa-
evolve.”
try experience, we also tremely detailed and com- ters. You also must under-
knew how to run a complete quantitative and quali- stand the difference in
pany. That is very impor- tative analysis, you don‘t terms of economics associ-
tant, because you might be want to second guess your- ated with the different ways
an excellent investor, but self on when to buy and of exploring, and how the
not necessarily a good busi- when to sell, and what size huge reserves of natural gas
nessman. each position should be. So previously trapped in the
Rational has another com- major shales are now being
G&D: You have an interest- ponent which is that our made economically available.
ing and unique investment portfolio construction is If it weren‘t for Danilo‘s
strategy. Can you give us an rules-based. We limit our experience in plenty of con-
overview of that? exposure, both long and sumer related businesses at
short – we want to limit McKinsey, and for my ex-
DS: The core of Rational, each individual position size perience with infrastructure,
which is very different from too. This is part of portfo- (Continued on page 25)
Issue X Page 25

(Continued from page 24) only a four person team. It have to make sure that the
we don‘t think we would is because of the number of models are updated and we
have the knowledge base in years we have spent study- are on top of whatever is
the detail that is necessary ing these companies. These going on not only in the
to build the huge checklist are not companies that we companies themselves, but
that is basically our model- decided one or two years also their industries.
ing. In this sense, we can do ago to analyze. These are
good work - we are able to companies that we have G&D: Do you know any
understand the industries been following for five, six other fund managers that
and the businesses not only years, or even more than follow such a strategy?
differently, but also better that. This is why we have
than most research analysts, DS: You know, it‘s funny,
and that gives us the neces- our impression is that there
sary edge to outperform. may only be one or two
that are doing this. But it‘s
G&D: What is the first step a typical black swan situa-
in the process?
“You can‟t start tion – it doesn‘t matter how
many white swans you look
DS: Initially, it‘s a lot of
with a company‟s at, you don‘t know if there
industry analysis. You un- are any black swans out
10K, because you
derstand how the industry there, and how many of
works, and then you jump won‟t know what them. But we don‘t think
into a company. You can‘t it‘s a common way of run-
start with a company‘s 10K, the results tell ning a portfolio. That may
because you won‘t know be because it‘s not appealing
what the results tell you. you. You need to on a day to day basis – it is
You need to develop indus- very systematic and boring
try-wide information stan- develop industry- for most people. But, we
dards from comparing each love it! It‘s about a process,
company. How does the wide information so you either like to do
company drive its sales? Is processes, or you don‘t. My
it correlated with something standards from first job was as a methods
in the industry, or does that and process engineer, so
company have its own par-
comparing each that may have something to
ticular niche market? So if company” do with this. In our opinion,
you don‘t look into compa- of course, it looks very logi-
nies within the industry con- cal. It is one of the best
text, you are missing an ways, for sure not the only
important part of the proc- one, but a very responsible
ess. We don‘t go as high as way of investing. It lowers
making macro economic these 85 companies, but we your chances of being com-
forecasts, but on the indus- would not feel comfortable pletely wrong in something
try level, you really need to coming back a year from because you have seen that
be a specialist. now and telling you that we company in different cycles
expanded our knowledge and you know how it be-
CS: We get lots of ques- base to 150. We would not haves. It‘s very hard when
tions from potential clients be able to follow such a you look at a company for
asking us how we could large number of additional the first time to understand
truly understand these 85 companies in a short period where the company is, until
companies in detail and fol- of time. Whenever we are you have studied one cycle
low them very closely with following a company, we (Continued on page 26)
Page 26

(Continued from page 25) that, because when we have because we need to build
and lived through another conversations with potential the knowledge base. Since
one. investors, with other man- that‘s not the plan, Rational
agers, they say, look, it is a one-trick pony. We
G&D: How do you think makes a lot of sense to do it focus on US equities. What
about forecasting? this way. defines us as investors is not
that we are Brazilians, but
DS: These cycles exist and that we are engineers who
it is important not to fore- were exposed to the idea of
cast against the extremes of “What helped us value investing. In other
a cycle. For instance, when words, we need data, we
the US was building 2.5 mil- to do that well like data. We know how to
lion houses per year, above run correlations, or what-
the long-term average of 1.5 was looking at the ever is necessary to help us
million houses per year, understand how the flow of
people were forecasting a same companies. information from the indus-
soft landing in housing. The try trickles to the company.
dominant rationale for Otherwise, you We also were both trained
housing was that it would in corporate finance. You
keep jumping need both, the industry
never fall below 1.5 or 2
million houses per year. from one industry knowledge and the ability to
Now we are at 600 thou- translate that.
sand and it‘s the opposite, to another, in
we‘ll never build houses So which country has a lot
again. So that‘s one thing different parts of of public information where
we try very consciously not we speak the language and
to do, is forecasting ex- the cycle, and which has a broad base of
tremes into the future. companies? Maybe Japan,
What helped us to do that how do you know but we don‘t speak Japa-
well was looking at the nese. Maybe Europe, but
same companies. Other- where you are?” then you probably have to
wise, you keep jumping speak Italian, French and
from one industry to an- German, so you can have
other, in different parts of the same depth of knowl-
the cycle, and how do you G&D: You have some per- edge that you have here. So
know where you are? You sonal experience with some clearly the US was the first
never know how long and of these companies, but choice for us. So after we
how high the cycles will go, other than that, how do you decided where we wanted
but you can clearly recog- choose your companies and to play, we had to decide
nize when you are in ex- industries? how to choose the 85 com-
treme modes. panies. An important point
DS: There is one major is the performance of those
There are many people on driver of the knowledge 85 companies over time has
both the buy-side and sell- base, which is it has to fol- had a very high correlation
side that do a lot of good low a broad index. We with S&P 500 or Russell
analysis. But, we think the want to represent the US 2000 – thus, there is not a
difference is the consistency economy. We are a super- bias in our knowledge base.
of our methodology, which specialized fund. People ask We also avoid industries
we think is unique. We us if we can do this in Brazil that we are not able to ana-
would love to know exactly – we might be able to in five lyze. Our methodology,
why people don‘t follow years, but not tomorrow, (Continued on page 27)
Issue X Page 27

(Continued from page 26) essarily looking for great will occur or not, how
even in the US, does not businesses. probable it is that the barri-
apply to banks, biotechnol- ers to entry or the econo-
ogy, or high-tech, because DS: One thing we find very mies of scale will be
you do not really know interesting is that a lot of achieved? It‘s very impor-
where the industry will go. value investors say that they tant for us that the industry
are looking for companies attract competition when “One thing we
G&D: What is the next with huge moats. If there return over invested capital
step? are huge moats though, gets high. In technology find very
then there‘s no earnings though, there isn‘t a number
DS: Then you need to variation, and without earn- that can be reliable in the interesting is that
search. You exclude the ings variation, there‘s no short, medium or even long
companies where the indus- confusion. For example, run. We don‘t have history a lot of value
try is not highly quantifiable. people get highly confused on those numbers and we
We look at trucking compa- when they see USG deliver- don‘t know whether the investors say that
nies, infrastructure, packaging $6-$7 per share in 2005 competition will be coming
ing, basic consumer compa- or 2006 and now they earn they are looking
or not.
nies like Coca-Cola, Pepsi, minus $2. This confusion
and Nestle. Take hard-line though, presents the oppor- One of the companies we
for companies
retailers like Home Depot tunity to go short or go considered putting into our with huge moats.
and Lowes, Staples, Office- long at different times. We knowledge base is Paychex.
Max, and OfficeDepot, for did just that. We shorted it, It‘s a very interesting busi- If there are huge
example. We can count then bought it, then sold it ness with very high barriers
how many square feet they and then bought it again. to entry, customer captivity moats though,
have, we can adjust by the Another company we‘ve and high return over in-
age of their stores - we can done this with is Advance vested capital; however, we then there‟s no
work with that data. Auto Parts. It has a totally wouldn‘t feel comfortable
different cycle. They are knowing when to short a earnings variation,
To summarize: choose the the quintessential mainte- business like that. We don‘t
country, exclude the indus- nance company. In this par- know what the limit is on and without
tries where the methodol- ticular case, we bought the ROIC that this company
ogy does not apply, and AAP‘s shares when we can achieve. From the long earnings variation,
make sure that the block of started the fund and sold perspective, we don‘t know
companies you focus on recently, with a good real- that competition is not ca-
there‟s no
correlates with an index and ized return. pable of entering and de- confusion.”
has no bias - otherwise you stroying their ROIC. Quan-
become a sector fund. CS: We are looking for tifiable information is very
Then, make sure that every businesses whose assets are much related to ROIC as
single one has a volumetric important from a valuation we understand it.
driver - miles driven for perspective because the DS: The opposite of this is
trucking companies, number anchor for our valuation is trucking. It‘s a highly com-
of trucks produced by long-term return over in- petitive sector with earnings
trucking manufacturing com- vested capital. Technology variation because of eco-
panies, square feet for the firms, for example, are usu- nomic cycles. We know
retailers. You need the ally light from an asset per- there will be reversions to
physical drivers. spective. This makes it very the mean from both sides.
hard to determine the long- Since the sector has very
G&D: That sounds like an run trajectory of the busi- low barriers to entry, it‘s
interesting contrast to many ness - how will capital ex- highly predictable. You
investors. You are not nec- penditures impact the busi- know that when they are
ness, whether competition (Continued on page 28)
Page 28

(Continued from page 27) scenarios. They are proba- There was a recession in
bly extreme for the indus- 2000, volume went down,
making a lot of money they try, but they are believable. their price went down, and
will ultimately buy a lot of You can always model a their stock traded consis-
trucks, and eventually either company going bankrupt, tent with our low case.
declining demand or excess but that‘s not a realistic
supply will bring the eco- worst case for most compa- The great case is a huge
nomics back to 8 , 9, 10% expansion of margins in the
ROIC. There are other in- rail industry due to higher
dustries that are always in fuel expenses. Trucking
trouble, like the airline in- companies need 3x more
dustry, so we don‘t touch fuel per mile on average
them. In other words, there than a rail company. That
is a limit to how competitive means when fuel doubles,
you want your companies to “We have to make the delta moves from 3-1 to
be. 6-2, a difference of 4 units
sure that we‟re rather than 2 units. The rail
CS: By its nature, the airline companies priced most of
industry is highly leveraged. comfortable buying this delta and it explained
So our bad case for an air- most of the increase in mar-
line business is almost al- a business below gins. In May 2008, we were
ways zero for the equity. short CSX and at that mo-
We have to make sure that our bad case, and ment the market was saying
we‘re comfortable buying a that the ROIC would be
business below our bad would feel 15% in perpetuity. It im-
case, and would feel com- plied that volumes would
comfortable
fortable shorting the com- keep growing and gaining
pany at a valuation above shorting the market share from trucking
our great case. and/or that people would
company at a consume more heavy goods.
DS: So it‘s a balance be- So, that‘s a great case.
cause we don‘t want a com- valuation above
pany with a super high bar- So our study of a company‘s
rier to entry because we our great case.” historical returns helps us
don‘t know how much they define what believable great
can potentially earn and and low returns on invested
there will not be sufficient capital are. Next, we take
earnings variation. On the into consideration changes
other side, we want to in the industry. Even our
avoid companies that would low case for CSX is much
bring permanent losses of higher than it would have
capital by going bust during nies. Take the rail company been 15 years ago when oil
the bottom of a cycle. CSX. A low case is sub- was much cheaper. The
historical return over in- excess supply from OPEC
G&D: You‘ve mentioned vested capital for the indus- was consumed, and we
using a low, great and base try, in that case 6-7%. In don‘t see huge expansion of
case valuation framework. that scenario, you are as- capacity coming online. So
Why use this approach? suming low volume growth if oil stayed where it is,
and lower returns than you there is more room for
DS: We try to simulate have observed in the indus- margins even in the long
what we think are believable try projected in perpetuity. (Continued on page 29)
Issue X Page 29

(Continued from page 28) G&D: How far out do your space to simulate cycles. For
term for rail companies. So base, low, and great cases instance, we are now in a
we do incorporate that. If forecast? bottom of the housing cycle.
there are new facts, we in- It‘s impossible to know
corporate them and don‘t DS: Every single methodol- what USG‘s normalized
blindly forecast off of his- ogy, whether the person earnings are when you have
torical information into per- thinks of it as such or not, is only two years‘ worth of
petuity. If we think that the projections. It is much eas-
low case before was even ier to simulate the next cy-
worse than our case today, “It‟s impossible to cle and bring this to an aver-
we‘re fine with that, be- age ten years from now.
cause we don‘t know what know what USG‟s Your mistake on that aver-
is going to happen in fifty age is much smaller.
years, nor does the market.
normalized
So everyone has a medium You can also see the impact
earnings are when
term bias, but what we try of different scenarios over
to avoid is what we call a you have only two the coming years. For ex-
mathematical impossibility. ample, what happens with
years‟ worth of their debt? Will they blow
G&D: Can you give us an up in some of the bear case
example that illustrates a projections. It is scenarios? If you have a
mathematical impossibility? two year template, how do
much easier to you know? The answer is
DS: For example, when you don‘t. We have all
USG was trading at $90 in simulate the next their debts modeled,
2006, it was implied that tranche by tranche, because
there would be a soft land- cycle and bring it matters how the company
ing in the housing market will be performing when
and the return over in-
this to an average they must renew their debt.
vested capital for USG ten years from If the company is luckier in
would remain in perpetuity that a bigger chunk is due at
around 30%. Our base case now. Your the next peak, they will refi-
is 11%, not very far from nance it at much lower rate,
the observed return during mistake on that so we can‘t simply ignore
normal parts of the cycle. that. It matters.
It‘s a very simple industry, average is much
very replicable. For in- In practice, after the 10 year
stance, there was a price fly- smaller.” forecast period, it ends up
up in the industry in 2005, being a perpetuity. The
the capacity was fully util- a perpetuity. When people difference is that we do it
ized and the pricing moves tell you that they do a cou- explicitly. We converge to
up the cost curve. But ple of years and use a multi- the long-term average re-
eventually capacity expands, ple because they don‘t turn. The growth should be
and prices are already very know what is going to hap- consistent with the popula-
close to where the cost pen in three, five or ten tion growth or whatever is
curve tells you it should be. years, they‘re using a perpe- the driver for that industry.
So what the market was tuity. The multiple repre- It‘s very dangerous when
forecasting back in 2006 is sents buying that cash flow you have a perpetuity where
close to a ―mathematical in some form of perpetuity. you can plug in 4% and say
impossibility‖. So, we go over ten years, it‘s reasonable. But if infla-
because we want to have (Continued on page 30)
Page 30

(Continued from page 29) DS: A good example of that also not thinking about do-
tion is 2%, and volume is is housing with USG. To go ing expansions or renova-
2%, that may imply huge out and project GDP, that‘s tions.
market share gain over 30 too much macro forecast-
years for a population that ing. It‘s always about a bal- We develop our expecta-
is growing at 0.5%-0.6%. ance. However, going tions on new home starts by
blindly into these industries looking at the number of
G&D: Can you talk about without knowing what mat- homes per thousand inhabi-
where USG is today relative ters is also not a sound tants in the US and revers-
to your base case? methodology. So we look ing this to the long-term
trend that we see in the US.
DS: USG is very close to It has to fluctuate around a
our low case scenario, “Interestingly, reasonable number of
which implies very low re- homes per thousand people.
turns in perpetuity. The three months ago, Our assessment of new
company was lucky that home starts over the next
they had this huge peak in we left the position 10 years is a major input
earnings, which allowed into our valuation of USG.
them to pay down a lot of at our fair value,
debt. It is a leveraged com- G&D: So is that more of a
pany, so it is classified in our
and then it return to long term trend
knowledge base as an ―at dropped by 50%, or do you simulate variation
risk‖ company. That‘s a around that trend line?
company that could be in and we bought it
trouble in the event of an- DS: For the next ten years,
other bad recession. They again. Same it‘s the real simulation, with
were in trouble earlier housing starts going from
when they were saved by company, nothing 600 thousand to 1.7 million
Warren Buffett through the and coming down to a mil-
help of the convertible is- changed, the lion. In practice, companies
sue. Interestingly, three will be impacted by it be-
months ago, we left the market decides to cause of their debt cycle.
position at our fair value, USG has no normalized
and then it dropped by 50%, take it from $5 to earnings. Their earnings are
and we bought it again. anything but normal in any
Same company, nothing
$25, more or less, given year. It‘s always in
changed, the market decides and drops again to transition between boom
to take it from $5 to $25, and bust. If you were the
more or less, and drops $10-12.” owner of this company, it
again to $10-12. would matter to you if the
cash flow came now, five
G&D: It sounds like you‘re at the sales of wallboard for years from now, or ten
building out a ten year fore- the industry in the US, and years from now.
cast with different scenarios see that the correlation
to capture different cycles. with the new home starts is G&D: Are you more con-
How do you think about 90%. Although not all wall- cerned with having a catalyst
those projections and the board is used for new home in your short positions, do
role they play in your proc- construction, this one vari- you rely on the same longer
ess? able has a lot of information. -term valuation reversion?
When people are not build-
ing new homes, they are (Continued on page 31)
Issue X Page 31

(Continued from page 30) position on the stock price will be. For example, you
DS: We short the same downward movement. think you are at the end of a
companies that we will po- recession, and then a sec-
tentially go long. We prese- G&D: How do you think ond leg, much bigger than
lect our companies not to about margin of safety, do the first, is coming, as it did
have extreme scenarios in you require a certain spread in 2008-2009. We design
either direction, either go- between the great and low risk controls, to guarantee “I think the
ing bankrupt or having the cases? that there‘s no permanent
company become ten times loss of capital, so we come biggest mistake
bigger in real value than DS: This is why we develop back after the recession. If
what we had forecasted. the three scenarios we do, our resources are pre- we will commit
When companies are selling so that the margin of safety served, we can keep moving
at our great case valuation is there. If we make a mis- as investors. But this is an from time to time,
and we are shorting them, take, we took a position in a inevitable mistake that will
chances are that they are company at the fair value. happen from time to time. which is
very close to their peak
earnings. It‘s just a matter CS: If you focus on always The only way to avoid it is inevitable, is
of patience that the valua- starting a position at a valua- to have a crystal ball. If we
tions will correct. We find tion such that you avoid had one, we would have
underestimating
that the correlation be- permanent loss of capital, started our fund net short how severe a
tween next 12 months‘ then you will understand in April 2008, rather than
earnings and price per share the methodology. You are net long because we were macro-event will
is extremely high. It doesn‘t buying at a price where at the end of one recession.
make sense, but that‘s how even if lots of bad things You can see this in trucking: be. For example,
the market works. We are happen to the company, you the first normal housing
creating alpha based on that, are still going to avoid per- recession was over already, you think you are
in the sense that price will manent loss of capital. And that was from 2006 to 2008.
follow earnings, and if there the same is true of shorts; Then the panic recession, at the end of a
is high probability that the you are shorting at a price with all the banks saying
earnings are above trend- where everything that can they were bankrupt, led to a recession, and
line, they will reverse. go in favor of the business is huge decline in real activity
already priced into the in companies. In the case of then a second leg,
CS: We also need to make stock. So the idea here is USG, they had to go after
sure that the portfolio risk to open positions making an expensive, dilutive instru-
much bigger than
controls are all set and sure that we may lose ment. This shaves almost the first, is
working. For example, even money in the short or me- 30% of their value that was
if the stock price of one of dium term, but we are not not in our forecast. And so coming, as it did
our short positions tripled going to lose from the per- this is unpredictable because
against the price at which manent perspective. it is an event that happens in 2008-2009.”
we shorted it, we could every 70 years. But you
potentially make money G&D: Could you talk about have to have a methodology
once the stock finally goes a mistake that you made, that even with your mis-
to our fair value estimate that you have corrected the takes, you don‘t blow up.
(base case). To make sure methodology to account We haven‘t changed any-
that is the case we need to for? thing from the beginning of
trim down our position to the fund in April 2008 until
our maximum exposure per DS: I think the biggest mis- now.
position on the stock price take we will commit from
upward movement and we time to time, which is inevi- The other kind of mistake
will be adding back to our table, is underestimating that we might commit, and
how severe a macro-event (Continued on page 32)
Page 32

(Continued from page 31) against a lot of things we investment, and we need to
this is more on an individual hear from other value inves- make sure that we limit our
basis, is with wrong analysis. tors. If we think that the losses. It is very important
For instance, if you look at fair value of a business is to recognize that we are
our implied return over doing the same kind of
invested capital, including analysis for eighty five busi-
capitalized leases, for Home
“There were some nesses, and we are not go-
Depot and Lowes, it is ing to double or triple down
value investors
higher than the average for on any one of them. The
other retailers we follow. that came out explanation that if you like
Those two companies have something with an x market
behaved very well for a long after the recession of safety, you should like it
time, including in this mas- more with 2x and you
sive crisis. There was no and said that they should die for it at 3x - this
price war. What should be is not within our methodol-
the base case for this du- were very ogy. Unfortunately, we will
opoly? There are limits to commit mistakes and we
what they can earn, but if concentrated and should make sure that our
they continue to behave as methodology will limit the
they have, it implies a higher they were chasing losses associated with such
valuation than in a fully com- mistakes. We intend to re-
petitive industry. How
something down munerate our investors for
could I make a mistake the bulk of our analysis and
to the bottom.
here? What if they started not necessarily for extreme
a long price war? The fair That‟s the danger, returns achieved from one
value will then be revised or two home-runs.
down. We thought we because you
were buying at the low case DS: There were some value
valuation, but it turned out expose your fund investors that came out
to be the real case. It is not after the recession and said
a permanent loss of capital doing this. that they were very concen-
because of the margin of trated and they were chas-
safety, but it would have Although it is ing something down to the
been a mistake nevertheless. bottom. That‘s the danger,
If you do a lot of this, your beautiful when it because you expose your
returns are going to be me- fund doing this. Although it
diocre. But again, with
works, the risks is beautiful when it works,
companies that you know, the risks associated with it
associated with it
that you have been follow- are gigantic. Our portfolio
ing for many years, some of are gigantic.” management was designed
those mistakes will happen before the 2008-2009 crisis
less frequently than com- $16, and now the low case and in such a way that it
pared to the average inves- valuation for that same busi- could withstand a very bad
tor. Therefore you can cre- ness is $10, and we buy that shock, which did happen.
ate alpha by stock-picking. company once it goes below There was a drawdown, but
$10, our methodology does we came back, without
G&D: How do you limit the not include buying more at emergency tweaks in the
impact of such mistakes? $9, buying more at $6, and methodology.
even buying more at $3.
CS: This is very important, We recognize that we might
and it goes very much be wrong on the subsequent (Continued on page 33)
Issue X Page 33

(Continued from page 32) fident that I was making a methodology - it‘s not about
G&D: Is there anything that good and responsible invest- having a dream one day and
you wish someone from the ment? becoming a great investor.
industry told you when you
were at Columbia Business CS: I think that before get-
School? ting into this industry I
would have liked to have
DS: There are many differ- dealt more with the impor-
ent ways to invest: choose “You research, tance of portfolio allocation
yours. Try to find it. I wish and risk control, in addition
someone had told me that it you know your to studying single businesses
is possible to invest being and investment ideas. I
very methodical. The feel- companies, you think people focus a lot, and
ing that I had when I started they should, in trying to
to invest, after speaking
know the industry, understand a business and
with a lot of people and the industry. But a lot of
and you know
reading a lot of books, is importance needs to be
really the same feeling when what you are placed on building a portfo-
I started in engineering. I lio from these ideas that will
remember when I was an doing under the maximize your gains and
engineer, reading a book by make sure that your losses
Lee Iacocca talking about best known are such that you can live
Chrysler. It was a must- with.
read book for people who circumstances.
were thinking about being DS: For students at Colum-
CEOs of companies. I re- Mistakes will still bia, the focus is more on
member feeling almost de- specific company analysis.
spaired when I read Lee happen, but there This makes sense, because
Iacocca saying that he knew one‘s initial job after Colum-
that the Mustang was the
is a methodology - bia is as an analyst. When
best name for that car and it‟s not about you make the jump to run-
that it was the key to its ning your own fund, you
success. I asked myself, having a dream eventually have to learn the
how does he know that? portfolio management part.
How does he have that kind one day and You are going to need to
of foresight? And it was a have a methodology. So it‘s
terrifying feeling to think becoming a great also an important part of
that I didn‘t have that type the job.
of intuition. investor.”
G&D: Thank you very much
When I went to investing, it Danilo and Claudio – that
was something similar to was very insightful.
this. How does this inves- So I wish someone had told
tor do it? Sometimes you me that there‘s another
see people presenting their way. You research, you
methodology in very generic know your companies, you
terms, as if all they did was a know the industry, and you
back of the envelope calcu- know what you are doing
lation. How am I supposed under the best known cir-
to do a back of the enve- cumstances. Mistakes will
lope calculation and be con- still happen, but there is a
Issue X Page 34
The Columbia Investment Management Association

and
The Heilbrunn Center for Graham & Dodd Investing
are proud to announce the 14th annual
CIMA INVESTMENT MANAGEMENT CONFERENCE

On Friday, February 4th, 2011
Columbia University in New York, NY
The CIMA conference is structured to be a full-day event with two keynote speeches
and three panels.
This year’s conference provides an excellent opportunity to get the perspectives of some
of the top names in the investment management business on current events, the global
economy and promising new investment trends.
Please check our website for updates on speakers and agenda:

http://www0.gsb.columbia.edu/students/organizations/cima/conference.html
Registration Opens: 25th October 2010
General Inquiries to:

David Yatzeck Sameer Agarwal
DYatzeck11@gsb.columbia.edu SAgarwal11@gsb.columbia.edu
Tickets priced at $350 (with available discount for CBS alumni and students.)
COLUMBIA INVESTMENT MANAGEMENT ASSOCIATION
The Columbia Investment Management Association is dedicated to the education and career development of
Columbia Business School students interested in working in the investment industry. The club's primary ac-
tivities include sponsoring guest lectures from industry practitioners, organizing stock-picking contests, and
assisting with the recruiting process.
http://www0.gsb.columbia.edu/students/organizations/cima/
HEILBRUNN CENTER FOR GRAHAM & DODD INVESTING
The Heilbrunn Center for Graham & Dodd Investing builds on Columbia Business School’s extraordinary tra-
dition of value investing by promoting the study and practice of the principles developed by Benjamin Gra-
ham and David Dodd, MS ’21. Established with the generous support of Robert and Harriet Heilbrunn, the
center serves as the leading global resource on investing. To learn more, visit www.gsb.columbia.edu/
valueinvesting
Get Involved:

New York, NY 10027
fill out the form below and send it in an e-mail to: newsletter@heilbrunncenter.org.
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Garrett Jones is a second year MBA student. This summer he in-

terned at Nicusa Capital, a concentrated long-short value fund. Prior to
Columbia, he was a Senior Consultant with Booz & Company in Dallas
and the Middle East. He received a BA in Music and Computer Science
from Dartmouth College.
Daniel Kaskawits, CFA is a second year MBA student and participant

in the Applied Value Investing Program. This summer he interned at
Steinberg Asset Management, a long-only concentrated equity value
fund. Prior to Columbia, Daniel worked for six years in investment
research at Citi, where he was a member of the US equity strategy
team. Daniel received a BSM in Finance and Marketing, with a minor in
Sociology from Tulane University in 2003.
Graham & Doddsville
Inside this issue: Issue XIII Fall 2011

Interview: p1 Lee Cooperman Mario Gabelli — “Think Like an
Leon Cooperman
— “Buying Owner”
Interview: p1
Mario Gabelli
Straw Hats in Mario Gabelli ’67, CFA,
the Winter” started his career as an
Interview: p1 automotive and farm
Marty Whitman equipment analyst at
Loeb Rhodes & Co. In
Alumni Profile p25 1977 he founded
GAMCO Investors
Student Write- p29 (NYSE: GBL), where he
is currently Chairman
up: GLDD and CEO, as well as a
portfolio manager and
Student Write- p31 the company’s largest
up: MSG shareholder. GAMCO
now manages roughly
Editors $36 billion dollars across
open and closed-end mu-
Anna Baghdasaryan tual funds, institutional Mario Gabelli
MBA 2012 and private wealth man-
Leon Cooperman agement, and invest- sity and his M.B.A. from
Joseph Jaspan ment partnerships. Mr. Columbia Business School.
MBA 2012 Leon “Lee” Cooperman ’67, Gabelli earned his B.S. (Continued on page 12)
CFA, began his post- from Fordham Univer-
Mike DeBartolo, CFA business school career in
MBA 2013 1967 with Goldman Sachs.
Jay Hedstrom, CFA
In addition to holding a Marty Whitman — “Business Skill
number of key positions
MBA 2013 within the firm, Mr. Cooper- Critical to Investment Success”
man was founder, Chairman
Jake Lubel
and Chief Executive Officer Mr. Whitman founded
MBA 2013 of Goldman’s Asset Manage- the predecessor to the
ment division. In 1991, he Third Avenue Funds in
Visit us at: left the firm to launch 1986 and M.J. Whitman, a
www.grahamanddodd.com full service broker-dealer
Omega Advisors, Inc., a
www0.gsb.columbia.edu/students/ value-oriented hedge fund affiliated with Third Ave-
organizations/cima/
which now manages roughly nue in 1974. He has man-
$5.5 billion. Mr. Cooperman aged the flagship Third
earned his B.A. in Science Avenue Value Fund since
from Hunter College and his its inception in 1990 and
M.B.A. from Columbia Busi- was Third Avenue’s Chief
ness School. Mr. Cooper- Investment Officer from
man and his wife are signa- its founding through Janu-
tories of Warren Buffett’s ary 2010.
“Giving Pledge”.
Marty Whitman
Page 2

We are pleased to present We start off this issue with Our third interview is with
you with Issue XIII of Gra- Lee Cooperman ‘67, foun- veteran value investor Marty
ham & Doddsville, Columbia der, Chairman and CEO of Whitman, Third Avenue
Business School‘s student- Omega Advisors, Inc. Mr. Management‘s Chairman and
led investment newsletter, Cooperman reflects on the Portfolio Manager, and an
co-sponsored by the Heil- path of his incredibly suc- Adjunct Professor of Dis-
Pictured: Bruce Greenwald, brunn Center for Graham & cessful career, describes tress Value Investing at Co-
named the ―Guru to Wall Dodd Investing and the Co- how his firm constructs its lumbia Business School. Mr.
Street‘s Gurus,‖ at the Colum- lumbia Student Investment portfolio, and outlines the Whitman shares his thoughts
bia Student Investment Man- Management Association. theses behind a few of his on some compelling areas of
agement Conference in Febru- top investment ideas. investment opportunity, dis-
ary 2011. This issue features a trio of cusses his approach to com-
legendary value investors, We also had the privilege of pany valuation and describes
who honored us with their speaking with Gabelli Asset some of his firm‘s most suc-
time and sage advice. One Management (GAMCO In- cessful investments.
thing became crystal clear: vestors) founder, Chairman
there is no single ―right‖ and CEO Mario Gabelli, Please feel free to contact us
way to practice value invest- well-known value investor if you have comments or
ing. Each successful value and alum of Columbia Busi- ideas about the newsletter.
investor adapts the practice ness School‘s class of 1967. We hope you enjoy reading
to his or her own style, Mr. Gabelli provides his Graham & Doddsville as much
although Graham & Dodd approach to security analy- as we enjoy putting it to-
and their famous disciples sis and discusses his interest gether!
remain an inspiration to so in BEAM, National Fuel Gas
many of us. and The Madison Square - Editors, Graham & Doddsville
Garden Company.
Investor Warren Buffett re-

ceives a gift from students on a tal or medical school to- tion, that the school would
(Cooperman from page 1)
Heilbrunn-sponsored trip in
ward your fourth year of be losing revenues for the
March 2008. G&D: After graduating college and receive a sepa- next four years and that I
from Columbia Business rate degree. I finished my couldn‘t possibly know what
School, you began your very science major in the sum- I wanted to do after eight
successful career at Gold- mer of 1963, which enabled days. The only person who
man. What drew you to the me to enroll in dental really appreciated the signifi-
sell-side following business school. After being in den- cance of my decision was
school? tal school for about eight the dean of Hunter College.
days, I wasn‘t sure that was I went back to Hunter and,
LC: Something that I the direction I wanted to since I had finished my ma-
should mention, before ad- go. This became quite a jor during the summer, took
dressing my time at Colum- traumatic situation. I had to 10 elective courses in eco-
bia and Goldman, was my go to the dean of the dental nomics and received 10 A‘s.
decision to not pursue a school and tell him I wanted That furthered my interest
dental education. This was to matriculate back into the in business. Upon gradua-
the most difficult decision I undergraduate school to tion I went to work for
had made in my life up to complete my fourth under- Xerox up in Rochester, NY
that point. Back in 1963, if graduate year unencum- as a quality control engi-
you completed your under- bered. The dean put me on neer.
graduate major and minor in a great guilt trip, telling me
three years, you could that I had deprived the 101st After about 15 months I
count your first year of den- applicant of a dental educa- (Continued on page 3)
Issue XIII Page 3
Lee Cooperman
(Continued from page 2) management that we were
decided I wanted to get an making a mistake not being My last day at Goldman was
MBA to advance my creden- in the asset management November 30th, 1991 and I
tials. I wanted to stay in the business. The firm, being a started Omega the very
New York area and I was brokerage house, was next day. Over the past
interested in finance, so strongly opposed to what twenty years I‘ve been rais-
Columbia was a natural fit. they considered competing ing the money, hiring the
With great modesty, I with their client base. Every people, running the money
“… there was one
would say that I was an at- brokerage firm at the time and setting up the infra- person who had a
tractive package coming out was largely in this business. structure. It‘s kind of been
of Columbia Business Once Salomon Brothers and non-stop. I‘m getting older profound influence
School. I was Beta Gamma some others announced but I‘m still handling it okay.
Sigma, had straight A‘s, a 6 their launching of an asset on me. I even have
month old child and was a management business, Gold- G&D: Did anyone or any
serious person. Wall Street man leadership asked me to investing class at Columbia a letter he sent me
was hiring with abandon, a establish one of their own. I Business School have a par-
lot of which had to do with left research at that time ticularly significant influence
in 1977 hanging on
the market cycle. I was and became Chairman and on you? my wall. His name
interviewing in 1966, which CEO of Goldman Sachs
was a year in which the Asset Management. LC: Yes, there was one was Roger Murray,
market was peaking, though person who had a profound
no one knew that. I ac- This was the beginning of influence on me. I even Benjamin Graham‟s
cepted an offer with Gold- my exit from the firm. They have a letter he sent me in
man Sachs, which at the wanted to capture as many 1977 hanging on my wall. successor as the pro-
time was not what it would assets as possible because His name was Roger
become a decade or two they wanted to build the Murray, Benjamin Graham‘s
fessor of security
later. This was fortunate business to a scale that successor as the professor analysis at Columbia
because I was able to con- would be relevant to a firm of security analysis at Co-
tribute, in a small way, to like Goldman Sachs. On the lumbia and, in fact, a subse- and, in fact, a subse-
the firm‘s later success. other hand, my motivation quent editor of the book
was the proper perform- Security Analysis. Mario quent editor of the
I got my MBA on January ance of the assets in my Gabelli, a very dear friend of
31, 1967. I had a six month control. I realized after a mine, also studied under book Security Analy-
old child and I had no short time I didn‘t want to him and would probably say
money in the bank so I was be on the road every week, the same thing. As our
sis.”
not in the position to take introducing a new product value investing professor, he
the obligatory trip to Hawaii and sourcing new funds. I showed a great deal of ex-
or Australia. I started as an wanted to spend my time citement for the subject
analyst at Goldman the next visiting companies and find- matter. I would also say
day. I then spent close to ing new mispriced stocks. I Warren Buffett influenced
25 glorious years with the wanted to manage money in me tremendously. I‘m an
firm. such a way that my interests expert in his writings and
and the clients‘ interests his views. Finally, Graham
I had a number of different were 100% aligned. I did and Dodd influenced me as
roles in the company. For not want to build a big busi- well. Their book Security
example I was made Partner ness like Goldman Sachs Analysis is sitting right there
in charge of research in wanted me to. I have the on my shelf.
1976 and, at the same time, highest respect for Gold-
I was Chairman of the firm‘s man, but it was the firm‘s G&D: How has your ap-
investment policy commit- reluctance to go into the proach to investing changed
tee. For a number of years, hedge fund business that led
I had been telling Goldman to me start Omega.
Page 4
Lee Cooperman
(Continued from page 3) buy something that we think perfect, the stock market is
since 1991? has a better risk/reward one of the better leading
ratio. Finally, the fourth indicators. Some people are
LC: Not in an appreciable reason we sell something is wary of the information the
fashion. The bulk of our when our market outlook stock market is imparting
portfolio is long-term ori- changes. Since I don‘t tend because, they would say, it
ented bets. We do a cer- to buy and sell market fu- has priced in 10 out of the
tain amount of trading - a tures to an appreciable de- last 7 recessions. In my
quarter of our portfolio gree, to effect this macro- opinion, however, that‘s a
turns over more actively. I driven repositioning, I have better record than most
think the major change was to sell specific securities. economists.
Pictured: Benjamin Graham, a result of the drubbing
father of value investing. most of us took in 2008. I So I would say the big G&D: What about the de
did not do a good job of facto value investing motto
controlling losses. I in- that if something you‘ve
vested a certain amount of “… there are times liked goes down, buy more
responsibility in my associ- and, if it falls further, just
ates and they showed, in the when the market buy more?
end, an inability to sell. So
now I‘m more willing to sell has figured out LC: Well, there are those
when things don‘t look like times when you‘ve made a
they‘re going in the right
what‟s going on fundamental mistake –
direction. before you, the you‘ve misjudged the com-
pany‘s competitive position,
I would sell a security for fundamentalist, you‘ve misjudged the econ-
one of four reasons. The omy, you‘ve misjudged the
first reason is the highest have figured it out. stock market. I think you
quality reason. That is just can‘t afford to say, ―I
when you buy something Let‟s face it, know more than the mar-
with a price objective. ket‖. Of course, it depends
although not
When it appreciates to that on the company. There are
price objective, and you perfect, the stock certain things you can be
think it‘s fully valued, you stubborn on such as when
sell it. The second reason is market is one of the you have a big dividend
when, based on calls to our yield, a big discount to book
companies, their competi- better leading value, an extremely low
tors and their suppliers, valuation. But I think, gen-
things are not moving along indicators.” erally, you have to respect
the originally anticipated the stock market. If you
lines so you get out before change is my willingness to don‘t, you‘re going to get
you get murdered. It is very sell. This is very difficult for wiped out.
hard in this market, which is a value investor because if,
choppy and not really going for example, you liked Ford G&D: How do you per-
anywhere, to make up for Motor at $20, you should sonally think about valua-
big losses so you have to like it more at $18 and even tion? What types of tech-
sell before you get creamed. more at $15. But there are niques do you use?
A third reason we sell is times when the market has
when we find an idea that‘s figured out what‘s going on LC: There are a lot of dif-
more attractive than the before you, the fundamen- ferent approaches. We use
idea we‘re acting on already. talist, have figured it out. the dividend discount model
So we‘ll sell something to Let‘s face it, although not (Continued on page 5)
Issue XIII Page 5
Lee Cooperman
(Continued from page 4) there‘s some combination of
to identify undervalued return-on-equity, growth G&D: What are the char-
stocks as a screen. Essen- rate, P/E ratio, dividend acteristics of a business that
tially, I know what the finan- yield, and asset value that you‘d want to own for a
cial statistics are for the S&P makes you act. We have a long period of time?
and as a value investor, I‘m diversified group here look-
looking for more but for less. ing for attractive ideas, and LC: To me, it‘s free cash
I‘m looking for more growth different industries get capi- flow sine qua non because
at a lower multiple. I‘m talized in different ways. If that gives you the ability to
looking for more yield ver- you want to be a broad- intelligently redeploy your
Columbia Business School is a
sus what I can get from the based investor you have to money. If you don‘t have
S&P. Or, I‘m looking for be willing to embrace differ- the free cash flow, you don‘t leading resource for invest-
more asset value. ent approaches. For exam- have anything. Number two ment management profession-
ple, although we are value- is a business that has a moat als and the only Ivy League
I‘d say a theme that runs orientated investors typi- around it, where it‘s com- business school in New York
throughout a lot of our petitively insulated to some City. The School, where value
portfolio holdings is the large degree. There are investing originated, is consis-
concept of public market very few businesses that tently ranked among the top
value versus private market actually have a monopoly programs for finance in the
value. About 95% of pub- “I know what the position today. Quality of, world.
licly traded companies have and incentives for, manage-
two values. One is the auc- financial statistics ment are also very impor-
tion market value, which is are for the S&P and tant. We look at manage-
the price you and I would ment ownership to see
pay for one hundred shares I‟m looking for more whether their interests are
of a company. The other is aligned with the sharehold-
the so-called private market but for less. I‟m ers‘ interests and we look
value, which is the price a for their compensation lev-
strategic or financial inves- looking for more els to be reasonable. The
tor would pay for the entire compensation levels in cor-
business. So one of the growth at a lower porate America are ridicu-
approaches I take is to look multiple. I‟m looking lous in my opinion, and this
for a stock in the public is a big problem today.
market that is selling at a for more yield versus Hedge fund guys are over-
significant discount to pri- paid but the good news
vate market value where I what I can get from about that is, you don‘t
can identify catalysts for a make the money unless you
potential change. In the last the S&P. Or I‟m make the money for the
year we had four take-overs investor. In corporate
in the portfolio. looking for more America, you‘re being paid
asset value.” to fail. A lot of times, guys
We try to find some set of are kicked out of companies
statistics that motivate us to and they leave with $10,
act. The analogy I have al- $15 or $20 million checks,
ways used is that when you which I think is ridiculous.
go into the beer section of cally looking at the tradi-
the supermarket, you see 25 tional valuation metrics, we Back to free cash flow; I
different brands of beer. do have a technology analyst would obviously weigh-in
There‘s something that who is studying things like the growth of the company
makes you reach for one rate-of-change and following too. I would love to own a
particular brew. In the par- Citrix Systems and Apple, company that has great in-
lance of the stock market, which we own. (Continued on page 6)
Page 6
Lee Cooperman
(Continued from page 5) how you construct your will tell you that being in the
“The next big vestment opportunities in portfolio? right asset class is more
which it‘s investing a lot of important than being in any
trended opportunity cash. I just want to make LC: My portfolio construc- individual stock in any one
sure the money is invested tion is some combination of year. Third, which is the
will be being short wisely. A company has a top-down and bottoms-up. bread and butter business
number of uses for free We try to make money for where I spend the bulk of
U.S. government cash flow. Management our investors in a number of my time, is looking for un-
bonds. They don‟t could choose to reinvest in different ways. Stocks are dervalued stocks on the
the business through capital high risk financial assets and long side. I have a very
belong at 2%. His- expenditures, buy other short term bonds and cash value-oriented approach.
businesses, reduce debt are low risk financial assets. Fourth, which has not been
torically, the ten loads, or pay out dividends. First, we spend a great deal particularly productive for
I just want to make sure of time trying to figure out us, is finding overvalued
year U.S. govern- management is channeling whether the market is going stocks on the short side.
their cash into the right up or going down because Finally, we take 2-3% of our
ment bond yield has opportunities. that will determine both the capital and invest in macro
tracked nominal predominant performance strategies. We might be
Corporate America has of our portfolio and how long or short the dollar, we
GDP...So if the ten been very busy, particularly much exposure we want to might be long or short a
in 2008, buying back stock. have to risky assets. The commodity.
year government Most of them have not second way we try to make
known what they‘re doing. money is looking for the It‘s a small part of what we
bond yield was in There‘s been a large amount undervalued asset class. do but I like the macro
of money wasted. I gave a We look at government strategies. The returns are
that range of 4-6% presentation at the Value bonds versus corporate not necessarily correlated
that would not be Investing Congress in 2007 bonds versus high yield to equities and at times you
where I said a lot of compa- bonds. We think about get a trend of opportunity
unusual.” nies were mispricing what bonds versus stocks, that you can capitalize on.
they were buying. I was whether in the U.S. or in In my own opinion, the next
highly critical and provided Europe. We‘re trying to big trended opportunity –
many examples of this de- look for the straw hats in though we haven‘t put the
velopment. the winter. In the winter, trade on just yet – is being
people don‘t buy straw hats short U.S. government
Analysts tend to be cheer- so they‘re on sale. We‘re bonds. They don‘t belong at
leaders for corporate repur- basically looking for what‘s 2%. They‘re just way too
chase programs. In my on sale. In 1993, we made a low. Historically, the ten
view, these programs only great deal of money in non- year U.S. government bond
make sense under one con- dollar bonds because we yield has tracked nominal
dition – the company is buy- made a play on interest GDP. If you think we‘re in a
ing back shares that are rates that was very right. In world of 2-3% real growth
significantly undervalued. 1995 through 1997, we and 2-3% inflation or poten-
Most management teams made a great deal of money tially more, that would give
have demonstrated the total in the debt of Brazil, Turkey you nominal GDP of 4-6%.
inability to understand what and other emerging mar- So if the ten year govern-
their businesses are worth. kets. In 2002, we made a ment bond yield was in that
They‘re buying back shares lot of money in high yield range of 4-6% that would
when the stock is up, and bonds, and the same is true not be unusual.
have no courage to buy for 2009 and 2010. So
when the stock is down. we‘re looking for the right I would also add that, over
asset class. Any study you‘ll the years, our portfolio has
G&D: Can you talk about read on portfolio returns (Continued on page 7)
Volume
Issue XIIII, Issue 2 Page 7
Lee Cooperman
(Continued from page 6) frustration over the lack of judged the significance of
on average been 70% net economic opportunity, par- Lehman. As I mentioned,
long, though right now ticularly by the youth, is 2008 was transformative for
we‘re about 80% net long. understandable. People are me because, at the time, I
We tend to be more in- looking for a scapegoat. I allowed my people to hold
vested than most hedge had hoped that Obama onto their positions when I
funds. would move more to the should‘ve started kicking
center and soften his anti- them out well before we Pictured: Glenn Greenberg at the
G&D: So you‘re optimistic wealth and anti-business got into the hole. One Security Analysis 75th Anniver-
about the general outlook stance. He doesn‘t seem thing nice about the invest- sary Symposium (Fall 2009), with
Bruce Berkowitz (left) and Tom
for the market? capable of doing that and his ment business is that, even
Russo (right).
election underscores the though I‘m 68, I continue to
LC: We‘re more optimistic unrest I‘m referring to. The learn. You learn something
than most. We don‘t be- largest country in the free every month and every
lieve that we‘re going into a world chose as its leader a quarter.
recession but rather an en- 48-year-old man who was a
vironment of slow growth. community organizer and G&D: Could you describe
We don‘t think we‘re an- had never worked in the the process your team goes
other Japan. That‘s our business world. His elec- through to generate invest-
opinion as well as Jeff tion was a clear result of the ment ideas at the company
Immelt‘s and Warren Buf- frustration of the populace. level?
fett‘s. Recent auto sales and
recent chain store sales G&D: Is your technique LC: When I hire an analyst,
suggest a decent economic for shorting mostly valua- we put together a FactSet
environment. I also assume tion driven? universe of companies that
that the ECB will do for are within their sphere of
European financial institu- LC: It‘s valuation driven or expertise and those are the
tions what the Fed did for it‘s driven by a belief that companies they follow. I
U.S. institutions. In the end, the company‘s competitive monitor and judge their
they have no choice and I position is in the process of performance by how well
think they‘ll do it. They changing. But if you look at they do penetrating the
need to ring-fence Greece the sources of our returns, opportunities that ‗Mr. Mar-
though, and make sure the short selling has not been an ket‘ has presented. The
mess doesn‘t spread to important part. The bulk of way it works is that the
Spain and Italy. our returns have come from analyst proposes an idea.
undervalued equities on the The stock selection commit-
One of the biggest concerns long side. tee, which consists of four
I have is social unrest. The or five senior people at the
labor force in America G&D: What have you firm, and me, dispose and
grows 1% per annum. Pro- learned from the market debate the idea. This proc-
ductivity of the labor force collapses of 2000-2001 or ess represents about 75% of
grows 2% per annum. So 2008-2009? the activity of the firm.
you need 3% growth to For example, this afternoon,
keep the unemployment LC: We made money in we‘re discussing an apparel
rate flat and we‘re not 2000 and 2001 because we company that my analyst is
growing at that rate. The stuck with value. You only strongly recommending we
global unrest and global got creamed if you were buy. He submitted his re-
demonstrations – ―Occupy buying these 100x revenues port for our review this
Wall Street,‖ the demon- technology companies. So it afternoon. I ask these ana-
strations in Zuccotti Park, was really 2008 that was a lysts, who are experts in
the Arab Spring, are all rough patch for us and it particular areas, to find
about unemployment. The was very simple. We mis- (Continued on page 8)
Page 8 “The next big trended opportunity will be being short U.S. government
Lee Cooperman
(Continued from page 7) of the day, they have a pipe- person would criticize Jobs
things that are going to outline of products already in but I will criticize the com-
perform the market. Later, place that could probably pany for their financial man-
we‘ll have a meeting about last several years and they agement. There is no basis
the New York Stock Ex- generate something like $15 for sitting on $80 billion in
change, which the associ- -$20 billion a year in free cash and not paying a divi-
ated analyst is also recom- dend and not buying back
mending. Periodically, we‘ll stock. They‘re projecting,
Pictured: Heilbrunn Center operate with a shorter term in my opinion, temporary
Director Louisa Serene timeframe because we think “To me, „value‟ success. They‘re saying we
Schneider at the CSIMA we‘ve developed some in- don‘t know where the busi-
conference in February formation that other people ness is heading long term
2011. Louisa leads the Heil-
means the value
don‘t have and we want to and we want to have this
brunn Center with much
act on it before it becomes proposition that is financial powerhouse. I‘m
skill and grace. commonly known. told by people close to Jobs
being offered. A lot that he wanted to do a con-
G&D: How do you evalu- tent acquisition, such as
ate management teams of companies Disney if it had not been in
prior to making an invest- Warren Buffett the theme park business.
ment? Regrettably, for the world
owns would not be and for him, he‘s not around
LC: Benjamin Graham, in to execute that ambition.
The Intelligent Investor, said considered value in
you evaluate management I think Apple will do fine for
twice in the decision-making the classical sense. a few years and we‘ll have
process. Once, through the to see after that. Right
face-to-face interrogation. A company can be now, the major plus in Ap-
You ask them questions and growing at an ple is the valuation. It
they respond and you make seems ridiculously low for a
a judgment about the quality extremely high rate company growing at its rate.
of their responses. In addi- Based on all of the checking
tion, the quality of manage- but happens to be I do, the users of the equip-
ment also manifests itself in ment at corporations are
the numbers: in ROE trading at a very making purchasing decisions
(absolute and relative to and the users all want iPads.
competitors), return on reasonable They have a phenomenally
total capital, growth rate, multiple. Or that high market share of a
industry position, trend of growing business that has
market share, and profit same company can very high profit margins. I‘m
margins. sure one day, Apple will
be giving you your have issues but for the next
G&D: Regarding the im- few years it looks like clear
portance of management, return through a fat sailing. Jobs left behind a
with the unfortunate passing financial powerhouse.
of Steve Jobs, how do you
dividend.” Maybe one change that
see Apple - one of your could be constructive is the
favored picks - impacted better use of their cash. So
going forward? you think eclectically. Apple
cash flow on top of $80 has no dividend and no re-
LC: You can‘t replace a guy billion in cash and market- purchase program but they
like Steve Jobs. At the end able securities. No rational (Continued on page 9)
Issue XIII Page 9
Lee Cooperman
(Continued from page 8) be in the best growth com- Another one I like is Sallie
generate gobs of free cash panies but had no regard for Mae (ticker: SLM). Roughly
flow and they‘re in the right what they paid. They didn‘t 81% of their loans are guar-
business. care if they paid 60x or 70x anteed by the U.S. govern-
earnings. During the even- ment and the bulk of the “What you want is
G&D: Many in the value tual recession which fol- remaining loans are co-
investing community say lowed a surge in interest signed by the student‘s par- some combination
that Apple is not a true rates, the prices of these ent. So I think the quality of
―value‖ stock. How would stocks declined 50% or these assets is not bad. I of financial
you respond? more. The multiples were think they‘ll earn $1.80 this
all wrong. Their philosophy year and the stock is $13, statistics that yell,
LC: I think their definition was ―only the right stock at so half of the market multi-
of ―value‖ has to be broad- any price‖ whereas my phi- ple. The yield is about 3.5%
“Buy me.” It
ened. It‘s not just about losophy is ―any stock or and they‘re buying back 5%
trading below book value. bond at the right price.‖ of their stock annually
could be an
To me, ―value‖ means the through the repurchase
unusually high
value proposition that is being G&D: It would be great if program and we think the
offered. A lot of companies we could discuss a couple of assets are worth $20 per growth rate at a
Warren Buffett owns would specific stocks that you find share. The company is a
not be considered value in compelling today. consolidator of FELP loans. proper multiple or
the classical sense. A com- FELP loans are shrinking
pany can be growing at an LC: Well, I like KKR Finan- part of all bank balance it could be a
extremely high rate but hap- cial (ticker: KFN), where sheets and therefore will
pens to be trading at a very the debt management arm slowly be sold as they‘re not return upfront
reasonable multiple. Or has the ingredients that I worth the effort to hold.
that same company can be look for. Right now their Sallie Mae is one of the few with modest
giving you your return dividend yield is 9.75% in a natural buyers in the market
through a fat dividend. My world of zero interest rates and is able to achieve attrac- growth. I‟m very
analyst thinks Apple can and the dividend is covered tive double digit IRR‘s on
earn $40 per share next twice by earnings. They these purchases. In addi- eclectic as an
year, which is 9.4x earnings. earn about $1.50-1.60 per tion, the ―sins‖ of Sallie
When this was printed, the share and they‘re only pay- Mae‘s past are burning off investor … my
S&P was at 11x earnings. So ing $0.72, so they can grow quickly. The amount of
is Apple a growth company the business over time. The ―non-standard‖ credit en- philosophy is “any
or is it a good value propo- real book value is some- tering repayment is drop-
sition? where around $10 and the ping very quickly. 2010 had stock or bond at
stock is $7.75. So I‘m buy- $572 million enter repay-
What you want is some ing something 20% below ment, 2011 has $320 mil- the right price.”
combination of financial book, yielding in the high 9% lion, and next year only
statistics that yell, ―Buy me.‖ range – which is competitive $112 million. With 40-50%
It could be an unusually high with the equity market‘s loss ratio on these ―non-
growth rate at a proper return annually, with moti- standard‖ loans, credit at
multiple or it could be a vated management that own SLM will naturally improve.
return upfront with modest a decent amount of stock in The company is shareholder
growth. I‘m very eclectic as a decent business. KKR friendly. As the FELP port-
an investor. In the ‗70s, the Financial is a mezzanine folio generates cash, we
dominant investing institu- lender and they have the expect the company to
tion was JP Morgan U.S. advantage of being on the complete the previously
Trust, which espoused a KKR platform, which sees a announced $300 million
philosophy of the ―nifty lot of interesting deals. repurchase program this
fifty‖. They only wanted to (Continued on page 10)
Page 10
Lee Cooperman
(Continued from page 9) past 24 months. It is a ture, improving profitability,

year, and repurchase $500 highly regulated business, selling non-core assets and
million in 2012. As financial and as it gets more regu- buying back stock. Multiple
institutions struggle for as- lated, it means that the new product cycles are
set growth, SLM could be- costs of entering these busi- coming in core franchises
come a nice niche acquisi- nesses increase. Utilization (stents, defibrillators,
tion target for any large will continue to increase women‘s health), that will
bank over the next several with demographics and with drive 500+ bps of operating
years in the low $20s range. healthcare reform, we will margin improvement in the
Bruce Greenwald holds the
likely see more people com- next few years.
Robert Heilbrunn Professor- G&D: Could you walk us ing into the system. In spite
ship of Finance and Asset through other ideas that of pricing pressure, margins We also like Transocean
Management at Columbia you find interesting today? are still very attractive. The (ticker: RIG). The stock is
Business School and is the new management is shifting currently around $50 and
academic Director of the I also like Boston Scientific its focus on creating share- we believe there is signifi-
Heilbrunn Center for Gra- (ticker: BSX). The company holder value in the near cant upside to it. RIG is
ham & Dodd Investing. Pro- generates $1 billion a year term, rightsizing cost struc- trading at a very low P/E, P/
fessor Greenwald is an au- in free cash flow, so you‘re CF, and EV/EBITDA multi-
thority on value investing
with additional expertise in
getting a free cash flow yield ples, and at a substantial
productivity and the econom- of about 17-18%. They just “BSX‟s private discount to NAV and Tangi-
ics of information.
achieved an investment ble BV. The offshore drill-
grade credit rating so market value is ing market is fast improving,
they‘re now in a position to especially in the ultra-deep
take that cash flow and buy much greater than water where RIG has the
back stock or do tuck-in largest fleet. The overhang
acquisitions to accelerate
public market of legal issues from the 2010
growth. Management seems valuation. Financial BP ―Macondo‖ disaster may
very motivated to follow- start to be resolved over
through. Of course, the buyers could easily the next six months. RIG
opportunity to buy cheaply has a $3.16 dividend (6.7%
is a result of their deal from pay $9.50/share. If current yield) that we be-
hell, that being the acquisi- lieve is sustainable for years,
tion of Guidant for nearly the company was so investors are being paid
$30 billion. Now we think to wait. Long-term con-
they‘re on the way back.
broken up and sold tracts on its deepwater fleet
Due to the past issues, in- off in pieces or if a will recover most construc-
vestors seem unwilling to tion costs and reduce the
look at the value of the strategic buyer were basic risk of RIG‘s business.
business objectively. Old RIG‘s 2011 EPS reflects low
management is gone. BSX‘s to step in, BSX ―revenue efficiency‖: con-
private market value is tracted rigs are out of ser-
much greater than public could fetch $13/per vice for replacement of
market valuation. Financial Blow-Out Preventers. This
buyers could easily pay
share based on process will continue
$9.50/share. If the company public comps or through 2011 but then end,
was broken up and sold off so ―revenue efficiency‖ will
in pieces or if a strategic transactions done in return to historical 90%+
buyer were to step in, BSX level, from 82% now. Many
could fetch $13/per share the past 24 Wall Street analysts don‘t
based on public comps or have higher ―revenue effi-
transactions done in the months.” (Continued on page 11)
Page 11
Lee Cooperman
(Continued from page 10) try.

ciency‖ in their projections.
We believe consensus 2012 “It doesn‟t matter G&D: What are the most
EPS could rise by $1.00- common errors that you
$1.50.
whether you are a see analysts make?
G&D: Which personal

lion or a gazelle. LC: Misjudging a company‘s
attribute has contributed When the sun competitive position would
the most to your success be one. Making valuation
over the years? comes up, you‟d judgments that are wrong is
another. Then there are
LC: I would attribute my better be macro mistakes, such as
success to hard work, sur- underestimating the degree
rounding myself with good running… Always of discontent with the banks
people, and a fair amount of following the credit crisis,
luck. I remind my team of try to surround which is leading to higher
this proverb often: ―Every capital charges and an inabil-
morning in Africa, a gazelle yourself with the ity for their earnings to
wakes up; it knows it must grow. In every sector it‘s
run faster than the fastest very best people. different. In technology,
lion or it will be killed. you may have overestimated
Every morning a lion wakes Don‟t feel the company‘s competitive
up; it knows it must outrun position and underestimated
the slowest gazelle or it will threatened by the competitive threat from
starve to death. It doesn‘t somebody else. You can‘t
matter whether you are a good people. You standardize the error.
lion or a gazelle. When the
sun comes up, you‘d better should feel that G&D: Any parting words
be running.‖ In the parlance of wisdom for our readers?
of my business, I like to put having them
this proverb in my own LC: The best advice I can
terms. There are roughly around is to your give anyone is exemplified
10,000 mutual funds that by the following Andrew
will manage your money for advantage. Carnegie quote: ―Here lies
1% or less and there are a man who was wise enough
roughly 10,000 hedge funds Lastly, no matter to bring into his service men
that have the audacity to ask who knew more than he.‖
for 1-2% management fees how rich you Always try to surround
and 20% of the profits. Our yourself with the very best
clients have a right to ex- become, people. Don‘t feel threat-
pect more because they‘re ened by good people. You
paying more. So what that arrogance is not a should feel that having them
means is that when the mar- around is to your advantage.
ket‘s high, I have to figure
luxury you can Lastly, no matter how rich
out how I can get hedged you become, arrogance is
and when the market‘s low,
afford. ”
not a luxury you can afford.
I have to figure out how I
can get leveraged to the You come to work with a G&D: Thank you very
opportunity. You‘re con- total commitment to the much, Mr. Cooperman.
stantly on the balls of your clients‘ interests or you go
feet. There‘s no relaxing. to work in a different indus-
Page 12
Mario Gabelli
(Continued from page 1) evolved over the years? it.‖ Why did I do that? I
G&D: How did you be- knew if I followed ABC,
come interested in invest- MG: I left Columbia on a NBC, and CBS, which were
ing? Friday and joined Loeb, in New York, I could con-
Rhoades & Co. next Mon- vince everyone that I should
MG: I used to hitch hike day, not taking the 3 months follow the movie industry. I
from the Bronx and caddy knew this because they
at a country club in West- were the program suppliers
chester. Later in the after- which would get me to LA.
“It wasn‟t until I had Growing up in the Bronx
noon after the
market closed the specialists Professor Roger you don‘t get a lot of op-
would arrive and talk portunities to go to LA.
stocks. The other caddies Murray at Columbia I later left Loeb, Rhoades
would go home at 4pm but I and went to William D.
would stay and listen to that I saw the sun, Witter which merged with
what the specialists were Drexel and 90 days later I
talking about. This was the moon and the started an institutional re-
maybe when I was in the 7th search firm. This was in
stars align 1977, and at that time the
grade. I still remember my
first stocks, Coca Cola, themselves and knew market had been at 1,000
AT&T, and Beech Aircraft. and started recovering but
[investment then quickly declined. The
G&D: Can you bridge us key question was how was I
from those days to business management] was going to convince individuals
school? and corporations and pen-
what I wanted to sion plans that they could
MG: I was always passion- make money in the stock
do.”
ately involved in the market market?
and would go into high
school and read the The At the time, there was a lot
Wall Street Journal and Busi- off like a lot of people do of inflation. If you had prop-
ness Week religiously. now. I inherited the indus- erty, plant and equipment,
When I went to college at tries followed by Michael the replacement cost was
Fordham I had some great Steinhardt who had left that significantly higher than
professors teaching finance day. Steinhardt went on to what you paid for it. Inter-
but it wasn‘t until I had Pro- start one of the most suc- est expense was 12% to
fessor Roger Murray at Co- cessful hedge funds. So I 15%, and taxes were not
lumbia that I saw the sun, covered farm equipment, predictable. So we came up
the moon and the stars align conglomerates, auto parts with the idea: what is the
themselves and knew this and automotive. value of the business if
was what I wanted to do. Sometime around 1969, one someone is trying to take it
Reading Graham and Dodd of the analysts who covered private? We figured out
helped me to learn the me- the broadcast and entertain- what was the value of the
chanics for how to evaluate ment industries left to start business today, what it
stocks. Their approach to his own firm and I walked would likely be worth five
stock analysis and valuation into my boss‘s office and years hence and how would
made a lot of sense. said ―I quit.‖ He said, one finance it. So we came
―Why, you‘re doing well?‖ up with the notion of pri-
G&D: How would you And I said, ―I want to cover vate market value and we
describe your approach to the broadcast industry.‖ did this because we were
investing and how it has And he said, ―Fine, you got (Continued on page 13)
Issue XIII Page 13
Mario Gabelli
“A catalyst could be
(Continued from page 12) rigorous discussion today that was not complicated.
trying to convince individu- with the analyst covering We are a touchy feely or- as simple as a new
als and institutions that this Apple. I love Apple‘s prod- ganization so I drink bour-
was a great time to buy ucts, and the company sells bon. It‘s a business we‘ve product
stocks. We wrote a re- at about $400 per share and been tracking for a long
port on a company called they‘ve had great numbers time and the value was introduction. We
Houdaille, and if I recall but it‘s hard for me to see there. Nowadays, Sara Lee
correctly, the stock was how financial engineering or is splitting into two parts, have been following
around $26 or $28 and a takeover with a catalyst Kraft is splitting into two
coffee for 40 years
Henry Kravis came around helps to surface increased parts, and there are so
and bought the stock at value for them, and that‘s many other examples. Why and coffee wasn‟t
about $39 or something how we look at companies. are all of these companies
like that and I took out an splitting up? They do so growing. And then
ad in the Wall Street Journal. G&D: What do you say to because it is a more tax
I said, ―to my friends at people who argue that cata- efficient way to let the value all of a sudden it
Houdaille and KKR, thanks lysts are usually already surface and allow someone
for surfacing the values in to buy pieces. But the key was November
priced into companies?
the market.‖ So that was is seeing that value ahead of
1989, the Berlin
in 1979 and that‘s how I MG: Nonsense. Let‘s say time and knowing the pieces
got to meet Henry. there is a company selling at ahead of time so that you Wall came down
$10 and you predict it‘s can take advantage of it.
G&D: Can you talk a bit worth $20 based on your For example, would Pepsi and it really helped
about how your approach analysis. Will the discount split the company in two
differs from the Graham or narrow between the $10 parts so that its snack busi- open the global
Buffett methodology? and $20 so that you can ness and its beverages busi-
earn your return? Will the ness can reach a higher pub- marketplace. ...
MG: It‘s the same thing. company‘s value grow to licly traded value? Would
more recently you
The analysts are trained to over $30? Will someone CVS do it? There are a lot
gather the data and read it come in and buy it? At the of candidates that you could had single serve
carefully. These days you time in the 1970s if there identify.
can get the data faster. was that sort of gap we coffee introduced in
We array the data in our would wonder if someone A catalyst could be as sim-
format. Project the data would come in and fire a ple as a new product intro- a number of
and then interpret it. In- ―thunderbolt‖ (a tender duction. We have been
terpret it in a way that offer). So the difference following coffee for 40 years countries. Another
assigns a value and then between the current stock and coffee wasn‘t growing.
example is oil and
build in a margin of safety. value and the intrinsic value And then all of a sudden it
So everything Graham and would lead to an event to was November 1989, the gas and shale
Dodd taught in the 1930s unlock the value. Look at Berlin Wall came down and
is still applicable today. what‘s happened in the last it really helped open the drilling. So a
year. Fortune Brands an- global marketplace. A lot of
G&D: Would you say nounced that they were the western companies catalyst can take
that your methodology breaking up. flocked to the Eastern Euro-
works better for some pean and CIS countries to many forms.”
industries than others? G&D: We remember you sell their products, including
recommending it on CNBC coffee. And more recently
MG: Of course. How do about two years ago when you had single serve coffee
you value Facebook or the stock was trading at introduced in a number of
how do you buy Apple about $20. countries. Another exam-
with an almost $400 billion ple is oil and gas and shale
market cap? We had a MG: Well the reason for (Continued on page 14)
Page 14
Mario Gabelli
(Continued from page 13) sumers still be willing to compare to a company that
drilling. So a catalyst can spend a certain amount of sells widgets that are hot
take many forms. their income on a particular but who knows how sus-
product? tainable it is, and based on
G&D: Conversely, if you relative and fundamental
have an investment thesis The ideal thing is to find analysis, try to come up
about a company and you‘ve businesses people are loyal with an approximate value
held the company for a long to, like alcoholic beverages to put on that business.
time and the catalyst isn‘t and coffee. You have to
coming to pass, how long do look at who the customers G&D: Was it through
you wait? are and how postponable is similar analysis that you
the purchase. So if you look found Fortune Brands?
MG: One of our oldest at a business like Cable TV,
funds, the asset fund, was We look at the pricing
incepted in 1985. The turn- power of an industry, such
over is 7%, so that‘s what, a as distilled spirits. The
15 year holding period? As global distilled spirits busi-
in the movie Waterboy, if the “The ideal thing is ness is about $250 billion.
CEO heads for the wrong We know the growth rate
goal line, we will try to stop to find businesses for distilled spirits in each
him and if they continue to sector (vodka, scotch, te-
do it, we will sell. Or, if the people are loyal to quila, etc.). Then we look at
stock goes above intrinsic like alcoholic the companies consolidat-
value, we will find better ing, such as Pernod in Paris,
options out there. beverages and Diageo, Anheuser Busch,
etc. We follow the industry
G&D: Could you give an coffee. You have to globally, and we have an
example of a company you analyst in New York who‘s
like and how you valued it? look at who the a Columbia Business School
alum as well as one in
MG: If you look at the
customers are and Shanghai who is following
human population there are how postponable is industries in which we have
about seven billion people. a core competency, such as
One and a half billion people the purchase.” beverages. So we were
are too young to drink or following Fortune Brands
don‘t do so for philosophi- and we watched what the
cal reasons. My first visit to company was doing and the
China was in 1981. Two changes in management.
things were clear: the cul- you have subscription reve- We could see the potential
ture loves to gamble and nues that are predictable for Bourbon. It wasn‘t be-
loves to drink. The impor- (albeit with some churn cause we liked Jessica Simp-
tant thing to think about is rate) and then you look at son and Dukes of Hazard.
which companies had pricing what customers are likely to We were seeing what all of
power. What companies want in the next 10 years, the other businesses in For-
had businesses that required which is probably speed, tune Brands were doing,
the least amount of capital mobility, video, voice. Then how management was allo-
expenditures to maintain we try to understand who cating cash, what the under-
the brand. Could the Japa- packages it up best and what lying value was and what all
nese and Chinese create a can go wrong with the pric- the catalysts were. We
vodka and then sell it at a ing power of that service. were buying the stock.
lower price? Would con- And how does this business (Continued on page 15)
Issue XIII Page 15
Mario Gabelli
(Continued from page 14) BEAM ticker, is probably nets, which can be very ex-
Then Bill Ackman came between $80-$85. Kevin pensive and postponable in
along and purchased 11% of Dreyer, Associate Portfolio terms of remodeling and
the company, and we knew Manager of Gabelli Asset also things like windows,
he was going to push them Fund, has done the work on which you probably don‘t
over the goal line. They this and we think the com- replace unless they break.
then announced the split. pany is going to be taken So we look at these busi-
So now the underlying value over. There are lots of en- nesses and believe you
of the individual businesses tities that could do it and really need housing to pick Pictured; Professor
Bourbon is a $6 billion cate- up in order for them to do Roger Murray and in-
gory. The only thing that well because most people
vestor Robert Heil-
bothers me is when I watch can put off upgrading their
“We meet with the brunn with their wives,
Boardwalk Empire and existing home needs. We
management and we ―prohibition‖. The other look at what the earnings Agnes Murray and
concern is sin taxes. power of the company is at Harriet Heilbrunn.
look at various com- 500,000 new homes per
G&D: What do you think year. What about
petitors and we be- of Fortune‘s other business, 1,000,000? Then we look at
the Fortune Brands Home & another of their businesses:
lieve five years from Security business, that is so Master Lock. What is the
tied to the housing industry? earnings power for each
now the distilled busi-
How do you approach and business, what will the earn-
ness of Fortune value that business? ings power be in five years
under a good environment
Brands (ticker: MG: There are 90 million or a bad environment and
single family houses in the whether there is a margin of
BEAM) is probably United States. Starting in safety. Can these busi-
2001 and 2002, Alan Green- nesses survive in another
between $80-$85.” span really wanted to get economic contraction?
the economy going and low-
ered interest rates. Every- The stock started trading
one was being sold on the the other day at $11.10 on
idea they should own a 155 million shares so it‘s
has surfaced. home, and so we built about about a $1.7 billion market
1.6 to 1.8 million homes per cap with about $500 million
We look at what will hap- year and everyone benefit- in debt so you‘re paying
pen on a reasonably predict- ted from that and in 2007 around $2 billion and you‘ve
able basis over the next five that bubble collapsed. Now got about $285 million of
years, we look at the cash we are building about base EBITDA. The earnings
flows, we look at the multi- 500,000 homes per year. would nearly triple if we get
ple we are paying today Eventually we will go back back to 1,000,000 homes.
based on enterprise value to the normalized amount EBITDA could reach $500
and EBITDA, and try to of 1 million per year or so. million.
evaluate the person that will
run the business. We meet So back to Fortune Brands G&D: Could you talk
with the management and – they have the Moen brand about a few other stocks
we look at various competi- of bathroom and kitchen you like?
tors and we believe five products. With Moen you
years from now the distilled go into Home Depot and MG: When we went pub-
business of Fortune Brands, pay maybe $200 for a fau- lic in 1999, the hot groups
now traded under the cet. They also have cabi- (Continued on page 16)
Page 16
Mario Gabelli
(Continued from page 15) pay to buy it? What is the MSG and it‘s trading in the
were AOL, Yahoo, and pipeline worth? What is low $20s and there is no
other dot-coms. We their midstream business debt and they have $300
started a utility fund. As worth? What are some of million in cash. They are
we looked around at the their oil holdings in Califor- putting their cash towards
utility world, it was some- nia worth? And their raw refurbishing the MSG arena.
what in shambles. Enron land? New technology So when I look at the Cable
“We‟re owners and went out and said to the comes along and instead of Network associated with
utility world, ―You are all drilling vertically down in the company, we put a value
we know how to dumb: you‘ve got to go the Marcellus area 10,000 on it, and when we do that,
global, you‘ve got to diver- feet below the surface, you we see we are getting two
think like owners. If sify, and you‘ve got to do have other options. If you sports teams for free: The
acquisitions.‖ Bottom line, put a well down, it costs Knicks and The Rangers.
you have 80% of the if you went back and looked about $3 million. If instead There are always super rich
vote and 3% of the at utilities, they were rate-of you went down and then people who want to buy
-return regulated. If infla- drill laterally it costs about sports teams. I think you
economics that tion was going to stay at 2% $5 million. And then hy- could buy those teams for
or 3%, they were going to draulic fracking is in the mix. $20 per share, and so the
bothers us unless it‟s do well. A company in Buf- And fracking unlocks huge question is should we own
falo called National Fuel amounts of oil and gas. this company to participate
something like the Gas, which we like today, Now, over the next ten in that upside? Now, the
was a business that sold years, who knows what questions are: is there going
14th generation of a home heating gas. They happens with the price of oil to be an NBA season this
family.” have 750,000 customers. It and gas? But the company year? We don‘t know.
gets cold in Buffalo, so it‘s a has land in an area of the
reason to stay in business. world that everyone wants G&D: Isn‘t there also an
About 80 years ago, they because of shale. They‘ve issue with the controlling
had the McKinsey of their got a midstream business family?
time recommend that they that they can transform into
go out and buy land. So an MLP and monetize. They MG: They are owned by
they bought a million acres also have an oil business the Dolans. I am friends
in land mostly from West they could sell. So we try with the Dolans. We voted
Virginia to New York. And to find the value of the busi- against Chuck Dolan‘s com-
periodically they would go ness over the next ten pany going private four
and drill down and put a years. If gas ever goes to $6 years ago at $36 a share
gathering system in and get over that time we make a because we thought there
gas. Then when the well ton of money, and if your were hidden assets and that
was depleted they would IRR is 25% to 35% and you the deal was leaving too
use it to store gas. It was a own the mineral rights as much on the table for our
nice little company, paying a opposed to leasing, you do clients. They ended up spin-
growing dividend, etc. Fast very well. ning off Cablevision and
forward to now, it is trading Madison Square Garden and
around $55, with 83 million G&D: Is there another AMC Cable. Chuck Dolan‘s
shares and $4.6 billion mar- company that you would son Jimmy is doing a better
ket cap with about $900 like to tell us about? job running MSG and is be-
million debt. Some of the coming more shareholder
questions we ask to under- Another company is right friendly and he won‘t sell.
stand and evaluate the busi- here in New York City. This is a keeper for him.
ness are the following: Cablevision spun off Madi-
What is the utility worth son Square Garden. There G&D: So do you in general
and what would someone are 75 million shares of (Continued on page 17)
Issue XIII Page 17
Mario Gabelli
(Continued from page 16) creating. Now if you go so we knew the company.
like those companies that back to ten years ago, the They tried to go private
tend to have high insider only card company we with Goldman Sachs a few
ownership? could follow was American years ago. So we looked at
Express. We owned it and them and told them not to “If you entrust
MG: Well, GAMCO In- still own it. More recently make any more deals and
vestors did go public, and I MasterCard and Visa went they sort of pushed back. money to us, we
have 98% of the vote. So public and Discover spun They pushed the owner‘s
we can‘t preach against A/B out. So now we have four son off the board. So we want to make a
shares. We‘re owners and companies we can look at said, ―Our clients own 10%,
we know how to think like and we are certainly inter- we should get some board return and also act
owners. If you have 80% of ested in the digital wallet. seats.‖ And then during
the vote and 3% of the eco- Can AXP adapt quickly? that period, Bear Stearns
like surrogate
nomics that bothers us Time will tell. went bust and Lehman col- owners. Sometimes
unless it‘s something like the lapsed, and the money mar-
14th generation of a family. G&D: You have a history kets shut down. We ran management teams
But it‘s hard to paint with of waging proxy battles with out of juice in that instance.
one broad brush – it de- some management teams. Are we going to go back? will go in the wrong
pends on the shareholder. What are you looking for in We haven‘t made a decision
a management teams and yet. Our clients now own direction. Starting
G&D: You have had a what makes you advocate 15% and there are two or
three other institutions that
in about 1987, we
long interest in American for change?
Express? What do you have been patient and may issued a Magna
think of the competitors MG: If you entrust get involved. Why not add
Visa and MasterCard? Do money to us, we want to another director who can Carta of
you see long term threats make a return and also act add some value?
to those companies? like surrogate owners. shareholder rights
Sometimes management G&D: To what do you
MG: Of course. There‘s teams will go in the wrong credit your success?
and what we would
always a threat. When I direction. Starting in about
vote for and against
started in the broadcast 1987, we issued a Magna MG: I do credit a lot to
industry, there was very Carta of shareholder rights Columbia and to Roger for our
little spent on capital expen- and what we would vote for Murray, my value investing
ditures. You could focus on and against for our share- professor. shareholders.”
some high growth cyclical holders. We said, if you try
company with great cash to put in a poison pill, we G&D: What is it that
generation and to buy a TV would vote against it. If it‘s you‘ve done so well that
station in a major market already in there, we can live others can‘t replicate?
you paid 12 or 13 times with it.
cash flow. Today a trade MG: A lot of people have
just took place at 7 or 8 G&D: In the case of a replicated what I‘ve done.
times cash flow. To buy a company like Myers Indus- Chuck Royce has done a
major market newspaper tries, where you‘ve tried to terrific job. Henry Kravis
you were paying 25 times advocate for change for has done better than I have
back in the day, and that‘s if many years, what do you in the private world, albeit
you could even get one. do? with some leverage.
Now they are trading at five There‘s clearly a bias to-
times cash flow due to tech- MG: In the case of Myers, wards success by following
nological change. Sony I started as an auto analyst value investing. I feel like
Walkman had the only game and I would go to Ohio re- I‘m not working for a living
in town and they stopped ligiously to visit with them, (Continued on page 18)
Page 18
Mario Gabelli
(Continued from page 17) wise become accustomed try relates to other indus-
and have the right northern to. tries. And then you need to
star. understand the stock. First
G&D: Do you have any understand the business and
G&D: What are some of advice for novice analysts then understand the stock.
the most common errors who tend to get lost in the Those two things don‘t al-
that you see young analysts weeds with the wealth of ways go in lockstep.
make? information surrounding
Pictured: Panelists Mario each company? G&D: When you came to
Gabelli ‘67, Charles Brandes, MG: Young analysts – Columbia last year, you pro-
Jan Hummel, and David Win- what about me? I still make MG: Yes, and that is that vided handouts of Sara Lee.
ters at the ―From Graham to plenty of errors. We you cannot study a company What do you think of their
Buffett and Beyond‖ Omaha bought Netflix at $40 and without feedback mecha- businesses now?
Dinner in April 2011. sold it at $80. It went to nisms and benchmarks. So
$300. the key is to start by getting MG: Sara Lee is a com-
pany with many products.
G&D: What about in The CEO, Brenda Barnes
terms of assessing the fun- parachuted in a few years
damentals of the business? “You cannot study ago and started looking at
the company and trimming
MG: Sometimes the a company without it down and selling various
younger analysts get con- businesses such as Hanes-
cerned about Mr. Market feedback brands. We knew the food
and the events of today, the mechanisms and business because we have a
volatility in stocks, especially team that does health and
due to all the new ETFs and benchmarks. So the wellness and then we also
high frequency trading and follow consumer products
the like. Mr. Market is now key is to start by companies so we knew well
more volatile than ever. the businesses they were
There were reasons the getting to know an involved with. And as we
uptick rule was eliminated. are closely following the
One of the reasons was industry extremely company, they came up with
because it made it easier for well. That gives the single serve coffee,
electronic trading. And so, which really took off in
there was a group of highly you a great Europe. Then I tried some
focused organizations and personally, and it was so
individuals that wanted to perspective. “ easy. Just look at the cate-
dismember regulatory ele- gories they are in. We
ments that had reduced watched the company and
volatility to a degree. So to know an industry ex- slowly but surely we‘re add-
what happened last year tremely well. That gives ing to it at times where we
with the flash crash was you a great perspective. could get the appropriate
partially the result of that For example, we have a margin of safety. Now we
lobbying group having suc- conference on the auto see the company being split
cess at changing the rules of parts industry. Start off by up in two parts and then
the game. So analysts need reading everything that‘s once they split, the question
to look at intrinsic value and happened in the last 20 is will one company be sold,
realize that the antics of Mr. years in an industry. So you or will both be sold? So at
Market to the fourth power read all the trade info and $16.70, I‘m still in the camp
are creating more volatility then you cross check. Then that I can make 30% on the
than they might have other- understand how that indus- (Continued on page 19)
Issue XIII Page 19
Mario Gabelli
(Continued from page 18) a $130 million market cap. dots. In World War II, how
upside and I think that‘s OK. Because we run a micro cap did the allies find out where
fund we can own it there the German V-1 bomb base
G&D: Is there anything and also in separate ac- was? An intelligence analyst
you wished you knew when counts for our private was reading the social pa-
you were getting started in wealth management clients. pers and he was wondering
the asset management busi- So we start buying the why all these German gen-
ness? stock. It went from $11 to erals were going to this lo- “So the notion of
$40 in a year. It then cation in the middle of no-
MG: Even though I could dropped back to $28, and where? And he figured out understanding the
make money for my clients now we own about 7% of that‘s where they were
in 1976, I probably struc- making the bombs and send- first rule of life is
tured my business in the ing them to England. So
wrong way. I should have gather the data, array the important: don‟t lose
been in the hedge fund data, and then figure out the
world. You can‘t be in the
“Everyone should go money. The best
valuation techniques.
business of ignoring over shark fishing. When way to learn not to
priced securities; you need G&D: Is there anything
to be able to short them. I you go shark fishing, you‘d like to leave our read- lose money is to lose
also don‘t think I‘d ever ers with?
have gone public. The bur- you leave a chum money. Going
dens of regulation are too MG: Everyone should go
great.
line. The sharks shark fishing. When you go through a market
shark fishing, you leave a
smell the chum line chum line. The sharks smell
like this is a great
G&D: What books or
publications should aspiring and follow it. So if the chum line and follow it. learning experience,
investors be reading? So if anything breaks the
anything breaks the chum line, you don‘t have because people
MG: I read annual reports nearly as much success. So
and reading them constantly chum line, you don‟t the notion of understanding realize no matter
is simply the best way to the first rule of life is impor-
learn about businesses. For have nearly as much tant: don‘t lose money. The how smart they are,
example, I got an annual best way to learn not to
success. lose money is to lose
things change very
report of a company in
Racine, Wisconsin. The money. Going through a quickly.”
company is Twin Disc. I market like this is a great
hadn‘t seen the company in learning experience, because
a long time but was just the company for our clients. people realize no matter
curious about them. And We have an analyst who how smart they are, things
then all of a sudden I no- graduated from Columbia change very quickly.
ticed they are producing a Business School within the
transmission dedicated to last few years following the G&D: Thank you for
fracking. Meanwhile, I had company. Now, for the last speaking with us, Mr.
been sensitized to the dy- 40 years I‘ve been reading Gabelli.
namics of shale because of Variety and Billboard and
National Fuel Gas, and here Automotive News and Farm
I see a company producing a Income Journal and all sorts
critical component. The of other things that give you
stock was at $11. They an idea of what‘s going on
have approximately 12 mil- around the world. The hard
lion shares, and at the time part is to connect all the
Page 20
Marty Whitman
(Continued from page 1) G&D: What about any would otherwise have. This
Mr. Whitman graduated differences? avails itself to certain types
from Syracuse Univer- of institutions – a good ex-
sity and holds a masters I don‘t think we can identify ample is integrated electric
degree in Economics high quality securities at utilities companies.
from The New School discount prices unless we
For Social Research. look at things not only as G&D: How do you think
Mr. Whitman is Adjunct passive investors, but also about valuation? What met-
Professor of Distressed from the point of view of rics do you tend to focus
Value Investing at Co- the corporations, manage- on?
lumbia Business School. ments, and creditors. So
“I don‟t think we instead of primacy of the MW: Earnings are very,
G&D: Can you talk about income account, we ap- very overrated. We can
can identify high
your approach and how it praise companies and man- look at the four ways cor-
quality securities at compares to the classic agements in terms of their porate value is created.
G&D approach? capabilities as operators. One is cash flow from op-
discount prices We look at management erations available for secu-
MW: Graham and Dodd, teams as investors and we rity holders, which is rela-
unless we look at in my mind, had three great look at management as fi- tively rare. The second is
things not only as contributions to investing. nanciers. Between those earnings, with earnings being
The first is the focus on things we have a balanced defined as creating wealth
passive investors, distinguishing between mar- approach. while consuming cash. Be-
ket price and intrinsic value. lieve it or not, it‘s what
but also from the This is very important since Graham and Dodd placed most corporations and gov-
modern capital theory as- great emphasis on dividends. ernments do. In order to
point of view of the sumes a price efficiency and In general, companies have have earnings in the long
corporations and ignores intrinsic value. Sec- three uses of cash. They term, you have to remain
ond, they preached the im- can expand assets, reduce credit worthy and you have
managements. So portance of basing decisions liabilities, or distribute funds to have access to capital
on solid facts. They did this to shareholders. The distri- markets to meet cash short-
instead of primacy in the 1960s, which was bution of funds to share- falls. The third element of
of the income ac- before companies were holders, with one exception, creating corporate value is
forced to disclose every- always has to be a residual resource conversion, which
count, we appraise thing they have to disclose from the company‘s point of can be massive changes in
today. Everything about an view. This distribution can assets, massive changes in
companies and investment decision should either take the form of liabilities, and changes of
be based on the facts you stock buybacks or dividends. control. This includes
managements in know and how reliable the Both have their advantages mergers and acquisitions,
terms of their capa- facts are. It is much easier and disadvantages. Graham take-privates, LBOs, MBOs,
to do this type of work to- and Dodd had a preference spinoffs. This is a very im-
bilities as opera- day than it was when they for dividends; we think buy- portant element. The
were doing it. The third backs can be a much more fourth element is having
tors.” great contribution of Gra- judicious use of cash some super attractive access to
ham and Dodd, in my mind, of the time. The one ex- capital markets. Let‘s say
was their idea of investing ception to dividends to you own some income-
with a margin of safety. stockholders being the re- producing real estate. Hav-
Everything we do at Third sidual is where a regular ing access to long-term non-
Avenue is based around increase in dividends im- recourse debt to finance
these tenets of the Graham proves the company‘s ac- 70% or more of your pro-
and Dodd method. cess to capital markets com- ject, that‘s a value creator.
pared to the access they (Continued on page 21)
Issue XIII Page 21
Marty Whitman
(Continued from page 20) Graham and Dodd, we are portfolio has a lot of finan-
not as concerned with past cials, income-producing real
We look at hurdle rates in earnings growth. estate, and a lot of private
most of our common stock equity. With these invest-
investments. We want to Taking the balance sheet at ments IFRS tends to be
get in at a substantial dis- face value is often mislead- more useful than GAAP.
count to readily ascertain- ing. For example, let‘s take Under IFRS, income produc-
able net asset value. We a mutual fund management ing real estate assets are “GAAP is essential,
want at least a 25% dis- company. Assets under carried at appraised value.
count. We don‘t go into management, where persis- but it misleads you
these types of situations tent, have a ready market G&D: Can you talk about as an analyst in
unless we think there are value even through they are one of your favorite new
very good prospects that, not a balance sheet asset. investment ideas? some respects. Cash
over the next 3-7 years, the There are a lot of liabilities
company can increase its that have equity characteris- MW: Cheung Kong Hold- accounting, which is
net asset value by no less tics. Take deferred income ings, an enormously suc-
than 10% per annum com- taxes for a going concern. cessful private equity and not GAAP, also mis-
pounded. We are more Since the company is going real estate development
conscious of growth in to reinvest cash savings company, has a net asset leads because it
readily ascertainable net when they aren‘t paying value of around HK$140 doesn‟t give you any
asset value than we are in taxes in assets which give per share. It is the world‘s
earnings per share. This is rise to tax deductions, this largest container port op- measure of wealth
unlike Graham and Dodd account is really more like erator with facilities
who said value is created by equity than a liability. throughout the world, other creation. GAAP mis-
operations. I don‘t think than the United States. Its
that‘s real in today‘s world, G&D: In the past you have real estate operations are leads because it fo-
in the 21st century. criticized how people use centered in Hong Kong and
GAAP. Could you explain mainland China. Cheung cuses on wealth
G&D: What about some these criticisms to our read- Kong, through its 50%- creation and buries
other differences between ers? owned subsidiary Hutchison
the Graham & Dodd ap- Whampoa, has interests in a cash accounting. It
proach and your approach? MW: I have criticized how leading integrated oil com-
people use GAAP, including pany in Canada; is one of is rules based, not
MW: Graham and Dodd Graham and Dodd, who the largest retail store op-
loved net-nets. When they thought it was so important erators in Europe and principles based..”
invested in them, all they did to find true earnings. GAAP mainland China; and also has
was look at classified bal- is essential, but it misleads extensive interests in tele-
ance sheets. In my opinion, you as an analyst in some phonic communication in
there are real limits to look- respects. Cash accounting, various countries; as well as
ing at companies like these which is not GAAP, also utility operations in the
so far as there are no cata- misleads because it doesn‘t United Kingdom. The stock
lysts. Graham and Dodd give you any measure of cratered recently due to
wrote about the unimpor- wealth creation. GAAP fears in Hong Kong regard-
tance of the balance sheet. misleads because it focuses ing the company‘s huge
From our point of view, if on wealth creation and bur- presence in Europe in ports
you want to predict future ies cash accounting. It is and retail. There has been a
earnings, one of the tools rules based, not principles lot of panic selling. One of
you will use is ROE. We based. However, GAAP is the things about the Hong
don‘t believe that you can critical in the USA because Kong stock market is that it
just pay attention to past it is the only objective is dominated by ―short term
earnings trends. Unlike benchmark you have. Our (Continued on page 22)
Issue XIII Page 22
Marty Whitman
(Continued from page 21) ing that period, net asset we sold our position a while
-ism.‖ I like to say that Hong values, after adding back ago and I don‘t really follow
Kong traders ―don‘t like to dividends, have increased by the company anymore.
buy green bananas.‖ more than 15% per year
compounded. Results for G&D: Can you talk about
G&D: Can you go through 2011 will be very strong. your investment in Brook-
a few other holdings? 2012 may be a year of mod- field Asset Management
erate recession. (BAM)?
MW: Sure thing. Applied
Materials, near $11, sells G&D: Can you talk about MW: Brookfield has a net
around 10x earnings. It has the characteristics of some asset value of around $40,
an extremely strong financial of your most successful in- through it trades near $29
position. It is the world‘s vestments? per share. It has ownership “For us, the key in-
leading producer of chip in a large number of Class A
manufacturing equipment MW: Some of my best office buildings in Manhat- vestment criteria
and, through a China-located investments have been in tan, Toronto, Calgary and
subsidiary, a leading manufac- companies that were going Washington, D.C. Equally are a super strong
turer of solar panels. through Chapter 11. K- important are its hydroelec-
mart was a good example, tric investments in Canada, financial position,
Capital Southwest trades at back in 2003. The first thing the U.S. and Brazil. Brook-
$84, yet has a net asset value we did was buy out a lot of field controls General buying at a dis-
around $140. Investor AB, trade claims from creditors. Growth Properties and has
which trades at 125 Swedish Then we kept averaging huge infrastructure, real count, and getting
Krona on the Swedish Stock down and we went on the estate and agricultural in-
Exchange, has a net asset official creditors committee. vestments in Brazil and Aus- comprehensive dis-
value of around 189. Both It was there that we met tralia. Finally, Brookfield is
are investment companies Eddie Lampert, who asked if the general partner in highly closure so we can
with extremely favorable we would join him in the successful hedge fund in-
long-term records for grow- reorganization, which we vestments. understand the
ing net asset value and divi- did. Eddie ran everything.
dends. To find these types of G&D: How do you think business.”
homeruns we really need about the macro when you
Last, I want to mention Hang good partners. We are invest?
Lung Group and Wheelock & good investors, but not
Company. Hang Lung is the great managers. MW: I think the reason
holding company for the that such a high percentage
leading developer of shop- Unfortunately he‘s tied up of our holdings are in the
ping centers in secondary with troubles at Sears now. Far East is that the region
cities in mainland China, fol- I think Sears is toast. Eddie has better prospects for
lowing its huge success in is very skilled, but I think it NAV growth than any other
building and operating two will be very hard to turn part of the world. For us,
shopping centers in Shanghai. this thing around. The com- the key investment criteria
Wheelock is a holding company has a nice cash posi- are a super strong financial
pany for a huge private eq- tion now from realizing the position, buying at a dis-
uity and real estate devel- value of the company‘s real count, and getting compre-
oper. Both common stocks estate. I don‘t know what‘s hensive disclosure so we
sell at substantial discounts left. I have the greatest can understand the business.
from net asset value. Third respect for Eddie, and if I think these things are rela-
Avenue has been invested in anyone can pull this off, it‘s tively easy to find, but figur-
Cheung Kong, Hang Lung and he. I‘m not as close to the ing out the macro is very
Wheelock since 2005. Dur- situation as I used to be, as (Continued on page 23)
Issue XIII Page 23
Marty Whitman
(Continued from page 22) MW: We like to go where strong financial position.
hard. The real thing inves- there are readily ascertain- We really lucked out.
tors should be thinking about able asset values at a huge We‘ve dealt with terrific
is creditworthiness. Credit- discount. ‗Readily ascertain- managements throughout
worthiness, for any eco- able‘ is not rocket science – the world.
nomic entity that has to bor- it includes income-
row, is a function of three producing real estate, secu- These discounts would “If I can buy these
things – the amount of debt, rities and private equity. I never exist if there were
the interest rate on the debt, like technology companies. catalysts, especially pros- well capitalized busi-
and how productive is the Microsoft (MSFT), Intel pects for change of control. nesses at big dis-
use of proceeds. I don‘t (INTC) and AVX (AVX) are Once that existed, they
know why everyone doesn‘t companies that have cash wouldn‘t sell at these discounts, I‟m not wor-
wake up to the fact that in well in excess of book li- counts. If there are no pros-
the aggregate, debt is almost abilities. These are very pects for change of control, ried about the mar-
never repaid, and doesn‘t profitable businesses gener- there is no reason security
have to be. Provided the ating a lot of cash, and they prices ever have to be ra- ket. I just think
entity can remain creditwor- have large cash balances. As tional. What we do is Gra-
thy, it can refinance, expand such, I feel confident that ham and Dodd on steroids. there are fantastic
the amount of debt and con- they will not burn the cash We are looking for growth opportunities in 363s
tinue the process forever. that serves as a sizeable in NAV if there are no read-
As long as the assets are portion of the asset value. I ily apparent catalysts. One (emergency sale of a
used productively, you can‘t think retail is often very of the reasons for the huge
call it a Ponzi scheme. prone to distress. Between discounts for securities on company in bank-
the banks, the landlords, the the Hong Kong stock ex-
G&D: Would you shy away bondholders, and the trade, change is because the rules ruptcy) and in capi-
from the equity market given companies are very danger- for change-of-control that
what‘s going on in Europe ously financed. It‘s often make it almost impossible tal infusions. You
right now? hard to call a bottom on for companies to go private could do very well
retailers. I remember what or do a cash merger. You
MW: First off, it‘s not going one of my college profes- need a shareholder vote of making capital infu-
on in Europe, its going on in sors used to say – 90% of the outside share-
parts of Europe. They are ―Everything is unpredictable, holders to approve a going sions like Warren
very happy in Scandinavia. especially the future.‖ private transaction. We‘ve
I‘m not smart enough to fig- gone to the Hong Kong Buffett has in recent
ure out if I can buy things G&D: What is the best Stock Exchange to try to get
cheaper than I have. If I can approach to find new ideas them to change the rule so years.”
buy these well capitalized that finding companies trad- that companies can go pri-
businesses at big discounts, ing at a substantial discount vate with a simple majority.
I‘m not worried about the to NAV, but also have a If something like this were
market. I just think there are quality business, a quality to happen, the discounts
fantastic opportunities in management team, and would not be as ludicrous as
363s (emergency sale of a growth prospects for NAV? they are right now. Mean-
company in bankruptcy) and while, the companies we are
in capital infusions. You MW: We usually tend to invested in have insiders
could do very well making be in bed with managements who continue to make open
capital infusions like Warren who don‘t really need the market purchases of their
Buffett has in recent years. capital markets. In 2010 stock, despite not being able
and 2011 these manage- to do a full transaction. The
G&D: What industries are ments were willing to sacri- absence of potential changes
you inclined to invest in and fice return on equity for the in control really hurts an
why? safety and opportunism of a (Continued on page 24)
Issue XIII Page 24
Marty Whitman
(Continued from page 23) an investment? risk. Market risk is just a
economy. It breeds manage- random walk. Without
ment teams that don‘t use MW: You can be wrong catalysts, any near-term
resources well. Japan seems about anything. One of the market prices are a random
a good example of this. things that is very important walk.
to understand is that diver-
On a different note, a good sification is only a surrogate, G&D: Who else in the
example of our being disci- and usually a poor surro- industry do you have a lot Bill Ackman and David
plined in finding bargains, was gate, for knowledge, con- of respect for? Einhorn at the G&D
not chasing things during the trol, and price conscious- Breakfast, 2010.
dotcom boom. We never ness. As a non-control in- MW: There is a great ten-
really suffered during the vestor you have to have a dency for the best people in
period. We had criteria moderate amount of diver- value investing to graduate “One of the things
when looking at tech compa- sification, which is not true and to do control investing
nies in those days. Cash had as much for control inves- and distressed investing. that is very impor-
to be well in excess of book tors. It is very hard to There are a lot of very suc-
liabilities. We would never make guarantees. A margin cessful people who will tant to understand
pay more than 2x annual of safety usually comes from never make a passive invest-
revenue and never pay more buying high quality securities ment. Take my friend Sam is that diversifica-
than 10x peak earnings. We at a discount. Secondarily, if Zell for example – he never
could meet these criteria you are a passive investor makes an investment where tion is only a surro-
with large blue chips, such as you need a moderate he doesn‘t have control.
Intel (INTC), AVX (AVX), amount of diversification. Warren Buffett is a control gate, and usually a
and Applied Materials This is really a probability investor and also is very
(AMAT). business, not a certainty much a distressed investor. poor surrogate, for
business. As an outside Bill Ackman, David Einhorn,
G&D: How do you get passive investor, you can be and Mario Gabelli come knowledge, control,
comfortable investing in Ja- wrong about anything. from the Graham and Dodd
pan and Hong Kong when school of passive investing and price con-
the catalyst may never actual- G&D: If an analyst comes and are all investors I re-
ize? into your office with a new spect. sciousness… It‟s
idea, what are the first few
MW: I‘m absolutely com- things you would want to G&D: What do you think been more business
fortable in most things when know? has made you a successful
I can find discounts to NAV investor?
skill than invest-
of 40%. I was a limited part- MW: What I want to do is
ner in Jim Grant‘s Nippon understand the business. I MW: I can spell that out.
ment skill that has
Partners. They went out and want to know the estimate L…U…C…K. It‘s been
helped me through-
bought 20 net-nets in Japan of NAV, and can we buy it more business skill than
in 1999. On this stuff, I have at a sizeable discount from investment skill that has out my career.”
to hope they have the this. We guard against in- helped me throughout my
growth in NAV and that the vestment risk, but we pretty career.
discount doesn‘t widen. A much ignore market risk,
real shortcoming of what we which is different from Gra- G&D: We appreciate you
are doing now, and what we ham and Dodd, who were sharing your thoughts with
doing then, is a lack of a cata- very conscious of how much us, Mr. Whitman. Thank
lyst. you suffer when the price you.
goes down. We try and
G&D: How do you get train our people that to be
comfortable that there is a successful, you need to
sufficient margin of safety in guard against investment
Page 25
Columbia Business School Alumni Profile: Eli Rabinowich

G&D: Tell us a little about cation at Columbia shape We utilize a proprietary
your background and your you and how did you de- screening system that iden-
current firm? velop as an investor post- tifies stocks that are cheap
graduation? on price-to-normalized
ER: I did not know what I earnings. The screen takes
wanted to do after business ER: Columbia is great in the last 10 years of history
school, but I knew Colum- the sense that it is almost a (revenue growth, returns
bia was famous for its value practical application on how on capital, and margins) and
investing tradition, and to invest. There are a lot of extrapolates future normal-
when deciding on schools, I real world practitioners ized earnings five years out.
thought that at a minimum I who come in and say ‗here For example we will run the
wanted to go to a great is what we do‘. The big screen for our large cap
business school and learn difference in what happens portfolio, where the pool of
how to invest my own at Columbia and what hap- companies is the 500 largest
money. I took all of the pens at other schools is that companies in the U.S. We
classes on value investing, Columbia really shapes the will then fish in the cheapest
and after the first semester temperament in terms of quintile. The analysts spend
figured out that this was buying cheap stocks – at their time doing deep dives
what I wanted to do. I Columbia they really drill into the companies that the
started the ‗Profiles in In- that into you. But in terms screen identifies and then
vesting‘ column at Columbia of how to really think about we will ultimately invest in
where I would interview a business, such as what the 30-40 of those 100 names.
different value investors. critical drivers are, and how
One of the investors I pro- to deal with the emotional G&D: What are some of
filed was Rich Pzena, and I volatility of the market, I the biggest challenges in
started working at Pzena really learned all of that investing?
Investment Management after school.
when I graduated. ER: The most challenging
G&D: The most difficult thing is having confidence in
I am now a portfolio man- part of investing is often just your earning‘s estimates
ager for Pzena Investment generating an idea and find- when the market moves
Management, where I co- ing mispriced securities – against you. What we do is
manage our mid-cap U.S. what is your search process we constantly reevaluate
portfolio. and how do you go about our normal earnings and
it? position sizes. We do it on
When I first started I cov- every major news event and
ered property & casualty ER: I fundamentally dis- on every quarterly report.
insurance, followed by agree that finding new ideas The analyst will write up
pharmaceuticals, medical is the hardest part of invest- what happened and the esti-
devices, chemicals and housing. I think ideas are all mated impact on normal-
ing. We rotate sector cov- over the place and there are ized earnings. Theoretically,
erage here every 3 to 4 many places to look for once we have locked in
years. The rotating cover- ideas such as new stocks normalized earnings, stock
age model is employed be- hitting 52-week lows, look- price moves should not
cause it gives the analyst ing at insider buying trends, impact the normalized earn-
exposure to different busi- etc. There certainly are a ings of a company.
ness models. From an in- lot of statistically cheap
vestment standpoint, it al- stocks most of the time. We have a morning meeting
lows the firm to get differ- The hard part is separating every day where analysts
ent perspectives on a given what is permanently cheap report on material news,
industry. and what is cheap for a tem- where the analysts will give
porary reason. an update on their compa-
G&D: How did your edu- (Continued on page 26)
Issue XIII Page 26
Eli Rabinowich
(Continued from page 25) G&D: What questions do worse.
nies. We generally will not analysts have to answer in
react to stock prices move- order to figure out if a par- G&D: Could you talk
ments, though if something ticular business is a good about a recent investment?
happened at the operational business?
level, we will sit down and ER: Mohawk Industries
discuss whether or not ER: The critical element is (MHK) is an interesting idea.
something has changed that understanding what the sus- Mohawk is the second larg- Pictured: Steve Eisman at the
fundamentally changes our tainable level of earnings for est manufacturer of carpet Columbia Investment Manage-
view of the company and its a company is. We start in the country. The comment Conference in February
normalized earnings power. with ‗what has the company pany has cyclically depressed 2011.
For example, if management historically done‘, and then revenue because the busi-
decided to make a large di- ‗is the future likely to be like ness is related to housing,.
lutive acquisition that was the history or different from Mohawk has three busi-
not in our forecast, we may the history?‘ Where we nesses, each of which is
then have to reduce our nor- spend a lot of time is trying about a third of the total
mal earnings. to understand what has companies business. These
changed to make a stock businesses are carpet, ce-
G&D: What is your typical cheap. Typically you have a ramic tiles, and laminate
holding period, and how do company that was going flooring. In carpet the big
you decide when to sell? along and everything was players are Mohawk and
fine, and then somehow it Berkshire Hathaway, which
ER: Our typical holding pe- ended up being a cheap together control roughly
riod is about three years, but company. For example, we 80% of the market. The
our horizon is five years, are finding a lot of opportu- business is characterized by
really ten years. Our sell nities in housing-related high returns on capital, good
process is fairly mechanical. stocks. Housing stocks are margins, and very stable
We buy names in the cheap- cheap because the macro market share, In ceramic
est quintile, and we sell when environment for housing tiles, Mohawk is the undis-
a names reaches the mid- stinks. -We used to make puted leader with roughly
point of fair value. Today, 1.5 million houses a year 35% market share and is the
the average stock in the uni- and now we are building only integrated manufac-
verse is trading at approxi- fewer than 600 thousand turer and distributor in the
mately 11x our normalized houses. The questions then ceramic space. In laminate
earnings estimate and we are becomes ‗what is the sus- tiling it has dominate posi-
currently buying names that tainable level of housing tioning in Europe. Cur-
are trading for 5-7x normal- construction?‘, and ‗are rently the stock has a dou-
ized earnings. We will sell these the same companies ble digit free cash flow yield
when the name trades at an with the same characteris- and then there is a lot of
average multiple. A lot of our tics and same return profile room to improve as the
holdings are depressed and it that they have historically macro environment gets
takes time for things to work had, but are now just oper- better. Here is a business
out. Some are facing some ating in a difficult environ- that has a dominate fran-
sort of problem and others ment?‘ Other companies chise in each of its busi-
are just disfavored by the could have had a change in nesses, currently generating
market. On average it takes the competitive structure, good investment returns,
a few years for the market to and then we want to under- with very good long-term
come around to our point of stand the competitive dy- prospects, trading at a cycli-
view about a stock‘s valua- namics of an industry, and cally depressed valuation.
tion. see if they are the same as
before of if they have gotten (Continued on page 27)
Issue XIII Page 27
Eli Rabinowich
(Continued from page 26) longer, not getting divorced, been very slow. About 15
G&D: How much do you etc. At some point there is years ago, carpet was 70%
think about the macro envi- going to be a need for hous- of square footage and since
ronment? Is it more of an ing. This is a macro call on then it has trended down to
opportunity to buy cheap housing starts as opposed to 60% of square footage.
stocks, or is also something call on the general econ-
you look at to try forecast? omy. G&D: So where do you
think the intrinsic value of
We are not sitting here Mohawk is?
“The most challeng- saying GDP is going to be
ing thing is having up a certain amount, nor do ER: At ~6x our normalized
we necessarily want to be earnings estimate of $7.50
confidence in your positioned cyclically or non- we find the stock very at-
cyclically – we care about tractive.
earning‟s estimates what stocks are the cheap-
est. In the current environ- “The critical element
when the market ment people are more
moves against you.” scared and that generally is understanding
means cyclical stocks are
probably cheaper right now. what the sustainable
What we want to own are
ER: We do not spend much companies that have the level of earnings for a
time forecasting the macro. wherewithal to make it to
company is. We start
For a company like Mohawk, the other side and do well.
you can look at the level of What‘s great about Mohawk with „what has the
housing starts, which is the is that if the economy gets
number of houses we create worse, Mohawk actually company historically
each year in this country. throws off cash because its
Household formation each working capital needs get done‟, and then „is
year is a little over 1 million reduced. It then needs cash
per year. At a minimum we as it is coming out, but the future likely to be
need to have a level of hous- that‘s a good thing and al-
like the history?‟ ”
ing starts that is commensu- most anyone would be will-
rate with household forma- ing to lend to them.
tion, plus a little extra when G&D: Can you tell us
you factor in teardowns, G&D: Do you think that about another investment
second homes and migration there could be a secular idea?
patterns. The majority, trend toward less carpet
more than 2/3 of sustainable and more hardwood? ER: Abbot Labs (ABT) is a
demand, comes from house- diversified healthcare com-
hold formation. While we ER: Clearly there is a trend pany. It has some very large
overbuilt during the boom away from carpet and to- pharmaceutical products.
we are now building below a ward other surfacing, and The company has one prod-
sustainable level. At some it‘s been going on for the uct that the market is very
point all of these households last 20 years. Mohawk has scared about right now.
are going to need a place to seen this, and it is part of Humira, an injectable drug
live. What we have seen in the reason that the com- used to treat autoimmune
the recession is that house- pany moved into ceramic disorders, accounts for $6.5
hold formations have col- tile and laminate flooring. billion of the company‘s $30
lapsed - people have been The share shift away from billion in revenues. The
living with their parents carpet has (Continued on page 28)
Issue XIII Page 28
Eli Rabinowich
(Continued from page 27) don‘t think you are going to ferent value investing firms.
company also has leading tell your boss ‗that is not It‘s important to find the
businesses in stents, nutri- how I would do it‘. You place where your tempera-
tion, and cardiovascular. should really be very re- ment and the temperament
There is a lot of value in sponsive to how your boss of the firm are in tune. For
these businesses, but the me personally, I was looking
market is discounting this for low position turnover
“In the current envi-
right now. The most immi- and low personnel turnover.
nent threat to Humira comes ronment people are
from potential alternative G&D: What do you think
therapies, such as Pfizer‘s more scared and that separates successful value
Tofacitinib. The value investors from less success-
proposition of these treat- generally means cy- ful ones?
ments is easy to understand
as they are oral therapies clical stocks are ER: The ability to under-
that will be competing in a stand the odds of their rec-
probably cheaper
category dominated by in- ommendations. Every in-
jectable products. Based on right now. What we vestment is essentially a bet
our analysis, however, we on, or a prediction of, the
believe the market is vastly want to own are future. Being able to make
overestimating the potential bets in such a way that you
impact of Tofacitinib, and we companies that have make money on the upside
think that Humira‘s sales will but don‘t lose much on the
likely persist for years. the wherewithal to downside is biggest thing an
There are a lot of hurdles for investor needs to be suc-
make it to the other
Tofacitinib. The drug still cessful. What I have found
needs to be approved by the side and do well.” is that people who are in-
FDA. Compliance can be a trinsically motivated to find
major factor for twice a day thinks about things. Even good investments tend to
oral treatments, vs. a once in within value investing there be better long-term per-
two week injection for Hu- are many different ways to formers in the industry.
mira. In addition, Tofacitinib slice it. You could look at a Over time these people will
may not be as successful as range of value investors and separate from others who
Humira in certain indications, their portfolios will look are just in the industry be-
for example, a recent clinical completely different. It is cause it is a lucrative field to
data released in May 2011 important to realize how be in. There will be a lot of
indicated that Tofacitinib your firm values companies times when the stress level
failed to meet the primary and to think about how they can get pretty high when
endpoint in a Crohn‘s disease evaluate businesses. positions start to move
study. against you, so if you don‘t
G&D: What advice do you really enjoy it you are in for
G&D: What is one thing have for newly graduating a tough time.
students should know before business school students
entering the investment looking for jobs in value G&D: Thank you very
world? investing? much, Mr. Rabinowich.
ER: The Applied Value In- ER: When I was interview-

vesting program at Columbia ing for positions it stood
gives you a great preparation, out to me how the style,
but you still have a lot to pace of investing, and tem-
learn. When you come in, perament varied across dif-
Page 29
Great Lakes Dredge and Dock (GLDD) - Winner of 2011 Sonkin Prize
Philip O’Brien
pobrien12@gsb.columbia.edu
Investment Thesis
Philip is a second year MBA
I recommend purchasing shares of Great Lakes Dredge and Dock Corporation (―GLDD‖ or the
student concentrating in
―Company‖) with a price target of $6.55. GLDD is a business with a 80% margin of safety on an asset
Finance & Economics. He
reproduction basis at current price levels, a conservative valuation on an earnings power value or free
spent the summer interning
cash flow basis, impressive barriers to entry and a dominant market position, recurring revenue from
with a private equity fund in
that smoothes over fluctuations in capital spending project demand and a demonstrated ability to
New York City. Prior to
make acquisitions at attractive prices.
enrolling at Columbia
Business School, he spent
Margin of Safety on an Asset Reproduction Basis: The book value dramatically understates (by
four years in investment
over $1 billion) the fair market value of the Company‘s vessel assets. In addition, the Company has
banking and private equity
real estate holdings with significant underlying value that is not reflected on its balance sheet due to
GAAP accounting conventions. I estimate that the Company‘s net asset reproduction cost would be
roughly $24.31 per share. At the company‘s current stock price of $4.91, this implies an 80% margin
of safety on the basis of asset value alone.
Trading Significantly Below Conservative Estimate of Earnings Power Value: GLDD exhib-
its upside of roughly 33% of its current share price based on a conservative estimate of its earnings
power value (following page). Historically, talented, private-equity backed management teams have
actually been able to achieve EBIT margins of 11% over the course of several consecutive years (e.g.
1999-2002). If management could improve cost discipline to get back to those levels, then the upside
from current price levels would be approximately 94% from the current share price (implied price
target of $9.53).
Significant Barriers to Entry: The combination of the Foreign Dredging Act of 1906 and Merchant
Marine Act of 1920 prohibits foreign competition in domestic U.S. dredging operations. The Company
owns and operates the only two hydraulic dredgers in the U.S., which are particularly important for
dredging the Port of Houston and the deepwater ports along the California coast. The Company has
a dominant market position with an estimated 46% of the domestic dredging bid market from 2008-
2010, so GLDD is several times the size of its nearest competitors, giving it unique advantages in
bidding on large contracts. Finally, the Company estimates the reproduction cost of its fleet at over
$1.5 billion versus a book value of $315 million, so any potential entrant would face unattractively
high upfront capital expenditures.
Demonstrated Ability to Make Acquisitions at Attractive Prices: GLDD‘s acquisition of

Matteson was done at ~3.0x EBITDA versus a GLDD trading multiple of 5.0x 2011E EBITDA. Signifi-
cant synergies will likely result in following years as well, as headcount can be removed from the G&A
expenditure line (G&A has historically been roughly 7.5% of sales).
Management: The GLDD management team has industry experience and a record of managing the
business prudently. Management has also been disciplined in making acquisitions in the past with only
one major acquisition in the last ten years, and that one was at an accretive multiple. I would note
however, that management‘s incentives are not perfectly aligned with shareholders, since the com-
pany‘s executives are expected to target EBITDA for its dredging segment alone rather than consoli-
dated EBITDA—giving management incentive to shift overhead costs between segments.
IssueXIII
Issue XII Page 30
Paul Johnson
Great Lakes Dredge and Dock (Continued from previous page)
Cash Flow
On an enterprise basis, GLDD generates substantial free cash flow and has low, manageable levels of
leverage at 1.8x net debt / 2011E Consensus EBITDA, which is down significantly from 3.7x as of the end
of 2008. At a multiple of only 6.3x TEV / (EBITDA—Maintenance CapEx), GLDD represents a unique
opportunity to buy a business with a substantial cash flow yield even at a cyclical trough for the industry,
with substantial asset coverage buttressing the cashflow valuation.
Business Description “GLDD represents a

GLDD is the largest provider of dredging services in the United States. GLDD provides dredging ser-
vices in the East, West and Gulf Coasts of the United States and worldwide. The Company also owns a unique opportunity
majority interest in NASDI, a demolition services provider in the Boston, MA area. The Company has a
50% interest in Amboy Aggregates, a sand mining operation in NJ. GLDD earned 89% of its FY2010 to buy a business
revenue and 103% of its FY2010 operating “ ” with a substantial
income from dredging operations and 11% of (US$ m)
its FY2010 revenue and (3%) of its operating 2011 Consensus Revenue $651.8
cash flow yield even
income from demolition operations. Average EBIT margin (1999-2010) 7.5%
Sustainable EBIT $48.9 at a cyclical trough
Valuation Average tax rate 38.0%
GLDD is an asset intensive business with Normalized NOPAT $30.3 for the industry, with
significant swings in margins, primarily tied to Excess depreciation after tax 13.6
swings in the capital project dredging cycle Normalized Earnings $43.9 substantial asset
and the overall economy. Therefore, I don‘t WACC 8.0%
consider this a franchise business and have Earnings Power Value $549.0
coverage buttressing
omitted a discussion of growth from our Net debt (161.5)
valuation here, since it is unlikely to be
the cashflow
EPV Equity $387.4
growth within the franchise. Instead, I looked Current market capitalization $290.6 valuation.”
at the earnings power of the business using Upside to current price 33.3%
average EBIT margins over the cycle and ad-
justing for excess depreciation. Based on my calculations the earnings power of the business, conserva-
tively valued, provides a 33% upside to the current share price. While I took the cyclical average margins
for the company‘s earnings power value, 2011 consensus revenue estimates are relatively depressed due
to a cyclical lull in the level of capital dredging projects, especially abroad. In the past, talented private
equity-backed management teams have raised EBIT margins to 11% over several consecutive years, sug-
gesting that there is significant potential upside from our earnings power estimates.
Economic Slowdown: Although the Company doesn‘t break out its margins by contract type, the
capital project (29% of 1H2011 Revenue) dredging margins are significantly higher than the maintenance
and nourishment dredging margins and would be especially vulnerable to an economic slowdown.
Labor Costs: GLDD, including Matteson, had 39% of its 2010 employees on salary and the remaining
61% on hourly wages that are largely determined by a handful of union contracts. Union contracts repre-
senting over 43% of the Company‘s hourly workforce will reset in 2012.
Bahrain Unrest: Foreign dredging revenue, comprised primarily of revenue derived from contracts in
Bahrain, contributed 14% of contract dredging revenue in the first half of 2011. The Company carries
insurance on property and personnel but not lost revenue. A significant spike in the unrest against the
government of Bahrain could lead to a significant loss of revenue and operating profit.
Contract Risk: The Company faces competitive bidding on most of its government contracts. Con-
tracts from the U.S. Government‘s Army Corps of Engineers accounted for 54% of 2010 revenues, al-
though it was spread over 47 contracts.
Page 31
Madison Square Garden Inc. (MSG) - Winner of 2011 Sonkin Prize

Michael Yablon
MYablon12@gsb.columbia.edu
Madison Square Garden, Inc. (Nasdaq:MSG) FYE 12/31
($ in millions except per share) FY Ends June 30 2009A 2010A 2011A 2012E(2) 2013E
Share Price as of 10/21/11 $25.07 Projections
Basic Shares Outstanding 76 Revenue $1,062 $1,157 $1,188 $1,151 $1,270
Options / RSUs 2 %YoY Growth 6% 9% 3% (3%) 10%
Total Shares Outstanding 78 EBITDA $106 $217 $208 $191 $346
Market Capitalization $1,961 % Margin 10% 19% 18% 17% 27%
Cash and Equivalents $305 EBITDA Multiple 15.6x 7.6x 8.0x 8.7x 4.8x
Capital Lease $4 PF for Renovation EBITDA Mult. 22.0x 10.7x 11.2x 12.2x 6.8x
Enterprise Value $1,660 FCF $29 $96 $91 $81 $177
MSG Renovation Cap Ex (1) $675 FCF Yield 1% 4% 4% 3% 8%
Michael is a second year PF Enterprise Value $2,335 Implied Valuation Using FY2013E EV/EBITDA Multiple PF for Renovation
% of Insider Ownership 21% EBITDA Multiple 8.0x 9.0x 10.0x 11.0x 12.0x
MBA student participating in 52-Week Low-High $20.28-$30.21 Market Capitalization $2,391 $2,737 $3,082 $3,428 $3,774
the Applied Value Investing Avg. Daily Volume (MM) 0.3 Implied Price Per Share $30.57 $34.99 $39.40 $43.82 $48.24
Program. While at school, Shares Sold Short (MM) 1.0 Implied Annualized Return 12% 22% 31% 39% 47%
he has worked at two value- (1) Analysis treats the $710M remaining cap ex to be used to renovate the Garden over the next three years as debt, discounted to present value at 3%
(2) All 2012 projections assume NBA misses half the 2011-2012 season
oriented hedge funds. Prior
to enrolling at Columbia Investment Thesis:
Business School, he was an I recommend purchasing shares of Madison Square Garden (―MSG‖). MSG is poised to benefit from
investment banker focused improvement in its core business segments and the unrecognized upside in the renovation of the
on mergers & acquisitions. Garden. The new Garden will boost earnings, allowing MSG to better harvest returns from an un-
Michael holds a BA from derutilized asset. Shares for the entire company, including the Knicks, Rangers and Madison Square
Columbia University. Garden Arena, are trading at 4.8x projected 2013 EBITDA while lesser regional sports networks
(―RSN‖) without the irreplaceable assets listed above have typically been sold in the 15x-25x EBITDA
range. Applying a10x EBITDA multiple gives a target price of $40 per share or a 30% annualized
return. A sum of the parts valuation discussed on the next page, which reflects the private market
value of MSG‘s unique assets, yields a target price of $50 per share, although a breakup is unlikely.
Buying Highly Profitable Regional Sports Network at a Steep Discount to Peers: RSNs are a must-
have for cable providers whose subscriber base demands local sports content. Cable providers pay a
premium fee of $3.50 per sub with 5% yearly escalators for the MSG Networks. Sports hit key male
demographics and are typically watched live with advertisements. MSG and MSG+ are arguably the
most valuable RSNs given that they serve the largest market in the US (16M subs), operate at a higher
margin due to vertical integration and have teams with dedicated fan bases. RSNs do not trade pub-
licly but have historically been acquired in the 15x - 25x range, with an average of 18x for the 37
transactions analyzed from 1994-2009 in DTV's S-4 filed on 6/08/09.
Garden Renovation provides Attractive Opportunity: MSG has undertaken a four year
~$850M renovation of Madison Square Garden. The Garden will be closed for three consecutive
summers from 2011-2013. The new Garden will increase the number of suites from 89 to 111 and
will result in general admission price increases throughout the stadium (prices haven‘t increased for
most seats in 8 years but will increase 49% and 23% this year for the Knicks and Rangers, respec-
tively). Renovation execution is critical but the market is unduly skeptical of ROI. Garden improve-
ments should yield $75M in incremental EBITDA in 2013. MSG has guided to the renovation costing
$850MM-$1B. However, Forest City Ratner, the builder of the Barclay Center in Brooklyn that will
be home to the Nets has estimated the cost to be $800M for building the new Center from the
ground up. Clearly, new construction requires significantly more raw material while the same unions
are employed on both projects. If the NBA returns from its lockout and the Knicks continue to im-
prove (potential Chris Paul acquisition in 2012) there is a lot of upside to ticket prices driving incre-
mental EBITDA beyond 2013.
NBA Lock Out Creates Buying Opportunity: The lockout creates a near term catalyst for the
stock price upon the work stoppage‘s resolution. Currently, the players and owners have little incen-
tive to negotiate in good faith given that neither side feels the impact financially prior to the start of
the season. In my opinion, this lockout will follow the pattern of the previous one in 1998 when half
a season was missed. Like the previous lockout, owners should prevail and gain better economics
that will benefit MSG long-term, while investors can take advantage of the short-term uncertainty.
Business Description: Madison Square Garden, Inc. was spun off from Cablevision, owned by the
Dolan family, on 2/9/10. MSG business segments include the Knicks and Rangers sports teams, Madi-
son Square Garden arena, the MSG regional sports networks, and a series of smaller entertainment
businesses, including the Christmas Spectacular at Radio City Music Hall, the Beacon Theatre, Chi-
cago Theatre and Wang Theatre in Boston.
Issue XIII Page 32
Madison Square Garden (Continued from previous page)

Business Segment Overview: Substantial Value in the Sum of the Parts
A sum of the parts/breakup analysis shows significant upside to the current stock price but should not be
considered viable given the interlocking nature of the businesses. A potential breakup scenario is the
Dolan‘s purchase the entire company and strip away non-core assets, like Fuse, and the MSG entertain-
ment business. Minority shareholders would insure full value is reached given the Dolan‘s track record
for unsuccessful takeover offers. The Dolan Family owns 70% of the total voting power of the stock.
MSG Media: Provides almost the entirety of EBITDA currently and is a strong cash generator with
exclusive access to programming for the Knicks, Rangers, NJ Devils, Buffalo Sabres, Liberty and Wolf-
pack, along with college sporting events (ACC, Big East, Pac-10). MSG Media showcases these teams on
MSG and MSG+. RSNs command premium subscriber fees because many cable subscribers view local Sum of the Parts Summary
sports as a necessary feature in any cable package. MSG‘s RSNs warrant a premium valuation due to MSG Media
their 35% EBITDA margin and top-tier market presence. By way of comparison, Liberty Sports Group‘s MSG/MSG+
RSNs sold for 13x EBITDA and had 22% EBITDA margins, generated just $45M (vs. MSGs $230M) and EBITDA $228
had far less iconic content. A 12x 2011 EBITDA multiple was used for the sum of the parts valuation. Multiple 12x
MSG Entertainment: Primary value is the Radio City Christmas Spectacular, which generates $125M Value $2,736
in revenue and is viewed by 2M people annually. The Spectacular was renovated in 2008 for arena tours, Fuse
which resulted in a decline in EBITDA of $25M. The segment has historically been profitable but operat- Subscribers 49
ing profit dipped due to cost associated with the renovation and the economic downturn. Peak EBITDA Per Sub $1
was in 2007 at $50M, so assuming that it returns to 50% of that level, applying a 5x multiple (Live Nation Value $49
trades at 6.3x), the business is worth $125M, plus another $25 for the other theaters. MSG Entertainment
MSG Sports: The Knicks and Rangers were purchased in 1997 for $300M and $195M, respectively, and Xmas Spec. / Theaters $150
are accounted for at historical cost on the balance sheet. The Knicks were valued at $655M in January MSG Sports
2011 by Forbes and the Rangers were value at $416M in 2009. While neither team can be sold for two Knicks $655
years post spinout, both teams are significantly undervalued on the balance sheet. Prior to last season, Rangers $400
the Knicks had missed the playoffs for 6 straight seasons, but were ranked #2 in the league in gate re- Other Assets/Liabilities
ceipts. The signings of Carmelo Anthony and Amare Stoudemire have rejuvenated the fan base and the MSG Air Rights $250
possibility of signing another big player in 2012 (Chris Paul?) will drive the Knicks to greater success in Live Nation Stake $34
the future. Any improvement with the sports teams has a multiplying effect on earnings throughout the Less: Corp. Cost $108
company – better teams mean playoff ticket sales, more tickets sold in general, higher ticket prices, more Total SOTP $4,166
merchandise and concession revenue and better per-sub affiliate fees and advertising rates for MSG and Plus: Net Cash $301
MSG+. Ticket prices will be raised for the first time (if there is a season, see below) but demand still Less: Renovation NPV $675
greatly exceeds supply. The renovated lower suite level is already sold out and a 10 year sponsorship SOTP Value $3,793
Price Per Share $48.49
deal with JP Morgan for $300M gives visibility into ROI. This analysis ascribes no value to the Liberty or
Implied Ann. Return 48%
the Wolfpack and the presentation rights for live sporting events that take place at the Garden, which
clearly have value. The sports teams are part of the cultural fabric of New York with very loyal fan bases.
Air Rights and Venues: MSG owns the land and the buildings on which Madison Square Garden rests
and it also possesses the air rights. Gabelli estimates that the air rights are worth $250M at a 50% dis-
count to the 4.5M capacity of MSG at $110 per square foot. The sum of the parts does not consider the
value of their other tier 1 entertainment venues, which is highly conservative, and values its Live Nation
stock at its market price.
NBA Lockout: In June, the NBA players were locked out after the Collective Bargaining Agreement
(CBA) between the players and owners expired. The negotiations are ongoing and the crux of the dis-
agreements revolves around the split of Basketball Related Income (―BRI‖) between players and owners
and a ―hard‖ salary cap that cannot be exceeded. Under the old agreement, players received 57% of BRI
and there was a ―soft‖ cap that allowed owners to exceed the salary cap but pay a penalty. The work-
stoppage could have a significant impact on MSG in the near-term. By my calculations, a loss of the
whole season could result in a loss of ~$170M in revenue and $85M in incremental EBITDA. Although it
is my opinion that the entire season won‘t be lost, the uncertainty is priced into the stock and the nego-
tiations will be a net positive for MSG‘s profitability and investors with a longer time horizon.
Overhang on Stock Due to Dolan Family Control: The ―Dolan Discount‖ will erode over time as
the Dolan‘s look to earn on their $400M position in the common stock. The Dolans have exhibited
shareholder friendly activity in the last two years with the spin out of MSG and AMC Networks and the
dividend and share repurchase at Cablevision. The typically 10%-20% discount associated with insider
control is warranted but the significant discount likely associated with Dolan control is excessive. The
Dolan‘s have offered investors in Cablevision numerous potential liquidity events over the years and
there has been plenty of speculation that James Dolan would like to take MSG private. I view the Dolan
ownership as a 'put' that offers investors downside protection.
The Columbia Student Investment Management Association
and
are proud to announce the 15th annual
CSIMA INVESTMENT MANAGEMENT CONFERENCE

On Friday, February 10th, 2012
Columbia University in New York, NY
The CSIMA conference is structured to be a full-day event with two keynote

speeches and three panels.
This year’s conference provides an excellent opportunity to get the perspectives of

some of the top names in the investment management business on current events,
the global economy and promising new investment trends.
Please check our website for updates on speakers and agenda:

http://www0.gsb.columbia.edu/students/organizations/cima/conference.html
Registration Opens: 31st October 2011
General Inquiries to:

Cara Majeski Melissa O’Connor
Cmajeski12@gsb.columbia.edu moconnor12@gsb.columbia.edu
Tickets priced at $350 (with available discount for CBS alumni and students.)
COLUMBIA STUDENT INVESTMENT MANAGEMENT ASSOCIATION
The Columbia Student Investment Management Association is dedicated to the education and career
development of Columbia Business School students interested in working in the investment industry.
The club's primary activities include sponsoring guest lectures from industry practitioners, organizing
stock-picking contests, and assisting with the recruiting process.
http://www0.gsb.columbia.edu/students/organizations/cima/
HEILBRUNN CENTER FOR GRAHAM & DODD INVESTING
The Heilbrunn Center for Graham & Dodd Investing builds on Columbia Business School’s extraordinary
tradition of value investing by promoting the study and practice of the principles developed by Benjamin
Graham and David Dodd, MS ’21. Established with the generous support of Robert and Harriet Heil-
brunn, the center serves as the leading global resource on investing. To learn more, visit
www.gsb.columbia.edu/valueinvesting
Get Involved:
8687 or valueinvesting@columbia.edu. Available positions also may be posted directly on

New York, NY 10027
fill out the form below and send it in an e-mail to valueinvesting@columbia.edu.
Name: _____________________________

Columbia Student Investment
Management Association (CSIMA) City: _____________ State: ________ Zip: ________
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Business Phone: _____________________________

Contact us at:
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jjaspan12@gsb.columbi.edu Would you like to receive e-mail updates from the Heilbrunn Center? __ Yes __ No
Anna Baghdasaryan is a second year MBA student in the Applied Value

Investing Program. She is currently working part-time for Clinton Group, a
multi-strategy alternative investments firm. Prior to Columbia Business
School, Anna worked in strategy and business development, and investment
banking. She can be reached at abaghdasaryan12@gsb.columbia.edu.
Joe Jaspan is a second year MBA student in the Applied Value Investing Pro-
gram. He is currently working part-time for a value-oriented hedge fund in
New York. Prior to Columbia Business School, Joe worked in private equity
and investment banking. He can be reached at jjaspan12@gsb.columbia.edu.
Graham & Doddsville
Inside this issue: Issue XIV Winter 2012
Interview: P.1 Sam Zell —

William von
William von Mueffling —
Mueffling “Going for “Financial Productivity At a
Greatness” Discount”
Interview: P.1
Michael Karsch
William von Mueffling ’95
Interview: P.1 is President of Cantillon
William Strong Capital Management, an
investment firm with
Interview: P.1 more than $8 billion un-
der management. He was
Sam Zell
previously a Managing Di-
Interview: P.2 rector at Lazard Asset
William C. Martin Management, where he
was responsible for hedge
Student Stock P.44 funds. Prior to joining
Sam Zell Lazard, he was with
Pitches
Sam Zell is Chairman of Deutsche Bank in
William von Mueffling
Editors Equity Group Investments
Anna Baghdasaryan (EGI), the private, entre-

Michael Karsch — “Be an Editorialist
MBA 2012 preneurial investment firm
he founded more than 40 Not a Journalist”
Joseph Jaspan years ago. Mr. Zell holds a
Michael A. Karsch is the Founder
MBA 2012 bachelor's degree and a
and Portfolio Manager of Karsch
J.D. from the University of
Mike DeBartolo, CFA Capital Management, LP
Michigan.
(―KCM‖), a global long/short eq-
MBA 2013 uity investment manager located
G&D: Could you tell us a little
Jay Hedstrom, CFA in New York City. Mr. Karsch
about your life growing up and founded KCM in July of 2000 and
MBA 2013 what impact that may have had
currently manages approxi-
on your future career as an
Jake Lubel mately $2.3 billion in assets
investor and businessman? across several investment funds
MBA 2013
and separately managed ac-
SZ: I was born 90 days after
Visit us at: counts. Prior to founding KCM,
my parents moved to this (Continued on page 11)
www.grahamanddodd.com (Continued on page 26)
Michael Karsch
organizations/cima/
William Strong— “Outstanding Assets
at Distressed Valuations”
Mr. Strong and his partner Sean Fieler manage Equinox
Partners, Kuroto Fund, and Mason Hill Partners. He began
his investment career in 1970 with Ruane Cunniff & Co.,
manager of the Sequoia fund. In 1986 he started his own
investment firm, Mason Hill, and in 1994 launched the global
William Strong
Page 2

We are very
pleasedpleased
to present
to pre-you Michael Karsch, founder and reer. We found Mr. Zell‘s dis-
with you
sent Issuewith
XIVIssue
of Graham
XIV of& Portfolio Manager of Karsch cussion of adapting and investing
Doddsville,
Graham & Columbia
Doddsville, Business
Columbia Capital Management, described through different business cycles
School‘s student-led
Business School‘s student-led
invest- his firm‘s intense focus on con- particularly interesting. We also
ment newsletter,
investment newsletter,
co-sponsored
co- ducting thorough diligence and enjoyed learning about his innate
by the Heilbrunn
sponsored by the Center
Heilbrunnfor finding a point of differentia- and consistent ability to recog-
Pictured: Bruce Greenwald at Grahamfor
Center & Dodd
GrahamInvesting
& Dodd and tion, while evaluating compa- nize, and then capitalize on,
the Columbia Student Invest- the Columbia
Investing and the
Student
Columbia
Invest- nies in a lifecycle framework. supply and demand imbalances
ment Management Conference Student InvestmentAssociation.
Manage- Mr. Karsch also provided valu- in different markets that other
in February 2011. ment Management
ment Association. able advice on the skills critical investors had overlooked.
The Heilbrunn Center sponsors to becoming one of the best in
the Applied Value Investing pro- TOO ADD
We have been privileged once the profession and discussed Finally, we are pleased to intro-
gram, a rigorous academic cur- again
Pleasetofeel
speak
freewith some ofus if
to contact the thesis behind his firm‘s duce you to William C. Martin,
riculum for particularly commit- the
you world‘s most renowned
have comments or ideas investment in Viacom. an entrepreneur-turned-
ted students that is taught by investors,
about the and are excited
newsletter. Weto investor, whose highly successful
some of the industry‘s best prac- bring a piecereading
hope you enjoy of theirGraham
wis- William Strong of Equinox investing record and unique
titioners. dom.
& Doddsville as much as we Partners reflected on his early background caught our eye. Mr.
enjoy putting it together! career at renowned value in- Martin outlined his strategy of
Famed investor William von vesting firm Ruane Cunniff, and investing in companies with
Mueffling ‘95, a proud
- Editors, Graham graduate
& Doddsville the subsequent founding of his compelling growth prospects in
of Columbia Business School firm. Equinox Partners‘ strat- conjunction with shorting some
and chairman of the advisory egy of investing in high quality of the most overvalued and
board of the Heilbrunn Center assets at distressed valuations corrupt companies.
for Graham & Dodd Investing, in emerging economies has led
shared with us Cantillon Capi- to many years of strong re- We deeply thank these investors
tal Management‘s strategy of turns. Mr. Strong discussed for sharing their time and in-
investing in companies with some of his current invest- sights with our readers. As
high sustainable financial pro- ments in HDFC and Bunas always, we welcome your feed-
ductivity. We found his discus- Finance. back or ideas about the newslet-
sion of the different business ter. We hope that you find it to
Pictured: Heilbrunn Center ―moats‖ particularly insight- We were thrilled to get a be as useful a source of informa-
Director Louisa Serene Schnei- ful. Mr. von Mueffling outlined chance to speak with legendary tion about these great investors
der at the CSIMA conference in the thesis behind his firm‘s investor Sam Zell, who shared as we do!
February 2011. investments in Bank Rakyat, his investing philosophy and
Louisa skillfully leads the Heil- Royal Vopak, Oriflame Cos- reflected on the path of his - Editors, Graham & Doddsville
brunn Center, cultivating strong metics, and others. phenomenally successful ca-
relationships with some of the
world‘s most experienced value
investors and creating numerous
learning opportunities for stu- William C. Martin — “Think Like An Entrepreneur”
dents interested in value invest-
ing. The classes sponsored by Capital Management, an has also served on the
the Heilbrunn Center feature investment firm he boards of CallStreet
guest lectures by legendary in-
founded in 2006. Prior (acquired by Factset
vestors, and are among the most
heavily demanded and highly to Raging Capital, he co- Research (FDS)),
rated classes at Columbia Busi- founded a number of ByteTaxi (dba Folder-
ness School. financial information Share — acquired by
and media companies, Microsoft (MSFT)), and
including Raging Bull in Salary.com (SLRY—
1997, Indie Research in acquired by Kenexa
2002, and InsiderScore (KNXA)). Mr. Martin
in 2004. He served four attended the
William C. Martin
terms on the board of University of Virginia.
Mr. Martin is the Chair- Bankrate (RATE) until it
man and Chief Invest- was acquired by Apax G&D: How did you first
ment Officer of Raging Partners in 2009. He (Continued on page 37)
Volume
Issue XIVI, Issue 2 Page 3

(Continued from page 1) stayed in the US. these investors were doing
Germany and France. really resonated with me.
He earned a BA from G&D: What led to your
Columbia College and move from the sellside to The overriding theme of
an MBA from Columbia the buyside? value investing is buying a
Business School in 1995. dollar for fifty cents and
Mr. von Mueffling is WvM: I realized I loved therefore investing with a
chairman of the advisory researching and investing in margin of safety. This prin-
board of the Heilbrunn companies, but felt that the ciple is one of the most im-
Center for Graham & job of the sellside analyst portant things I took away
Dodd Investing at Co- was constrained in the from Columbia. It wasn‘t so
lumbia Business School. sense that you typically had much about a particular
a sector or small group of style or strategy, as there
G&D: Could you tell us a companies to follow. I are many different styles
little about your background found this boring and under the value investing
―We believe that
and how you first became wanted to broaden the umbrella. there are many
interested in investing? number of companies I fol-
lowed. I recognized that G&D: Can you talk about different types of
WvM: I was very lucky the only way I was going to your specific style of invest-
because between my junior make the jump from the ing at Cantillon? moats to be
and senior years at Colum- sellside to the buyside was
bia College I interned at to get my MBA. This is how WvM: One can broadly found, and that a
Shearson Lehman Hutton in I ended up at Columbia divide value investing into
investment banking. After Business School. two camps. The first camp moat around a
doing that for the summer I is the Graham & Dodd style
realized that there was G&D: What do you think which is buying assets at a business should
nothing more miserable you got out of your time at discount or cash at a dis-
than doing it for two years Columbia Business School count. The second camp is allow it to pro-
as an analyst, so I thought that made a difference later the Buffett style, which I
about other areas of finance in your career? characterize as buying finan-
duce outsized
that would be interesting, cial productivity at a dis- margins and won-
and research jumped out at WvM: I got much more count. We fall into the sec-
me. I didn‘t want to do it in out of business school than I ond camp. We believe that derful returns on
New York City, so I ended ever thought I was going to there are many different
up doing research with get. There are two main types of moats to be found, capital. The trick
Deutsche Bank in Frankfurt. areas where I really im- and that a moat around a
In the early 1990s working proved. First, I gained an business should allow it to is being able to
in sellside research in understanding of business produce outsized margins
Europe for a German bank cycles. I had read a lot and wonderful returns on buy this stream of
was not considered a glam- about business cycles in the capital. The trick is being
orous job, but it created a past but my own under- able to buy this stream of cash flows at a
great opportunity for me. standing of them really de- cash flows at a discount.
No one in my office wanted veloped during business Unlike Graham & Dodd discount.‖
to cover any stocks outside school. Second, a real ―light investing where you might
of Germany, so at a very -bulb‖ moment for me was look at low price-to-book
young age I was able to do taking Bruce Greenwald‘s value companies or net-net
research on big companies value investing class and companies, we are trying to
that were listed in Europe. hearing some of the best buy high financial productiv-
To be able to write, publish, investors in the world ity at a discount to its intrin-
and meet executives so speak. Things started to sic value.
early in my career was a click for me in terms of de-
unique opportunity, which I veloping my own style of G&D: Can you talk about
would not have had if I had investing. What many of (Continued on page 4)
Issue XIV Page 4

(Continued from page 3) returns on capital and very
some of the companies you high visibility. What is inter- Then there are a group of
own and the moats that esting is that both Bank companies where the moat
make them attractive? Rayat‘s and Vopak‘s moats is a network. Names we
are based on significant tan- own in this area are Right- ―…the best place
WvM: Bank Rakyat is an gible assets, yet they still move, the leading property
Indonesian bank that has have very high returns on website in the UK and to be in high-ROE
one of the highest ROAs for equity. Not all high ROE OpenTable, the dominant
a bank in the world because restaurant reservation web- investing is in
it specializes in micro lend- site in the US. OpenTable
ing. If you think of Indone- ―What is interest- is a destination website names that are
sia and the geographic area without physical assets.
that you have to cover, mi- ing is that both One of the things happening neither super-
cro lending means going to on the internet now is that
outer islands and remote Bank Rayat’s and verticals are being owned by expensive nor su-
parts of the country. Bank dominant portals. People
Rakyat has several thousand Vopak’s moats are do not go to multiple web- per-cheap, where
small offices, often as small sites for things like travel,
as a kiosk, in such remote based on signifi- dinner reservations, and real the market has a
locations. Such a network estate. If there is a domi-
would be very hard for a cant tangible as- nant portal then there is a hard time trying
company like Citibank to winner-take-all phenome-
replicate. This is a huge sets, yet they still non. For example, Priceline to figure out what
moat that results in high is the dominant portal for
returns on capital. In Indo- have very high re- travel in Europe. Similarly, the right price is.
nesia today, just having the Rightmove ―owns‖ real es-
infrastructure for a business turns on equity. tate in the UK. The This is where the
is a huge moat. It may not stronger these portals get,
be forever, but it is today. Not all high ROE the bigger the network ef- best investing re-
fect and the higher the prof-
Another company we own businesses are like its. turns can be
is Royal Vopak. Vopak is
the world‘s leader in the ours in asset man- G&D: The Graham & made.‖
storage of liquids at termi- Dodd vision of investing in
nals. Finding the space for agement where underfollowed, obscure
these terminals and getting companies might say that
all of the regulatory approv-
you have few as- the companies you look at
als is a long and complicated are over-followed and that
process. In addition, multi-
sets. You can have there are too many eyes
national companies that are looking at them. How do
great returns if
shipping highly volatile you think about this?
chemicals or gas want to your physical asset
work with reputable compa- WvM: The true cigar-butts
nies. The terminals that is truly unique.‖ and underfollowed compa-
Vopak owns or has long- nies in the classical G&D
term leases on represent a sense are now few and far
huge moat that is hard to businesses are like ours in between. You can‘t manage
replicate. Vopak is global asset management where a large amount of money
and can offer terminals all you have few assets. You and play in that space, and I
around the world. This can have great returns if would argue that you can
enables the company to your physical asset is truly earn very good returns in
have extraordinarily high unique. (Continued on page 5)
Page 5

(Continued from page 4) moats and a very low multi- screening prospective it
the space that we play in. ple for high-ROE businesses makes sense to use all of
Our job as analysts is to that have structural issues – the tools that are out there.
spend the entire day asking neither of these places is But when we set our price
ourselves: ―what do we get the best area to search for targets on companies, we
and what are we paying for ideas. Rather, the best use PE multiples because, at
it?‖ There is a reason why place to look is in the mid- the end of the day, we are
large cap pharmaceuticals dle of the pack and to figure equity investors and we are
trade at low PE multiples out which of these compa- valuing businesses based on
and a reason why Ama- nies is mispriced. the earnings a company can
zon.com trades at a very deliver. Even if we are
high PE multiple. We all G&D: Do you tend to use looking at a company that
Pictured: Benjamin Graham.
have to work very hard for price-to-earnings multiples has temporarily depressed
our keep. The market un- earnings, we will still be
derstands the strengths and pricing it off of the potential
weaknesses of various com-
―… when we set earnings power.
panies. You have to pay
our price targets
more for a company with a G&D: Could you illustrate
great moat. Tano Santos, on companies, we that with an example?
Columbia Business School‘s
David L. and Elsie M. Dodd use PE multiples WvM: Oriflame, a manu-
Professor of Finance and facturer and marketer of
Economics, has done some because, at the cosmetics, has been in exis-
great work on high-ROE tence since the 1960s, so
investing recently. His work end of the day, we there is a long-term operat-
indicates that the best oping history that we can look
portunities are not in the are equity to in order to gain some
high-ROE companies with comfort. This is a perfect
the lowest PE multiples – investors and we example of a company
these companies usually where there is a disconnect
have some structural prob- are valuing between what you get and
lem such as a lack of what you pay for. The com-
growth, or in the case of businesses based pany‘s share price is the
large cap pharmaceuticals, same as when it went public
patents that are expiring. on the earnings a in 2006 despite the fact that
Tano‘s work suggests that sales and profits have grown
the best place to be in high- company can and the company is in more
ROE investing is in names markets now than it was
that are neither super- deliver.‖ then. The company has
expensive nor super-cheap, suffered from three things
where the market has a more than others? Is this that have not been in their
hard time trying to figure how you screen for new control. First off, Russia
out what the right price is. ideas? accounts for approximately
This is where the best in- 30% of their sales. They
vesting returns can be WvM: For cyclical compa- manufacture their products
made. This is where we are nies and turnarounds, price- outside of Russia, and there-
generally most successful to-sales is a much better fore there is a currency
finding opportunities. What ratio than price-to-earnings. mismatch between part of
typically happens is that the Using price-to-book multi- their revenues and costs.
market pays a very high ples makes sense if you are This has hurt their margins
multiple for fast growing looking at companies that in the past few years as the
companies with the best are losing money. From a (Continued on page 6)
Issue XIV Page 6

(Continued from page 5) tion to its brand. G&D: When investing
Russian Ruble has been overseas how do you think
weak. But the company is G&D: Some investors have about the risk foreign gov-
now taking steps to address discomfort investing in di- ernments might pose to
this issue by building pro- rect selling companies given companies you own?
duction capabilities in Rus- the high rep turnover char-
sia. Second, the Russian acteristic of the industry and ―You also have to
market for cosmetic prod- multi-level marketing
ucts has been weak this past scheme. What would you remember that your
year. Lastly, the company say to the critics?
was kicked out of Iran, a
benchmark is the Columbia Business School is a
leading resource for invest-
country which accounted WvM: In the senior levels United States, a ment management profession-
for only 1.4% of sales. This of these organizations, gen- als and the only Ivy League
spooked investors, although erally there is little turn- country with huge business school in New York
given the repressive regime over. The most senior reps City. The School, where value
in Iran, this should not have are very loyal to the com- problems. We were investing originated, is consis-
been so much of a surprise. pany. The high turnover tently ranked among the top
recently looking at programs for finance in the
Oriflame‘s multiple has his- occurs with the lower-end
torically been quite high as reps, typically because a lot world.
Thai banks, though we
the company is perceived as of them are buying the
an emerging markets products for themselves. don’t own any, and we
growth company given that There are a few reasons
it is the leading player in that investors do not like compared Thailand to
Indonesia, Russia, and India. the direct selling model in the United States on a
The market has historically the US. First, it is in a secu-
paid a high multiple for the lar decline in the US. Direct piece of paper. If I
company, so you didn‘t have selling has historically been
a margin of safety. But to- an emerging markets busi- covered the names
day, you pay only 10x earn- ness – as the market gets
ings for the company. You more mature, people go to
and asked you which
don‘t have to put a high a store to buy things. Sec- country would you
multiple on those earnings ond, if you look at the com-
to have a lot of upside. Ad- panies listed in the US, would rather invest in,
ditionally, the co-founder of every so often one of them
the company recently took will blow up, which has you would be shorting
8 million euros of his own tainted the overall industry. the US and going long
money to buy shares, and In emerging markets like
other members of the ex- India and Indonesia, direct Thailand. Thailand
ecutive team also bought selling may be the only way
shares. This is the type of that many people have ac- has a current account
situation we look for – a cess to these products. So I
company with a very de- differentiate between direct surplus, full
pressed share price, but selling companies in the US employment, low
which has a leadership posi- and in emerging markets.
tion in a number of emerg- Part of the reason that Ori- inflation, and other
ing countries and therefore flame is so cheap right now
solid and sustainable earn- is that mainly Western in- advantages.‖
ings power going forward. vestors own the name, and
Oriflame‘s moat is in the 3.5 their judgment has been
million reps that promote clouded by US companies WvM: There is no black
and sell the company‘s that have had issues. and white answer. It mat-
products each day, in addi- (Continued on page 7)
Page 7

(Continued from page 6) live in today is very different and therefore the company
ters what country you are from the world 20 years has been a great investment
in, what‘s the domicile of ago. for us despite the fact that
the company, how big the the Spanish business has
company is, and a whole G&D: How does your been stagnating. Part of the
macro view shape how you reason that high ROE
invest today? strategies have had more
―The single biggest difficulty in recent years is
WvM: The single biggest that there are plenty of high
thing that has thing that has changed from ROE companies that are
when I started my investing primarily exposed to the
changed from when I career to today is that the West and cannot grow.
started my investing macro environment has
enormous risks that are
now coming to a head. As a ―Going to the pond
career to today is
result, I think that there are
of low ROE stocks
that the macro many more value traps to-
day. Until the financial cri- is like going to the
environment has sis, every company seem-
ingly was growing. In the pond with only one
enormous risks that aftermath of the credit bub-
ble and in the years ahead, fish. You may get
are now coming to a one thing we can say with
some confidence is that we lucky and catch
head. As a result, I will not have much growth
in the West for some time. that one fish, but
think that there are If a company has a lot of
Western exposure, you why would you
many more value
have to be able to explain
why they are going to grow ever waste your
traps today.‖
even if Western growth is
zero. OpenTable and
time doing it. A low
host of other factors. You Google don‘t need Western
also have to remember that ROE business will
growth to be bigger compa-
your benchmark is the nies five years from now,
United States, a country
do poorly over
even though both are pri-
with huge problems. We marily exposed to Western time in the stock
were recently looking at economies. Another per-
Thai banks, though we don‘t fect example is a Spanish market so we don’t
own any, and we compared security service company
Thailand to the United called Prosegur that we bother looking at
States on a piece of paper. have owned for many years.
If I covered the names and Prosegur‘s management it.‖
asked you which country realized about ten years ago
would you would rather that to be able to grow, it G&D: How do you feel
invest in, you would be needed to expand outside about situations where the
shorting the US and going of Spain and began making founding family is a major
long Thailand. Thailand has the right investments. To- shareholder in a company?
a current account surplus, day its cash-in-transit busi-
full employment, low infla- ness has leading position in WvM: I think it depends
tion, and other advantages. many Latin American coun- who the founding family is
One of the things we can‘t tries and is growing rapidly, (Continued on page 8)
forget is that the world we
Volume
Issue XIVI, Issue 2 Page 8

(Continued from page 7) to the pond with only one
and how involved they are. fish. You may get lucky and WvM: It is different with
There are some great com- catch that one fish, but why every company. Since we
panies, such as chemical would you ever waste your know who the high ROE
company Wacker Chemie time doing it. A low ROE companies are around the
based in Germany, where business will do poorly over world, we try to visit them
the founding family is heavily time in the stock market so and talk to them over time.
involved. I don‘t think you we don‘t bother looking at Take Oriflame for example Pictured: Tom Russo at CSIMA
can make a general state- it. Sure we will miss the – we have met with them Conference in February 2011.
ment about founding fami- low ROE companies that many times over the years
lies. We own a company, become high ROE compa- although we only recently
Aalberts, where the foun- began investing in the com-
der, Jan Aalberts, refuses to pany. Even if we don‘t in-
allow any of his children to ―The most vest with some companies
work for the company. He initially, we get to know the
thinks that if you have your common mistakes different industry players
children work in the busi- well, and knowledge accu-
ness then it‘s not a meritoc- that people make mulates over time.
racy.
in high-ROE G&D: Can you talk about
G&D: How does Cantillon your sell discipline?
maintain large global cover- investing is
age with a small team of WvM: In high-ROE invest-
analysts? Are your analysts confusing high
ing your time horizon really
sector specialists or general- should be infinite. The fan-
ists?
operating margins
tasy is that you never ever
and high ROEs sell any of your holdings. If
WvM: Our analysts are a company generates very
generalists. The problem with a moat. If it high ROEs and does good
with specializing in sectors is things with its cash flow
that you tend not to have smells like a such as reinvesting in the
your eyes open to other right projects or buying
sectors. We don‘t have to commodity back stock, they will con-
cover the world of stocks tinually grow earnings.
for our strategy; we only business but the Your price target, which
have to follow the world of you base on next year‘s
high-ROE stocks. We do returns are higher earnings, will always be in-
not own McDonald‘s, but creasing so you will reset
given that it‘s a very high- than a commodity
your price target and con-
ROE company, we have a tinue to hold the stock.
price target on it. For us
business, it is likely
The poster child for this is
there is no point in follow-
still a commodity Swedish Match, a company
ing low-ROE companies, as which I first invested in
it is a fact that low ROE business.‖ 1995 at Lazard Asset Man-
companies will underper- agement, and later when I
form the stock market over nies, but we would waste a founded Cantillon. It has
time. It is like if you are substantial amount of time been one of the most amaz-
going fishing for the day and trying to find these compa- ing stocks in Europe during
there are two ponds, one nies. that time. The multiple
that is stocked full of fish never gets higher than 17x,
and the other has one fish in G&D: What is your dili- but every krona of free cash
it. Going to the pond of gence process like? (Continued on page 9)
low ROE stocks is like going
Page 9 ―The next big trended opportunity will be being short U.S. government

(Continued from page 8) with the returns generated one of the competitors
goes to buying back shares. by a company and failed to started to go after market
They have actually had to pay attention to the nature share by cutting prices and
change the rule in Sweden of the business. There used the whole industry just col-
on having negative equity as to be three listed companies lapsed. This is one of the
a result of Swedish Match‘s that made sausage casings: reasons that we work on
share repurchases, because Devro in the UK, Viscofan ideas in teams at Cantillon –
Pictured: Howard Marks, key companies weren‘t allowed in Spain, and Viskase in the we don‘t want to fall in love
note speaker at CSIMA con- to have negative equity. So US. Devro had 40% operat- with returns.
ference in February 2011. that‘s the fantasy that you ing margins and generated
will never have to sell these unbelievable ROIC, and the G&D: Has your strategy of
stocks. The reality is that focusing on high return
companies do get to be too companies changed during
expensive. The best exam-
―I call our
your investing career?
ple of this is Coca-Cola. In
1999 or 2000 it traded at
portfolio today
WvM: The one thing that
60x earnings – if you bought
it then you haven‘t done too
the ―dream team has changed is that we keep
raising the bar around what
well even though over that of high ROE constitutes a good company.
time Coca-Cola has grown I remember one time I met
sales and earnings. The PE investing‖ because with the chairman of Hunter
multiple has gone from 60x Douglas - a great company
at the peak down to where it consists of some that manufactures window
we bought it at 13x. We blinds - and he asked me
have price targets for all of of the best moat about our strategy. I told
our companies and we say him that we invested in high
that we hope we never have businesses in the -ROE businesses like his.
to sell any of our compa- He asked me what a good
nies, but as companies ap- world.‖ ROE was and I told him
proach our price targets we 15%, and he responded that
sell them and put proceeds market for sausage casings a minimum ROE for a great
into names that are far away was highly consolidated. company was 20%. Over
from their price targets. When I first looked at it I time, we have come to be
thought it was a commodity more in tune with his way
G&D: Can you talk about business that was not diffi- of thinking. I think that
some common mistakes cult to replicate. I hopped there are enough amazing
that investors tend to make? on a plane and went to companies out there where
Glasgow to take a factory you can create a portfolio of
WvM: The most common tour and learn how sausage 60 names with an average
mistakes that people make casing is made. What I ROE in the mid-20% range.
in high-ROE investing is learned confirmed my pre- I call our portfolio today the
confusing high operating sumptions – this is a simple, ―dream team of high ROE
margins and high ROEs with easy business. Still, I walked investing‖ because it con-
a moat. If it smells like a away thinking that the com- sists of some of the best
commodity business but the panies had such incredible moat businesses in the
returns are higher than a margins because this was an world.
commodity business, it is oligopoly and convinced
likely still a commodity busi- myself this was a good busi- G&D: Are there any situa-
ness. Mistakes I‘ve made ness because the returns tions where focusing on
have been situations where I were so good. Very shortly ROEs can be misleading?
have not adhered to this after we invested in Devro, (Continued on page 10)
advice and I‘ve fallen in love
Issue XIV Page 10
―The next big trended opportunity will be being short U.S. government

(Continued from page 9) being smart and having an
WvM: If it was just about MBA, there would be a lot
WvM: ROE can be mis- of great investors. So there
leading if the ROE is not must be some other quality
sustainable. Technology can ―If someone tells
that is necessary to be a
disrupt an ROE. At the great investor. I think that
same time, you can have
you that ―we buy
quality is good judgment.
industries that go from low eyeballs‖ and that a An analyst needs the judg-
ROE to high ROE through ment to determine that
consolidation. A good ex- stock is cheap businesses, moats, and man-
ample of this is the US alu- agement teams may not be
minum can industry, which based on price to as good as they seem. The
was highly fragmented in the problem is that this is a very
early 1990s. The industry eyeballs, ask the
tough thing to interview for.
went through rapid consoli-
dation during the 1990s
question ―is buying
G&D: Any parting words
until there were two main something based on of wisdom for our readers?
players remaining, Ball Cor-
poration and Rexam. ROEs eyeballs a valid WvM: Only follow back-
went from very low levels testable investment strate-
to roughly 20% after the investment gies. If someone tells you
consolidation. However, that ―we buy eyeballs‖ and
for every example like this I strategy?‖ The
that a stock is cheap based
can give you another where on price to eyeballs, ask the
an industry goes through
great news is that
question ―is buying some-
consolidation but the return all of the successful thing based on eyeballs a
profile does not improve. valid investment strategy?‖
The way many companies investment The great news is that all of
destroy high ROEs is the successful investment
through making expensive strategies are strategies are known and
acquisitions. Heineken‘s haven‘t changed since the
core business is an amazing known and haven’t
efficient market hypothesis
one, but in the late 1990s was first put out there. The
and early 2000s, it was pay-
changed since the
problem is that many firms
ing very high multiples for efficient market don‘t pursue these strate-
many low-quality brewers. gies, and that these strate-
This drove Heineken‘s ROE hypothesis was first gies require a lot of pa-
down and destroyed share- tience. When you see so
holder value. All of the put out there. The many mutual funds with
companies we own throw 100% turnover, you know
off a ton of cash, so you problem is that
that they are not following a
have to know what manage- robust strategy. Most im-
ment is going to do with it.
many firms don’t
portantly, find someone that
We spend a lot of our time pursue these you enjoy working with.
getting comfortable with And read a lot.
what management will do strategies, and that
with the cash their busi- G&D: It was a pleasure
nesses generate. these strategies speaking with you, Mr. von
Mueffling. Thank you for
G&D: What makes a great require a lot of
your time.
investment analyst in your
mind?
patience.‖
Page 11
Michael Karsch
(Continued from page 1) called Timberland, and for resume to Chieftain Capital.
Mr. Karsch was a Manag- the first time I was able to The three main principals at
ing Director at Soros marry my own personal Chieftain were all Columbia
Fund Management and view on the stock with MBAs. I was very excited
was one of four invest- some of the more system- about joining Chieftain be-
ment professionals at atic valuation techniques cause, unlike many hedge
Chieftain Capital Man- that I learned in investment funds at that time, it was
agement. Mr. Karsch banking. With Timberland, I structured to really teach an
began his career as an noticed it had been more of analyst. At Chieftain there
investment banking ana- a suburban brand but that it were ten stocks and four
lyst at Wasserstein Per- was increasingly gaining people, and I felt like it was
ella & Co. Mr. Karsch traction among urban kids a great way to get an educa-
graduated Phi Beta as well. I realized this could tion. I stayed there for
Kappa with a B.A. from breathe new life into the three years and afterwards
Michael Karsch Tufts University in brand. At the time the got an opportunity to work
1990. He obtained his company wasn‘t making at Soros Fund Management
Master of Arts in Law much money but I saw its for two and a half years
―Sometimes you and Diplomacy from potential. I started spending before starting my own
Fletcher School of Law a lot of time checking out fund.
learn things and Diplomacy in 1991 their shelf space at places
and obtained his M.B.A. like Foot Locker, cold call- G&D: Could you tell us
explicitly... and from Harvard Business ing the company, etc. I about a few of the key
School in 1995. ended up paying for busi- things that you learned
other times you ness school with profits along the way?
G&D: Can you tell us a bit from that investment as the
learn things about how you got inter- stock went from about $14 MK: Sometimes you learn
ested in investing? per share to $80. I remem- things explicitly, such as
implicitly, just
ber running in between being told something by a
through MK: As a teenager, I started classes at Harvard Business colleague, and other times
investing in gold. This was School calling the Charles you learn things implicitly,
experience. My during a very volatile time in Schwab phone number to just through experience.
the late 1970s, and I proba- find out where Timberland My education involved both
education involved bly did all of the wrong was trading. A bunch of my of those things and the key
analysis, but it worked classmates and family then is figuring out how to prop-
both of those out…and then it didn‘t ended up owning Timber- erly integrate them. Chief-
work out. But the experi- land because of my retain taught me that you have
things and the key ence got me hooked in search. I was really hooked to figure out what your
is figuring out how terms of thinking about at that point. point of differentiation is.
how to make money in the They felt their point of dif-
to properly markets. Subsequently, I At business school, I got to ferentiation was to know
started reading about and hear Seth Klarman speak. I their names better than
integrate them.‖ following some stocks. At had been more interested in anyone else and have a lot
the time I probably didn‘t ―Growth at a Reasonable of discipline. Most of all,
have the right reasons for Price‖ investing up to that what they taught me is that
investing in these stocks, point, but Seth‘s emphasis you need to know your
but nevertheless I thought I on value investing with a stocks cold. We‘d sit down
had a method for it. Later, margin of safety made a lot to lunch together and they‘d
my investment banking ex- of sense. Seth actually ask many questions, like
perience at Wasserstein asked me to interview, but I ―What‘s the growth rate in
Perella & Co. helped to for- wanted to be in New York, this company been the last
malize my opinions about so he graciously sent my (Continued on page 12)
stocks. I found a company
Issue XIV Page 12
Michael Karsch
(Continued from page 11) investor until they start losing money.‖ Once you start
three years? What‘s the living through volatility, you
trend in margin? What‘s the ―Simplistically at understand what that
ROE? How will they be able means. People have in their
to expand that ROE going Karsch Capital Man- own mind how they would
forward? What is the com- agement, we seek to like to see themselves as an
pany‘s competitive advan- investor, but often this view
tage?‖ So I learned from invest on the long side isn‘t consistent with the
them that there‘s a method- duration of their capital or
ology to analyzing and think- in stocks which are their own temperament.
ing about stocks. And I For instance, everyone
think sometimes people ascending the lifecy- wants to be Warren Buffett.
forget that – they just want But very few people have
to talk instinctively without
cle and short stocks the temperament, the stom-
a methodology behind it. which are descending ach for the investment dura-
Having this methodology tion, the capital, or the con-
clear in my mind made me the lifecycle. Our viction of Warren Buffett.
more thorough and objec- Mike Tyson has a similar
tive in analyzing different area of greatest quote that I like: ―Everyone
investments. has a plan until they get
strength has been to punched in the mouth.‖ So
What I learned later from invest on the long side those are just some exam-
Stan Druckenmiller at Soros ples of the many things I‘ve
Fund Management was to be in stocks which might learned.
more creative, to think
about the industry before be classified as value G&D: Could you talk a bit
the company, and to be about the lifecycle of invest-
more thematic, because and GARP and to ing approach that you write
stocks are not just a mathe- about in your letters and
short stocks which are
matical exercise. There‘s a how that applies to the
whole group of people who either ―broken mo- checklist that you use in
just focus on how cheap a evaluating companies?
company is, and there are mentum‖ or ―value
others who gravitate to MK: The lifecycle of invest-
finding a ―great company.‖ traps.‖ Our area of ing is a framework that
In my own view these things states that markets, indus-
are relevant, but they‘re
discomfort lies in in- tries, companies and stocks
hugely overestimated. From vesting (long or short) typically move through 5
Stan I learned to think more stages over time. These
creatively about a secular in momentum stocks, stages are: 1) distressed,
theme and then how to fit it discarded and/or undiscov-
into the overall systematic primarily because ered, 2) value, 3) growth at
way of thinking about com- a reasonable price (GARP),
panies that I learned at these stocks and busi- 4) growth, and 5) momen-
Chieftain. Then over time, nesses attract and en- tum. The lifecycle analysis
you learn many life lessons. and an appreciation for a
I keep some of these notes courage speculation company‘s evolution
on a board in my office to through the cycle often lead
remind me of them all the which overrides tradi- us to ask whether a com-
time. Stan used to say, pany will be perceived as
―Everyone‘s a long-term tional analysis.‖ (Continued on page 13)
Issue XIV Page 13
Michael Karsch
(Continued from page 12) this means for our exit an innovator, an imitator, or
better (up the cycle) or strategy. an idiot? As an example,
worse (down the cycle) over when activist investors first
a reasonable investment ho- The key is figuring out what pitched Deutsche Börse,
rizon. Simplistically at your point of differentiation they spoke about manage-
Karsch Capital Management, is with each idea. Are you ment change, cost cuts and
we seek to invest on the long share repurchase. All of
Pictured: John Spears of
side in stocks which are as- these initiatives were in- Tweedy, Browne Company at
cending the lifecycle and ―The lifecycle frame- triguing to value investors, CSIMA Conference in February
short stocks which are de- especially because the stock 2011.
scending the lifecycle. Our work is premised on traded at less than 12x for-
area of greatest strength has ward FCF. The stock had
been to invest on the long microeconomics, re- already appreciated by the ―Apple is the ulti-
side in stocks which might be time we analyzed the Com-
classified as value and GARP
flexivity and human mate lifecycle
pany, so we pondered
and to short stocks which behavior. Determin- whether we could still find a
are either ―broken momen- point of differentiation. We
stock. We started
tum‖ or ―value traps.‖ Our ing where an invest- concluded that existing in-
writing about our
area of discomfort lies in vestors understood the cost
investing (long or short) in ment resides in the cutting and capital allocation
momentum stocks, primarily story being pitched, but
interest in the
because these stocks and lifecycle is more art were not focusing on the
businesses attract and en-
company almost
revenue growth story. In
courage speculation which
than science and re-
other words, investors saw seven years ago,
overrides traditional analysis. quires debate about Deutsche Börse as a solid
The lifecycle framework is company, but not a growth and we talked
premised on microeconom- which variables are company. We have followed
ics, reflexivity and human Chicago Mercantile Ex- about what a great
behavior. Determining most relevant. So, change since its IPO and we
where an investment resides strongly believed in deriva- opportunity there
in the lifecycle is more art when thinking about tive exchanges as strong
than science and requires
the lifecycle, we con- secular growth businesses. was for the iPod if
debate about which variables Therefore, we believed in-
are most relevant. So, when sider who is on the vestors would reward it addressed the
thinking about the lifecycle, Deutsche Börse by allowing
we consider who is on the other side of the it to move up the lifecycle market that Sony’s
other side of the trade and to GARP and growth. Tim-
what their argument is. We trade and what their berland was another exam- Walkman had ad-
ask ourselves why the stock ple of the importance of
is trading at its current price, argument is. We ask understanding where a com- dressed.‖
whether it can be impacted pany is in the lifecycle as
by reflexivity in any way,
ourselves why the
well, as people thought
whether we expect an accel- stock is trading at its things were going very badly
eration or deceleration when for them and were bearish
it comes to earnings beats, current price, on the company, but in fact
and whether this is consis- the brand was being revital-
tent with where we think the whether it can be ized. There were a number
company is in the cycle. Fi- of mini lifecycles going on
nally, we try and think about impacted by reflexiv- within the company, but its
how far in the lifecycle each cycle ended on an upswing
company can go and what
ity in any way ...‖
Page 14
Michael Karsch
(Continued from page 13) their profit. And Priceline get rich figuring out
because Nautica took them has around a $25 billion whether Porter‘s five forces
―Just identifying over. Now, related to look- market cap! fit into a given company or
ing at where a company is in not. The value-add is on
great companies the lifecycle, we use our Another example is Apple. the editorial side. You be-
checklist to evaluate all of Apple is the ultimate lifecy- come a superstar by devel-
with large moats the components of the busi- cle stock. We started writ- oping and using your own
ness, the industry, the man- ing about our interest in the judgment, rather than what
around them isn’t agement team, potential company almost seven years textbooks tell you, to figure
catalysts, valuation, and ago, and we talked about out what‘s a great stock and
enough. In my many other factors. what a great opportunity why. You can start by iden-
there was for the iPod if it tifying and learning from
opinion, you’re a G&D: Given that you focus addressed the market that great stock pickers. Obses-
a lot on mid-cap and large- Sony‘s Walkman had ad- sively try and figure out
journalist in that cap stocks, do you still find dressed. At that time, you what they‘re doing. And it‘s
case and you will many companies that are in were basically getting the not just, ―oh, I‘m going to
the earlier stages of the company for cash, and the follow XYZ investor, and do
probably be a lifecycle? And does a com- iPod presented optionality exactly what he does.‖ You
pany like Priceline fit the for the company. The big have to try to understand
solid role player, bill? debate around Apple now why they are investing in a
is: could a technology prod- particular company and
not a superstar. MK: Priceline is a fantastic ucts company really be what their point of differen-
example of a lifecycle stock. worth $700 billion to $1 tiation is.
... You become a It was a 1999 darling. Eve- trillion dollars? Or, is it just
ryone thought that they trading at 10x earnings? G&D: How do you think
superstar by were the geniuses of the You could argue that many about the macro picture
world. They had this inter- of the financial companies in these days?
developing and esting notion of how to do a 2009 represented lifecycle
reverse auction. It turns opportunities. MK: We certainly have to
using your own out that there was a very take the macro picture into
limited niche for it and the G&D: At Columbia we are account in our thinking, and
judgment, rather CEO was a big spender who taught to look for compa- that‘s disappointing because
got reckless. We started nies with sustainable moats that‘s not what is most fun
than what looking at it again when the around the business. But to me about the business.
stock had declined almost you tend to be more of a The fun for me is finding a
textbooks tell ninety percent from its ―growth at a reasonable creative new idea and realiz-
peak. The attraction of the price investor.‖ How do ing that the company has
you, to figure out company at that point had you try and blend the two transformed but the market
to do primarily with its large together? hasn‘t caught onto the
what’s a great NOLs, with optionality on transformation yet. Unfor-
the operating business, MK: I‘ve always asked, "Do tunately, in this type of envi-
stock and why.‖ rather than any good oper- you want to be a journalist ronment you need to give
ating metrics. The company or an editorialist?" Just extra thought to all of the
subsequently got rid of the identifying great companies issues affecting the invest-
old CEO, was able to turn with large moats around ment landscape. For the
the business around, and them isn‘t enough. In my first time, I‘ve considered
buy Bookings.com for about opinion, you‘re a journalist hiring a macro analyst who
$300 million. Bookings.com in that case and you will could help synthesize all of
was a phenomenally suc- probably be a solid role the data points that are af-
cessful acquisition, as it now player, not a superstar. I fecting the markets. I don‘t
represents two thirds of don‘t think you‘re going to (Continued on page 15)
Issue XIV Page 15
Michael Karsch
(Continued from page 14) ployment rate is already rary respite because the
know when all of this focus pretty high, so how much state of many foreign
on the macro issues relating higher can it really go? economies is so poor that
to the US recovery will end. There are a lot of other plenty of capital is coming
The recovery has been so areas, like housing starts and towards the U.S. dollar.
weak that any improvements auto sales, where it‘s start- Four years from now, it
seem like a big deal. Are we ing to feel now that we‘re could be very different.
on a sustainable path to re- operating at more of a base
covery, or not? What will level. The only question is: G&D: Could you talk about
the impact of the presidential some of the common errors
election be? There are elec- that you see young analysts
tions all over the world this ―I think analysts make?
year. There is a new regime
coming in China. I never spend too much MK: Well, one thing we
fully understood what people already talked about is that
meant by kicking the can time building mod- too many analysts just try to
down the road, but when define a ―good company‖ or
you look at the U.S., we‘re els and being my- ―bad company‖ without
just growing our deficit every taking a more sophisticated
year. So while corporate
opic in that regard view. Too many analysts
balance sheets look better and they don’t have not experienced a lot
and such, is all of this super- of failure and can be ill pre-
seded by the fact that our spend enough time pared to deal with it. They
debt to GDP keeps growing? have incentive to convince
It‘s hard to know. trying to take a themselves that they are
doing great and avoid con-
G&D: Your fund significantly broader perspec- structive, objective feed-
outperformed your peers back. Good analysts realize
back in 2008. Are you seeing tive. That’s why we you have to fail and have
issues in the macro environ- setbacks in order to eventu-
ment that are similar to that try to stress focus- ally succeed. Most of the
time, and if so are you posi- people I know who are suc-
tioning your fund defensively? ing on an industry cessful have a great deal of
perseverance, and they
MK: The current U.S. pic-
before a specific learn from their problems.
ture does not feel like 2008. company.‖ Most analysts are too
For one thing, the jobs pic- money-focused early-on. At
ture seems to be improving. Chieftain, I knew I would be
Credit has not gotten worse, do we have a looming time giving up plenty of money
which is a big difference. The bomb that will eventually compared with some of my
banks are better capitalized manifest itself in some way friends who went to other
and rail volumes are going like in Italy? We all want to places. But that job was
up. During 2008, the stock believe that our debt mar- worth an enormous amount
market was still going up and ket is safe because the US to me. A lot of young ana-
up but the rail volumes had 10 year Treasury yield did- lysts have no idea how to
fallen off a cliff and no one n‘t go up even with the rat- behave in a performance
seemed to care. Capacity ing downgrade in August review, and they often focus
utilization now is at a level 2011. The temptation is to on a very small amount of
about where we were right say that these things won‘t money rather than seeing
before the collapse of Leh- happen. But we may just be the big picture. This tends
man Brothers. The unem- in the middle of a tempo- (Continued on page 16)
Issue XIV Page 16
Michael Karsch
(Continued from page 15) like right now and why? the various threats are real,
to alienate people who but they are hitting Viacom
would otherwise become MK: We started buying at a rate of 1% or at most
their mentor. Some analysts Viacom stock in the high 2% per year, and I‘m not
aren‘t good at managing up- thirties. We believe it is in convinced it‘s going to ac-
ward and aren‘t skilled at the value stage of the lifecy- celerate dramatically in the
cultivating relationships with cle. People have made the next five years. You can
people who are senior to assumption that cable pro- already see Netflix having
them. Good analysts show a gramming isn‘t a great busi- some problems with their
desire to continuously learn. ness anymore because there model in terms of the busi-
Professional athletes are isn‘t much room for pene- ness not scaling as much as
amazing continuous learners tration for multi-channel they expected. You also
and are so much better at distribution in American have some people who are ―Good analysts show
that than stock pickers, and cable. Viacom doesn‘t have worried about advertising
yet, the education level of a tremendous international and things like ratings. Rat- a desire to continu-
the stock pickers is supposed business either, although ings at Nickelodeon right
to be exponentially greater that existing business is now are weak and people ously learn. Profes-
than the athletes. growing. People are wor- extrapolate that kids are sional athletes are
ried that multi-channel too busy playing on their
G&D: With all the data out penetration will actually iPads and therefore don‘t amazing continuous
there and all the reading ma- decrease over time due to watch Nickelodeon. I tend
terial, what do you ask ana- Netflix, or better antennas, to think ratings just bounce learners and are so
lysts to focus on and what do or people moving into their around. When ratings are
you tell them to avoid? parents‘ home. Some be- bad, people make up ex- much better at that
lieve that the cable opera- cuses and reasons for why
MK: I think analysts spend tors or Congress will come that will persist, but I think than stock pickers,
too much time building mod- up with an a la carte service, it just fluctuates. In terms and yet, the educa-
els and being myopic in that meaning that you won‘t of advertising, 35% of cash
regard and they don‘t spend need to buy 50 channels all flows come from predict- tion level of the
enough time trying to take a at once. Instead, you could able subscription fees. Yes,
broader perspective. That‘s decide to just buy Disney there could be some volatil- stock pickers is sup-
why we try to stress focusing and MTV. Some think that ity in the advertising, but the
on an industry before a spe- unbundling would kill the impact on cash flow won‘t posed to be expo-
cific company. This has be- business model since not be dramatic. The changes
come a more complex busi- everyone wants all of these that are taking place now, nentially greater
ness over time. It used to be other channels. This has like Netflix, etc., won‘t than the athletes.‖
enough for a professional been brought on by the fact really dent the free cash
football player to be over that everyone is basically flow. So, the perception
300 lbs or a professional paying $7 or $8 per month and reality are quite differ-
basketball player to be over for ESPN. So, obviously, if ent.
7 ft. Now you have to be 7 you‘re not a sports fan and
ft. and fast, or 300 lbs and it‘s a tough economy, that The company has also said
quick. Stock-picking is the sounds terrible. But the they are going to redistrib-
same way. You need to be reality is if a la carte hap- ute $20 billion in free cash
very good with the computer pens, it will be many years flow back to their investors
and going through the docu- from now. These compa- over the next five years.
ments but you also need to nies have five year contracts This basically means $2.5
be creative. with cable operators. billion in dividends and
These contracts actually call $17.5 billion in buybacks.
G&D: Could you talk about for price increases, not So you‘re talking about a
a particular name that you price decreases. Netflix and (Continued on page 17)
Page 17
Michael Karsch
(Continued from page 16) ter. We think there is still of the growth in free cash
company that is basically value in the MTV and Nick- flow that I expect. If you go
buying itself back over the elodeon brands. Maybe the to a 10x multiple on that,
next five years. Despite the industry will go to a la carte the stock is a triple or quad-
buyback announcement, the pricing like what‘s happened ruple, with optionality for a
stock is flat. So people ei- in the music industry. In takeover. So I just look at it
ther don‘t think that free this industry, however, you and I think people are mis-
cash flow will come guided and myopic in terms
through, or they are being of worrying about the short
too myopic… I don‘t really ―Great analysts term ratings.
know what their reasoning
is. My view is, if advertising see bumps in the Right now they actually
Pictured: Marty Whitman, gets worse and cash flows benefit to a degree from
Adjunct Professor, Heil- go down, they will have less road as sources of Netflix because Viacom
brunn Center for Graham cash for buybacks but they owns Paramount. All of
& Dodd Investing, at Gra- will buy back a similar per- pride and those shows and movies
ham & Doddsville breakfast centage of shares because they‘ve licensed to Netflix
in October 2011. the stock price will be necessary have actually provided some
lower. I actually think the very nice cash flows. One
free cash flow will grow situations because could say, well what hap-
from $2.5 billion to $3 bil- pens if that cash flow stream
lion to $3.5 billion over the they understand from Netflix goes away? If
next five years. In five that goes away then by defi-
years, if the stock is flat, you that this is a nition Viacom‘s core busi-
will have a company with a ness must likely be still
market cap of $7.5 billion business where the thriving. I‘m not saying that
down from $25 billion be- the business won‘t change
cause of all the repurchases. best-case scenario ten years out, but investing
At that point, the market is a probability business, and
would be saying that they is that they’ll be in my opinion, the probabil-
will only generate $700 mil- ity of their cash flow going
lion in free cash flow when I right 60% of the down by half to two-thirds
think they can generate $3 over the next five years
billion or so. Therefore, time.‖ instead of going up by 30%
there‘s an incredible margin is very low. I haven‘t heard
of safety. still have contracts in place a realistic, convincing argu-
for five years, and you don‘t ment yet as to how that will
You could say, well, if the even know if they‘ll be able happen.
stock goes higher they to do an a la carte scheme
won‘t be able to repurchase after five years. There are G&D: In our remaining
all of those shares. But plenty of forces fighting moments, could you finish
that‘s fine. In that case I‘d against it. Finally, a lot of the following sentence? A
just sell the stock and make people still watch Nickelo- great analyst…
a nice profit. If the price deon and MTV. It‘s not as if
doesn‘t rise, you‘re talking everyone is paying lots of MK: A great analyst is a
about a stock that in five money for these channels continuous learner. A great
years is probably trading at and not watching them. In analyst knows how to get
2.5x P/E. Maybe the world terms of a status quo view, the best out of everyone
will be different at that let‘s say that the company they work with. There‘s a
point. Maybe it will be has flat free cash flow over tendency for analysts to say,
worse, maybe it will be bet- the next five years instead (Continued on page 18)
Page 18
Michael Karsch
(Continued from page 17) and be that famous? It is his takes in order to win.
―That investor is so great! choice, and he is willing to I have chosen this industry
I‘m going to do what they‘re overcome whatever pain it where the pain is acceptable
doing‖ and they look solely for me. That is not to say
at outcomes instead of using that this is an easy business.
their own brain. In other There is rejection from the
words, ―don‘t worship false ―A great analyst market, from clients, from
gods.‖ A great analyst rec- peers. I‘ve taken whatever
ognizes that this is a men- recognizes that pain I‘ve needed to for 16
toring business and actively years in a row now in order
seeks out mentors in order
this is a mentoring to continually grow and
to become successful. They persevere, because this is
also understand it‘s a non-
business and my equivalent to his foot-
linear progression business. ball. But my impression is
When an analyst under-
actively seeks out that most young people
stands that, they‘re able to mentors in order have a sense of entitlement.
think about their game plan They‘ve been told how
very differently. They un- to become great they are by their par-
derstand that the market is ents. They‘ve gotten into a
always improving and their successful. They great school, and then a
skill set needs to also. You great business school and
can‘t just rely on investment also understand they think that everything
banking exercises or Por- will come their way. I think
ter‘s five forces to help you it’s a non-linear people felt that way when
truly understand what‘s the economy was doing
going on at a company. progression great. Factset just said they
Great analysts see bumps in lost subscribers for the first
the road as sources of pride business. When time in their history.
and necessary situations There‘s a high probability
because they understand an analyst that the world is only going
that this is a business where to get tougher than it has
the best-case scenario is understands that, been for the last ten years.
that they‘ll be right 60% of I haven‘t seen young people
the time. they’re able to change their attitude to
reflect this more difficult
G&D: Any parting words think about their environment, and I already
for our readers? felt they weren‘t tough
game plan very enough to face the previous
MK: In order to be good at environment. To be good
anything, you need to figure differently. They in this business, you must
out how and where you can carefully cultivate the im-
absorb pain. I have a friend understand that portant relationships that
who is a professional foot- will get you to where you
ball player. I always say, ―I the market is want to go. To be success-
don‘t know how you are ful, you have to be resilient.
willing to be tackled by 300 always improving
pound people.‖ But he feels G&D: Thank you very
that football is where he is and their skill set much for your time Mr.
at his best. Where else Karsch.
would he be able to make
needs to also.‖
the kind of money he makes
Page 19
William Strong
(Continued from page 1) decided that markets were friend of Warren Buffett.‖
long/short hedge fund perfectly efficient and these At the time, I thought to
Equinox Partners. classes were a total waste of myself: ―Who is Warren
Mr. Strong graduated everyone‘s time. But the Buffett? I‘ve never heard
from Williams College Graham and Dodd approach that name before.‖ I
with a BA in Economics to investing made sense to worked at Ruane Cunniff
in 1971 and received his me. To make a long story for seven years and then I
MBA from Harvard started my own business in
Business School in 1979. ―We were drawn to 1986.
G&D: When did you first businesses that had Bill Ruane had taken Benja-
become interested in invest- min Graham‘s course in
ing? strong competitive business school and had met
Buffett while in school. So
WCS: When I was ten
positions and Ruane had something like
years old, my mother be- sustainable, high the Buffett approach to
William Strong longed to an investment value investing, which I
club. I talked about invest- returns on capital. would define as preferring
ing with her and soon de- better quality businesses
cided I wanted to buy a We spent most of and managements and will-
stock. My uncle suggested ing to pay a bit more for
that I buy one share of our time analyzing them. We were drawn to
Blackwell Oil & Gas Co. So businesses that had strong
I did… and then it went
companies’ competitive positions and
bankrupt. That was the competitive sustainable, high returns on
beginning of my investment capital. We spent most of
career. positions and if they our time analyzing compa-
nies‘ competitive positions
I‘ve always been interested could generate high and if they could generate
in investing as well as his- high ROEs for a long period
tory and economics. I ROEs for a long of time. That‘s the basic
earned a degree in econom- orientation of how I started.
ics from Williams College.
period of time. One of the first things I
After a brief stint in the That’s the basic worked on at Ruane Cunniff
Army, I worked as a munici- was Ginnie Mae bonds yield-
pal bond underwriter for orientation of how I ing 18%. Those were the
Loeb Rhoades & Co. This days of the 15% 30yr non-
was in the early 1970s when started.‖ callable treasuries. We also
interest rates went up a lot looked at high quality US
and New York City de- short, a small New York companies. I remember I
faulted on its debt. So I had value investing firm, Ruane worked on Gillette and
an interesting initial experi- Cunniff, was looking to hire tried to figure out if 7x
ence in the financial mar- somebody out of our busi- earnings wasn‘t cheap
kets. I went back to business school‘s investment enough. Ruane wanted me
ness school and they actu- class, and they hired me. to focus on big name US
ally taught Graham and That job opportunity turned stocks when I started. I
Dodd investing at Harvard out to be possibly the lucki- moved from there onto
Business School for a week. est thing that‘s ever hap- smaller cap US stocks as
This was probably the last pened to me. I remember well as some European
year they ever did that be- interviewing with Bill Ruane companies in the latter part
cause, of course, they then and recall him saying, ―I‘m a (Continued on page 20)
Issue XIV Page 20
William Strong
recently promoted Daniel

of the 1980s. Gittes, who‘s been at Equi- G&D: Could you describe
―So we’re looking
nox for seven years, to join the types of businesses you for companies that
G&D: Could you talk Sean and me as a Portfolio target for investment?
about your style of value Manager. We have 7 ana- have a strong
investing and what you lysts who are generalists yet WS: What we‘re really
focus on today? have focused industry ex- trying to do is find busi- franchise and a
pertise as well. As you can nesses that have a sustain-
WS: At Equinox Partners imagine, this kind of work able competitive advantage. strong competitive
we apply the Graham style requires a lot of travel: we Bruce Greenwald talks
about the power of a fran-
advantage. And, in
chise. He talks about how the last 10 or 15
only businesses that can
invest sustainably at high years, we’ve come
returns are adding value
when they grow. That‘s a to understand and
really good point. We‘ve
seen lots of companies that appreciate that if
have grown while destroy-
ing value. So we‘re looking
you have such a
for companies that have a franchise in the
strong franchise and a
strong competitive advan- context of growth –
tage. And, in the last 10 or
15 years, we‘ve come to maybe not
understand and appreciate
William Strong at a CSIMA conference in Feb’2011 that if you have such a fran- specifically in a
of buying businesses each travel about two chise in the context of
cheaply but with a prefer- months a year and in total growth – maybe not specifi-
growth business but
ence for better quality see about 1,000 companies cally in a growth business in the context of
businesses. What we‘ve a year, though not all are but in the context of
done over the years is to unique visits. We think growth, which takes us to growth, which takes
take that approach global. we‘ve met and monitor the emerging markets –
After looking at Asian some of the best businesses then you have a really pow- us to the emerging
companies and resource and managements in the erful investment. The com-
companies in the ‘90s, the world and our team is con- bination of a strong fran- markets – then you
last step in our develop- stantly on the hunt. chise that generates high
ment was in 2008 – when returns on capital and the
have a really
we made a big foray into We do two other things, possibility of reinvesting a powerful
Brazil and in Asia after the which I‘ll mention briefly. large portion of retained
world fell apart. At this One is short-selling, which earnings and cash flow back investment.‖
point our scope is basically almost put us out of busi- into that high return fran-
the whole world. We look ness in the ‘90s because we chise is a fabulously valuable
everywhere to find out- were short during the tech business. That‘s really what
standing businesses and bubble. The other thing we‘re looking to find.
managements that are we‘ve done is take on a
really undervalued. In large exposure to precious G&D: Don‘t these great
terms of our investment metals because for a long businesses trade at higher
team and process: in addi- time we have been con- multiples? If so, how do you
tion to my partner of 17 cerned about the value of get comfortable as a value
years, Sean Fieler, we‘ve fiat currencies. (Continued on page 21)
Page 21
William Strong
(Continued from page 20) Equinox, we make a tre- know them well and we
investor investing in these mendous effort to try to actually have owned some
businesses? understand where corrup- of the same positions.
tion is, how it works and They‘re helpful in that they
WS: Most of the time they how to avoid it. Corruption can help us see the local
do trade at higher multiples, is a big problem, not just in landscape from the ground
but we are getting paid to emerging markets, but eve- level and they know the
find such businesses that are rywhere. people and their back-
attractively priced. Rick grounds. We have brokers
Cunniff used to call it an G&D: In these emerging locally that we‘ve known for
―Easter egg hunt‖. They‘re economies, do you tend to 15 or 20 years. We know a
really hard to find. Some- utilize partnership struc- few brokerage firm research
times you find a really great tures or other arrange- folks here and there that
business that‘s buried in can help us. Additionally,
these other businesses that managements of companies
aren‘t so great. Sometimes that we‘ve known for years
you find a really great busi- ―We try to look ten will opine about other man-
ness in a country that‘s out agement teams. There‘s a
of favor. Sometimes you years down the lot of work that needs to be
find a really great business in done but we‘ve got a long
a bad environment, like road… we’re really record and a pretty good
2008, where investors had a set of relationships now that
trying to look at the
lot of great opportunities. helps us sort through a lot
There are a number of ways structural trends in of this.
in which we can find these
paradoxes, where you have the country and in G&D: What is one aspect
a great asset that‘s selling at of your investment process
a really low valuation. Obvi- that business, which that distinguishes you from
ously, this doesn‘t happen other firms?
very often, so when it does, will help translate
we try to buy as many WS: I think one thing that
the investment into
shares as we can and own distinguishes us is our long-
them for a long period of success.‖ term investment horizon.
time. That‘s the nature of We try to look ten years
the challenge we‘re faced down the road. That trans-
with. We‘re trying to find lates into a four to five year
outstanding assets at dis- ments to position you bet- holding period. For in-
tressed valuations. ter? stance, there‘s a tech com-
pany in India that we have
G&D: Given the impor- WS: We‘ve been investing met with several times. The
tance of emerging markets in emerging markets for a CEO of this company said
to your investment strategy, long time – we first went to after one of our more re-
are you concerned about Asia in 1994. We‘ve been cent meetings that, based on
corruption? going to Brazil for ten years. some of the questions we
We‘ve developed relation- had asked, it reminded him
WS: I have some bad news ships in a lot of places, some very much of their last
for you. Corruption is eve- of which are with other board meeting. Whereas
rywhere. It‘s a little more investors. For example, we some other managers may
sophisticated in Europe, and have a good relationship have a two or three year
if you go to Washington, it‘s with a small value invest- outlook, or maybe even
not a pretty picture. At ment firm in Sao Paulo. We (Continued on page 22)
Issue XIV Page 22
William Strong
(Continued from page 21) in the shareholders‘ well- issues or themes. We are
next quarter as an outlook, being. The ROE for an av- global investors but, with
we‘re really trying to look at erage Western company few exceptions that have
the structural trends in the over the years has been been painful, we‘ve stayed
country and in that business, around 12-13%. Now, if away from Japan.
which will help translate the you look at the ROEs of
investment into success. Japanese companies since On the other hand, we have
Fortunately for us, our in- 1928, it‘s 400-500 bps be- gone to India, which offers
vestors understand and low that of the Western businesses that have pro- Pictured: Professor Roger
Murray and investor Robert
agree with our long-term companies. The last 20 duced much stronger re-
Heilbrunn with their wives,
perspective. years have particularly been turns compared to compa- Agnes Murray and Harriet
a disaster for Japanese com- nies in Japan. This is not to
Heilbrunn.
G&D: Could you talk panies. What‘s shocking is say India doesn‘t have its
about some of your major that you had these compa- problems. It has lots of
successes over the years? nies with very low profit problems: big, political prob-
margins and extremely low lems. But in India, you have
WS: Another thing that a company like Sun Pharma-
we‘ve done really well is ceutical, which is growing at
―...we apply over-
meld together good com- 15-25% per year and gener-
pany-specific, bottoms-up arching themes to in- ating net cash while growing
research with a thematic that fast! We don‘t own
overview of what‘s going on vestment ideas while Sun, but this is a great busi-
in the world. For example, ness in an environment
we‘ve owned precious met- being very focused on where you can reinvest in a
als since the late ‘90s based business with really high
on the idea that there are finding good bar- returns. So we apply over-
major financial imbalances in arching themes to invest-
gains. We narrow
the world that are not being ment ideas while being very
addressed. Those imbal- down the set of the focused on finding good
ances will ultimately cause bargains. We narrow down
stress in the financial system universe of stocks. the set of the universe of
and that should take gold stocks. About 95% of the
from the depressed levels of About 95% of the uni- universe we don‘t even
the late ‘90s to much higher bother to look at. We‘re
levels. So we‘ve had success verse we don’t even really trying to find great
with gold mining stocks and businesses that are cheap.
bother to look at.
gold itself over the last dec-
ade, although that theme We’re really trying to G&D: How would you
didn‘t work in 2011. define ―cheap‖?
find great businesses
One of the other major WS: We look at P/E ratios,
successes we‘ve had is to that are cheap.‖ Price/Book, EV/EBITDA –
avoid places in the world we use many valuation tech-
that are just problematic to ROAs leveraged six or niques. We‘re trying to find
invest in. We spent a lot of seven to one. That‘s three businesses that we think can
time over the years looking or four times what the lev- generate 15-20% returns, so
at Japanese companies and erage ratios would be in the one can work backwards
had a really difficult time US or in Europe. This is a from the valuation to see if
getting comfortable with business model we‘re not a particular investment
managements. They just comfortable with. We think would translate into that
don‘t seem to be interested about these types of large (Continued on page 23)
Page 23
William Strong
(Continued from page 22) 2.25%. Their reputation is screen out people who
type of return. In a rapidly very strong – because their wouldn‘t qualify – they pro-
growing business, one can service is so good people file all potential applicants
pay a double digit multiple are happy to pay them 10 or based on profession, his-
and still enjoy a 20% return. 20 bps extra on a mortgage. tory, and where they come
We look at all these metrics They seek to match the from. They know the kind
and then think about what durations of their assets and of applicants they want and
we can expect to earn from liabilities and thus avoid the don‘t even take applications
this business if it continues ―borrow short lend long‖ from anyone else. So they
to operate as it has been game that many of their have virtually no loan losses
operating. peers play. The company whatsoever. In 2008, when
―Everyone else has done extremely well on the subprime mortgage cri-
G&D: Could you share its operational and credit sis hit the US, HDFC didn‘t
hates volatility, but some specific ideas with our risk management side. have an asset problem.
readers that you find com- They had funding problems
volatility is our pelling? HDFC has an unbelievably as the capital markets froze
low cost-to-income ratio of up, but they had almost no
friend. We like WS: We own an Indian 7.7%, whereas most banks loan losses. HDFC also
company called HDFC. It average 40%-50%. They are tries to minimize their inter-
volatility.‖ has been in the mortgage incredibly efficient. Assets actions with each customer.
origination business for a per employee have grown One way they do this is
long time. It is a very suc- from $500,000 in 1990 to through agreements they
cessful company and gener- $18,600,000 today. Em- have with large employers
ates 20%-plus returns on ployee count has slightly where the employers allow
equity. With financial com- more than doubled in the HDFC to take an em-
panies in general, it‘s hard same time frame. Average ployee‘s mortgage payment
to create a competitive ad- loan size is very small at from a paycheck before the
vantage because interest $40,000 per mortgage and employee even sees the
rates are what they are and loan losses are four basis money, or they accept post-
demand for money is what points since inception! The dated checks from borrow-
it is. HDFC has grown its low costs translate into an ers once at the beginning of
mortgage book by 24% per incredibly high ROE. HDFC the mortgage.
year over the last ten years has such a good operating
and they‘ve grown their ratio that we are always HDFC is a company that has
earnings and book value at trying to figure out how been growing at a nice clip
20% for the last ten years. they are able to do this. My for a long time. Rapid
We‘ve owned this company partner Sean Fieler was in growth does not exist for-
on and off for five or six India a few years ago and ever, but one of the nice
years and we‘ve known for met with the senior general things about emerging mar-
a long time that the manage- manager for their Mumbai kets is that there is a long
ment here is key. The man- region, who explained to fairway before the slow-
agement has developed a him how they get these low down point. This contrasts
very low operating cost costs. The company ap- with America where a com-
business. They have a na- proves something like 99% pany can only enjoy a rapid
tionwide network of of all loan applications. growth phase for 3-5 years.
branches and have a bank They figured out years ago Mortgages as a percentage
subsidiary that they use to that they wasted time and of GDP in India have grown
help originate mortgages. money rejecting people, so from 4% to 9% in the past
They borrow money in the they only let people apply four years, and I would
marketplace and price their who they will accept. They guess could likely grow to
mortgages with a spread of have all these ways they (Continued on page 24)
Issue XIV Page 24
William Strong
(Continued from page 23) trucks, minibuses, motorcy- as an investor?
30% before growth starts to cles and Jeeps, are generally
slow down. used for productive pur- WS: It‘s a two-sided coin.
poses, which makes bor- If you have a perfectly effi-
G&D: Emerging market rowers more likely to pay cient market, where busi-
stocks tend to be volatile. back the loans because they ness values are always re-
How do you explain to your need the vehicle to run flective of business funda-
―In our mind the
investors that volatility isn‘t their business. Most of the mentals, then we are out of
relative risk
always bad? underwriting effort is spent business. If you have a per-
evaluating the borrower and fectly imperfect market, equation has
WS: Everyone else hates the borrower‘s business where the stock market
volatility, but volatility is our rather than the collateral – never reflects fundamentals, changed a lot of
friend. We like volatility. agents are sent out to as- then we are out of business.
We had sold HDFC in late sess the borrower‘s busi- Markets generally value fun- in the last few
2007 when the valuation ness and its cash flow. damentals properly. Our
had gotten rich, but HDFC There is not much competi- job is to find exceptions to years, but it still
declined along with the mar- tion from large banks be- this and take advantage of it.
ket in 2008, so we were cause the banks cannot un- This is what value investing has a way to go.
able to buy back the shares. derwrite like this, so Bunas is all about.
HDFC is owned 70%-80% is able to earn very high Emerging equities,
by foreigners, so the panic interest rates on their as- G&D: How many positions
selling in 2008 was due to sets. Competition consists do you hold and what is the at the valuations
international fund managers of pawn shops and loan geographic breakdown?
selling the stock. If we get sharks. Blended net interest that we see today
another bad period in the spread is currently around WS: We have 51 long po-
market, we could see a simi- 9.3%, which is huge. Be- sitions, 14 of which are in of high-single digit
lar situation with the stock. cause the collateral is hard the mining space. Our prin-
to value and the process is cipal operating business and low-double
Another idea we really like messy, management main- holdings are in Brazil, India,
right now is a small finance tains a very conservative Indonesia, and other emerg- digit P/Es, are very
company in Indonesia, Bunas balance sheet. Bunas has a ing markets. We don‘t own
Finance, started as a JV with negative duration mismatch anything based in the US attractive.‖
Manufacturers Hanover – in other words, their as- and have a few small posi-
Corporation, formerly a sets mature quicker than tions in Japan and China.
NYC-based bank. The sen- their liabilities. The com- Russia and China have been
ior management has been pany has virtually no lever- difficult for us to get com-
with Bunas for a long time age – banks are often lever- fortable with management
and has a solid track record. aged 12 – 15x and other teams, though there are
The business has very big financial companies are lev- exceptions. Russia also has
spreads because the under- ered at 5 – 7x. Bunas is some bad demographics. In
writing process is very diffi- only leveraged at 2x. So China we have a hard time
cult to duplicate, as they they are able to generate trying to understand why a
lend money to small busi- very high returns – 20%+ business is like it is and
ness owners using collateral ROE – without using much where it came from. We‘ve
which other finance compa- leverage. seen similar things in Russia
nies consider imperfect: – one company we looked
used cars and motorcycles. G&D: Given the fact that at has a majority owner
It is not hard to value a new the business had been grow- who is Vladimir Putin‘s judo
car, but oftentimes it is diffi- ing but that Bunas‘ stock partner. We try to avoid
cult to value used vehicles. was flat until approximately these types of situations.
These vehicles, consisting of a year ago, was it frustrating (Continued on page 25)
Page 25
William Strong
(Continued from page 24) uries are trading given the last.
On the short equity side we amount of debt that the US
have very little right now. has? G&D: What do you look
Where we see a real asym- for when hiring an analyst?
metry of risk/reward is sov- WS: We are not only sur-
ereign debt. We are short- prised, we are short treas- WS: One of the things that
ing low-yielding sovereign uries, so we are losing is really important is the
debt in developed markets, money. The irony of the ability to think independ-
Pictured: Panelists Mario which is an expression of S&P downgrade of US debt ently. So much of the value
Gabelli ‘67, Charles Brandes, our thematic observations. was the rally in the price of in what we do is disagreeing
Jan Hummel, and David Win- treasuries. This is similar to with the consensus, so you
ters at the ―From Graham to G&D: Can you go into want someone that is com-
Buffett and Beyond‖ Omaha some detail on your fortable doing that. Also
Dinner in April 2011. thoughts on Europe?
―One of the things important is the ability to be
that is really rational and have good
WS: We are not surprised quantitative skills.
with how events have tran- important is the
spired. We have had a G&D: What is the competi-
negative view of the man- ability to think tive advantage that sets you
agement of fiat currency in apart from others in the
the West for some time. independently. So industry?
Europe is an example of
what we have been worried
much of the value in WS: What we do different
about. We don‘t have any what we do is from others is to maintain a
great insights other than the very long time horizon. In
fact that there are funda- disagreeing with the our industry this is a luxury,
mental issues that are not as many other investment
being addressed. This is consensus, so you firms have clients that do
true for the whole devel- not let them do this. As a
oped world – we have too want someone that is result of having a very long
much debt. This is unlike time horizon, we can sit
Brazil, Indonesia, and India.
comfortable doing back and try to logically
We think the risk in the that.‖ imagine a very different fi-
developed world is finally nancial environment than
being properly perceived as what happened in Japan the one we are in today.
being much higher than it where Japanese bonds ral- We are looking for larger
used to be, and the risk in lied every time there was a themes that will produce
emerging markets is prop- downgrade. epic investment results. We
erly being viewed as having think about the themes that
been reduced. In our mind G&D: What advice would we want to be in, and in
the relative risk equation you give to students inter- those themes, find different
has changed a lot of in the ested in a career in invest- great businesses that we
last few years, but it still has ing? want to own. We look for
a way to go. Emerging equi- jurisdictions where there
ties, at the valuations that WS: My strong advice is to are maximum misconcep-
we see today of high-single do what you like to do. I tion and extreme valuation
digit and low-double digit P/ think there are too many anomalies.
Es, are very attractive. people going into the invest-
ment business because of G&D: Thank you very
G&D: How surprised are outsized compensation much Mr. Strong.
you about where US treas- which I don‘t believe can
Page 26
Sam Zell
Michigan. Then, during my
―My parents placed
country, so I grew up in an junior year at Michigan, my
immigrant household with a an emphasis on friend told me the owners
very strong father and a of his apartment building
supportive mother. My achievement and planned to tear down the
parents placed an emphasis building to construct a new
on achievement and had had little regard for 15-unit apartment building.
little regard for time spent I said to my buddy, ―We are
on fun. That orientation time spent on fun. students. We understand
distinguished me from my what students want. Let‘s
That orientation
peers. I operated under pitch him an offer to man-
Sam Zell
different rules and different distinguished me age the building and maybe
expectations than most of we can get a free apartment
my friends. Initially, that from my peers. I out of the deal.‖ We did,
was very difficult for me. I and our pitch worked. We
wasn‘t very adept at becom- operated under took over management of
ing one of the ―in-crowd‖. the building, helped to de-
Everybody wants to belong, different rules and sign it and rented out the
but I didn‘t feel that being a units. In exchange, the
different
part of ―the team‖ fit my owner gave us two one-
personality. Eventually, I expectations than bedroom apartments in lieu
gained the self-confidence to of a fee. We were so good
trust my instincts rather most of my friends. at it that the building own-
than be influenced by my ers soon gave us the oppor-
peer group or by conven- Initially, that was tunity to manage another
tional wisdom. building, and then another.
very difficult for me. By the time I graduated law
I had several businesses in school four years later, we
grade school and high
I wasn’t very adept managed something like two
school. The most notable becoming one of or three thousand apart-
developed when I was 12 ments.
and going to Hebrew school the ―in-crowd‖. ...
in Chicago and living in the During law school, we also
suburbs. I discovered these Eventually, I gained started buying buildings.
newsstands underneath the Raising capital wasn‘t even
elevated train tracks that the self-confidence an issue. The first asset was
sold magazines that didn‘t a three unit apartment
to trust my instincts
exist in the suburbs. In building that cost $19,500
1953, this new magazine rather than be and required only $1,500
called Playboy was published down. That was all it took
and I saw a terrific opportu- influenced by my for me to become a land-
nity. I would buy the maga- lord. My simple premise
zine for $0.50 and re-sell it peer group or by was that I thought I could
to my friends for $3.00. do something better with
That was my first lesson in conventional that building. I repainted
supply and demand. the apartments, bought new
wisdom.‖ furniture and doubled the
Other businesses I had over ing photos of the kids at rents.
the years included selling prom, and selling party fa-
book-holder straps to my vors to fraternities and so- G&D: How did you transi-
friends in grade school, tak- rorities at the University of (Continued on page 27)
Page 27
Sam Zell
(Continued from page 26) could continue to duplicate Arbor MI, buying mostly
tion from managing a three double-digit returns in these apartment buildings. If you
unit building to managing a ancillary markets. So in the are successful in the first
substantial amount of real first phase of my career, I deal, it‘s not too hard to
estate a few years later? invested in Orlando, raise the money for the
Tampa, Jacksonville, Arling- second deal. Pretty much
While I was in law school, ton, TX, Reno, NV, and Ann after that first investment in
my father was a jeweler, but Toledo, I never really had
he was also a passive inves- trouble raising money again.
tor in real estate. After I ―I start by not
had bought my first building, G&D: How do you think
paying much
I came home from school about valuation, whether it‘s
one year and I asked him attention to the a real estate or a non-real
about his property invest- estate asset, and could you
ments. He said he was get- market. I think the perhaps give us an example
ting about a 4% return. of your approach?
Well, I was getting about a Street reflects the
16% return in Ann Arbor, SZ: I start by not paying
MI, from my 3-unit building. value of the last much attention to the mar-
Our conversation made it ket. I think the Street re-
share, but the true
clear to me there were two flects the value of the last
different investment worlds value of the asset share traded, but the true
out there – major metro- value of the asset may be
politan areas like Chicago, may be more or less more or less than what‘s
New York, Los Angeles and indicated publicly. In the
San Francisco, which would than what’s same manner, I don‘t make
always attract a lot of real investments predicated on
estate investment from indicated publicly. the assumption that there‘s
wealthy investors — and a greater fool out there
In the same
second-tier cities and uni- who‘s going to buy it from
versity towns, which re- manner, I don’t me for more than I paid for
ceived little or no invest- it. I look for situations that
ment. I developed the the- make investments logically make sense to me.
sis that if I was willing to go
to these second-tier cities, predicated on the As an example, in 1985 I
particularly cities with took over Itel Corporation.
growth, I could generate assumption that At the time, Itel had been
significantly greater returns the largest bankruptcy in
there’s a greater
because, frankly, there was the history of the United
no competition. fool out there who’s States. Coming out of
Chapter 11, the company
After law school, I raised going to buy it from still owned a subsidiary that
capital to buy my first major leased 17,000 railcars. Busi-
building, which was a 99- me for more than I ness had been so terrible
unit building in Toledo, OH. that utilization of the rail-
That‘s really where it all paid for it. I look cars was 32%. While others
started. On that first major might have considered this a
for situations that
deal, we produced a 19% really horrible situation, I
return (as opposed to the logically make sense looked at it and said: ―These
4% my father was earning) railcars are almost new be-
and I discovered that I to me.‖ (Continued on page 28)
Page 28
Sam Zell
―I reminded myself
(Continued from page 27) ket rates. Now, you could schools. The only thing
that everything is cause they haven‘t been tell me I‘m a genius but the that‘s relevant to me is re-
used.‖ By virtue of this fact, truth of the matter is that dundancy. Everything else is
about supply and I bought them at dramati- the information I‘ve laid out if-come-maybe. So, I ac-
cally less than their replace- was available to everybody. quired the number three
demand. I knew ment cost. I then looked at All anyone had to do was business in the industry, put
the broader rail business put the pieces together. the two companies together
that when the and determined how many For some reason, that‘s and the revenue was still
supply and demand railcars there were, who what I do well. I see things $200 million but the ex-
had built them, when they differently. penses were now $85 mil-
curves for boxcars had been built and what the lion instead of $100 million.
general story of the business G&D: Could you give us We picked up a 15% ex-
met, I could make a was. It turned out that in another example where you pense difference, which was
1979, the US government saw something that was all profit, and we became
fortune. So I went had changed the tax laws obvious to you but not to the low-cost producer. We
and created a special one- others? then acquired the leasing
out and bought all year 100% tax deduction for company that was number
of the used railcars heavy equipment. Further- SZ: Another division of Itel seven in market share and
more, in 1979, the United was in the container leasing became number one in the
in America. ... We States had built 120,000 business. At the time, the container leasing industry.
boxcars. But between 1979 container leasing industry By virtue of this, we had the
did extraordinarily and 1985, the United States was comprised of the lowest costs in the business
had built a total of only 20 ―seven sisters,‖ which were and a real competitive ad-
well because we boxcars. seven container leasing vantage.
companies that represented
had bought these In the meantime, demand 95% of the world‘s con- So that‘s the way I look at
railcars at for boxcars was as flat as a tainer leasing business. The things. It isn‘t like there are
dead man‘s EKG. There- one I acquired through Itel six rules of investing or
significant discounts fore, nobody wanted to was number four. This busi- something like that – cer-
touch the business because ness had $100 million of tainly there haven‘t been in
to replacement cost there was no growth. Dur- revenue, $50 million of my life. One of my criti-
ing this same period, 65% of expenses, and $50 million of cisms of business schools is
and yet rented the boxcars in the country cash flow. Then I looked at that the definition of an
were scrapped. I reminded the number three business MBA graduate is someone
them at market myself that everything is in the industry, which had who knows how to do the
rates. … All anyone about supply and demand. I roughly $100 million of numbers; they just don‘t
knew that when the supply revenue and $50 million of know what the numbers
had to do was put and demand curves for box- cash flow. I considered mean. This is the product
cars met, I could make a what would happen if I put of business schools empha-
the pieces fortune. So I went out and these two container leasing sis on formulas. In other
bought all of the used rail- businesses together. All of words, business schools
together.‖ cars in America. By the a sudden, I would need only teach how the pieces should
time I was done, we owned one shipyard in Hong Kong be put together. But for
92,000 railcars and became and only one shipyard at the me, there is no formula.
the largest lessor of railcars other ports throughout the Similarly, I‘m pretty agnostic
in the United States. We world, and I would need about industries. We‘ve
did extraordinarily well be- only one computer system. been in the container leasing
cause we had bought these I don‘t really believe in syn- business, the railcar leasing
railcars at significant dis- ergies, such as cross-selling business, the insurance busi-
counts to replacement cost and all the other elements ness, the real estate busi-
and yet rented them at mar- they teach in business (Continued on page 29)
Page 29
Sam Zell
(Continued from page 28) other interesting story. In league told me that there
ness, the agricultural chemi- November of 1986, a col- was a wire and cable distri-
cals business, the oil and gas bution company for sale.
business, and I could go on The company had done very
and on. well and the price was 2x
―We don’t invest in book. Sam Zell buying
G&D: Are there any indus- high tech, simply something at 2x book was
tries where you‘re less extraordinarily difficult for
comfortable investing? If because we don’t people to conceive. The
there are, why is this the seller told me I had a week
case? understand it and to decide and there was no
chance for negotiation. I
SZ: We don‘t invest in high because it’s valued worried about it for six
tech, simply because we days. Then, on the seventh
don‘t understand it and be-
on if-come-maybe. day, I realized that there
cause it‘s valued on if-come- ... I can do much were really two assets for
maybe. Maybe I‘m a good sale – the business and
prognosticator of value but I better Anixter‘s ownership inter-
would tell you that I can do est in a distribution pipeline
much better prognosticating prognosticating that determined the fate of
value on something I under- other manufacturers. This
stand than on companies value on something I pipeline was a key determi-
that are valued by a third nant of these manufacturers‘
party. That‘s really key to
understand than on ability to sell their products.
how I look at things. I‘ve companies that are Once I thought about the
never been willing to de- acquisition as buying a key
pend on a third party to valued by a third distribution pipeline, rather
value my investments. I than just a distribution busi-
have to value them myself party. That’s really ness, the values changed
and I have to look at my dramatically. The company
investments as though I‘m key to how I look at we bought on January 1,
going to own them perma- 1987 had $600 million in
nently. That‘s a very differ-
things. I’ve never revenue and $36 million in
ent perspective than valuing been willing to operating profit. We still
investments as though I‘m own Anixter today, and it
going to own them until I depend on a third produces $6 billion in reve-
determine it‘s the right time nue, earns about $300 mil-
to sell. Generally speaking, party to value my lion per year and operates
we start by focusing on the all over the world. It‘s been
fact that we‘re going to own investments. I have a phenomenally successful
the investment forever. In deal really just by taking that
some cases we have done
to value them myself pipeline into consideration,
this. and I have to look at and expanding it when ap-
propriate.
G&D: Can you provide an my investments as
example of a company When I bought that busi-
you‘ve owned for a long though I’m going to ness, we had operations in
period of time? the US, Canada and a small
own them operation in England. I was,
SZ: We own a company and am, a great believer in
called Anixter, which is an-
permanently.‖
Page 30
Sam Zell
(Continued from page 29) less than 20% of the stock have to pay as much as
globalization. Consequently, ownership. Hopefully, I competitors in taxes and we
I thought it was critical that create and provide the kind could acquire and operate
this company expand world- of leadership that adds ex- businesses with that in
wide. The problem was ponential value – enough mind.
that this kind of expansion that people are willing to
was extraordinarily expen- follow my direction. Following the 1990 real es-
sive. When I bought Anix- tate collapse, there was no
ter, I acquired it in a manner G&D: Could you discuss source of capital available to
such that it could be a sub- some of the different busi- real estate – the S&Ls were
sidiary of Itel. So on top of ness cycles you‘ve experi- broke, the banks were
Anixter, you now had rail- enced and how you adapted broke and the insurance
―It’s not my car and container leasing to each new development companies had backed away
businesses and a dredging that followed? from the asset class. The
personality to be business, each of which public markets became the
were large cash flow and SZ: A lot of things have only viable option. Thus, in
passive. Where I depreciation-generating changed. I went from buy- 1988, I wrote an article en-
assets. Over the next three ing up distressed real estate titled ―From Cassandra,
can control or years, I think we spent $300 in the ‘70s to building indus- With Love…‖ where I laid
significantly million rolling out Anixter trial companies in the ‘80s. out what I thought would
worldwide. If I had tried to In 1981, Congress changed happen to real estate over
influence the do that with Anixter as an the law on net operating the next ten years. This
individual company in a pub- loss carryforwards. Up until included my expectation of
direction taken by a lic market, I would‘ve gotten that point, you were al- the monetization of real
slaughtered, but hidden un- lowed to use NOLs forward estate and the creation of a
company, my der all of these other busi- or backward three years. modern REIT era. From
nesses as a smaller asset, no Then, in 1981, because 1960 to 1990, REITS were a
judgment - at least one really paid attention. there were all of these backwater with capital allo-
so far - has proven We gradually sold the other busted REITs with NOLs, cated to the entire industry
businesses of Itel as we they changed the laws to amounting to $6 billion.
to be on the better grew Anixter to the point allow companies to use the Sure enough, 1991 was the
where it was a viable inde- NOL deduction 15 years beginning of the modern
side of good. You pendent company. forward. As far as I was REIT era. I created three of
concerned, they instantly the largest REITs and be-
don’t necessarily G&D: Is it fair to say you changed the value of every came a spokesman for the
always see potential invest- NOL. Yet, when I looked at industry, serving as its rep-
have to have ments in the context of the stock prices, there was resentative in the interview
absolute control.‖ control, where you have the never any value given to with Standard and Poor‘s
ability to effect change? these deductions. We when they were deciding
bought Great American whether to include REITs in
SZ: It‘s not my personality Management, which was a the S&P 500. In 1999, we
to be passive. Where I can busted REIT with $127 mil- then created Equity Interna-
control or significantly influ- lion in NOLs. Itel had $450 tional because we felt that
ence the direction taken by million in NOLs. We also the monetization of real
a company, my judgment - bought New Corp, which estate that was occurring in
at least so far - has proven had $250 million in NOLs. the United States would
to be on the better side of Then we monetized all ultimately occur in the rest
good. You don‘t necessarily these carryforward deduc- of the world.
have to have absolute con- tions through the ‘80s. So
trol. I manage/chair five or again, we had a comparative G&D: How has your
six public companies with advantage because we didn‘t (Continued on page 31)
Page 31
Sam Zell
(Continued from page 30) would be 50/50 by 1990 – tion, redundancy, and barri-
method of investing evolved 50% allocated to real estate ers to entry were viewed as
over the years? and 50% allocated to assets critically important.
in other sectors. We began
SZ: Well, as an example, in applying our same principles I had an inherent skepticism
‘80 and ‘81, we no longer to non-real estate asset of marketing because I felt
liked the real estate busi- classes. Ideas like consolida- that it wasn‘t measurable.
ness for various reasons. My philosophy was to invest
We had been a great benefi- in businesses that served
ciary of inefficient markets. ―I had an inherent externally created demand –
However, the creation of businesses where I didn‘t
the HP12 and other tech- skepticism of have to generate demand.
nologies changed the playing As an example, in the mid-
field. All of a sudden, a bro- marketing because I 80s, I bought the largest
ker in New York could send dredging company in the
out 27 different packages felt that it wasn’t world because I knew that
and elicit bids. Prior to that, measurable. My every day the rivers and the
there was little or no com- harbors are silting, creating
petition. Secondly, we had philosophy was to demand for the product I
always taken advantage of produced. That‘s been the
long term fixed rate debt, invest in businesses way we‘ve always func-
but in the early ‘80s, the tioned.
banks and the insurance that served
companies started shorten- We were also very focused
ing terms and putting in externally created on creating verticals that
kickers. So the world as we demand – businesses work. In the early 1980s,
perceived it changed. In we bought an agricultural
addition, in roughly 1980, where I didn’t have chemicals distribution com-
we started to see assets pany. Then we went to a
trade for a combination of to generate demand. bankruptcy court and
their economic value and bought an ammonia nitrate
their tax benefits. As far as As an example, in plant in Iowa. Then we
I was concerned, tax bene- went to Canada and bought
fits were what you received the mid-80s, I a source of potash. We
in exchange for the lack of bought the largest rolled it all up together into
liquidity in real estate, not one company and found that
an additional value element. dredging company in it was much more efficient
than the disparate parts.
We came to the conclusion the world because I Eventually, we took that
that, ―If we were really good company public.
at the business of real es- knew that every day
tate, then we were also These are all pretty simple
good businessmen.‖ The the rivers and the concepts from my perspec-
very concepts and ideas that harbors are silting, tive but I live by them.
influenced the way in which
we invested our capital in creating demand for G&D: Do you have an-
the real estate industry defi- other example of a unique
nitely applied in non-real the product I investment opportunity that
estate industries. So, in presented itself due to a
1980, my partner Bob Lurie produced.‖ shift in an economic cycle?
and I decided that our firm (Continued on page 32)
Page 32
Sam Zell
―In the early 1990s, (Continued from page 31) -market, so I tried to figure for roughly three years,
out ways to preserve the from ‘88 to ‘91. I would
when I was again SZ: As was true for my principal of the asset for the buy a building from a bank
philosophy of being the first seller and still make the deal and they‘d ask, ―How about
buying up all of the national real estate investor work. It basically amounted three more?‖ At some
in second-tier cities, I‘ve to lowering interest rates point I stopped to question
distressed real always been willing to shift on the debt to the point my thesis, but I went
my ideas and criteria, but where you could almost through my whole thought
estate I could in the I‘ve also always believed in carry it or you had a defined process once again and re-
US, I kept looking what I‘m trying to imple- carry. We realized that if mained confident that I was
ment. In the early ‘70s, buy- we could accumulate assets right.
over my shoulder ing apartments became too - particularly in an inflation-
expensive so I started fi- ary time - with cheap fixed G&D: We‘ve touched on
asking myself, nancing builders to build rate debt, it was hard not to this already but could you
apartments. By 1972, eve- make a fortune. talk a bit more about how
―Where is everyone ryone believed the world you value assets?
was going to grow to the When people looked at our
else?‖ It’s not that I sky; there were cranes on performance during the SZ: It starts with replace-
like competition, every block. But I knew ‘70s, they always asked, ment cost. In other words,
that supply and demand ―How did you pick all those if we take the example of
but you do start to were out of balance, and I ripe projects?‖ But the the Anixter pipeline, there
stopped backing developers. truth of the matter was that was no physical pipeline, but
wonder why you Then, seemingly overnight, I created $3 billion worth of I could figure out what it
market sentiment shifted, 5% fixed rate debt in an would cost to replicate that
continue to be the and in 1973, everyone inflationary environment of pipeline. I‘ve bought all
seemed to believe there 10, 12 or 13%. In this situa- kinds of real estate at below
only game in town. was no future. Asset prices tion, it was hard for it not replacement cost, before
... At some point I plummeted, and I realized to work. And yet, like many considering the value of the
that this didn‘t make sense others in my career, most land. Ultimately, what does
stopped to question either. So, I began aggres- people thought I was crazy. it cost per square foot to
sively acquiring property, I‘ve spent my whole life lis- build the property and what
my thesis, but I financed very cheaply, to tening to people explain to is your cost basis?
take advantage of what I me that I just don‘t under-
went through my thought was a once-in-a- stand, but it didn‘t change Another question to con-
lifetime distressed opportu- my view. Many times, how- sider is how difficult a par-
whole thought nity. ever, having a totally inde- ticular business or real es-
process once again pendent view of conven- tate market is to enter. I
Between ‘73 and ‘77, I ac- tional wisdom is a very spoke a lot about the inter-
and remained quired $3 billion worth of lonely game. net during the ‘90s. I
real estate. The banks had a thought it was a lot like an
confident that I was problem carrying a large In the early 1990s, when I interstate highway except
amount of distressed real was again buying up all of that a highway has limited
right.‖ estate with so many proper- the distressed real estate I access. The internet had no
ties in foreclosure. They could in the US, I kept look- limitations to access.
weren‘t looking to make ing over my shoulder asking Therefore, an internet-
money. They were just myself, ―Where is everyone based business is totally
trying to mitigate the losses else?‖ It‘s not that I like vulnerable. One of my pro-
their real estate loan portfo- competition, but you do tégés created Groupon and,
lios were expected to gen- start to wonder why you although he has the first
erate. In those days, institu- continue to be the only mover advantage, the reality
tions didn‘t have to mark-to game in town. And I was -- (Continued on page 33)
Page 33
Sam Zell
(Continued from page 32) to how the plan is actually Offer.‖ I started Equity
with Groupon is that there‘s going to be executed. Office and built it into the
no barrier to entry for com- largest real estate company
―… it’s all about petitors. G&D: Two critical yet in the world. Every quarter,
sometimes forgotten char- we conducted a detailed
replacement cost – I don‘t know how to answer acteristics every investor valuation of the company,
the question any more con- needs is a sense of when to so we felt confident we
whether it be
cisely than to say it‘s all sell and the confidence to knew the true value of the
ephemeral about replacement cost – follow through. Can you business. Then one day,
whether it be ephemeral talk about your timely sale someone made us an offer
replacement cost replacement cost like the of Equity Office Properties that was significantly greater
Anixter pipeline or brick in 2007 and how you gener- than our own internal analy-
like the Anixter and mortar replacement ally determine when to sell sis – an offer we couldn‘t
cost – and barriers to entry. an asset? refuse. Many people
pipeline or brick You have to ask yourself, thought at the time that
and mortar how difficult is it for some- SZ: In the case of Equity selling Equity Office was a
body to compete with you Office, it was a ―Godfather very hard decision for me.
replacement cost – and what is your compara- But it was a relatively easy
tive advantage. decision because the dispar-
and barriers to ity in our valuation versus
G&D: Are there any other ―… one of the the bidder‘s was so great.
entry. You have to key tenets of your invest- Of course, a bidding war
ment process? greatest risks of any began with a second bidder,
ask yourself, how and the disparity got even
SZ: I philosophically be- investment is greater. So number one, I
difficult is it for
lieve that if you can‘t deline- point to what I would call
ate your idea in one or two execution risk, and I the ―Godfather Factor.‖
somebody to
sentences, it‘s not worth think it is highly
compete with you doing. I‘m the Chairman of Number two, some busi-
everything and the CEO of overlooked. I have nesses have lifelines and
and what is your nothing, which means that others don‘t. I think Anix-
the people who work for great respect for ter continues to grow be-
comparative me come to see me with cause it provides a very
ideas all day long. My crite- execution risk and valuable service. This isn‘t
advantage.‖
rion is if they can‘t concisely always the case. For in-
explain their idea, then I am always sensitive stance, we started a com-
throw them out of my office pany called Adams Drugs,
to people coming
and tell them to come back which created the over-the-
when they can. Simplicity is up with ideas that counter drug Mucinex. The
critical. entire premise for develop-
don’t have all of the ing that business was that
Additionally, one of the there were a series of
greatest risks of any invest- t’s crossed and i’s drugs, such as Aspirin, that
ment is execution risk, and I were grandfathered by the
think it is highly overlooked. dotted with respect FDA. The second largest
I have great respect for exe- to how the plan is drug was the expectorant
cution risk and am always guaifenesin. The FDA stipu-
sensitive to people coming actually going to be lated that if you could take a
up with ideas that don‘t pre-FDA drug and prove
have all of the t‘s crossed executed.‖ efficacy through clinical tri-
and i‘s dotted with respect (Continued on page 34)
Page 34
Sam Zell
(Continued from page 33) ereign debt crisis in Europe, ago – maybe 15 or 20 years
als, then you were granted a are you interested in invest- ago – that European banks
―Jack Welch once
monopoly. Somebody came ing in Europe? had ―hidden reserves.‖
said, ―Either you’re to us with the idea to con- What in the world were
duct clinical trials, we SZ: We don‘t view Europe ―hidden reserves‖? They
number one, funded them and we proved today as a particularly good were money that banks kept
efficacy. As a result, we investment opportunity. I for a rainy day, but that
number two or were given exclusivity for think there‘s just such a high wasn‘t disclosed to share-
production of the drug and degree of uncertainty com- holders. You simply could-
you’re in trouble.‖ I thus the company did ex- bined with a historical ap- n‘t do that in the United
traordinarily well. But I proach by European compa- States. In the same manner,
certainly endorse
recognized that this was a I think European accounting
that sentiment. I business that could easily be is suspect. Finally, I can‘t
subject to competition, and come up with a reason why
am a great believer that it was a little bar fly in a ―We’ve been very Europe should grow. And,
land of giants. How were in the end, as an investor,
in competition and we going to compete with
involved in you have to have growth.
Pfizer or any of the big emerging markets, Europe is great for castles,
I’m particularly OTC drug companies? We cheese, wine, and après-ski
interested in couldn‘t. As far as I was particularly Mexico, though! Likewise, I have no
concerned, selling Adams interest in Russia at all. All
competition for two or three years after we Brazil and one has to do is think about
had proven the concept and Yukos. If Russia can do
you. For me, I’d generated revenue made all Colombia. These what they did in the case of
the sense in the world. Yukos, they can do anything.
like a monopoly. If are enormously
Jack Welch once said, powerful growth G&D: Are there any coun-
I can’t have a ―Either you‘re number one, tries or areas that you find
monopoly, I’d like number two or you‘re in markets. In the particularly attractive?
trouble.‖ I certainly en-
an oligopoly. As an dorse that sentiment. I am case of Brazil, the SZ: We‘ve been very in-
a great believer in competi- volved in emerging mar-
investor, I am tion and I‘m particularly country is self- kets, particularly Mexico,
interested in competition Brazil and Colombia. These
constantly focused for you. For me, I‘d like a
sufficient in fuel, are enormously powerful
monopoly. If I can‘t have a water and food, growth markets. In the case
on competition monopoly, I‘d like an oligop- of Brazil, the country is self-
because I think it is oly. As an investor, I am and has a trained sufficient in fuel, water and
constantly focused on com- food, and has a trained ex-
not necessarily petition because I think it is executive class, and ecutive class, and is growing
not necessarily always ra- at something like 4% a year.
always rational.‖ tional. As a matter of fact, it growing at I think Brazil is probably the
often times it is irrational. best single major market in
There‘s nothing worse than
something like 4% a the world.
to be in a competitive situa- year.‖
tion with an irrational com- G&D: Can you provide an
petitor. example of a current invest-
ment in Brazil?
G&D: Given your firm‘s nies to be much less trans-
expertise in distressed in- parent than American com- SZ: We started BR Malls,
vesting and the ongoing sov- panies. It wasn‘t too long (Continued on page 35)
Page 35
Sam Zell
(Continued from page 34) We‘ve done hundreds of maybe +200 bps relative to
which today is the largest transactions and I take investment grade debt, then
shopping center company in great pride in the fact that for the next level it was
―Any time you go the country. Same store people are willing to do another +200 bps and so on
sales are 12-14%. Compare repeat deals with me. It‘s as you went up the risk
into emerging that to a top-performing US very common for us to get scale.
shopping center company phone calls from previous
markets, you are where same store sales are partners who want to intro- Today, there are investment
at 1-2%. We also have a duce us to new opportuni- grade spreads and then
trading the rule of
homebuilder in Brazil. ties. Then, of course, there there are 1,400 bps spreads.
law for growth. When you look at the num- are about 30 or 40 manag- All of the past incremental-
bers, you discover that Bra- ing directors who work in ism, at least at the moment,
Anybody who thinks zil has seven million units of my office, and they in turn is gone. Therefore, I‘ve
pent-up demand. Just like have contacts and those never seen a market better
that they could go with dredging, it makes a big connections generates ideas. for investing capital in high
difference if you‘re building We‘re very opportunistic yield debt instruments or
into a Brazilian into a scenario where pre- and we‘re very comfortable high yield debt instruments
existing demand exists ver- looking into new ideas. We with kickers. There is a real
court and be
sus trying to generate de- have resources in a wide shortage of cash and appe-
treated like a local mand. variety of industries so we tite for risk in that arena.
can learn a lot about a busi- Note that this is a change
is very naïve. The G&D: Have you found ness pretty quickly. We‘ve from only a few months ago.
Brazilian and other Latin also been in many indus-
same thing is true American governments to tries, so a lot of what we In March of ‘09, you could
be investor friendly or oth- know or have learned in the buy anything at an unbe-
of Mexico. You erwise receptive to outside past is transferrable. lievably cheap price. By
investors? June of ‘09, everything was
have to start with
G&D: A lot of readers are trading at a premium, and
selecting a good SZ: Any time you go into also interested in current this continued to be the
emerging markets, you are ideas. Could you talk about case until maybe six months
partner who can trading the rule of law for any current investments ago. Early in 2011, there
growth. Anybody who that you like? were a lot of cases where
protect you or who thinks that they could go the value we had assessed
into a Brazilian court and be SZ: In keeping up with the for a particular investment
is strong enough to treated like a local is very environment today in the was X and it was trading at
naïve. The same thing is US, we are primarily provid- 2X or X plus 20%, particu-
give you a real,
true of Mexico. You have ing debt to the non- larly in the more liquid debt
credible perspective to start with selecting a investment grade world -- markets. That phenomenon
good partner who can pro- distressed debt instruments, has certainly changed in the
of any situation.‖ tect you or who is strong debtor-in-possession financ- last six months. In May or
enough to give you a real, ing and anything else oppor- June of ‘09, companies were
credible perspective of any tunistic. Changes in the last selling junk bonds at 5% or
situation. few years have brought 6% and those same bonds of
about a tremendous bifurca- the same company trade at
G&D: How do you or tion. If you‘re an invest- 12% today.
your team typically generate ment grade company, you
investment ideas? can get all the capital you We did a deal last year
want, and at these rates it‘s where there was a company
SZ: I have a pretty good practically free. In the past, with $130 million of debt
address book and a lot of if a company was sub- coming due. The company
people call me with ideas. investment grade, it was (Continued on page 36)
Page 36
Sam Zell
(Continued from page 35) willing to take. I knew that I exposure I am taking.
negotiated with the banks could always survive the Investors stumble when
until it was a week before good days, but the critical they take risk and don‘t
the debt‘s maturity and the element is to be able to receive commensurate re-
banks rejected the com- ward. Investors stumble
pany‘s proposals. The com- when they get bull-headed
pany then had a week to ―The definition of a or when they shift to doing
decide how they were going something that is outside of
―I’ve always been a
to meet that maturity. We great investor is their core competencies.
great believer in provided them with $130 My success has been related
million in return for an at- someone who starts to being a very good ob-
logic. I have a lot tractive assemblage of op- server, having opinions and
portunities. It wasn‘t like by understanding the being willing to implement
of common sense our deal was more or less them, and understanding
expensive; it was the only downside. You must and believing in the Bernard
and I see things deal on the Street. Baruch saying ―nobody ever
make the judgment
went broke taking a profit.‖
differently. Many
G&D: What is it about in advance as to how
people see your personality or process Lastly, in the simplest phi-
that has allowed you to be much downside risk losophical phrase, I‘ve al-
problems, but so successful? ways believed in going for
you are willing to greatness. I‘m highly moti-
entrepreneurs see SZ: Number one, I always vated and I‘ve always been
seemed to have a lot of self- take. I knew that I highly motivated, not neces-
solutions, and confidence so I didn‘t pay sarily because it translates
could always survive
attention to conventional into dollars, but because
that’s really what I
wisdom. Number two - you the good days, but there‘s a great satisfaction in
do. I recognize may have heard the quote, achievement. I think, more
―common sense isn‘t so the critical element than anything else, that is
differences that common‖ - I‘ve always been what has always driven me
a great believer in logic. I is to be able to and been a major contribu-
other people don’t have a lot of common sense tor to my success.
and I see things differently. survive when the
seem to see.‖ Many people see problems, G&D: It was a pleasure
market isn’t doing
but entrepreneurs see solu- speaking with you, Mr. Zell.
tions, and that‘s really what well or the Thank you.
I do. I recognize differences
that other people don‘t investment isn’t
seem to see.
performing. I always
Third, and most impor-
tantly, what I have been able focus on how much
to do is to assess risk and exposure I am
reward accurately through-
out my career. The defini- taking.‖
tion of a great investor is
someone who starts by un-
derstanding the downside. survive when the market
You must make the judg- isn‘t doing well or the in-
ment in advance as to how vestment isn‘t performing. I
much downside risk you are always focus on how much
Issue XIV Page 37
William C. Martin
(Continued from page 2) was an intersection of my perience. Most notably, I
become interested in invest- passion for technology and spent nine years from 2000
ing? the markets. to 2009 on the board of
Bankrate, during which time
WCM: I started investing After selling Raging Bull and the company grew from a
when I was 10 years old; my prior to starting Raging roughly $20 million market
first stock was Hershey Capital Management in cap to a $570 million sale to
Foods. My grandparents 2006, I started my own in- private equity. Again, it
invested my college money dependent research com- was nice to have such men-
with Mutual Series, which pany in Princeton, where I torship at such an early
was run by Michael Price. wrote an investment news- point in my career. In this
He was literally one of the letter. Of course, I no case, I got to see share- William C. Martin
first investors I was ever longer write newsletters but holder friendly corporate
exposed to, via his letters this business ultimately grew governance in action. All of ―Being an entrepre-
which I read when I was a to include InsiderScore.com, the directors owned a ma-
kid. From there, I attended which is an analytics and terial amount of stock and neur has really taught
the University of Virginia. In research tool that is today there was a true, long-term me a lot about the
my sophomore year, I be- used by approximately 250 focus towards building
came president of the stu- hedge funds and mutual value. In contrast, at some importance of having
dent investment fund. The funds. I am still an owner of the companies where we
capital for the fund was proof InsiderScore.com, but I have been activists, the the proper patience
vided by John Griffin of Blue am no longer involved in the board members often own
Ridge Capital. Like Price, day-to-day operations. little to none of the com- and perspective.
John Griffin‘s approach to pany‘s stock, so there is no
investing, particularly on the G&D: Your background urgency or alignment of Wall Street is so fo-
short side, was very influen- clearly sounds unique and incentives with stockhold- cused on quarter to
tial to me as I was beginning differentiated. ers. I think these entrepre-
to learn and think about in- neurial and hands-on experi- quarter issues, but
vesting. WCM: Being an entrepre- ences are a differentiator
neur has really taught me a for me. businesses do not
After my sophomore year I lot about the importance of
took a bit of a career detour, having the proper patience G&D: What led to estab- move as quickly as
as the company I had started and perspective. Wall lishing your own investment
in my dorm room, online Street is so focused on firm? the whims of inves-
finance site Raging Bull, at- quarter to quarter issues, tors. It takes time to
tracted $2 million in venture but businesses do not move WCM: Writing my invest-
financing from internet incu- as quickly as the whims of ment newsletter for a num- roll-out a new prod-
bator CMGI. My partners investors. It takes time to ber of years helped me to
and I left school and ended roll-out a new product, hire develop and refine my ap- uct, hire a new ex-
up raising another $20 mil- a new executive, or turn proach to investing and
lion in financing less than a around a company. I also build a documented track ecutive, or turn
year later, ultimately selling think the creativity of being record. I eventually felt it
the company in early 2000. an entrepreneur is valuable was time to take the next around a company.‖
It‘s safe to say we gained when you‘re thinking about step, which was to manage
quite an education in a short investing, particularly in outside capital. We
period of time, both on the small to mid-cap companies. launched Raging Capital
up and the down of the cy- It helps you to see what‘s Management in April 2006.
cle. Like many of the compa- possible and think creatively
nies I have been involved about a situation. G&D: Can you tell us
with, either in terms of start- Finally, I have also had some about your firm and what
ing or funding, Raging Bull public company board ex- (Continued on page 38)
Issue XIV Page 38
William C. Martin
(Continued from page 37) creativity in order to con- of what we do. We esti-
has changed since you nect the dots and find com- mate that we have gener-
started it? panies that can really show ated on average more than
break-out growth. Usually 1,500 basis points of alpha
WCM: We are based in those ideas represent about per year on the short side.
Princeton, NJ, manage $275 a third of our capital. We For example, in 2011, our
million, and are entering our don‘t have a set limit on strategy was up over 30% ―We try to short the
seventh year of business. that amount, but usually net of fees, and we made
these ideas are harder to 69% of our returns on the largest, most diversi-
―We look for com- find, and they are typically short side. The short book
higher risk so we size them usually has around 40-50 fied basket of what
panies undergoing a bit smaller. names in it spread across 50
to 70 points of gross expo- we believe are
management or Our other area of focus on sure. We don‘t believe in crappy, overvalued,
board changes, com- the long side is finding deep using ETFs for shorting, as
value investments with a we view that as lazy. We fraudulent, funda-
panies where there is catalyst. I‘ve always enjoyed also don‘t use derivatives to
hunting for out of favor create synthetic short expo- mentally-challenged
activism (sometimes stocks. Of course, along sure. We try to short the
the way I‘ve made my share largest, most diversified businesses, and then
our own), or a com- of mistakes and invested in basket of what we believe
plenty of value traps. There are crappy, overvalued, try to size them ap-
pany with a chang- are certainly a lot of cheap fraudulent, fundamentally- propriately in our
ing technology or stocks out there, and a lot challenged businesses, and
of them are cheap for a rea- then try to size them appro- portfolio so that we
product cycle.‖ son. Further, corporate priately in our portfolio so
governance is very poor and that we can sleep well at can sleep well at
The team includes two Co- hard to change at many night and be emotionally
lumbia Business School companies. Over time, I neutral. We don‘t want to night and be emo-
graduates, Wolf Joffe and have learned from my mis- be over-thinking and worry-
Fred Wasch, who is our takes. Today we look for ing about one or a few large
tionally neutral.‖
CFO, as well as Allan Young beaten down stocks, but shorts.
and Matt Furnas. ones that have a clear cata-
lyst. We look for compa- Whereas on the long side
On the long side we usually nies undergoing manage- we try to connect the dots,
hold 30-35 names. Our top ment or board changes, read a lot, and talk to many
10 ideas typically represent companies where there is people to source ideas, on
half of our capital, so we do activism (sometimes our the short side we try to be
take larger positions when own), or a company with a more systematic and me-
we believe we have a clear changing technology or thodical in terms of screen-
edge and conviction. We product cycle. These posi- ing names. For example,
focus on two general areas tions are typically weighted over the years we‘ve built a
on the long side. The first is higher because the down- proprietary key word data-
emerging growth businesses, side is often protected by base for SEC filings which
where we can hold the com- the company‘s cash buffer includes approximately 500
panies for a few years and or what we think is a high keywords of names of insid-
ideally make ―multi-bagger‖ intrinsic value. ers, auditors, or terms that
returns. It is a very entre- raise our level of interest.
preneurial approach to public The short book is a very For example, a term like
market investing. We try to important, and probably the ―preferred ratchet,‖ which
leverage our network and most underappreciated part (Continued on page 39)
Page 39
William C. Martin
(Continued from page 38) panies to miss their 2011 10

you often see in venture WCM: Shorting fraudulent -K filing deadlines. That‘s
capital, can indicate distress, Chinese companies that exactly what happened as
as the reset provision can were listed in the U.S. was eight shorts in our portfolio
be toxic on the wrong bal- one of our biggest winners had trading halted in Q2
ance sheet. One of our over the past two years, and 2011 alone due to account-
senior analysts, Allan Young, accounted for nearly 40% of ing irregularities and govern-
has a forensic accounting our short side profits in ance issues. Some of these
background, and he will 2011. We started sourcing stocks now trade for pen-
regularly go through the some of these ideas one-off nies, if at all.
most interesting hits. That‘s in the Spring of 2009 from
one of the ways we have the SEC filing alerts I talked G&D: This was clearly a
sourced ideas on the short about earlier, as promoters very big opportunity that
side. who had previously been you spotted. Do you try to
―Shorting fraudulent involved with sham Internet find themes around which
G&D: How does your companies began to get to invest or do you see a lot
Chinese companies team split up industry cov- involved with Chinese re- of one-off opportunities?
erage and the opportunity verse mergers and IPOs.
that were listed in set? By the end of 2009, we had WCM: On the long side,
systematically looked at all it‘s very company-specific
the U.S. was one of WCM: We‘re generalists 600 Chinese companies and a matter of connecting
who seek out value wher- who had listed in the U.S. the dots. Over time, 70% of
our biggest winners ever it may lie. In the last We narrowed this list down our average gains on the
over the past two year, some of our biggest by focusing on auditing long side have been long
positions were a copper firms, EBITDA margins vs. term capital gains, so out of
years, and ac- wiring company, a generic peers, accounts receivables a portfolio of 30 longs, you
pharmaceutical company, an metrics and a number of don‘t need all that many
counted for nearly asset manager, an insurance other risk flags. In some new ideas each year. On
company, a telecom equip- cases, we hired MBA stu- the short side, we have a lot
40% of our short side ment company, an advanced dents in China to help us more names and we turn
wound care business and with deeper field diligence, them over more frequently.
profits in 2011.‖ pre-IPO positions in Face- such as taking pictures of The short side often has
book and LinkedIn. We products in stores. We one or more macro or bas-
also helped a company, ended up building a diverse ket themes as part of it, but
SMG Indium (Ticker: SMGI), basket shorts around this that‘s just a component of a
go public that is stockpiling theme. broader book with 40-50
a critical metal called In- individual shorts. Another
dium, which is used in LCD, We began pressing this bas- example of one of our suc-
LED and solar technologies. ket trade after one of our cessful short themes was a
Each member of the team shorts, Rino International, a basket of some 15 targeted
has specific areas of exper- Nasdaq-listed Chinese com- regional banks with specific
tise, but they are not limited pany, admitted to fraud in geographic and construction
in what they can work on. late 2010. Further, in De- lending exposure that we
cember 2010, the SEC sanc- shorted in 2006 and 2007.
G&D: In your recent quar- tioned a U.S. auditing firm, This contributed to a strong
terly letters you write about Moore Stephens, which year in 2007, when we re-
successfully shorting a few prompted us to note in our turned 35% net with half of
Chinese companies earlier year-end letter that we be- our gains coming from the
this year. Can you tell us lieved that greater scrutiny short side.
how you came up with the over auditors would cause
idea? many of these Chinese com- (Continued on page 40)
Page 40
William C. Martin
(Continued from page 39) bit of ―financial engineering‖ dramatically more competi-
G&D: What do you think that made their same store tive today than it was five
is the next big short oppor- sales numbers look tempo- years ago. It is no longer
tunity in the market? rarily good when they went the greenfield market op-
WCM: I‘m not sure I have public. We recently cov- portunity it once was, as a
that crystal ball. However, ered this short for a nice lot of companies have now
today we do have a quarter gain, but it remains on our adopted cloud-based solu-
Pictured: Bill Ackman, who of our short exposure in radar. tions. Further, at their cur-
sponsors the Pershing Square commercial REITS. We rent size, they are a sub-
Capital Challenge at Columbia view much of the group as G&D: Was your decision scale competitor competing
Business School, in April 2011. still facing fundamental head- to close your short position against the likes of Taleo
winds while also being very based on a feeling that there and SuccessFactors. In our
exposed to any increase in was no longer a big down- view, Cornerstone is many
interest rates or spreads. side or less of a downside at years away from gaining
Their stretched valuations the current $16-17 price true operating leverage be-
and levered-balance sheets range? cause any incremental gross
leave them with little margin dollars are going to have to
for error. We have also WCM: In short, we are go back into R&D and sales
been shorting some of the not yet convinced it‘s the and marketing just to try to
smaller cap rare earth min- next Rainforest Café, so gain scale. They‘re already
ing companies. Another area we‘re erring on the side of in a bit of a catch-22 be-
where we have spent a lot conservatism by booking cause growth is starting to
of time as of late is on re- our gains to date. Remem- decelerate and they‘re los-
cent IPOs with very frothy ber, if Teavana can maintain ing money. Management
valuations. This isn‘t neces- current returns on invested can either show the operat-
sarily companies like capital and scale from 160 ing leverage on the bottom
LinkedIn and other high to 500 stores this could be line by slowing growth,
profile deals. Rather, a very valuable business. So which is the reason for the
there‘s a whole group of you have to give some big valuation multiple in the
companies below the radar. credit to that optionality, first place, or they can
For example, one of our even if we don‘t believe erode their bottom line
best shorts last year was that‘s likely at the moment. further to reaccelerate
Teavana (ticker: TEA). growth.
They went public with 160 G&D: Could you give us
stores and a $1 billion mar- another example of a com- G&D: What kind of impor-
ket valuation. The company you have shorted? tance do you place on meet-
pany‘s pitch was: we have ing with management teams
high returns on capital and WCM: A current short is of companies you‘re either
now we‘re going to deliver Cornerstone OnDemand long or short?
exceptional square footage (ticker: CSOD), which is a
growth, growing to 500 nearly $1 billion market cap WCM: For most of the
stores over the next few talent management software companies on the long side,
years. In contrast, our company. It is on an ap- we meet with management
view was that this was not a proximate $80 million reve- regularly. Our sweet spot
breakout retail concept, a la nue run rate. This is an in- on the long side is $250
Lululemon or Chipotle, as dustry I know very well due million to $1.5 billion mar-
evidenced by the unimpres- to my time spent on the ket caps that are under-
sive same store sales board of Salary.com, which covered both by big manag-
growth, declining productiv- competed with Corner- ers and by Wall Street ana-
ity at new store locations, stone. Cornerstone‘s indus- lysts. For the most part,
and the fact that there was a try of talent management is (Continued on page 41)
Issue XIV Page 41
William C. Martin
(Continued from page 40) take a lot of the ―trap‖ risk defined downside risk, and
we‘re important sharehold- out of that value equation. you can serve as the catalyst
ers for these firms so we get to unlock value. We often
pretty good access to man- Credibility and track record feel comfortable over-
agement. On the short side, are very important for activ- weighting these types of
we rarely speak with man- ists so we‘ve been focused, positions in our strategy, to
agement. Sometimes we will particularly early in our ca- a point where we could
meet with them to gut check reer, on hitting singles and have 8-12% of our capital in Bill Ackman and David Ein-
our thesis. doubles so that we can a single name. Thus, if horn at G&D Breakfast in
show that we can add value we‘re successful in catalyz- October 2010.
G&D: Could you talk about and do the right things, but ing the situation, we can add
your efforts where you take also that we are serious and a lot of incremental alpha.
on more of an activist share- will flex our muscle if neces- ―Boiling it all down,
holder role? sary. To the extent that G&D: Could you talk a
you start gaining some suc- little bit about your due we believe there’s a
WCM: We view ourselves cess in this area, the next diligence and valuation ap-
as active and engaged owners project should become eas- proaches? tremendous amount
of businesses, and we‘re of- ier, because you can walk in of option value in
ten communicating and the door with credibility. WCM: We like inexpen-
working with our portfolio sive assets and options, but having the ability to
companies. For the most One activist project we‘re we don‘t have hard and fast
part, these are constructive, involved with today is MRV valuation rules. Said an- walk into that value
productive, and low profile Communications (ticker: other way, a stock doesn‘t
conversations. At times MRVC). While the stock is need to have a certain PE to trap situation and be
though, we do find ourselves essentially a net-net, this is fit in our portfolio. For
in situations where we need also a company that has example, a recent invest- the catalyst. You can
to exercise our ownership destroyed a lot of capital ment is a company called take a concentrated
rights in a more vocal and over the years. You would Pacific Biosciences (ticker:
direct manner. not have wanted to be a PACB). They are one of a position, with fairly
passive investor in this com- number of companies that
I think the biggest opportu- pany. Like other engaged have gone public in the ge- well-defined down-
nity with activism is with the shareholders, we have nomic sequencing space.
value traps. There‘s no pushed MRV to return a Genomic sequencing is quite side risk, and you can
shortage of cheap stocks out substantial amount of capital interesting but it‘s an indus-
there, particularly in our to shareholders, take steps try that‘s still in its infant serve as the catalyst
market cap sweet spot. to divest assets, and to re- stage. We bought a block of to unlock value.‖
These are companies with structure the board. We Pacific Biosciences at the
material revenues, oftentimes are the largest shareholders end of December in a tax-
hundreds of millions of dol- in the company and we‘re loss sale at a roughly $140
lars of cash on their balance pushing to see further pro- million market cap for a
sheet, but they just don‘t gress at the company this company that has spent
have the necessary scale to year. over 10 years developing its
drive bottom line returns for technology with premier
shareholders. We‘re not Boiling it all down, we be- Silicon Valley venture back-
interested in being a passive lieve there‘s a tremendous ing. It had raised $400 mil-
investor in this situation. To amount of option value in lion as a private company
the extent though that we having the ability to walk while building its technology
can utilize activism to serve into that value trap situation and another $200 million
as our own catalyst and gain and be the catalyst. You when it went public. So we
at least some control over can take a concentrated were buying it for about
our destiny, we believe you position, with fairly well- (Continued on page 42)
Issue XIV Page 42
William C. Martin
(Continued from page 41) OpenTable (Ticker: OPEN) past one of the big risks for
70% of its cash on hand and to restaurant owners. pharmaceutical companies
less than 25% of total in- has been that they had to
vested capital for a company G&D: Can we talk about build expensive, FDA-
with really good management another one of your firm‘s approved manufacturing
and breakthrough technology positions? facilities. The industry is
in a very competitive and now moving towards out-
young industry. But, it‘s also WCM: Our current largest sourced, custom-batch Pictured: Steve Eisman at the
burning a lot of cash and the position is ATMI Inc. (ticker: manufacturing, which is Columbia Investment Manage-
competitive and adoption ATMI). The company pro- similar to the semiconduc- ment Conference in February
risks are significant. In our vides specialty gas and mate- tor foundry model. ATMI 2011.
eyes, though, if we size this rials used to manufacture has some relevant technolo-
position correctly, and at gies that they have been
cost this was a less than a 2% ―In this business, we able to apply to this nascent
portfolio weighting for us, market. We estimate that
this is an attractive value really do try to wipe revenues for this business
stock – not to mention a line grew substantially in
compelling tax loss trade. our minds clean of 2011 to over $40 million, up
from $10 million in 2010.
We generally have models
past mistakes. This is The investments in this busi-
for important positions, but not to say that we ness have depressed profit
at the same time we sub- margins in recent years, and
scribe to Warren Buffett‘s don’t try to learn that should begin to reverse
view that if you can‘t figure it as the unit reaches profit-
out on the back of envelope, from our mistakes, ability in the near future.
a big spreadsheet model is We also think there is ineffi-
not going to give you the but as with golf, you ciency in that the semicon-
right answer either. But, ductor analysts who follow
modeling is important when
need a clear and con- the company have not done
you need to dive into the fident mind to be suc- in-depth work on the life
details on a position and to sciences business.
confirm or deny a hypothe- cessful in an ever-
sis. For example, we own The second growth driver
the TARP Warrants in Hart- volatile world.‖ for ATMI is driven by the
ford Insurance (Ticker: HIG). company‘s relationship with
This is a complicated com- semiconductors. This is a Intermolecular (ticker: IMI),
pany, and we have spent a lot good annuity-like business, a company that went public
of time modeling out their and the boom-bust charac- in November. Intermolecu-
annuity exposure to under- teristics as a volume-based lar has pioneered a new
stand the potential risks and supplier are less intense method of research and
rewards in the position. than for the rest of the in- development for semicon-
Additionally, we also spend a dustry. ATMI has a $700 ductor companies. What is
lot of time on the phone, million market cap and underappreciated is that
aiming to get that nugget of nearly $150 million of net ATMI owns 14% of the
insight that provides clarity cash and investments on the company and has a strategic
for an investment. For ex- balance sheet. It trades at supply relationship with
ample, our analyst Matt Fur- roughly 5x EV/EBITDA. Intermolecular, so as new
nas recently called over 100 The company has two inter- chips are designed on Inter-
restaurants to better under- esting growth drivers. First, molecular‘s platform, we
stand the value proposition ATMI has incubated a life believe ATMI is poised to
and importance of sciences business. In the (Continued on page 43)
Page 43
William C. Martin
(Continued from page 42) G&D: Can you talk about ness was that I would turn
win a lot of new supply busi- some mistakes you‘ve made into one of those managers
ness. We should start to over the years? who‘s overly focused on
see the benefit of this mar- short-term performance to
ket share growth as produc- WCM: Where do I begin! the detriment of long-term
tion of 28 and 22 nanome- In this business, we really do returns. In fact, the oppo-
ter chips begin to ramp, as try to wipe our minds clean site has happened in that I
we have recently started to of past mistakes. This is not believe the regular perform-
see. In fact, what was most to say that we don‘t try to ance reporting structure has
intriguing for Wolf as he learn from our mistakes, but been a positive construct
was researching ATMI was as with golf, you need a for me. Specifically, as a
that he found himself piecing clear and confident mind to ―long-term‖ investor, I
together the market share be successful in an ever- found I was often willing to
puzzle for some of the in- volatile world. Our biggest look past a company‘s bad
dustry participants with frustration last year was numbers or ignore my gut.
whom he spoke. Normally actually in one of our activ- Now, I have no excuse—
ist positions, Moduslink intellectual honesty has
―I believe the regular Global Solutions (ticker: been forced upon me. My
MLNK). We helped to put job each day as a portfolio
performance someone on the board that manager is to look for the
was very capable and who best places to put my capital
reporting structure was working to add value, to work, and avoid and
but in our view, manage- manage the risk. Our port-
has been a positive
ment was more interested folio is still dominated by
construct for me. in collecting their salaries true long-term or con-
than unlocking value. trarian ideas, but a lot of the
Specifically, as a Worse, as one of the first intellectual dishonesty has
activists in, and with the been rooted out.
―long-term‖ investor, board protected by stag-
gered terms, we underesti- G&D: Thank you very
I found I was often mated how long it would much, Mr. Martin.
take to create change. Ulti-
willing to look past a
mately, we grew tired of the Important Disclosure:
Mr. Martin provides advisory services through his
company’s bad position and exited it – investment advisory firm, Raging Capital Management,
LLC and only to qualified investors. This is not an offer
which is one of the benefits of sale of securities or any other products to any person.
Investing in products managed by Raging Capital
numbers or ignore of this business: you are Management, LLC involves significant risk of loss. Past
performance is not a guarantee or a reliable indicator of
always free to wipe the slate future results. There is no guarantee that the investment
strategies discussed will work or are suitable for all
my gut. Now, I have clean of your frustrations investors. Each investor should evaluate his or her
ability to invest on a long-term basis, especially during
and get back to focusing on periods of downturn in the market.
no excuse—
This article contains the current opinions of Mr. Martin
new ideas. which are subject to change quickly and without notice.
This article also reflects Mr. Martin‘s verbal and written
responses to specific questions asked by the interviewer
intellectual honesty and should not be considered a complete description of
G&D: Can you talk about the strategies, methods of analysis and risks associated
with Mr. Martin‘s investment philosophy or those of
has been forced an area where you have Raging Capital Management, LLC . Forecasts, estimates,
and certain information contained herein are based upon
improved since starting Rag- proprietary research and should not be considered as
investment advice or a recommendation of any particular
upon me. ‖ ing Capital Management? security, strategy or investment product.
it‘s the other way around. WCM: I‘ve always thought

That makes us pretty ex- of myself as a long-term
cited about our investment focused, value investor, and
edge. frankly one of the worries I
had when starting my busi-
Page 44
BJ’s Restaurants, Inc. (BJRI) - Short

Michael Yablon
MYablon12@gsb.columbia.edu
($ in MMs USD except per share data)
Current Capitalization Multiples Summary Financials
Share Price as of 1/27/12 $48.91 LTM 2011E 2012E LTM 2011E 2012E
Basic Shares Outstanding 28 EV/EBIT 40.4x 40.2x 35.0x Revenue $582 $621 $704
Diluted Shares Outstanding 2 EV/(EBITDA-CapEx) NM NM NM EBIT $41 $41 $47
Market Capitalization 1,454 EV/EBITDA 22.5x 20.9x 18.0x EBITDA $73 $79 $92
Cash and Equivalents 40 FCF Yield NM NM NM EPS $1.04 $1.11 $1.26
Capitalized Leases 237 P/E 47.0x 44.0x 38.7x
Enterprise Value 1,650 P/Book 4.6x 4.6x 4.1x EBITDA-CapEx ($10) ($9) ($10)
Trading Statistics Returns Free Cash Flow ($22) ($24) $18
52-Week Low-High $32.84-$56.64 LTM 2011E 2012E
Float % 87% ROIC 11% 12% 11% Book Equity $319 $319 $354
Short Interest % 16% ROE 12% 10% 10% Total Assets $467 $460 $540
Borrowing Cost ~50 bps ROA 8% 7% 7% Divident Yield 0% 0% 0%
Recommendation:
BJ‘s Restaurants, Inc. (―BJ‘s,‖ ―BJRI‖ or ―the Company‖) represents an attractive short investment
with near-term catalysts. BJ‘s operates a chain of casual dining restaurants and trades at a premium
valuation. The stock currently trades at 47x LTM earnings but is forecasting just 13% growth. Fur-
thermore, BJ‘s growth is dependent on a maturing base of restaurants and its ability to secure large
restaurant spaces in high traffic areas while improving unit economics and returns on its capital in-
Michael is a second year tense business. The Company‘s execution to date has been strong, creating high expectations and no
MBA student participating in room for a decline in same store sales or margins. BJ‘s success has been driven in part by preferential
the Applied Value Investing terms received from its largest supplier who is also its largest private shareholder. This supplier only
Program. While at school, operates in California and Nevada where BJ‘s is reaching saturation. BJ‘s margins will decline as it
he has worked at two value- expands away from this supplier out of its highly concentrated base in California. I projected the
oriented hedge funds. Prior Company‘s growth out until 2020 to show the extreme and unrealistic bullishness implied by the
to enrolling at Columbia stock‘s current price. I believe the fair market value for BJRI today is $22/share.
Business School, he was an Business Description
investment banker focused BJ‘s Restaurants, Inc. owns and operates 116 casual dining restaurants in the United States, including
on mergers & acquisitions. 56 in California and 24 in Texas. BJ‘s offers American-style comfort food in large restaurants that
Michael holds a BA from average 8,000 square feet. BJ‘s competitive positioning is best described as a ―premium‖ casual dining,
Columbia University. with a typical restaurant build-out cost per square foot similar to Cheesecake Factory and PF Chang‘s
but with average meal prices in line with Applebees, Chilis and TGI Fridays. The company was
Michael was the winner of founded in 1991 and is based in Huntington Beach, California.
the 2012 Moon Lee Prize Investment Thesis
for his pitch on BJ‘s Same Store Sales Set to Decline as BJ’s Restaurant Base Matures: BJ‘s states that its restau-
Restaurants and was the rants grow fastest from the time they open until year four. As the base of BJ‘s restaurants matures,
2011 winner of the Sonkin fewer locations as a percent of its total restaurant count will be in this honeymoon, high-growth pe-
Prize for his pitch on riod. This decline will reach its lowest level in Q3 of 2012 when the percent of growth locations will
Madison Square Garden. have fallen from 35% to 21%. This natural maturation process has affected peer‘s same store sales
(including Cheesecake and PF Chang‘s) once they reached 110 units. BJ‘s has historically outper-
formed peers on a same store sales basis (―SSS‖) and this strong performance has driven revenue
growth and fueled bullish projections. Any reduction in same store sales will undermine the growth
story and reduce BJ‘s high multiple.
The Jacmar Relationship – BJ’s Largest Supplier is also its Largest Private Shareholder:
BJ‘s margins and returns are artificially high, aided by the fact that BJ‘s largest supplier is also its largest
private shareholder. Jacmar, along with its CEO, owns 11% of the company down from 16% last year
and 53% in 2000. Jacmar‘s CEO, a BJ‘s board member, was a big seller in 2011, reducing his position
by 32%. Jacmar only operates in California and Nevada and this explains BJ‘s disproportionate con-
centration in these states versus its peers. The Jacmar relationship has allowed BJ‘s to bill less in a
quarter and make it up later when earnings have improved. As evidence of this in 2008 and 2009,
Jacmar‘s growth in cost of sales moved inversely to the growth of total cost of sales. This relation-
ship led BJ‘s to disproportionately expand around Jacmar, who only operates in California and Ne-
vada, and is part of the reason BJ‘s margins outperform peers. BJ‘s growth in California is nearing
saturation and new units in other regions of the US will have a negative impact on margins.
Peers Have Struggled to Grow Past 200 Restaurants, making BJ’s Projection of 300+
Locations Unlikely: Large casual dining chains have historically been unable to grow to 300 restau-
rants, while maintaining margins and returns, and ultimately do not live up to their high multiples.
Issue XIV Page 45
BJ’s Restaurants (Continued from previous page)

10 years ago, three companies traded above 40x earnings, Cheesecake Factory, PF Chang‘s and Califor-
nia Pizza Kitchen. However, in 2001 each of these firms had many fewer units and therefore a much
bigger runway for growth. Cheesecake Factory had just 41 units, PF Chang‘s 52 and CPK 71. By the
times they reached BJ‘s current restaurant count, the multiples better reflected their limited growth
opportunities, with the average multiple of the three equaling 28x. With 116 units, BJ‘s multiple is not
justified given its current stage of growth. A decade later, which is how long it will take BJ‘s to reach
300 units, growth has stagnated for these three competitors around 200 units and the stock prices are
either flat or way down. Since passing the 110 location threshold, Cheesecake Factory, PF Chang‘s and
California Pizza Kitchen‘s stocks have returned 2.3%, (7.2%) and 1.1% on an annualized basis, respec-
tively, with CPK‘s return calculated inclusive of its take-out premium.
The US Real Estate Market and Mall Infrastructure Cannot Support 300+, 8,000 Sq. Ft. Lo-
cations: The Company thinks it can get to 300 units, but the question becomes at what size restau-
rant. Smaller restaurants have worse economics because less square footage prevents the restaurant
from effectively leveraging the fixed cost of the kitchen. The current format requires a large space
(>8,000 sf) in a high traffic area. If BJ‘s is forced to open smaller locations, returns will suffer. Like
Cheesecake and PF Chang‘s, BJ‘s expansion has centered around large malls due to their traffic density.
But there is limited space in Class A Malls and significant competition over a dwindling supply. According
to the International Council of Shopping Centers, the national vacancy rate at the top 80 regional malls
by size rose to 9.4% in Q3:11, the highest level in 11 years. The ICSC also reported that the total num-
ber of shopping centers in the US has not grown in three years. The dearth of quality sites has re-
stricted PF Chang‘s and Cheesecake Factory‘s growth. Unit growth at these peers has slowed over the
last few years well below BJ‘s target of 300 restaurants. PF Chang‘s has added only 4 units since the end
of 2009 for a total of 201 and Cheesecake Factory has 154 large-format units. In its Q4:10 earnings call,
PF Chang‘s cited the scarcity of quality locations as limiting the opportunities for expansion.
Mediocre Return on Capital with No Barriers to Entry: Assuming a ten year life for new con-
struction (per the Company‘s depreciation schedule), the average pretax IRR for a restaurant is 32%,
which assumes that no capital improvements are made over the course of ten years. This return is
around the 25%-30% range the company touts to the street as its target for new restaurants. However,
when G&A is allocated on a per store basis returns drop to 16%, and when taxes are applied the return
drops to 12%. BJ‘s returns are above its cost of capital but nowhere near the 25% it projects to the
street. Granted, the company will be able to leverage its G&A expense over a bigger base of restaurants
over time, but at square footage growth of 13%, this margin expansion will not have an impact in the
near term. In reality, margin compression will likely offset G&A leverage and value creation will be flat
to moderate, especially compared to high multiple companies that do not require heavy capital invest-
ment to fuel growth.
Valuation BJ's Restaurants DCF and EPS Valuation Summary
To value the company I projected earnings out to 2020 in Street Bullish Likely
three different scenarios. Each DCF scenario assumes a Case Case Case
discount rate of 8%, using a mid-year convention, and ap- DCF

(1)
$46.00 $28.00 $20.00
plies a conservative 17x multiple to 2020 net income. The Normalized EPS Multiple
EPS $3.88
13.0x
$2.75
12.0x
$1.91
11.0x
Street Case illustrates the unrealistic assumptions implied by Implied Price - EPS Mult. $50.44 $33.00 $21.01
the current stock price. BJ‘s must grow to 300 restaurants Implied Price - Avg of DCF & EPS $48.00 $30.50 $20.50
while increasing gross margins to 22.5% (up from 20.5% Current Share Price
Upside/(Downside)
$48.91 $48.91 $48.91
1.9% 37.6% 58.1%
currently and well above its peer average of 18.5%) and have (1) Average of 2011E-2020E Projected EPS Estimates
SSS of 4% until 2014 and 3% thereafter. In the Bullish Case,
which represents a best-case scenario for BJ‘s, the stock is worth just $31/share. In the Likely Case,
restaurant growth stops at 220 locations, above peers like Cheesecake Factory, PF Chang‘s and Califor-
nia Pizza Kitchen, while margins decline slightly to 20.0% and SSS grow at 3% until 2015 and 2% thereaf-
ter. A short of BJ‘s is protected by the Company‘s maxed out unit economics and slow, self-funded
growth.
The Multiple Continues to Defy Gravity as the Internally Funded Growth Strategy Takes
Time to Unravel: Mitigant - SSS will decline in 2012 and BJ’s will have just 13% square footage growth,
meaning the multiple is unlikely to expand rapidly and will more likely shrink
It’s Too Soon to Short the Stock - Market Cap is just $1.5B: Mitigant: Unit productivity is essen-
tially maxed out and it is very unlikely that BJ’s will be able to comp +5% over the next two years. If margins or
SSS decline, the growth story will be undermined and the stock will fall hard. One doesn’t have to wait for the
unit growth to slow to see that the stock is overpriced.
Page 46
Chicago Bridge & Iron Company N.V. (NYSE: CBI)

Noah Snyder, NSnyder12@gsb.columbia.edu
Capital Structure Guidance, Estimates, and Consensus Multiples and Share Price
Price $42.00 Revenues 2009A 2010A 2011E 2012E 2013E Multiples 2009A 2010A 2011E 2012E 2013E
Shares Outstanding 99.8 Guidance $4,300-$4,700 $5,200-$5,600 NHS Adj. P/E 17.0x 22.4x 15.9x 11.6x 9.6x
Market Capitalization $4,192.2 NHS $4,557 $3,642 $4,613 $6,044 $7,692 Consensus P/E 17.0x 22.4x 16.7x 13.9x 12.2x
Cash $539.9 Consensus $4,557 $3,642 $4,548 $5,572 $6,473 NHS EV/EBIT DA 8.0x 9.9x 8.6x 6.7x 5.5x
T otal Debt $80.0 Consensus EV/EBIT DA 8.0x 9.9x 8.8x 7.2x 6.3x
Net Debt ($459.9) EPS 2009A 2010A 2011E 2012E 2013E
Enterprise Value $3,732.3 Guidance $2.40- $2.50 $2.75-$3.05
Dividend Yld 0.5% NHS $2.47 $1.87 $2.65 $3.61 $4.39
Consensus $2.47 $1.87 $2.52 $3.02 $3.43
52 Week High $45.12 (1.2%)
52 Week Low $23.88 135.0% EBITDA 2009A 2010A 2011E 2012E 2013E
Volume (3 months) (000's) 1,095 NHS $466 $376 $435 $559 $674
Volume (3 months) (000's) $45,990 Consensus $466 $376 $425 $518 $596
Company Background: Founded in 1889, Chicago Bridge & Iron N.V. (―CBI‖ or ―the Company‖) is an integrated
engineering, construction (―EPC‖) and design company with a major portfolio of 2,000 patented energy technologies,
delivering comprehensive solutions to customers in the energy resource industry. Essentially, CBI specializes in build-
ing football stadium-sized liquefied natural gas (LNG) facilities and cross fertilization and synergies across CBI‘s busi-
Noah is a second year MBA ness segment is allowing the Company to win a disproportionate amount of new energy projects. During 2010, CBI
student. As an MBA he has executed 700 projects in ~70 countries and >80% of its backlog is non-US. Nevertheless, the Company remains a
interned at East Coast Asset very misunderstood equity story.
Management, Columbia
(Wanger) and Halycon Asset CB&I Steel Plate- Legacy CBI (120 years). Global fabrication/construction of storage tanks & steel plate structures.
Management. Prior to school, 1H ‘11: 40.4% of revenues, 51.7% of EBIT, 10.2% EBIT Margin.
he was a long/short investment
analyst for Arlon Group. He CB&I Lummus (E&C)– Traditional engineering, construction, and design services for upstream & downstream
holds a BS in Finance from the energy infrastructure facilities. 1H ‗11: 49.3% of revenues, 24.2% of EBIT, 3.9% EBIT Margin.
University of Illinois-
Champaign/Urbana. Lummus Technology- High quality hidden gem. >2,000 proprietary gas processing and refining technology patents.
1H ‗11: 10.2% of revenues, 24.2% of EBIT, 18.9% EBIT Margin.
Michael won second-place at
the 2012 Moon Lee Target Price and Valuation
Competition for his pitch on CBI is a long with a ~$60 target price or ~40% upside. Target price is based on two proprietary methods of valua-
Chicago Bridge & Iron tion: 1) Sum-of-parts and 2) Share of global LNG spend.
Company.
Sum-of-Parts: CBI has three distinct, yet somewhat overlapping business segments. I modeled out each segment
based on its current backlog and I layered in potential new awards based on various end markets. For EBITDA mar-
gins I used guidance of Steel Plate 7-10% and E&C 3-6%. I used 2013 as I think this is a mid cycle year and I applied
EBITDA multiples of 7-9x 2013 EBITDA based on business quality and barriers to entry for each segment. Steel Plate
should trade at 8x EBITDA as it earns ~10% EBITDA margins and it is a low cost producer of steel tanks/storage with
fabrication all over the world which would be costly for a new entrant to replicate. CB&I Lummus (E&C) should trade
at 7x EBITDA, or in-line with historical engineering multiples as this segment earns mid-single digit EBITDA margins
just as its comps do. Finally, Lummus Tech. should trade at 9x EBITDA as it is a higher quality reoccurring licensing
Sum of Parts Valuation Mid LNG Cycle Valuation

2013 EBITDA Multiple Segment Value % of EBIT Enterprise
Revenues Revenues Margin EBIT Multiples Value
CB&I Steel Plate $311.9 8.0x $2,494.9
LNG Potential $6,500.0 79.3% 8.0% $520.0 8.0x $4,160
CB&I Lummus (E&C) $213.2 7.0x $1,492.6 Other Big Projects $500.0 6.1% 4.0% $20.0 8.5x $170
Lummus Tech. $148.4 9.0x $1,336.0 Book & Burn $1,200.0 14.6% 10.0% $120.0 9.0x $1,080
Enterprise Value $673.5 $5,323.5 Total $8,200.0 100.0% 8.0% $660.0 $5,410
Net Debt ($459.9)
Net Debt ($459.9)
Equity Value $5,783.4
Enterprise Value $5,869.9
Diluted Shares 99.8
Target Price $57.94 Target Price $58.81
business with >20% EBIT margins.

Share of LNG Spend: Most analysts expect only ~$200-250bn LNG spend, however my proprietary ―project by
project‖ research concludes there is >$300bn of worldwide LNG projects on the horizon and most of them will be
required just to fulfill Far East demand. I conservatively estimate CBI‘s share of LNG spend will be at 13% vs. a 11.7%
share in 2010 even though CBI is winning a disproportionate share of new pre-feasibility and design studies. I use
historical average EBIT margins and different EBIT multiples for earnings power based on certainty of revenue realiza-
tion.
Investment Merits
Backlog Surge Not Priced In & More to Come– YTD 2011 new awards are ~$7bn compared with $2.3bn for
the corresponding 2010 period. Over the last six months CBI has booked >$5bn of new awards, yet the stock re-
mains at mid July levels. Subsequent to Q2 ‘11, CBI has been awarded an LNG construction project in Gorgon, Aus-
tralia ~$2.3bn, >$1bn of tank work in Asia-Pacific and an additional $500mn of Kearl oil sands work bringing CBI‘s
backlog to ~$9.3bn. This is nearly an all-time high, but equity traders have not priced in this recent surge. Investors
are now paying ~4x backlog EBITDA (using historical ~10% EBITDA margin) and getting all future earnings power for
free.
Issue XIV Page 47
Chicago Bridge & Iron (continued from previous page)

Entering Golden Age of Gas Use- Oil‘s share of total energy is now 34% vs. >45% in the 1970s and due to eco- In China, which is now the
nomic, environmental or energy security concerns nat gas will continue to steal share of total energy consumption from largest energy consumer
coal and oil. In China, which is now the largest energy consumer worldwide its current 5 year plan (2011-2015) calls for
nat gas to move from 4% of energy consumption to 9%. To accomplish this China will need to import considerable worldwide its current 5 year
amounts of LNG as it is impossible to generate sufficient nat gas internally. In addition, with US supply being geographi- plan (2011-2015) calls for nat
cally constrained due to lack of export, CBI Tech. will benefit from the nat gas renaissance in the USA as the cost curve
has shifted downward making domestic natural gas ~10x cheaper than crude oil for the foreseeable future. Japan‘s nu- gas to move from 4% of energy
clear meltdown has lead to surging nat gas demand as only 10 of Japan‘s 44 nuclear generators are operating and Ger- consumption to 9%.
many has agreed to cancel its nuclear program by 2022 (20% of supply). Globally, leaders are reassessing nuclear plans
and shifting consumption towards natural gas. Over the next decade nat gas will continue to take share from coal and
nuclear power as it produces ½ the CO2 and it is cheaper and more abundant than it has been in decades. CBI will be a In 2010, CBI enjoyed a ~48%
huge beneficiary of this secular shift in global energy markets.
market share in LNG storage
Barriers to Entry in LNG– As most of the end market demand drivers can not produce nat gas internally the gas will units along with ~9% of total
need to be processed, liquefied, and imported through LNG. Driven almost entirely by Asia-Pacific demand for Austra- LNG liquefaction spend. CBI
lia LNG, there will be 13-5 huge LNG projects sanctioned over the coming three years and global LNG spend could
is now winning a
disproportionate share of new
LNG liquefaction investment.
reach >$50bn by 2013. CBI can complete an entire

CBI is positioned to benefit from this shift with competitive advantages as one of only ~5 companies that can effectively LNG project and now 25% of
compete for >$300bn of Australian and global LNG investment that will be required over the next 6 years just to meet
EBIT comes from recurring
nat gas demand. CBI enjoys a ~48% market share in LNG storage units along with ~9% of total LNG liquefaction spend.
However, CBI is now winning a disproportionate share of new LNG liquefaction investment. CBI has already completed high (~20%) EBIT margin
a ~$1.5bn fully integrated Peru LNG liquefaction project below budgeted time and cost proving that CBI can execute an technology business.
entire LNG project and CBI is no longer just a storage tank builder. Additionally, CBI has teamed up with Chiyoda
(Japan) and Saipem (Italy) in forming CJV, a JV which is a premier worldwide LNG liquefaction team. Finally, CBI has
scale, relationships and know-how, providing CBI w/ insurmountable barriers to entry in competing for $5bn facilities. Sustainable cash flow stream
Misunderstood Business Quality- In late 2007, CBI made a game changing deal in acquiring Lummus for $820mn. with minimal CapEx ($50mn/
Lummus Tech. has patented proprietary technologies for refineries which helps upgrade thicker, lower quality energy yr) leading to a ~20% FCF
resources along with key strengths in ethylene and olefins conversion technology (OCT) in gas processing markets. This
diversified CBI‘s business model allowing CBI to complete an entire LNG project and now 25% of EBIT comes from yield in 2013.
recurring high (~20%) EBIT margin technology business. By bundling and offering technologies and E&C services, CBI
can further differentiate itself from many of its competitors in winning new projects. CBI now boasts a more steady,
sustainable cash flow stream with minimal CapEx ($50mn/yr) leading to a ~20% FCF yield in 2013. However, CBI is yet
Currently doing feasibility
to re-rate vs. the E&C sector, nor have investors been able to see the ―new‖ CBI fire on all cylinders.
Attractive Valuation– CBI is trading at 12.2x 2013 Consensus P/E and ~9.6x 2013 My EPS, or at the low end of studies on several >$1bn LNG
historical trading range of 10x-25x. CBI is cheap as changing energy consumption will be secular and not cyclical or
projects….which the Company
based solely on commodity prices. As CBI‘s business model is design/engineering heavy, CBI consumes little capital
(CapEx = ~1% of sales) and its cost structure is flexible as engineers can easily be hired and fired. Industry standard for will probably win E&C con-
construction contracts has also moved to cost plus from fixed price and CBI has executed on this de-risked business
tracts for over the next 2 years.
model with nearly three years of flawless execution.
Catalyst Rich Story– CBI is currently doing feasibility studies on several >$1bn LNG projects including Yamal, Ar-
CBI will have ~$1.9bn of
row, and Browse which the Company will probably win E&C contracts for over the next two years. On top of that CBI
is realizing >$500mn per quarter in ―book and burn‖ nat gas and petrochemical projects in the US due to the US shale capital for shareholder value
gas revolution. CBI has several project in its pipeline which can help investors unlock value. creation.
Potential Value Creation not Baked Into Estimates– Finally, CBI has cash of $540mn and only $40mn maturities
in 2011 and 2012, respectively. CBI should generate an additional ~$650mn of FCF over the next five quarters and CBI
also has a $1.1bn untapped revolver which won‘t expire until July 2014. CBI is well positioned to make another sizeable
deal in niches that round out its product offering or the Company can buy back shares with its 10% share buyback in
place. As CBI is comfortable at 25% of Debt/EV this means CBI has ~$1.9bn of capital that it can use for shareholder
value creation. By using $1.5bn to acquire businesses at 20x P/E along with $400mn for a share buyback (10% out-
standing approved) this would allow CBI to add an additional ~$15 of shareholder value.
Investment Risks: Cost overruns: Industry standard now cost plus vs. fixed price. CBI >50% cost plus contracts vs.
10% in 2005. Short term misses due to delayed investments. Oil prices weaken globally. Competition picking up in less
differentiated projects. Overwhelming efficiency gains and/or tighter EPA legislation lead to reduced need for fuel
power.
Page 48
Hewlett Packard (HPQ) - Long

Michael Zapata
MZapata12@gsb.columbia.edu
___________________________________________________________________________________
ticker: HPQ mkt cap: $55.8b price: $28 intrinsic value: $51 upside: 83%
Michael is a second year

MBA student participating in
the Applied Value Investing
Program. While at school,
he has worked at a value-
based hedge fund. Prior to
enrolling at Columbia
Business School, Michael
Recommendation
served nine plus years as a
Hewlett Packard is a buy at $28 with an intrinsic value of $51 for 2014, representing an 83% upside. A
Navy SEAL officer. Michael
downside scenario, with flat line EBIT and a low 6x EV/EBIT represents an 18% upside to $33.
holds a BS from Texas A&M
University.
Key Points
Why Undervalued?
Michael was selected as a
finalist of the 2012 Moon Key management concerns- three CEO change in the past year
Lee Prize for his pitch on Uncertain long-term plan– PC business spin, caused fear and confusion
Hewlett Packard. Losing market share- Servers
Poor acquisitions- $10 billion Autonomy bid
Strong Industry Leader

HP is the global leader in PC, Printers, Servers
#2 market leader in Networking and Management products
#3 market leader in Operating System and Storage
Tremendous brand recognition and economies of scale
Strong Financial Position

Strong Cash Flow Generator- $13 billion in 2011, 14% FCF yield
Ability to pay down debt
Steady share repurchases and stable dividends
Stated the current focus on paying down debt and increasing sales force and R&D in 2012
Potential Catalyst Primers

New CEO, $1 salary, performance based bonus, will provide clarity and focus
Strategic roadmap pending announcement in 2012
Activist investor recently appointed to BOD
Issue XIV Page 49
Hewlett Packard—Long (Continued from previous page)

Executive Summary
Thesis
Hewlett Packard is a strong cash flow generating, market-leading company that is being punished by the
market for recent company announcements and multiple CEO changes. The sell off has been overdone,
with HP stock moving from the year high of $50 to the recent low at $22 in September. The current
price of $28 represents an opportunity to buy HP with a 45% margin of safety to its intrinsic value.
Overall, the underlying business has not changed, the company has recently appointed a focused, goal
oriented CEO, has appointed a seat on their board to a prominent activist investor, and is primed to
communicate a long-term strategy that will provide a well-defined road ahead for investors to regain
confidence in the company.
Summary
The current state of the IT industry is stable and across each of HPs segments, the company is reposi-
tioning its foothold to propel the company forward through its focus on short and long-term strategic
implementations. HP is a world leading company with brand, economies of scale, and customer captivity
represented through it market leading positions in PC, printers, and server divisions.
From a management standpoint, the incoming CEO, Meg Whitman, will allow the company to be focused
by providing the structure needed through the pending release of its strategic vision. Additionally, while
only on a performance based salary for the first year, the CEO will look to fewer headlines, which will
benefit HP as this will be a positive sign that the company is moving forward and management is not
hindering growth.
Organically, the refocus of HP on its hardware division, while working to increase its software sales
across its business segments, will provide a clear picture to both its customers and the market. The
commitment to its PC segment will allow the company to move forward to provide a comprehensive
ecosystem for its customer base. Additionally, the increase in the critical operating expenses of research
and development and sales staff will provide short and long-tails to supporting HP‘s focus and dominance
in the IT industry.
Growth wise, although overpriced, the recent Autonomy acquisition provides the company a spring-
board to the higher margin software sales. Autonomy will increase HP software sales by 33%, which will
affect the bottom line. The company will also allow HP the opportunity to cross sale the unstructured
search software into its hardware and server divisions. This is a great starting point for long-term HP
opportunities.
Financially, HP generates strong cash flows and is dedicated to the return of a strong balance
sheet, which translates to a commitment to pay down its debt. Ms Whitman has stated that the company
will not make any major acquisitions in 2012. With a 14% FCF yield, HP is well positioned. Additionally,
with the appointment of activist Ralph Whitworth to the board, HP working to provide confidence to
investors, as the company will likely pursue additional options to return capital to shareholders.
HP is the world leader in PC, printer, and server sales, and the number-two leader in server and net-
working sales. The company is primed to grow software sales, which will expand margins and increase
the potential for higher multiples. At the current EV/EBIT of 6.7x (and P/E of 6.2x, record lows of past
20 years), resulting in a $28 stock price, HP represents a compelling buying opportunity with a 45% MOS
and 83% upside.
Potential Catalyst
HP‘s recent appointment of Meg Whitman represents the beginning of an HP turnaround. However, due
to potential Euro and macro headwinds, the decision to increase operating expenses to expand the sales
force and research and development, and the current higher debt, the potential catalysts will be slow
burning until Ms Whitman communicates HP‘s long-term vision in 2012. This pending catalyst, couple
with aligned and diligent actions across HP, will convey a roadmap and clear vision to investors, who will
be able to invest with confidence in Hewlett Packard.
Page 50
Hankook Tire (000240 KS) - CBS Finalists at WIN Conference

Young Ju Ko Jane Wu Sachee Trivedi Jing Wu
yko13@gsb.columbia.edu zwu13@gsb.columbia.edu strivedi13@gsb.columbia.edu jwu13@gsb.columbia.edu
Investment summary Key stats

Year to 31 Dec 2009 2010 2011F 2012F 2013F Close Price KRW 42,750
Young Ju is a first year MBA student.
Revenue (KRW b) 5,145 5,813 6,647 7,354 8,324 Pricing as of Nov 8 2011
Prior to school, she was an
Growth (%) 15% 13% 14% 11% 13% Total market Cap KRW bn 6,207
investment analyst at Blue Pool
Diluted EPS (KRW) 2,356 3,017 3,111 4,186 5,468 Total market Cap USD mn 5,589
Capital and Citadel Investment
Growth (%) n.m. 28% 3% 35% 31% Enterprise value KRW bn 7,088
Group in Hong Kong. She holds a
P/E (x) 18.1 14.2 13.7 10.2 7.8 Avg daily turnover (3M) USD mn 40
BBA from Seoul Natl. University. EV/EBITDA (x) 7.4 7.2 7.2 5.5 4.5 12M Range (KRW) 27,200-50,000
P/B (x) 3.1 2.6 2.2 1.9 1.6 Total shares Out. (mn shares) 145
ROE (%) 18.6% 20.0% 17.5% 20.0% 21.7% Free float (%) 52%
ROIC (%) 16.3% 18.8% 17.0% 19.9% 23.1% Net debt (FY11, KRW bn) 881
Div yield (%) 0.8% 0.8% 0.9% 1.2% 1.6% Net debt / equity FY11 47%
Net gearing (%) 56.9% 46.0% 47.0% 27.1% 18.7% KRW/USD exchange rate 1,111
Recommendation:
Jane is a first year MBA student. We recommend buying the Hankook Tire share (Hankook or ―the Company‖) because we believe
Prior to school, she was an equity market is underestimating the product price growth potential of Hankook led by improvement in
research analyst with CLSA in Hong brand value. Our target price is W71,000 (13x 2013E PE) implying 66% upside.
Kong. She holds a BEcom degree
from Tsinghua University and a
master of finance degree from Company Description:
University of Melbourne. She is a Hankook manufactures radial tires for passenger cars, truck and buses. In 2010, Hankook‘s global
CFA charter holder. production capacity was 80mn units with the largest production facility located in Korea (45mn) fol-
lowed by China (30mn) and Hungary (5mn). Replacement tires (RE tire) account for 65% of revenue
and original equipment tires (OE tire) account for 35%. Hankook makes 80% of revenue from over-
seas market. Hankook is No.1 player both in Korea and China with 52% and 19% market share, re-
spectively. Hankook‘s global market share is 3.1% (7th ranked). Hankook‘s customers are Hyundai,
Volkswagen, Ford, BMW, Toyota and Audi.
Sachee is a first year MBA student. Investment Thesis:

Prior to school, she was a Product price growth potential on the back of improving brand: In the past, Hankook has
consultant at KPMG in London. She
holds a masters degree in electrical
not been a price setter for the tire industry but has followed the industry leaders‘ (such as Michelin,
engineering from Univ. of Maryland Bridgestone) pricing policy. However, the trend is likely to change because Hankook enters a virtuous
and a bachelor‘s degree in electrical cycle on the back of strong growth from emerging markets and improved brand image. The expansion
engineering from Indian Institute of of customer base to the leading auto makers such as BMW and Toyota in 2011 sets a favorable pric-
Technology. ing environment for Hankook. We expect Hankook will be able to achieve 9% ASP growth during
next 3-5 years vs consensus estimates of 2-3%. In 2010, Hankook‘s implied ASP (total revenue / total
capacity) was still 50% lower than the top tier tire companies indicating there is an ample room for
Hankook to raise product price.
8 Years
1941 2003 2004 2005 2009 2011
Jing is a first year MBA student.

Prior to school, she was an
Toyota
associate in Investment Banking Founded
62 Years
VW Ford General
Modeo Motors
Audi A3
In talks with
BMW Mini BMW 3 Series
at Royal Bank of Scotland in Cooper
Hong Kong. She holds a
Bachelor of Economics & Why 9% growth? Hankook today is the Bridgestone in Japan in 1980s: We believe Hankook
Finance from University of today is comparable to Bridgestone in 1988 based on the size of business. From 1988 to 1998, Bridge-
Hong Kong. stone was able to grow its revenue at 13% CAGR . Considering a stable volume growth (4%) during
that period, it implies Bridgestone was also able to raise ASP (either through a voluntary price hike or
through product mix improvement) at c9%. This supports our price argument of 8-10% for Hankook
for next five years. Furthermore, Hankook has a stronger volume growth outlook than Bridgestone
because of much larger emerging market exposure (37% vs Bridgeston‘s 19%). The stronger demand
in emerging markets can lead to a more favorable pricing environment.
Bridgestone Hankook Bridgestone Bridgestone

US$ Mn (1988) (2010) (2010) CAGR from 88-98
Revenue 5,276 5,813 32,617 13%
Operating Profit 567 536 1,897 13%
Net Profit 190 147 1,127 16%
Total asset 5,285 4,979 30,850 12%
Issue XIV Page 51
Hankook Tire (continued from previous page)

Product price growth will lead to margin expansion: We forecast 9% increase in ASP across all
regions will lead to 2ppt gross profit margin expansions in 2012-2013 because of lower rise in unit cost-
growth(5%). This will lead to 32% and 29% bottom-line growth in 2012 and 2013, respectively. We are
not taking any bet on the foreign exchange rates. However, highly likelihood of Rmb appreciation could
2011F 2012F 2013F 2011F 2012F 2013F

ASP increase in local currency 9% 9% 9% Volume (k unit) 85,200 87,180 92,100
ASP per tire (USD) 61.8 67.0 72.3 % change 6% 2% 6%
Cost per tire (USD) 50.5 53.1 55.6 Gross profit (KRW bn) 1,036 1,265 1,502
% change 9% 5% 5% Gross margin 28.0% 30.0% 31.7%
Gross profit per tire (USD) 11.3 13.9 16.7 Net profit 441 584 752
% change 4% 23% 20% % change 1% 32% 29%
surprise on the upside.
Valuation:
Our 2-year price target for Hankook is W71,000 per share, representing 66% upside from the current
price of W42,750. We have applied current FY2011 PE multiples (13x) to FY2013E earnings to arrive at
the intrinsic valuation of Hankook in 2 years. The base case assumes an annual ASP growth of 9% from
2011-2015, the bear case assumes 3% and the bull case assumes 12%. Based on these cases, we believe
Hankook is worth between W29,000~W99,000 (risk reward –32% ~ +123% off of the current price of
W42,750) with upside/downside ratio at 4x.
Risks:
Sharp rise in rubber price: Rubber costs (both natural and synthetic) accounts for 50% of raw mate-
rial cost and 20% of revenue. If rubber price goes up too quickly, Hankook may not fully realize benefit
from price increase.
Currency risk Hankook is short position of US dollars (raw material cost is mostly denominated in
USD) and long position of Euro and other foreign currency. If KRW depreciates 10% against USD, im-
pact on EPS is -24% assuming KRW stays flat against other currency. Against Euro, if KRW depreciates
10% , impact on EPS is +4%.
Get Involved:
8687 or valueinvesting@columbia.edu. Available positions also may be posted directly on

New York, NY 10027
Name: _____________________________

Management Association (CSIMA) City: _____________ State: ________ Zip: ________
E-mail Address: _____________________________
Business Phone: _____________________________

Contact us at:
abaghdasaryan12@gsb.columbia.edu
jjaspan12@gsb.columbi.edu Would you like to receive e-mail updates from the Heilbrunn Center? __ Yes __ No
Anna Baghdasaryan is a second year MBA student in the Applied Value

Investing Program. She is currently interning for Cantillon Capital Manage-
ment, a global equity investments firm. Prior to Columbia Business School,
Anna worked in strategy and business development, and investment banking.
She can be reached at abaghdasaryan12@gsb.columbia.edu.
Joe Jaspan is a second year MBA student in the Applied Value Investing Pro-
gram. He is currently working part-time for a value-oriented hedge fund in
New York. Prior to Columbia Business School, Joe worked in private equity
and investment banking. He can be reached at jjaspan12@gsb.columbia.edu.
Graham & Doddsville
Issue XVI Fall 2012

Inside this issue:
Joel Greenblatt P. 1 Joel Greenblatt Loews
Loews P. 1 — “Thought Corporation
Corporation Process and —
Royce & P. 1 Clarity are Key” “Patience is
Associates
part of our
Omaha Dinner P. 3 DNA”
Joe Rosenberg and Jim Tisch
Loews Corporation is one of the largest diversified hold-

ing companies in the United States. Since its founding
in 1959, Loews has been rooted in the principles of value
investing as a means of generating wealth for its share-
holders. CEO Jim Tisch (one of three members of the
company’s Office of the President along with his brother
Editors Andrew and cousin Jonathan) and Chief Investment
Jay Hedstrom, CFA Joel Greenblatt Strategist Joe Rosenberg shared their thoughts and ex-
MBA 2013 periences with G&D.
Joel Greenblatt is the (Continued on page 14)
Jake Lubel Managing Partner of
Gotham Capital, an in-
MBA 2013 Royce & Associates —
vestment firm he founded
Sachee Trivedi in 1985, and a Managing
Principal of Gotham As-
Legendary Small Cap Investors
MBA 2013
set Management. Mr.
Richard Hunt Greenblatt is the author
MBA 2014 of four investing-related
books, including the New
Stephen Lieu York Times bestseller The
MBA 2014 Little Book that Beats the
Market and You Can Be a
Stock Market Genius. Mr.
Visit us at: Greenblatt is the former
www.grahamanddodd.com Chairman of Alliant Tech-
systems, a Fortune 500
www0.gsb.columbia.edu/students/ Charlie Dreifus, Chuck Royce, Buzz Zaino, Whitney George
organizations/cima/ company and the current
Chairman of Success Royce & Associates, investment advisor to The Royce
Charter Network, a net- Funds, is one of the industry’s most experienced and
work of charter schools in highly respected small-cap investment manag-
New York City. He is an ers. Founded in 1972, Royce & Associates has produced
Adjunct Professor in Fi- outstanding returns over its 40 year history by main-
nance at Columbia Busi- taining its value-oriented discipline regardless of market
ness School and a gradu- movements and trends. G&D sat down for a group in-
ate of the Wharton MBA terview with portfolio managers Chuck Royce, Charlie
program. Dreifus, Whitney George, and Buzz Zaino.
(Continued on page 4) (Continued on page 23)
Page 2

Welcome
We are pleased
back to
toanother
present year
you an adjunct member of the Co- nate to be granted a group in-
with
of Graham
Issue XV
& Doddsville.
of Graham &We lumbia Business School faculty, terview with Chuck Royce,
Doddsville,
are delighted
Columbia
to bringBusiness
to you describes his shift from special Whitney George, Charlie
the 16th edition
School’s student-led
of Columbia
invest- situations investing to a for- Dreifus, and Buzz Zaino
ment newsletter,
Business School’s co-sponsored
student-led mula-based approach. He de- from Royce & Associates. This
by the Heilbrunn
investment newsletter,
Centerco-for scribes how the most glaring quartet of legendary small cap
Pictured: Bruce Greenwald at Graham & Dodd
sponsored by theInvesting
Heilbrunn and inefficiencies in the market investors speaks candidly about
the Columbia Student Invest- the Columbia
Center for Graham
Student
& Dodd
Invest- today are caused by a wide- the similarities and differences of
ment Management Conference ment Management
Investing and the Columbia
Association. spread focus on very short- their respective investment
in February 2012. Student Investment Manage- term performance which isn’t styles – from the importance of
The Heilbrunn Center sponsors ment
TOO Association.
ADD likely to abate any time soon. meeting with management to
the Applied Value Investing pro- Mr. Greenblatt notes that de- the safety of a clean balance
gram, a rigorous academic cur- Now
Pleaseinfeelits free
seventh year, Gra-
to contact us if spite the market’s run this sheet. They also detail how
riculum for particularly commit- ham & Doddsville is still going year, he still believes it is cheap they believe small-cap investing
you have comments or ideas
ted students that is taught by strong. We would like We to offer based upon the measures that has changed over time, and how
about the newsletter.
some of the industry’s best prac- ahope
special
youthank
enjoyyou to Anna
reading Graham he follows. it has impacted where they find
titioners. Baghdasaryan
& Doddsville asand muchJoeasJaspan,
we ideas.
last
enjoyyear’s
puttingeditors, for showing
it together! Jim Tisch and Joe
us the ropes and ensuring that Rosenberg from Loews Cor- This issue also contains pictures
the product
- Editors, presented
Graham to you
& Doddsville poration detail some of the from the 2012 “From Graham
last year, in three spectacular history behind a few of their to Buffett and Beyond” Dinner,
issues, was of the highest qual- best investments. Mr. Tisch which takes place each May in
ity. We would also like to expands on the importance Omaha, Nebraska. We thank
recognize Graham & permanent capital has had on our featured investors for shar-
Doddsville’s founders, Joseph his investment style and the ing their time and insights with
Esposito, Abigail Corcoran, and inherent dangers in acquiring our readers. Please feel free to
David Kessler. What you are companies. Mr. Rosenberg, contact us if you have comments
reading today is a product of who recently celebrated his or ideas about the newsletter as
their initiative and inspiration. 50th year on Wall Street, re- we continue to refine this publi-
counts how he got started in cation for future editions. We
Now on to our distinguished the industry. He also shares hope you enjoy reading this
Pictured: Heilbrunn Center and diverse lineup of successful with us his introduction to issue of Graham & Doddsville as
Director Louisa Serene Schnei- value investors as well as some Larry Tisch many years ago and much as we have enjoyed put-
der at the CSIMA conference in of the interesting topics you what brought him to Loews, ting it together.
February 2012. will see them address in the his home since 1973.
Louisa skillfully leads the Heil- following pages. Joel Green- - G&Dsville Editors
brunn Center, cultivating strong blatt, now in his 17th year as We were also extremely fortu-
relationships with some of the
world’s most experienced value
investors and creating numerous
learning opportunities for stu-
dents interested in value invest-
ing. The classes sponsored by
the Heilbrunn Center are among
the most heavily demanded and
highly rated classes at Columbia
Business School.
Alex Porter and Jon Friedland of Porter Panelist of Judges at the Pershing Square
Orlin with the first and second place Value Investing and Philanthropy
finishers at the Moon Lee Prize Challenge which was held in April 2012
Competition which was held in January at the Center for Jewish History
2012 at Columbia Business School
Page 3
2012 “From Graham to Buffett and Beyond” Dinner, Omaha
Panel: Prof. Greenwald, Mario Gabelli, David Winters, Tom Russo Greenwald making a point
Russo explaining Nestle Winters answering a question Russo posing with audience
Gabelli with Columbia students and Louisa Schneider Gabelli in a light moment
Page 4
Joel Greenblatt
(Continued from page 1) year as undergraduates.
G&D: Professor Green- “… when I was a When we first joined that
blatt, what was your intro- program in our senior un-
duction to investing and junior, I read an dergraduate year, I had told
who were some investors him about some of the read-
who directly or indirectly article in Forbes ing I had done regarding
influenced you early in your Graham’s belief that formu-
career? about Ben Graham.
las could be used to deter-
The article outlined mine profitable investments.
JG: I went to Wharton, We decided to do a mas-
and, as they still do today, how he had this ter’s thesis with another
they taught the efficient good friend of mine analyz-
market theory. This didn’t formula to beat the ing Graham’s approach. At
resonate with me all that the time, we didn’t have
well. Then, I think when I market, provided an access to a database of
Joel Greenblatt
was a junior, I read an arti- stock market information.
cle in Forbes about Ben explanation of his
Standard and Poor’s used to
Graham. The article output out a Stock Guide with
lined how he had this for-
thought process, and
some balance sheet and
mula to beat the market, described “Mr. income statement informa-
provided an explanation of tion on about 5,000 compa-
his thought process, and Market” a little bit. I nies monthly. The school
described “Mr. Market” a library had about 10 years’
little bit. I read that article read that article and worth of these guides.
and a light bulb went off – I
thought: “boy, this finally a light bulb went off –
Not having access to a data-
makes some sense to me.” base, we actually went to
I thought: ‘boy, this
the library. We wanted to
I started reading everything finally makes some go back and test Graham’s
I could by Benjamin Gra- formulas, so to speak. So
ham. I also read a book sense to me.’ ” we went to the library and
called Psychology and the manually went through the
Stock Market by David Dre- G&D: You spent some S&P stock guides. We
man. He was one of the time with Richard Pzena, started with the A’s and B’s,
first people to focus on be- who happened to be the which covered about 750
havioral finance and was first interviewee for Graham companies, and analyzed
really ahead of his time. I & Doddsville, while at Whar- eight or nine years’ worth
started reading about Buf- ton. Do you have any sto- of financial data. It was very
fett and his letters. All that ries or anecdotes that you time intensive. Rich was
stuff resonated very well could share from your time also very good with com-
with me. I would say that together at Wharton? puters. We had a DEC10
I’m self-taught in that sense. computer that was about six
I learned the basics, I under- JG: Sure. We were in the times the size of this room.
stood how to tear apart same program and were Rich knew how to take the
balance sheets, income also the same year at Whar- data that we had all com-
statements, and cash flow ton. We were in an under- piled and, with the little
statements from school and grad/grad program where punch cards, get the data
from growing up in a busi- you earned your MBA and into the computer. So we
ness family, but my under- undergraduate degrees in were able to test some sim-
standing of the stock market five years. We were in that ple Graham formulas. That
really came from my own same cohort. I became work ended up actually get-
independent reading. friendly with Rich in our last (Continued on page 5)
Volume
Issue XVII, Issue 2 Page 5
Joel Greenblatt
(Continued from page 4) the book in ’95 or ‘96. I is that they make a lot of
ting published in the Journal also started teaching at Co- money, and then they get a
of Portfolio Management. lumbia in ’96. I hadn’t little too big to invest in
taught MBAs yet. So when I some of the smaller situa-
G&D: How long did you was writing the book, I did- tions that are out there. In
spend on that? n’t realize that I was really the book I wrote that some
writing it at an MBA level. I of these opportunities are
JG: That was many hours; I had assumed that because I less liquid or smaller, so a
really couldn’t tell you. I had been doing it so long, lot of people aren’t looking
guess my time was cheaper individuals knew a lot more at them as a result. I think
back then! than they actually do. in the book I said something “What happens to
to the effect of: “don’t people who become
G&D: What inspired you So I ended up writing a worry about getting too big
to write You Can Be a Stock book that most hedge fund for these strategies until you
Market Genius?
very good at special
managers have read, but get to about $250 million.
one which was perhaps at a When you get there, give situation investing is
JG: The motivation for me little higher level than I had me a ring.” I would bump
was the recognition that I intended. I wrote it accessi- that number up to over $1 that they make a
had really learned about the bly, so I had fun writing it, billion today. You can’t run
business from reading. I but I think it was at more of $10 billion and get ridicu- lot of money, and
thought it was pretty cool an MBA level, not just a lous rates of return, most
that these investors had then they get a
regular investor level. I likely. A few people can,
been willing to share with think that was a mistake but they have a large staff,
readers what they knew and
little too big to
that I made because I was or they have concentrated
had learned during their looking to educate a much positions. invest in some of
careers. I’m not a very more needy bunch than
good listener, so I like to MBAs and hedge fund man- There are still many strate- the smaller
learn by reading. When I agers. That was really one gies in that book that could
was in school, there were of the things that drove me make you a lot of money. I situations that are
two things that seemed like to continue writing until I think that these opportuni-
interesting pursuits if I ever out there...people
could accomplish my origi- ties are out there. Since I
became successful: one was nal goal. I am very proud of wrote Stock Market Genius,
to write and one was to
aren’t looking at
that book, but I just think we had an internet bubble
teach. it’s written at such a level where people were pricing them as a result.”
that you have to be fairly things stupidly, and then we
We ran outside capital at sophisticated in financial had 2008, where stocks
Gotham Capital for ten analysis, at least, to fully halved and a few years later
years and then returned the profit from its advice. they doubled. So to say
outside capital in ‘94, though assets were accurately
we continued to run our G&D: Given the prolifera- priced all along, or that
own money. We had been tion of hedge funds since there were no opportuni-
quite successful during that the Stock Market Genius’s ties, or that the market
time and so I thought that if release, are the opportuni- doesn’t get very emotional
I put together a group of ties in some of those same and throw you opportuni-
war stories as examples and types of special situations ties, is kind of silly in my
described the principles that similarly available today? mind. That doesn’t make it
I had used to make money, easy to tune out all of the
it would be very instructive JG: I think they are. I think noise that’s out there, but
for people. I wanted to there are always opportuni- there are still ample oppor-
write it in a friendly, accessi- ties. What happens to peo- tunities that one can find.
ble way so that individual ple who become very good
investors could profit from at special situation investing (Continued on page 6)
it as I had. I started writing
Page 6
Joel Greenblatt
(Continued from page 5) professionals systematically agency problem where the
My definition of value in- avoid companies that are people who are allocating
vesting is figuring out what perhaps not going to do as the capital are not making
something is worth and pay- well in the short term. In the investment decisions. I
ing a lot less for it. I make a some ways, there’s actually was talking to a gentleman
guarantee the first day of more opportunity in those at one of the top endow-
class every year that if areas now than ever before ments, and he said, “I would
you’re good at valuing com- due to the greater institu- like to tell you that we have
panies, the market will agree tionalization of the market. a long-term horizon, be-
with you. I just don’t guar- cause we should. But I’ve
antee when. It could be a True, there are some areas been here 11 years, we’ve
“I make a couple weeks or it could be that are more followed. For had three chief investment
guarantee the first two or three years. And instance, I wrote about spin- officers, and none of them
the corollary is simply that, offs in Stock Market Genius. left after a period of positive
day of class every in the vast majority of cases, Of course a lot of people performance.” Jeremy
two or three years is follow spin-offs, yet if you Grantham spoke at a Gra-
year that if you’re enough time for the market look at the studies, they still ham and Dodd Breakfast
to recognize the value that seem to outperform the several years ago and one of
good at valuing you see, if you’ve done good market after they’re spun his lines that I thought was
valuation work. When you off. Certainly a lot of the funny, and probably very,
companies, the put together a group of smaller situations are the very accurate, was: “for the
market will agree companies, that process can situations where there is a best institutional investors,
often happen a lot faster, on huge dichotomy in size or their time horizon is
with you. I just average. One argument I popularity between the par- 3.000000 years.” That is
make in another one of my ent company and the spin- the horizon for the best.
don’t guarantee books (which few have off. These opportunities are For many institutional inves-
read), called The Big Secret still there, partly because tors, it’s even shorter. So I
when. It could be a for the Small Investor, is that some are too small for most think that’s about all you
the world has become firms to take advantage of. can hope for as an invest-
couple weeks or it much more institutionalized Other opportunities are the ment manager.
over the years, even more result of volatile emotions in
could be two or
than it was when I wrote the market. Given the insti- I think the reason for this is
three years. You Can Be a Stock Market tutionalization of the inves- that your investors – your
Genius, and that is a real tor base, the fact that mar- clients – generally just don’t
advantage for longer-term kets are emotional, and the know what the investment
investors. For institutional fact that there are still lots manager’s logic was for each
investors, you can track all of nooks and crannies out investment. What they can
money flows by one simple there that even successful view is performance. It’s
metric – which managers hedge funds can’t pursue, pretty clear that for mutual
did well last year and which I’m not concerned about funds, for instance, the per-
did poorly. Managers who the size of the existing op- formance of a given fund
did well last year attract all portunity set. over the last 1, 3, 5, and 10
the money and managers years has very little correla-
who did poorly lose the G&D: Do you see anything tion with the future per-
money. that could lengthen institu- formance for the next 1, 3,
tional investors’ time hori- 5, and 10 years. So institu-
If you’re an active manager, zons, thereby reducing the tional investors are left with
you may have a long-term “time arbitrage” from which predicting who’s going to do
horizon but your clients many value investors profit? well in the future, which
probably don’t. So, most they attempt to do by look-
managers feel that they JG: No, not really. The ing at the manager’s proc-
need to make money over reason is that there is an (Continued on page 7)
the short term. Therefore,
Volume
Joel Greenblatt
(Continued from page 6) So we tested the principles based on quantitative meas-
ess. For most clients, the behind what we look at ures indicating that they
manager’s process is not when we value companies. were both cheap and good,
transparent and the ration- The results were very ro- performed better than
ale behind investment deci- bust. My write-up of the those in the second decile,
sions is not clear. Clients which performed better
tend to make decisions over than those in the third, and
“...those companies Pictured: Bill Miller of Legg
much shorter time horizons so on in order. It was quite
than are necessary to judge Mason Capital Management
that were in the top powerful and surprising. It at CSIMA Conference in
skill and judgment and other just started us on a long February 2012.
things of that nature. So I decile, based on path of research which tried
think time horizons are get- to systematize the way we’d
ting shorter, not longer. quantitative always valued companies.
We’re not in danger of peo- We were able to achieve
ple expanding their time measures indicating
very robust long/short re-
horizons when they’re judg- turns. We were able to add
that they were both
ing managers. I think time as much value on the short
arbitrage will be the “last cheap and good, side as we were on the long
man standing,” pretty side. So we were able to
clearly. performed better create very diversified long/
short portfolios with rela-
G&D: Your career has than those in the tively smooth returns. We
really been, from an invest- didn’t even know we could
ment standpoint, composed second decile, which
do that before seeing the
of two parts. Earlier in your results of our research.
career, you made more performed better
concentrated investments in than those in the There’s absolutely nothing
special situations. Now, you wrong with what I wrote in
invest in a more diversified third, and so on in You Could Be a Stock Market
manner in higher quality Genius – it’s what I did for
companies. What drove order. It was quite almost 30 years. But about
this shift? three or four years ago, my
powerful and
partner and I decided that
JG: I already talked about conducting really in-depth
the research we did on Gra- surprising. It just
research on a handful of
ham’s strategies. Around started us on a long companies is a full-time job
2003, my partner, Rob if you want to do it well.
Goldstein, and I decided to path of research Alternatively, more system-
do some research on our atically valuing a large num-
own strategies, which had which tried to ber of companies over time
evolved to resemble the is a huge job itself due to
way Buffett looks at the systematize the way
risk management and other
world. Graham’s invest- responsibilities. Though
ment world view was to we’d always valued
they’re a little different,
“buy it cheap.” Buffett companies.” both strategies are great
added a little twist that and they’re both full-time
probably made him one of results of our very first test jobs. I had been doing one
the richest people in the formed the basis for The thing for a long time and I
world. He essentially said, Little Book That Beats the was fascinated by our re-
“well if I can buy a good Market. The upshot was search results of the sys-
business cheap, that’s even that those companies that tematic valuation approach.
better.” were in the top decile, (Continued on page 8)
Page 8
Joel Greenblatt
(Continued from page 7) pretty good stock pickers JG: When we buy things,
When you are very concen- over history, and we have we like companies that in-
“Part of the future trated, you have the chance not been able to improve vest their capital well; they
to make 20, 30, 40% annual- our results by picking the generate large amounts of
is unknowable but ized returns. Perhaps if I’m things that we clearly don’t cash flow relative to the
willing to accept somewhat want. There’s a certain price we’re paying. On the
there are some lower returns, say mid- medication on the market short side, we would like to
teens, and achieve a that’s made by a small phar- be short, in general, high-
instances where you smoother return com- maceutical company. This priced, cash-eating compa-
pounded at the same time, company was considered a nies. So it is essentially the
can take a then that’s pretty attractive very attractive buy accord- opposite of our long ap-
calculated risk/ too. One approach is not ing to one of our screens. proach. You do have to
better than the other. But I knew why it looked balance your risk, though.
reward bet. One There’s an interesting trade- cheap – its key medication
off between how much vola- was coming off of patent the In the original edition of The
thing I would say is tility you’re willing to accept next year and the stock was Little Book That Beats the
and how much money priced accordingly. My incli- Market, I grouped the
that a common you’re potentially going to nation could have possibly “magic formula” stocks as I
make. If I were starting all been to override the formu- called them – or stocks
characteristic of over again, I’d do exactly laic recommendation be- which were systematically
many of the stocks what I did before. And now cause I knew exactly what considered good and cheap
that we’re well established, I was going on. It wasn’t like – into deciles. Decile one
that we buy is that think the main attraction of it was a big secret. I didn’t was the best combination of
the systematic approach is override anything, however, good and cheap. Decile two
everyone hates that it’s something a bit new and the company subse- was the second best, and
and different, although I quently figured out a way to the tenth decile was com-
them. We do that a would reiterate that it’s extend the patent a little posed of companies that
really the same thing that longer which then led to a earn lousy returns on tangi-
lot.” we’ve always done with just doubling of the stock price ble capital, yet nevertheless
a slightly different approach. over the next six months. I were expensive. There was
think that’s really been our a big performance spread
G&D: We’ve heard other experience. Part of the between decile one and
investors who use their future is unknowable but decile ten when we did the
own formulaic approach to there are some instances study, and it worked in or-
investing say that, from time where you can take a calcu- der as I mentioned earlier.
to time, they get an itch to lated risk/reward bet. One Decile one beat two, two
change their model or to thing I would say is that a beat three, three beat four,
otherwise override it. Have common characteristic of all the way down through
you ever had this urge and many of the stocks that we decile ten. Pretty much
is it difficult to resist? buy is that everyone hates every student I’ve had, and
them. We do that a lot. hundreds of e-mails after
JG: The only way Rob and I the book was published,
know how to value compa- G&D: You mentioned tak- have said, “Joel, I have this
nies is through various ing short positions earlier. great idea for you. Why
measures of absolute and Can you be successful in don’t you buy decile one
relative value. Of course it this area merely by shorting and short decile ten? You’ll
won’t work for every com- the companies in the lowest take out the market risk and
pany, but on average it deciles of your screens – you’ll make 15% or 16% a
works quite well. There are that is, by systematically year.” I did that experiment
some companies that we doing the opposite of your in the afterword of the re-
buy that might make you long approach? vised addition of The Little
scratch your head. On the (Continued on page 9)
other hand, we’ve been
Volume
Joel Greenblatt
(Continued from page 8) the 87th percentile towards one I choose works out. It
Book, and the results cheap, meaning that the doesn’t matter that I missed
showed that you couldn’t market as measured by the out on 11 or 12. Not losing
figure out a compounded Russell 1000 on a free cash money is a good way to
rate of return because you flow basis has only been ensure that your portfolio
lost all of your money. cheaper 13% of the time has a good risk/reward pro-
Somewhere around the first over the last 23 years. file. One of the things I said
quarter of 2000, the shorts When it has been this in You Can Be a Stock Market
went up a lot and the longs cheap, the forward return Genius is if you don’t lose
went down such that the for the Russell has been money, most of the alterna-
combined loss was so se- about 17% and then about tives are good. Even if you
vere you went broke. the mid-30’s two years out. don’t know what the upside
That’s not to say that the is – if you just know there’s
There were a couple things market’s prospects are bet- upside – you can create
a bit unfair about that be- ter or worse going forward scenarios where you have
cause we kept the portfolios – they’re probably a little an excellent risk/reward.
for a year, and we didn’t re- below average for the for- Positions with limited down-
adjust as we lost money. ward period and therefore side are the types of posi-
What I was trying to show you could say that perhaps tions that I have loaded up
at a high level was that if I you won’t do quite as well on in the past. Not the
wrote a book that had a as would be implied by his- positions with the biggest
formula and it worked every torical returns. But, even in payoff. I could buy a lot
day and every month and the 50th percentile, you knowing that I wouldn’t lose
every year, everyone would would expect to make 8% much and that there were
use it and it would stop or 9% based on the history good possibilities that it was
working. So, the magic for- of the last twenty-something worth a lot more over time.
mula, like all value investing, years, so I would just say At the very least, I knew
can give you noisy returns that if I had a choice be- that my downside was well-
over the short term, but tween being more long or protected and so I could
that’s also why it continues more short, I’d be more create an asymmetric risk/
to work. long. It’s a very attractive reward by saying if I don’t
time to invest in the market, lose much, there are not
G&D: In class, you talked despite the run-ups that many alternatives other than
about how you try to assess we’ve seen in the last year. to make money.
how cheap or expensive the
market is at any point in G&D: Harkening back to Something else that I’ve said
time. Can you talk about the first part of your invest- in my class is that if you are
your views on the market ing career, you talked about trying to analyze an invest-
today and how you look at passing on ideas. How ment and there’s a lot of
it? many ideas did you pass on uncertainty regarding a
for every idea that you company – whether it’s new
JG: Sure. Well we’ve ended up acting upon? technology or new competi-
looked bottoms-up at each tors, or something else – or
stock in the Russell 1000 JG: It’s a tough one. I the industry in general is
Index, the thousand largest would say it obviously de- uncertain such that it’s very
stocks in the U.S. by market pends on how selective you hard to predict what’s going
cap. We’ve looked at those are. If I looked at 40 or 50 to happen in the future, just
over history, meaning the ideas, and, while perhaps 12 skip that one and find one
market-cap-weighted free or 13 of them would have you can analyze. If you in-
cash flow yield of the Rus- worked out, if I end up only vest in six or eight things
sell 1000 on each day over buying one, that’s okay. that you’ve analyzed closely,
the last twenty years and That’s fine as long as the (Continued on page 10)
right now we’re in about
Page 10
Joel Greenblatt
(Continued from page 9) value certain companies way to go. You’re not
and if you’re pretty good at well. And that’s what I throwing all of your money
“If you’re a long- valuation and you have a would think about doing. into one business, you’re
term holder and long time horizon to see picking six or eight busi-
your target valuation even- G&D: With respect to nesses that you researched
you own a chain of tually play out, then you’re your risk management strat- carefully; have strong man-
going to do incredibly well egy, appropriately sizing agement and look like they
stores in the even if you’re right on only positions has traditionally have good franchises. That
four or five of the ideas. been one area of focus for sounds fairly conservative to
Midwest and This is especially true if you you, correct? me. That’s how I look at
include a margin of safety so owning a portfolio of stocks.
something bad that you’re not losing too JG: Yes, people would say Once again, they’re not
happens to Greece, much on the ones where ‘how can you own only six pieces of paper that bounce
you’re wrong. or eight companies,’ be- around.
there may be some cause during a lot of my
What I said in the beginning career, six or eight positions If you’re a long-term holder
small impact, but is true: if you’re good at represented 80+% of my and you own a chain of
valuing businesses, the mar- portfolio. People thought stores in the Midwest and
you’re not going to ket will eventually agree that was crazy because of something bad happens to
with you. But that’s eventu- the volatility and the Sharpe Greece, there may be some
sell your business ally. It could be in a couple ratio or whatever you might small impact, but you’re not
for half of what you weeks or a couple years, want to look at, but the going to sell your business
and that’s a big difference. point is that I look at it dif- for half of what you think
think it’s worth all The traditional definition of ferently. I look at stocks it’s worth all of a sudden. If
arbitrage always went some- not as pieces of paper that I’m a shareowner in busi-
of a sudden. If I’m thing like this: buy gold in bounce around. I look at nesses, I need to have a long
New York and sell it simul- them as ownership stakes in -term perspective that
a shareowner in taneously in London, and businesses. things will work out roughly
you’ll make a dollar. But if I as I expect, otherwise I
businesses, I need to told you, “well, I guarantee One of the examples that shouldn’t own them.
have a long-term you’ll make a dollar, but you Buffett gives is as follows:
could lose half of your suppose you sold your busi- G&D: Is there something
perspective that money first, and it could ness and you had $1 million. in your background that
take three years for you to You walk into a town and made you predisposed to
things will work out make that dollar, and it’s you want to invest the having a long-term mindset
going to bounce around money conservatively. You and a commitment to ensur-
roughly as I expect, randomly in the interim,” might look around and see ing a margin of safety for
that’s not quite arbitrage in that there are 50 businesses each investment, or is this
otherwise I the traditional sense. It’s in the town but you want to something which you devel-
shouldn’t own certainly not riskless arbi- try to pick ones that you oped over time?
trage, but it is a type of arbi- think have a nice future that
them.” trage – it’s a type of time you could buy at a reason- JG: This is a mindset I de-
arbitrage. That’s very hard able price. If you pick six or veloped as early as an un-
for people to do. Throw in eight of them, most people dergraduate student. As I
the fact that you don’t al- would think that owning a mentioned earlier, I became
ways get the valuation right. stake in the barbershop, the interested in this business
Yes, if you did good valua- hotel, and whatever other by reading Ben Graham.
tion work, the market will businesses you thought had That’s what resonated with
agree with you. I would nice repeat customers that me, so what can I say? Mar-
submit that most people would continue to grow gin of safety and how to
cannot value most compa- over time as the town grew, think about Mr. Market are
nies well. If you’re very was a pretty conservative (Continued on page 11)
selective, however, you can
Volume
Joel Greenblatt
(Continued from page 10) those who fail is perspective and that the thought proc-
things that I thought about – the viewpoint of how they ess was clear. Those who “The difference
very early in my investing look at the market – which think clearly, stand out.
career. Graham’s tenets really just comes back to Some people are good at it; between those who
seemed logical and simple – Ben Graham and keeping some people are great at it.
simple enough even for me are successful and
that long-term horizon and I’ve graded a zillion papers
to understand actually! So I understanding how to filter and I’ve talked to many peo- those who fail is
started reading and thinking out the noise. People are ple, and I’ve listened to
and experiencing. Some bombarded left, right, and many ideas over time. perspective – the
things you have to learn by center with information, There is a certain thought
doing them wrong, so I en- even more so now; you can process and clarity of viewpoint of how
courage people to risk being bury yourself as much as thought that those who are
wrong. You can’t be a good you want. Therefore, you great at it have. Or maybe they look at the
investor without investing. need a simple filter through they’re going through the
As you gain experience you market – which
which to look at the world. steps that I would hopefully
start to understand risk/ Those who have a baseline go through if I were looking really just comes
reward; you start under- from which they can really at the same idea. It doesn’t
standing what looks like a contextualize everything mean that what they’re say- back to Ben
good opportunity and what they look at are the people ing will always work out, but
doesn’t; you recognize who are successful. A lot of it does indicate that they Graham and
when you have more things are driven by emo- could have a pretty good
knowledge than the market tion. When things get batting average over time. keeping that long-
about a given issue and bouncy, as long as I con- It doesn’t mean that there
when you don’t. So it’s a term horizon and
tinue to believe that my aren’t other ways to make
matter of comparing situa- work was good, and my money – those just aren’t understanding how
tions to your history of op- thought process was right, I my areas of expertise. In
portunities. I’ve also said in have to ride it out. As easy my circle of competence, I to filter out the
class that one of the impor- as it sounds, it’s really hard can perhaps recognize other
tant things to look at is not to do. people that think similarly, noise.”
just what’s available now but who I think do the work,
what you think might be G&D: Over the years and that’s really who I’m
available in the future, and you’ve seeded some differ- drawn to over time.
that perspective comes with ent investors – Robert
time. Goldstein, Brian Gaines and G&D: A couple of school
some others along the way. related things… Do you
Here’s the other thing – Was there some commonal- find it more difficult teaching
unfortunately you don’t ity that you saw amongst what you know about in-
learn from your successes these investors that gave vesting to MBA students
all that much; you learn you the confidence to pro- than actually investing? Are
from the things you vide them with capital rela- there parts that are more
screwed up. You have to tively early in their careers? difficult or frustrating for
screw up a little bit to learn you?
what not to do again and to JG: I really just look at
remember it as well. But thought process. I found JG: This is my 17th year
you have to combine this them before they had a teaching, so I think that the
with the right thought proc- track record, right? So you frustrating part was present
ess, which I think is the key. want to find people who more so when I first got
There are a lot of smart think correctly. When I started. I wasn’t particularly
people out there. A lot of listen to an investment pitch good at expressing myself
people have financial skills or an investment thesis, I’m and what I was thinking
and most of them fail. The looking to see if all of the early on. The great part
difference between those right questions were asked (Continued on page 12)
who are successful and
Page 12
Joel Greenblatt
(Continued from page 11) hadn’t gone up in 13 years, successful with them, that
about teaching is that you so it wasn’t a very popular they use that success for
really have to boil down to thing to do. There have good. In other words, I ask
the basic principles of why been waves. During the my students to figure out a
you did certain things and internet bubble, teaching way to give back in some
why you didn’t, what has value investing was, let’s just way that’s meaningful to
been successful and what say, not appreciated as them.
has not. You boil that down much. I would say that the
into some principles that growth of the hedge fund G&D: On that note, we
Pictured: Ellen Ellison people can learn to use so business and the money know that the Success
(Executive Director of that they can do well them- management business over Academy Charter Schools
Investments at University selves. Learning to do that the years has caused more organization is something
of Miami) at CSIMA Con- has actually been very help- people to be interested in about which you’re particu-
ference in February 2012. ful to me – it was helpful in larly passionate. Could you
writing, it’s been helpful for tell us a bit about this or-
my own investing. I try to “I just ask that if
ganization?
sit down and figure out
they learn the skills
what’s the best way to ex- JG: Sure. It really goes
plain something that I’m in the class and are back to teaching a man to
looking at in a very simple, fish. You want to give back
straightforward way. If you successful with in a way that’s leveraged and
can’t explain it very simply that allows you to help
and straightforwardly, then them, that they use someone have a nice life
you probably don’t under- that might not have that
stand it all that well your- that success for
opportunity otherwise. You
self. I’m not a rocket scien- could do this in such a way
good. In other
tist and none of this is whereby they’re helping
rocket science. It is just words, I ask my themselves and doing it with
about understanding some the tools that you give
very simple, basic principles students to figure them.
that for some reason many
people can’t stick to. But out a way to give Education to me is one of
there are others who can. the most leverageable ways
Columbia MBAs have tools back in some way
to give back. Typical public
to be successful investors school systems are soviet-
that’s meaningful to
but many won’t be. Some, style systems, where there
however, if they have the them.” are no rewards or punish-
right mindset and the right ments for good or bad per-
work ethic, will be success- this area. formance. The usual excuse
ful. I think it’s become a more for the lack of success of
popular field and that’s why, kids in need is that there is
G&D: As you said, this is on the first day of each se- not enough money or that
your 17th year teaching. mester, I tell my students the parents don’t care or
Have you noticed any that I don’t think that that the kids are stupid.
change in the students over there’s a great social value Those are usually the rea-
the years? from this career. On top of sons given. Rather than
that, if I’m teaching it, that’s argue against those points –
JG: I think the “money even one more step re- because I’m not very politi-
management business” has moved from doing some- cal – what I hoped to do
become more popular over thing socially valuable. So, I through the Success Acad-
the years than it was when I just ask that if they learn the emy was to be involved in a
got started. I took my first skills in the class and are (Continued on page 13)
job in 1981 and the market
Volume
Joel Greenblatt
(Continued from page 12) to do it with less money or putting facts in black and
project where we could use the same money as the state white, we’re able to make a
the same or fewer re- and then to replicate it over nice statement.
sources compared to the and over, which is the really
existing schools and be suc- hard thing to do while keep- G&D: Any other parting
cessful with the same kids. ing the culture and achieve- words of wisdom for our
We thought about it like a ment levels high. Since we readers?
business model – you set up have the same kids as the
a prototype and then you regular public schools, all of JG: If you want to get good
replicate that and refine that Pictured: Julian Robertson
our kids are selected by at investing, read a lot and
process over and over of Tiger Management and
lottery. If the Success practice a lot. Even if it’s Anna Baghdasaryan ‘12
again. My hope was that if schools can show that it can not a lot of money, it’s real (Co-Editor of G&D).
we could replicate such a be done, hopefully they will money. Don’t fool yourself
thing 30 or 40 times with help move the system. into thinking that this is all
the same kids, with less you need to do to
money, then lead a successful life.
those old This is fun for me;
excuses it’s fascinating.
would stop. There’s nothing
Well it’s the wrong with this field
same kids, we but, as I said before,
have less I don’t think there’s
money, and much social value in
parents do it. You can proba-
care and bly say that about a
these kids are lot of occupations
pretty darn that aren’t saving
smart. Even a lives every day, so
kid who may you don’t have to
have been feel bad about it.
considered Pictured: Value Investing Program member Patrick Staub ‘13 But I would just
average in discussing current events with Success Academy students. encourage people
another pursuing an investing career
school can achieve at an The great thing about this who are ultimately success-
extremely high level. business is that if we are ful in it, to figure out a way
successful, other communi- to give back. Many people
We now have 14 schools ties can look at what’s reading this are Columbia
and we’re hoping to build working here and can MBAs and pretty much all of
40. We’ll open another six “steal” the intellectual prop- them are, or will be, suc-
schools next year while erty of the organization. cessful in some field or an-
trying to replicate the suc- The goal is to first demon- other. If you can figure out
cess we’ve had to date. So strate that we’ve been suc- a nice way to give back
far these kids in high-need cessful with this system and that’s meaningful for you,
communities are beating out then share it with as many that’s even more fun than
Scarsdale and all the top people as possible who being successful in whatever
school districts in New want to learn how to do it you choose to do. Keep
York. The problem has too. If it works, hopefully it that in mind.
been replication. You can becomes built into the sys-
always just throw money at tem. Right now every G&D: It was a pleasure
an individual school, turn it school we open is chal- speaking with you, Profes-
into a private school, and lenged in one way or an- sor Greenblatt.
maybe it’ll be very good. other. Hopefully just by
The challenge, however, is
Page 14
Loews Corporation
(Continued from page 1) family has a very significant fleet had built up signifi-
G&D: You were recently stake in Loews, and that we cantly because the amount
labeled the “dealmaker who have a history of over 52 of oil coming out of the
won’t make a deal” in a years with the company. In Persian Gulf was increasing
widely read financial publica- essence it is a follow the dramatically. Then in the
tion due to the fact that fortunes type of thing. early 1980s there was the
Loews hasn’t done a large Iranian oil embargo and as a
deal in over five years de- G&D: We’ve heard about result oil prices shot up and
Joe Rosenberg and Jim Tisch
spite its solid cushion of the famous ‘Jim Tisch $5 demand for oil went down.
investable cash. What’s million test’ that you formu- Since the Persian Gulf is the
your reaction to this? lated aboard an oil tanker in marginal producer of oil,
“Some would say
the 1980s that preceded and since the Iranians had
Jim Tisch (JT): Some your purchase of six oil shut down, there was no
that this pa- would say that this patience tankers. The test is elegant demand for ships. So all of
tience is part of is part of our strategy, but I in its simplicity. Do you a sudden there were three
would say it’s more than look for a way like this to times as many ships as there
our strategy, but that. I’d say it’s part of our synthesize the thesis behind was demand for them. So
DNA. I like to say, “If each investment you make? the oil companies took their
I would say it’s there’s nothing to do, do four and five year old ships
nothing.” We don’t have to JT: So, honest to God, the and they laid them up.
more than that. do deals. We’ve got busi- ‘$5 million test’ originated These ships were such a
nesses that generate income just the way I said it – when drag on the market that
I’d say it’s part and do very well on their I was standing on the deck they were being scrapped
of our DNA. I own. We are constantly of a ship – 30 years so the scrap value of the
looking to improve those younger. It was a way of ship was $6 million but it
like to say, ‘If businesses. We are also saying “Wow! I can’t believe cost $1 million to get from
always on the lookout for how cheap this is!” Then I Europe to the scrap yard in
there’s nothing other companies to add to coined this pithy little Taiwan. So we found them
our portfolio of businesses phrase – the ‘$5 million for $5 million. We bought
to do, do noth- but we don’t feel the need test’. In fact the ships did these ships like you buy
to do it. And we may hear cost $5 million. We bought hamburger meat, but in-
ing.’ ” in the press that we haven’t two of them. It is just a stead of dollars per pound
done something for a while pithy way of saying that of hamburger it was dollars
but we tend not to hear it sometimes something is so per ton of steel. The mar-
from our shareholders. cheap that it is almost be- ket for the ships had col-
You know if you say some- yond belief. It’s like getting lapsed. We thought it could
thing long enough people this building we are sitting in be an interesting investment
will ultimately realize that now for $20 million. because there wasn’t much
you mean it – if you say it downside, as the ships were
consistently. One of the G&D: Have you felt that trading for scrap value, and
things that we say consis- way in general with every we figured maybe something
tently is that we don’t man- deal that you’ve done? good could happen. Once
age earnings and we’re not we got into it and found the
in a rush to add a new busi- JT: No, not a lot of them. right person, sort of seren-
ness. We’ve said this for so But I definitely felt that way dipitously, we really con-
long and so consistently that with the ships. structed for ourselves a
people who select to buy very credible case for how
our stock understand that G&D: What were others the ships can go from scrap
it’s part and parcel with missing? value to being worth a lot of
ownership of the stock. money – which in fact they
These people understand JT: Oh! It’s very simple. In did. The ships cost $50
that I have a very significant the mid-1970s, the VLCC (Continued on page 15)
stake in Loews, that the
Volume
Loews Corporation
(Continued from page 14) market just went up. So we Devanney, and he helped us
million to build. So we have bragging rights in ships get into offshore drilling.
knew there was a long way but that’s about it, because
to go between $5 million we couldn’t put enough Joe Rosenberg (JR): To-
and $50 million before money to work doing more day a deep water rig will run
somebody else would ever deals like the ones we did. you in the ballpark $635
build another ship. The The best part about the million.
other thing we knew is that whole thing was that we
ships were being scrapped, were introduced to Jack G&D: Loews owns compa-
so they were being taken Devanney. He was instru- nies in their entirety and
out of the market forever, mental in helping us get into holds both majority and
never to come back again – the offshore drilling business minority stakes in public
supply was coming down. where we did go in whole companies. Given the dif-
The other thing we saw was hog and were able to make ferent ways you are willing
that at some point the de- some real money. Devan- to invest, have you had in-
mand for oil from the Per- ney, who was a naval engi- stances where being a ma-
sian Gulf was going to in- neering professor at MIT, jority owner of a company
crease again. It was just a had worked on nuclear sub- gave you insight that helped
classic microeconomic case. marines and was the most you invest capital in public
We saw the supply coming academically honest busi- companies, or where devel-
down and the potential for ness person. Jack watched opments in the public mar-
demand going up. We also over our ships for us and ket alerted you to private
understood, because it then one day in 1988 he assets you ultimately pur-
takes three years to make a realized that the offshore chased?
new ship, that the supply drilling market at that point
curve would go vertical at in time was like the tanker JT: You know, I would say
some point. When a supply market seven years prior. I to the extent that we own
curve goes vertical and you asked Devanney to arrange an insurance company,
have a small shift in the de- for us to look at some as- sometimes we’ll invest in
mand curve, you get ex- sets to do our diligence. insurance stocks but not
traordinary increases in Three weeks later we were that often. Likewise, we
rates, which is why there is on the deck of a semisub- don’t invest in offshore drill-
such volatility in shipping mersible rig and the ‘$5 ing stocks because we figure
markets. The people that million test’ came into play we have enough with Dia-
were in the business that again, though the $5 million mond Offshore. So we
owned the ships thought price tag was purely coinci- really keep the different
the ships were a plague on dental. If the rigs had been buckets separate.
the market. They were $7 million we still would
focused on the shipping have bought them. Except G&D: Do you look at
markets and their own need at this time we remembered things from a valuation basis
for the ships. They weren’t to go big. We bought a differently for these differ-
thinking like an investor or small company in 1989, ent types of ownership
speculator. again serendipitously, called stakes, given that when you
Diamond M Drilling. Dia- own a company outright or
We bought two ships from mond owned seven rigs and have a majority stake you
Shell, three ships from we already owned three have more impact on capital
Exxon, and then a few oth- prior to that. In 1992 we allocation decisions?
ers. The problem we had went big when we bought a
was that the day we decided company called ODECO, JT: We only have control
to go into this whole hog it which owned 30 rigs or so. over the cash flows to the
was like somebody had a tap So, doing the deal for the extent that either, one, the
or bug in the room and was ships introduced us to Jack (Continued on page 16)
eavesdropping on us. The
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Loews Corporation
(Continued from page 15) good about those busi- moved from someone an-
cash is reinvested in that nesses and bid them up in swering questions at the
“...Even though we business or two, the com- the marketplace, it will inure information desk to being a
pany pays a dividend and we to the benefit of Loews sellside junior analyst. I
are the control get the cash up to Loews. shareholders through a started following the airline
We can only use it for higher valuation based on industry. There was no
shareholders, we Loews once it’s paid out to the sum of the parts valua- senior transportation ana-
us and to other sharehold- tion for Loews. lyst at Bache, and no one
need to treat the ers in the form of a divi- wanted to cover the indus-
minority like they dend. What we do with G&D: Joe, what was your try because they thought it
each of these businesses is introduction to investing? was a dead end following
are the majority work with the management Do you remember any good airlines. From the beginning
and come up with an inter- investment ideas from your of the airlines industry in
because the mediate- and long-term early days? the mid-1920s until today,
strategic plan for them that they’ve never made any
valuation of Loews focuses on the finances and JR: Actually I didn't start money if you took the ag-
also focuses on the capital college until I was 24. Two gregate of the business. But
is driven based spending. Then we figure weeks after high school, I in 1962, which is when I was
upon the value of out what earnings or what went to Israel for three analyzing the sector, I got
cash they have in the com- years. I came back to the the sense that there was
our subsidiaries. To pany that could be available States, joined the army, and something dramatic going
to pay dividends – that’s within a year I was stationed on in the industry in the
the extent that the how the dividend policy is in Germany. After return- form of conversions from
determined. We like get- ing from Germany, I went piston air planes to jet air
minority ting cash back but we also to college at night, I really planes. Most old-line trans-
want to make sure that the didn’t know anything about portation analysts covering
shareholders of our companies only pay divi- Wall Street. One day a the industry thought only
subsidiaries feel dends after we are abso- friend of mine and I were about how expensive it was
lutely, positively sure that sitting on the floor of the going to be to make this
good about those they aren’t going to need apartment we had, as we transition. What I saw was
the cash at the parent. We didn’t have any furniture, that the planes would fly
businesses and bid currently have three major- and we were talking about two to three times the
ity-owned companies (CNA an investment idea. He rec- speed with the same num-
them up in the Financial, Diamond Offshore ommended that since I ber of crew members. It
Drilling, and Boardwalk loved talking about invest- was a reduction in unit la-
marketplace, it will Pipeline Partners) that are ment ideas so much, I bor cost. This was one of a
inure to the benefit public, and we also used to should pursue a career in few times in history when
have a tobacco company the field. I tried getting a you could make money with
of Loews (Lorillard) that was public job on Wall Street but no airlines and I was in the
through Carolina Group. one would hire me, since I right place at the right time.
shareholders…” So we are accustomed to was still in college. I didn't I didn't fully understand
being a control shareholder. even have a bachelor’s de- what I was doing, which was
The thing that we found out gree and at this point I was fortunate because I would
over the years is that even 26. have been more fearful. I
though we are the control started recommending air-
shareholders, we need to Shortly after finishing col- lines and they had a mete-
treat the minority like they lege I started working for oric 10-fold rise.
are the majority because the Bache & Co. (now part of
valuation of Loews is driven Prudential). I really took to After Bache I moved to Em-
based upon the value of our it like a duck to water. I pire Trust Company on the
subsidiaries. To the extent was very serious about it. buy side and, in the eve-
that the minority sharehold- In pretty short order, I (Continued on page 17)
ers of our subsidiaries feel
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Loews Corporation
(Continued from page 16) summer off and joined two fellows who look over
nings, took classes at NYU Loews in the fall of 1973. our subsidiaries. One han-
for my MBA. I soon be- Three or four years into my dles Boardwalk and High-
came head of research at career, Larry walked into Mount and the other han-
Empire Trust. Then, in my my office and mumbled that dles Loews Hotels, CNA,
final year of business school his son Jimmy was coming and Diamond Offshore.
I wrote my thesis on the to Loews, and he was going Then we have a develop-
airline industry. What was to be working for me. I ment officer who is charged
happening then in the airline asked Larry what he wanted with looking for other busi-
industry is the same thing me to do with Jimmy and he nesses for Loews to pursue.
that happened to the tanker said, “Why don't you take Our subsidiaries tend to
industry some 20 years half an hour and tell him have their own develop-
later. Airlines became so everything you ment people who look for
profitable that they soon know.” (Laughs) I still re- businesses that they buy.
became unprofitable be- member his first assignment. Our development officer
cause they began over- I asked him for a spread- has five analysts working for
ordering equipment. From sheet on the metals indus- him. This place is an open
interviewing airline manage- try. We didn’t use com- door place. All senior execs
ment teams, I realized that puters then; we had slide are here together and we
each company was increas- rules. Jimmy was a very see each other and talk all
ing capacity and at the same good analyst. He was very the time. I have meetings
time underestimating the inquisitive and came up with once a week, both infor-
capacity that other airlines an idea a minute. mally and formally, with our
were adding. I started to top guys to talk about our
aggregate what they were all G&D: Jim, can you talk businesses. We have an
telling me and realized that about running Loews at the acquisitions meeting once
it was nearing the end of the holding company level? every other week and we
party. What is your idea genera- have a strategy committee
tion process and how many meeting every 3-4 weeks to
G&D: What brought you people are scouring for discuss the major issues at
to Loews? ideas? Loews and our subsidiaries.
So there’s a lot of talk. Peo-
JR: In 1971 I was working JT: Let me tell you about ple know to chime in and
for Schroders, a British bank the structure here. We state their opinion. It’s a
where I ran an internal have an investment depart- very collegial place. I like to
hedge fund. At this time in ment in which the vast ma- think it’s also a place with-
my career I would some- jority of people deal with out a lot of politics, though I
times go to investment fixed income. We manage, may not see that because
luncheons. At one of these under a management agree- I’ve been here so long and I
luncheons, I met Larry Tisch ment, the roughly $40 bil- appreciate when people
who, during our conversa- lion investment assets of suck up! (Laughs) Gener-
tion, suggested that I con- CNA Financial. We also ally, when I talk to senior
sider joining him at Loews. manage the cash of Loews, executives before they’re
I didn’t take him up on the which is about $3.7 billion. hired, I talk to them about
offer at the time, but we In addition we also manage the culture and atmosphere.
kept in touch, often talking our pension funds. So over- Then six months or a year
about investment ideas. all we are managing roughly later I ask them if what I
About a year and a half $50 billion. We have a said is true or not and, of
later, in 1973, I called Larry Chief Investment Officer, course, they say ‘yes’; but
and asked him if his earlier and Joe is our Chief Invest- what can they say? We do
offer was just a throwaway ment Strategist. At the not impose our culture on
line or a real offer. He said, holding company we have (Continued on page 18)
“I meant it.” I took the
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Loews Corporation
(Continued from page 17) important is having perma- much as they were in 2007.
our subsidiaries. We leave nent capital to your ability The private equity guys have
it to each one of those to make investments at the to put up more equity,
CEOs to manage their busi- right time? which reduces their lever-
nesses on a day-to-day basis, age and returns, making it
and we just get involved JT: There is good news and more difficult for them to
with them on major strate- bad news that comes with
gic and finance issues and permanent capital. We
management selection and have permanent capital, but “We couldn’t even
succession issues. other investors that we countenance buying
compete with for assets can
G&D: Over the last few be much more cavalier with a subsidiary think-
years a few hedge fund man- their capital than we can
agers have started P&C in- afford to be. Private equity ing that at some
surance businesses. Given funds are often willing to
how well you know the pay much more than we are point it might go
space, what are your because we think of invest-
thoughts on this? ing like owners of the busi- bankrupt, but for
ness, and they’re thinking of the private equity
JT: I think they are crazy! I it as a call option. We
haven’t looked at this care- couldn’t even countenance guys that’s their
fully at all but the thing I buying a subsidiary thinking
know is that they are gener- that at some point it might business. Each of
ally going into the reinsur- go bankrupt, but for the
ance business. It’s really private equity guys, that’s our investments
easy to lose a lot of money their business. Each of our
in the reinsurance business. investments stands on its
stands on its own.
There are a lot of people in own. For us, each invest-
that business who sound For us, each invest-
ment represents a significant
like they are really smart portion of our capital, and I ment represents a
and who know a lot about like to sleep at night. Being
it. One thing I think these on the cusp financially does significant portion
upstarts need to remember not lead to sound sleep.
is that it’s not written that From time to time this of our capital, and I
your losses can be only makes it difficult to compete
100% of your premiums. with private equity firms.
like to sleep at
They can go much higher On the other hand they are
than that. And I assume night.”
also really jealous of us. I
that these hedge funds are have a lot of friends in the do deals.
getting into this business hedge fund and private eq-
because they see it as a uity businesses and they G&D: Speaking of deals, is
source of permanent capital, would love to get their it frustrating when you like
but the reinsurance business hands on permanent capital. an asset, and do your dili-
is not an easy business, as They could quit going out gence, but a more cavalier
it’s basically blind risk that on road shows to raise buyer is willing to pay more
you are taking. You don’t money. And there are than you?
really know what the risk is times, in fact, when we can
and it’s easy to lose a lot of be very competitive versus JT: No, I learned from our
money. the private equity funds in previous General Counsel
buying businesses. Today is to never fall in love with an
G&D: Following your com- one of those times because asset. If you get deal fever
ments on hedge funds want- banks aren’t lending as (Continued on page 19)
ing permanent capital, how
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Loews Corporation
(Continued from page 18) centric operations. Would were really smart when it
you can do really stupid you invest in something that went to $8 and by the time
things. So if it’s going to be, has a majority of its opera- it went to $15 within a year
it’ll be. If not, it won’t be. “…never fall in love
tions outside of the United – we thought “Wow! This is
And the thing we always States? really good!” And then with an asset. If
focus on is to make sure we boom! The next stop had a
are not overpaying. So we JT: We are looking to buy $1 handle on it! I think that you get deal fever
tend not to get our heart businesses that are head- we, along with everyone
focused on one deal or an- quartered in the United else in the industry, missed you can do really
other, and we try to incul- States and whose primary a major trend. Exxon Mobil
cate that in our subsidiaries business is in the United bought XTO Energy for stupid things. So if
when they are trying to buy States. I have a few things about $40 billion. Even be-
bolt-on acquisitions. When it’s going to be, it’ll
to say about opportunities yond the big macro issues, if
we can buy something at in foreign countries: They you are not working in the be. If not, it won’t
the right price, it makes don’t make airplanes that industry, you don’t really
sense for us. If not, it was- travel fast enough; they have the same feel for it be. And the thing
n’t meant to be. haven’t eliminated time that you do by being in it
zones; and I’ll always won- and talking to the people in we always focus on
G&D: How many different der why we are buying this it. It’s just different. It’s the
deals do you look at for company instead of the local difference between reading is to make sure we
each deal you actually do? guy. This is combined with a book and actually experi- are not overpaying,
the fact that we feel some- encing something. When
JT: We look at lots and what comfortable with the we think about buying sub- so we tend not to
lots of stuff – we have five political environment here – sidiaries, we always try to
people to keep busy, and it the laws, the rules, and the remember that there is a lot get our heart fo-
can be several years be- customs. That’s all com- more about the industry
tween purchases. We are pletely different when we go that we don’t know relative cused on one deal
happy to look and kick tires to a foreign country. As a to what we do know, and
and learn and only buy general rule we wouldn’t therefore when we think or another and we
something when we think take on the chore of buying about whether we really
it’s right. try to inculcate that
a foreign-based company. It want to do a specific deal,
doesn’t mean that our sub- we think about whether we in our subsidiaries
G&D: How do those five sidiaries can’t expand over- considered the downside
people decide where they seas – we are happy for enough. The way we think when they are try-
are going to look for attrac- them to do that – but we about it is that there are
tive assets? don’t want to start by buy- three things to do with our ing to buy bolt-on
ing a business that is based cash. First, we can keep it
JT: We focus on a few spe- overseas. on our balance sheet. Sec- acquisitions.”
cific industries, which is evi- ond, we can buy in shares.
dent in what we own. We G&D: You once said that Third, we can buy a new
wouldn’t want to venture buying a company is like business. It’s easy to keep it
too far from those indus- walking into a room that is on our balance sheet.
tries to, say, focus on the pitch black, with danger When we buy in shares we
tech industry. We tend to lurking everywhere. Can know exactly what we are
go where you’d think a you give any specific exam- buying. But when we buy a
value investor would go. ples of how this is so? new business from some-
We try to get knowledge- body else, we are never
able in those industries and JT: Yeah! Look what hap- really sure what we are get-
see what’s available. pened to us in the E&P busi- ting. It has to be a really
ness. We bought High- good value. Over time
G&D: Companies in which Mount when gas was $7.50 we’ve gotten better at kick-
you have majority or com- per Mcf. We thought we (Continued on page 20)
plete ownership have US-
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Loews Corporation
(Continued from page 19) been immense skepticism in to read stuff. I spend hours
ing the tires, but it doesn’t the stock market and I view over the weekend reading
matter. We still recognize this as beneficial for some- different reports and com-
that we are not in the indus- one who is bullish, like me. mentaries on the markets,
try. A lot of investment fiduciar- as does Joe.
ies and the public are liqui-
G&D: Joe, are there any dating equities and buying JR: We alert each other to
sectors where you are cur- bonds. The amount of sell- things so that sometimes he
rently finding value in the ing the public is doing in doesn’t have to read stuff –
public market? domestic equity funds is someone has alerted him to
it and if they are smart they
JR: I’ve publicly spoken “I still view the are reading what they send
negatively about the big him carefully so it’s not a
banks, but in the last two to market in general waste of Jim’s time. When
three months I have you are in this kind of a
changed my mind a bit. I as cheap. There position, people alert you to
still don't know what the things.
banks own, but given the has been immense
fact that it has been a few skepticism in the JT: It probably takes four
years since the crisis, they to five hours a day just to
have had time to clean up stock market and I read stuff and respond to
most of their problems. emails before you can even
Also, because of the banking view this as think about being produc-
crisis in the rest of the tive. It’s just what you need
world – particularly in beneficial for to do to stay afloat, not to
Europe – there could turn move forward.
out to be a tremendous someone who is
bonanza for U.S. banks. bullish, like me.” JR: My favorite book to
Think about it. If you are a recommend is The True Be-
large corporate or individual more than offset by the liever: Thoughts on the Nature
depositor or wealthy per- amount of buying that cor- of Mass Movements by Eric
son, and you have an option porations are engaging in Hoffer. There is no discus-
of putting your money in through share repurchases. sion about investing in the
banks that have already That the public is doing the book, but in my opinion it is
been through the crisis and wrong thing at the wrong extremely helpful in under-
are now in a good shape like time is nothing new in the standing markets. It con-
the U.S. banks – let’s say a history of investing, but the veys the nature of human
bank like Citi or J.P. Morgan fact that professionals are is behavior in mass – how
– or putting your money in what surprises me. people act as a group. One
a European bank, what are of his great examples is ex-
you going to do? A com- G&D: What do you read plaining why people riot.
pany in Mumbai is going to and are there any invest- There is no reason and no
go with a U.S. bank because ment books that you would logic. People just get caught
they are afraid of what’s recommend? up in it. Riots don’t end all
going to happen with the at once, they end person by
European banks. This could JT: I tend not to read in- person – that’s markets.
become a major benefit to vestment books. I read lots People panic in a group, but
these banks, as they aren’t and lots of other stuff they come back to their
paying anything for these though, and this contraption senses one by one. That’s
deposits today. here (points to iPad) has why stocks move incremen-
totally lightened my brief- tally the way they do.
I still view the market in case. It makes it really easy (Continued on page 21)
general as cheap. There has
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Loews Corporation
(Continued from page 20) phenomenal delegator and because the law states that
he wasn’t a second guesser. he or Vikram Pandit or
G&D: What’s the best someone like him should be
piece of advice that your JR: He’d never look back. on the board. That’s num-
father (Larry Tisch) ever He never said “I told you ber one. Number two –
gave to you? so” or anything like that. the board does not get in-
He assumed you knew your volved in supervision and it
JT: Watch out for the own mistakes and he didn’t does not get involved in
downside. Don’t worry have to remind you of them. monetary policy. The board
about the upside. He was at his best when is there for two reasons.
you were at your worst, First, it oversees the busi-
JR: [to Jim] In the early which was very important ness operations of the bank
years, I think your father because most people are and second, it gives the
also encouraged you a great the opposite of that. Most president of the bank and
deal to pursue an idea when people, when you make a other bank officials a view of
you had one and to go big- mistake are ready to beat what’s going on in the busi-
ger than you might have
“Watch out for the
up on you. He would en- ness world and with the
because you were young courage you. economy. We received no downside. Don’t
and cautious. He would say, information, no winks, no
“if you like it then why don’t JT: Joe would pile into nods, nothing from the offi- worry about the
you do much more?” stocks and they would go cials of the bank as to what
down and his response the Fed was doing. It was upside” - Best
JT: My father was really an would be, “buy more.” all basically a one-way con-
investor. I would say that I piece of advice
versation in terms of the
am a combination of an in- G&D: Jim, you were re- economy. To the extent
vestor, capital allocator and
Larry Tisch gave to
cently a director of the Fed- they would tell us some-
manager. But my father eral Reserve Bank of New thing, I would have already his son, Jim Tisch
bought a whole bunch of York. Is there anything that read it a long time ago so
businesses and he was a you learned in your time they didn’t enlighten me as
phenomenal delegator there that changed the way to the economy or to
rather than a control freak. you look at things? monetary policy. Where
So he had an enormous there was a lot of color
amount of bandwidth be- JT: There’s a massive mis- added was in my meeting
cause he didn’t clutter him- understanding about what the personalities; getting to
self with day-to-day things. the directors of the Federal see how they worked and
Reserve Bank branches do. getting to see the interac-
JR: He never wrote a Each of the 12 Federal Re- tions. It was a good experi-
memo in all the years that I serve Banks has nine direc- ence. I had to leave after
was at Loews with him. I tors – A, B and C directors. two and a half years because
defy you to show me one The A Directors are from I had joined the board of
memo signed by him. bank companies – one from General Electric, and I
a big bank, one from an in- couldn’t be on the board of
JT: He also had a very termediate size bank, and the Fed too because there
good stock market instinct. one from a small bank. The might have been a percep-
He was a CEO but he was B directors are recom- tion of conflict because the
also a stock trader, though mended by the banks; I was Fed regulates General Elec-
he never had three screens a B director. The C direc- tric.
(points to his screens)! tors are independent direc-
tors. When people com- G&D: What do you have
JR: He was a phenomenal plain about Jamie Dimon to say to young people and
delegator. being on the board of the business school students
New York Fed, he’s there (Continued on page 22)
JT: Two things. He was a
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Loews Corporation
(Continued from page 21) be kept up at night worrying
who would want to be on G&D: Since you mentioned about our businesses. They
the buy side? How should the importance of being able are all well-managed. I have
they think about investment to sleep at night, is there learned that when bad news
and time horizon? anything today that keeps hits, the thing that you really
you up at night related to have to do to is just think
JR: Young people today in Loews or to the economy? calmly, sanely and rationally.
business are much more Rather than keep it to your-
macro-oriented than micro- JT: Nothing keeps me up at self, you should talk to eve-
oriented. They spend much night. I like to consider ryone around you. Often
more time on what is going myself a realistic optimist. when it looks like there’s no
on in Europe or Federal solution and no way out of
Reserve policies. They the box, a way develops. It
don't focus much on com- “My advice to might be that the combina-
pany specifics. Even when tion of a little change in
they do they have a very young people, if
things here and a little
low level of confidence in they really want to change in things there, make
what they are doing. It’s a big difference in the prob-
very unfortunate. I hate be successful in this lem. By thinking about it
that they don’t teach finan- and constantly focusing on
cial history in business business, is to learn it, a solution appears or the
schools. If it was up to me, problem dissipates. That’s
I would make financial his- financial history. the manager in me as op-
tory and all history a num- posed to the investor in me.
ber one requirement for Learn history in
business schools. Under- general and then G&D: Thank you both very
standing how a spreadsheet much for your time.
works can be learned on dig deeper into
the job pretty easily, but
understanding the contin- financial history
uum of history requires
certain intellect. I cannot and you will not be
for the life of me under-
stand why business schools in such awe of
are not teaching financial everything that’s
history.
going on.
My advice to young people,
if they really want to be First of all, we maintain a
successful in this business, is very conservative financial
to learn financial history. structure because I like to
Learn history in general and sleep at night and because I
then dig deeper into finan- realize that from time to
cial history and you will not time, there are three, four,
be in such awe of everything five and six-sigma events
that’s going on. I see the and times like 2008 and
same problem in my office. 2009 when you can’t rely on
People just don't know any others to help you out.
financial history and they You have to build your pro-
think that everything that is verbial house out of bricks
happening is unusual. Every- rather than hay or whatever
thing else can be learned on else there is. I tend not to
the job.
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(Continued from page 1) doing similar things to what bump into Chuck on week-
G&D: Whitney, Buzz and you’re doing. In those days day mornings at the front
Charlie, what inspired each we were doing something desk of the hotel sending
of you to join Royce & As- very radical – screening. telexes to submit trade or-
sociates? This was a big deal at the ders.
time because there were no
Whitney George (WG): personal computers. There On one of the weekends
I started off as a broker and were only mainframes at while we were in Australia,
worked at several different firms like Merrill Lynch and we visited the Great Barrier
firms in the 1980s, eventu- you needed to find some- Reef where 38 out of the 40 “I had the
ally conducting value-based one who had programming people from our group
research with a couple of experience. In those days, were either snorkeling, opportunity to see
colleagues, though we were Chuck and I were separately swimming with the dolphins,
not necessarily focusing on conducting the same playing golf or doing some-
how he (Chuck
small caps. We were intro- screens based on return on thing similar. Meanwhile, I
duced to Chuck in early Royce) conducted
assets. Independent from was walking two or three
1987 and my two col- one another, and over time, miles to the next town in himself through
leagues, who had much we modified our screens to search of some way of
more experience keeping up the crash in ’87,
than me, were em- with the mar-
barrassed by how ket – The Fi- which was quite
much more Chuck nancial Times
knew about each or something.
impressive. Being
idea they presented Unbeknownst
than they did. My a great contrarian,
to me at the
partners soon de- time was that he was buying
cided that I would Chuck was
be the one who doing the very stocks when you
solicited Chuck for same thing.
orders. Charlie Dreifus, Chuck Royce, Buzz Zaino, Whitney George
Once I couldn’t get
search based on returns on learned that he was doing
I had the opportunity to see invested capital. Chuck also that too, it convinced me
anyone else on the
how he conducted himself shared the idea of looking that Chuck shared the pas-
through the crash in ’87, telephone.”
for really great companies sion that I had for this busi-
which was quite impressive. or, said another way, business. We were obviously
Being a great contrarian, he nesses that had sizeable friendly competitors over
was buying stocks when you moats. the years, but I told myself if
couldn’t get anyone else on I were to ever change firms,
the telephone. When the The clincher for me, how- I’d see if Chuck would have
time came for me to be- ever, occurred in March of me. In 1997, I decided to
come serious about my ca- 1987. Chuck and I and leave Lazard and in January
reer after my first child was three others were selected of ’98 I was fortunate
born, I approached Chuck. to manage a fund of funds in enough to join Royce and
After lengthy discussions on Australia and New Zealand. work with Chuck.
his porch, I convinced him It was an entourage of
to give me a job as a senior about 40 people – four of Chuck Royce (CR): The
analyst in 1991. the five managers showed cool thing about this period
up and the rest were sales of time was that both Buzz
Charlie Dreifus (CD): I people. Remember that this and Charlie joined within
first met Chuck in 1974 or was 1987 so cell phones, two months of each other.
’75 through a broker at Op- laptops and computers I had known them both in-
penheimer. This broker weren’t available. I would (Continued on page 24)
said there’s a guy who’s
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(Continued from page 23) shape anything. They both last week! It’s perfectly
“But even within the dependently – Buzz was at have very different value acceptable and a normal
TCW and Charlie was at approaches, but both have business practice. We’re a
firm’s core ap- Lazard. I’d known them superb records and both large firm in this space so
very well for a long time and continue to do what they’ve it’s expected and completely
proach, there will both “raised the flag” at the always done. We’ve cre- okay.
same time indicating to me ated the ability to do that
regularly be minor that it was a good time to here. We do have a group CD: I’m a classic margin of
change firms. I had tried, that Whitney leads which safety guy. If it’s really
differences. In fact, I
unsuccessfully, to convince represents the core side of cheap by my standards, it
just bought a stock Buzz to join the firm in the firm. But Charlie basi- doesn’t need a catalyst. It
prior years too. cally runs his own shop, as doesn’t need anything other
from Charlie last does Buzz. than the fact that it’s cheap
Buzz Zaino (BZ): I joined and I’m comfortable that the
week! It’s perfectly the firm from TCW. The WG: Today we have a earnings are not going to
atmosphere when I joined large team. While Chuck erode. Most other inves-
acceptable and a TCW was very free and invented the discipline, I like tors, including the other
easy. The most important to think of myself as the portfolio managers in the
normal business
thing for a manager is that chief disciplinarian. It’s a room, are willing to pay a
practice. We’re a they’re able to do what they straightforward discipline. It little more for the prospect
do without internal pres- can be replicated in the of a catalyst. Something
large firm in this sures. TCW was very much right environment with the may look fully valued to me,
like that initially. The foun- right kind of people. So we based on the lower of trail-
space so it’s ex- der, Robert Day, was very have built out a team of ing earnings and forecasted
well off at the time so the portfolio managers and ana- earnings for the next pe-
pected and com- firm and the investment staff lysts on a variety of prod- riod, but there may be a
were free to spend what ucts that use the core ap- very good reason to pay
pletely okay.”
money they needed on the proach to small-cap invest- something higher for the
business while still operating ing that Chuck invented. stock due to some impend-
without internal pressures. ing event or some outlook
Day continued to spend G&D: Are there instances for the stock. That’s just
money to grow the busi- where a couple of you have not my approach. It’s a
ness. Then he decided to diametrically opposed views nuance that non-investment
sell the company to cash in regarding a company or an professionals don’t neces-
on those prior investments. industry? sarily grasp. Think of our
He hired a corporate man- different approaches, and
ager and then everything CR: Absolutely. the resulting differing opin-
changed for employees of ions on specific stocks, as
TCW. It was around this WG: All the time. I’ve refinements on the basic
time that I decided to join bought stocks that Buzz was definition of value investing.
Chuck. selling and sold stocks to
Buzz. G&D: Chuck, when you
G&D: How have you began looking at the small-
shaped each others’ ap- CR: You have to remem- cap space, it was really un-
proach to small-cap value ber that Whitney and Buzz charted territory. The same
investing, if at all? have completely different can’t be said today. What
approaches more often than about this world of the mar-
CR: Charlie and Buzz were not. But even within the ket has changed over the
both very successful inves- firm’s core approach, there years?
tors when they joined the will regularly be minor dif-
firm. I felt my role was to ferences. In fact, I just CR: The big change, which
be as non-disruptive as pos- bought a stock from Charlie (Continued on page 25)
sible and to not really try to
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(Continued from page 24) which I mentioned. These places, so the money move-
has affected each of the in- were natural market ineffi- ments are more like tides
vestors in the room, is that ciencies that really don’t coming and going rather
information is available in- exist anymore. than daily surprises. So you
stantly to everybody. All can see trends and start to
filings appear simultaneously WG: Now, there are react to those trends, in
on our monitors and are other kinds of inefficiencies, both directions, when they
available to everybody. such as human nature and happen because they don’t
That wasn’t the case until emotion, which are still very jump around on a daily or
the early ‘90s. Prior to this much present and haven’t weekly basis.
period, you had informa- changed. If anything, inves- Pictured: Bill Ackman of Per-
tional advantages that do tor and client investment CD: The other thing that shing Square Capital Manage-
not exist today. Of course horizons have shortened. If we’ve done, perhaps more ment at Pershing Square Chal-
what you do with the infor- you have a longer term successfully at certain times lenge in April 2012.
mation is always the trickier view, you can take advan- than others, is educate our
part – discerning noise from tage of the market’s ineffi- investors with respect to
what’s important. ciencies that result from appropriate expectations. If
other investors’ biases. you frame what your inves-
CD: Another change is the tors should reasonably ex-
idea discovery process. CR: One thing that I think pect, and you deliver on
Early in my career, I’d go we all would say is that we those appropriately set ex-
through the pink sheets or arbitrage time horizons. pectations, over time you
the Moody’s manuals look- Our time horizon is long build a reasonably stable
ing for ideas. I’d find com- while for other investors it’s audience that’s investing
“Prior to this period,
panies that were trading short. When they are pan- with you for the right rea-
over-the-counter that peo- you had informa-
icking, we must not panic. sons. What you don’t want
ple didn’t even know exis a mismatch of client ex- tional advantages
isted and then I’d try to G&D: Given the non- pectations relative to what
research them. Occasion- permanent nature of the the product can be reasona- that do not exist to-
ally, I’d come across $100 capital within the funds the bly expected to do.
bills selling for $10. firm manages, how are you day. Of course what
able to maintain a commit- CR: Something else which
BZ: It’s also worth noting ment to a long-term invest- we all do in our written and
you do with the in-
that around the time Char- ment horizon when your web communications is try
lie is referencing, there formation is always
clients, or potential clients, to lower investor expecta-
were public quotes and then are likely to be much less tions, reiterate our long- the trickier part.”
there was an “inside” mar- patient? term principle, and remind
ket. If you were a member investors that it’s perfectly
of the general public and CR: It’s a great question appropriate to be out of
wanted to buy 200 shares of and I don’t have a perfect sync with the market or out
a pink sheet company, you’d answer for you. Money of sync with the benchmark,
pay an extraordinary price. goes in and money goes out which is a defining feature of
If you were an institutional within our open-end fund strong long-term perform-
investor buying 10,000 products. We have to be ance. Now, we say these
shares, it was more of a prepared for it and we have things over and over again
negotiated price somewhere to almost program our- to our investors, but it
between the high and the selves for that; it’s just a fact doesn’t mean they abso-
low offer prices. of life but it’s not as bad as lutely know it. Neverthe-
you’d think. less, we spend a great
CR: These are examples of amount of time trying to set
structural inefficiencies WG: We have a lot of the right expectations.
which were additive to the investors in a lot of different (Continued on page 26)
informational inefficiencies
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(Continued from page 25) With Regulation FD, the sell me a bill of goods; let
WG: And we try to man- danger these days is associ- me see what you’ve done.
age what we have under ated with the managers of
management responsibly. smaller companies, who CR: My view of interacting
Money always chases per- aren’t trained in exactly with management is mixed.
formance, so it tends to what to say by a team of Maybe I enjoy meeting man-
mostly show up after you’ve lawyers and who may have agement too much, but I
done really well for a long the tendency to talk off the like getting to know the
period of time, probably ten top of their heads. An in- people running these firms.
minutes before you’re about vestor can run the risk of The real problem in meeting
to look really silly. So over freezing himself from trading management is that it’s a
time, we’ve been willing to in a name merely because a social experience and you
close funds to new investors member of the firm’s man- risk being unduly attracted
when we get to the point agement accidentally dis- to the way the executive is
where the number of ideas closed material non-public presenting the idea. It can
is diminishing relative to the information. That’s one work the other way too if
cash flowing into the fund. negative of talking to man- management does a poor
That does help when the agement teams. job presenting a good idea.
downturn comes because at The real way to get a feel
least you didn’t catch the CD: Of the investors here for a company’s strategy is
latecomers who would be today, I’m probably the one through discussions with
very disappointed and run who travels the least to customers and competitors.
for the door immediately. meet with management Customers and competitors
teams. The critical question give you the truth. Manage-
G&D: Some investors be- to me when I see management may or may not give
lieve that meeting with man- ment teams relates to how you the truth.
agement is nearly always a they allocate capital. I want
waste of time, as manage- to get into their minds to WG: True. They’ll some-
ment teams can be trained see how they might allocate times give you the truth
to deceive, while others capital in future periods. about their customers and
place more weight on man- competitors. There’s some-
agement interactions. The problem with meeting thing to be said about hear-
Where do you gentlemen with management is that it is ing what they have to say
fall in this spectrum? the classic case of salesman- about their own competi-
ship. The executive could tion. Through discussions
BZ: There are many indus- be “on” that day and they with management, one tries
tries and there’s much to sell you a bill of goods. to understand how their
learn about each of those, Over the years, we’ve all business got to be so strong
but we’re all experienced developed a sense for who and to see if they plan on
investors and we’ve ana- we can trust, is ethical, and continuing to do what made
lyzed companies and indus- responsible. Physically see- them successful. It’s also
tries many times so we tend ing a person can help you in important to meet with a
to understand what’s going this regard. new CEO because he may
on. However, management change a lot of things and
can provide a useful re- Rather than relying on not necessarily for the bet-
fresher on their industry or meetings with management, ter. You might even find a
teach us about some of the I instead rely on deep dives new idea through manage-
newest developments within into firms’ accounting. If the ment’s discussion of their
their industry. They can company’s business hasn’t competitors. One aspect of
also educate us on the nuts changed, and management our investment approach is
and bolts of how things hasn’t changed, my litmus to look around the
work within their organiza- test is the numbers. Don’t (Continued on page 27)
tion.
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(Continued from page 26) solute standard and the quantitatively, by taking the
“neighborhood” at a given same standard across all opposite of our long ap-
firm’s competitors when we industries. Because of this, proach for shorting stocks,
find a name we think we there may be whole indus- and it hasn’t been successful.
like. This is because very tries that we’re not buying. It’s a whole different disci-
often it’s not a company- It’s not a relative value ap- pline that takes a whole lot
specific issue that’s bother- proach. of time, so why bother
ing the market and creating when your job is to find
the value in our eyes – it CD: That’s an important great long-term invest-
could be a macro issue, an point. It’s an absolute met- ments.
industry issue, or some ric. There are different
other reason. variations of it, but it essen- CR: You can’t really do it
tially gets down to a cap by shorting all the stocks we
G&D: Could you describe rate, and it involves compar- think are overvalued and
the firm’s general valuation ing this to a presumed cost going long all the stocks we “The real way to
approach and perhaps high- of capital. If you have a think are undervalued. I
light some similarities and get a feel for a
spread between the two, know that way doesn’t
differences in how you each and you’re comfortable that work. company’s strategy
conduct valuation? that earnings level is real
and has permanency, then CD: I’ve had clients ask me is through discus-
CR: In the core part of our you’re likely to pursue the why I can’t just flip my met-
business, we try to ap- idea. But the important rics and I’ve screened for sions with custom-
proach valuation as if we thing that both Whitney and this, but amazingly you don’t
were buying the whole Chuck said is that you’re get many short candidates. ers and competi-
company. If we were buying buying absolute value. I It’s not uncommon for peo-
the whole company, would tors. Customers
think that absolute value will ple to ask that. Also, these
we be satisfied with the translate over time to abso- days there are a scarcity of and competitors
absolute return that we lute returns, although we’ve short ideas, so everyone
could take out in the form never done an official study. ends up chasing the same give you the truth.
of dividends and free cash ideas and it becomes expen-
flow. Certainly, we want to WG: It’s really about sive to short them. In our Management may
understand the engine be- what’s the business worth, earlier days there were the
hind the company, which at what price can we buy it, ‘one-decision stocks’ that or may not give
basically entails looking at how can we double or triple were overpriced for the
returns on capital computed you the truth.”
our money over three to longest time, so if you were
in a lot of different ways. five years if we get it right, shorting them you would
That’s a critical part of the and what’s our risk if we get need great patience.
process. But ultimately we it wrong.
use a business buyer’s, or G&D: The firm also tends
what I call a real estate, ap- G&D: Given the focus on to focus on strong balance
proach that focuses on absolute return rather than sheets, and we know based
earnings yield. There’s relative returns, have you on your investment history
nothing unique about that ever thought about ventur- that you have avoided
approach – many, many ing into a long/short prod- banks, which employ a lot of
investors use it – but we’ve uct? leverage relative to other
used it for a long time and industries. What is the
it’s the right way to do it. CR: We have experi- genesis of this conservative
We’re not comparing the mented, largely unsuccess- view of leverage?
multiple of a company with fully, with long/short strate-
the multiple of the Russell gies. CR: There is fragility in
2000, for example. small companies just by the
WG: We have tried it (Continued on page 28)
WG: Right, we use an ab-
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(Continued from page 27) that, you could have made a been buying recently?
nature of their size. They lot of money in many of
are probably only 10 or 15 those banks. There was a WG: We’ve been buying a
years old, and they are likely bank that had a $10 per lot of economically sensitive
still run by the founder. So share book value which I companies because this is
there are a lot of business started buying at $9 and the third year in a row that
risks that relate to their size dollar cost averaged down everybody is worried about
and maturity that you don’t to $2. It continued to fall to the economy falling off a
want to combine with finan- $1 per share and people cliff. Industrial companies
cial leverage. Specifically were talking about it going have been fairly hard-hit
regarding banks, there is no out of business. Ten because of those expecta-
way to determine the value months later the stock was tions. Energy stocks, even
of the loans, so by and large taken over at $15 per share though oil prices are very
we haven’t done much in- in a stock deal, and three high, have been punished
vesting in that space, though years later the position was pretty hard because they’re
Buzz has done a little. worth $63 per share. So viewed as early cycle kinds
here was this very large gain of stocks. I also like materi-
BZ: I don’t necessarily fo- with a balance sheet that als and especially certain
cus on strong balance you didn’t really know much mining companies. In fact, I
sheets. I have a different about. own several silver mining
definition of a good balance companies that are generat-
sheet. It takes a little more WG: There’s this saying: ing free cash, paying divi-
stomach and a little more “Balance sheets don’t really dends and even buying back
analysis. You are trying to matter until the day that stock.
project what the balance they do. Then they’re all
sheet will look like in the that matters.” Something Where I’m not finding a lot
future. A lot of what I do is has to have gone a little of value right now is where
looking for companies that wrong with a company for everyone has been running
are going to go from nega- us to be interested, and we to, which is to anything with
tive cash flow to positive don’t want the balance an above-average yield.
cash flow. The price of the sheet to get in the way dur- These defensive stocks are
stock usually reflects the ing the time it takes the actually expensive as busi-
recent past and not the op- company to improve itself nesses, and some really
portunity to improve the or for the market to im- good businesses are inex-
balance sheet over time. prove. pensive because people are
worried about the business
In the instance of banks, I CR: The balance sheet is outlook. Lots of tech, not
went through the 1989- the barrier to the long-term social media, not cutting-
1991 timeframe, where arbitrage. We want to have edge tech, is very inexpen-
their balance sheets were our investment right even if sive. I’m talking about good
terrible. I started buying we have the timing wrong. old analog semiconductor
these things in 1989 and manufacturers and equip-
every time I bought one of CD: In the current envi- ment makers. Because
them I got slapped and they ronment, quality, in terms of we’ve been worrying for
would go lower and lower. great balance sheet strength three years about the econ-
Finally in 1991, I hired a guy and other attributes, is inex- omy slowing down these
and all we did for three pensively priced in the mar- stocks have been beaten up
months was travel around ket. to levels that probably al-
the country visiting banks. ready reflect a very slow or
We realized that these bank G&D: Can you talk about negative global economy.
managers didn’t have the some themes around some Everyone is putting their
slightest idea what their of the companies you’ve (Continued on page 29)
assets were. Having said
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(Continued from page 28) upgrades as a percentage of generally been with busi-
money into certain stocks total rating changes has de- nesses that make a little bit
for yield, such as these mas- clined. of money over and over
ter limited partnerships again, and then the day that
(MLPs), where you get a Going back to your ques- they don’t, they lose a lot of
pipeline that rusts and then tion about what sectors we money all at once. Engi-
it pays out all of its cash are looking at right now, I neering and construction
flow to investors. It’s kind think of myself as a junk firms come to my mind. Pictured: Tano Santos speak-
of like you giving me $20 dealer. People have dis- We had a recent company ing at the Moon Lee Price
and me giving you $1 a year carded whole industries like this in the financial Competition in January 2012.
over the next 20 years. right now based on some world – it was this high pro-
You’re basically just getting macro outlook. The ques- file company that made
your money back slowly tion is has that outlook money every day, domi-
with nothing at the end. been more than adequately nated its market, and was
That desperation for yield, priced into the market? I not a risk-taking type of
as the Fed has been beating agree with what Whitney model. Then one day a
up on savers pretty badly, said about there being a lot software program goes hay-
has led to people buying “That desperation
of real businesses that gen- wire and the company goes
things that aren’t great busi- erate tremendous free cash long $7 billion worth of for yield... has led
nesses and that cannot sus- flow and have a history of securities and shareholders
tain or increase their divi- raising dividends. These end up getting diluted 80%. to people buying
dends. We’re looking for ‘dividend aristocrats’ as
companies that can grow they’re called are probably a G&D: Given all of the things that aren’t
their dividends and have the decent place if you can get companies you’ve looked at
cash flow and balance sheet them at the right valuation. over your careers, do you
great businesses
to back it up. get a lot of your new ideas and that cannot
G&D: Can you talk about from just keeping track of
G&D: As another example some mistakes that you’ve things you’ve looked at in sustain or increase
of that search for yield, made and things you’ve the past?
we’ve noticed that the drive learned from them through- their dividends.
into high yield fixed income out your career? WG: If we find a really
products has been shock- great business, we rarely We’re looking for
ingly robust for a number of CR: (Laughs) How much liquidate our entire position
months now. time do you have? (even if it has done every-
companies that can
thing we had hoped). In- grow their dividends
CR: Some firms have CD: I always say that in my stead, we typically maintain
closed their high yield funds portfolio there are plenty of a small position in the back and have the cash
recently because they can- mistakes, the names of of the portfolio so we con-
not invest the inflows they which I don’t know. Come tinue to track it. There are flow and balance
are getting. Companies back in a year or two and I’ll a lot of companies that you
have been doing whatever be able to tell you. (Laughs) can revisit through different sheet to back it
they can to issue as much Generally, my mistakes are parts of the business cycle.
debt as possible, but they some misunderstanding Energy companies are cycli-
up.”
still aren’t doing it fast around the business model cal – as commodity prices
enough to keep up with the or underestimating the se- go up, their stock prices go
appetite of yield-starved verity of some issue the up, and when commodity
investors. company is facing, and as prices go down the stock
such, the earnings don’t prices go down. We write
CD: This is occurring while sustain themselves at the down where we want to
the underlying financial con- level I had expected. buy and sell things and keep
dition of a lot of these com- track of that. It’s much eas-
panies is deteriorating. Ac- WG: My mistakes have (Continued on page 30)
tually the number of rating
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(Continued from page 29) first job was with RCA career that will be this way
“I think of myself as ier to buy companies with Corp. in a financial training for you. Life is much easier,
conviction if you’ve had a program, which was really a you’ll be much happier, and
a junk dealer. Peo- history with them. We great third year to a MBA you’ll work longer if you are
know how management will program because you spent really passionate about what
ple have discarded react when things happen six to eight weeks at a vari- you’re doing. Try not to
whole industries and we know that they will ety of the different divisions, settle into something you
buy back stock when they which included a computer won’t like. If your livelihood
right now based on say they will. You can be business, a semiconductor is that thing that you would
more aggressive when the division, Hertz, NBC, and do on your own if you
some macro out- valuation is right when others. I then went to NBC weren’t getting paid, that’s
you’ve seen something for a short period of time the best of all worlds.
look. The question through a few cycles. before leaving to work at
is has that outlook Lehman Brothers. CR: I would say the same
CD: We’ve all owned thing. A job can’t be a job.
been more than stocks that we’ve sold and G&D: Do you have any The world of investment
bought back. If you have words of wisdom or advice management to me has eve-
adequately priced that accumulated history for business school students rything one could want.
and knowledge and know as they think about their You can be creative, it’s
into the market?” what to expect of manage- careers and life ahead of changing on a daily basis,
ment, as Whitney says, you them? you can be focused on the
really do have an edge that macro environment or the
you bring to the table. WG: I think making mis- micro environment, you can
takes is important, and it’s have social interaction, and
G&D: For Columbia Busi- better to make them early you have time to be a deep
ness School alumni Chuck in life when they’re likely to thinker. It’s competitive and
and Buzz, what did you be smaller. I have two sons you can approach each
learn at Columbia that im- in college, one about to situation in multiple ways.
pacted your career choice, graduate. I think you can Our big job is looking at
investment style or life in look at life like college. The other companies. After
general? first 10 years after college seeing what people do at
are like your freshman years these companies, many
CR: From high school on I of life – you’ll figure out times I walk away apprecia-
wanted to go into somewhere you may want to live, tive that I don’t do what
thing related to the stock who you may want to be they do for a living. To me,
market, so it wasn’t Colum- with, find some things that investment management is
bia Business School that did are interesting, and find just an inherently more in-
that. The school didn’t have some people who are inter- teresting business.
the Value Investing Program esting and good role models
that it has today, but its and mentors. My first 10 G&D: Thank you for shar-
finance department has al- years were very much like ing your time with us.
ways had a great reputation. this. Then in your sopho-
I loved it there. more years of life you can
start to be serious about
BZ: What I got out of Co- having a career and you
lumbia was a solid under- better be prepared to pick a
standing of business and major.
accounting. The credentials
provided by the Columbia CD: Buffett always talks
MBA open the door to about enjoying his job so
many different things. I ac- much that he tap-dances his
tually didn’t start out in the way to work. Choose the
investment business. My
A full-day event featuring some of the most well-known
investors in the industry, presented by

and
Visit our website for updates: http://www0.gsb.columbia.edu/students/organizations/cima/conference.html
For inquiries contact:

Geoff Abbott GAbbott13@gsb.columbia.edu
Matt Christ MChrist13@gsb.columbia.edu
Ashley Miller AMiller13@gsb.columbia.edu
Get Involved:
Director, Employer Relations, in the Office of MBA Career Services at (212) 854-8687
or valueinvesting@columbia.edu. Available positions also may be posted directly on the
Columbia website at www.gsb.columbia.edu/jobpost.

Dodd Investing Alumni should sign up via the Alumni website. Click here to log in,
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Contact us at:
jhedstrom13@gsb.columbia.edu Please also share with us any suggestions for future issues of Graham and Doddsville:
jlubel13@gsb.columbia.edu
strivedi13@gsb.columbia.edu
Jay Hedstrom is a second-year MBA student and a member of the Heilbrunn Center’s
Value Investing Program. During the summer Jay worked for T. Rowe Price as a Fixed
Income Analyst. Prior to Columbia Business School, Jay worked in investment grade
fixed income research for Fidelity Investments. He can be reached at jhed-
strom13@gsb.columbia.edu.
Jake Lubel is a second-year MBA student and a member of the Heilbrunn Center’s
Value Investing Program. During the summer he interned at GMT Capital, a long-short
value fund. Prior to Columbia Business school he worked under Preston Athey on the
small-cap value team at T. Rowe Price. He received a BA in Economics from Guilford
College. He can be reached at jlubel13@gsb.columbia.edu.
Sachee Trivedi is a second-year MBA student. Over the summer this year, she in-
terned at Evercore Partners in their Institutional Equities division as a sell-side research
analyst. Prior to Columbia Business School, Sachee worked as a consultant in KPMG’s
Risk Advisory business and at Royal Bank of Scotland in London. She can be reached at
strivedi13@gsb.columbia.edu.
Graham & Doddsville
Issue XVII Winter 2013

Inside this issue:
Graham & Dodd
Breakfast P. 3 JANA Partners —
JANA Partners P. 4
Collaboratively Frank Martin
Unlocking Value —
Daniel Krueger P. 14 Winning by
Not Losing
Frank Martin P. 28
Frank Martin
Russell Glass P. 42 Frank Martin is the founder and owner of Martin Capital
Management, an investment partnership based out of Elkhart,
Jon Friedland P. 50 Indiana. He is the author of two books on investing,
Speculative Contagion (2005) and A Decade of Delusions (2011).
Barry Rosenstein Scott Ostfeld
Founded in 2001, JANA Part-

ners is a value-oriented in-
Editors vestment advisor specializing Russell Glass
Jay Hedstrom, CFA in event-driven investing.
G&D sat down with two of
—
MBA 2013 the firm’s partners, Barry
Rosenstein and Scott Ostfeld
Arbitrageur of
Jake Lubel
MBA 2013
’02. Barry Rosenstein is the Value
founder and Managing Part-
ner of JANA Partners. Prior Russell Glass
Sachee Trivedi (Continued on page 4) Russell Glass is founder and managing partner of RDG Capital
MBA 2013 Management, a New York-based investment management
firm that specializes in activist investing. Prior to RDG
Richard Hunt Capital, Mr. Glass served as President of Icahn Associates, the
MBA 2014 Daniel Krueger investment firm of Carl Icahn. A passionate sports fan, Mr.
Stephen Lieu — “Uncertainty
MBA 2014 is our friend”
Visit us at:
Jon Friedland —
www.grahamanddodd.com Searching for
www.csima.org
International
Battleships
Jon Friedland
Daniel Krueger
Jon Friedland ’97 is the Director of International Research at
Daniel Krueger ’02 is a Man- Amici Capital (formerly named Porter Orlin). He is
aging Director and Partner responsible for sourcing and analyzing the firm’s international
at Owl Creek Asset Manage- long and short ideas. Prior to joining Amici in 2001, he
ment, a hedge fund in New worked at Zweig-Dimenna Associates, a New York-based
Page 2

We are proud to bring you the very attractive risk-return sce- the coming years.
latest installment of Graham & narios, as well as how he en-
Doddsville. This is the 17th edi- courages his team, in their Jon Friedland ’97 from
tion of Columbia Business early work on a company, to Amici Capital shared with us
School’s student-led investment zero in on the key questions the factors that make a com-
newsletter, co-sponsored by the that need to be answered. pany a ‘battleship’ company.
Heilbrunn Center for Graham & He then conveyed the attrac-
Dodd Investing and the Colum- Frank Martin from Martin tiveness of searching for these
Pictured: Professor Bruce bia Student Investment Manage- Capital Management de- companies in emerging mar-
Greenwald. The Heilbrunn ment Association. scribed how he picks compa- kets.
Center sponsors the Ap- nies on a bottom-up basis, yet
plied Value Investing pro- We were very fortunate to sit spends much of his time thor- This issue also contains pic-
gram, a rigorous academic down with six well-respected oughly studying the macroeco- tures from the 22nd Annual
curriculum for particularly and successful investors that nomic environment. He also Graham & Dodd Breakfast,
committed students that is span the value investing spec- explained his reasoning for which took place on October 5
taught by some of the in- having a conservatively posi- at the Pierre Hotel in New
trum – they prove the old ad-
dustry’s best practitioners. tioned portfolio today. Mr. York. Investing luminaries
age, ‘there is more than one way
to skin a cat.’ Martin goes into detail about Tom Russo, Bill Ackman, Mario
the behavioral aspects of in- Gabelli, William von Mueffling,
Barry Rosenstein and Scott vesting and what he does to and others were on hand to
Ostfeld ’02 from JANA Part- avoid traps to which many mingle and listen to keynote
ners explained their process for investors fall prey. speaker Meryl Witmer from
constructively engaging manage- Eagle Capital Partners.
ment in activist situations. They Activist Russell Glass from
also talked about how their RDG Capital made us very We thank our featured inves-
entrepreneurial backgrounds envious when he shared his tors for sharing their time and
have helped shape their careers unique business school and insights with our readers.
and the way they look at compa- early career experiences. Mr. Please feel free to contact us if
nies. Glass thoroughly shared how you have comments or ideas
his firm has been able to profit about the newsletter as we
Distressed expert Dan handsomely by actively advo- continue to refine this publica-
Pictured: Heilbrunn Center Krueger ’02 from Owl Creek cating for the sale of underval- tion for future editions. We
Director Louisa Serene Asset Management shared ued companies. He also illumi- hope you enjoy reading this
Schneider. Louisa skillfully the intricacies of distressed debt nated for us how the large issue of Graham & Doddsville
leads the Heilbrunn Center, investing that make it his favor- amounts of cash in private and find the interviews as infor-
cultivating strong relation- ite hunting ground for ideas. He equity and corporate hands mative and thought-provoking
ships with some of the also explained how the econom- could lead to a robust mergers in written form as we found
world’s most experienced ics of averaging down create and acquisitions environment in them to be in person.
value investors and creating
numerous learning oppor-
tunities for students inter-
ested in value investing. CSIMA Scholarship
The classes sponsored by
the Heilbrunn Center are
among the most heavily The Columbia Student Investment Management Association (CSIMA) will be
demanded and highly rated awarding its inaugural scholarship this spring with the proceeds from today’s
classes at Columbia Busi- conference. Through this program, we will award a $10,000 scholarship to
ness School.
an incoming Columbia Business School student that exhibits an outstanding
aptitude and commitment to investment management. All incoming MBA
students in the Class of 2015 are eligible to apply and the recipient will be
chosen by a panel of CSIMA students.
We are excited to initiate this scholarship and look forward to making this
an annual tradition.
Volume
Issue I, Issue 2
XVII Page 3
22nd Annual Graham & Dodd Breakfast, Oct 5, 2012 at Pierre Hotel
Keynote Speaker – Meryl Witmer Bill Ackman Mario Gabelli with William von Mueffling
Tom Russo in deep conversation with Sid and Helaine Lerner Dean Hubbard thanks Ms. Witmer
Prof. Greenwald makes a point Engaged audience

“Bring a sharp pencil and leave your emotions at home!” – Meryl Witmer
Page 4
JANA Partners
(Continued from page 1) out of business school. The answered the phone. I
to founding JANA Part-
interviews didn't go that started talking as fast as I
ners, Mr. Rosenstein was
the founder and Managing well for me, and there could and he finally said,
Partner of Sagaponack weren't big banking pro- "Well, come on in." This
Partners, a private equity grams like there are today. led to me becoming Edel-
fund. Mr. Rosenstein re- What did lead to a job was man’s co-head of takeovers,
ceived his MBA from cold-calling. The trick I a job for which I really was-
Wharton and his B.S. from used to get jobs coming out n’t qualified.
Lehigh University. Scott of business school was to
Ostfeld is a partner of call people after 5:00 p.m., G&D: Can you tell us the
JANA Partners and is re-
when their secretaries had story of how you actually
sponsible for special situa-
tions investments, includ- left, so that the person I got the job offer from Asher
ing active shareholder en- really wanted to speak to Edelman?
gagement. Prior to joining would likely pick up the
Barry Rosenstein JANA Partners, Mr. Ostfeld phone themselves. In the BR: Asher was the corpo-
was with GSC Partners in case of my first job oppor- rate raider back then, and I
its distressed debt private tunity, I cold-called a Whar- was a nobody associate at
equity group. Mr. Ostfeld ton alumnus at a boutique Merrill Lynch; no one there
received his MBA from firm called Warburg, even knew who I was. He
Columbia Business School,
Becker, Paribas. Unfortu- started by telling me that
his J.D. from Columbia Law
School, and a B.A. from nately, the first week on the he'd been talking to the
Columbia University. job, the firm was sold to heads of the M&A depart-
Merrill Lynch and I was ments at various investment
G&D: Can you tell us again without a job. That banks about coming to
about your background and was the start of my career. work for him to co-head his
how you became interested Fortunately, Merrill called takeover business. I didn’t
in investing? me about a week later and understand why he was tell-
told me I could interview ing me this as it had nothing
Barry Rosenstein (BR): I for a job with them and, to do with me. After about
wasn't one of these people apparently, they needed 15 minutes, he turned to me
who invested when I was bodies so they hired me. I and said, "I think you and I
nine years old. I was good worked in banking for about are going to do a deal here."
at math and I was interested two and a half years but I I had no idea what he
in business. Frankly, I didn't frankly didn't like it that meant. Then he asked,
really know much about much. "What's it going to take to
Wall Street at all but as I get you to take this job?"
read more about the busi- Back in the mid-80s, corpo- At the time, I was making a
ness world when I was in rate raiders were beginning salary of $40,000 and hoping
college, it became clear to to make themselves known, for a $30,000 bonus, but my
me that I should go back to and I would excitedly read reviews were not strong so
Scott Ostfeld business school. I did so at about their exploits at the I didn't have high hopes. I
Wharton. There seems to time. That was an interest- had heard that the top mer-
be a hot industry anytime ing world to me, so the chant acquisition bankers
that you are in graduate question was how to get made $1 million, which was
school. When I graduated into that field? I once again more money than I had ever
from Wharton in 1984, in- tried the cold-call technique heard of in my life. So I said
vestment banking was the (I don’t remember how I to him, “one million dol-
hot field, so that's where I found his number) to speak lars." He stared at me for
focused my efforts. to one of the main raiders 30 or 45 seconds, which is a
of the time – a guy named long time when you're com-
I actually didn't have a lot of Asher Edelman – and pletely full of crap. Then he
luck getting a job coming wouldn't you know it, he (Continued on page 5)
Volume
Issue I, Issue 2
XVII Page 5
JANA Partners
(Continued from page 4) jaw hit the floor. Asher. I learned technical
said, "Alright, done. You G&D: Clearly you had a balance sheet analysis and
just have to start tomor- lot to learn essentially start- business analysis more
row," to which I responded, ing from scratch. What are through working on situa-
"I'll start right now. I'll sleep some of the things that tions, talking to bankers,
here tonight if you want." stand out in your mind that and talking to some of the
That's how I became co- you learned during that pe- other people who were
head of takeovers for Asher riod working for Asher that working at the firm. But
Edelman. I wasn’t prepared shaped the way you run the from Asher, I probably
for the position when I learned more important
started, so I had to figure skills. These had more to
out the responsibilities of do with taking risks while
the role as I went along. not blinking and remaining
This made for a uniquely fearless. I give him a lot of
amazing experience. “But from Asher credit. He wasn't the most
technically savvy guy, but he
G&D: How old were you [Edelman], I had great instincts and he
then? never showed fear, even if
probably learned he felt it at times. That was
BR: I was 27. an important lesson.
more important
G&D: That was quite a skills. These had G&D: Mr. Ostfeld, can you
career advancement at that walk our readers through
age! more to do with your unique background?
How has this background
BR: I'll add a funny post- taking risks while impacted your investment
script to it, as well. The style?
very first deal I was working not blinking and
on, we were trying to take Scott Ostfeld (SO): I was
over a supermarket chain
remaining fearless.
an Art History major when I
called Lucky Stores and sure I give him a lot of was in undergraduate school
enough, Edelman had ap- at Columbia, so that didn’t
proached Merrill Lynch for credit… he had necessarily portend a career
the takeover financing. in finance. I started two
About a week into my job great instincts and businesses in college. I
as co-head of takeovers, started a menu business
Merrill’s senior M&A team he never showed where the restaurants
came in to our office to talk around Columbia paid me
to us about the financing. I fear, even if he felt
to put their menus into a
noticed the Merrill people it at times. That menu book that I distrib-
looking at me as they were uted to students for free.
probably thinking, “What's was an important This was just before the
he doing here? I didn’t know Internet had taken off,
he was assigned to the lesson.” which certainly would have
deal.” I was so insignificant put me out of business. I
at Merrill Lynch that nobody also started an event plan-
even knew I had left. So ning business. One of the
Asher gave his 30-second problems back then as a
introduction and then said, firm today? Columbia undergraduate
"My co-head of takeovers, student was that there was
Barry here, is going to take BR: I didn't really learn no central place to congre-
you through the financing anything technical from (Continued on page 6)
we're looking for." Every
Page 6
JANA Partners
(Continued from page 5) During my time in business tender offer to try and buy
gate at night – you may have school and law school, I a public company called
seen somebody on campus, spent a summer at Wachtell Justin Industries, which was
but you never saw them at Lipton, which today happens the largest manufacturer of
night. So I started initiating to be on the other side of cowboy boots and bricks in
events at different venues our firm in activist situa- the country. I never ac-
for Columbia students, tions. That was an interest- quired control of the com-
where I was paid to bring ing experience that helped pany, however. [Editor’s
students. It grew to the frame the debate on share- Note: This Company was later
point where I was organiz- holder versus board and acquired by Berkshire Hatha-
ing events for Tahari and management power. After way in 2000.] It was an in-
Lacoste in New York and graduation, I went into interesting experience being
even Miami. Toward the vestment banking, where I the person on the firing line,
end of my time as an under- focused on helping compa- as opposed to somebody's
graduate, I applied to the nies unlock value. From right-hand man. It was also
law school thinking I wanted there, I moved into dis- interesting trying to go after
to be a lawyer, though not tressed private equity. That the oldest company in the
necessarily understanding was basically investing in the state of Texas.
what that meant. I also had context of a legal process to
an entrepreneurial orienta- gain control of a company I also became involved in
tion, so on a whim I said, and improve value as an the cellular industry. I was
“Maybe I should go to busi- equity owner, which was invited by a group of gentle-
ness school as well.” I was again leveraging many of my men to form a partnership
lucky because the business skills and experiences. I then that submitted applications
school typically doesn’t ad- moved to activism when I for all of the remaining rural
mit candidates with no real joined JANA Partners about cellular licenses in the U.S.
work experience. seven years ago, which puts that had not yet been
all of my experiences to awarded. The FCC didn't
The foundation of entrepre- work evaluating companies hold auctions at that time –
neurial experience, law with an owner orientation they just held a lottery – so
school, and business school to figure out how to unlock all one had to do was apply.
has helped me as an activist value. We invested a relatively
investor. Entrepreneurial small amount of capital to
experience gave me an G&D: Mr. Rosenstein, you meet the legal fees associ-
‘owner orientation’ that is were involved in many en- ated with applying and we
very helpful in thinking trepreneurial situations be- then applied to every loca-
about how to create value fore you founded JANA – tion in the country. We
at companies. Business will you talk about a few of figured we had a one in
school and law school gave them? three chance of winning one
me many of the foundational of them. It was like playing
tools to be a competent BR: My career is not very the lottery but with much
analyst. Believe it or not, I conventional. I didn't grow better odds. In fact, we
had never even used Excel up in the hedge fund busi- won Mississippi and the
before I attended business ness and work for a bunch Poconos and, after building
school. Courses like Ad- of people and then decide the necessary systems, sold
vanced Corporate Finance, to start my own firm. I was them for a terrific return.
Corporate Restructuring kind of a serial entrepre-
and Corporate Tax gave me neur. Some things worked I then moved to San Fran-
a great foundation for ana- and some things didn't cisco at the end of 1991.
lyzing companies and think- work. When I left Asher, I Remember that this was
ing about ways to unlock did two things. First, I went back when New York was
value. off on my own and I made a (Continued on page 7)
Volume
Issue I, Issue 2
XVII Page 7
JANA Partners
(Continued from page 6) and use them again and was an incentive to get bet-
going through extremely other people buy them for ter pricing. He had all kinds
difficult times – the home- the parts. of ideas that no one in his
less problem was out of industry had done to date. I
control, Wall Street was I became curious about auto returned to my office in the
completely dead, and there salvage after someone had city and tried to scrape to-
was nothing to do. In the mentioned that it could be gether the $7 million to
meantime, I met some peo- attractive. So I started call- back him. I remember eve- Pictured: Mario Gabelli at
ple in San Francisco who ing one participant in the rybody telling me that I was Omaha Dinner in May 2012.
asked me if I wanted to join industry after another, each crazy being in this industry
them to start a new invest- more unsavory than the last. and backing this person.
ment and merchant banking I finally met a guy named But I just saw something in
business. Not having any- Willis Johnson who had a him. I was able to back him
thing else to do, I decided little company called Co- and he turned out to be one
to give it a try for a year or part. At the time, Copart in a million. He bought a
two and then return to had one location in Califor- number of companies, inte-
New York. I ultimately nia, generated $8 million in grated them very well, and
stayed in San Francisco for revenue, and offered neither started to build a real com-
16 years! After about five audited financials nor GAAP pany. Copart went public a
years of helping build that accounting. Copart was little over a year after my
successful little boutique basically a dirt lot with a investment. Today, it's a $4
business, I left to start my barbwire fence and dogs billion market cap company
own firm. running around. The head- and it has hundreds of loca-
quarters building was a tem- tions all around the world.
G&D: Towards the end of porary corrugated metal Their business has shifted to
your time in San Francisco, building, and Johnson frac- the internet now, of course,
you made an investment in tured the English language and today it's the biggest
Copart, the salvage vehicle regularly. The only thing online seller of automobiles
auction company. Could that I could think of, as I in the world.
you tell us about this busi- was trudging around in the
ness and your thesis at the mud with the CEO, was G&D: What inspired you
time? that I can't believe my ca- to found JANA Partners and
reer has fallen this far, this to include a distinct activist
BR: That’s right. Near the rapidly. Nevertheless, I investing approach within
end of my time on the west probably spent four hours part of your business?
coast, I did a deal which was with Johnson. I remember
something of a life changer calling my wife on the phone BR: So I made some
for me in certain ways. Yet on the way back to San money on my various ven-
again, I cold-called someone Francisco and saying, "You tures and that provided a
– this time it was a partici- know, I think I just met the springboard for me to start
pant in the auto salvage in- smartest guy I have ever my own private equity firm
dustry. Auto salvage is a met in business." in 1997. I ran that for about
fragmented industry that three years and produced
runs an auction on behalf of Willis Johnson was a self- very average results for my
insurance companies for taught, self-made business- investors. It was a very
permanently damaged vehi- man. He had a vision for difficult time for the private
cles. This is the company creating a national company equity market and I was just
that the insurance company and signing national con- happy that the investors
calls and says, "Go pick up tracts. He also believed he were returned their princi-
the car for us, turn it into a had a way of sharing the pal plus a small return. But I
salvage vehicle, run an auc- proceeds with the insurance really didn't like the busi-
tion, and sell it." Some peo- companies so that there (Continued on page 8)
ple buy the cars to fix them
Page 8
JANA Partners
(Continued from page 7) through 2008 and a big
ness. I felt like I couldn't be downturn, with assets under G&D: Does your activist
entrepreneurial – if we won management falling a lot. I approach stem from the fact
a deal, it was because we restructured the whole firm that you have a sense of
had offered to pay more over the last couple of years what good businesses are
than everybody else. It was and how a business should
right around 2000 when I be managed to get to the
Pictured: Louisa Schneider decided to not raise another “I think we’re ‘right- private market value? Is
and Glenn Hubbard at Gra- fund. that how you convince the
ham & Dodd Breakfast in term’ because we
management to unlock the
October 2012. I instead saw an opportunity try to consider all value?
in the public markets to
close what I saw as a gap available BR: Right. Nobody was
between the price at which really doing that when we
public companies were trad- information and started. There were a lot of
ing and what I felt their ulti- companies that were value
mate private market values construct the traps. They either needed
were worth. So not know- to restructure, sell off
ing anything about how a optimal plan for the
money-losing businesses,
hedge fund works, I set up a spin off an unrelated busi-
company under the
hedge fund. ness, or they just didn't be-
circumstances that long independent and
I remember when I was needed to be sold. My ini-
trying to raise money, trav- are known or tial impetus was to try and
eling to various institutions force that kind of change.
and talking about being an knowable and
activist. People would say, G&D: Many value inves-
“That's not a strategy; you'll predictable over a
tors talk about having a long
never raise money; nobody -term approach, but at
reasonable period
does that; forget it.” Things JANA you have a medium-
have really changed. My of time to best term time frame. Why is
very first investor was Lee this the right time frame?
Cooperman [Editor’s Note: position the
Cooperman was featured in SO: I wouldn’t even call it
Issue 13 of Graham & company for medium-term; I’d call it
Doddsville], who had been a ‘right-term’. I think we’re
close friend for many, many success. I think
‘right-term’ because we try
years and someone I viewed to consider all available in-
that’s the right time
as a mentor. He largely formation and construct the
understood the idea and frame, frankly, for a optimal plan for the com-
believed in what I was trying pany under the circum-
to do. He backed me when board to be stances that are known or
nobody else really would. knowable and predictable
evaluating the over a reasonable period of
I started with $17 million time to best position the
and no expectations beyond opportunity set for
company for success. I
that. Before I knew it, the think that’s the right time
the company.”
business grew and by 2007, frame, frankly, for a board
we had over $8 billion un- and we are back flying again. to be evaluating the oppor-
der management. We gen- Other than probably 2008 tunity set for the company.
erated a pretty strong track and a year or two after that, So I think our horizon maps
record over this period of it's actually been a lot of fun. (Continued on page 9)
time, as well. Then I lived
Volume
Issue I, Issue 2
XVII Page 9
JANA Partners
(Continued from page 8) the last 10 years, but it's you'll be pushed as far as
appropriately with the never come down to a you're willing to go and then
board’s horizon. proxy vote and you’ve you have nothing. Nobody
G&D: How much overlap never been very vocal about ever questions whether
is there between JANA’s your position. How do you we're prepared to go all the
passive efforts (that is, non- way. We are very careful
activist ideas in this context) about how we prosecute
versus its activist efforts? “Basically, we have to
activism. We've never had
be comfortable buying one actually go to a final
SO: We are one team, one vote because management
portfolio, all on one floor, in at a valuation that
comes to the realization
all interacting on a regular provides us with a that there's no point going
basis. So there is a constant to a final vote because
flow of ideas from passive margin of safety,
they're going to lose.
to active, and frankly, many irrespective of any
of us can’t separate our The reasons are twofold:
brain and say, “This one’s activism we will
one is our approach and the
clearly active, this one’s attempt to initiate and other is our structure. In
passive.” Frequently posi- our approach, we're ex-
tions fall in the middle. But that may be
tremely disciplined. I don't
my primary focus is on the unsuccessful. We have want to be only an activist
activist side, and that’s what because then you force
I’m paying attention to 90% to be comfortable that
things and the quality of
of the time. if it really came down your ideas is diluted. We
don't ever have to be an
G&D: Does your activist to a vote that we would
activist here. We can just
style impact your portfolio have shareholder invest in event-driven situa-
construction – meaning, tions. For something to be
does the fact that you are support. And variety of
an activist play, all of the
often the catalyst enable ways to win – you want criteria have to be present
you to be more concen- for us. We came up with
trated than you would oth- to make sure that
this rubric we call V-cubed,
erwise feel comfortable there's more than one which is Value, Votes, and
being? Variety of ways to win.
lever you can pull in
Basically, we have to be
SO: Yes. Our highest con- case circumstances comfortable buying in at a
viction ideas are the ideas valuation that provides us
where we have the most change. In my
with a margin of safety, irre-
impact on the outcome. experience, if you have spective of any activism we
Those are our activist ideas will attempt to initiate and
which tend to be our largest all three of those
that may be unsuccessful.
and highest returning posi- checked off, you're We have to be comfortable
tions in the portfolio. that if it really came down
You’re also, frankly, doing a guaranteed victory.”
to a vote that we would
lot of work on these posi- have shareholder support.
tions, so you want to bene- engage management? What And variety of ways to win
fit from that work by mak- makes the strategy possible? – you want to make sure
ing it a large position. So that there's more than one
our portfolio can be a bit BR: Well for the first part lever you can pull in case
more concentrated. of that, I would say you have circumstances change. In
to be prepared to go all the my experience, if you have
G&D: You've been an ac- way because if you're not, (Continued on page 10)
tivist in many companies in
Page 10
JANA Partners
(Continued from page 9) are. reputation we are able to
all three of those checked attract very accomplished,
off, you're guaranteed vic- SO: When we become experienced, and successful
tory. If you're missing one involved in situations, we value creators who get a
of them, there's a good typically are working with very good reception when
chance you're going to lose. industry operators who are we do bring them to com-
We're extremely judicious. helping us carefully analyze panies or run them for
the situation and are on slates. For example, when
In terms of our approach, I we were involved in CNET
have no ego with respect to in 2008, we ran a slate of
these activist pursuits. I directors to help turn the
don't need to claim victory company around. We had
or get credit. I try to work very qualified people like
behind the scenes. I tell John Miller, who had run
every one of these CEOs AOL, and Julius Gena-
that they can be the hero, “In terms of our
chowski, who only months
and we'll be their biggest after being on our slate was
approach, I have no
advocate, if they do what nominated by President
we want them to do. In- ego with respect to Obama to be chairman of
stead of going on TV and the FCC. As with CNET,
forcing people or embar- these activist when we do run a slate, it’s
rassing people, I find it much designed and tailored to
more effective when I give pursuits. I don't address the very specific
them a chance and I treat need at the company.
them with respect. We can need to claim
go hard at somebody if we G&D: How do you go
victory or get credit.
have to, but in my experi- about finding your activist
ence you convince people I try to work behind targets? Do you screen for
to go along with you a lot companies through valua-
more successfully if you the scenes. I tell tion screens or do you gen-
treat them the right way. erally find your ideas
every one of these through other means?
G&D: How is JANA Part-
ners structured to conduct CEOs that they can
SO: A friend who works at
activist investing? another activist firm aptly
be the hero, and
described it: it’s a bit like
BR: We run our activism we'll be their panning for gold. You need
activities like a machine. It's a lot of throughput to find
what these guys do every biggest advocate, if that gold nugget. I can’t say
day, all day long. We also we ever know where our
bring in industry partners in they do what we next idea is going to come
all of these situations; so from, but looking for activist
we're not just financial guys. want them to do.”
ideas is very similar to how
We bring in industry opera- you would look for tradi-
tors who have greater ex- tional investment opportuni-
pertise and track records ties in public equities.
than existing management There’s screening, reading
teams, so it's very hard for research reports, talking to
the management teams to standby to become board industry operators, talking
argue against us when members if necessary. to companies about their
they're arguing against peo- Given our successful track competitors, and bench-
ple who are better thought record and collaborative (Continued on page 11)
of in the industry than they
Volume
Issue I, Issue 2
XVII Page 11
JANA Partners
(Continued from page 10) sue us or put a poison pill in
marking peers. Ideas can place. We don't get any of G&D: What, in your opin-
come from other sharehold- that anymore, because the ion, is a driving motivation
ers calling and from follow- companies have come to behind the subset of corpo-
ing events that create op- realize that all they're doing rate America management
portunities such as an an- is alienating their own teams that have a penchant
nounced acquisition that shareholder base and it's for limiting or destroying
doesn’t make sense for counterproductive. We value for shareholders? Is it “...we don't face the
shareholders. hire the same bankers and related to self-preservation?
kind of fights that
lawyers all the time and we Empire building? Disen-
G&D: Mr. Rosenstein, you know what they tell man- gaged boards?
said that last year was the
we used to face.
agement teams, at least in
strongest environment for our case. They tell them, SO: It’s very difficult to Ten years ago, I'd
activist investors that you “You can't ignore JANA. answer because it runs the
had seen in your career. They do their homework, spectrum. You sometimes show up in front of
Do you think that's still the they come up with good have companies with good
case, and why is this? ideas, they're really tough, operators who think they’re a company and
they're not going to go doing things that make
BR: I do. I think there are they would sue us
away, and you're better off sense for shareholders, but
a couple of reasons for this. just trying to work things they may not be as experi- or put a poison pill
In terms of opportunity set, out with them.” I think enced navigating the capital
there are a lot of companies those two broad dynamics markets or as thoughtful in place. We don't
that are undervalued. I find continue to create a great about ways to increase the
stocks at very reasonable environment for what we value of a stock. You also get any of that
prices. I think that you still do. have situations where CEOs
have a dynamic today that or boards are not prioritiz- anymore, because
exists where a lot of compa- G&D: Has the recent in- ing the right things. Some
nies are worth a lot more the companies have
crease in funds with activist may be interested in grow-
than where they’re trading strategies made it any ing at the expense of come to realize that
and where they would trade tougher for you to find your unlocking value. Other
as private companies. I also ideas? times you get people in all they're doing is
think balance sheets are situations that are not com-
very healthy with lots of SO: There really aren’t petent enough to execute alienating their own
cash. You have financing that many activists, and the appropriate strategy to
rates that are very low. there certainly aren’t that maximize value. shareholder base
You also have the dynamic many activists with a 12-
where companies and man- and it's
year track record of col- BR: A big part of the prob-
agements are having diffi- laboratively unlocking value lem is that the incentives
culty generating internal
counterproductive.”
the way that we have. are all wrong. If these were
growth and so they're as There are also not that family businesses and they
open to value creating ideas many activists that focus on owned all the stock, they
as they have ever been. the market cap size that we probably wouldn't be mak-
That's from an opportunity have participated in ($10- ing a lot of the decisions
set standpoint. $20 billion), particularly in that they're making. But
the past two years. It is they own very little stock
Then, if you think about the actually much less competi- and most of the stock they
environment for activism tive today than it was prior own has been given to them
and the market's perception to the financial crisis when or is in the form of options.
of activism, we don't face everybody was an activist Their current compensation
the kind of fights that we investor. Yet the opportu- is probably more valuable
used to face. Ten years ago, nity set today is very attrac- and important to them. As
I'd show up in front of a tive for activism. (Continued on page 12)
company and they would
Page 12
JANA Partners
(Continued from page 11) tions where assets are held back stock ahead of all that.
a result, the incentive is to in inefficient structures, ei- If an activist is pillaging a
run a bigger and bigger ther because there is a business for some kind of
company. The bigger the more appropriate structure short-term gain, then that’s
“If you went back company you run, the more to own it in like an MLP, or problematic, but if they are
and looked at the you can justify higher com- you’re combining assets that advocating steps that make
pensation levels and it don’t make sense together. the stock more valuable,
activist situations makes you feel like a big I think it’s actually a coinci- then they are doing exactly
shot in town. The incen- dence that we’ve had a few what the board and manage-
we’ve been involved tives are all perverse. I in a row that have been ment are supposed to do. If
in, and you were to think ultimately when you more spin-off focused. If an activist were harming a
start to point out irrefutable you went back and looked company’s future prospects
categorize them, they facts and you get share- at the activist situations every time they showed up
holder support they see we’ve been involved in, and at a company, they would
are actually fairly
your point. I would say in you were to categorize not be successful winning
balanced among most cases, management is them, they are actually fairly over shareholders who may
trying to do the right thing, balanced among capital allo- end up owning the stock
capital allocation, but they're either blinded or cation, capital return, block- after the activist has sold
they are not necessarily ing M&A deals, separations and moved on.
capital return,
always looking to maximize or divestitures, buybacks,
blocking M&A deals, value. They're just going sales of companies, and op- G&D: Is there any mistake
about their business every erational turnarounds. The from your career that might
separations or day and they're lost in the common thread is that we stand out or something that
divestitures, forest a little bit. But you advocated steps that best you really learned from
also have some people who positioned the companies to them that sticks with you
buybacks, sales of are just not thinking about create value. today?
things the right way and are
companies, and thinking about themselves G&D: One oft-heard criti- BR: I’ve made so many
operational and not the shareholders. cism of activist investors is mistakes I can't even think
They may protest and say that you are simply ‘pulling about it. I'll give you one
turnarounds. The that's not the case but it is. value forward’ and harming thing that's not an investing
It's not until someone like a company’s future pros- concept, but something that
common thread is us shows up and they feel pects. How would you re- I've come to realize that
that we advocated threatened that they actually spond to this characteriza- might be helpful. Being po-
move. The proof is in the tion? lite to people and treating
steps that best returns we generate. In people with respect is good
virtually every situation, the SO: As long as you’re do- business. It's not just a
positioned the stocks have reacted ex- ing something that doesn’t good thing to do, it actually
companies to create tremely positively and not harm the value of the com- inures to your benefit as
just short-term bumps, but pany, accelerating the bene- well. If you're a jerk to
value.” companies have been fits to shareholders is ex- somebody, they remember.
rerated. All of a sudden actly what creating value is They may never get the
companies go from being all about. The best exam- opportunity to pay you
value destroyers to value ple, of course, is buying back back, but if they do, they
creators. stock. If you have a great surely will. I've had more
long-term story and a value- instances where I've inter-
G&D: Recently, JANA has creating plan ahead of you, acted with somebody I don't
pushed for spin-offs in sev- why would you wait and buy even remember, perhaps 10
eral companies. Is that sim- back stock after the market years prior and this person
ply a coincidence, or do you fully reflects the value? shows up working for a
prefer to deal in spin-offs? From a capital allocation potential investor or is in-
standpoint, you want to buy (Continued on page 13)
SO: We like to find situa-
Volume
Issue I, Issue 2
XVII Page 13
JANA Partners
(Continued from page 12) hire people unless they have some of these things. Just
volved with the company significant work experience. take chances, go for it, and
and they say, "You were I don't necessarily care that don't look down.
really good to me. You they went to business
were really nice to me. I school, but they've got to SO: Investing is a lot
didn't forget that." And have significant work ex- harder than Columbia Busi-
they've invested with us or perience at an investment ness School. A hypothetical
they've helped us get a com- bank and another hedge 'A' in the investing world, Pictured: Bill Miller at CSIMA
pany to do something. To the point at which you are Conference in February 2012.
me there's no upside to performing at the highest
treating people badly. level, only requires being
right more than half the
SO: When I was working time. The truth is investing
in investment banking, I had “Being polite to
can be very frustrating, diffi-
this naïve and mistaken view people and treating cult, unpredictable, and gru-
that if you have a good idea eling. So you should only
that a company should pur- people with respect pursue the career if you
sue, it will automatically be have the passion, if you’re
adopted and pursued. is good business. intellectually curious, and if
Changing the status quo at a you’re committed to it, be-
company isn’t easy and It's not just a good cause at every turn, you can
sometimes requires more be very quickly humbled.
than just logic. thing to do, it
That’s the nature of the
actually inures to business.
G&D: Do you have any
advice for the readers who your benefit as well. G&D: Mr. Ostfeld, you
are keen to get into invest- started with an entrepre-
ing or activist investing? If you're a jerk to neurial background and
ended up in a career in in-
BR: Go to places where somebody, they vesting. What advice would
you can learn. You can you give students who are
learn from every experi- remember. … To
interested in both investing
ence, but just provide your- and being involved in an
me there's no
self with the best opportuni- operating business?
ties to work with people upside to treating
who you think are smart SO: If you learn how to
and who you respect. people badly.” invest and manage money
Maybe the world's changed that’s portable to anything
and you can go right into you want to do.
the hedge fund space today,
but I still think there's fund or private equity fund, G&D: Mr. Rosenstein and
something to be said for and probably five plus years Mr. Ostfeld, it’s been a
having more of a fundamen- of experience before we'll pleasure speaking with you.
tal background, getting bring them in as an analyst
training at an investment here. Don't be afraid to
bank or private equity firm, make changes and jump. If I
and then moving into the thought about the down-
principal side and the public side, I wouldn't have done
markets. I think that's a half the things that I did.
good way to access it. But And after the fact, as I sit
again, maybe hedge funds here, I think I must have
are hiring directly out of been out of my mind to do
business school. We don't
Page 14
Daniel Krueger
(Continued from page 1) the debt was worth less distressed. I really enjoyed
York that manages over $3
than face value and the eq- the complexity, the way that
billion. He is Co-Portfolio
Manager of Owl Creek’s uity was trading at option different people had differ-
Flagship Funds and is the value. I noticed that some ent motivations, and that
firm’s Global Head of representatives of a dis- the power shifted from eq-
Credit. Prior to Owl tressed hedge fund that uity holders to creditors in
Creek, Mr. Krueger owned the bank debt of one such situations.
worked in distressed debt of the companies were sit-
at Chase Securities and ting silently in the back of I eventually progressed to a
Angelo Gordon. Mr. the room at every meeting distressed analyst position
Krueger earned his A.B.
on the loan desk and then,
from Harvard College and
his MBA from Columbia against the advice of my
Daniel Krueger Business School. colleagues, decided to go to
business school. I went to
“It was very clear Columbia Business School in
G&D: What was your in-
troduction to investing? that the math had 2000. Right around that
time, the default rate had
DK: When I was graduat- broken down, and it started to ramp up. Every-
ing from college, I had no body told me, “Krueger
idea what investment bank- was because these you're being an idiot. Why
ing was, but I knew that all are you going back to busi-
of the smart kids were going
were distressed ness school? You're picking
to New York to do it, so I the exact wrong time to go.
companies where the You're going to miss the
figured I would join them. I
came to New York and debt was worth less entire cycle.” I figured they
worked for five years at may be right about that, but
Chase in investment banking than face value and I planned to be doing dis-
and private equity, as well as tressed for a really long
on the distressed loan desk. the equity was time, not just for the next
As a junior analyst in the few years. I thought the
healthcare group, I vividly
trading at option tools I could gain in business
remember my boss and me school outweighed not be-
value...it was very ing able to work on a few
working on a proposed
M&A deal between two clear that [the distressed credits over the
companies that had stock next couple of years. Luck-
prices that were trading creditors] were in ily for me, they turned out
pretty close to zero. What to be only partially right –
I had learned in analyst charge, not the although the default rate
training, and what had been had moved materially higher
reinforced through that
stockholders.” while I was in business
point in my career, was that school, there was still a lot
the total enterprise value of to work on when I got out,
a company is the sum of its including Enron, Adelphia,
debt, plus the number of and, even though they were WorldCom, and others. I
shares times the market creditors, it was very clear started working at Owl
price of the shares, minus that they were in charge, Creek part-time during the
cash. But that math didn't not the stockholders. As a second semester of my sec-
really work in this situation. junior analyst, a year out of ond year at Columbia Busi-
It was very clear that the college, I found that dynamic ness School and stayed on
math had broken down, and very interesting and very full-time after graduating.
it was because these were intellectually stimulating. So I've been here for almost
distressed companies where That gave me a taste for (Continued on page 15)
Volume
Issue I, Issue 2
XVII Page 15
Daniel Krueger
(Continued from page 14) ple of major distressed cy- next 12 months – Greece
11 years. cles. I've certainly learned a may do this, the Japanese
lot from Jeff since I joined Yen will do that, China may
G&D: How did you make him and I've learned a lot have a hard landing or a soft
the decision to join Owl from being in this position. landing – the liquidity of the
Creek, a start-up fund at the I’m now a Co-PM of Owl issuer, which we spent ex-
time? Creek’s Flagship and Credit tensive time analyzing, is
strategies and Global Head almost entirely independent
DK: During the summer of Credit. of those things. I know that
between my first and sec- I don't need other investors
ond years of business
“We take risk for a
G&D: Could you share in the market to pat me on
school, I worked at Angelo some of the unique aspects the back and say, "Good living, all investors
Gordon, which was a leader of distressed credit investing job. That’s a smart invest-
in distressed debt investing. that you particularly appre- ment and now I want to do, and we are
I really liked my experience ciate? make it too." The treasurer
at Angelo Gordon. Those of that company will either comfortable with
guys have mostly moved to DK: I feel very fortunate to wire us the money at ma-
different places now, but Jeff that. What I like
work in distressed debt, turity or not. If they do,
Aronson and the other especially in schizophrenic then we know exactly what
members of the team are
about the distressed
markets like these where our return profile will be –
some of the smartest guys there is massive volatility all the 20 points from 80 to asset class, though,
I've ever been around. They around the world. This is 100 plus the coupons.
weren't hiring full-time ana- an event-driven investor’s That's a huge asset to have is that the risks we
lysts at the time, so they did dream, and no style of value in investing – these defined,
me a big service by intro- investing is more event- built-in events. are taking are
ducing me to other people driven than distressed, in
like Jeff Altman, who is the concentrated
my opinion. I always ap- We take risk for a living, all
Managing Partner of Owl proach things with the same investors do, and we are
Creek. When Jeff gave me
around the things
mindset asking myself: comfortable with that.
an offer, it was really a no- “What is it that I don't What I like about the dis- we are analyzing,
brainer because I was join- know, and do I really know tressed asset class, though,
ing somebody who already any better than the next is that the risks we are tak- leaving fewer
had a tremendous pedigree guy?” What I love about ing are concentrated around
and background (from his credit, and distressed in the things we are analyzing, unanalyzable risks
time at Franklin Mutual particular, is that you have leaving fewer unanalyzable
working with Michael Price), to worry about.”
built-in events that you can risks to worry about. Your
who was a known money- analyze. For example, here results should, over time,
maker, and somebody from at Owl Creek, most of our more accurately reflect the
whom I would learn a lot. I best investments are ones quality of the work that you
was getting in at the ground that we never need to sell. do and the soundness of the
floor, so I looked at it and We’ll buy loans or bonds investment thesis, as op-
thought, “This is great, if it and then get taken out for posed to other big-picture
works it's going to really, cash at maturity, or there things that can make valua-
really work and I would will be a liquidation. tions move up and down
have been the first analyst There’s an element of sepa- every day.
that he hires. If it doesn't ration from macro events.
work – I'm twenty some- We may buy a bond at 80 G&D: Are you involved at
thing years old and single. (meaning that the market all in the equity side of
I'll go find another job.” price equals 80% of the face things?
Luckily for me, it did work amount) that matures in a
and it's been a great ride year, knowing that while the DK: I will occasionally
over the past 11 years, dur- market may move over the (Continued on page 16)
ing which we've seen a cou-
Page 16
Daniel Krueger
(Continued from page 15) for a security, which scenar- well if they stick to their
work on equities. I head up ios are more or less likely discipline and don’t get car-
the credit side of the port- to occur, and how much ried away with the sea of
folio and my colleague, Jeff money you can make or noise that exists in the fi-
Lee, heads up the equity lose in the different scenar- nancial media.
side and we both report to ios. Once you’ve estab-
Jeff Altman. But there have lished a proper framework, G&D: Could you talk a bit
been periods of time over the answer jumps off the about idea generation at
the past 11 years where page, and it’s a matter of Owl Creek?
“If you use there has been less to do in deciding if the opportunity is
credit. Distressed is a cycli- attractive enough to go into DK: Ideas are generated by
intellectual honesty cal business and you need to the portfolio or not. everyone, from Jeff Altman
know when to really press at the top to the summer
to ascribe your bets and you need to G&D: Do your analysts analyst. We don't take a
probabilities to know when to walk away. focus on specific sectors or whole lot of pride in idea
The trick is that in those are they generalists? ownership here. We're
different sets of times when you are sup- trying to make money with
posed to be loading the DK: Most people here the capital that we invest. If
events, over time boat, it usually makes you start off as a generalist but an analyst comes up with an
sick to your stomach to add over time develop expertise idea, they'll bounce it
smart investors risk, so it’s easier said than in certain industries. In around with the PMs and
done. But in those periods terms of division of labor, it other analysts, getting differ-
should do well if of time when we are doing makes sense to have some- ent people’s perspectives.
they stick to their less in credit, I might work body who's already looked As an example, one of our
on equities. at five media companies analysts was a bankruptcy
discipline and don’t look at the next one, if they lawyer for a number of
The analyst team here is can. On the other hand, years before going to the
get carried away pretty fluid between credit some of the most interest- buy-side and his niche at
and equities. You don't ing conversations we'll have Owl Creek is to evaluate
with the sea of really notice a difference in around here are the ones the legal component of our
terms of the conversations where we get a fresh set of ideas – mostly on the credit
noise that exists in around here, whether eyes looking at an industry side but occasionally on the
the financial you're talking about a credit or company, which I think is equity side as well. So you’ll
or a stock. It's all about: what really separates good usually have multiple people
media.” “What is causing the mis- investors from average chiming in on an idea. Our
pricing in the market price? ones. We don't think that belief is that the more peo-
What advantage do we we're the smartest people ple you have taking a look at
think we have in terms of that work at hedge funds. If something, the higher the
our view? How high is our we’ve added a secret sauce probability that you either
conviction level? What is to our portfolio construc- eliminate what is only a me-
our margin of safety for tion, it has come through diocre idea or recognize
being wrong?” The answers our group dynamic, con- when you’ve got something
to those questions help us stantly reminding ourselves pretty special. To us, that’s
decide whether an idea will that we can be shocked by just simple math. I hear
go into the portfolio or not, things that were previously some people at other places
and, if it does, what size it unknown, and reminding argue that if you open up
should be. The framework each other to remain intel- the discussion to too large
for analyzing risk/reward is, lectually honest. If you use of a group, then you make it
to us, identical no matter intellectual honesty to as- too hard to get ideas into
what type of security you’re cribe probabilities to differ- the portfolio, because it’s
looking at. Namely, you ent sets of events, over time easy for one or two people
need to understand the smart investors should do (Continued on page 17)
range of possible outcomes
Volume
Issue I, Issue 2
XVII Page 17
Daniel Krueger
(Continued from page 16) if the price moves against thought “Why did I buy in
to torpedo the sentiment. us. If you think about it the 30s?” Then it was in the
But I think that’s exactly the mathematically, in a perfect low teens and they thought,
point. There are thousands world, if you're looking at a “Wait a minute, what am I
of securities out there that bond that's trading at 50 missing? I must not be get-
we can invest in today that cents on the dollar and you ting something.” Then the
are “pretty good,” but if pass on it, if it moves to 49, CDS [credit default swap]
that’s the burden required Pictured: Michael Karsch of
it should be slightly more auction (which occurs a Karsch Capital Management
to get into your portfolio, attractive now, assuming all month after a default) at CSIMA Conference in
then what are you really else is equal. And then at priced the bonds around February 2012.
doing to differentiate your- 48 it's even slightly more nine. Granted, Lehman's a
self? You know when you attractive, etc., etc. Eventu- very bizarre animal because
have something special ally it could get to a point that was of course the big-
when four, five, or ten where you think it's attrac- gest bankruptcy of all time.
smart people can sit in a tive enough to go into your A huge amount of debt all of
room and agree that the portfolio, and let's say that's a sudden went from invest-
risk/reward is uniquely at 43. Now, you couldn't ment grade hands to looking
good, and I’m fortunate at possibly want to make it a for a home in the distressed
Owl Creek to be sur- giant position at 43, other- market, which was not
rounded by such people. wise you should have nearly large enough to ab- “...a good investor
bought some at 44 because sorb that amount of paper.
G&D: When you’ve fully the risk/reward isn't that But that’s the point: a good needs to
analyzed something and dramatically different. So investor needs to under-
you’re comfortable that it’s we'll usually dip our toe in stand that the value of a understand that the
still attractive, do you to start and let the risk/ security is built from the
gradually build a position in reward come to us. bottom up, using good value of a security
the name or do you estab- analysis, and that markets
lish the full position immedi- Our best investments are follow valuation. Not vice
is built from the
ately? ones where we dip our toe versa. bottom up, using
in at, to take the prior ex-
DK: As you can imagine, ample, 43 cents on the dol- G&D: Since it's more likely good analysis, and
we pass on more than 90% lar and a few days or weeks that a judge or some other
of the things that we look or months later it's trading third party will get involved that markets follow
at. If it does pass the initial at 31. In distressed, that in the distressed space rela-
smell test, analysts will happens all the time. Bonds tive to non-distressed credit valuation. Not vice
come into my office if it’s on can move up and down by or equity investing, how do
the credit side or Jeff's office 10 points on headlines like you get comfortable with
versa.”
if it's on the equity side, and litigation outcomes, a the risk/reward of your in-
we'll bounce the idea busted financial covenant, vestment ideas given this
around a little bit. If it con- the sale of a business, or additional layer of uncer-
tinues to look interesting, something else significant, tainty?
we'll usually get the whole but sometimes the price can
investment team together swing around on no news at DK: That's a great ques-
to talk about it. The last all. If the latter happens, tion. You're teeing up an
component is to decide that then you can load up the answer that is very impor-
we’re ready to dip our toe boat at the lower prices. tant to get across in order
in. We very rarely will Lehman Brothers is a great to properly describe the
make something a full posi- example of irrational price opportunities in distressed
tion right off the bat. Usu- moves – that bond started investing. First of all, uncer-
ally what we prefer to do is trading in the 30s the week tainty, to us as distressed
make it a small- to medium- that it filed, and then it was investors, is our friend, be-
sized position but leave in the 20s and people (Continued on page 18)
plenty of room to add to it
Page 18
Daniel Krueger
(Continued from page 17) man entities, you knew that that a judge's decision on
cause uncertainty is some- the numerator in a recovery litigation is an unanalyzable
thing investors will pay to calculation was going to be a blue cell. We talk about
avoid – sometimes pay a giant number. such things every day here
large amount. We love at Owl Creek. We also
situations like Lehman which At that point the analysis hire outside counsel to
we call “high uncertainty, turns to the denominator – chime in on these issues,
low risk.” In those few the other unsecured claims. which is money very well
weeks after Lehman filed, In that regard, some people spent when considering we
any person's analysis of were talking about these manage a few billion dollars
“...uncertainty, to what the ultimate recovery really scary things, swap of credit investments on the
would be on those bonds contracts, guarantee claims, long and short side. We
us as distressed had enormous holes in it. customer losses, etc., and it run a pretty concentrated
Every good analyst who was sounded really bad. But book. We're not the sort
investors, is our looking at that situation had what you were supposed to of investors that want to
friend, because dozens or possibly hundreds be doing is building your sprinkle our assets across
of unanswered questions. waterfall model, under- 100 different ideas. Our 10
uncertainty is But we knew these would standing all of the different biggest positions represent
eventually get answered variables, and coming up the vast majority of the
something investors over the coming months, with a realistic range of out- credit portfolio, so we
quarters, or years. comes from bad to good. If know those 10 positions
will pay to avoid – you had done this, you extremely well and we have
What's interesting about the would have realized that very high conviction in
sometimes pay a process, and about the dis- even in the worst possible them. I can assure you that
large amount. We tressed asset class, is that scenario, you still got an as they're trading lower,
occasionally you'll be given answer where you're not with very few exceptions,
love situations like an opportunity to buy going to lose a lot of money we're not selling them and
something at a price where from nine cents on the dol- running for the exits, we're
Lehman which we even though you have a lar because you were essen- buying more. And when
hundred unanswered ques- tially the most senior part of they trade higher we try and
call ‘high tions, you realize that re- the waterfall, and where remind ourselves of the
gardless of what the an- across most of the range of need to have the discipline
uncertainty, low swers are, you probably outcomes you would be to start to sell things as the
risk.’” can't lose a lot of money, making very good risk- risk/reward becomes less
and most of the time you adjusted returns. To put favorable because of price
will make a little or a lot. numbers around this, if your moves. This buy and sell
This obviously assumes that base case showed a recov- discipline sounds pretty
you correctly understand ery of 30 cents on the dol- simple, yet all of us know
the capital structure, which lar, your estimated claims, that it’s a lot easier said
is key in distressed invest- the denominator, could be than done. We try to use
ing. Some people looked at twice as bad as in your base the group dynamic to re-
a Lehman Brothers holding case and you’d still get a mind ourselves of that on-
company bond trading at recovery of 15 cents on the going challenge and to make
nine cents on the dollar and dollar and earn a double- sure that we don't get
thought about the fact that digit IRR over five years. caught in a trap where we
if you deconsolidated the That’s a pretty massive mar- fall in love with our own
balance sheet and calculated gin of safety. So high uncer- positions.
what the assets of the hold- tainty, low risk is a subcate-
ing company were, which gory within distressed that G&D: You mentioned at
included individual assets, as we love. the CSIMA Conference last
well as tens of billions of year that it's very important
dollars of intercompany Secondly, we don't think (Continued on page 19)
receivables from other Leh-
Volume
Issue I, Issue 2
XVII Page 19
Daniel Krueger
(Continued from page 18) and build the model very there is to know about eve-
to stick to your investment early in the process. If I ask rything else in the universe,
process. Could you de- you to analyze a bond that's and these were the last few
scribe Owl Creek’s invest- trading at 52 cents on the things you didn’t know. But
ment process and how you dollar, and let's say it's a most of the time there's
built it over the years? company that makes TVs, two or three big things that
your first inclination is to really matter and it makes
DK: Generally speaking, read a hundred things about sense to focus the research
we're big believers in the the company and go talk to effort there. “This buy and sell
notion that you need to them and do a bunch of calls
focus early on in the analysis and other stuff. That's all In distressed, specifically, discipline sounds
on the major drivers of important work to do, of sometimes you can have a
what's going to make or course, but I might suggest situation where the out-
pretty simple, yet
lose you money in the in- to you that you should do a come is dependent on a
vestment, and avoid the all of us know that
little bit of work first, and single variable. For exam-
temptation to simply go out then you should start to ple, does the intercompany it’s a lot easier said
and gather a lot of data. think about what's going to loan exist between Subsidi-
The reason I say that is not make that price look cheap ary A and Subsidiary B? It's than done. We try
only because it’s a waste of or expensive. Think about either there or it's not, and
time to do the latter, but in the variables that go into if it's there your bonds are to use the group
the worst examples, extra- the analysis: sales growth, worth par, and if it's not
neous data are a red herring margins, capex, whether your bonds are worth zero.
dynamic to remind
that can cause a person to they win or lose a contract, In that scenario, does it
draw an incorrect conclu- ourselves of that
things like that, and then really make sense to ask
sion. There’s an interesting build your valuation model why ARPU at the holding ongoing challenge
book written by the CIA for in Excel, and think about company was down 2% in
their internal use that talks what the blue assumption the third quarter? That’s an and to make sure
about this concept. The cells are. Without doing a exaggeration, of course, but
book can actually be read lot of hard work, you won’t the point remains the same. that we don't get
online for free on the CIA’s yet have good views about
website – just Google “CIA what the right numbers are We also do a lot of primary
caught in a trap
intelligence analysis book” to plug into your blue as- research. It's a cliché obvi-
and you should be able to where we fall in
sumption cells, but you'll ously, but then again there
find it. In it, it describes then go out and talk to the are a lot of things in invest- love with our own
how the human mind can company and be able to ask ing that people can agree
keep very few concepts in targeted questions that spe- are important but which positions.”
mind at any one time. As an cifically address the blue they don't actually do. It's
example, the book asks the cells. Over time the model not enough to just hear
reader to try to multiply any will evolve and become from the sell-side that a
pair of two-digit numbers in more refined, and you’ll be certain contract has very
one’s head, say 47 X 63. building on earlier work and loose language surrounding
This is a task that is easy to making improvements, not the termination rights of a
do with a pen and paper but just gathering more facts. large customer. You need
is tricky to do in one’s head What I found in my time to go find that contract, if
because it’s hard to keep all doing this and going to con- it's in the public domain, and
the pieces of the puzzle at ferences or sitting in small you need to read it. Maybe
the forefront of one’s mind group meetings, is that a lot you need to ask a lawyer
together at the same time. of people will have an hour who's an expert in contract
with the CEO and ask about law to read it as well and
In that regard, what I say to a lot of industry jargon that give you his or her opinion,
the students in my class as a could only possibly matter if especially if that's a big part
tip, and something that we you knew absolutely all (Continued on page 20)
do around here, is to try
Page 20
Daniel Krueger
(Continued from page 19) etc. – these are things for mediocre to bad economy,
of the risk/reward. which you need a special because it has a lot of catch-
The process for analysis in toolkit to analyze. You ing up to do.
distressed is very tedious, need to be willing to invest
very labor intensive, and the time to look through all Another thing we do as part
“I think a lot of very boring. Sure, parts of of the documents and, let's of our investment process is
it can be action-packed, like not forget, this is all on top remind each other to tune
people mistakenly when you're sitting in court of the valuation work that out the market noise that a
and the judge walks out to every analyst would need to lot of us have been tacitly
think the task in give you the answer to the do to analyze an equity. So trained to tune in. I think a
investing is to try to key question on your invest- you need to be skilled at lot of people mistakenly
ment, and you know the valuation, but you also need think the task in investing is
predict in which bonds will move 20 points to be strong in your under- to try to predict in which
in a few minutes, you’re just standing of all of the struc- direction market prices will
direction market not sure if it will be up or tural aspects of distressed go next. It’s a subtle differ-
down. But to get to that investing. Then, if that ence, but I think it’s a mis-
prices will go next. place you need to have read weren't complicated take from the start to think
two credit agreements, 16 enough, you need to under- about it that way, as op-
It’s a subtle indentures, understood the stand the motivations of posed to thinking about
difference, but I financial covenants back- different people: What potential outcomes and the
wards and forwards, mod- does the LBO sponsor want payoff structure across that
think it’s a mistake eled out the company's op- to do? Do they want to range of outcomes. What
erations quarter-by-quarter extend their option on their the great investors that I
from the start to for the next eight quarters out-of-the-money equity or respect most recognize is
to understand exactly when file the company tomorrow? that the market is not some
think about it that they'll run out of cash, What currency might they wild beast in need of being
looked through 8-Ks, pro- have with which to get a tamed, but that mispricings
way, as opposed to spectuses, regulatory filings deal done with creditors? in the market are what cre-
thinking about to look for intercompany What does management ate the opportunities. And
loans or special dividends want? What do employees if your analysis causes you
potential outcomes that could have been paid want? What do competi- to have a certain view, long
up or down in the struc- tors want? How are com- or short, you cannot expect
and the payoff ture, etc. We're generally petitors going to react if this that every day, or every
looking at big organizational company goes into bank- week, or even every year
structure across structures that have a lot of ruptcy? For example, one you will be rewarded for
different pieces, which in- of our current investments your view. We try to use
that range of creases the complexity and is in an industrial company. our team environment to
outcomes.” workload, but also maxi- A few years ago when the remind ourselves of that,
mizes the chances of finding company was distressed and and it’s easier to stick with
mispriced securities. their EBITDA was negative, one’s conviction when you
their competitors went out have a lot of smart people
Take a company like TXU. of their way to lower prices around you also buy into
This was the largest LBO of to make it that much worse the investment thesis, as
all time, has a huge amount and try and force the com- opposed to being alone in
of debt, multiple layers of pany to liquidate. The your view.
the capital structure whole industry got screwed
(subordinated, senior, and up because of these pricing G&D: Can you talk about a
secured) at multiple differ- actions. That didn’t work current investment idea that
ent subsidiaries with cross- and the company is still in you like?
guaranties, funds flows in business today. Pricing is
many different directions, now going through the roof DK: There's a company
tax issues that arise from in that industry, even in a (Continued on page 21)
the corporate structure,
Volume
Issue I, Issue 2
XVII Page 21
Daniel Krueger
(Continued from page 20) the company, and we cer- would sue these companies
called Aiful where we own a tainly didn’t believe that that and drain out cash, and,
lot of debt. It's a Japanese liability was fictitious or that indeed, you could see in
company that does con- it should be ignored. But their historical financial
sumer finance. They pro- what we did recognize was statements the cash coming
vide consumers with small out of these companies.
micro-loans, generally What we liked about this
equivalent to a few thou- dynamic and the risk/reward Pictured: Bruce Greenwald
sand dollars. This business of the position at the time is at Graham & Dodd Breakfast
doesn't exist in the U.S., that their assets were in October 2012.
where credit cards serve “You need to be willing largely unencumbered,
this purpose. The back- to invest the time to meaning they had not been
ground here is important, pledged as collateral to
so let me spend a couple look through all of the other lenders, and, thus, the
minutes on that. The rea- documents and, let's company was free to use
son this company was inter- these assets however it
esting to us initially was be- not forget, this is all on wanted. We reasoned that
cause they got into trouble top of the valuation one option for the company
a number of years ago when was to sell those assets and
the Supreme Court in Japan work that every analyst use the proceeds to pay our
ruled that Aiful and certain would need to do to bonds as they came due.
competitors had been Another option was to get
charging an interest rate analyze an equity. You us to voluntarily extend our
above the legal limit. You need to be skilled at bond maturities into the
might ask yourself why they future if they granted us the
would do something that's valuation but you also assets as collateral. The
illegal. In Japan, there are need to be strong in latter was a deal we would
different interest rate caps have done because we
based on different types of your understanding of would have gone from own-
businesses and these com- all of the structural ing unsecured bonds with a
panies always pushed the lot of downside in the event
envelope in terms of what aspects of the distressed of a default to being secured
category they fell into. The asset class. Then, if and very well protected.
Supreme Court came back Ultimately, the path chosen
and said, "You're wrong and that weren't by the company was one
you've been acting too ag- complicated enough, where the assets were
gressively all these years." pledged to the banks to get
Overnight, giant contingent you need to understand them to extend their ma-
liabilities popped up for the motivations of turities a number of years.
these companies because As soon as that was done it
their former customers different people...” cleared a pathway for our
would now be able to sue bonds to get repaid at par
them to recover damages upon maturity.
for this excess interest. The
size of this new liability Fast forward to today –
caused Aiful’s bonds to that the liability was not what we own now is that
eventually trade down as going to “mature” and be- bank debt which got ex-
low as the 30s around the come payable anytime soon. tended, which is a different
summer of 2009, for bonds In that respect, we viewed bet. The original idea was a
that were maturing in a year our near-dated bonds as liquidity bet where if we got
or two. quasi-senior to these liabili- it wrong we were going to
ties. Over time, people (Continued on page 22)
We didn't necessarily love
Page 22
Daniel Krueger
(Continued from page 21) capped at par plus interest; proved from 2-to-1 to 5-to-
get creamed in terms of our i.e. the shareholders are 1. However much you liked
recovery, but where we getting that 67% upside. it at 50, you should really
thought our probability of love it at 40. I think a lot of
getting paid off at par was Lately, in this environment, people miss this relationship
good enough to warrant the we love buying 1st lien bank because they are overly
downside risk. Today it's debt. It's very comforting focused on their base case
Pictured: Whitney Tilson the opposite – it's a valua-
of T2 Partners LLC at
to know that when you're a outcome and the return
tion bet, not a liquidity bet, secured creditor, you are that one scenario would
CSIMA Conference in Feb-
where we think our down- first in line and that, almost generate rather than think-
ruary 2012.
side is limited even in the always, you will get some ing about the range of possi-
worst case outcome. We recovery on your paper ble outcomes. If you're not
think that the assets of this because it's highly unlikely thinking about how much
company, in our base case, that the residual recovery capital you have at risk, i.e.
should create enough value value on the assets after the downside, then I think
for this bank debt to get bankruptcy fees and liquida- you're leaving out a very
back par. In addition to tion fees would be zero. So important part of the equa-
that, the fundamentals of if you’re comfortable that tion.
the company have been you’ll have some recovery in
improving because the cash a worst-case scenario, then G&D: What is another
outflows from the excess the upside/downside analysis investment that you like
interest liabilities have been becomes really important. currently?
coming down recently. We What we say to each other
think that the market has around here is that it's only DK: Sometimes distressed
“...it's only with the been overly cynical about with the benefit of under- opportunities come in the
the ability of this company standing your downside that form of equities, and we’ve
benefit of to dig itself out of its hole you can start to dream played a lot of distressed
operationally. There’s a about the upside. For ex- equities over the years. We
understanding your maturity date in the summer ample, if you have 1st lien like buying out of the money
downside that you of 2014, so you’ll eventually bank debt at 50 cents on options at a cheap price,
get an answer to the ques- the dollar, and you think the and that’s what you get to-
can start to dream tion. In our view, it has ultimate recovery can be day owning Leap Wireless
very good downside protec- somewhere from 30 to 90, equity. In fact we would
about the upside.” tion because it is secured you would probably buy it argue it’s not even “out” of
debt, and you've already because your upside is 40 the money. Leap is a wire-
built in a large margin of points and your downside is less company that trades at
safety just in the discounted 20 points, so you have a 2- a little over $6 a share. The
price from par down to 60, to-1 upside/downside ratio. market value of equity is
where it trades today. The Your expected return, as- around $500 million, but
upside/downside is very suming a normal distribu- that represents only a sliver
compelling, meaning you can tion, is +20% (from 50 to of the total enterprise value.
make enough money on the 60). Now imagine that, on What we love about this
upside owning it at 60 – i.e. no fundamental news, the idea, and the reason we
+67% on your money – to bank debt trades down 20% bucket this as a credit idea,
justify the downside risk. to 40 – your upside/ is that you need to under-
That's very distinct from downside is now dramati- stand the capital structure
buying a bond at 100 cents cally different, even though and the liquidity of this com-
on the dollar, where your the price is down “only” pany in order to understand
valuation work may indicate 20%. Think about it, from the risk/reward. We think
that you’re “covered” on 40, you've got upside of 50 the liquidity profile is decent
valuation by 67%, but you and downside of 10, so your enough that it doesn’t need
don’t keep that upside be- upside/downside has im- (Continued on page 23)
cause a bond is always
Volume
Issue I, Issue 2
XVII Page 23
Daniel Krueger
(Continued from page 22) So we’ve got a highly vola- ton of spectrum that it is
to file for bankruptcy any- tile asset where we’ve made not using and it seems sur-
time soon, and you’ve got a a bet in a small part of the prising that the management
very large shareholder as capital structure and we team has not tried to
Chairman of the Board, so have a long period of time monetize it sooner given its
you shouldn’t see manage- to find out how things end leverage profile.
ment proactively filing the up. So, figuratively speaking,
company to the detriment if we roll the “spectrum DK: Actually, my under-
of shareholders. So our valuation” die and it hits on standing is that over the
starting point is that we’ve one of the upside cases, we past couple of years the
got an option that will sur- should make multiples of company has sold a signifi-
vive for at least a few years. our money owning this eq- cant chunk of out-of-
uity. You can do this math footprint spectrum to raise
Then we think about what for yourself and you'll see liquidity, so I don’t immedi- “[With Leap
our asset is and what it pretty clearly that you can ately agree with the premise
could be worth in different make two, three, four, five, of the question. And as I Wireless equity],
scenarios. A lot of people six times your money in said, we think the company
like to look at EBITDA mul- scenarios that are not pie in has a decent liquidity run-
you can do this
tiples for this company, but I the sky. Plus, we get to roll way. Let's say we’re wrong,
think that’s really missing math for yourself
that die multiple times, given though. The other possible
the point, because Leap’s the company’s liquidity. If path for this company is that and you'll see
most important asset can- we’re wrong, the stock may they go into bankruptcy. As
not be discerned on the go to zero, but we believe I say to my students on the pretty clearly that
income statement, but even that is questionable first day of class every year,
rather on the balance sheet. given management’s expec- bankruptcy has a negative you can make two,
It’s not how much EBITDA tations of turning the corner connotation in society, but
they generated over the and getting to positive free bankruptcy and Chapter 11
three, four, five, six
past 12 months, it's the cash flow. The debt trades exist for a reason. It exists
spectrum that they own, as times your money in
around par, at least for now, to allow a company to tran-
well as the subscriber base so raising some money in a sition out of its old, bad scenarios that are
that they have and all the debt financing is another capital structure into a new,
plant and equipment that option for the company if more manageable capital not pie in the sky.”
they've accumulated over they choose it. We would structure as smoothly as
time. If you think about it never make this a giant posi- possible, as well as restruc-
that way and then you rea- tion in our funds given the ture operations via renego-
son that other people are downside risk. Rather, we tiation of leases, supply con-
buying and selling the stock would size it so we can live tracts, union agreements,
based on EBITDA multiples, to fight another day if we etc. So if Leap went into
it strikes you that you may roll snake eyes. The point bankruptcy, theory tells you
have something interesting of portfolio construction is that creditors will get into a
to look at here. We’re not to have enough of a mix of room and negotiate a plan
the world's leading experts these in your portfolio of reorganization, vote it
on spectrum and we’re not where over time you should through, and then come out
going to pretend to be, but do pretty well if you’ve of bankruptcy and continue
we know enough about it to properly analyzed the prob- along its path of operations.
know that most people are abilities of various outcomes But another thing that fre-
in the same camp as we are and how much you make or quently happens in bank-
in, even if they don’t admit lose in each scenario. ruptcy is that the assets get
it to themselves. The sold to the highest bidder.
traded values of spectrum G&D: What do you think If that happens, and if you
over time have been all over about the management team go back to that bottom-up
the map. there? The company has a (Continued on page 24)
Page 24
Daniel Krueger
(Continued from page 23) nize that no amount of including a lot of other good
valuation work around the work can make an opportu- short ideas, especially when
spectrum and other assets, nity appear in front of you. you think about the fact that
you can certainly build a The best one can hope for we're a global investor that
case for why this stock as the reward for a lot of can invest in any part of the
might be worth a lot of hard work is to uncover world. Today, we’ve got
money in a bankruptcy. opportunities that already roughly 40% of our credit
Pictured: Daniel Krueger GGP is an example of a
at CSIMA Conference in exist, but that is not a given portfolio invested in situa-
stock that came out of upfront. The reason I mentions outside the U.S. on
February 2012.
bankruptcy with substantial tion this is that we try not the long side.
value. So it wouldn’t be the to get too wrapped up in
worst thing if this company trying to predict what the G&D: Do you utilize credit
was on the cusp of bank- future opportunity set will default swaps (CDS) and, if
ruptcy and the market in- look like. We find that do- so, how?
correctly traded the stock ing so can sometimes cause
at pennies on the dollar additional, unnecessary DK: We tend to use CDS
because it equated bank- pressure to trade. a lot on the short side. Oc-
ruptcy with a worthless casionally we use it on the
stock. Clearly, you should The measure of how attrac- long side as well. And
be adding a lot more stock tive the opportunity set is at sometimes we do both, on
in that scenario if the analy- any given point in time is the same company, by using
“We don't play sis hasn’t changed much and how much stuff is getting what's called the “CDS
if you thought the risk/ into the portfolio. Right curve” to make very precise
very much at all in reward was good at $6 per now we’ve got over 60% of credit bets at some precise
share. our assets invested on the point in the future. The on-
the new issuance long side in credit, and the-run CDS contract that
G&D: As a guest lecturer we’ve also got a lot of expo- most people quote is the
market. We view in Columbia Business sure on the short side, so five-year contract. This
School’s Special Situations clearly we are finding plenty represents how much you
that as our future class recently, Howard to do. Remember that even have to pay per year to buy
Marks showed several when the default rate is low, protection against the de-
supply of distressed
charts of how surprisingly as it has been recently, you fault of a company for five
credits.” consistent the high-yield can still have situations years. You pay the same
market cycles are. We've where companies are get- amount each year for five
been in a period of a lot of ting into trouble but not years, and if a default occurs
high-yield issuance and rich defaulting, which creates within the five-year period,
valuations for a while now. opportunities for very high then the owner of protec-
How are you positioned or returns within a defined tion gets the benefit of get-
thinking about taking advan- period of time – i.e. owning ting 100 cents on the dollar
tage of the eventual oppor- stressed bonds to maturity. for the notional amount,
tunities in that market? and the protection holder
Like I said before, we run a returns the post-default
DK: We don't play very very concentrated credit value of the bond to the
much at all in the new issu- book. You don’t make party who sold the protec-
ance market. We view that more money by owning tion. But think about it:
as our future supply of dis- more names, you make why five years? It’s a totally
tressed credits. We've seen more money by owning arbitrary number. If you
this movie before and How- better names. So I don't were properly analyzing the
ard Marks is telling you a worry that we're not going credit risk of a company,
story of how it ends – it to be able to find 10 to 20 you should be able to form
usually doesn't end pretty. high-conviction ideas to a view of the credit profile
We don't disagree with that, own at any one time, not (Continued on page 25)
but it’s important to recog-
Volume
Issue I, Issue 2
XVII Page 25
Daniel Krueger
(Continued from page 24) September 20th of 2013 for they bust covenants due to
within discrete buckets of which we paid 87 cents on financial performance before
time. the dollar. the end of the third quarter.
Nowadays, a lot of traders In that case, the company
will trade CDS contracts So why did we do that? We would survive past the expi-
that are four, three, two, did that because this is a ration of the CDS that we
and one years out, and distressed company with sold in September, so we
sometimes even shorter, in bank debt trading at dis- would again keep the 13
addition to the more cus- tressed levels, and we think points, as both the contract
tomary five-year contract. that there's a reasonable we bought and the contract
That's very interesting to us probability that in the next we sold would have expired
because in very complex few months, the auditors worthless. So we're fine
situations you could form will go in to do their review with the company defaulting “So we've
the view, for example, that a and they will look at the before June, defaulting after
company’s credit risk is company's liquidity profile September, or never de- essentially
largely in the twelve months and projections and say “no faulting. If the company
between three and four clean opinion.” If that hap- defaults in July, of course, constructed [using
years from now, but not pens and they don't get a we have a problem. But
before or after that. This CDS contracts] a
clean opinion in their 10-K, that's a calculated risk we
sort of unnatural credit that would be an event of are taking, and we've sized three-month bond
curve could exist for a lot of default under the bank the position accordingly. I
reasons, such as how much agreement. We find it very wouldn't advise you to put that is issued on
cash the company has on its unlikely that lenders would your entire 401K into this
books versus the cash burn, not use that as an opportu- one trade, but within a June 21st of 2013
whether it has an unfunded nity to push the company portfolio of a bunch of dif-
revolver, when it might vio- into bankruptcy – and for ferent event-driven ideas, and matures on
late the financial covenants good reason – because this it's a good one to have be-
in the credit agreement, September 20th of
company pays out an enor- cause we think the ability to
whether it has a big subordi- mous amount of money in earn the equivalent of 15% 2013 for which we
nated bond maturity in a coupons to junior creditors for three months of risk, or
few years, whether it has a every year. And every time the equivalent of 75% on an paid 87 cents on
big customer contract that a dollar goes to a junior annualized basis, is a mis-
might roll off, etc. creditor, that's a dollar less priced opportunity given the the dollar.”
that the first-lien secured facts here. As we say
I won't mention the name, creditors get to keep upon around the office when try-
but right now we have a a bankruptcy filing. So we ing to illustrate the risk/
position in our books where think they would love to use reward of a binary-outcome
we own protection through that as a lever to push the idea, if we put this same
June 20th of 2013 that we company in. trade on a hundred times
bought for 18 points up- over our careers, we will
front, but we simultaneously The timeframe for that de- have done very well, even
sold protection through fault exists before the expi- though not every time will
September 20th of 2013 at ration of our June protec- we have made money.
31 points upfront. We’re tion, and if there is a default,
long the credit risk of this our short and long positions G&D: Could you describe
company for only three cancel each other out and your strategy on the short
months, but we got paid 13 we keep our 13 points. On side and how it’s different
points (the delta between the other hand, if the com- from your strategy on the
31 and 18) to take that risk. pany gets a clean opinion, long side, if at all?
So we've essentially con- then it will keep chugging
structed a three-month along – we don't think DK: In terms of doing the
bond that is issued on June there's any material risk that (Continued on page 26)
21st of 2013 and matures on
Page 26
Daniel Krueger
(Continued from page 25) if something bad happens – tion per year for a couple of
analysis on the short side, maybe supply and demand in years, and we'll take the
it's the same as it is on the the steel market gets out of position off and move on
long side. As you might whack because of all the with life. But if any of these
“Let's remember that guess, we tend to short new supply in China, or positions end up working,
companies that aren't yet maybe there is a bad global we'll make many multiples
in credit – to perceived as stressed or slowdown – we would be of what we're investing in
distressed. Occasionally paid handsomely. We don't this trade per year to keep
oversimplify it – you we'll press a short when the pretend like we can predict it on. On the short side the
are analyzing only company has already bro- with certainty what's going analysis is the same but usu-
ken, but most of the time to happen, but we own an ally the attraction is that
two questions: First, we will simply buy CDS on option on something hap- we're looking for problems
companies where we fore- pening in a realm where that the market doesn't give
what is the
see some higher probability there's a lot of inherent much weight to today that
probability of a that things will get really volatility due to operating we think should have a
messy than what is reflected leverage, financial leverage, higher weight.
default, and second, in current credit spreads. and cyclicality.
Let's remember that in G&D: You’ve been teach-
if there is a default,
credit – to oversimplify it – The one pushback we al- ing at Columbia Business
what will the recovery you are analyzing only two ways get on this idea is that School since 2006. Could
questions: First, what is the in Japan, whenever compa- you describe the genesis of
on the debt be? probability of a default, and nies get into trouble, the your class and whether
Clearly the answers second, if there is a default, banks just come in and bail you’ve seen any change in
what will the recovery on them out. They say that the the students since you be-
to those two the debt be? Clearly the banks don't really do any gan teaching it?
answers to those two ques- credit analysis, it doesn't
questions depend on tions depend on a thousand matter what a company’s DK: When they first asked
a thousand other other questions being an- leverage is, what its cash me to teach the class, I said,
swered, but if you're not flow is – if it’s a big indus- "No thanks. I think that's a
questions being thinking about it that way trial company, it asks for the poor idea for a class be-
then you're not really doing money and gets it. First, we cause distressed investing is
answered, but if credit analysis in my view. disagree that this is always really the intersection of
you're not thinking So as credit investors, and true, as we've seen some value investing (I'm not go-
especially as distressed in- Japanese companies go into ing to compete with Bruce
about it that way vestors, we're built to ana- insolvency proceedings. Greenwald and all these
lyze and opine on tail out- Japan Airlines and Elpida are other fabulous professors
then you're not really comes. examples. I also feel like in on value investing), bank-
doing credit analysis an environment where ruptcy law (no one can
Japanese steel companies, there's already a tough eco- compare to Harvey Miller,
in my view.” on which we own a lot of nomic landscape, to think who teaches that at the Law
CDS, are extremely lever- that the system needs to School), and turnaround
aged, and bankruptcies in continue to exist to subsi- management (again, some-
Japan tend to produce hor- dize the highest-cost pro- thing that is already taught
rible outcomes. I think the ducer of steel in the world very well).” They asked me
average historical recovery doesn't ring true when again a year later, and I rea-
over a long period of time viewed through an eco- soned that rather than try
has been roughly 13 cents nomic lens. and teach those things, I
on the dollar, much worse would just be the professor
than in the U.S. where it's in We may get this wrong, and who gathers it together and
the 40s. The steel industry if we do we will have lost a puts it in a package that
as we all know is a very couple of hundred basis involves making money –
cyclical industry. By owning points on the notional posi- (Continued on page 27)
CDS we own an option that
Volume
Issue I, Issue 2
XVII Page 27
Daniel Krueger
(Continued from page 26) think it will be almost im- bor. It was just the three of
making good risk/reward possible to teach these 40 us on the investing side and
decisions. to 45 students about dis- we were trying to make a
I tell my students that, first tressed investing because go of it. In that sort of sce-
of all, I truly believe the it’s a very daunting topic and nario, the world is your
class and the skill set of dis- something that, in a lot of oyster.
tressed investing is some- ways, you really can't teach. “In a Warren
thing that doesn't only apply You learn it on the job over In distressed specifically, like
to distressed investors. I Buffett-style of
a number of years. I still I said before, you learn on
think it's a very useful class learn something new every the job. A lot of people in
to have taken if you're going
value investing, if
day, which is why I like my distressed have a broad
to work in private equity or job so much. array of different back- your most
if you're going to work in grounds: turnaround advi-
equities. How many times G&D: Do you have any sors, lawyers, bankers, sell- important asset is
have we seen equity inves- advice that you would give side analysts, private equity
tors and equity sell-side to students interested in investors, etc. So if you're a your human capital
analysts get caught in a trap distressed investing? second-year student at Co-
because they didn’t look at a you need to set it
lumbia Business School to-
company's capital structure DK: My advice for business day and you think you defi-
or think about its liquidity?
on a growth
school students generally is nitely want to go into dis-
If you're just looking at a P/E that the most important tressed, don't think that if trajectory with
multiple, you're not captur- asset you have at this stage it's not your first job out of
ing a lot of other things that in your career is your hu- business school that you double digit CAGR
are important to your stock. man capital, not your finan- can't find your way in even-
Areas such as advisory and cial capital. Occasionally I tually. When we hire peo- for a number of
consulting at some time or see people worrying about ple to come in at the analyst
another also touch the dis- years. In a number
who's going to pay them the level here at Owl Creek, we
tressed landscape. Even if most or which firm has the expect them to have a pas-
you're the CEO of a com-
of years that will
most glamour attached to it, sion for investing and a lot
pany and your company which I think is a mistake. of raw horsepower, but have grown into
never goes into bankruptcy, In a Warren Buffett-style of they don't need to be Seth
your competitor might. If value investing, if your most Klarman their first day on something that's
this happens, what is the important asset is your hu- the job. They need to be
competitor going to do? man capital, then you need people who are smart, who powerful and useful
Who's going to buy them? to try to set it on a growth have the right skill set, and
Are they going to shut all of and something that
trajectory with a double- who we think can develop
their plants? Are they going digit CAGR for a number of into good investors over
to slash their labor costs
will be even more
years. After a while, that time.
and use that to under-price will grow into something important to you.”
you? There are a lot of powerful, and then you’ll G&D: Thank you very
different things that could have many more options. much for your time, Mr.
happen. So these are all The way you do that is to, Krueger.
things that pop up in dis- first of all, find a job working
tressed and pop up in my with people who you like
class. and in an environment
where you can do meaning-
I've always been very im- ful work and learn a lot.
pressed by the students in Certainly that's what I got
my class. I'm always very when I joined Jeff here at
excited to see the progres- Owl Creek. It was Jeff, me,
sion from the first day of and one of my classmates
class to the last day. At the from Columbia, Shai Tam-
start of every semester, I
Page 28
Frank Martin
(Continued from page 1) a fighter or attack aircraft primarily comes in print
After graduating from
off carriers. I defaulted into form. I also watch Bruce
Northwestern University in
1964, Mr. Martin served as my investment management Greenwald, your professor
an officer in the Navy for career because I flunked the at Columbia Business
two years. He is an avid flight physical three times School, from time to time
reader, writer, and due to an astigmatism, on video, along with other
philanthropist. He is which is a minor eye investors I respect such as
Frank Martin founder and chairman of disorder. So I didn’t lend Kyle Bass and David
DreamsWork, a mentoring Coke machines or conduct Einhorn.
and scholarship program other for-profit endeavors
for inner-city children. He
as the child prodigy, Warren Another positive is that my
“We call Elkhart received his MBA with
honors from Indiana Buffett, did. commute is 10 minutes.
‘Omaha University South Bend in Compare that to how long
1978. Finally, perhaps as a means the average New Yorker
East’ [laughs]. I of compensation, a latent spends getting to and from
G&D: Can you tell us and almost insatiable desire work, and you get an idea of
can’t think of a for knowledge and wisdom the competitive advantage I
about your background and
better place to be how you became interested emerged and I became an have. But I also have
in investing? avid reader. I suspect I read another edge. I get up
than in Elkhart, or a at least 30 hours each week, seven days a week at 4:30 in
FM: As an investment between books, periodicals, the morning. The first four
better place not to and the current news. I hours are the most
management major, I took a
be than in New course during my senior avoid all the social media productive in my day.
year at Northwestern on sites but am fastidious about There’s an old adage that
York. I don’t get the security analysis. The emails. says, “An hour in the
teacher was an adjunct morning is worth two any
typical distractions G&D: Your firm is located other time of the day.” In
faculty member, Corliss
in Elkhart. … I think Anderson, who was one of in Elkhart, Indiana, far away terms of staying current, at
the founders of Duff, from New York City, the 4:30 I begin with the
it’s a lot easier to be Anderson & Clark, which hub of the investing world. internet versions of the
was a Chicago-based In what ways has this been a Financial Times and The New
independent without
municipal bond firm that has positive for you? York Times. I then read The
the herd pushing since been broken into Wall Street Journal and sign
pieces. Anderson was the We call Elkhart ‘Omaha onto Bloomberg early to
you toward the perfect mix between the East’ [laughs]. I can’t think read the news and check
theoretical and the practical. of a better place to be than the global markets. I usually
mediocre middle. I
He had been in the field, in Elkhart, or a better place get this done before 5:30 in
know for sure it’s and he used Graham’s not to be than in New York. the morning. The Economist
Security Analysis as his I don’t get the typical is on my list, but not as a
much easier to think textbook. It was a distractions in Elkhart. We daily read. Given the
independently.” watershed event for me. have no watering holes, at abundance of information,
least so far as I am aware. I the biggest challenge for all
But I have to tell you, unlike haven’t been to a bar in my of us is to separate the
a lot of the investors you’ve life for after-work drinks. I wheat from the chaff. By
featured in Graham & think it’s a lot easier to be limiting myself to an hour
Doddsville, if I had any independent without the for current news at the
epiphany, it really occurred herd pushing you toward beginning of each day, I
in slow motion. I went to the mediocre middle. I effectively impose a time
Northwestern primarily to know for sure it’s much filter that forces me to seek
become a Navy pilot, so I easier to think out the meaningful over the
was a naval ROTC student. independently. I control trivial.
My dream as a kid was to fly most of my input because it (Continued on page 29)
Volume
Issue I, Issue 2
XVII Page 29
Frank Martin
(Continued from page 28) CDs yielding 14%, why came down those high
G&D: What led you to the would I lock myself into a coupons kept looking better
founding of Martin Capital 20% tax-exempt bond?” As and better. So I was kind of
Management? we know, one of the great a local hero there for a
challenges in our profession while. Then, when the
FM: It took me 20 years to is to see beyond the municipal yields fell, the
get there! I started in 1966 moment, even though most spreads narrowed. The
on the sell side with people live in that space. M&A world came alive. So
Walston and Company. My since I was used to doing
mandate was to go out and these kinds of long-tailed
sell. The product de jure transactions, it was an easy
was, believe it or not, transition to M&A. When
Hedge Fund of America. I Walston failed, I sold our
was told as a rookie that “At one point in the office to McDonald and
Hedge Fund of America was Company in 1974, which
designed to make money on
early 1980s, the
had a strong presence in the
the long and the short side. lowest-yielding tax- municipal market, and were
But I learned in 1969 that guys who I greatly admired
you could actually lose exempt bond I had who were very skilled in the
people money, even with M&A arena. They were
hedge funds, which left a in my own portfolio great teachers. One of
really bad taste in my those teachers, Mark
mouth. was 14%. That was Filippell, eventually co-
back with 50% tax founded Western Reserve
I didn’t like this idea of being Partners and I sit on the
in a position where you rates. So gross that M&A firm’s board.
could actually lose people
money as a fiduciary. So I up, and that’s a I cut my investment teeth in
spent the next 10 years on the early 1980s; I had to
the municipal finance side of 28% equivalent, make one correct decision
the business. As interest at that time – I had to
rates rose through the which is three times believe that interest rates
1970s, it was a very fun would come down. That
business for me. At one
the Ibbotson return
was an easy call, I felt,
point in the early 1980s, the since 1926. That’s because the U.S. Dollar was
lowest-yielding tax-exempt clearly the world’s reserve
bond I had in my own a no-brainer type of currency, and in that role,
portfolio was 14%. That we simply couldn’t be
was back with 50% tax investment.” running a double-digit
rates. So gross that up, and inflation number indefinitely
that’s a 28% equivalent, or we’d lose our credibility
which is three times the completely. If interest rates
Ibbotson return since 1926. came down, then P/E’s
That’s a no-brainer type of Through sheer persistence would come up, and stocks
investment. and force of will, I managed would be an excellent play.
to convince some people. If interest rates came down,
Since I originated these The nice thing about selling bonds would be an even
financings and had some people 20-year tax-exempts, better play. I put my entire
access to investors in the which were all callable in 10 retirement plan in 13.5% 20-
area, I asked them if they years, is that they think year zero-coupon bonds.
wanted to participate. Of you’re a genius for the next That was an automatic 12-
course, most of them said in 10 years because as rates (Continued on page 30)
the early 1980s, “Jeez, with
Page 30
Frank Martin
(Continued from page 29) U.S. treasuries when fascinating and equally
bagger without any credit or October 19th hit. I had been perilous time because the
duration risk – all in U.S. writing for a long time public, which had long been
treasuries, which then about the dangers that I had absent from the market as
allowed me to do a lot of seen. So even though I was measured by the ICI fund
other things. In the 1980s I a startup and didn’t have flows, came back in spades.
had more ideas than I had that many clients, I was able I think there were 5 million
money. Three clients and I to call all of them that night families that were in funds
bought a 25% stake in a and say, “Your portfolios at the beginning of the
bank at 50% of book value are actually up for the day decade and nearly 50 million
that was well capitalized and because of the flight to at the end. So it became an
returning 15% on equity. safety.” I got off on a good increasingly retail-oriented
Once again, the math is foot with my new clients in market. The 1990s were
pretty simple – 15% on 1987. capped off with the dot com
stated equity is 30% on my bubble and the insane
cost. I bought a lot of it, valuations, so during that
and it was ultimately a 10- time I was mostly playing
bagger. We had a few “When it comes to defense. Of course, I was
other ideas like that and I still collecting good coupons
thought it was prudent to compounding, I’m
from the tax-exempt bonds.
make big bets because The year 2000 was a
not sure everyone
investors were generally watershed year for me. I
over consumed with understands that thought anything technology
avoiding risk. In other -related or dot com-related
words, the antithesis of percentage losses was insanely expensive. But
today. The 1980s were just the bifurcation of the
an incredible time to be an and gains are not market was clear. I could
investor. And I hope – and buy mundane manufacturing
expect – that someday we equal. I’ve always
companies – the ‘main
may find ourselves in an street’ companies, if you will
managed to avoid
environment where risk is – on the cheap. So if you
overvalued and return is the large losses. look at our investment
underpriced! And this time, results from early 2000 to
double-digit interest rates Imagine something 2001, we were up sharply
may not be the cause. while the market was down.
as simple as that As you can imagine, we fell
When I was 36 (1978), I was behind the markets in the
diagnosed with multiple being one of your
late 1990s. There was no
sclerosis (MS). I knew that way you could keep up with
secret sauces!”
the life of a mergers and the near doubling of some
acquisitions banker, which is of the technology-related
all travel and pure madness, indices during the height of
would not be the career for G&D: Given that the the bubble. But we made it
me in the later stages of my macro environment plays an up by going up when the
life. So I went back to important role in your market went down in the
school at night and had a investment style, can you early part of the next
wonderful time earning my talk about how you’ve decade. When it comes to
MBA and the CFA charter. thought through some of compounding, I’m not sure
Just before the market crash the significant events of the everyone understands that
in 1987, I hung out my past 25 years? percentage losses and gains
shingle. 1987 was beautiful are not equal. I’ve always
because I was fully invested The 1990s were a (Continued on page 31)
in tax-exempt bonds and
Volume
Issue I, Issue 2
XVII Page 31
Frank Martin
(Continued from page 30) you hope to achieve well. It was a simple call.
managed to avoid the large competitive long term Deep out-of-the-money
losses. Imagine something compounding. Although puts were exceptionally
as simple as that being one most of the time I am a long cheap, unlike today. You
of your secret sauces! -only investor, the financial almost couldn’t afford not
system had become so to do it. Kyle Bass calls
The same thing really untethered from reality that such situations “asymmetric
happened later on as we I wound up doing what bets,” where the payoff is
approached the financial Michael Burry later many times the risk
crisis. It was pretty easy to described as “going long the incurred. They are as rare
see that what I called “the short side.” I tried to sell as they are profitable.
easy money fool’s rally” of everybody in the firm on [*Editor’s note: all of the
2003-2007 was going to end the idea of buying puts on opinions/events/decisions and
badly. You couldn’t the investment banks. As so on referred to in the
describe it exactly. Ben was thoroughly documented interview were chronicled real-
Graham said, “You don’t in Chapter 10 of Decade of time in Martin Capital
have to know a man’s exact Delusions*, it was Management’s annual reports
weight to know if he’s understandably a tough sell. – several reaching 100 pages
obese.” Like in the early So I went through the – that became the grist of two
1980s when buying long- investment banking section books, Speculative
term bonds, I only had to be in Value Line and picked Contagion (2006) and A
generally right. Anecdotally four or five companies that I Decade of Delusions
you could look at things, thought were candidates. (2011).]
such as house prices, the Bear Stearns had won the
impending end-game of Investment Bank of the Year Let’s go back to the year
Hyman Minsky’s financial award for three years 2000. I looked at valuations
innovation hypothesis, a running, so I figured that using a crude approximation
shamefully lax financial they had lots of hubris. Like of what Bob Shiller turned
regulatory environment, and a superficial Michael Burry, I into something incredibly
the perverse incentives up read a couple of their high- helpful. The Shiller P/E ratio
and down the food chain, yield money market fund uses inflation-adjusted data
which included the rating prospectuses from cover to and 10-year moving
agencies that became cover, which was quite a averages of earnings.
complicit by abdicating their job. I thought, “Oh my Valuations were in the
role as watchdogs. And the goodness, these guys are insane area – they were
list goes on. I looked at smoking dope!” So Bear much higher than where
structured finance deals, and Stearns was an easy they were in the late 1920s.
the whole idea of candidate. Of course, I looked at the broad-based
overcollateralization or Lehman was always playing inclination to take
redundancies, to the extent it a bit fast and loose and unrewarded risks – the
they had any, and the idea of too close to the edge in speculative contagion, which
layering risk in tranches to terms of leverage, so it was had permeated Wall Street
get higher ratings struck me another easy candidate. and particularly the retail
as insanity. I didn’t know it Merrill Lynch was our investor. We hadn’t gotten
would end as badly as it did, custodian before we moved into the huge leverage
however. to Fidelity, so I had some problem yet. I believed
personal experience in then as I believe now that
I came back from the dealing with the chaos at we were at a secular market
Berkshire meeting in May Merrill. Call it envy, but I, top. If you look at the
2007 thinking that Charlie like Michael Lewis, always Shiller data, these markets
Munger was right – you felt that Goldman Sachs was typically don’t clear until the
must avoid catastrophic pushing the envelope as (Continued on page 32)
losses in your portfolio if
Page 32
Frank Martin
(Continued from page 31) the downside. If our FM: I would like to think
Shiller P/E gets below 10 competitors behave that that being defensive is an
times, and sometimes way and we understand the educated conclusion. The
materially below. difference between time- first book, Speculative
weighted and dollar- Contagion, came out in 2006.
Buffett at the same time was weighted returns, the At the time people said to
writing about 17-year “edge” of our sword cuts me, “Gee, I like your book,
cycles, which I had thought two ways! but I have no idea how to
a lot about, and I agreed pronounce the title.” I
with. Around 2000, I wrote would say to them, “You
that I wouldn’t be surprised wait, in a few years, the
if a 6% coupon U.S. treasury word ‘contagion’ will be
would outperform the part of the common
equity markets through the vernacular of the trade.”
next cycle. Once again, the This is, of course, what has
beauty is in its simplicity. “The problem with happened. So the title was
Let's say in 2000 you bought ahead of its time, but I’m
a 6% 20-year zero-coupon [investing in not sure the book was. A
treasury. Today, it’s got Decade of Delusions was sort
seven years to run. It government bonds] of a capstone in 2011 for
would have cost you 33 the preceding decade, which
cents on the dollar. I think is the institutional was a decade that I have felt
because of the low five-year had been way too risky for
rates, it would be selling at imperative. People
two reasons. First,
96 cents on the dollar. don’t pay us to valuations had been
That's an internal rate of stretched, certainly if you
return of just under 9%, think, they pay us used the aforementioned
versus a sub-2% return, Shiller P/E. Second, because
including dividends, for the to act. They don’t of increased financial
S&P 500. The S&P 500 leverage throughout the
would have to be at 3,500 pay you for playing world, tail risks had
to match the zero. increased greatly. With that
good defense; they
overhang throughout the
The problem with that is pay you for playing decade, I was thinking to
the institutional imperative. myself, “Wow, what I don’t
People don’t pay us to think, good offense.” need to do is get blindsided
they pay us to act. They because we are paid on
don’t pay you for playing performance. I don’t want
good defense; they pay you to get underwater.” You
for playing good offense. can’t afford to get deep
One would think that underwater if you really
everybody understands expect to achieve good long
Einstein’s great insight – that G&D: Much like in the late -term compounding. I’m
compound interest is the 1990s, your defensive invariably defensive too
most powerful force in the nature served you well early as I was then. And I
universe. We all are aware during the market run-up justified that because of the
of the simple example that a and collapse following the optionality of cash, the
50% loss requires a 100% financial crisis. Could you aforementioned
gain to equal things out. Be describe your defensive overvaluation, and the tail
that as it may, people would nature and this latter period risks that I think people had
rather play offense and then a bit? not priced in. I hope that
lick their wounds after they (Continued on page 33)
have a bad experience on
Volume
Issue I, Issue 2
XVII Page 33
Frank Martin
(Continued from page 32) I also think people’s be on the global stage. I
sometime in the not too expectations related to jobs could see a renaissance in
distant future, the markets have been greatly manufacturing in America
will complete what I downsized. People are because of the traumatizing
consider the ultimate end thinking much more events through which labor
phase of a secular bear rationally. A job is no has gone. Workers have
market that really began longer an entitlement, it is a reordered their
with the peak in 2000. This expectations – we’re not Pictured: Mario Gabelli and
is clearly a minority view. going to have folks at GM David Winters at Omaha
“I would ask the making, with benefits, Dinner in May 2012.
G&D: In your opinion, are anything comparable to
the market and the question, can the what they made in the
American economy on their heydays. I think we’re going
way to being mended and excesses built up to spend a lot of time
attractive or does it remain focusing on those areas
as “deluded” as it was from the success where manufacturing can
during the last decade? enjoy a renaissance and
generated by a long
where labor inputs will be
I would ask the question, period of conserva- reasonable on the world
can the excesses built up stage. I think that’s really
from the success generated tive economics and exciting. Matt Ridley’s, The
by a long period of Rational Optimist, helps one
conservative economics and deregulation be understand where the
deregulation be cleansed in opportunities just might
a matter of six months from cleansed in a mat- arise.
September 2008 to March
of 2009? I don’t think ter of six months
On the other hand, profit
human behavior works that from September margins are peaking. Top-
way. Most of us need to line growth hasn’t been
have a trip to a woodshed 2008 to March of there. You can’t cut costs
before we begin to mend to prosperity. You
our ways. There’s a good 2009? I don’t think eventually have to have top-
analogy with the labor line growth. The economy
market. Labor has been human behavior continues to struggle. I’m
bludgeoned in part because worried about the fact that
of the excesses in the works that way.
tax revenues have averaged
financial sector. And many 18% of GDP – true over the
Most of us need to
homeowners, who are part long-term, with a low
of the labor pool, have also have a trip to a standard deviation, and
been suffering greatly. I seemingly impervious to
think this will be resolved woodshed before how high the top marginal
through a significant tax rate is – and we’re
behavioral change. People we begin to mend spending at a rate of more
will not use their home as than 24%. It’s that issue
an ATM. They will not use our ways.”
that I think we have to
homes as a way of making a privilege. What’s going to address at the legislative
quick profit. Throughout happen, I think, is that the level, which I don’t think has
my investment life, people longer this goes on, the much of a chance of
used their home as a way to better our workforce’s occurring for some time to
build up equity by paying attitude toward laboring is come.
down their mortgage, not as going to be, and the more
a speculative vehicle. competitive we’re going to (Continued on page 34)
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Frank Martin
(Continued from page 33) today. That’s why I think down, especially over the
Additionally, I do think that Dodd-Frank is the toothless last decade, that I’ve missed
the capital markets have not tiger. All this leads me to a lot of layups that I could
gone through any kind of believe that we’re just have had if I had been just a
catharsis of the sort that playing games with little more open-minded and
labor has. Labor no longer ourselves. The bell curve is shorter-term oriented. I’m
has a powerful lobby but a joke, and value at risk is a like Bob Rodriguez in that
capital does. I recently read concept that is a really lousy I’ve been very defensive
that $3.6 trillion of measure of true risk. I think since the summer of 2010,
corporate bonds were sold you’ve got to gross up risk and that has not paid me
by mid-December 2012 – at the big banks, derivatives very well because the
who’s buying those? Well, risk in particular. If you do default asset class, for a guy
it’s in part the small investor that today you’ve got who’s looking for some
who’s disaffected with yourself a crisis. So the place other than the market
equities and bound and world’s financial system to put his money, doesn’t
determined to get some remains in a critical state. yield anything. So for the
yield out of something, so Basel II allowed the first time in my investment
he’s stretching out the risk European banks to go to a life, there is not an
curve and scrambling for 2% capital ratio. Is that not alternative that actually pays
some sort of return. a prescription for disaster? me something.
I just don’t think we’ve
The shadow banking system written the final chapter in But believe it or not, when
in the United States is $25 this. We are at a critical it comes to individual
trillion, I believe, and $65 state, but I have no idea security selection, we are a
trillion globally. Neither what the catalyst is. bottom-up firm. We’re not
domestically nor globally interested in cigar butts;
have the numbers changed G&D: Can you talk about we’re a classic Buffett-type
much since 2007. In the the investment strategy at investor. We want
United States, total assets in Martin Capital Management? companies that we don’t
our banking system are $13 have to sell unless the
trillion. So the shadow FM: I would like to say that market bids them up to
banking system, which is we’re a situationally- uneconomic prices. For
mostly asset-backed lending, sensitive value investor. example, Gentex is one of
is double the size of the Everything is situation- our current holdings.
regulated lending market. specific. The situation I’ve We’ve actually bought
Ben Bernanke really doesn’t just described is one that Gentex twice. I love buying
have as much control over suggests that tomorrow’s the same company twice
the financial mechanism as opportunity set may be because you’ve already done
most of us would like to better than today’s. So your work. It’s very
think. You would have sometimes you have to play efficient. I bought it the first
thought that the whole defense. You’re always time in late 2008 and again
shadow system – the arms- trying to find fish that swim recently. The business
length securitization system against the stream, but performed beautifully during
– would have collapsed, but shopping in a crowded big- the recession, but the stock
the numbers suggest box store shortly before became too expensive.
otherwise. This all tells me Christmas is really Then they had some news
that 2008-2009 wasn’t problematic. What’s your regarding their rear camera
cathartic, and that we’re edge if you’re piling in there display option, which was
kind of back to the old with everybody else? This is negatively received. The
games. often a significant failing on cameras were going to be
my part – I think I’ve been placed on the dash instead
The banking lobby is just so preoccupied with top- (Continued on page 35)
incredibly strong, even
Volume
Issue I, Issue 2
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Frank Martin
(Continued from page 34) G&D: Many value both human and institutional
of in the mirrors on a investors tend to avoid behavior are vital to long-
couple of their big macroeconomic thinking in term investment success.
customers’ cars. But I their individual stock I’ve seen a lot of very smart
didn’t think that this selection. Why is it so people who have lacked
development was that important to understand the these virtues.”
material, and I love the top-down perspective along
demonstrated productivity with bottom-up analysis? I was reading this and
of their research process. thinking, “Where’s the
The stock tanked a number FM: Because I think this is bottom-up stuff in this?”
of months ago, so we took a really a fascinating subject, Was this kind of a quiet
big position in it again. I and I notice that most value warning to the world that “But I think
also really admire the CEO. investors are primarily things were crazy? Based
bottom-up. I took you on his subsequent behavior, [Warren Buffett]
The first document I read through the decade of I don’t think it was. But I
on any company is the delusions, but let’s go back think he hit the nail hit the nail
proxy statement because I to 2006. The 2006 absolutely on the head.
want to know where the Berkshire Hathaway annual There are times where absolutely on the
incentives and rewards are. report came out in March of you’ve got to think top-
Obviously I like owner- head. There are
2007, and the meeting was down when the risks I
operators, but you don’t May 5th of 2007. So I’m mentioned earlier are times where you’ve
find those in the big-cap reading the annual report present, perhaps in spades.
companies. Then you’ve got about what Buffett was That’s why I think as I do, got to think top-
to read the 10-K to find out looking for in a successor. and that’s why I hope that
what the real story is, Let me read you these two my job will become down when the
because the 10-K is the short paragraphs: immediately redundant
annual report without the when we experience the [macroeconomic]
adjectives. If you strip out “Over time, markets will do downside of the cycle. This
the adjectives in an annual risks I mentioned
extraordinary, even bizarre, is really critical to how this
report, it looks pretty bland. things. A single, big mistake might differentiate me. As I earlier are present,
Of course the 10-K requires could wipe out a long string say, it’s situational. When
disclosures like risk factors of successes. We therefore stocks are cheap, and tail perhaps in
that you would never put in need someone genetically risks are priced in, or we’ve
an annual report. If you’re programmed to recognize gotten rid of some of the spades.”
comfortable with a company and avoid serious risks, tail risks by addressing some
after you get through those including those never before of the still excessive
two documents, then it’s encountered. Certain perils leverage throughout the
time to see if management that lurk in investment entire system, then you
squares up with what the 10 strategies cannot be spotted really won’t have to worry.
-K says. I also always read by use of the models The biggest tail risk,
five years’ worth of glossy commonly employed today obviously, is still financial,
annual reports, and I always by financial institutions.” unless you listen to Leon
read them in one sitting. Panetta saying that we might
It’s a great exercise. You Now I would say that have a cyber Pearl Harbor.
would not believe how there’s nothing micro about But that’s so abstract that I
many companies’ reports that, nothing bottom-up. can’t price it in. But the
are so different year-to-year And then he goes on to say: “gray” swan risk of another
that you don’t even leg in the financial crisis is
recognize them as the same “Temperament is also real. While we can’t assign
company. I want to make important. Independent a probability to it, it’s
sure that one year is not thinking, emotional stability, nonetheless real.
inconsistent with the year and a keen understanding of (Continued on page 36)
preceding.
Page 36
Frank Martin
(Continued from page 35) The Crowd, written in 1895 that we’ve barely begun a
G&D: Could you describe by Gustave Le Bon, is deleveraging cycle that will
the interaction between you probably the most impact growth for a long
and your team? instrumental book in time, that’s not a bet I’m
framing my ability to go willing to make.
FM: The dynamic tension against the grain of
that exists between my conventional thought and At Northwestern I took a
Pictured: Bruce Greenwald team and me is a good thing not feel insecure. Le Bon survey course in religion in
and David Einhorn at because the guys force me
CSIMA Conference in Feb-
basically said that when one which I read the great
to keep my bottom-up eyes joins a crowd – when one theologian Reinhold
ruary 2012.
open, and I force them to becomes part of the herd – Niebuhr’s Moral Man and
keep their top-down eyes he tends to function at a Immoral Society and was
open. So I like that tension. much lower level. In the enamored with it. It was
We all get along. This is a capital markets – because of my first introduction to
group that appreciates my the Bloomberg terminal, crowd behavior. When
perspective, and I appreciate because of instantaneous Extraordinary Popular
theirs. We have an open communications, because Delusions and The Madness of
forum – everybody can say everything is live and online Crowds came along, I
what’s on his mind. – we can create devoured that. The title is
Ultimately, I make the final instantaneous synthetic so descriptive and so
decision, but I respect these crowds. This whole timeless; think of how well
guys, so I listen to them. business with ‘the Fed has it describes the mood of
our back, that as long as the today. Bob Shiller is a
G&D: You said in your Fed is going to keep the leading light among a
book, A Decade of Delusions, spigots open, you’re not growing group of behavioral
that you attempt to going to get a bear market,’ economists, and his Irrational
continually understand the is a simple suggestion – Exuberance, published in
psychology of the according to Le Bon, the early 2000, revealed his
marketplace to gain a crowd loves simple multidisciplinary capacity. I
competitive edge. What is suggestions. almost didn’t read the
the genesis of your interest Understandably, it is second edition that came
in, and commitment to, incapable of complex out in 2005, because it was
understanding the reasoning. Imagine the edge essentially a reprint…
psychology of groups? one has if one simply except for a rather
disassociates himself from fascinating discussion on the
I think this is something that the crowd. emerging real estate bubble!
I hope you will put in your What he said in a practical
mental hard drive, because For example, I think many sense resonated so well
it’s been a great asset to me investors are misreading with all the social science
over the years. Again, I live what the Fed is doing today. theory I had read. I’m
in Elkhart, IN. It can be Once they submit to the deeply in his debt. I just
very intimidating reading the will of the crowd they are read Daniel Kahneman’s
guys interviewed in Graham almost Pavlovian in Thinking, Fast and Slow, and I
& Doddsville, or, if I’m responding to the simplicity think that he and the late
inclined – which I’m typically of the “Bernanke put” and Amos Tversky are some of
not – to watch CNBC and are thus oblivious to the the great behavioral
the talking heads. There are long-term consequences. scientists. Since nobody in
some guys in this industry Somehow this has to be our industry thinks about
who are really smart. So I unwound. Everybody this very much, I think about
may ask myself, what edge thinks, “Well we’ll just grow it a lot.
do I possibly have with this our way out of it.” Well,
crowd? perhaps we will, but given (Continued on page 37)
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Issue I, Issue 2
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Frank Martin
(Continued from page 36) there’s a chance the future that cash is a good hedge
G&D: Even Kahneman will prove that I’m wrong against deflation and a
admits that knowing about about a decision that I’m respectable hedge against
the failings of human considering, whether I’m inflation, and offers huge
psychology and decision- wrong because of biases or optionality, is that I’m going
making doesn’t mean you I’m wrong because I to let an opportunity slip by.
won’t still fall prey to them. incorrectly assessed the The beauty in this business
Are there specific steps in situation, if the downside is is that there are just hordes
your investment process permanent loss of capital, I of future opportunities
that ensure you won’t fall waiting and some of them
prey to these biases and may be huge if you’re
heuristics? “If there’s a patient. And I think Ben
Franklin summed it up well:
FM: That’s a problem chance the future “He who has patience can
everybody has to have what he will.”
acknowledge that they have. will prove that I’m
It’s painful to read a book For those who are long with
wrong about a
like his because you wonder the throng, they’re going to
just how much of your decision that I’m have to explain, if I’m right,
subconscious biases are why they’re down, say, 50%.
ruling your decision-making. considering, I’ve never been in that
I try to benchmark my position; our clients have
thinking, and thus try to whether I’m wrong never suffered a bear
override my biases, by market. In bull markets,
frequently looking at a host because of biases
you underperform. Being
of charts I’d made using Bob down under 7% in 2008 and
or I’m wrong
Shiller’s 10-year moving being up so nicely in 2009
average data. I’m aware because I probably put us in the top
that biases exist. What I 5% of our class. But we
don’t know is to what incorrectly trailed pretty significantly
extent they invade my from 2003 to 2007. And
otherwise rational mind. assessed the I’m trailing now again. So
Clearly they do but I am I’m a classic ‘win by not
utterly uncertain as to how situation, if the
losing’ guy, at least for the
much. I find some solace in time being – at least in this
downside is
the Bertrand Russell quote: high-tail risk, overvalued
“The trouble with the world permanent loss of market. But I will welcome
is that the stupid are when “this too will pass”
cocksure and the intelligent capital, I can’t go because this is no way to
are full of doubt.” live. I’d rather be totally
forward with that focused on individual
I agree with Nassim Taleb – companies, fully invested,
whose work I find incredibly decision.”
and sticking the ones I really
stimulating although he can like in a lockbox – like
be an offensive writer – that can’t go forward with that Gentex – not even thinking
everything has to go decision. If the downside is about it for five or ten
through the Pascal’s Wager the loss of an opportunity, years.
filter (he couldn’t even then I’m okay. By playing
resist taking issue with the defense like I’m playing right G&D: Your firm’s annual
great French now, the worst that will report shows that since
mathematician’s and happen to those for whom 2000, you’ve never been
probability theorist’s use of I’m a fiduciary, if you believe (Continued on page 38)
the spiritual metaphor!). If
Page 38
Frank Martin
(Continued from page 37) nets around 5.6%. That’s your hedge fund valuable
more than 70% invested. just awful. So I thought, enough?” And I reply, “I
Were there times in the let’s come out with a pricing don’t know. Look at our
late 1980s or during the structure that I would want track record for yourself.”
1990s where you were fully when my estate comes to And they say, “Well, your
invested? be managed by my firm after track record is pretty
my death. So I came up good.” And I say, “Why
FM: I started managing with a 90 basis points should I charge 2 and 20?”
money for others in 1987 maintenance fee for most And they say, “Well, if you
and for myself for many accounts, or – ‘or’ is the don’t, you give the
years before. I was always critical word – 10% of the impression that your service
100% invested. That could gains above a high water isn’t as valuable.” The “you
be long tax-exempt bonds mark. Granted, this is pay for what you get” belief
at 14%. It might have been Elkhart, but this money is so well entrenched – with
owning a bank in the early management business, if you substantial justification in
1980s. In fact, the 1980s actually make money for most cases – that the
were a most atypical period clients, is nicely profitable, weaker players among the
for me. I actually borrowed even at 90 basis points or hedge funds have been able
money for a while. I’m a 10% of gains above a high to thrive unexposed under
guy who doesn’t like to use water mark. that perceptual umbrella. I
leverage. I haven’t suspect that 2 and 20 will
borrowed money for the If you look at this in the have changed dramatically
last 30 years of my life for context of the grand sweep by 2020 because it simply
anything – I pay cash for of history, we are living in a cannot survive forever in a
everything, because I think if most unusual time that is low-return environment.
an investment doesn’t work surely getting long in the Maybe we’ll be seen as
without leverage, it’s not an tooth. In finance everything leading the charge.
investment you should do. is cyclical whereas in, say, Admittedly, I think it’s hard
But the 1980s were a time technology, today’s ideas for a value investor to
where I had many more are built on the shoulders of understand the appeal of
ideas than I had money. I yesterday’s. Think iPod, Veblen goods – like the high
can envision a period in the iPhone, and iPad. You can -end German cars or Rolex
future where this could make incredible fortunes in watches – or even most
happen again. It’s easy to this business, and you don’t hedge funds.
imagine a number of have to overcharge to do it.
scenarios that could cause You get to build equity, G&D: What was the
prices to sell as dramatically which means you never impetus for launching your
below what they’re worth have to worry about your first mutual fund in May of
as they have been selling finances, unless you’re a bad 2012?
dramatically above what investor. If anything, our
they’re worth. industry has become an FM: We never had a
embarrassment of riches. In marketing person until two
G&D: Your separately the aggregate, after fees we years ago. We brought on a
managed accounts don't are a negative value-added fellow who I believe is a
have a traditional fee proposition. great marketing thinker and
structure. Can you talk strategist. He asked me
about your fee structure People say to me at parties, when he came aboard,
and why you feel it’s a “How come you’re not ‘Why don’t you have a
better alternative to the charging regular hedge fund product for the retail
traditional 2 and 20? fees?” (People mistake us investor?’
for a hedge fund because of
FM: Obviously a 10% gross our investment style.) “Isn’t (Continued on page 39)
return with a 2 and 20 fee
Volume
Issue I, Issue 2
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Frank Martin
(Continued from page 38) If you can reach those kinds 1989, ultimately getting as
Sometimes you need a of people, you’ll have the low as 7500 and currently
catalyst to overcome inertia. kind of investors you want trading around 10,800, it’s
First of all, it takes you and deserve. We take the been a trader’s or
about a year, if you are relatively unusual tact of contrarian investor’s
methodical, to get the posting commentaries to market. I hope that we
concept from inception to the fund’s website [Martin don’t go into a Japan-style,
market. Then we went out Focused Value Fund] to lethargic period, but unlike
and talked to some people Pictured: Bill Ackman of Per-
keep investors regularly the post-2009 episode, I
that we like as long-term shing Square Capital Manage-
apprised of our thinking. don’t think we’re going to ment at Pershing Square Chal-
investors. We said to them, The most recent was “Why go back to the races lenge in April 2012.
“Are there buyers for a fund Would an Enterprising following the next down leg.
that is basically a call option Investor Hold Cash Today?” If it’s more like the post-‘74
on financial assets becoming With our fund, like our experience in the U.S.,
more rationally priced, separately managed sentiment will be negative
maybe even cheap?” Bob accounts, we depart from and prices will remain cheap
Rodriguez, who’s been as the mainstream: we control and investors will stay risk-
risk-averse as I have, says the critical asset allocation averse for a much longer
that in expensive markets, decision like the FPA funds time. Stocks will be
he'd try to get people to do. Done right, it has a unpopular and the whole
buy his fund. He'd say, very salutary effect on dollar process will be anything but
“We’ve got a lot of dry -weighted returns. Most glamorous. In that
powder take advantage of investors chase environment, I think the
opportunities as they performance while we are fund could do well because
appear” (Of course they looking for value. I doubt then we could strictly focus
think 30% cash is that we will ever have a on stock-picking and grow
extravagant. I think 30% problem of too much slowly, while attracting the
cash is straddling the money coming in over the kind of clients who just
fence!). What Rodriguez transom. But still, biggest is might stay the course. I
found is that they’ll say, “I not always best. openly admit that trying to
don’t want to put my find permanent capital in the
money with you now, and If I can read the tea leaves mutual fund space
pay fees, because you’re not and we do go through this admittedly may be insanity
earning anything. Call me cathartic process, it’s by another name. I think
when things get cheap.” probably going to be like Chuck Royce talked about
post-1974. Buffett knocked that in his Graham &
But, most investors are the ball out of the park from Doddsville interview (Fall
afraid to buy when 1974 to the early 1980s in a 2012 issue).
everything’s cheap. Even if bumpy, flattish market. The
they know things are cheap, public was exiting the G&D: Can you walk us
they worry that they will markets, particularly through your process for
become cheaper and they through funds. But what he finding new ideas?
find it difficult to pull the found was lots of individual
trigger. So the trick for us values. If I could paint a FM: Obviously one thing
is to see if we can get picture of the future, I’d say we don’t have, which
people into the fund it’d be something like that, Warren Buffett and Seth
without any assurance other or maybe something like Klarman do have, is
than that we have the Japan. There have been incredible sourcing
courage of their convictions great opportunities in Japan. opportunities for
– when prices were higher! But ever since the Nikkei investment ideas. We have
We’ve been good at 225 began its long about 40 names that we’ve
stepping up when times are meltdown from 39,000 in (Continued on page 40)
tough and stocks are cheap.
Page 40
Frank Martin
(Continued from page 39) G&D: What advice do you managements and looking
identified as businesses we’d have for students interested for little clues about
like to own at a price. The in the investment whether their behaviors
cost structure of building management industry? reconcile with their talk.
and maintaining an inventory When I see a value investor
of “ideas” is quite different FM: As soon as you can who lives really big, it
from manufacturing. In our disabuse yourself of the strikes me as a
fixed-cost business, we importance of money, it will contradiction in terms. I
“People don’t talk analysts think of ourselves help you immensely. All the know there are many
as Santa’s elves, working day stuff that’s important in life, exceptions and there are
about this very of- in and day out to build you get for free. All the dangers in stereotyping –
inventory for Christmas. stuff that’s unimportant, you but when you see such
ten, but it’s clear in Our job is to build an buy with money. When I lifestyles, it makes you want
inventory of investable first started, I said to myself, to dig a little deeper.
John Templeton ideas, so that when prices ‘Boy, as soon as I make a
come to us, we’ll get to pick million dollars, I will be G&D: It’s obvious from
and certainly in maybe 15 or 20 names. secure.’ Now that shows this interview that you are a
Buffett, that the We’d like to get it up to you how misguided I was. voracious reader. Keeping
about 50, and then we’d like But as a starving student, the list pretty short, what
great value inves- to do what Gerald Loeb, you’re really low on books would you
from E.F. Hutton, Maslow’s hierarchy. It’s not recommend that students
tors have a lifestyle recommended years ago – unnatural to think, ‘money read?
every time you add one, you will fix my problems.’ But if
that’s earmarked by take one away. you can disabuse the notion Toward disabusing money
frugality. … In fact, that money is a measure of as a measure of success, I
We obviously won’t know success, it will really help recommend two books.
I’ve never really unin advance which you. One is Viktor Frankl’s Man’s
companies, out of these 50, Search for Meaning. In that
derstood how a guy we’ll buy, but we’ll follow Money is very corruptive. book, he says that success,
them closely and add them Obviously it’s not been the money, and all the
can claim to be a individually to the portfolio case with Buffett. You’ll accouterments of the so-
when they get down to a notice the way he lives. called “good life” should
fully committed price that is likely to People don’t talk about this never be sought for their
produce an expected very often, but it’s clear in own sake, but should be the
value investor and return of, say, at least 15%, John Templeton and unintended side effect of
live big.” properly risk-adjusted. So it certainly in Buffett, that the devoting yourself to a cause
won’t be top-down at all. great value investors have a greater than yourself, or
It’ll just be when individual lifestyle that’s earmarked by loving a person more than
names like Gentex fall to a frugality. There is no doubt you love yourself. If you
price range where I can say, in my mind that Buffett can identify what you’re
this thing’s going to double discovered early on that doing as a cause, and it
in five years or less. We’ll redundant personal assets happens to be remunerative,
default into being fully are really liabilities in it can be a good thing. One
invested. Obviously, disguise – that you can easily of the things I decided when
exogenous forces like bear lose your personal freedom I made my career choice is
markets produce a plethora by becoming slave to your that if I’m going to be good
of buying opportunities. possessions. In fact, I’ve at what I did, I’d like to be
One must be more never really understood paid for it. This profession
circumspect when the how a guy can claim to be a does that. It’s what you do
precipitating forces that lead fully committed value with your largess that
to lower prices are investor and live big. You defines you. “The measure
endogenous. talk about going to see (Continued on page 41)
Volume
Issue I, Issue 2
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Frank Martin
(Continued from page 40) Adam Smith is famous for exploiting the asymmetry of
of a man is not what he Wealth of Nations. But my information between agent
gets, but what he gives.” favorite book of Adam and principal in increasingly
Smith’s is The Theory of complex systems, capitalism
I’d also have people pick up Moral Sentiments. Smith broke down. It’s because
Kahlil Gibran’s The Prophet. basically says, if you take everybody forgot the
He writes about work, and care of your customers’ second of Adam Smith’s
he writes about giving. interest, you’ll take care of two great books. It’s a
Those are two chapters that your own. So if you sell the great system, but only if the
I would highly recommend best good and if you meet players live by the Golden
to young people. I think the customers’ needs better Rule.
that will help shape who you than your competitors,
become. you’ll always do well. The Lastly, some of the most
important of life’s lessons
I’m 70 years old and I’m in a are not taught in books. By
wheelchair. Even though I all means, find mentors who
no longer play golf, I’m like you think are really worthy
the golfer who shoots of respect, people who have
(works) his age [laughs]. It “If you want to, lived their lives in ways that
isn’t work at all. I love it. I you admire. You can’t
don’t want to acquire you can make all imitate Buffett, but you can
knowledge for knowledge emulate him. I have a
sake, rather for wisdom’s the mistakes by try- mentor wall that is the first
sake. When I read that thing you see in my small
Todd Combs researches an ing to learn every-
office. By identifying men
idea for 500 hours before who you really admire, you
thing yourself, or
he buys it, that’s kind of can shortcut your learning
impressive. That’s what all you can sit at the curve tremendously. You
of our analysts and I should learn ethics by example.
aspire to. If you’ve read feet of the masters, Jack Bogle and Warren
Outliers, you’ll understand Buffett, in terms of shaping
that you’ve got to do the which I have chosen my values, have really had a
10,000 hours. There are no huge impact. And I
shortcuts. Too much IQ to do, and shortcut
probably have another 10 or
can actually be an 15 people on the list of
that.”
impediment. When I read people to whom I am in
the stories of the great debt in perpetuity. If you
achievers in our industry, want to, you can make all
most of them appeared to the mistakes by trying to
have ample intelligence. learn everything yourself, or
What seems to differentiate theme of Smith’s second you can sit at the feet of the
them is that they appear to book explains why the masters, which I have
have overcome the system broke down in the chosen to do, and shortcut
limitation embedded in the last 15 years. The Theory of that.
idea that “because I’m so Moral Sentiments spoke
smart I don’t have to work about the importance of G&D: Mr. Martin, it’s been
very hard.” ethical behavior throughout a pleasure speaking with
the system. So when you.
Don’t limit yourself to just people – and this is Charlie
reading business and Munger’s big criticism which
economics. Read he calls “moral drift” –
philosophy and read the started cutting corners and
great economic thinkers.
Page 42
Russell Glass
(Continued from page 1) construction figuring they afternoon.
Glass is co-owner of the
do a great deal of future
New York Mets and is a
director of the San Diego traffic pattern analysis and After graduation from
Chargers. He also advised demographic research to Stanford Business School, I
Jerry Jones on the $140 determine attractive set up Premier Partners, a
million acquisition of the locations. A few years later, merchant bank in Dallas
Dallas Cowboys when he in high school, I used to with a close friend and
Russell Glass was 26 years old. Mr. Glass read Value Line investment classmate of mine from
earned his B.A. in research reports and was Princeton. Our first
economics from Princeton fortunate to get a summer transaction was advising
University and his MBA
internship at LF Rothschild Jerry Jones on the $140
from Stanford Business
School. Unterberg Towbin where I million acquisition of the
worked in the risk arbitrage NFL Dallas Cowboys when I
G&D: What was your department. It was a great was 26 years old. Although
introduction to investing? learning experience to many who did not know
analyze companies involved him at the time thought
“My schedule at in M&A activity. I then went Jerry may have overpaid
RG: Growing up, my main
Stanford was interests were investing and to Princeton and majored in because the highest price
sports, though I found I was economics. After for an NFL franchise until
unique in that I more successful with graduation, I started my then was only $100 million,
investing. I have been career at Kidder Peabody & the investment has yielded
would go to class in fortunate to pursue both Co., where I worked in greater than an estimated
these interests throughout corporate finance advising 20x return, or $3.5 billion in
the mornings, then companies on their defense value, as the team is
my career. On the
investment side I have of hostile takeovers, which currently appraised for
frequently take the put me at the forefront of approximately $2 billion and
served as the President of
Spanos corporate Icahn Associates, the the 1980s hostile takeover has probably generated
investment firm of Carl wave. Afterwards, I decided cumulative operating profits
jet to attend Icahn, and later as the to go to Stanford Business in excess of $1.5 billion.
founder of RDG Capital School where I had a The Cowboys went 1-15
business meetings Management. On the roommate who happened during Jerry’s first year of
sports side I recently to be the nephew of Alex owning the team but ended
during the day, and Spanos, the owner of the up winning the Super Bowl a
became a co-owner of the
New York Mets and, for a NFL’s San Diego Chargers few years later. The fact
later fly back in and founder of the A.G. that Jerry was able to sell
number of years, I have also
time to attend class been a director of the Spanos Companies, one of luxury suites in a very weak
Spanos-family-owned San the top real estate economy at the time and
in the afternoon.” Diego Chargers. My developers in the country. turn around an
interest in investing started Eventually, I started working uncompetitive team early in
at an early age. I made my as a financial advisor for the his ownership tenure
first investment at age 13 privately held Spanos demonstrates what a
when I bought some organization on a part-time consummate marketing
California real estate in basis while in graduate expert and extraordinary
northern Los Angeles school. My schedule at entrepreneur he is.
County prior to the Stanford was unique in that I
construction of a new would go to class in the G&D: How did your
highway that would reduce mornings, then frequently career progress from
commute time from the take the Spanos corporate advisory into investing?
property to downtown by jet to attend business
half. I purposely selected meetings during the day, and RG: My focus has always
land close to a new later fly back in time to been on investing in
McDonald’s that was under attend class in the (Continued on page 43)
Volume
Issue I, Issue 2
XVII Page 43
Russell Glass
(Continued from page 42) as well as investor Carl whom you’ve worked with
companies that are Icahn. After some time or have come in contact
undervalued – I’m a value though, I realized that being with throughout your “The idea of the
investor. After advising a principal had a number of career?
Jerry Jones on the Dallas advantages over being a fund was to use
Cowboys purchase, I set up research analyst. RG: In my opinion, Carl
an independent investment has been the pioneer of corporate
research firm called Premier I decided to partner with a catalyst-driven, activist
Investment Research and governance as a
group of former executives investing. He is both a pure
served as an investment and associates of T. Boone value investor and tactician means to hold
advisor to a select group of Pickens forming Relational who has produced
investors including the Hunt Investors, an activist fund investment success with a management
family, owner of the NFL based in California. The multitude of companies,
Kansas City Chiefs, led by idea of the fund was to use both on the long and short accountable to
Lamar Hunt, who was both corporate governance as a sides. Carl’s returns have
a sports visionary and means to hold management been excellent and he is an shareholders. I saw
successful businessman. accountable to impressive short seller,
Our investment research the efficacy of
shareholders. I saw the which most people don’t
firm provided investors with efficacy of being a proactive know or pay attention to. being a proactive
in-depth, fundamental, 100- investor in companies years His investments have
page research reports. We earlier, after seeing Boone compelling risk-adjusted investor in
were hired on an annual Pickens’ success with Gulf return profiles. When you
retainer basis – so it was Oil, which when he invested look at other investors or companies years
truly an independent in it, was trading at a steep hedge funds, you cannot just
research service with no discount to the intrinsic look at the headline return. earlier, after seeing
conflicts of interests. We value of its reserves because You need to know how
were not paid on our ability Boone Pickens’
it was so poorly managed. much leverage was used and
to trade or set up After a couple of years at what other types of risks success with Gulf
management meetings, but Relational, Carl Icahn were taken to generate
rather on our ability to help recruited me to become those returns. Carl’s Oil, which when he
our clients find profitable President of Icahn portfolios are prudently
ideas. Back then, 99% of Associates. Carl was a hedged, so I would say that invested in it, was
Wall Street research had a great mentor. He is a self- his risk-adjusted returns are
‘Buy’ recommendation, but made professional with even more impressive than trading at a steep
our research was 1/3 ‘Buy’, great intelligence and most realize.
1/3 ‘Sell’, and 1/3 ‘Fair discount to the
strategic acumen – he went
Value’. to Princeton from a public G&D: Can you talk about intrinsic value of its
high school that had your current firm, RDG
We took the approach of probably never sent a Capital? reserves because it
looking at public companies student to Princeton before.
from the perspective of a Carl was one of the first and RG: At RDG, I have was so poorly
private equity owner. Our most prominent investors essentially replicated the
research consisted of who believed in taking a staffing and structure at managed.”
thorough due diligence as proactive approach to Icahn Associates. We have
opposed to just predicting investing in public four investment
next quarter’s earnings. companies. When I joined professionals, all of whom
This thoroughness caught his firm he had already have M&A backgrounds.
the attention of a number of established himself as a Our investment style is
mutual funds, hedge funds, legendary investor. private equity oriented – we
and investment managers employ a hybrid private
such as Fidelity Investments, G&D: How does Carl equity / public investment
Wellington Management, compare to other investors (Continued on page 44)
and Neuberger & Berman,
Page 44
Russell Glass
(Continued from page 43) if we believe an opportunity opening expenses, growth-
strategy. We look for is compelling, not just oriented R&D and capital
undervalued public because we have to put expenditures, or other
companies that can benefit money to work. As a result costs associated with
from a catalyst to both our investment process investing for the future. If
enhance and unlock value. yields a high rate of you find cheap companies
We focus on U.S. equities, profitable investments that are unfairly penalized
consider ourselves to be because we have such a high for making long-term
“I have always industry agnostic, and invest threshold for value – we investments in the business,
across the market typically require at least a those investments can
believed some of capitalization spectrum, 50% “margin of safety” as become very productive and
although most of our Seth Klarman from Baupost yield significant returns for
the best investment historical investments have would say. the business and its
generally been in small and investors. We also favor
decisions are those midsize companies. Among G&D: Can you give us a companies which trade at
you choose not to the catalyst events we little detail on your research low valuations relative to
generally focus on are their
make. Our special private equity sustainable
and strategic free cash
situations buyouts, flow that
corporate have
investment spinoffs and operating
divestitures, margin
approach allows us monetization improvement
to invest if we transactions of potential and
non-core which often
believe an assets, share have a sum
buybacks, of the parts
opportunity is special value in
dividend excess of
compelling, not just distributions their trading
and other price.
because we have to
RDG Capital team
put money to Once having
recapitalization events, and process? identified interesting
work.” improvements in operating undervalued companies, we
management and corporate RG: We first conduct a then conduct extensive due
governance. statistical valuation screen diligence with management,
to generate ideas, and if industry analysts, customers,
Historically we have they pass our screen, we competitors, bankers, and
structured special purpose perform a more detailed often private equity firms
investment partnerships quantitative assessment and who have relevant sector
with co-investors who we analyze companies on a expertise. I have also been
believe bring strategic value qualitative basis. While our on the board of several
or industry experience to systematic screen finds companies in an array of
each investment public companies that trade industries, including real
opportunity. I have always at a significant discount to estate, energy, biotech,
believed some of the best peers, we also look at things manufacturing, and business
investment decisions are others often do not focus services. These
those you choose not to on or issues for which the directorships give our team
make. Our special market unjustly penalizes insights into many types of
situations investment companies, such as pre- (Continued on page 45)
approach allows us to invest
Volume
Issue I, Issue 2
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Russell Glass
(Continued from page 44) million, despite the fact that independently), improving
businesses and provide the company had only staff scheduling, increasing
valuable operating executive recently invested $150 higher-margin beverage
relationships. We have a million in cumulative capital revenue mix, and licensing
great pool of industry expenditures over the prior the Benihana brand to
contacts that we can call on few years. The market was selected grocery products. “As industry-
when we need to do a deep discounting the recent Finally, we were also
dive to learn about an capital improvements by attracted to the fact that in agnostic investors,
investment opportunity. If 50% and assigning zero value addition to owning its
we still find the opportunity we look for public
to the existing restaurant flagship restaurant chain,
attractive after such an chain generating $25 million Benihana also owned two
evaluation process, we then
companies that
in recession-level EBITDA other restaurant concepts,
consider what catalyst which you were essentially New York-based Haru and would be better off
events may enhance and getting for free. Mid-Atlantic-based RA
unlock shareholder value. Sushi. These restaurant being private
Finally, we consider the At the time, the company chain subsidiaries separately
corporate governance was trading at less than 3x were worth nearly the entities. If you look
structure and shareholder EBITDA and, moreover, entire market value of the
composition of a company at a typical industry
owned about $50 million parent company.
to determine the feasibility worth of real estate
of implementing the desired
-focused fund, the
underlying several of its We decided to team up
catalyst initiatives. restaurant locations which with a restaurant-focused sector that it
Ultimately, we seek to could be monetized via a private equity firm and
invest in those companies sale/leaseback transaction. made a buyout offer to the focuses on would
which meet all our If you took the near $75 company. Though our offer
investment criteria. It is a million enterprise value and was rejected, the company likely be compelling
very time- and labor- subtracted the approximate subsequently hired Jefferies
intensive process, as we as an undervalued
$50 million in real estate to explore strategic
want to understand the value, the company was alternatives and eventually
business and not just the
opportunity only
really trading at just 1x sold itself to Angelo
security. That process EBITDA adjusted for the Gordon. The stock went 5% of the time, and
usually takes about three to modest incremental rent from $4 to $16 per share in
six months before we make expense. Furthermore, at less than two and a half it would be
each investment. By the time of our initial years.
maintaining these investment, the economy reasonably valued
investment disciplines and was just starting to come As industry-agnostic
acting like private equity or overvalued the
out of the recession, and we investors, we look for public
investors in publicly traded believed that the company companies that would be
companies, we have
other 95% of the
could increase EBITDA better off being private
historically generated from $25 million to $40+ entities. If you look at a time.”
unlevered IRR in excess of million just based on a typical industry-focused
30%. recovery in same store sales fund, the sector that it
growth and without any focuses on would likely be
G&D: Can you provide an operational improvements. compelling as an
example of this strategy as it Yet, we were also able to undervalued opportunity
applied to a past identify a number of only 5% of the time, and it
investment? operational improvements would be reasonably valued
that could be made, or overvalued the other
RG: A couple of years ago, including centralization of 95% of the time. This is the
we invested in Benihana, the purchasing (many of the nature of a reasonably
Japanese steak house chain. restaurants at the time had efficient capital market –
At the time, the enterprise been buying supplies (Continued on page 46)
value was less than $75
Page 46
Russell Glass
(Continued from page 45) professionals have M&A retail and manufacturing
much of what is out there is backgrounds, which we find industries. For large
fairly priced at any given helpful to navigate these retailers and manufacturers,
point in time. We try to corporate governance this is mission critical
focus on the 5% of matters. software – approximately
companies that are valuation 75% of the top retailers and
outliers, regardless of the G&D: Can you talk about a manufacturers use JDA’s
Pictured: Tom Russo industries that they’re in,
speaks at the Omaha Din- recent investment? software. The supply chain
and because of this, we will management software
ner in May 2012.
typically only invest in half a industry has been
dozen to a dozen companies undergoing significant
on an annual basis. consolidation.
G&D: What is your When we started looking at

targeted time horizon for a the company, we were able
typical investment? to identify a high quality
company trading at a low
RG: We’d ideally like to valuation relative to its
“We’d ideally like
see value created within a sustainable free cash flow
year’s time, if not sooner, to see value created with significant costs that
but we are not short-term could be cut out by a
opportunists. As within a year’s time, strategic acquirer. Trading
arbitrageurs of value we are around $27 per share, the
content to invest in longer- if not sooner, but company had an
term opportunities. Our approximate $1 billion
investments have generally we are not short-
enterprise value and,
ranged from six months to term opportunists. generating nearly $200
two years. The longer million in EBITDA, was
you’re in an investment, the As arbitrageurs of trading at only 5x EBITDA,
longer you’re subject to or an approximate 20% free
exogenous risks. If you can value we are cash flow yield given the low
influence change sooner, it capital-intensive nature of
increases your IRR and content to invest in the business, with
reduces macroeconomic substantial recurring
risk. We aim to generate longer-term
revenue from long-term
the highest return with the software maintenance
opportunities.”
least amount of risk, so the contracts. Based on our
faster we can help push analysis, we believed a
along the value-unlocking strategic buyer could
moves that need to be extract as much as $125
made, the better. million in synergies so, in
reality, the company could
We also view a company’s generate more than $300
annual meeting as a way to million in adjusted EBITDA,
enact change and gain RG: Several months ago, implying an approximate 3x
support from other we became involved with an pro forma EBITDA multiple,
shareholders. Every public enterprise software an especially attractive
company is required to hold company called JDA discount to the 10-12x
an annual meeting, and Software. JDA is primarily average EBITDA multiple of
some companies allow for known as a best-in-class its enterprise software
the calling of a special supply chain management industry peers.
meeting. As I mentioned software vendor for the (Continued on page 47)
earlier, all of our investment
Volume
Issue I, Issue 2
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Russell Glass
(Continued from page 46) recently completed spent in the next 24 months
At the time, the company acquisition and the pending before LP capital
was under investigation for introduction of new commitments expire.
accounting irregularities by products. JDA also had an Private equity firms are “We figure
the Securities and Exchange M&A value according to our eager to put this capital to
Commission. We looked analysis that indicated a work. We figure altogether altogether there is
into the accounting issue private equity or strategic there is $300+ billion in
and determined that it was $300+ billion in
acquirer could justify paying private equity “dry powder”
not fraudulent in nature, but $45+ per share or a 50%+ plus $750 billion in readily
rather a minor issue
private equity “dry
premium and still expect to available low-interest debt
regarding the historical generate an attractive 25%+ financing in a robust credit powder” plus $750
timing of revenue equity IRR and an active market (in which leveraged
recognition. JDA was also shareholder base with buyout debt/EBITDA billion in readily
in the process of completing customary corporate multiples have increased to
the integration of an governance policies. In fact, near historic levels); this available low-
acquisition and preparing to we believed the private translates into $1+ trillion in
introduce a promising new interest debt
market value was double private equity-sponsored
multi-channel software the public market value. acquisitions in the next 24-
product, so we expected
financing in a
36 months. Additionally,
better results going We liked the investment there is $1.7+ trillion in robust credit
forward. because there were multiple cash on the balance sheets
ways to win, either through of non-financial market (in which
Based on the steady nature an accretive share buyback corporations, nearly one
of its business – high-margin or a sale of the company at third of which is higher than leveraged buyout
long-term contracts, sticky a substantial premium. In amounts typically held under
customer relationships, and debt/EBITDA
the end, the company normal economic
low churn – we thought the recently received a $45 per conditions. We believe a
company could easily do a
multiples have
share buyout offer from Red reasonable portion of this
highly accretive leveraged Prairie, an enterprise capital (together with new increased to near
recapitalization share software company owned public equity issuance and
buyback which would result by private equity firm New additional debt financing) historic levels); this
in stock appreciation from Mountain Capital. It was a will be directed toward
$27 to $40 per share. One good outcome for public company M&A translates into $1+
of the two largest management, private equity activity.
shareholders had already trillion in private
investors, and shareholders.
achieved board Our thesis is that in the last
representation and was
equity-sponsored
G&D: In a recent guest few years, most companies
advocating for a sale of the lecture at Columbia have grown earnings by acquisitions in the
company. The company’s Business School you cutting costs. By now, most
valuation metrics and mentioned that you believe companies cannot cut costs next 24-36
fundamentals were there will be a tsunami of much more because there is
compelling. It had a low EV/ buyouts in the next couple no room. Economic growth months.”
EBITDA multiple on both an of years. Could you expand is going to be slow for the
absolute and relative basis on that? foreseeable future, which
compared to its peers, was means that for most
trading at a 20% free cash RG: We estimate there is companies, top-line revenue
flow yield, was growing approximately $150 billion growth will be sluggish.
revenue and earnings at high in private equity capital that Therefore, in order for
single digits on an organic was raised a few years ago companies to grow bottom-
basis, and had operating in vintage 2007-2008 buyout line earnings there is strong
margin improvement in funds that has yet to be motivation to acquire
process from the cost deployed and needs to be (Continued on page 48)
savings implemented in a
Page 48
Russell Glass
(Continued from page 47) RG: Working with Carl at companies through the
industry competitors and (Icahn) helped me see the lens of a private equity
eliminate duplicative costs. merits of being a proactive investor. We like a hybrid
This scenario should result investor in companies. Just approach – being a public
in an increase in both as Steve Schwarzman and shareholder but thinking and
friendly and hostile M&A Henry Kravis find attractive acting like a private equity
activity in the next few fractional business owner.
years. In fact, this Although we lack the
expectation is supported by absolute control of a private
a relatively recent Ernst & equity owner, in cases
Young survey which where we garner the
“It’s important to look
indicated that 36% of U.S. support of a majority of
corporations intend to at companies through shareholders, we become
engage in M&A activity the informal voice of the
the lens of a private
within the next year or so. majority and thereby have
equity investor. We like influence on management.
G&D: It sounds like some In the past we have hosted
a hybrid approach –
of those supportive informal shareholder forums
dynamics have been in place being a public to discuss the management
for a while. Why do you and future direction of
shareholder but
think the buyout activity companies in which we are
hasn’t ramped up this year? thinking and acting like a stakeholder. The benefit
a private equity of being a public investor is
RG: The election certainly that you can typically
played a part – corporate fractional business acquire equity at a
executives don’t like to significant discount to its
owner. Although we
make important M&A intrinsic private market
decisions in an uncertain lack the absolute value (rather than a buyout
environment. They want to premium), employ no
control of a private
know what the tax, leverage (rather than 4x or
healthcare, and regulatory equity owner, in cases often greater debt/EBITDA
environment is going to in an LBO), and still have an
where we garner the
look like. With the election element of constructive
over, there is more clarity. support of a majority of influence on the company.
Companies have reached
shareholders, we
the end of their cost-cutting There’s been a positive
ability, as well. To put this become the informal change towards shareholder
in a sports analogy, we activism in the past 10
voice of the majority
believe that we’re in the 7th years. The rise of proxy
or 8th inning of companies and thereby have advisory firms has provided
reducing internal costs and a level playing field. After
influence on
will now begin to see a shift recognizing years of
to acquiring businesses. management.” corporate mismanagement
and malfeasance,
G&D: Do you think activist institutional investors have
investors are still viewed become justifiably more
with a stigma? It seems like active and now have a
it is now more socially businesses and enhance greater willingness to
acceptable, if you will, to those businesses, we believe support dissident
engage management and professional public market shareholder initiatives.
advocate for change than it shareholders can do the Unlike in the past when
was 10 or 15 years ago. same. It’s important to look (Continued on page 49)
Volume
Issue I, Issue 2
XVII Page 49
Russell Glass
(Continued from page 48) management does not have 10-15 years ago?
institutional investors their personal interests
almost always sided with properly aligned to RG: While the number of
incumbent management maximize shareholder value. activists has grown modestly
against activist shareholders, In these cases, we organize in recent years I believe the
in recent years dissident shareholder forums, engage opportunity set has grown
shareholders have actually in proxy contests, and more and that we are still at
more often than not won exercise other corporate the early stage of public
the majority of proxy governance measures to shareholders taking more
contests or reached
“In a study
hold management initiative in the governance
favorable settlements, such accountable to serve the of the companies they own. conducted by
as board representation, to best interest of
avert a proxy contest. shareholders. G&D: Can you talk about a researchers at
Although there is still the few mistakes you've made in
classic management / agency G&D: You’ve done your career? Wharton and
dilemma in corporate academic research around
America, the board and Columbia Business
activist investing and how I should have bought more
management of more once an activist becomes land in southern California
companies, recognizing their
School, companies
involved, a company’s stock when I was 13 years old.
fiduciary duties to price outperforms the which had been the
shareholders, have become market. Can you talk a little G&D: What’s the best
appropriately more about your research? advice you’ve ever received? subject of 13D
responsive to activist
investors. We think activist RG: As an undergraduate RG: Working with Alex filings indicating the
investing is still in its early majoring in economics at Spanos taught me to have a
stages here, and presence of an
Princeton I wrote an “can-do” attitude. From a
international markets are 10 academic research report man who overcame
to 20 years behind the U.S.
activist shareholder
on the efficiency of capital adversity early in his life to
with regard to corporate markets and the economic become one of America’s generally
governance and activism. benefits of shareholder true Horatio Alger success
activism and hostile stories, Alex advised me to outperformed the
G&D: In terms of the takeovers. Since then, there set achievable goals in life
range of activists, from have been numerous and, when confronted by S&P 500 by
friendly activists such as academic studies highlighting challenge, to act with
Relational at one end to the approximately 5%-
the efficacy of shareholder integrity and dedication to
more antagonist activists on activism on investor returns. “just make it happen.”
the other end of the
7% per annum.”
In a study conducted by
spectrum, where do you researchers at Wharton and G&D: Thank you very
stand? Why is this Columbia Business School, much for your time, Mr.
approach best for you? companies which had been Glass.
the subject of 13D filings
RG: We are in the middle indicating the presence of an
of the activism spectrum activist shareholder
with flexibility to work on a generally outperformed the
constructive, collegial basis S&P 500 by approximately
with incumbent 5%-7% per annum.
management to the extent
they are legitimately willing G&D: Do you feel that the
to explore ways to enhance activist investor field is
shareholder value, but also getting crowded? Are there
to work as a staunch still the same opportunities
defender of shareholder for you that were available
rights in cases where
Page 50
Jon Friedland
(Continued from page 1) the stock was widely owned backpacked around Asia.
hedge fund, where he was
by many hedge funds. After This was perhaps my first
responsible for media,
entertainment, and leisure a few years at that fund, Pat explosive learning
ideas for the firm. Mr. Duff, a fellow CBS Alum experience. I traveled by
Friedland received his B.A. who had been one of my boat, bus, train, and plane all
in Political Science from visiting Security Analysis over China, Tibet, Thailand,
Vassar College in 1991 and professors, introduced me Vietnam, and Nepal. For
his MBA from Columbia to Paul Orlin and Alex someone that grew up in
Business School in 1997. Porter of Amici Capital. Ohio, this was really an eye-
We hit it off very well in opening trip. I fell in love
G&D: How did you first terms of investment with learning about different
Jon Friedland become interested in philosophy and approach. cultures, which led me to a
investing and what brought That was over 10 years ago five-year career in foreign
you to Amici? and I still come to work aid prior to attending CBS.
happy every day.
JF: At Columbia Business The great thing about the
School, I took a number of G&D: What is the meaning investment business is that
classes that had a profound behind the name of your there are investment
impact on the course of my firm, Amici Capital? opportunities to suit
career. Bruce Greenwald’s anyone’s background,
“The great thing Value Investing class was JF: As of January we interest, and creativity.
one. The creativity and changed the name of the When I came to Amici in
about the clarity with which he management company from 2001, there was little
analyzed businesses was Porter Orlin to Amici international investment.
investment business fascinating. Second was Capital to align it with the Then in 2002 we saw a
Security Analysis with Jim name of our funds. ‘Amici’ number of restructurings of
is that there are Rogers. He put students in in Latin means ‘friends’. The international companies in
the role of a real time capital that was initially industries that I had studied
investment company analyst. New raised was from friends, so carefully in the U.S. –
opportunities to York-based investment from the beginning Amici specifically the
managers with expertise on was used in our funds’ telecommunications and
suit anyone’s our companies would come names. Since the firm’s cable television industries.
to Jim’s class to grill us. It establishment in 1976, we Companies like NTL
background, was great. It gave me a have maintained the Incorporated in the UK and
sense of how much you philosophy that our pan-emerging market cell
interest, and should know before making investors and partners phone operator Millicom
an investment. And I fell in should be treated as friends. International were trading at
creativity.” love with the explosive Amici is also reflective of distressed levels because of
learning process that the cooperative culture forced sales and complexity.
accompanies primary within the firm. The comfort that I had from
research on an industry or my foreign aid work in
company. G&D: What drew your Africa, Asia, and Latin
initial interest to investing America was important. It
I was hired out of CBS by a primarily outside of the helped us to become more
large hedge fund because I U.S.? What are some of the comfortable applying the
had done some original advantages and Amici investment process of
primary research on an disadvantages with an deep fundamental business,
ultrasound system international focus? industry, and valuation
manufacturer for that analysis to recognize that
Security Analysis class. My JF: Halfway through my these companies were
research suggested the college career at Vassar, I trading at a significant
company’s stock was highly took a semester off and (Continued on page 51)
overvalued, at a time when
Volume
Issue I, Issue 2
XVII Page 51
Jon Friedland
(Continued from page 50) How do you narrow down inwardly driven. Imports to
discount to intrinsic value. your hunting ground to a GDP plus exports to GDP
manageable level from sum to a mid-30% of GDP
Around this time we were which to sort through to in both, which is quite low
also short automotive find new ideas? by comparative standards.
manufacturers in the U.S. in We like internally-driven
large part because JF: We try to invest in the economies because they are
competitors in Japan and same way and in the same less subject to global
elsewhere were gaining types of companies no economic winds.
market share and operated matter where we invest. Increasingly we have also
with structural advantages. We are looking for great developed contacts and
Additionally, we were short franchises trading at experience in these
some IT consulting substantial discounts to countries, which has
companies in the U.S. as intrinsic value. increased our comfort level
their most profitable further.
business lines were facing We invest in emerging
stiff and increasing markets because our view is Secondly, we invest in global
competition from Indian IT that consumers, corporates, companies that do business
outsourcing companies. and sovereigns in emerging in a portfolio of emerging
markets have far better markets countries, many of
I think at that time, and balance sheets than they do which we would not invest
increasingly since then, the in the developed world. As in directly. We are able,
ability to apply our a result, we believe that through a portfolio
investment process to an economic growth in approach, to take advantage
expanded universe of emerging markets is going of positive trends in
investment candidates to be far greater than it will countries in which we
improves the likelihood of be in the developed world. would not take a
our success. I think this is a The World Bank just concentrated position.
big advantage for us. published a study projecting Brazil and India have
that GDP growth in predictable government
G&D: Are international / developed countries in 2013 policies and a rule of law
domestic pair trades, such will be 1.2% and in that we understand. We
as the aforementioned ones developing markets it will be cannot say this about many
from a decade ago, a big 5.5%, which is a huge other countries.
part of what you look for? differential.
G&D: How do you go
JF: We do not seek out Within that context we take about looking for new ideas?
pair trades. We are quite a multi-pronged approach.
active in our industry First, we invest in JF: As our team travels,
analysis in trying to identify companies doing business in reads, and speaks to people,
both winners and losers. specific emerging market we are always looking for
Sometimes this will result in countries, India and Brazil great companies that we
a short or hedge from the being primary examples, would love to own at the
same industry, but each where we have a high right price.
investment, long or short in degree of confidence in the
our portfolio, goes through long-term macro outlook. We enter these companies
the same investment Both countries have large into a database and refer to
scrutiny and must stand on populations and diversified these companies as our
its own. economies that are capable ‘Battleships’. These are
of supporting world-class large, highly profitable, and
G&D: There is an companies. Second, both of well-capitalized companies
extensive universe of those countries are fairly (Continued on page 52)
international companies.
Page 52
Jon Friedland
(Continued from page 51) opportunities presented to list, the 101st company?
that have demonstrated them. We have met and
pricing power in studied management at JF: It comes slowly. We
consolidated industries with most of these companies, may add two to five
low competitive intensity. and have done extensive companies a year, while at
They are run by the same time a few
management teams that companies will come off of
have established a record of “We believe that the list if some missteps
intelligent capital allocation have happened or the story
and have made strategic investing in has changed. We do a lot
decisions we understand. of traveling to Latin
We believe that investing in ‘Battleship’
America, Asia, and Europe
‘Battleship’ companies, as companies, as distinct looking for new ideas and
distinct from very small we like to meet with new
upstart companies with from very small companies. We are always
Pictured: Jon Friedland
speaking at the Moon Lee illiquid stock, gives us an looking for new candidates.
added margin of safety upstart companies
Prize Competition in Janu-
ary 2012. because these companies with illiquid stock, G&D: How important is
are less likely to be blown meeting with a management
around by economic gives us an added team face to face?
volatility. We believe this is
margin of safety
an important risk JF: It is very important.
management component because these We believe that strong
when investing in emerging management teams play a
markets, where both companies are less critical role in the ultimate
operating performance and success of an investment.
likely to be blown
stock price performance can We need to know that
be more volatile. around by economic management teams are
thinking like owners and we
G&D: It sounds like you volatility. We believe
have to understand their
are looking for ‘Warren long-term outlook for their
this is an important
Buffett-like’ companies and company and their industry.
have a longer-term time risk management We need to understand
horizon than the typical what is important to them,
hedge fund. component when
how they incentivize their
investing in emerging employees, and what their
JF: In a way that is right. company culture is like. For
Our Battleships list contains markets, where both us, this interaction is
roughly 100 international important and can be telling.
companies that we would operating
I can recall one otherwise
like to own at the right performance and promising investment that
price. We may own only a we passed on after meeting
certain number of these stock price the CEO who was very
companies at any given time, crude, which we feared was
but pick our entry and exit performance can be
an indication of poor
points based on current more volatile.” judgment in other areas.
valuations. They may not all
be attractive investments in work on them over the G&D: How do you manage
any particular year, but the years. your long and short
common thread is our high exposure? Is there any
degree of confidence in G&D: How do you find mathematical component to
their long-term ability to the next name to add to this (Continued on page 53)
capitalize on the
Volume
Issue I, Issue 2
XVII Page 53
Jon Friedland
(Continued from page 52) that the much faster growth RFPs for $65 billion worth
it, or is it more based on rates of the developing of infrastructure products.
the quality of long and short
“Sometimes you
world economies described
ideas at a point in time? in the World Bank report A lot of emerging markets have to go outside
we discussed, coupled with are turning the global
JF: The Amici Global Fund a valuation discount to liquidity surge from the U.S. to find a
that I manage is somewhat developed market stocks, developed market central
different than our core creates a rich opportunity banks into their advantage, ‘grand bargain’. We
funds. It offers set in emerging countries. trying to steer capital
concentrated exposure to believe that the
toward foreign direct
the international positions Now is an interesting time investments as opposed to
within our core Amici funds
much faster growth
to invest in emerging portfolio flows. We look at
managed by Paul Orlin. The markets because emerging this as a third, and smarter, rates of the
Amici Global Fund was market governments are stimulus tool in addition to
established to take increasingly making positive the more conventional fiscal developing world
advantage of the attractive long-term policy decisions, and monetary tools.
emerging market dynamics having exhausted most economies
we discussed before. It other options. This is in G&D: Can you talk about
generally has a larger net described in the
part because many an idea that you like right
long exposure and accepts countries are bumping up now? World Bank report
more volatility on the against more governors on
assumption of a highly their growth rates than they JF: Our compliance we discussed [1.2%
attractive long-term have in the past decade. department will not allow
opportunity. At any given Inflation recently has been me to mention specific growth in
time, our exposure is a stubbornly high and a lot of names, but I can speak more
function of the risk/reward labor has already come into broadly. Real estate in India developed countries
opportunities we are seeing the labor pool. More is currently an area that is
with individual stocks. We vs. 5.5% growth in
fundamental changes and ripe for investment. There
are not macro investors. action from governments is are a few ‘Battleship’ emerging markets],
required than has been companies that have
We also pay close attention necessary over the past managed to come through coupled with a
to valuations across the decade. What gives us the latest down-cycle intact
emerging market asset class comfort is that we are and are in a good position. valuation discount
on an absolute basis and on starting to see that happen. We have a position in a
a relative basis compared to company that owns a land to developed
developed markets. This For example, in India since parcel outside of a major
analysis goes back 20 years market stocks,
September we have seen Indian city, in an area akin to
to give us a sense of liberalization relating to Greenwich, Connecticut
whether the odds are
creates a rich
foreign direct investment in outside of New York, which
stacked in our favor. retail and aerospace, a it is developing into opportunity set in
Emerging market stocks are reduction in subsidies for residential and commercial
volatile and correlated, so diesel and natural gas prices, space. We believe it has an emerging
we think it is important to and the first hike in asset value substantially
be conscious of this data. government-run railroad greater than its current countries.”
fares in a decade. Real market value. The question
G&D: Where are we interest rates in Brazil have is whether this asset value
today in terms of emerging plummeted from over 10% will ever be realized for the
market attractiveness versus to less than 2% in the past benefit of minority
developed markets? eight years, much of this investors.
reduction in the last year
JF: Sometimes you have to and a half. The government We are seeing signs of
go outside the U.S. to find a in Brazil has recently issued (Continued on page 54)
‘grand bargain’. We believe
Page 54
Jon Friedland
(Continued from page 53) Brazil. But to support catalysts to help get the
positive strategic changes in growth, Brazilian Brazilian government to
operating practices that homebuilders began to take some positive actions
suggest the asset value may outsource oversight of as discussed earlier.
become visible and we are construction to such an
hopeful that it will extent that they lost G&D: It seems that you
appreciate in the next year. complete control of the are primarily focused on
Pictured: Paul Orlin of We have seen developers process. The cost and time hard asset plays in emerging
Amici Capital speaking at the sell down crown-jewel overruns were enormous markets. Do you spend
Moon Lee Prize Competi- assets and non-core assets and destroyed profitability. much time looking at other
tion in January 2012. to shore up their balance Because of the way things types of businesses in these
sheets. We see a are accounted for, the markets?
willingness to re-focus entire hit to profitability
business models on core comes at the end of a JF: Absolutely. There are
competencies. The roots of project – you can’t go back such powerful tailwinds
these management teams and restate prior periods. behind consumers, such as
are as buyers, developers, Financial results look rapidly rising wages and
and marketers of land. terrible now but new standards of living.
They have now outsourced construction launches have Consumer-focused
construction and project declined substantially from a companies are among our
management to best-in-class few years ago. We think favorite investment themes
companies and substantially that profitability of these in developing markets, as
reduced the volume of companies may very well long as we can purchase
product they seek to bring return to high levels. These them at reasonable
to market annually. This companies are currently valuations. We have
will improve quality, pricing trading at or below invested in drugstore and
integrity, and ultimately cash liquidation value, with no mall companies in Brazil.
flows. value ascribed to the There is a big secular shift
ongoing value of the from informal to formalized
Furthermore, in India we business. retail in the country. Some
think there is a good chance of these companies that
that interest rates come G&D: We remember the have scale, buying power,
down in the next year, impact that the Beijing and systems are benefitting
which will increase Olympics in 2008 had on tremendously. In India we
valuations and will increase the level of investment have invested in beverage
the availability of mortgages spending in China. How companies. Last year we
from extremely low levels. much do the impending invested in a company that
Mortgages are below 5% of 2014 World Cup and 2016 had substantial share in the
GDP in India, well below Olympics impact the way beverage industry. It ran
the global average. you look at construction in into some distribution
Brazil? issues that had impaired
We see a similar situation profitability in the short
with Brazilian homebuilders. JF: I look at these events as term. We studied how
Over the last residential real helping force good similar disruptions had
estate cycle, all of the decisions. Airports, rail impacted profitability at the
developers raised money at lines, and roads around the company over medium-term
the same time and began to country are going to have to periods, and realized that
grow launches at multiples see some investment. Brazil the company was likely to
of prior 5- and 10-year has among the worst recover and pass through
rates. Unlike in India, infrastructure in the world. incremental costs that it
project oversight and I am hopeful that these faced. In fact, it was one of
management was a core events are serving as (Continued on page 55)
competence historically in
Volume
Issue I, Issue 2
XVII Page 55
Jon Friedland
(Continued from page 54) Your Core funds were ultimately becomes a long-
the largest contributors to down less than 6% versus a term proposition, but once
last year’s profitability. 37% decline for the S&P you are seasoned and have
500. How were you able to some maturity allowing you “We have an
G&D: What is Amici’s achieve such a great year to understand yourself
“secret sauce?” What has investment process
when many other hedge better, you might discover
led to you outperformance funds and the broader that you should be that has been refined
over the long term? market struggled? elsewhere instead. Find a
place that you are since 1976 and we
JF: We have an investment JF: We have a culture of comfortable with. I was at a
process that has been seek constant
risk management at Amici growth-oriented hedge fund
refined since 1976 and we Capital. It is always primary prior to coming to Amici improvement in that
seek constant improvement in our minds. We are never and found myself as the ‘low
in that process. We know going to chase performance -beta’ guy there, whereas at process. We know
how to identify great if we don’t think the Amici Capital I tend to be
businesses and broken how to identify great
opportunity set looks more comfortable as the
businesses. We have the attractive. We are heavily ‘high-beta’ guy. Find a place businesses and broken
ability to judge management short single names – this is a where you can bring your
teams by meeting with them core part of what we do. In interests, your passions, and businesses. We have
and by analyzing quantitative the process of turning up your experience and try to
changes that occur in a the ability to judge
great businesses you are differentiate yourself.
business while a specific always going to turn up management teams
team is in charge. We also some losers. It is important G&D: Thank you for
constantly assess risk/ to hedge the portfolio with sharing your thoughts with by meeting with them
reward in our individual a set of companies that are us, Mr. Friedland. and by analyzing
positions and pockets of misunderstood from a
risk in the portfolio. perspective that is too quantitative changes
optimistic. Our
Over the past eight years, performance in 2008 was a that occur in a
we have developed a wide function of sensing the risks business while a
array of contacts across the in the global
globe. There are not many macroeconomic specific team is in
funds that are U.S.-based environment and reducing
value investors that have the charge. We also
exposure slightly, and, most
ability or the inclination to importantly, having a set of constantly assess risk/
look intensively for single shorts that were oriented
names in many foreign toward the leverage that reward in our
countries. We’ve found had built up in the system.
ourselves increasingly individual positions
capable of monitoring many G&D: Do you have any and pockets of risk in
different situations via our parting words of wisdom
list of ‘Battleship’ for our readers? the portfolio.”
companies. When a
disruption takes place with a JF: As you come out of
company on this list, due to business school it is
our team-oriented nature, important to take the best
we are capable of collapsing opportunity you can find
a lot of resources on an idea where you can get the best
and quickly coming to a exposure to a variety of
conclusion. situations so you can see
what you like and what you
G&D: Amici had great firm are good at. Ideally that job
-wide performance in 2008.
Get Involved:
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jhedstrom13@gsb.columbia.edu
jlubel13@gsb.columbia.edu Please also share with us any suggestions for future issues of Graham and Doddsville:
fixed income research for Fidelity Investments. He can be reached at jhed-
strom13@gsb.columbia.edu.
value fund. Prior to Columbia Business school he worked under Preston Athey on the
Graham & Doddsville
Issue XVIII Spring 2013

Inside this issue:
CSIMA
Conference P. 3 Preston Athey Li Lu —
Omaha Trek P. 4 — Holding Know What You
Winners Longer Don’t Know
Moon Lee Prize P. 5
Preston Athey P. 10 Li Lu ’96 is the founder of
Himalaya Capital, an invest-
Li Lu P. 24 ment partnership focused on
both public and private op-
Pershing Square portunities in Asia and North
Finalist Pitches P. 36 America. Mr. Li grew up in
China and was a student Li Lu
Paul Isaac P. 46 leader in the 1989 Tianan-
men Square protests. Prior to founding Himalaya
Capital in 1997, Mr. Li worked in investment bank-
ing. He earned his B.A. in economics from Colum-
bia College, a J.D. from Columbia Law School, and
Editors Preston Athey
an M.B.A. from Columbia Business School.
Jay Hedstrom, CFA
MBA 2013 Preston Athey is a vice (Continued on page 24)
president of T. Rowe
Jake Lubel Price Group and has led
MBA 2013 the $8 billion T. Rowe Paul Isaac — Know Your Style and
Price Small-Cap Value
Sachee Trivedi Fund since 1991. During
Enjoy the Ride
MBA 2013 that time, the fund has
returned nearly 11.9% per Paul Isaac is the founder
Richard Hunt year after fees, making it of Arbiter Partners, a
MBA 2014 a superior performer New-York based hedge
among its peers. Prior to fund and nephew of
Stephen Lieu joining the firm in 1978, noted value investor
MBA 2014 he was a contract Walter Schloss. Prior to
administrator on Admiral Arbiter, he was the Chief
H. G. Rickover’s staff at Investment Officer at
the U.S. Atomic Energy Cadogan Management, a
Visit us at:
Commission. Preston fund of funds. Mr. Isaac
www.csima.org earned a B.A. in began his career at the
economics from Yale Allied International-
University and an M.B.A. American Eagle Trading
from Stanford University. Corporation. He
He has also earned the graduated from Williams
Chartered Financial College with Highest
Analyst designation and is Paul Isaac Honors in Political
a Chartered Investment Economy and was a
Counselor. Thomas J. Watson Foundation Fellow.
Page 2

It is our pleasure to bring you Chinese car manufacturer Doddsville, we want to spend a
the 18th edition of Graham & BYD. In reading this interview, brief moment looking back at
Doddsville. This student-led we expect you will also have a our time leading this publica-
investment publication of Co- sense of Mr. Li’s commitment tion. The many interviews we
lumbia Business School is co- to intellectual honesty, some- conducted with successful,
sponsored by the Heilbrunn thing he believes is critical to respected and contemplative
Center for Graham & Dodd being a successful investor. value investors are some of our
Investing and the Columbia Stu- fondest memories of our time
Pictured: Professor Bruce dent Investment Management We also had the opportunity at Columbia Business School.
Greenwald. The Heilbrunn Association (CSIMA). to sit down with Paul Isaac of It has been an experience we
Center sponsors the Ap- Arbiter Partners, who de- have truly appreciated from
plied Value Investing pro- Our first interview is with Pres- scribed the experiences and our first day on the “job”. We
gram, a rigorous academic ton Athey, the long-tenured influences of growing up in a leave Graham & Doddsville in
curriculum for particularly portfolio manager of the T. family closely tied to the value the eminently capable hands of
committed students that is Rowe Price Small Cap Value investing community. He also Chris Brigham, Jackson Thies
taught by some of the in- fund. Mr. Athey discussed how fielded questions regarding and Jason Yang, and we look
dustry’s best practitioners. he thinks about selling stocks, investing internationally - which forward to reading the thought
something which so many value included the discussion of a provoking interviews they will
investors find to be one of the promising (if illiquid) invest- assemble in next year’s three
toughest parts of the profes- ment opportunity among re- editions. We also want to
sion. He also walked through gional banks affiliated with share our great appreciation
the theses on a couple of stocks Crédit Agricole - and the risks for the diligent efforts of Rich-
he currently likes and imparted that potentially face markets ard Hunt and Stephen Lieu.
other bits of wisdom gained when the Fed eventually ceases They did an excellent job this
from more than 20 successful its extraordinary monetary year and we were lucky to have
years as a money manager. operations. them as part of the team.
CSIMA will be in good hands
Li Lu, founder of Himalaya Cap- Due to popular demand, after a next year with those two at the
ital and annual guest lecturer in two issue hiatus, student pitch- helm as co-presidents. Lastly,
Professor Greenwald’s value es are back! We are glad to be as always, we thank our great
investing course, was gracious able to share with you seven lineup of investor interviewees
Pictured: Heilbrunn Center enough to spend time with us great ideas from the 2013 for sharing their time and in-
Director Louisa Serene and detail his thoughts on in- Moon Lee Prize Competition sights and we thank you for
Schneider. Louisa skillfully vesting. Mr. Li highlighted how and the 2013 Pershing Square reading.
leads the Heilbrunn Center, he initially received the value Challenge.
cultivating strong relation- investing “inoculation” from G&Dsville Editors
ships with some of the Warren Buffett himself as well With this being our last issue as
world’s most experienced as his thesis for an investment in editors of Graham &
value investors and creating
numerous learning oppor-
tunities for students inter-
ested in value investing.
The classes sponsored by
the Heilbrunn Center are
among the most heavily
demanded and highly rated
classes at Columbia Busi-
ness School.
Bill Miller of Legg Mason chats with a Jane Siebels of Green Cay Asset
guest at the 2013 CSIMA Conference Management answers questions at the
2013 CSIMA Conference
Volume
Issue I, Issue 2
XVIII Page 3
2013 CSIMA Conference—February 1, 2013 at Columbia Business School
Bruce Greenwald and Seth Klarman Jeremy Grantham speaking with Tom Russo
Louisa Schneider presents a tribute to Ben Graham Bruce Berkowitz during Q&A
Student conference coordinators Matt Christ, Geoff Jean-Marie Eveillard talks with audience members in
Abbott, and Ashley Miller deliver opening remarks between panels
Page 4
Columbia Business School Trek to Omaha — Fall 2012

An annual tradition at Columbia Business
School, a group of 19 students traveled to
Omaha in November 2012. The first event on
the agenda was a dinner with Todd Combs ’02,
an investment manager at Berkshire Hatha-
way. Combs spent time discussing his invest-
ment approach and his in-depth research pro-
cess, and took questions from students. The
following day, along with other schools, CBS
students enjoyed an hour-long Q&A session
with Warren Buffett ’51, followed by a custom-
ary lunch at Piccolo’s. The trip also included a
tour of local Berkshire retailers Borsheims and
Nebraska Furniture Mart.
Warren Buffett speaks to students visiting Omaha
Meeting the Oracle of Omaha Shopping at Berkshire-owned Borsheims
Dining at Piccolo’s, Warren Buffett’s favorite restaurant Participants pose with “Lulu,” their trusty Omaha bus
Volume
Issue I, Issue 2
XVIII Page 5
2013 Moon Lee Prize Competition

On March 1, 2013, Amici Capital hosted the 4th annual Moon
Lee Prize Competition. The prize is given in memoriam of Moon
Lee, a dedicated value investor with Amici Capital from 2003 to
2008, who demonstrated a tireless ability to identify and analyze
deep-value opportunities that few could see. In his honor, his
friends at Amici Capital initiated this competition. Finalists
(selected based on pitches submitted by students taking a course
in Applied Value Investing) included Andrew Gordon (Crocs),
Arjun Bhattacherjee (Precision Castparts), David Magid (Motors
Liquidation Company GUC Trust), and Patrick Staub
(Groupon). Magid walked away with the $15,000 first-place
prize while Bhattacherjee was awarded $5,000 for his second-
place finish.
Alexander Porter
The four finalists Professor Tano Santos
The judges listen intently Paul Orlin

Page 6
Motors Liquidation Company GUC Trust Units (MTLQU) - Long

David Magid
dmagid13@gsb.columbia.edu
Investment Thesis: Motors Liquidation Company General Unsecured Creditors (GUC) Trust Units
(MTLQU or Trust Units), publicly traded units of the liquidating trust set up to resolve remaining
disputed general unsecured claims of the General Motors bankruptcy, currently provide a compelling
risk-reward opportunity. The Trust Units, which receive a higher pay-off the more disputed claims
are disallowed, are currently pricing in an unrealistically high level of allowed claims. Further, the
Trust Units pay out in New GM Securities, which themselves are trading at a compelling valuation. At
$22.90/unit, the Units provide 15% - 85% upside, plus a free option on the underlying GM stock price.
David Magid
David is a second-year MBA

student, participant in
Columbia’s Applied Value
Investing Program and the
co-president of CSIMA. All the Pieces in Place for a Mispricing (1) Complex structure and underlying assets: The mechanics
Prior to school, he was an of the Trust Units payout is complicated and does not easily lend itself to traditional equity or credit
investment banker at Credit analysis. (II) Forced selling: All initial holders of Trust Units receive their stake as a result of the resolu-
Suisse and next year will be tion of their previously disputed claims, and the vast majority of these holders are natural sellers. (III)
a research analyst at York Obscure: The Trust Units are outside most traditional funds’ investment mandates, have a relatively
Capital, focused on credit small market value (~$700mm), and have very limited sell-side coverage.
and distressed debt. He Descriptions of the Trust: The Motors Liquidation Company GUC Trust is a successor to the
holds a BA from Brandeis Motors Liquidation Company (the old General Motors Corp.). The Trust was formed on March 30,
University. 2011, for the purpose of resolving disputed general unsecured claims against the former GM (i.e. al-
lowing GM to exit bankruptcy without resolving all outstanding claims). The Trust’s assets comprise
David was the winner of the of GM common stock and warrants to purchase
2013 Moon Lee Prize for his GM common stock. For each $1,000 of GUC
pitch on the Motors that is allowed, the Trust pays out “New GM
Liquidation Company GUC Securities” in the following proportion:
Trust Units. Since inception, the Trust has been very effective
in resolving outstanding claims to the benefit of Trust Unit holders. Only 9.7% of the $4.4bn in re-
solved claims to date have been allowed. There are ~$5.3bn disputed claims remain outstanding, and
current trading prices of the Units imply ~50% of remaining claims will be allowed.
Analysis of the Remaining Disputed General Unsecured Claims:
As of 12/31/12, there were $5,259mm of remaining disputed GUC’s. If these claims are allowed at
under 50%, there will be a positive return to the units. There are three major buckets of remaining
disputed claims, and for each bucket, allowed claims are highly likely to be well below 50%.
1) Term Loan Avoidance Claim ($1,500 million)
In November 2006, the old GM entered into a $1.5bn term loan agreement with a group of lenders,
secured by a first-priority lien in certain assets of GM. Post Chapter 11 filing, GM secured a $33 bil-
lion DIP loan from the U.S. Treasury Department and Export Development Canada. GM received
court permission to use a portion of the proceeds to repay in full the Term Loan obligation, given its
first-priority claim status. Subsequently, it was discovered that a lien securing the term loan was not
properly perfected. As a result, the Unsecured Creditors Committee is seeking to have the proceeds
of that repayment clawed back (proceeds would not benefit Trust Unit holders), and the $1.5bn claim
would become a general unsecured claim (thus the potential for $1.5bn incremental allowed GUC).
The matter has been awaiting a ruling from the judge from approximately two years. While there is
uncertainty in how Judge Gerber will rule, it is highly unlikely that most of the $1.5bn potential for
incremental allowed unsecured claims will be realized:
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MTLQU (Continued from previous page)

I. The court will likely reject the request. The 2008 UCC-3 Termination Statement, which canceled
the lien perfection, was filed erroneously, for a totally unrelated transaction, and by a law firm not
representing JP Morgan (the admin agent) in term loan. Further, JPM did not authorize the filing.
II. It is undisputed that the term loan was also properly secured by additional collateral, consisting of
26 fixture filings filed by JPM in counties where term loan collateral was located and a UCC-1
financing statement against Saturn as debtor. The value of this uncontested collateral alone was
more than sufficient to cover the term loan (book value of $5.6bn 3 days prior to filing).
Therefore, a reasonable range of outcomes (i.e. new allowed claims) for the Term Loan Avoidance is
between $0 (0% allowed) and $600mm (40%).
2) Nova Scotia Litigation Claim ($2,680 million)
In 2003, GM’s wholly-owned, unlimited liability subsidiary, GM Nova Scotia Finance, issued ~$1bn of
notes, which were guaranteed by GM. In March 2009, a group of holders of these notes sued GM enti-
ties for “oppressive conduct,” as a result of transfers of funds from Nova Scotia Finance to GM. In an
effort to settle before filing and keep the Canadian unit out of bankruptcy, holders dropped the suit and
released GM from liability in exchange for (i) a $367mm consent fee; (ii) the right to assert $2.7bn in
claims against the GM estate (double dip claim plus swap claim). While this is the area with the greatest
variability in potential outcomes, there is a strong case that much of the $2.7bn claim will be disallowed:
I. The deal was completed post-petition (and backdated) and without court approval. Judge Gerber
was “shocked” to learn of the transaction and berated the “lack of disclosure to the court.”
II. The “consent fee” of $367mm was egregious and uneconomic. It represented over 35% of the
notional amount of notes at issue, as should there-
fore be reclassified as a principal pay down. Trust Unit Valuation build-up
III. Strong fraudulent conveyance argument: In the deal, Current High Low
Implied
GM did not receive the reasonably equivalent value Ad'l allowed claims ($BN): 2,635 70 2,151
necessary in any pre-petition transaction. Total Allowed Claims $32,834 $30,269 $32,349
Therefore, a reasonable range of outcomes for the Nova Total Units 32.8 30.3 32.3
Scotia Litigation Claim is between $0 (0% allowed) and GUC Trust Assets (in millions):
$1,340mm (50%). This issue is currently in trail before Judge GM Common Stock:
“A” Warrants
17.24
15.67
27.45
24.95
19.17
17.42
Gerber. “B” Warrants 15.67 24.95 17.42
3) Miscellaneous Claims ($1,079 million) Asset Distributions / Unit:
The composition of the remaining $1,079mm of claims GM Common Stock:
“A” Warrants
0.53
0.48
0.91
0.82
0.59
0.54
closely mirrors all the claims resolved to date. It is reasona- “B” Warrants 0.48 0.82 0.54
ble to assume these claims will follow the historical resolu- Value of Distributable Assets / Unit:
tion pattern (~10%), albeit incrementally more will be al- GM Common Stock:
“A” Warrants
$13.83
$8.16
$23.88
$14.10
$15.60
$9.21
lowed as it is later in the process. However, this is offset by “B” Warrants $5.13 $8.87 $5.80
fact that the $377mm of these claims are likely all duplic- Total (pretax) $27.12 $46.85 $30.61
itous debt claims, and will be disallowed. Therefore, it is Less: Trust Tax on Capital Gains / share:
Total tax / unit ($4.22) ($4.58) ($4.28)
conservative to assume, for the remaining “other” claims,
Total Value/unit (post tax) $22.90 $42.27 $26.32
$70mm (10% ) – $210mm (30%) of claims will be allowed. Implied % Allowed 50.1% 1.3% 40.9%
Combining that analysis , the Trust Units are worth Change vs current 0.0% 84.6% 15.0%
between $26 and $43, or up 15 to 85% (see right).

Underlying GM Securities are Cheap as Well: While not central to my analysis, the GM securities
underlying the Trust are currently cheap, only making the Trust Units more compelling:
 Cheap absolute valuation: 4.9x EV/EBITDA – Maint-Capex (20% yield); 1.4x P/B; 9.3x P/E (LTM)
 Good business: ~15% ROIC; strong brand power, global presence (#1 in China).
 Post-bankruptcy GM has a much stronger balance sheet and improved cost structure.
 Levered to continued global economic recovery.
 Impacted by temporary bankruptcy overhang, concerns about pensions and weakness in Europe
Investors can also hedge out the price risk of these securities, and just invest in the “discount to NAV”
type situation that currently exists in the Trust Units.
Key Investment Risks
 Adverse tax implications of rising GM stock price (mitigant: gains from rising stock price more than
offsets losses from increased tax liability).
 Timing uncertainly of ultimate claim resolution (likely resolved within year due to trust expiry).
 Underlying value of GM securities (margin of safety in both valuation and claim allowance).
 Unexpected, adverse ruling from Judge Gerber.
Page 8
Precision Castparts Corp (PCP) - Long

Arjun Bhattacherjee
abhattacherjee13@gsb.columbia.edu
Precision Castparts (NYSE:PCP) (“PCP”, “the Company”) manufactures highly engineered and critical,
alloy based components for the commercial aerospace, power generation and oil & gas industries.
PCP is a leading supplier to all jet engine manufacturers and as such, almost all aircraft in the
sky fly with parts (turbine parts, fasteners, subassemblies, nickel alloys) made by PCP. The
Company’s unique ability (stems from ownership of unique assets and decades of knowledge/
Arjun Bhattacherjee experience) to make complex parts out of nickel and titanium has resulted in very high market
share. This combined with the fact that PCP’s parts are not especially expensive in the context
Arjun is a second-year MBA of overall costs (e.g. PCP represents ~ 5% of a 787) allow PCP to earn high returns.
student participating in the
Applied Value Investing Recommendation
Program. While at school, I recommend a long position in PCP with a price target of $275.00, which represents 50%
he has worked at three upside from current levels. I believe PCP will beat near term numbers and that, consequently, long
long/short equity hedge term expectations will be revised significantly higher.
funds. Prior to enrolling at
Columbia Business School, Investment Thesis
he was in private equity and Given its sustainable competitive advantages (unique production capabilities and vertical integration),
investment banking. Arjun strong management and pristine balance sheet, PCP is well positioned to take advantage of the near
holds a BA from Macalester term accelerated growth in aerospace to continue its successful strategy of vertical integration, con-
College. solidation of lucrative niches of the aerospace supply chain and entry into fast growing adjacent mar-
kets.
Arjun was the second place  With 787 production still on track to double by the end of 2013 and with increasing
winner of the 2013 Moon exposure to this platform, PCP is poised to reap over a $1.0 billion in sales and $300 million
Lee Prize for his pitch on of EBIT from the 787 alone over the next three years
Precision Castparts and was  This increased production will drive higher utilization across PCP’s platforms thereby im-
part of the second place proving incremental margins
winning team of the 2012  This accelerated near term growth in aerospace and the related improvement in margins will
Pershing Square Challenge result in record free cash flows—a $6.5B hoard in three years
for an activist pitch on
 PCP has been a successful consolidator in the past and this cash hoard represents a huge
Ingersoll-Rand.
and undervalued opportunity
 PCP acquired five companies in the fragmented aerostructures segment in 2012 and in-
tends to build out this segment
 Both Airbus and Boeing want the supply chain, especially aerostructures, to consolidate
to ensure reliability
 PCP’s scale and vertical integration allow it to extract synergies that none of
its competitors are able to
 Vertical integration in nickel and titanium allows PCP to lower costs through
maximizing utilization of assets and maximizing scrap use across the chain
 PCP’s competitors are highly levered and unable to participate in this consolidation
 Increased titanium and nickel usage in aircraft (e.g. 787, A350Neo) represents an expansion
of PCP’s TAM
 Specialty oil & gas pipe represents an attractive new market given the need for cor-
rosion resistant alloys for deepwater and shale plays
 PCP’s industrial gas turbine business is at a cyclical low point—recent GE numbers suggest a
nascent recovery in IGT
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Precision Castparts (Continued from previous page)

The Street has historically underestimated the Company’s ability to successfully deploy free
cash flow and extract synergies from acquisitions. Having completed seven acquisitions, including its
largest ever, in the last twelve months alone and poised to generate the most cash in its history, long
term consensus expectations now are significantly below true earnings power thereby cre-
ating an attractive entry opportunity.
Situation Overview
During 2005 – 2008, PCP vertically integrated nickel alloys and used rising cash flows to consolidate
aerospace fasteners. During the last twelve months, PCP has effectively been setting itself up
to repeat the success of the 2005 – 2008 period. PCP acquired five companies in the aerostruc-
tures niche to create a platform to begin consolidating that segment and acquired its largest supplier of
titanium. But in the context of the aerospace cycle, post 2012, there will be 50% more aircraft being
delivered annually (than the 2005 – 2008 period) resulting in significantly higher cash flows.
Valuation
Based on a conservative set of assumptions, PCP will likely earn > $17.00 / share by FY 2016 vs. $15.08
consensus. A 16.0x P/E multiple is at historical averages and mid-cycle levels and leads to a $275.00 price
target—and represents a 20% IRR. In summary, the record backlog in commercial aerospace
supports a near term acceleration in growth, but the natural replacement cycle, emerging
market demand and the introduction of new, more fuel efficient platforms will support
growth thereafter.
Risks / Mitigants
 Prolonged 787 Issues / Issue appears to center around batteries and appears to have been resolved
 Cycle Peaks in 2015 / New engine platforms (737 and A320) and continued demand from EMs
Catalysts: Q4 2013 (March) and Q1 2014 earnings re: Timet synergies; 787 production updates
Page 10
Preston Athey
(Continued from page 1) simple. At the time, we had take a lot of time to really
G&D: Could you tell us a draft and the Vietnam get to know the companies
about your background and War was going on, so I in the fund and learn about
how you became interested made the decision that for potential new additions. I
in investing? me, being a Naval Officer realized you couldn't do
was probably a smarter both jobs effectively, so I
Preston Athey (PA): I thing than getting drafted asked to be switched off the
was very fortunate because and being an enlisted soldier growth portfolios to work
my father was an investment in Vietnam. I wasn’t moving full-time on Small-Cap
counselor in Chicago. As a to Canada to try to avoid Value, which T. Rowe Price
boy, my dad would often the draft, but I wanted to allowed me to do.
talk about the investing have a little more say on
business, about his clients, how I served. The second point is that
and about managing there are significant
Preston Athey portfolios. Because we had G&D: Before managing the differences in running
a very good relationship, Small-Cap Value Fund, you growth and value portfolios.
one day I told him that I'd managed the small-cap Interestingly, my natural
like to own a stock. That is growth portfolios. How did proclivities in my personal
not particularly unusual you make the transition account are to buy and hold
except for the fact that I from growth investing to growth stocks that are great
“As a boy, my dad was seven years old. I value investing? What were companies. They may not
would often talk bought one share, which some of the challenges in be super high growth, but
was all I could afford at the doing so? they're really solid
about the investing time. Then I bought companies. You buy them
another stock the following PA: I came to T. Rowe and hold them forever, and I
business, about his year and another stock the Price in 1978 and spent four have a number of those in
year after that, which meant years as a technology the portfolio today. I was
clients, and about that as a little kid, I was analyst covering mostly not somebody who
reading annual reports. I'd telecom companies and naturally liked to go find the
managing portfolios look at the pictures and I some electrical equipment classic Ben Graham half-
… one day I told didn't understand the companies. In 1982, I began smoked cigar butt on the
financials, but I could kind of managing small-cap growth ground and try to get a few
him that I'd like to understand what the portfolios, which are more puffs out of it. I had
companies did. By the time separate accounts run in the to teach myself that. It was
own a stock. That I was in college, I'd pretty same style as the New not my natural inclination to
much figured out what I Horizons Fund, our small- do it; I was not a natural
is not particularly wanted to do in life. I took cap growth product. Then value investor.
Economics as a major in 1991, a spot opened up
unusual except for because that seemed to be a on the Small-Cap Value On the other hand, I believe
the fact that I was good foundation. Then in Fund, and the firm asked me that you should develop the
business school, I took all to take that on. Within two skills that enable you to do
seven years old.” the finance and investment or three weeks, it was almost anything in your
courses offered. That's pretty clear to me that business. That's really the
basically how I got into it. managing the value fund was definition of a professional.
a completely different job For example, if an
G&D: After graduating than managing the growth investment professional is
from Yale, you decided to fund. asked to run a portfolio for
postpone your career in an order of nuns and it
investing and you spent five First of all, it was a different needs to be 75% blue chip,
years in the Navy. What set of stocks. There was high dividend-paying stocks
led you to that decision? almost no overlap between and 25% good quality bonds,
the two, and it was going to (Continued on page 11)
PA: Well, it was pretty
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Issue I, Issue 2
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Preston Athey
(Continued from page 10) what value investors look small-cap investors?
even if you’re a small-cap for, so it was a question of
investor, you still ought to just putting it into practice. PA: First of all, over that
be able to put a different set 21 ½ year history, value has
of eyeglasses on and say, "I done a little bit better than
can do this. I know what growth, so I’ve had a
the client needs. I know tailwind versus the Russell
basically what has to 2000 which is a blend of
happen. We'll take a value and growth. That is
conservative approach and part of our outperformance.
do it." That's really the way The second thing is that
I approached it. I trained when you're running a fair
myself to do what's “The one thing that amount of money and you
necessary to do a good job have a lot of names, you
in small-cap value and put
makes me
cannot do it by yourself. T.
aside my natural beliefs somewhat different Rowe Price is just a
about growth stocks. It wonderful organization.
took about a year to change than most of my We have a lot of analysts,
my mindset, but I did it. and part of our job is to
value peers is train them. We're asking
G&D: How did you train them to find interesting
yourself to be a value perhaps the good companies, not necessarily
investor? Did any particular great companies because
books or investors inspire
fortune of having
sometimes cheap companies
you? spent that first nine that have a catalyst to
change can be a great
PA: I got to know the key years as a growth investment. We train them
competitors in the industry. to look for things that make
I studied Chuck Royce of investor. The result sense. So the second
Royce & Associates, who reason I'd give is that we
has done a marvelous job is that when I get a have great research analysts,
over many years. I think of as I wouldn't be able to do
Chuck as the preeminent
winner, I'm less
it by myself.
and certainly the earliest likely to sell it too
small-cap value The one thing that makes
practitioners. The quickly. I'm more me somewhat different than
organization that he's built is most of my value peers is
still focused on small-cap likely to let it run. ” perhaps the good fortune of
value investing. I also having spent that first nine
looked at John Neff, who years as a growth investor.
had run the Windsor Fund The result is that when I get
at Vanguard for years, and is a winner, I'm less likely to
certainly a very well-known sell it too quickly. I'm more
value investor. Also, I had likely to let it run. I follow a
personally been a pretty good value discipline
shareholder in Berkshire G&D: You've been running in adding new names to the
Hathaway and I understood the Small-Cap Value Fund portfolio. But some people
what Warren Buffett was since 1991, and your fund might argue, probably
trying to do. I had read a has outperformed the legitimately so, that several
couple of Ben Graham's Russell 2000 over that time of my top 25 holdings don't
books. I understood period. What would you look like value stocks; they
intellectually what it meant say is your edge over other (Continued on page 12)
to be a value investor and
Page 12
Preston Athey
(Continued from page 11) before. That tells me you and where is the company
look like growth stocks. need to rethink what a fair relative to everything else?
They were value stocks or overvalued price would You need to constantly put
when I first bought them, be. A lot of people don't do all of that together to know
then the catalysts came that. whether or not you're
“You can imagine about and they began to be selling a stock too early.
that when money's appreciated in the market. The danger is, of course,
Then their PEs went up and that some people constantly G&D: How has the
sloshing in and out growth rates accelerated. raise their price targets as landscape changed for the
I'm not that quick to sell the stock goes up. They're investing opportunities out
of these passive those. So even though I always going to be 30% there? Has it become
follow a value discipline, the higher than where the tougher to beat the market?
portfolios, some of portfolio looks like a blend current price is, even if
portfolio in its nothing fundamentally good PA: Interestingly, I think
these small-cap characteristics because has happened at the that in some respects it's
stocks become some of the top holdings company and if the market become easier in the small-
are big winners. hasn't done a whole lot. I cap world. First of all,
collateral damage. look at the valuation of the there's relatively less Wall
G&D: Do you set price company relative to the Street research. Wall
When that targets for the companies in market and its peer group. I Street firms don't make as
your portfolio? How do look at where the company much money trading the
happens, if you're you know when to sell? is in its cycle. If it's early in stocks and there have not
nimble and know an economic cycle, then it been as many IPOs and
PA: When I buy a stock, I may have gone up awhile secondary opportunities to
the company well, personally don't have a price but it still might have make money on the banking
target in mind, and here's another two or three years side. If you look at all of the
you can pick up a the reason why. If you set a left to go. various firms, there's
price target without any somewhat less research
bargain, or trim reference behind it, it An example today would be being done on small-cap
becomes an excuse to sell homebuilder stocks. companies, particularly
some at a high price too quickly, and you may They've had a great run off companies below $1 billion
leave a lot of money on the the bottom. On the in market cap. That means
that's well outside table. For example, let's surface, they look ahead of there is some opportunity
of its normal range. assume that you buy a stock themselves, and if one were for mispricing in the market
and you've set a price target to say you should take some with less analysis being
That happens more 30% above your buy price. profits in homebuilder done. Second, a greater
Six months go by and it stocks today, I'd have a hard percentage of the trading
today than it did 20 comes close to hitting your time arguing against that. volume is now being done
price target; is it now really However, the housing cycle, one of two ways: either
years ago.” a sell? What happens if the even six to twelve months with high frequency traders,
company has actually from now, could still be in who are really just
reported two wonderful the early to middle innings. arbitraging pennies, or with
quarters where earnings We've got a long way to go trading that's done in
were up 25% each and as some of these companies passive portfolios such as
where the market itself is have earnings potential of ETFs and index funds. One
up 15% in that period? You two to three times what would think that trading
now have a company that they generated in 2012. If done in passive portfolios
might be just as undervalued they earn three times what shouldn't have much impact
– relative to the market, its they did in 2012, today's on the price level of
peer group and any other price will look pretty cheap. individual companies, but
metrics you might want to That's how I think about it. surprisingly it does have an
look at – as it was when you Where are we in the cycle, (Continued on page 13)
first bought it six months
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Issue I, Issue 2
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Preston Athey
(Continued from page 12) effects in related companies. initiated. Historically on
impact when fairly large You still get that today. I'm that 10% turnover rate,
amounts of money get hard pressed to say that the about 3% or 4% was related
moved in and out of passive ETFs per se have created to takeovers. The other 6%
portfolios. From time to more volatility because to 7% would be considered “Unless [a position
time, some of these stocks we've had plenty of high- manager initiated. The last
will move fairly significantly volatility periods. You two years have had lower- is] demonstrably
with almost no fundamental could look at the VIX for than-average takeover
news to account for it. You overpriced, I'm
the past 35 years and tell opportunities, so the low
can imagine that when me whether there is more turnover rates have been
money's sloshing in and out
reluctant to sell it.
volatile today or not – I'm partly due to that.
of these passive portfolios, not an expert on that. First of all, a
some of these small-cap However, more of the Additionally, if a scenario
stocks become collateral volatility today is unrelated that I had painted for a sizeable fraction of
damage. When that to fundamental news from particular company is still
happens, if you're nimble the companies, which may playing out, then unless it's my shareholders
and know the company well, lead to investing demonstrably overpriced,
you can pick up a bargain, opportunities. I'm reluctant to sell it. First
are taxable, so if I
or trim some at a high price of all, a sizeable fraction of
that's well outside of its
sell something at a
Volatility affects all equity my shareholders are
normal range. That happens investors who worry about taxable, so if I sell something gain and make
more today than it did 20 volatility. I don't think it at a gain and make them pay
years ago. All of that means makes a difference whether the tax, I have to find them pay the tax, I
active managers who know they're in a passive product something that's better than
what they’re doing can or an active product. If they what I sold. It has to be have to find
actually gain an edge. don't like volatility, it will substantially cheaper and
something that's
make them less willing to have a better future to
G&D: ETFs have been invest in equities. If they make up for the capital gains
growing rapidly, and like you
better than what I
can shrug it off and look lost to tax. Studies show
alluded to, they seem to long term, then I don't think that it's very difficult to sold. It has to be
have some potential for it has an impact. create enough alpha from
volatility since many buy and trading to still come out substantially
sell large baskets of G&D: Over the past two ahead after taxes. The
securities. How do your years, you've had turnover studies are very clear, and cheaper and have a
shareholders absorb the of 4.8% and 5.5%, which is yet 98% of the trading in the
potential for additional better future to
unusually low in the stock market either ignores
volatility from those passive industry. Can you talk a them or doesn't even
portfolios? Does it
make up for the
little bit about the rationale believe them. I believe the
contribute to additional behind that? studies. To get me to sell capital gains lost to
volatility? something, particularly
PA: The last two years something that's up, means tax.”
PA: When I think about have been extraordinarily I've either completely lost
some of the moves that low. The prior 10 years, I faith in the company or I
small-caps stocks have had averaged around 10%. think it is highly overvalued
before ETFs existed, my gut Historically, part of my and I can do substantially
tells me no. The difference turnover is not investment better in some other stock.
is, in the past, you’d see driven but rather forced on If you follow that philosophy
volatility based on sector me by takeovers. If religiously, it leads to quite
moves such as the whole someone takes over one of low turnover. In a very
technology sector being your companies, you have volatile market where
down 10% in the month, or to sell it. That is turnover, stocks are up a lot one
based on fundamental news but it's not one that you (Continued on page 14)
that would have spillover
Page 14
Preston Athey
(Continued from page 13) chart, you can see it’s or has a catalyst for realizing
month and down a lot the bounced off the bottom and change. Third, I have a
next month, I'll probably do it seems like it's gone stock that is clearly washed
some trimming here and put sideways for six months. out. It could go down more
that money back to work They just reported a or it could be flat for a long
the following month. If quarter that was better than time, but it's unlikely that
takeovers pick up, turnover anyone was expecting. there's much euphoria
Pictured: Tom Russo will go up.
speaks at the Omaha Din- However, the stock went surrounding the company. I
ner in May 2012. up only about half a point. don't have a lot of downside
G&D: How do you It's clear that nobody on risk because everybody who
generate your investment Wall Street cares – all of owns it wants to own it.
ideas, and what do you look the momentum investors When it's an experienced
for in a good investment? are long gone. Here's the analyst who has followed
scenario – over the next the company for a while and
PA: About 90% of new we can look at it together, it
ideas are generated by our just gets me excited.
analysts. We’ll discuss the
idea and if I agree that it G&D: It sounds like you're
makes sense for the not necessarily looking for a
portfolio, I'll generally buy a company with a moat.
starter position and ask
“I generally tend to
them to formally follow the PA: You would always like
company. Over time, as we avoid companies to see a company with a
get to know the company moat. Several companies
better, we may increase the with stressed that I own that have small-
holding. We may buy it to mid-sized moat in their
cheaper if we happen to balance sheets. … niche area. But I generally
have a dip in the market, or tend to avoid companies
we could buy it at a higher I've been through
with stressed balance
price, assuming the sheets. The types of
too many cycles
company is meeting its companies that I probably
goals. That's how we where debt kills would not be interested are
generate most of our ideas. those with high leverage,
you.” where debt significantly
In terms of what I look for exceeds book equity, or
in an investment, here's an companies that have made a
example of the type of string of acquisitions in the
company that gets me past and had to write half of
excited. An analyst walks them off. There is no
into my office and says, capital discipline in a
"Preston, I've been following three years, if results company like that. I've been
this particular company for improve as I think they will, through too many cycles
two years. I've been the stock could be a very, where debt kills you.
listening to conference calls, very big stock.”
looking at the earnings, and G&D: Given that you focus
I think there's definitely So first of all, I have a on small-cap value stocks,
something here. They have company with a decent you have the elevated risk
a product or service that product or service and a of companies going under.
makes sense, but they've decent balance sheet. How do you factor in that
had some rough times and Second of all, I have a risk when looking at
the stock is down from its management that's either investment opportunities?
all-time high of five years turned around the company (Continued on page 15)
ago. When you look at the
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Issue I, Issue 2
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Preston Athey
(Continued from page 14) stocks of the group that I the value of the cash on
PA: There's absolutely held, so in a scary market their balance sheet, and
some bankruptcy risk in where people are worried another half dozen met Ben
investing in small-cap value about balance sheets or Graham's favorite net-net
companies. By definition, businesses that maybe aren't standard where they were
they are considered value as solid as others, the selling for below their net “I would say if the
stocks because there's stocks are going down a lot working capital. I felt pretty
something wrong. Perhaps stock goes below a
more. The bottom line is comfortable holing those
their record isn't very good they're all below $1.00. The stocks. Fast forward a year,
or they're overburdened
$1.00, the market is
question was asked by the four of those 20 actually did
with debt or they've had reporter, “Doesn't that go bankrupt. Let's say that I telling you they
some bad news that's really mean they're all going sold them at some point
knocked the stock. In the bankrupt?” In a normal either right before or right think it's going
22 years that I've run the market, I would say if the after they filed and realized
Small-Cap Value Fund, I’ve stock goes below a $1.00, something less than $1.00. bankrupt. In a
averaged less than one the market is telling you it Of the remaining 16
company per year go market like today,
think the company is going companies, all of them
bankrupt while I own the bankrupt. In a market like eventually recovered well
stock. It happens
that's probably a
today, that's probably a above $1.00. Some tracked
occasionally, but it doesn't reasonable guess – 20% to the market, while some reasonable guess –
happen very often. I 30% of those companies went up two times to four
consider it an overblown probably will go bankrupt. times. One of them, Dollar 20% to 30% of those
concern and it's not But, at the bottom of a bear Thrifty, went from $0.60 to
something I spend a whole market when people are $45.00 in a year and half, at companies probably
lot of time worrying about. worried about everything, which point I sold it.
will go bankrupt.
my experience was that
In March 2009, which was they're not all going to go If you took that portfolio of
the bottom of the bear
But, at the bottom
bankrupt. 20 companies and evenly
market, I gave an interview weighted them at 5% each, I of a bear market
to Barron’s on the topic There were 20 of my guarantee you the two-year
‘Stocks selling for below positions trading at below returns on that portfolio when people are
$1.00’. After giving the $1.00. I believed that from were better than the
interview, I decided to that point on, when the number one small-cap value worried about
check how many stocks I market came back, most of fund in the country. But
actually had below $1.00. everything, my
these stocks would recover. who has the guts to invest a
Remember, this was at the A small fraction would lot of money at the bottom
bottom of the market. At
experience was that
probably go bankrupt, some of the market into what the
the time, 20 stocks out of would track the market, market perceives as horrible they're not all going
300 in the fund were selling some would do substantially companies? I didn't sell
for below $1.00. I better, and one or two them, but I held on and to go bankrupt.”
guarantee you, not one of would be home runs. The when the junk rallied, I
them had I bought below question was asked "Well if realized my fair share of
$1.00. In fact, most were that's the case, why don't profits.
bought at prices significantly you sell the ones that are
above that, often above going to go bankrupt and G&D: Did you add to your
$5.00, so that shows you buy the ones that are going positions at the time?
how much they had come to be home runs?" If we
down. So what was going knew that, obviously we PA: Not substantially. In a
on? First of all, we were in wouldn't hold the ones that few cases, I added a little
a horrible bear market, so a were going bankrupt. Two bit, but not in most cases. I
lot of stocks were down. of those 20 companies were had to think about risk. The
Secondly, these were literally selling for less than (Continued on page 16)
probably the lower-quality
Page 16
Preston Athey
(Continued from page 15) how management really questions. Ask about
bottom line is there is thinks. Many analysts new strategy and long-term
bankruptcy risk in small-cap to the industry have their goals. Ask about how they
value stocks and sometimes questions and don't really deal with problems and how
that's reflected in the stock think about follow-ups. they think about capital
price. Though even when They're not actually thinking allocation. Those are CEO
it's reflected in the stock about what it is that they’re questions. When you
Pictured: Jason Zweig,
price, only a small fraction trying to determine. interview other members of
Mark Cooper, Jean-Marie
Eveillard, John Spears and
of companies actually go out They're just asking a lot of the management team, ask
Jennifer Wallace speaking of business. questions that are specific
in the Graham and Dodd to their area.
Investing Panel at the G&D: You're known to
2013 CSIMA Conference. have a knack for G&D: How much weight
interviewing management – do you put on the quality of
in fact, you lead the “The longer I’ve the management versus
“interviewing management” other quantitative or
training session for T. been in the qualitative factors?
Rowe’s new hires. Could
you talk about how you business, the PA: The longer I’ve been in
developed this ability over the business, the more I
time? more I think think management really
makes a difference. In small
PA: I don't think I have an management companies, I think
unusual knack at all. There management makes a huge
are other people who are
much better at the business
really makes a difference. The main
question is, how do you
of interpreting management determine if it's a good
body language – I'm not difference. In
management? The
very good at that. I think interview is not sufficient;
what I do well though is to, small companies, it's only a first step.
over time, learn to read Interestingly though,
management teams on I think studying the past record of
whether or not they’re that management more
telling the truth. If you see management often than not is a pretty
a management enough times good indicator of what the
over the years, you can makes a huge future will be. Is the
really begin to see whether manager someone who
they are trustworthy or not, difference.” grew up in that company
or if they're always and was made CEO last
optimistic or always year? The previous 10-year
pessimistic. That's the big record at the company is
advantage. When you've not that person's record, as
got a lot of experience, you questions. I try to teach he or she has only been
don't really have to sit there our analysts to have a line of CEO for a year. However,
and ask questions and take questioning. Figure out if he or she was the COO
notes all the time. You can what it is that you want to or had run one of the
ask a general question, hear know and have a line of divisions, you could study
the answer, and think questioning that will help that division’s record, or
through what the next you to get to that point. you could study the time
follow-on question is that Also, when you're with a period that the individual
extends that line of CEO, don't spend time was COO. You can also
reasoning. By doing that, asking about CFO-related (Continued on page 17)
you get a good indication of
Volume
Issue I, Issue 2
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Preston Athey
(Continued from page 16) relevant either, as there obvious question: “If this
ask other people in the probably isn’t a lot of cash stock is so cheap, why is it
industry about the person’s flow, particularly in small- cheap?” The cheaper it is,
background and experience. cap mining companies. On the more the market is
What is it that the person the other hand, if you can telling you that there is
has done that would give value the proven reserves something wrong. If that's
you confidence that he or based on takeout prices of the case and you're still
she will be a good CEO and other companies in the intrigued, you better dig
take the company forward? industry, that's the way a really deep. Maybe what
If the person has been at
the job for a few years, then
CEO of a competitive firm you'll find is that it's a cheap “The best way to
might look at valuation. stock because management
you can more easily judge You can begin to build a uses all of the cash flow that
the record. avoid a value
framework around what the company generates to
NAV would be and assess make poor acquisitions. By
G&D: Do you have a the current market studying the past several
trap is to ask the
preferred valuation valuation’s discount or years of their acquisitions,
framework to assess the premium. If it's a premium, that may become clear. If
obvious question:
attractiveness of an it's likely not interesting at there's no chance that
investment? all, but if it's a discount, how management is changing ‘If this stock is so
large is the discount? If it’s because they either own
PA: Yes. My preferred more than is usual, that too much stock, the board cheap, why is it
valuation framework is to makes it attractive. is in their hip pocket, or
use those measures of value whatever the reason is, it cheap?’ The
that are most relevant for As an alternative example, almost doesn't matter how
the company and the take a service company that cheap it is. You're going to cheaper it is, the
industry you're looking at. I own called G&K Services, be throwing your money
If you think of all the various which does uniform rentals. away. That's really how you more the market
metrics you might use, Price-to-earnings is a pretty avoid value traps.
some are very readily good measure, price-to-cash is telling you that
available through databases flow is a pretty good I'll give you another example
and some you may have to
calculate yourself because
measure, and price-to-book – Cliffs Natural Resources is there is
value is a reasonably good an iron ore company that I
there's a measure of measure. You would want first bought in 2000. The
uncertainty. Net asset value something
to look at these ratios stock was down because its
is an uncertain number and relative to the market, sales and earnings were
it may rely on your forecast relative to other companies down and they were
wrong.”
of cash flows and what in its industry, and relative expected to decrease
discount rate you want to to its own history over the further that year. The U.S.
use. What is really relevant past 10 years. When I find steel industry was hurting,
is how a knowledgeable companies that are cheap and some were betting that
investor in that industry on those relevant measures, the domestic steel industry
would look at the company that's when I start to get would fade away and we
and what metrics that interested. would import all of our
person would use. For steel from Asia. Cliffs had
example, if we were talking G&D: On that point, how essentially all of its reserves
about a mining company do you avoid value traps at in Northern Minnesota, and
where the majority of the companies that seem if that played out the
value in the company is its statistically cheap but are so Chinese would not need
proven reserves, price-to- for a reason? Minnesota iron as they
earnings is an irrelevant could get it from Australia.
measure because there are PA: The best way to avoid The market was essentially
probably no earnings. Price a value trap is to ask the (Continued on page 18)
to cash flow is probably not
Page 18
Preston Athey
(Continued from page 17) well go through the various Industries, which is a
making the bet that the stages of ownership. The cement producer. It was
steel industry wasn't coming first owners are the deep considered very risky and it
back. On the other hand, value investors, followed by wasn't earning money. You
we took the opposite view the relative value investors. had to bet on a recovery in
that the U.S. steel industry Then you have the GARP-y the housing cycle and the
would come back, and that's (growth at a reasonable road-building cycle, and
exactly what happened. price) investors, followed by anything that's a big user of
the fundamental growth cement. If I thought I only
G&D: You mentioned investors. Pretty soon, you had 10% or 20% upside,
earlier that you do not have the momentum growth then I wouldn't have
assign price targets. How investors and after that, the bothered. But I could see
do you compare two last stage of investors based on where it'd been in
opportunities? Also, given focuses on pure the past and what earnings
that you have very low momentum. They don't could be in the future, that
turnover and hold things for really care what the there was some likelihood
a long time, at what point company does or what the that I could get a double in
do you actually get around earnings are. All they know three years. That for me
to selling? is that the stock is going up was a good buy trigger.
and they want to ride it.
PA: First of all, with as That type of shareholder is G&D: Given your 20+
many companies as I have, the most risky for me. At years of experience running
there’s almost never a the first hint that there's a a value fund, are there any
situation where I have to little perturbation in what common mistakes that you
sell something in order to people are expecting, see value investors make?
buy something else. I've momentum investors will You mentioned earlier
always got some cash and I sell a stock that could be about how you hold most
always have many things on down 25%, 30%, or 40% in a positions longer than others
the sell desk and many day. When I see the do – would you consider
things on the buy desk. shareholder base shifting that a mistake that other
There's some point at which towards that end of the investors make?
a stock truly gets spectrum, that is my sign to
overpriced and you have to get out because I don't need PA: It's hard to say that's a
figure out what that is. As that kind of risk. mistake if investors take a
for selling, I have a number 50% profit over a
of sell triggers. The obvious G&D: What are your buy reasonable period of time
one would be if the stock triggers? and re-deploy it into the
just gets too big. I'm next great underpriced
running a small-cap fund, so PA: If there's nothing stock, and they have a good
if the company gets to be spectacular about the stock track record of doing that.
over $5 billion, I move it or if I don't think I can Who am I to say that
out. Another trigger is if theoretically get a double in they're making an error?
the stock chart goes 12-18 months, in most cases That’s just a different style
parabolic. The stock has I probably won't buy it. An of investing. All I'm
tripled in 12 months and exception of that rule would suggesting is that for me,
although earnings are good, be something like a utility. holding winners longer has
it's now trading at 35 times For example, if you have to worked very, very well. I
earnings. own some utilities, you're haven't had that many
just trying to find good experiences where I've
Another trigger could be relative value among all the ridden a stock all the way
that the character of the various utilities. Last year, I up and then ridden it all the
shareholders has changed. bought shares in Texas (Continued on page 19)
Companies that have done
Volume
Issue I, Issue 2
XVIII Page 19
Preston Athey
(Continued from page 18) So why do I own it? Well, reason to think this
way back down. It's just a the stock in the last five company couldn't earn
function of constantly re- years has been as high as $1.50 in 2015. If they earn a
evaluating what you have $18, and in the depths of $1.50 and you put a 10x
and where that stock is in 2009, it was actually below multiple on earnings at the
relation to what you think a $1. The stock fell from the beginning of 2015, that's
full market cycle might high teens in 2011 because close to a double in the Pictured: Mario Gabelli at
mean. the truck cycle turned next two years. That would the 2012 Graham & Dodd
downwards and their auto be a pretty attractive Breakfast.
G&D: Do you mind talking business deteriorated. This return. There is no
about an idea that you was despite the fact that guarantee that this will
currently like? management had done a happen, but the stock
good job of improving doesn't seem to want to go
PA: I own shares in a operations. There's nothing below $6 because there's
company called Modine. It's they can do when the book value support. The
a Wisconsin-based demand falls off. The balance sheet is not too
manufacturer of automotive market saw that, the stock stressed. The risk-reward
radiators and heat exchange came down, and at around seems pretty good to me.
equipment. The company is $8, we got interested. At
particularly strong in trucks that point, it was selling for We talked a little bit about
and off-road vehicles, but slightly more than book what makes me different
they also have some value. What we saw was a from other investors: one
business in regular company with a good thing we’ve discussed is that
passenger cars. They also product set, good market I hold winners longer. The
make industrial HVAC position, decent balance other thing is, I'm willing to
products. It's certainly one sheet, and a management time arbitrage my
of the world's leaders in its that was doing what they investments. You can show
market, with well over a could to pay down debt and a lot of investors an idea
20% market share. The improve operational and they'd say, "Well that is
company has a checkered efficiency. Management also a good price and I can see
history over the past 25 seemed to understand how sometime in the future
years because it operates in capital allocation. the stock could be a lot
a very cyclical industry; it’s higher given a normal
difficult for them to predict So this was really a cyclical recovery in their earnings
exactly what their sales and company with nothing and sales. But the problem
earnings will be from year fundamentally wrong, where is, it isn't going to happen in
to year. It's totally if you could wait out the the next six months. Come
dependent on what the cycle, the stock could be to me when it looks like it's
customers are doing and worth substantially more. starting to happen and I'll
their customers are in a We started buying at buy the stock.” So they just
very cyclical industry. around $8, and we refuse to buy the stock.
Additionally, before the continued buying it down With Modine, I asked a
current CEO took over five into the $6s, and also during particular Wall Street
years ago, the company's its way back to about $9 analyst who was following
capital allocation was not today. If we have a normal the company when the
great. While they had a truck cycle in the next three stock was at $6.50, "Why
good product, they did not years, if some new business aren’t you recommending
manufacture it in the most they picked up in Europe is this stock?" He had a weak
cost effective manner, so as profitable as we think it hold on it at the time. He
even in good times, their will be, and if they continue responded, "I know what it
return on capital wasn't to do well on the industrial could be three years from
very high. HVAC side, there's no (Continued on page 20)
Page 20
Preston Athey
(Continued from page 19) sharing another idea that own, but typically you get
now, but the next 12 you currently like? paid for that risk. The
months look bad to me. second thing they do is
There's no reason their PA: I'll talk about another securitize. They buy loans,
earnings are going to turn, stock that I've been buying package and securitize them,
they're barely breaking over the past year. It's and market them through
even, and I just can't afford starting to work now, but if an investment bank.
to get out there in front of things go as well as I think Investors buy the AAA
this. I have to wait until I they will over the next tranche and the AA tranche
have a lot more confidence three years, it still has a long and Redwood makes a fee
in the next quarter or two.” way to go – it's a company on it. Often, in addition to
When he finally has the fee, Redwood will make
confidence in the next a spread on the sale.
quarter, that stock will be Therefore, a typical
$11. A move from $6.50 to securitization for Redwood
$15 is a whole lot better would be a pool of jumbo
than a move from $11 to “One thing you home loans that would be
$15. Also, if you're only generated by dozens of
running a small amount of
money, you might be able to
can do as a value banks around the country.
These banks typically will
get a decent position at $11, want to hold onto the five-
but if you want to make this investor is to
year ARM for their own
a 50 basis point position on balance sheet, but if it's a 15
$11 billion, you have to arbitrage time -year fixed or a 30-year
start buying it today. You fixed, they don't want to
can't wait until it’s at $11 and to recognize take that kind of duration
because you will move it up risk, so they'll sell those to
to $13 all by yourself. that you're going Redwood and Redwood will
That's time arbitrage. package them together.
to be early, but if That market completely
I'm willing to build a went away in mid-2008, and
position and wait, not you get the right the first securitization
knowing when the turn will wasn't until Redwood did it
happen, because there will price, it all works in the fourth quarter of
be other stocks in my 2010. They did two in 2011
portfolio that are working out in the end. “ and five in 2012. They'll
just fine that I bought two probably do well north of
or three years before. half a dozen, maybe as many
People ask me how I can as 10 or 12 this year.
run a lot of money. It's They've been working on
harder than a small amount called Redwood Trust. their pipeline. So the result
of money and you have to Redwood Trust is a is accelerating activity,
do things differently. One mortgage REIT based in which means they're going
thing you can do as a value California. Its business is to generate more fees,
investor is to arbitrage time twofold – first, it owns they're going to get more
and to recognize that you're mortgage securities, spread, and they're going to
going to be early, but if you typically the lower-rated get more products at the
get the right price, it all tranches of mortgage bottom end for them to
works out in the end. By securities such as BBB, BB, hold. That's the simple
the way, the truck cycle is B and the equity of a story. It's very
just starting to turn now. mortgage RMBS or CMBS. conservatively managed.
It's a highly risky thing to (Continued on page 21)
G&D: Would you mind
Volume
Issue I, Issue 2
XVIII Page 21
Preston Athey
(Continued from page 20) business. Redwood's sitting more bankruptcies before
They got through the there looking very, very we're done. Energy stocks
problems of 2008 and 2009 smart. are not quite hated but
when the rest of the they're certainly way down
industry was dying. They G&D: Any particular from where they were a
had seen it coming and sold industries that you are couple of years ago. Also,
a lot of assets in 2007. finding very attractive right mining stocks are
They were very now? increasingly hated these
conservative and had no days. Those are the areas
recourse debt on their PA: Not so much where I would say there are
balance sheet. The only industries. I would say that opportunities. On the
debt they had was tied one of the questions I'm other hand, can I say that
specifically to securitizations always asking broker it's a great time to be buying
and was non-recourse to salespeople is, “I don’t want software as a service
the parent, so that was not to know what your analysts companies? Most of those
an issue. Now they're like. Tell me what your are trading at high
starting to lever up. clients hate. What are the valuations and there aren't
sectors that are most hated? too many bargains in that
I like the company because I What are the industries that area.
see an increasing set of fees your clients don't want to
and assets on which they hear about?” It doesn't G&D: Are there any
can generate returns. The even necessarily mean that's companies that you would
stock has done very well the best value, but I just have traditionally invested in
over the past six months, want to know what the which now you stay away
but there's no reason to world hates. When it's out because of destructive
think that if we have a really of favor and really hated, technologies like Amazon or
good housing market and that to me is a good sign, e-commerce?
Redwood continues to sell and it means it's time to do
RMBS securitizations, the the work and move PA: Years ago, a lot of
stock could still double over forward. people would have told you
the next two or three years. that newspapers are a great
It's at $23 today. That's one I'll tell you some areas that business. Newspapers are
where when the stock was seem to be relatively hated not a great business
at $12 and somebody might today, but I can't necessarily anymore. Some individual
say the target price is $20, tell you that they're good newspapers may still have a
people would laugh. Well, values. Education stocks good return on capital and a
it went through $20 last today are relatively hated, good margin, but let's face
month. So should you sell it and that's tied to increasing it, newspapers are a dying
because it hit its target regulatory constraints from industry. Most of them
price? If Redwood was Washington and the fact have not found a way to
selling two securitizations a that in an improving monetize the content if
year and had no opportunity economy, fewer people feel people don't actually buy a
to do more than that, then that they have to go back to physical paper. I don't know
the stock would be kind of school, particularly a school one that's really making
expensive. But it's where they have to borrow enough money from their
absolutely staggering to a lot of money. Shipping website to pay for all the
think of how they've stocks in general and oil journalists on the staff.
increased their pipeline of tanker stocks in particular
loans – even the big are really hated. Again for In a related field, TV and
investment banks are now good reason, almost nobody radio are still decent
hard pressed to do this – is making any money in that businesses, but an awful lot
while so many of their industry and there will be (Continued on page 22)
competitors went out of
Page 22
Preston Athey
(Continued from page 21) or foreign bonds, then U.S. been absolutely clear and
of TV and radio stations equities are still reasonably deliberate about what he
were bought at very high attractive but may or may intends to do. Until we get
prices over the last 10 not be the first choice. to a 6.5% or lower
years, so people who made unemployment rate and
those investments are not G&D: How much cash do until we get to inflation well
getting a good return on you hold currently? north of 3%, I think he's
Pictured: 2013 CSIMA
their investment. I probably going to keep very loose
Conference
would not invest in any PA: Typically I will not go money. Someday, it will be
newspaper company today, below 3% cash. That's really a problem, but that's not a
and I would only invest in a an amount that I feel I need problem today, and I'm not
radio or TV company if I in case we have a very bad necessarily preparing for it.
found that it was really market and I get I just want to be alert to it.
cheap, and if management redemptions. I would One of the interesting
understood the need to prefer not to have to sell things people say is that
generate cash to pay a some of my key holdings when interest rates go up, it
dividend or buy back stock, down 25% just to meet the is bad for stocks. If you
and not spend cash buying needs of shareholders who look at all of the economic
other stations because the decide to get out. cycles since World War II in
return on capital would be Fortunately though, the the U.S., you'll find that on
pretty low. Small-Cap Value Fund has a average, four to six
very loyal group of tightening rounds on Fed
G&D: How would you rate shareholders that do not funds occur before it really
the attractiveness of the whip us around. We don't begins to affect the stock
equity markets generally attract hot money, so it's market. In fact, early on it's
today? also less likely to mean that a good sign because it
they're going to get out means the economy is doing
PA: They're certainly less quickly. well and profits are good.
attractive than they were While price-to-earnings
four years ago. In March Typically I won't have more multiples might stall out or
2009, in hindsight one could than 10% cash at the top. even begin to come down,
say that was a once in every That’s a function of finding corporate earnings are
10 years kind of a valuation fewer stocks to buy when doing very well. Stocks still
that you had available. We the market is high. It's also continue to go up even as
all know that if you had had more likely to happen if we the Fed starts to tighten.
the guts to buy at that time, have a surge in takeovers. It's only when we are well
you'd have made very, very So my cash percentage into the second or third
handsome returns on a generally ranges between year of the tightening cycle
diversified portfolio of U.S. 3% and 10%. Today, I'm that it begins to have an
equities. Having said that, I somewhere a little below impact on the economy.
think the stock market is the midpoint of that range. We haven't even started to
fairly valued today on its tighten yet, so I think we're
own right, but I think the G&D: Are you concerned still many months away
bond market is overpriced. about the Fed eventually before I even get the least
If the choice is to put turning off the spigot and, if bit concerned on that score.
money in cash, bonds, or so, how are you preparing
stocks, I think stocks are for that eventuality? G&D: Next year, you will
clearly the best investment be transitioning your
in that group. If you expand PA: I'm not worried about portfolio management
it to other things that the Fed turning off the duties to David Wagner.
particularly large institutions spigot any time soon What advice will you give
can invest in such as direct because Mr. Bernanke has (Continued on page 23)
real estate, private equity,
Volume
Issue I, Issue 2
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Preston Athey
(Continued from page 22) to have the highest a job that they hate. They
him? paycheck. Do not ask themselves, is this
automatically assume that something I want to do the
PA: David is going to be a some glamorous job that rest of my life? The
worthy successor. He's a requires 80 hours a week answer's going to be no.
very good investor today will be all worth it three Two or three years later,
and very experienced. He's they move onto something
been with us for 13 years. else and maybe they've
My advice to him will be to gotten some good
follow his instincts, know experience, but it's really
what he's good at, and be made them cynical. I
his own person. If he encourage students to think
figures out what he's good more broadly about what it
at, then I'm not worried is that you really want to
about it at all. “As you think about do in life and begin to point
toward that and recognize
G&D: Are you going to a career, think in a that a balance between
miss managing the portfolio? work and personal life is
mature, long-term really important.
PA: Yes, but there's a time
and a season for everything fashion about what
As far as going into the
in our lives, and it'll be time you really want to investments business, the
for me to step down from one thing I would say is
managing institutional do in life, and whether you want to be on
portfolios. I'm perfectly at the sell side or the buy side,
peace with that decision. especially for the whether you want to work
It's time to turn it over to for a long-only shop or
the next generation. I've next 15 or 20 years. prefer greater flexibility
had a wonderful run, I love with a hedge fund, that's
the business, I love what I Do not accept the
really a personal choice and
do, but it's not right for me first job that comes some people have
to block the next personalities that are more
generation. along that seems to fitted for one over the
other. Before you sign up,
G&D: What advice would have the highest understand the stresses and
you give to students risks involved in each job.
interested in a career in paycheck.” Really check out the firm
investing? you're going with. How
have they treated the
PA: I love that question employees that they've
and we could go on for hired? What's the average
hours talking about it. This tenure? If it's 18 months,
is something I would say to what makes you think
all business students, not you're going to be any
just those interested in years later. I've seen too different?
investing. As you think many examples of people
about a career, think in a who get into those jobs and G&D: Thank you very
mature, long-term fashion frankly regret it. They have much for your time, Mr.
about what you really want no life, they can't keep up Athey.
to do in life, and especially with their friends, and after
for the next 15 or 20 years. a while, they're wondering
Do not accept the first job why are they slaving away at
that comes along that seems
Page 24
Li Lu
(Continued from page 1) money.” I wasn’t sure what through right out of the
G&D: How did your it was all about. I just re- gate. And I thought this
unique experience as a member thinking that there fellow was just so intelligent
Tiananmen Square protest was a “buffet” involved. So I – he could put very com-
leader lead you to where assumed that it was some plex ideas into such simple
you are today, running kind of talk with a free terms. I was immediately
Himalaya Capital? lunch! I said it was a good drawn to value investing. By
combination – a free lunch the time the lecture was
Li Lu (LL): When I first plus a talk about how to over, I thought that this was
came to Columbia Universi- make money. So I went. what I was looking for; I
ty, I was dirt poor. I did not To my dismay there was no could do this.
choose to come here – I
Li Lu just ended up here because I At the time, I couldn’t really
had nowhere else to go, start companies, and I didn’t
having just escaped from want to work in a big com-
China after Tiananmen. I pany because of the differ-
was in a new country where “There are few ences in language and cul-
I didn’t understand the lan- ture. Investing, on the oth-
guage, didn’t know anybody, people that switch in
er hand, sounded like it re-
and didn’t have a penny to between or get it quired a lot of reading and
my name. So I was desper- mathematics, hard work,
ate and afraid. In retro- [value investing] and good judgment – I was
spect, that is good inspira- confident that I could do
tion for trying to figure out gradually. They those things well. And the
how to make money! I just fundamental principles of
wanted to know how to either get it right value investing appealed to
survive. me – buy good securities at
away or they don’t
a bargain price. If you’re
For the first couple of years, get it at all. I never wrong, you won’t lose a lot,
I really struggled with the but if you’re right you’re
language, but I eventually really tried anything going to make a lot. It fit
became much more com- my personality and temper-
fortable. I always had this else. The first time I ament very well. Warren
fear in the back of my mind used to say, “Value investing
of how I was going to make heard it, it just made is like an inoculation – ei-
a living here. I didn’t even ther it takes or it doesn’t.”
think about success at the sense; and I heard it
I totally agree with him.
time – I just wanted to pay from the best.” There are few people that
my bills. I grew up in Com- switch in between or get it
munist China and never had gradually. They either get it
much money to my name, right away or they don’t get
and then all of a sudden I it at all. I never really tried
had giant student loans. So lunch. [laughs] There was anything else. The first time
naturally I tried to make a just a guy with the name I heard it, it just made
buck or two. “Buffett.” sense; and I heard it from
the best. I guess it turned
One day, about two years Mr. Buffett really made a lot out better than a free lunch.
after I arrived, a friend of of sense during that talk. It
mine who knew my issues was like a punch in my eyes. G&D: How did your in-
said, “If you really want to It was like I had just woken vesting process develop
make money you have to up and a light had switched differently from Buffett’s?
listen to this fellow. He on. His honesty came (Continued on page 25)
truly knows how to make
Volume
Issue I, Issue 2
XVIII Page 25
Li Lu
(Continued from page 24) against the best counterar- LL: Oh, there are so many.
LL: Part of the game of gument of the smartest op- We share a fundamental
investing is to come into ponent.” He is right about ethos about life and about
your own. You must find that. approaching investing. So I
some way that perfectly fits learn more about how to
your personality because Investing is about predicting conduct myself personally as
there is some element of a the future, and the future is much, if not more, than
zero sum game in investing. inherently unpredictable. investing.
If you buy, somebody else Therefore the only way you
has to sell. And when you “There is some
can do it better is to assess G&D: How would you
sell, somebody has to buy. all the facts and truly know define your circle of compe- element of a zero
You can’t both be right. what you know and know tence?
You really want to be sure what you don’t know. sum game in
that you are better in- That’s your probability edge. LL: I let my own personal
formed and better reasoned Nothing is 100%, but if you interests define my circle of investing. If you
than the person on the oth- always swing when you have competence. Obviously I
er side of the trade. It is a an overwhelmingly better know something about Chi-
buy, somebody else
competitive game, so you’re edge, then over time, you na, Asia, and America –
going to run into a lot of has to sell. And
will do very well. those are things that I am
very intelligent, hardworking really familiar with. I have when you sell,
fellows. G&D: How did you be- also over the years expand-
come friends with Charlie ed my horizon [in terms of somebody has to
The only way to gain an Munger? Do you have a analyzing businesses].
edge is through long and friendship with Warren Buf- buy. You can’t both
hard work. Do what you fett as well? I started out looking for
love to do, so you just natu- cheap securities. When you
be right. You really
rally do it or think about it LL: Charlie and I have start out, you really have no
all the time, even if you are want to be sure
some very close mutual choice. You don’t have
relaxing, and even if you’re friends. Over time, we enough experience, and you that you are better
just walking in the park. started talking about busi- don’t want to lose money,
Over time, you can accumu- nesses, and then it evolved so what do you do? You informed and better
late a huge advantage if it into a strong bond. I view end up buying dirt-cheap
comes naturally to you like him as a mentor, teacher, securities. But over time, if reasoned than the
this. The ones who really partner, and friend, all in you are interested in busi-
figure out their own style one. I am also friendly with nesses in addition to securi-
person on the other
and stick to it and let their Warren, but not nearly as ties, you begin to become a
natural temperament take side of the trade.”
close as with Charlie be- student of businesses.
over will have a big ad- cause Warren is in Omaha.
vantage. I admire him, and I learn Eventually, one thing leads
more about him from his to another and you begin to
The game of investing is a writings and deeds than learn different businesses.
process of discovering: who through interpersonal inter- You learn the DNAs of
you are, what you’re interactions. I have a lot of in- businesses, how they pro-
ested in, what you’re good teraction with Charlie, so I gress, and why they are so
at, what you love to do, know him both as person strong. Over time, I really
then magnifying that until and through his writing and fell in love with strong busi-
you gain a sizable edge over personal deeds. nesses. I morphed into find-
all the other people. When ing strong businesses at bar-
do you know you are really G&D: Do you have a fa- gain prices. I still have a
better? Charlie Munger al- vorite Charlie Munger streak in me that favors
ways said, “I would not feel quote? finding really cheap securi-
entitled to a view unless I (Continued on page 26)
could successfully argue
Page 26
Li Lu
(Continued from page 25) the people who bought the ty. We learned quickly that
ties – I just can’t help it! business from us. we couldn’t really compete
But over time, I’ve become with Bloomberg.
more attracted to looking I like win-win situations. I
for great businesses that are do not complain about sell- G&D: You don’t short
inherently superior, more ing Capital IQ too early. stocks at Himalaya, correct?
competitive, easier to pre- We made a lot of money on
dict, and with strong man- that investment, and we LL: That’s right; not any
“The only way to agement teams. I’m just not contributed a great deal. I more. That change oc-
quite satisfied with the sec- remain friends with the curred nine years ago.
gain an edge is ondary market. As I said, founders. That aspect gave Shorting was one of the
there is an aspect of the me enormous pleasure. But worst mistakes I’ve made.
through long and securities business that is the venture side is hard to
hard work. Do zero-sum. And that’s the scale; you must put in a lot G&D: Is your lack of a
area in which I don’t feel of effort. So, over time, I short book due to your
what you love to entirely comfortable. I’m gradually moved into helping desire to be a constructive
more interested, by my na- in a different way. Even in third-party for companies
do, so you just ture, in win-win situations. public securities, you can and their management
still be very helpful and con- teams?
naturally do it or I want to create wealth to- structive. So, that’s who I
gether with the business am. I’m still learning, and LL: Yes. But also, you can
think about it all operators and employees I’m still interested. I’m still be 100% right, and you
the time, even if when I invest. So that led young, and still incredibly could still bankrupt yourself.
me to venture businesses. I curious. So, who knows? That aspect of shorting just
you are try to apply the principles of Hopefully, I will continue to frustrated me too much!
intelligent investing there, gradually expand my circle [laughs]
relaxing...Over but I actually can contribute of competence.
quite a bit, so it becomes a Three things about shorting
time, you can win-win situation. G&D: How were you able make it a miserable busi-
accumulate a huge to figure out that Capital IQ ness. On the long side, you
Over my career, I’ve had would become so success- have 100% downside but
advantage if it the satisfaction of building a ful? unlimited upside. On the
number of different venture short side, you have 100%
comes naturally to businesses. Some of them LL: In the beginning it was upside and unlimited down-
became enormously suc- Bloomberg. We wanted to side. I do not like that
you like this.” cessful, even after we sold create something just like math. Second, the best
them. You could say we Bloomberg, and in the pro- short has some element of
sold them too early! I was cess, we grew to appreciate fraud. However, a fraud can
the first investor in Capital Bloomberg much more be- be perpetrated for a long
IQ, and then look at what cause it was so hard to time. Of course you bor-
happened. If we would have compete with them. Then row to short, so they could
kept it, we would have been we realized the investment really just wear you down.
far richer! It’s not like we banking side was not fully That’s why I could be 100%
didn’t make a lot of money penetrated. right and bankrupt at the
in that investment. We did. same time. But, you know
[laughs] But I like it that So we basically applied what what, you go bankrupt first!
way. I like to create some- we learned about Bloom- Lastly, it screws up your
thing that everybody finds berg and created a similar mind. Shorts just grab your
useful. We created employ- product for the investment mind and take away from
ment, and we created a banking side. Over time, we the concentrated effort that
beautiful product that’s sus- also penetrated different is required to do proper
tainable, and everybody businesses like private equi- (Continued on page 27)
made a lot of money, even
Volume
Issue I, Issue 2
XVIII Page 27
Li Lu
(Continued from page 26) bunch of different problems. feel comfortable with. They
long investing. So, those are So you have to admit the have that $11 billion invest-
the three reasons why I just record is impressive. They ment in IBM, which, I can
stay away from shorting. also happen to be in the argue, is a technology com-
right industry and the right pany. But I can guarantee
It was a mistake on my part. environment, and they get that’s not how they think
I shorted for a couple of the right support from the about things. It has nothing
years. I don’t discard peo- Pictured: Christopher Davis
government. Their engi- to do with whether it’s a of Davis Advisors at the
ple who are really doing neering culture consistently technology stock or not. 2013 CSIMA Conference.
well at shorting – it’s just demonstrates its ability to
not me. If I want to add a tackle big, difficult problems. G&D: Buffett admitted in a
fourth reason, it is that the It works. So it’s hard not to 2009 Fortune article that he
economy overall has been be impressed by the record doesn’t really understand
really growing at a com- the guy has. At the time we BYD.
pounding rate for 200-300 invested, we had quite a bit
years, ever since the mod- of a margin of safety. LL: That is true. Warren
ern science technology era. and Charlie have a great
So, naturally, the economic partnership and Charlie
trend favors long positions knows more about BYD
rather than short. than Warren. But I would
not bet against the collec-
But you cannot live life tive track record of those
without making a mistake. “...you cannot live two. It’s not that they don’t
Every time I make a mistake make errors from time to
I learn something. life without making
time. Everybody is capable
a mistake. Every of doing that. They have a
G&D: How were you able few, but very, very few over
to get Charlie Munger inter- time I make a a long investment career.
ested in a company like
BYD [a Chinese company mistake I learn G&D: Do you see the
which manufactures electric quality of BYD cars improv-
cars, batteries, electronics something.” ing?
and solar equipment] given
that Berkshire Hathaway LL: This company is a
typically shies away from learning machine. Think
technology-oriented compa- about it – they really didn’t
nies? get into industry until 10
years ago. They didn’t pro-
LL: I don’t think that War- They play in a big field with duce their first car until
ren and Charlie are ideolog- open-ended possibilities and eight years ago. They are in
ical. Neither am I. It’s real- have a reasonable chance of a market where every single
ly how much you know. being successful. As I said, international major brand is
The story of BYD is rela- nothing is a sure thing, but competing, with an all-out
tively simple. This guy, who this strikes me as having as effort, because it’s such a
is a really terrific engineer, good of a chance as any. big market. So they never
started the business from Charlie was equally im- had any home advantage
just a $300,000 loan with no pressed by the company, whatsoever because China’s
additional money until the which then led to the in- auto market started out
IPO. He created a company vestment. Berkshire is not completely open with every-
with $8 billion in revenue ideologically against technol- body competing. Yet
and 170,000 employees and ogy stocks. They’re just there’s a little car company
tens of thousands of engi- against anything they don’t (Continued on page 28)
neers. He solved a whole
Page 28
Li Lu
(Continued from page 27) tomers, suppliers, and man- LL: Well, management
with very little money, and, agement? always has a big influence on
in less than 10 years, it’s your success, no matter
selling more than half a mil- LL: All of them. I don’t how good or how bad the
lion cars a year and has talk to as many investors – business is itself. Manage-
carved out a position for very few. I am more inter- ment is always part of the
itself. You have to say, the ested in talking to people equation of making the
record is not too bad, and who are actually running company successful, so the
so there’s something to it. businesses and entrepre- quality of management al-
They also have an engineer- neurs or CEOs or just good ways matters. But to assess
ing culture and a can-do businessmen. I read all of that quality is not that easy.
spirit. They consistently the major newspaper publi- If you can’t assess the quali-
demonstrate that they’re ty of management, you may
able to tackle really com- have to make a decision in
plex engineering problems spite of that. That’s just
and come up with very part of the process. So you
practical solutions faster, “You can recognize have to figure out other
cheaper, and better than ways such as looking at the
most other people. That is good ideas by quality of the business, the
an advantage in the manu- valuation, or something else
facturing economy. reading a great deal until you can justify an in-
vestment.
G&D: Can you talk about and also by studying
your investment process? If you do have a way to as-
a lot of companies
sess the quality of the man-
LL: Ideas come to me from and constantly agement team, either be-
all sources, principally from cause you’re an astute stu-
reading and talking. I don’t learning from dent of human psychology,
discriminate how they or you have a special rela-
come, as long as they are intelligent people – tionship with the people,
good ideas. You can recog- then you’ll take that into
nize good ideas by reading a hopefully more
consideration. Why would-
great deal and also by study- n’t you? The management
ing a lot of companies and
intelligent than you
team is part of what really
constantly learning from are, especially in makes a company.
intelligent people – hopeful-
ly more intelligent than you their field.” But, it’s not that easy. It’s
are, especially in their field. not that easy to have an in-
I try to read as much as I depth, solid understanding
can. I study all of the inter- of the management team.
esting and great companies, Very few people are able to
and I talk to a lot of intelli- cations and annual reports do that. I admire people
gent people. You know of the leading companies. I that say, "Hey, look. What-
what? In some of those get a lot of ideas out of ever the information, what-
readings or conversations, those too. ever the kind of presenta-
ideas just click. Then you tion they make, I will never
do more research and then G&D: How do you assess be able to learn about man-
you get comfortable or you if the management is being agement beyond that. I
don’t get comfortable. forthright with you? How know it’s a show for me, so
useful is it to speak with the I might as well just discard
G&D: Are the people that management? it." I respect that.
you talk to fellow investors (Continued on page 29)
or are they people like cus-
Volume
Issue I, Issue 2
XVIII Page 29
Li Lu
(Continued from page 28) tunity cost. That’s my goal, and there-
fore the compensation
Investing is about intellectu- G&D: Is your fund open to structure of the fund re-
al honesty. You want to new investors? flects that. Over time, I
know what you know. You switched into the best com-
want to know, mostly, what LL: The fund has been pensation structure I knew
you don’t know. If under- closed to new investors for in the industry, the original
standing the management nine years. However, we “Buffett partnership formu-
team is not in the cards, it’s will open it up a bit this la”. We don’t take any
not in the cards. year. We have more op- management fee. We pro-
portunities than we have vide a 6% return for free to
G&D: What is your do- money around, but that’s our investors and then take
mestic versus international 25% after that. I don’t in-
allocation? vest anything outside of the
“That way we’re all fund. I put all of my invest-
LL: I don’t have a precon- ment capital into my funds.
ceived notion about alloca- So it’s a true partnership.
in the same game
tion. I let the opportunity There are very few conflicts
dictate where I end up. I together. … That between the general part-
just happen to have more ners and the limited part-
interest in Asia and the U.S., ethos is what makes ners.
so that’s where I end up. I
do not feel that interest in Charlie and Warren That way we’re all in the
Europe. I do not feel that in same game together. I have
Africa. But I approach it so special. They
zero incentive to take new
with an open mind. I want money for the sake of taking
believe in
to really find the best com- new money because I don’t
pany at the best price, run fundamentally take things off the top. The
by the best people and avail- minute that new money
able to me at the time I am earned success. arrives, it begins to com-
looking. Those don’t neces- pound 6% on an annual basis
sarily always meet, and it’s That’s why, despite against me, so I better be
OK. able to find something that
their enormous
is worthwhile and doing
You start out by holding better. When I make mon-
success, nobody
cash, and that is a pretty ey, I feel like I earn it, and
good opportunity cost, be- criticizes them very when my investors make
cause it doesn’t go down. money, they earn it. It is
So any time you find an in- much.” just a better way to struc-
vestment, it has to be an ture a business – you feel
improvement on an overall rare. I usually don’t want to that everybody’s success is
risk-adjusted basis. You increase our size. My ambi- deserved. That ethos is
may find some very interest- tion has never been to run what makes Charlie and
ing things, and now you’ve the largest fund. I never Warren so special. They
got a basket of a few inter- wanted to earn the most believe in fundamentally
esting securities plus cash. money out of a fund. I just earned success. That’s why,
That is a pretty good oppor- wanted to have, by the time despite their enormous suc-
tunity cost, and the next I finished my career, one of cess, nobody criticizes them
time you add another secu- the best track records on a very much. When you cre-
rity, it better make the risk-adjusted basis. ate the hundreds of billions
portfolio better than the If I achieve that, I will feel in wealth for everybody
existing one. You just con- very good about myself. (Continued on page 30)
stantly improve your oppor-
Page 30
Li Lu
(Continued from page 29) 10 years from now? panies are the ones that are
while taking a salary of capable of reinventing them-
$100,000 per year for more LL: Most businesses are selves and dealing with
than 40 years, it’s hard to subject to change if you stay change. Take the example
criticize them. with them long enough. of Intel. The whole business
There’s not a single business changes every 18 months.
G&D: Are there industries that I know of that will nev- Failure to change leads to
that you completely stay er change. That’s the fasci- quite a substantial disad-
away from? nating thing about business. vantage and yet they’re able
Successful businesses have to build their culture based
LL: I’m not ideologically some combination of things on that change.
opposed to anything. I am
against any ideology. Take Samsung – their early
[laughs] memory chip business de-
creased in price by 1% every
There are lots of things I “I think you want to
week, and yet they really
don’t know. I’ll be the first developed a culture that
one to admit. But it doesn’t
avoid wrong
precisely deals with that
mean that I’m not curious decisions as much change. So when they apply
from time to time. Maybe I the same culture to some-
know some aspect of the or more than you thing like a cell phone, they
story. That little aspect get ahead very quickly.
might even constitute the want to get it Now they’re outselling Ap-
investment. I don’t know. I ple. So culture really plays
don’t want to rule it out, approximately
an important role in those
but I can say that when you faster-changing environ-
present me an idea, I can
right. If you avoid
ments, enabling certain
quickly tell you whether it’s the wrong decisions, companies to always surge
a “no” within a few minutes. ahead of everybody else.
you’ll probably
There are basically three G&D: Do you need to
buckets that Charlie has. come out okay over understand the technology
“Yes”, “no”, or “too hard”. on an engineering level to
Most of the things fall in time.” have a good sense of the
"too hard." Some get a risk/reward?
quick “yes” or “no”, but if
it’s too hard, it’s too hard. LL: It certainly is a plus,
So you end up not doing a that enable them to adapt but not a must. If you were
lot. You end up really con- to changes better than any- really a great engineer in the
centrating on the ideas one else. In each situation, product the business is sell-
where you truly have the it’s slightly different. ing, obviously it’s a plus.
time and energy to fully But it’s certainly not a must
understand the situation Every company in today’s because no matter how
better than anybody. age is a technology company good you are at a certain
somehow, but the technolo- area, you’re not so good in
G&D: How to you get gy may not be on the cut- other areas. The pace of
comfortable with the risk/ ting edge, and may not play change is such that whatev-
reward of a high tech com- an important role in the er you are now specialized
pany like BYD that is under- success or failure of the in will become obsolete.
going pretty rapid techno- overall business. But that doesn’t disqualify
logical change? Do you you from making a judgment
think you have a good sense Successful technology com- (Continued on page 31)
of what BYD will look like
Volume
Issue I, Issue 2
XVIII Page 31
Li Lu
(Continued from page 30) that don’t appear to be very your sell decisions?
on how a company can de- stable actually turn out to
velop a culture to deal with be. LL: One should make sell
that. Successful companies decisions on one of three
are able to deal with change I think you want to avoid occasions. Number one, if
consistently by hiring the wrong decisions as much or you make a mistake, sell as
right people, building the more than you want to get fast as you can, even if it’s a
right culture, and staying it approximately right. If correct mistake. What do I Pictured: Mason Hawkins of
ahead of their competitors. you avoid the wrong deci- mean by a correct mistake? Southeastern Asset Manage-
That’s the aspect that really sions, you’ll probably come Investing is a probability ment at the 2013 CSIMA
makes them successful. And Conference.
game. Let’s say you go into
that’s kind of a predictable a situation with 90% confi-
aspect of businesses. dence that things will work
out one way and a 10%
There is always a certain “The most chance they work out an-
element that is unpredicta- other way, and that 10%
ble. And there is a certain
important thing in
event happens. You sell it.
element that is predictable. our business is Then there’s a mistake that
You want to have a little of your analysis is completely
both. But overall, I think intellectual honesty. wrong. You thought it was
you’re right. In a business 99% one way but it was
that is subject to rapid What I mean is four actually 99% the other way.
change, it is a lot more diffi- When you realize that, sell
cult to make a reliable fore- different things: as fast as you can. Hopeful-
cast. There is no question ly at not too much of a loss,
about that. But it doesn’t
know what you
but even if it is a loss it
mean an investor cannot know, know what doesn’t matter – you have
make a few predictions that to sell it.
could indicate that the odds you don’t know,
are in your favor. You want The second time you want
to play when you feel very know what you to sell is when the valuation
comfortable that the odds swings way too much to the
are in your favor. Many don’t have to know, other end of the extreme. I
times, that’s searching don’t sell a security because
among typically stable busi-
and realize that
it’s a little overvalued, but if
nesses where something has there is always a it is way overboard on the
changed all of a sudden. other side into euphoria,
possibility that ‘you then I will sell it. If you are
Take Eastman Kodak for right and hold a company
example. It used to be one don’t know that you for a long time, you have
of the best companies; it accumulated a large amount
invented photography. But don’t know.’” of unrealized gains. A big
look at where they are now. portion of those unrealized
Take Bell Labs and AT&T. gains act like borrowings
They used to really have all from the government inter-
the power. They had mo- out okay over time. But, I est free and legally. So
nopoly businesses. Where agree with you, it’s not easy when you sell that position,
are they now? Just a name. and it’s not precise or a you take all the leverage and
That is the nature of brutal science at all. Hopefully one you take a bunch of the
capitalism. It’s the nature of improves overtime. capital out, so your return
the business. Things that on equity has just become a
appear to be predictable G&D: How do you make (Continued on page 32)
and stable are not. Things
Page 32
Li Lu
(Continued from page 31) possibility that “you don’t the whole country could go
little less. know that you don’t know.” down!” Everyone was con-
Those four things are dis- stantly in crisis mode. All of
The third occasion when to tinctly different. In a crisis, the things come out that
sell is when you find some- things emerge that test you you don’t normally care
thing that is better. Essen- on all four categories. about and normally don’t
tially, a portfolio as I said is pay attention to. Normally
Pictured: Tom Russo of opportunity cost. Your job
Gardner Russo & Gardner
For example, during the you think, “Well, that has
as a portfolio manager is to nothing to do with my in-
and Timothy Hartch of
constantly improve on your vestment in this company.”
Brown Brothers Harriman
at the CSIMA Conference basket. You start with a Then all of the sudden, you
in February 2013. high bar. You want to in- “The most say, “Oh Jesus, it has every-
crease the bar higher and thing to do with my compa-
higher. You do that by con- important thing in ny.” Well, you are right or
stantly improving the oppor- you are wrong. That crisis
tunity costs; you find some- our business is
will put those questions to
thing better. Those are the intellectual the test.
three reasons that I would
sell. honesty. What I That’s why people freeze in
the midst of a crisis. People
G&D: In your 16 years mean is four freeze because they were
running Himalaya, you’ve not intellectually honest
experienced three major different things: before. They never quite
financial crises: the Asian distinguished certain issues
financial crisis of 1997, the know what you
or questions and put them
dot com bubble burst in know, know what into the appropriate basket.
2000, and the financial crisis If you make an overall judg-
of 2008. How have you you don’t know, ment, for example, of how
navigated these crises as a the U.S. is going to perform
fund manager, and what know what you over time through ups and
have you learned from downs, and you go into it
them? don’t have to knowing that there is a pos-
know, and realize sibility something much
LL: That’s an excellent worse could happen. Maybe
question. You know every it’s small, but when it hap-
that there is always
time that that happens, they pens, it happens. At that
always bill it as “once in a a possibility that time, the question becomes
century,” except these ma- “Is it an unknown un-
jor events happen every five “you don’t know known,” or do you know
years in my case. [laughs] that you don’t have to
What is interesting about that you don’t know? You absolutely will
crisis is that it puts your be asked that question.
intellectually honesty to the know.”
test. So the financial system
might be in trouble. Yes, a
The most important thing in Asian financial crisis, all of business needs financing, but
our business is intellectual the sudden the world was I suppose if life goes on, my
honesty. What I mean is saying, “how much debt do business will be there, how-
four different things: know these companies have?! Oh ever it will end up. So the
what you know, know what my goodness, they really question then becomes,
you don’t know, know what have that much of a depend- “Do I have to know how
you don’t have to know, and ence on debt! Oh my God, (Continued on page 33)
realize that there is always a
Volume
Issue I, Issue 2
XVIII Page 33
Li Lu
(Continued from page 32) force in our global market- China and the U.S. together
the financial system will sort places because of the sheer would make the Pacific Ba-
out its problems for me to size of it and the path that sin somewhat of an eco-
predict my business?” they’re on. nomic center the same way
That’s the question and that the Atlantic Ocean was
that’s the question that you China is on a historic path around Europe and the U.S.
want to answer before a of continuing to grow into a A lot of opportunity will
financial crisis hits. modern economy. They emerge. That doesn’t mean
that it’s a one-way street or
If you can answer that ques- a smooth pass. All sorts of
tion honestly and correctly, things could happen. It
you will do more after the doesn’t mean you’re going
financial crisis. Christopher “China is so big. It to make money guaranteed.
Davis’s grandfather used to But it does offer a tremen-
say that you make the most has all sorts of
dous amount of opportunity
money out of a bear market to those who can navigate
financial panic – you just
extreme
this development. The im-
don’t know it at the time. phenomena. Yes, portance of China cannot be
It’s always the case. Less ignored.
intelligent investors will be there are ghost
sorted out. Intelligent in- G&D: Do you have any
vestors are the ones who towns, but there concerns on a real estate
are always intellectually bubble in China? We saw a
honest. They can distinctly are also towns that
60 Minutes piece about the
know whether they know ghost cities in China, and it
or they don’t know, and
are utterly, utterly
was very striking.
know what they don’t have crowded … China
to know, and that there China is so big. It has all
exist unknown unknowns. is a case of sorts of extreme phenome-
If you can really put things na. Yes, there are ghost
into those categories cor- contradiction, as it towns, but there are also
rectly, you will pass the test. towns that are utterly, ut-
Otherwise, you will have has always been,
terly crowded. I mean, eve-
gotten yourself in trouble. ry space is occupied, and
and will always be;
there are towns seemingly
G&D: In 2010 panel at you’ll always find out of nowhere that have an
Columbia Business School, enormous number of high
you mentioned that Asia’s evidence of every rises that are all occupied. I
role in the global financial remember, twenty years
system is becoming increas- theory you want to ago that Pudong was viewed
ingly important. Can you as a semi-ghost town. To-
talk about this view for our prove.”
day, you cannot help but be
readers? impressed by the economic
vibrancy there.
LL: Asia will become an
important economic force, still have a long way to go, We live in Manhattan, but
not necessarily just in a fi- but they have come a long think about it: there are
nancial sense. The financial way from the starting point. 10,000 high rises in Shanghai
part is a derivative of Asia’s Because of the enormity of that are taller than thirty
overall economic perfor- the size of China, it will have floors, multiple times that of
mance. Asia, and particular- a huge impact in Asia and Manhattan – that is enor-
ly China, is shaping up to the rest of the world. So (Continued on page 34)
become a bigger economic
Page 34
Li Lu
(Continued from page 33) things to worry me. energy is the next big revo-
mous. Manhattan probably lution. You’ve done a lot of
has the highest concentra- G&D: How do you view work on battery technology
tion of high rises in the the overall attractiveness of and BYD, so is that some-
whole world other than equities today? thing that you think about
Shanghai. The scary part is beyond batteries? What do
that China’s not done. So, I LL: I also put that into "too you think the energy revolu-
say China is a case of con- hard" and "I know I don’t tion will look like?
tradiction, as it has always have to know." I only think
been, and will always be; LL: I pay attention to those
you’ll always find evidence macro trends only in the
of every theory you want to hope that I can have com-
prove. fort that they’re a tailwind
as opposed to a headwind.
But overall, the economy Now, how much they can
still has a long way to go. “I pay attention to
help if they’re a tailwind, or
They still have a sense that those macro trends how much they can hurt if
this is their time. It doesn’t they’re in my face, I don’t
mean that they don’t have only in the hope know. But I want such mac-
problems; they have an ro trends to be behind me
enormous amount of prob- that I can have rather than in front of me.
lems, but so does America, So that’s the extent that I
and so did America over the comfort that want to know mega trends.
last 200 years.
they’re a tailwind as
But as a concerned citizen,
If you go through the Amer- opposed to a I’m intellectually curious
ican Civil War, the country about it. But it doesn’t
killed two percent of its headwind. Now, mean that I’ll be able to
population. And yet, not know for sure how a given
only was it rebuilt, but it how much they can development is going to
was rebuilt at a furious pace. come about. In fact, we
And it went through two help if they’re a don’t know, and that’s why
great world wars. After the free market with mil-
World War II, if you tailwind, or how
lions of participants acting in
thought Japan and Germany much they can hurt their own self interests will
were doomed, boy were figure out a way. To predict
you wrong. if they’re in my ahead of time is not easy,
and the good thing is that
G&D: Do you think real face, I don’t know.” you don’t have to be able to
estate has gotten a little do that.
ahead of itself where there
would be a need for a cor- If such trends are at your
rection, or do you think back, that’s fabulous, espe-
that demand will just catch about it when things go to cially if you don’t need them
up? an extreme. I don’t foresee to be at your back. If
that as going to the ex- they’re really a headwind,
LL: I put that in the "too treme, either way. In that you do want to examine
hard” basket. I also put in case, I know I don’t have to them a little more. So that
the basket of "I know I don’t know. is how I view this renewable
have to know." It certainly energy issue. I know that at
is “I don’t know”, but I also G&D: A lot of smart peo- some point, human civiliza-
know that I don’t have to ple believe that renewable (Continued on page 35)
know! I don’t want those
Volume
Issue I, Issue 2
XVIII Page 35
Li Lu
(Continued from page 34) gone through the discipline finances, how management
tion will have to find some- of understanding one busi- makes its decisions, how it
thing other than fossil fuels. ness as if you own 100% of compares to the competi-
We don’t have enough fossil that business is very valuation, how it adjusts to the
fuels, and we need to pre- ble. environment, how it invests
serve them for agricultural extra cash, and how it fi-
and food security reasons. To start, take an easy-to- nances the business.
We also can’t afford to have understand business. It
the weather deteriorating could be a tiny business – a You should understand eve-
the way it has been over the ry aspect of one business as
last few decades. Eventually if you own 100% but you
it will catch up to us. don’t actually run it. This
“Start learning from
causes you to be desperate
So for multiple reasons I the best — to understand every aspect
understand why we need to to protect your investment.
figure out alternatives to listening, studying That will give you a sense of
fossil fuels. But am I quali- a disciplined approach.
fied to make an informed and reading. But That’s how you truly under-
investment decision based stand business and investing.
on that now? Probably not. the most important Warren always says that to
But if that one happened to be a good investor, you
be at my back, hey I’m all thing in
need to be a good business-
for it. understanding the man, and to be a good busi-
nessman, you need to be a
G&D: Do you have any investment business good investor in terms of
advice for students who are capital allocation.
interested in getting into is by doing it.
investment management, Start by understanding one
especially for those readers There is no thing within your control
who can’t go and listen to that you can understand
Warren Buffett speak during substitute for
inside and out. That is a
their lunch break? actually doing it. terrific starting point. If you
start from that basis, you
LL: If you do get a chance The best way to do are fundamentally in the
to meet Mr. Buffett, I’d run right direction of becoming
to it if I were you. I would- it is to study one a great security analyst.
n’t even take an airplane; I
would just run to Omaha! business inside and G&D: It was a pleasure
[laughs] speaking with you, Mr. Li.
out for the purpose
Start by learning from the of making the
best – listening, studying,
and reading. But the most investment.”
important thing in under-
standing the investment
business is by doing it. little concession store, a
There is no substitute to restaurant, or a small public-
actually doing it. The best ly traded company. It
way to do it is to study one doesn’t matter. Understand
business inside and out for one business and what really
the purpose of making the makes it tick: how it makes
investment – you may not money, how it organizes its
actually invest. But having
Page 36
Hertz Global Holdings, Inc. (NYSE: HTZ) - Long

Winner — 2013 Pershing Square Challenge
Richard Hunt Stephen Lieu Rahul Raymoulik
rhunt14@gsb.columbia.edu slieu14@gsb.columbia.edu rraymoulik14@gsb.columbia.edu
Recommendation
As of 4/19/13; in USD m except per share data
Richard Hunt We recommend investors buy Hertz stock with a 12-month target Current Capitalization
share price of $36, which represents ~52% upside to the current Stock Price $23.72
Richard is a first-year MBA share price. There are four main points to our investment thesis: Diluted Shares Outstanding (M) 462.0
student at Columbia Business Market Cap $10,959
1) The market significantly underestimates the impact of Hertz's
School. Richard is Co-President
recent merger with Dollar Thrifty, which marks the completion Corporate Debt 6,545
of the Columbia Student
of a ten-year industry consolidation that dramatically improves Cash (1,105)
Investment Management
the competitive dynamics of the industry Unfunded Pension Liability 227
Association. Prior to CBS,
2) The market underestimates the levers Hertz can pull to coun- Enterprise Value $16,626
Richard was a Senior Financial
Analyst at New Constructs. ter the negative impact of falling used car prices
Trading Statistics
3) Hertz has strong growth opportunities in the U.S. and will 52-Week Range $10.22-$24.28
realize significant revenue and cost synergies through its acqui- Dividend Yield 0.0%
sition of Dollar Thrifty Avg. Daily Volume (M) 7.7
4) A divestiture of the non-core Equipment Rental segment would Short Interest as % of Float 11.0%
unlock substantial value by deleveraging the balance sheet
Summary Valuation
2013e 2014e
Hertz operates two main segments: car rental and equipment rental. EV / Revenue 1.5x 1.4x
Car rental is the company’s core business – it operates over 10,000 EV / EBITDA 7.4x 6.4x
Stephen Lieu locations worldwide and generated $7.6 billion in revenue last year. P / E 12.5x 9.9x
The equipment rental segment rents out industrial, construction, and
Stephen is a first-year MBA material handling equipment. It generated $1.4 billion in revenue last year.
student at Columbia Business
School. Stephen is Co-President Investment Thesis
of the Columbia Student 1) The market underestimates the industry consolidation’s impact on car rental pricing
Association. Prior to CBS, Ten years ago, there were six major rental car companies.
100%
Stephen worked for four years Since then, there have been a number of acquisitions: Avis
acquired Budget in 2002, Enterprise acquired National Alamo 90%
in investment banking and
private equity. in 2007, Hertz acquired Advantage in 2009, and in the past six 80%
months, Avis acquired Zipcar and Hertz acquired Dollar 70%
Thrifty. This marks the completion of an industry consolida-
tion with the three remaining players controlling 95% of the 60%
market. We believe this oligopoly structure dramatically 50%
improves the competitive dynamics and profitability of the 40%
industry, as the three players can now focus on profitability
30%
instead of market share.
20%
We’re seeing signs of this already playing out – prior to the 10%
closing of the Dollar Thrifty acquisition in November 2012,
Rahul Raymoulik Hertz had experienced nine consecutive quarters of pricing 0%
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
declines and Avis had experienced 11 consecutive quarters of
Rahul is a first-year MBA pricing declines. Since the acquisition closed, pricing has in-
student at Columbia Business creased every month. Enterprise Hertz
School. Prior to CBS, Rahul was Avis Dollar / Thrifty
a Sector Specialist at Fidelity We believe the market is significantly underestimating the National / Alamo Budget
Investments, focusing on the improved pricing environment that has resulted from the Other
technology, media, and telecom industry’s consolidation. Management’s EPS guidance assumes Strong Pricing Environment w/ Price Signaling
industries. 0% pricing growth. Sell-side consensus estimates assume only “One of the headlines I'd like to make is we don't want to
a 1% increase in pricing. Pricing is the single biggest driver of gain share by reducing price. We want to gain share by
our model, as a 1% price increase results in a 6% increase in increasing value, and that's how we're doing it.”
our target share price. – Hertz CEO in April 2013
Post the Dollar Thrifty acquisition, the pricing environment “We're seeing our competitors move for profitability, rather
has been very strong, with consistent price increases and than share, and that has a positive impact on all of us.”
cooperative matching among the three players. There has – Avis CFO in February 2013
also been blatant price signaling by Hertz and Avis. We be-
lieve this is the beginning of long-term rational behavior in the “We've been very aggressive in initiating price increases
U.S. car rental industry and management and the market’s over the last 4 months or so and I think that's had a
positive impact. And we've seen a fairly good matching of
assumptions on pricing are too conservative. increases by both Hertz and the Enterprise.”
– Avis CFO in March 2013
“We made a strategic decision to minimize our

participation with less profitable commercial accounts.”
– Hertz CEO in February 2013
Volume
Issue I, Issue 2
XVIII Page 37
Hertz Global Holdings (Continued from previous page)

2) The market underestimates the levers Hertz can pull to counter negative impact of falling used car prices
The market believes that Hertz’s used car residual values closely follow the Manheim Market Index, the most widely
followed index of used car prices. This is simply not true. Since January 2011, the Manheim Market Index is down 3%,
but Hertz’s residual values have actually increased by 10%. So how is this possible? It’s possible because of the dramatic
shift in how Hertz purchases and sells its fleet. In 2012 alone, the company reduced its purchase of program cars,
whose residual values are guaranteed by auto manufacturers, from 45% in 2011 to just 19%. Not only does the compa-
ny save about 1% on the purchase of these non-program cars, it can also realize substantially higher residual value selling
its cars via much more profitable channels, and can keep cars on rent for longer.
For example, in 2009, the company sold 88% of its non-program cars at auction, the least profitable remarketing chan-
nel. In 2012, only 33% of the company's cars were sold at auction. So where are these cars going? Hertz sold 47% of
its cars directly to dealers, which netted them $500 more per vehicle than a comparable sale at auction. Hertz also sold
13% of its vehicles via retail, a channel that didn't exist four years ago, but today nets them an additional $1300 per
vehicle. We expect retail to triple by 2014.
These changes are possible because consumers and dealers are now willing to purchase cars online. Thanks to the
internet, local markets have been transformed to national markets, which makes it easier and more profitable for Hertz
to dispose of its fleet. We believe that the market does not appreciate the impact that these new channels have on
Hertz’s fleet cost. The market also misses the fact that declines in residual values affect all rental car companies equally,
so pricing can simply increase to offset the impact of falling used car prices.
3) Hertz has strong growth opportunities in the U.S. and will realize significant revenue and cost synergies
through Dollar Thrifty
There are substantial growth opportunities in the U.S. rental car market, as well as significant synergies from the Dollar
Thrifty acquisition. First, we expect Hertz to increase its profitable off-airport locations. In just six years, Hertz has
increased its off-airport locations by 60%, and we expect continued double-digit growth. Second, we expect double-
digit growth in the value segment, a segment that grew by 25% in 2012. Third, Hertz is significantly expanding its busi-
ness by using 24/7 Kiosks that allow the company to increase fleet utilization and operate in more areas in a cost-
effective manner. Lastly, we expect Hertz's entire fleet to have the 24/7 car sharing ability by 2014.
Also, as a result of the Dollar Thrifty acquisition, Hertz will realize $600 million in revenue and cost synergies over the
next three years. One of the largest areas of synergies is fleet sharing, because Hertz experiences peak demand on
weekdays while Dollar Thrifty experiences peak demand on weekends, and thus sharing fleet results in lower fleet costs
and higher utilization. As part of our primary research, we visited a couple of Hertz locations in Manhattan and found
that Hertz has already begun sharing fleet.
4) A divestiture of the non-core Equipment Rental segment would unlock substantial value
A divestiture of the non-core Equipment Rental segment (HERC) would provide shareholders with 20% incremental
upside to our base case. Divesting HERC would make sense for two main reasons. First, it allows management to
focus on the core and higher-return car rental business and the integration of Dollar Thrifty. Second, it would be highly
deleveraging for the company, pushing it closer to its goal of becoming investment grade, and leading to an immediate
EPS accretion of $0.14 to $0.19.
Based on our analysis, Hertz would maximize shareholder value by levering up HERC, using proceeds to pay down
corporate debt, and spinning off HERC in a manner that qualifies for tax-free treatment under IRS Section 355(e) “Safe
Harbor” rule. The EPS accretion plus additional value in the spun-off company would lead to a 20% incremental upside
Capital Allocation
($ millions except per share) Base Bear Bull Street
We project a steady increase in FCF
FY2014 Estimates
going forward with FCF yield reaching
Car Rental EBITDA $2,413 $1,828 $2,727 $2,143
14% by 2014. Management plans to Equipment Rental EBITDA 509 432 539 453
use the free cash flow to pay down Consolidated EBITDA $2,922 $2,261 $3,266 $2,596
debt and has stated that once it reach- EPS $2.87 $1.90 $3.39 $2.38
es its target leverage of 1.6x, it will
Target Forward Multiples
start returning cash to shareholders.
P/E 12.5x 11.0x 13.0x 12.5x
We believe Hertz will hit this mark
EV/EBITDA 7.4x 6.0x 8.0x 7.4x
within the next 18 months, at which SOTP: Car Rental 7.4x 6.0x 8.0x 7.4x
point shareholders will see significant SOTP: Equipment Rental 6.2x 5.0x 6.5x 6.2x
cash returns. Deploying one third of
Price per Share
FCF towards share repurchase would
P/E x EPS $35.93 $20.91 $44.06 $29.80
lead to incremental EPS accretion of
EV/EBITDA x EBITDA $36.73 $18.87 $46.90 $31.53
$0.13 or 6% EPS growth to our base
SOTP $35.41 $17.89 $45.16 $30.36
case estimate.
Target Price $36.00 $19.00 $45.00 $30.56
Valuation Upside (Downside) 52% (20%) 90% 29%
Using an average of three valuation
methodologies (P/E multiple, EV/ Key Assumptions
RPD CAGR (FY'12-'14) 2.5% (1.0%) 3.5% 0%-1%
EBITDA multiple, and SOTP analysis),
Manheim Index CAGR (FY'12-'14) (3.0%) (5.0%) (2.0%) (2%)-(4%)
we arrive at a target share price of $36
Chg. in Residual Value due to Channel Mix Shift $256 $0 $383 $125-$175
or ~52% upside to the current price.
Cost Synergies (FY2014) $250 $150 $300 $300
Page 38
Advance Auto Parts (NYSE: AAP) - Long

Finalist — 2013 Pershing Square Challenge
Joe Fleury John Gallagher, CFA Seth Kirner
jfleury14@gsb.columbia.edu jgallagher13@gsb.columbia.edu skirner14@gsb.columbia.edu
Recommendation: BUY
($ in millions except per share values)
CAPITAL STRUCTURE TTM FINANCIAL METRICS CURRENT PRICE TO 2015 ACTIVIST CASE STOCK PRICE
Current Share Price $ 80.00 Enterprise Value/EBITDAR 6.7x
Joe Fleury Avg. Daily Vol. (mm) 1.3 Enterprise Value/EBIT 12.0x $180
Cash YE 2015
Buildup/ Activist
Change in Stock
52 Week Low- High $61-$93 Price/Free Cash Flow 14.1x
$170 Share
Buyback
ND Price
Prior to CBS, Joe worked as an

$160 $6 $166
Short Interest 2% Price/Earnings 15.3x $150

Multiple
Expansion
$14
Shares - diluted 74.14 ROIC

analyst at Ionic Capital 23% $140
$19
2016 EBITDAR
SG&A
Market Cap $ 5,931 Free Cash Flow Yield 7.1% $130 Savings
Management, a multi-strategy (+) Debt 605

$120
Gross New
$22
$127
hedge fund in New York. Joe

$110 D&A
Margin
(-) Cash 598 $100
Store
SSS
$3
$2
$10
holds a BA in Economics from

1 Growth
(+) Capitalized Oper. Lease (6x) 1,922 COMPS 2011 2012 $90
Current
$10
Px
$80
Total Adj. Net Debt $ 1,929 SSS Growth 2.2% -0.8%
Yale University.
$80
$70
= Total Enterprise Value $ 7,860 Total Sales Growth 4.1% 0.6% Implied Fwd EBITDAR
Multiple
6.2x
$80 $137
7.0x
$167
Implied Fwd 13.0x Financial Impact 13.7x
(1) 6x lease capitalization is industry standard used by companies, credit agencies, and analysts P/E Multiple
Operational Impact
We recommend a long position in Advance Auto Parts (“AAP”) stock with a three year target price of ~$165.
AAP trades at a significant discount to its intrinsic value as well as its peers due to an inefficient cost structure as a
result of historical strategic decisions. Our target price represents a ~100% upside to the current share price of
$80, and is based on a 7x forward 2016E EV/EBITDAR multiple (13.6x forward 2016 P/E). We believe that AAP is
undervalued with an attractive margin of safety and that there are multiple ways to win with Advance Auto Parts.
With management’s current plan, a passive investor could achieve a three year IRR of 20%, resulting in 2015 stock
price of about $140. However an activist investor advocating necessary changes in operations could receive a
three year IRR of 28%, resulting in a stock price of approximately $165. In addition we believe there is a measure
John Gallagher of downside protection because AAP could likely be a takeover candidate if the price dropped below $70.
Prior to CBS, John worked with Key Investment Highlights

the TARP funds at the U.S. 1) Strong Barriers to Entry
Treasury Department. Before  Significant scale needed to compete on a national scale
TARP, he worked for the
Federal Reserve. John holds a  Economies of scale on sourcing allow AAP to finance majority of inventory on attractive terms
BS in Finance from George 2) Significant Free Cash Flow Generation
Mason University and is a U.S.  $400+mm in annual free cash flow; 7% 2012 free cash flow yield
Army veteran.  Inventory almost fully funded by trade
3) Attractive Growth Opportunities in Commercial
 The aftermarket auto-parts industry is highly fragmented
 Significant room for consolidation
 Growth opportunities in the commercial segment for larger competitors
4) Multiple Ways to Win
 Activist proposal
 Passive investment — recent signs of a turnaround
Seth Kirner  Merger or buyout
Prior to CBS, Seth worked in  Continued share buybacks
Restructuring at Loughlin Business Description
Management Partners. Prior to Advance Auto Parts is a leading specialty retailer of automotive aftermarket parts, accessories, batteries and
that he worked at Jennison maintenance items primarily operating within the United States. As of December 2012, AAP operated 3,794
Associates. Seth holds a BA in stores throughout 39 states, Puerto Rico and the Virgin Islands. AAP operates in two segments: Retail, or “Do-it-
Finance from Northeastern yourself” (62% of 2012 sales) and Commercial, or “Do-it-for-me” (38% of 2012 sales).
University.
Investment Thesis
We believe AAP is a great business with meaningful competitive advantages but has been mismanaged, primarily
due to underinvestment in its distribution network over the past 5 years. We believe this is the root cause of an
approximately 400 basis point EBITDAR differential to O’Reilly Auto Parts, AAP’s main competitor and only direct
comp (AutoZone is almost entirely a retail business). This margin gap results in AAP trading at a 6.2x forward
EBITDAR versus O’Reilly’s 9.0x, a premium of 50% to AAP. We propose that AAP invest $300mm over the next
three years to augment their distribution network, building 6 additional distribution centers. Investing in the dis-
tribution network has two positive effects: 1) increases AAP’s ability to raise prices in the commercial segment
and 2) decreases AAP’s distribution costs, as costly, rushed deliveries are reduced. We believe the combination of
the two will help narrow the 400 basis point EBITDAR gap that currently persists between AAP and O’Reilly and
also narrow the valuation gap.
Volume
Issue I, Issue 2
XVIII Page 39
Advance Auto Parts (Continued from previous page)

Investment Thesis Continued:
Increase Prices in Commercial Segment: Commercial customers we talked to stated that delivery speed and
reliability are the top factors when deciding who to use as a supplier. Currently AAP discounts its prices to compete
in the commercial segment to compensate for not having daily replenishment. As such, by improving service and
speed, AAP should be able to increase prices inline with peers without losing volume.
Decrease Distribution Costs in SG&A: The investment we propose in distribution centers would allow AAP to
reach a critical level of 2,000 sq. ft. of distribution center per retail store, which is the level that O’Reilly, the best in
class operator in the industry, cites as the necessary level to achieve daily part replenishment. Daily replenishment is
critical for best-in-class service in the commercial segment, but more than 90% of AAP stores are unable to re-stock
on a daily basis, and, as a result incur significant additional SG&A costs to procure and deliver parts that are stocked
out. As a result, AAP spends 300bps more, as a % of sales, in SG&A than O’Reilly does. We believe that our plan to
build 6 new distribution centers would allow AAP to meaningfully reduce its SG&A expenditure and close the gap
versus O’Reilly.
Management: The natural question is why hasn’t management implemented these changes in the past? Our analy-
sis suggests that 1) management did not previously have the expertise to build out a distribution network for a com-
mercial driven business and 2) management was not properly incentivized to do so. The current management team
comes from a retail background and was put in place in 2008 when AAP was largely a retail business. Since 2008,
AAP’s percentage of sales from commercial has risen from ~25% to ~40%. Management must shift its focus towards
providing the infrastructure necessary to run a commercial business.
“And there are certain things I do
Recent Positive Signs of Change / Near Term Catalysts: well, but to be honest, I didn't
1) On April 4, 2013, both the COO and SVP of Commercial Sales were fired. George Sherman, an executive who grow up in a field organization.
has experience at Best Buy, Home Depot and Target was hired to be President and lead the operational change And one of the changes here that
and commercial focus we're trying to affect in our senior
2) On March 7, 2013, AAP announced that they would implement a one-time bonus incentive to get operating leadership team is to add that
margins to 12% in three years (vs. ~10% currently) field customer execution…”
3) During 2012, AAP completed its first new distribution center in five years. This distribution center is the first Darren Jackson — CEO
one to offer daily replenishment
4) After halting share repurchases in 2012, Management stated that they will resume buying back shares at their
historic levels starting in 2013 “It’s the first distribution center
we’ve opened in many, many
These signs are positive and are indications that the Board is willing to make the necessary changes to make AAP years, the first DC that I’ve
more cost effective and increase shareholder value opened in the five years that I’ve
been here.”
Kevin Freeland — COO
Valuation: Our activist target price represents a ~100% upside in three years to the current share price of $80.
Our price target assumes a 7x forward EBITDAR multiple (currently 6.2x) and a 13.6x forward P/E (currently 13.0x),
We believe these are conservative assumptions on both a relative and absolute basis. On a relative basis, AAP’s best
comp, O’Reilly currently trades at 9.0x forward EBITDAR and 17.4x forward P/E. On an absolute basis, we think
AAP’s business justifies such multiples. Replacement auto-parts are not discretionary, AAP has significant barriers to
entry, produces strong free cash flow, has attractive unit economics and has strong pricing power over suppliers
(more than 85% of inventory is financed by trade).
Estimated Year End 2015 Valuation EBITDAR Bridge

($ in millions) 2012 2016 $ Impact Passive Active
Financials Current Passive Activist
Sales $ 6,205 $ 7,686 $ 7,908
Gross Profit 3,098 3,843 3,993 $2,000 2016
margin 49.9% 50.0% 50.5% SG&A Active
SG&A 2,441 2,933 2,860 Saving EBITDAR
% sales 39.3% 38.2% 36.2% $1,800
New
Gross $161 $1,803
Improvement vs. 2012 117bps 317bps 2016 D&A
SSS/ Margin
Passive Store
EBIT $ 657 $ 910 $ 1,134 SG&A
EBITDAR Growth
Pricing
2016 EBITDAR
margin 10.6% 11.8% 14.3% $1,600 Saving $40 $19

SSS/ $41
+ D&A 190 235 261 Store Pricing $90 $1,541 $1
Organic Growth
+ Rent 320 397 408 Store
$1,400 Acq. $102
EBITDAR $ 1,167 $ 1,541 $ 1,803 Growth
margin 18.8% 20.1% 22.8% 2012
$64
EBITDAR $118
1-yr Fwd EV/EBITDAR Multiple 6.7x 7.0x 7.0x $1,200
1-yr Fwd P/E Multiple 13.0x 14.4x 13.6x $1,167
Enterprise Value $ 7,860 $ 10,789 $ 12,620
Net Debt + Leases $ 1,929 $ 2,281 $ 2,339 $1,000
Stock Price $ 80.0 $ 138.3 $ 166.0 Implied Fwd 6.2X 7.0x 7.0x
EBITDAR Multiple
Current Stock Price $ 80.0 $ 80.0 $ 80.0
Total 3 Year Return n/a 72.9% 107.5% 2015 Stock Price $80 ~$140 ~$165
3 year IRR n/a 20.0% 27.6%
Key Investment Risks: (1) failure to execute commercial business focus; (2) O’Reilly competing for same geo-
graphic areas as AAP; (3) consumers shift more towards buying new cars and the age of vehicles on the road declines
significantly.
Page 40
Dollar Tree, Inc. (NASDAQ: DLTR) - Long

Jeremy Colvin Eric Lai Akhil Subramanian
jcolvin14@gsb.columbia.edu elai14@gsb.columbia.edu asubramanian14@gsb.columbia.edu
Recommendation: BUY
We recommend a BUY on Dollar Tree (DLTR) shares with a target price of $64.75. This target price represents
~40% upside to today’s price of $45.99, and is based on 19.3x forward P/E (consistent with last three year aver-
Jeremy Colvin age) as well as $4.90 from a leveraged recap.
Prior to joining CBS, Jeremy
served as an investment banking
Current Valuation Price Target DLTR Stock Price
associate and analyst in the
Stock Price $45.99 Stock Price $64.75 $60
Financial Sponsors Group at
Shares Out. (mm) 227.2 Shares Out. (mm) 227.2
Goldman Sachs. He holds a BA $55
Market Capitalization $10,449.2 Market Capitalization $14,712.2
from Columbia College. $50
Total Debt 271.3 Total Debt 1,500.0 $45
Total Cash 399.9 Total Cash 399.9
$40
TEV $10,320.6 TEV $15,812.3
$35
FY2014E EPS $3.10 FY2014E EPS $3.10
$30
Implied FY2014E P/E 14.8x Implied FY2014E P/E 20.9x Apr-12 Jul-12 Oct-12 Jan-13 Apr-13
Dollar Tree is a value-oriented chain of discount varie-
Eric Lai ty stores that sells every item for $1 or less. The Com- Customer Customer
Prior to joining CBS, Eric pany currently has 4,531 stores in 48 states in the U.S. finds great receives
served as a private equity and an additional 140 stores in Canada, with a total of deals at paycheck
associate at American 40.5 million selling square feet. In 2012, Dollar Tree
Securities. Prior to that, he was opened 345 new stores, expanded 87 others and
an investment banking analyst in closed 25, which led to an additional 2.9 million square
the Industrials Group at feet. The average store has ~8,100 selling square feet,
Deutsche Bank. He holds a BA which management believes to be the optimal size
operationally, giving customers a shopping environment Customer
from Yale University.
that invites them to shop longer but also return more wants to Customer
maximize shops at
often (thereby increasing customer traffic). Initiatives
bang for buck
the company has undertaken include debit and credit
card penetration and a continued roll-out of frozen and
refrigerated merchandise. The Company focuses on Customer
customers looking to spend the leftover change from has
their purchases at Wal-Mart or Target; and ideally it leftover
provides them with the best and biggest bargains in the change
industry.
Akhil Subramanian Investment Thesis
Prior to joining CBS, Akhil was

DLTR is unlike other dollar store competitors: DLTR is the only dollar store that sells substantially all of its
a consultant at Freakonomics
products at a $1 price point. This allows DLTR to be the pre-eminent treasure hunting store where customers
Consulting. Prior to that, he
can maximize their bang for buck. The Company also takes advantage of not having planograms to maximize its
was an investment banking
merchandising flexibility; this leads to industry-leading price markups. Despite close proximity to Wal-Mart (75%
analyst in the M&A Group at
of stores within 3 miles of WMT vs. 43% and 48% for DG and FDO respectively), DLTR enjoys the highest mar-
Credit Suisse. He holds a BS
gins among dollar stores. Said another way, DLTR is a fill-in store to Wal-Mart as opposed to a competitor; it
from University of Chicago.
can exist in a symbiotic relationship as shown in the chart above.
Market has runway of at least 10,000 more stores and DLTR has superior store opportunities: DLTR
(4,600 stores) sits well behind DG (>10,000) and FDO (~7,500). The U.S. currently has 64mm households making
<$50K annually (DLTR’s target customer base). There are currently 30K dollar stores, which represents ~2,100
household/store nationally. Some regions such as the Southeast (1,600 households/store) are fully penetrated
while other regions such as the West Coast (15,000 households/store) are under-penetrated. We estimate that at
1,600 households per store (nationally) the U.S. can support a market of ~40K stores, representing another 25%
of runway. DLTR enjoys first-mover advantage in the under-penetrated west coast as it has already established a
distribution center in California. This gives DLTR an advantage in the push toward market saturation.
Volume
Issue I, Issue 2
XVIII Page 41
Dollar Tree (Continued from previous page)

Convenient locations drive consumer traffic regardless of economic environment: The average DLTR cus-
tomer drives 15-20 minutes per visit, and DLTR stores are conveniently located close to Wal-Marts (75% stores within
3 miles). Since customers think about total dollar spend as opposed to dollar per unit DLTR provides customers a con-
venient shopping experience; the average ticket is only ~$8.
Industry leading unit economics and store returns: The average DLTR store costs less than $400K to start up
and enjoys a payback period of ~2.7 years. DLTR new store productivity has been ~87% with full-ramp by year three.
First-year stores typically operate at 11% EBIT, translating to post tax ROIC of 20%. Over the past five years, DLTR has
averaged an ROIC of 28% (vs. 21% and 9% for FDO and DG respectively).
The market is undervaluing DLTR: DLTR is superior in almost every single industry operating metric, notably
enjoying significant advantage on EBITDA margin and ROIC. However, DLTR is trading in-line with the industry average
and below DG. Over the last year, DLTR’s stock price has been down 4.6% (vs. up 10.4% for DG).
Retail Operating Metrics Returns (5yr. Avg.) Margins (5yr. Avg.)

Name Sales / Sq. Inventory SSS (5yr. Levered
ROA ROE ROIC GM EBITDA
Ft. Turns avg.) FCF
Dollar General $216 5.0x 6.8% 8.0% 13.8% 9.3% 31.2% 10.9% 3.2%
Family Dollar $181 4.8x 4.8% 11.7% 26.4% 21.0% 34.9% 8.9% 1.7%
Dollar Tree $182 4.9x 5.4% 17.6% 29.6% 28.3% 35.5% 13.4% 6.1%
TEV / NTM
Name Price Shares (MM) Mkt Cap Net debt TEV Div yield NTM P/E NTM EPS
EBITDA
Dollar General $49.85 327.2 $16,312 $2,632 $18,944 0.0% 8.9x 15.4x $3.28
Family Dollar $59.80 115.8 $6,925 $604 $7,529 1.8% 7.4x 14.8x $3.99
Average 0.9% 8.2x 15.1x
Dollar Tree $45.99 224.6 $10,329 ($129) $10,200 0.0% 8.3x 14.8x $3.10
DLTR has maintained profitability despite moving to lower margin consumables: From FY2005 to FY2013,
DLTR shifted its consumable mix from 41% to 51%, while lower variety and seasonal decreased from 50% to 44% and
8% to 4% respectively. Consumables consist of food, drinks and other high turnover + lower margin products. Howev-
er, DLTR has maintained gross margins at 36% despite this mix-shift. Indeed, DLTR’s SSS has remained robust; custom-
ers who intend on purchasing lower margin consumables end up impulse-buying seasonal and variety products.
Potential to unlock value via leveraged recapitalization: DLTR currently has $271mm of debt on its balance
sheet, representing leverage ratio of less than 0.25x. Given DLTR’s strong and consistent cash flow profile ($360-
$380mm FCF over the past 4 years), we believe that DLTR can unlock significant value by tapping the debt markets. By
adding $1.5bn senior secured bonds at 1.875% and paying the proceeds as a dividend, DLTR can unlock $4.90 of value
for shareholders or 10.9% return. The 1.875% coupon is based on what DG received less than three weeks ago. Given
DLTR’s superior financial metrics, we believe that DLTR could receive equal (or better) rates from investors.
Valuation
At 2014E EPS of $3.10 and a P/E multiple of 19.3x (which is in-

$3.40
line with 3 year average), DLTR should be trading at ~$64.75/ $0.14 $3.10
$3.20
share (including the $1.5bn leveraged recap with a share price $3.00
$0.09
$0.07
($0.08)
$0.20
impact of $4.90). In order to reach $3.10, we assume relatively $2.80 $2.68
conservative new store growth of (340 stores), 3% same store $2.60
sales growth (below historical average 4.4%), 20bps margin $2.40
uptick (below 2012 improvement) and $500mm of share buy- $2.20
backs. $2.00
Near-term Catalysts
1. On pace to opening 250+ stores in FY2014
2. Q1 2014 earnings of flat to improving margins with continued roll-out of freezers
3. Q1 2014 SSS of 2-3%
4. Leveraged recap
Key Investment Risks: (1) increasing competition from market saturation and Wal-Mart; (2) increasing payroll taxes
could hurt discretionary spending in 2014; (3) long term inflation could be a detriment to single price point model; (4)
sustained period of economic growth could see core customers trade up.
Page 42
Stanley Black & Decker (NYSE: SWK) - Long

Arjun Bhattacherjee Rory Ellison Colin Kennedy
abhattacherjee13@gsb.columbia.edu rellison13@gsb.columbia.edu ckennedy13@gsb.columbia.edu
Arjun Bhattacherjee
Prior to CBS, Arjun worked in

Private Equity at Olympus Recommendation: BUY
Partners. Arjun holds a BA in We recommend a long position in Stanley Black & Decker (“SWK” or the “Company”) stock with a target price
Mathematics and Economics of $107.00. The stock has an asymmetrical risk/reward profile from current levels. The Company trades at a 15-
from Macalester College. 20% discount to its peer group and has significantly underperformed the market in 2012-2013. Our target price
represents a ~43% total upside to the current share price of $76.40, and is based on a Sum-of-the-Parts analysis.
Our downside case generates $68.00 (down ~11%) which equates to a base case Up/Down of 3.9x.
SOTP Analysis
($ in mm)
Segment FY14E EBITDA Current Base Case Avg. Comparable Company

CDIY 1,144 10.0x 10.0x 10.6x
Industrial 737 9.0x 9.0x 9.5x
Security 537 1.6x 10.5x 10.8x
Corporate Expenses (427) 7.8x 9.8x
Total 1,991 7.8x 9.8x
Enterprise Value 15,618 19,605
Rory Ellison
Current Share Price $76.40 $107.00
Prior to CBS, Rory worked in Dividend / Share 1.96
Private Equity at Leonard Premium / (Discount) to Current 43%
Green & Partners. Rory holds
a BA with Honors in Business We believe that SWK is in a cycle of suboptimal capital allocation and has significant activist poten-
Admin. from the Richard Ivey tial. The Company is a collection of superior market leading businesses whose intrinsic value is obscured by a
School of Business at the conglomerate structure. SWK has strong FCF, but currently ~80% of that cash is generated overseas. This dynam-
University of Western Ontario. ic coupled with management’s desire to build a ‘diversified industrial company’ forces the Company to undertake
risky acquisitions outside of its core competency. SWK has 30% end market exposure to US construction mar-
kets, yet due to a lack of managerial focus and execution the Company has struggled to grow organically and is
losing share in its core power tools and hand tools segment (CDIY). We believe an activist solution that spins
out the SWK Security segment will unlock significant value for current shareholders. In addition, we believe that
spinning out security will allow SWK Management to better focus on core segments and drive organic growth
initiatives.
Key Investment Highlights

Market Leading Businesses
#1 and #2 Market Share
Macro Tailwinds
30% exposure to domestic construction end markets
Colin Kennedy In addition, we believe there is incremental upside available to SWK
shareholders by undertaking a split off and simultaneous merger (via Significant FCF Generation
~9% 2014E FCF yield
Prior to CBS, Colin worked in a Reverse Morris Trust structure) with Ingersoll-Rand’s Security
Private Equity at FdG segment. We believe this would create an Irish-domiciled security Activist Potential: Hidden Value
Associates. Colin holds a BA in powerhouse, and the RMT transaction would add an incremental 1) Spin off SWK Security Asset
2) Reverse Morris Trust with Ingersoll-Rand Security Asset
Economics and Psychology from ~$7.50 per share due to the combined company receiving a higher
Duke University. valuation than a straight spinoff scenario. The longer term earnings Cheap Valuation
power of such an entity significantly exceeds this initial valuation Trades below peers
11.4x 2014E P/E
increase.
Incremental Upside: RMT

RMT Value Creation $7.57
4.8x
Total Value $116.53
Premium to Current 53% Up/Down
SWK provides power and hand tools (50% of revenue), industrial and auto repair tools and engineered fasteners
(28% of revenue), and mechanical access solutions and electronic monitoring systems (22% of revenue) globally.
Volume
Issue I, Issue 2
XVIII Page 43
Stanley Black & Decker (Continued from previous page)

Market Leading Businesses: SWK has the #1 market position in hand and power tools within its CDIY segment and
has occupied this leadership position for over 100 years. SWK’s principal brands include Stanley, Dewalt and Black &
Decker and these brands are front of mind of contractors and pros in the industry. This segment will continue to bene-
fit tremendously as housing and non-residential construction recover domestically (30% exposure) from their current
depressed levels. In addition, CDIY has significant exposure to LATAM—a driver of future growth in this industry. In
its Industrial Segment, SWK holds the leadership position in industrial automotive tools and engineered fasteners. This
segment has high barriers to entry due to its highly engineered products, many SKU’s and mobile distribution network.
In addition, the Industrial Segment has a highly fragmented and significant Total Addressable Market (~$80 BN) that will
allow for accretive acquisitions over time. In Security, SWK is the dominant player in the automated and mechanical
security market and competes directly with Assa Abloy, Ingersoll-Rand and Tyco’s security division. This segment bene-
fits from high barriers to entry as network effects are developed through longstanding relationships, code driven rules
create millions of SKU’s and a high degree of customization prevent offshore competition.
Significant FCF Generation: SWK generates an approximately 9% 2014E FCF yield. The Company currently sup-
ports a strong dividend of $1.96/share on an annual basis representing a 2.6% dividend yield at current levels.
Macro Tailwind: SWK has significant exposure to US residential and non-residential construction markets—markets
that are improving but continue to operate at depressed levels. 20% of SWK revenues are tied to US residential hous-
ing, and housing starts remain ~50% below average levels. In addition, SWK has significant exposure to US commercial
construction and recent improvements in the Architectural Billings Index (a leading indicator) support a nascent recov-
ery in US commercial construction likely to occur in 12-18 months. Finally, SWK CDIY is still 20% below peak
levels (PF for SWK and Black and Decker transaction) supporting significant upside from a continued recovery in end
markets.
Significant Activist Potential: Management has been using its significant FCF to become a diversified industrial com-
pany. This strategy has not worked and has led to a vicious cycle of poor capital allocation as SWK management has
been focused on non-core acquisitions in weak geographies. In addition, these acquisitions have led to management
losing focus on their core business (selling power tools and hand tools) and losing domestic share. Organic growth has
been roughly flat in the last decade despite management’s stated goal of 4-6% annual growth. Thus, we believe an ac-
tivist shareholder can address SWK’s problems, as a push for a tax-free spin (similar to TYCO and Inger-
soll Rand) of SWK Security would unlock significant value. Assa Abloy (a pure-play Security comparable) trades
at ~12x EV/EBITDA, a significant premium to the current implied valuation for the SWK Security segment in the SWK
conglomerate structure. In addition, a separation of SWK Security would enable SWK management to better focus on
organic growth in the tool industry. Further, we believe the PF SWK entity (CDIY + Industrial) would be an attractive
pure play acquisition target due to its significant FCF, market leading brands and strong growth prospects.
We also believe there is incremental upside available to SWK shareholders by pursuing a double RMT, which is a tax-
efficient separation of the SWK Security segment and simultaneous merger with Ingersoll-Rand Security (IR announced
its intention to spin-off Security in Q4 2012). This strategy would create an Irish-domiciled Security entity, which is a
significant tax-benefit for future earnings and capital allocation, and form the second largest global security company
with ~$1BN EBITDA. The levered RMT structure could also allow for a dividend distribution of up to $1.3 billion to
SWK shareholders. The combined entity would create significant additional value for both SWK and IR shareholders
due to its strong market position and earnings power.
SOTP Valuation Incremental RMT Upside
($ in mm)
Segment 14E EBITDA Current Base Case

Stanley Black and Decker, Inc.
CDIY 1,144 10.0x 10.0x
Industrial 737 9.0x 9.0x
Upstream To SWK Shareholders:
Security 537 1.6x 10.5x Tax-free split-off
$1.3BN dividend from debt issuance
Corporate Expenses (427) 7.8x 9.8x $5.5BN equity stake (55%) in NewCo
Total 1,991 7.8x 9.8x
SWK Security Ingersoll-Rand
Enterprise Value 15,618 19,605 SpinCo, Inc. Security Corp.
M erger
Current Share Price $76.40 $107.00 RMT Value Creation $7.57

Dividend / Share 1.96 Total Equity Value $116.53
Premium / (Discount) to Current 43% Premium / (Discount) to Current 53%
Outside Executive / Board Member

We also believe that an outside Director would be beneficial to help expedite the process to unlock hidden value for
SWK shareholders. A potential candidate for this position is Edward Breen (the former chairman of Tyco, where he
oversaw several spin-offs and breakups of divisions).
Risks
Failure of Activist Campaign: 30% exposure to US construction markets and growing emerging markets present a clear
path to near term earnings growth. A 9% FCF yield is an effective floor.
Page 44
Yum! Brands, Inc. (NYSE: YUM) - Long

Omar Elangbawy Ranjan Ramchandani Andrew Woodruff
oelangbawy13@gsb.columbia.edu rramchandani13@gsb.columbia.edu awoodruff13@gsb.columbia.edu
Capitalization Trading & Liquidity Implied Multiples
Stock Price $65.04 Name Yum! Brands 2012 2013
Shares Outsanding 449.9 Ticker YUM Revenue $13,633.0 $14,053.0
Market Cap $29,261 Date 4/19/12 EBITDA 2,758.0 2,983.0
52-Week High $74.75 EBIT 2,227.0 2,264.0
Omar Elangbawy 52-Week Low $59.68
Cash $776
Debt $2,942 Free Float (m) 449.5
Omar is a second-year MBA Insider Ownership 0.3% EV / Sales 2.3x 2.2x
student. Prior to Columbia, he Minority Interest $158 Short Interest 2.3% EV / EBITDA 11.5x 10.6x
worked in Private Equity for Enterprise Value $31,585 Daily m Volume 2.9 EV / EBIT 14.2x 14.0x
FLAG Capital and interned as
an analyst for a small-cap, value- Recommendation
oriented hedge fund. Omar
We recommend a long position in Yum! Brands, which we believe is undervalued due to its suboptimal operating
holds a BA in Economics and a
structure. Given the predictable, steady cash flows in the U.S. and Yum’s broad international footprint, we believe
BS in Computer Science from
the inherent stability of the business lends itself to an asymmetric risk-reward profile. While the short-term focus
the University of Pennsylvania.
on recent food safety and avian flu scares in China has depressed the stock price, our view on the long-term sus-
tainability of the business makes a stake in Yum! an attractive proposition.
Our thesis revolves around two drivers of value. In order to capitalize on the value creation mechanisms we’ve
identified, an investor would need to take an activist stance and create his/her own catalyst. The crux of our thesis
is as follows:
1) Yum’s operating structure exposes US investors to a high degree of emerging markets risk. A
spinoff of Yum’s domestic operations into a separate entity from the high growth international
business would allow investors to more efficiently define their risk tolerance .
Ranjan Ramchandani  Yum U.S. - a stable, highly cash-generative business focused on returning capital to shareholders
Ranjan is a second-year MBA  Yum International - a growth-focused entity working to expand Yum’s footprint in developed and
student focusing on healthcare emerging markets outside of the U.S.
management and
entrepreneurship. Before
 A split would allow investors to better allocate their risk between two fundamentally different risk /
growth profiles. We believe the split would reverse an estimated 25% discount on the combined entity.
school, he worked for 3 years
in the New York office of the 2) A spinoff would drive increased management discipline, improving the likelihood of capitalizing
Boston Consulting Group, on operational improvements within each entity to drive both top-line growth and margin ex-
where he will be returning after pansion.
graduation.  Yum U.S. - Continue to focus on innovative product development and franchise-level operational im-
provements while also improving G&A efficiency.
 Yum International - Invest in smart growth in underpenetrated cities in China. Capitalize on largely un-
tapped India and RoW opportunity. Consolidate suppliers and rationalize supply chain logistics where
possible to improve margins.
Yum! Brands is the world’s largest quick service restaurant company with over 39,000 stores all over the world.
Stores are both corporate owned and franchised under three main brands: KFC, Pizza Hut, and Taco Bell. In addi-
Andrew Woodruff tion to these brands, Yum also owns a number of smaller, local brands primarily throughout China. Approximate-
Andrew is a second year MBA ly 75% of revenues and operating income comes outside the U.S., with China making up about two-thirds of that
student. Before CBS, Andrew amount. Approximately 80% of Yum’s stores are franchised or licensed, leaving 20% corporate owned.
worked three years in emerging Financial Summary
markets sales & trading for J.P. Year Ended December 31, Quarter Ende
2007 2008 2009 2010 2011 2012
Morgan. He has worked as an Revenue $10,435 $11,304 $10,836 $11,343 $12,626 $13,633
analyst for two different long/ % Growth - 8.3% (4.1%) 4.7% 11.3% 8.0%
short equity funds over the past Gross Profit 2,662 2,839 2,902 3,223 3,486 3,781
year. He has also passed all % Margin 25.5% 25.1% 26.8% 28.4% 27.6% 27.7%
three levels of the CFA exams. G&A 1,293 1,342 1,221 1,277 1,372 1,510
% Margin 12.4% 11.9% 11.3% 11.3% 10.9% 11.1%
EBIT 1,369 1,497 1,681 1,946 2,114 2,271
% Margin 13.1% 13.2% 15.5% 17.2% 16.7% 16.7%
EBITDA 1,911 2,053 2,261 2,535 2,742 2,916
% Margin 18.3% 18.2% 20.9% 22.3% 21.7% 21.4%
Volume
Issue I, Issue 2
XVIII Page 45
Yum! Brands (Continued from previous page)

Investment Thesis
1) Rationale for spinoff
 Current operating structure is an inefficient capital allocation vehicle. Yum’s International operation is concen-
trated in China, a market that entails significant upside but also significant volatility. By contrast, the US business
is largely franchise-owned and generates stable, high-margin revenues. Yum! investors are obliged to participate
in risk inherent in the emerging markets portion of the business and cannot choose the level of exposure to this
risk relative to the stable US business. Consequently, we believe the combined entity trades at a discount. A
spinoff of the US operations would close this discount.
 The spinoff is feasible from an operational perspective. Yum! US is organized by brand vertical, whereas Yum’s
International divisions (China, India, and YRI) are organized by geography. Management teams and supply chains
are already totally distinct. Additionally, financials are reported in line with our proposed spinoff structure,
allowing investors transparency into forecasted NewCo results.
 From a governance perspective, there are few impediments to a successful spinoff. Ownership of Yum! is con-
centrated among institutional shareholders (>70%), insiders hold a very small percentage of the firm (less
than .3%), and short interest is low. The Board is up for re-election every year and the proxy statement indi-
cates no active poison pill mechanism.
2) US opportunities
 Yum’s US brands have continued to innovate, both in terms of product development and in terms of operating
model improvements. The introduction of the Doritos Locos taco in 2012 by Taco Bell was widely regarded as
one of the most successful product launches in QSR history, and Taco Bell is on track to sell 500 million units in
2013. KFC will soon be making a shift to a largely boneless menu, a change it believes will align its menu closer
to the tastes of younger consumers. Pizza Hut has shifted many of its locations to a “Delco Lite” model, cutting
the store footprint in half and focusing on delivery/carryout operations.
 Yum US lags its peers in terms of G&A as a percentage of US sales. While this metric is highly sensitive to fran-
chise mix and same-store sales, it is indicative of the fact that there are opportunities for increased G&A effi-
ciency. Yum US’ brand vertical operating structure has created duplicative functions (HR/IT/Finance) across
business units; centralization of these functions could drive synergy value. Furthermore, menu rationalization at
the brand level could allow for more efficient use of corporate ad dollars, driving increased top line. We believe
the combined effects could generate an additional 200bps in margin over the next two to three years.
3) International operational improvements
 China will continue to be a growth engine. Yum! is the market leader among QSR chains but is still underpene-
trated in “lower tier” smaller cities, implying significant room for growth. Additionally, Yum!’s recent acquisition
of Little Sheep, the world’s leading hotpot chain, suggests opportunities for growth through M&A.
 Management’s focus on China growth has come at the expense of capitalizing on rest-of-world opportunities. A
spinoff would allow management to focus on expanding Yum’s footprint in other developing markets, particular-
ly in India. Management guidance suggests India system sales growth will top 40% per annum over the next
several years. India is also a candidate for a first major toehold for Taco Bell abroad, as pilot locations in Delhi
have proved extremely successful, likely due to the relative familiarity of Indian consumers.
 The historical focus on China growth has also led to a “long tail” of international markets in which Yum! has a
limited presence. A more concentrated approach to expansion in these markets will drive enhanced synergies at
the franchise and corporate level as penetration in these markets approach scale.
Valuation
Our model assumes the two business units, Yum! Intl. and Yum! US, will each trade at a more appropriate multiple in
line with their individual growth/risk prospects. Given the inherent stability of the US business, we have assumed the
business will trade at 11x EBITDA, which is below some of the larger QSR chains in the US that have a similar mix in
terms of franchised vs. company-owned stores (e.g. McDonald’s). For Yum! International, we believe the growth pro-
spects in China and RoW would allow the company to trade in-line with its competitors with a similar growth profile at
15x EBITDA. As a result, we believe an investment in Yum! Brands represents an attractive investment opportunity for
an activist investor with 50-70%+ upside in two years (price target of $100-$110 per share by 2015).
Key Investment Risks
Given the scope of the proposed activist maneuver and the size of Yum! ($30B), the spinoff proposal could encounter
resistance from management and the Board. A proxy contest could be a protracted and difficult endeavor, though the
concentrated institutional ownership and relatively lax anti-activist governance provisions mitigate this risk.
The investment is also exposed to operational risk for both the US and International businesses. Though we believe the
US business is largely stable—particularly given its high proportion of franchisee ownership—a secular trend toward
healthy eating could negatively affect system sales. Yum’s brands are attempting to preempt this with healthier menu
options (e.g. the Cantina Bell menu at Taco Bell). Internationally, the business is subject to the volatilities of emerging
markets—regulatory, food safety, political, and currency risks—and to competitive threats from other multinational and
international QSR chains. Nonetheless, we believe the existing infrastructure and store footprint mitigate these con-
cerns to a certain extent.
Page 46
Paul Isaac
(Continued from page 1) trading was in the distressed Walter studied under at the
G&D: You were brought securities of public utility stock exchange institute
up in a family involved in holding companies, back in the 1930s.
early value investing circles railroads, or a lot of the real
(for example, Isaac’s uncle is estate companies that got Graham-Newman was an
Walter Schloss). Barron’s into trouble in the 1930s. investment company with a
said that you have the limited balance sheet in
“value gene.” How was it In many ways, the early 1946. They had six or
growing up with relatives arbitrage business was seven people on staff, and
like that, and how did that essentially following the they were running about $7
Paul Isaac influence your career and outcomes of those or $8 million. Graham-
decision-making? securities, which any market Newman was doing a range
maker would do, especially of event- and cheap-
Paul Isaac (PI): I don’t given the relatively limited securities-type investing in
know that it was that secondary turnover in the the 1940s. Walter got a job
unique. When I was securities markets of the there as an analyst and
working on a money 1930s. You can see stayed with Graham-
markets trading desk, the references to how difficult it Newman virtually until the
head of the money markets was to maintain some of end. He later set up a
department at DLJ said, those positions in Phil partnership because one of
“People think that all these Carret’s memoir, A Money the Graham-Newman
guys in New York are so Mind at 90, and in Peter investors said they would
sophisticated, but they’re Drucker’s Adventures of a stake him with $100,000,
really nothing but a bunch of Bystander. Drucker which even at the time was
tree toppers. If they’d been describes working on some a modest amount of money.
born in Astoria, Oregon, Kreuger & Toll bonds for a
they’d be out topping trees poorly disguised Singer & People can be active money
for Weyerhaeuser, but they Friedlander in London in the managers in the way they
were born in New York, so 1930s. So these were are today partly as a
the job at the end of the essentially a side activity of product of a long bull
subway line was working in the business of being a market and partly as a
a cage or working at a market maker. product of developments in
trading desk. They’re just trading, analytics, the
tree toppers.” My father always had the availability of information, as
idea that you basically well as the separation of the
There’s some truth to that. worked in the securities execution function from the
This was a local business. business. Investing on the investing function as a result
Active principal investing as side meant that you could of regulatory changes and
a separate activity, as be somewhat more intrepid. compliance concerns. What
opposed to being a portfolio You had another source of I remember most about
manager at a fiduciary income and you did well growing up was that most of
institution (a very different partially because it gave you my father’s friends were in
thing), was really a side an opportunity to both see the business. Many of them
activity of people mainly flow and to be patient. My came out of the arbitrage
engaged in intermediary uncle, Walter Schloss, who community. A few of them,
functions, often as market actually worked in the cage Max Heine, for example,
makers in various types of at Loeb Rhoades in the were really in the brokerage
securities. So my father, for 1930s before he went into business. When they came
example, graduated from the service, came out and over, I heard a lot more
the NYU School of got a job at Graham- about Spingarn Heine than I
Commerce in 1928, and Newman. Benjamin did about Mutual Shares,
wound up working at a Graham was an instructor (Continued on page 47)
trading desk. Some of the
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Paul Isaac
(Continued from page 46) My father was much more more complicated. You
which was really a sideline interested in the dynamics have to be sensitive to both.
for customers too small to of complex situations and When a stock is relatively
have independent brokerage how things would ultimately expensive, it is much harder
accounts at Spingarn Heine. get picked apart. For to assess whether other
example, he closely people have simply done a
Walter didn’t talk too much followed the reversion of better job than me at
about the people he knew – the Waddell field to assessing the probabilities of
he talked about stocks, and Southland Royalty from Gulf successful outcomes. So
that was always interesting Oil. This was a major case you have to start with
and very memorable. But a in the 1970s which hinged something that is
lot of what I remember was on whether the lease on the demonstrably cheap
really how prosaic it actually field could be involuntarily because, first, it is harder to
was. When Bob Heilbrunn extended as a result of the get hurt if you fall out of a
came over for dinner with Texas Railroad basement window, and
Harriet, they were talking Commission’s proration second, it’s so difficult to
more about kids and less policies after the lease was assess whether other
frequently about something put into effect in 1925. My people have a more
like the utility industry. father became very involved accurate handle on
There was no great sense of in looking at that and favorable characteristics
the sorts of corporate decided there was going to than you do.
battles that people talk be a reversion, and he was
about today. It all seemed right. But as with so many G&D: How do you ensure
to move at a very slow other things in investing, that the statistically cheap
pace. Southland Royalty was a stocks aren't value traps?
spectacularly successful
G&D: What are the most investment less because PI: They are always value
important things you they were right on the traps in retrospect, right? In
learned from your uncle or reversion, but rather other words, if it works, it's
your dad about investing? because the case was not a value trap. There are
launched before the Arab certain characteristics that
PI: They actually had very oil embargo and was lead to value traps. For
different styles. Walter was resolved after oil had tripled example, a company with an
always vociferously opposed in value. So it was a extremely conservative
to the idea of owning bonds. serendipitous event that financial policy and
My father, who was in many drove a large part of the entrenched management
ways more aggressive than return. My father was much that has no desire to
Walter, probably stayed more interested in finding a increase the dynamism of
about 30% in T-bills for deeper edge. He was more the company or to realize
most of the post-war of a company analyst in the value in the security can
period. I think Walter really some ways than Walter lead to a value trap – you
had the courage of his was. can be sitting with
convictions in terms of something for a very long
principles and ideas about G&D: Are you more like time with relatively little
valuation. With Walter, Walter Schloss, in that you uplift in the asset value or a
what you saw was what you look for statistically cheap corporate event which
got. If a stock was really stocks, or more like your captures much of the
cheap, Walter basically took father, in that you look for disparity between the
the view that as long as complex situations? secondary market price and
managements weren't asset value.
crooks, the valuation would PI: The process has moved
eventually reach fair value. on and become somewhat (Continued on page 48)
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Paul Isaac
(Continued from page 47) money on your first the broad equity markets,
But those situations have a purchase. If the valuation and the broad bond markets
way of eventually resolving never becomes really for institutional investors.
themselves. There was a compelling, there is always a
company, Stern and Stern tendency to be less It's a frustrating business.
Textile, which was a textile involved. Pain is nature’s It's like trying to become a
importing business that way of telling you that professional three-legged
Pictured: The four finalists accumulated a tremendous you’re doing something racer – you're trying to put
of the Moon Lee Prize Com- amount of cash and always wrong, and mindlessly together a variety of funds
petition in March 2013. sold at a very cheap price buying more just because where you want them to be
relative to its book value. It something goes down is a great runners, but not
disappointed an awful lot of poor practice. But it is also collectively run too fast, and
people. But then a family equally true that just they have to do it in the
member died who was because you’ve discovered approved form. I met some
“The question in active in the business and something cheap with long- fascinating people, and it
had a major holding in the term merit does not mean was very interesting to see
avoiding a value trap company. So they worked a that the rotation out of a the different ways in which
is twofold. First, are deal where they sold off the previous population of people thought about and
textile business and merged investors that is currently structured their portfolios.
the dominant the company into one of the occurring is going to stop
Neuberger Berman mutual just because you’re buying Running a hedge fund is
shareholders or funds. Ultimately it worked some. This is a tension you more to my taste partly
management out very well, but for years have to look for, assess, and because I like coming up
it was a value trap. accept as a fact of life. with an idea and seeing it
incentivized to have through on my own. I also
The question in avoiding a G&D: There were a have something of a Lewis
some kind of a value trap is twofold. First, number of years where you Carroll/Red Queen
transaction that's are the dominant ran both a fund of hedge approach to investing –
shareholders or funds and a hedge fund at you’ve got to run really fast
going to increase the management incentivized to the same time. Can you to stay in the same place in
have some kind of a compare and contrast these the long run, particularly
market value of the
transaction that's going to two experiences? when you're dealing with
company in the near increase the market value of taxes and inflation. So I’m
the company in the near PI: First of all, there's the relatively aggressive in terms
future? And second, future? And second, is the question of what's a hedge of how I run money. As
intrinsic value of the fund. It's pretty much long as the underlying value
is the intrinsic value
company increasing at a anybody who is running of the securities I own is
of the company relatively attractive rate of tradable assets and gets an continually improving, I'm
return? If you've got the incentive fee. So it's a very somewhat indifferent to
increasing at a latter, then presumably the inclusive definition. A fund what happens on an interim
relatively attractive valuation is going to rise at of funds is really somebody market basis. That is the
least at that rate of return, who's running assets antithesis of what you're
rate of return?” even preserving a big sum-of invested in a collection of doing in the fund of funds
-the-parts discount under an hedge funds. The fund of business. A fund of funds
unfavorable value trap funds business that I was business can be thought of
situation. What you'd love involved with provided a as an annuity with a
to have is both, but what zero-beta-targeted portfolio knockout option – if you
you want to avoid is where of hedge funds that aimed have too much of an
you have neither. for a moderate rate of investor drawdown, you're
return at low volatility with going to lose your annuity.
My father had a saying that diversification away from This has adverse feedback
you never make a lot of the return characteristics of (Continued on page 49)
money unless you lose
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Issue I, Issue 2
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Paul Isaac
(Continued from page 48) that would give you pause, PI: Every security that you
effects when other investors apart from things like the own, with the exception of
flee and cause instability in accountants, which we new issues, has already been
your organization. So, it never actually got to. One owned by somebody else.
requires you to think very of them was that nobody So it’s really the standard
much in terms of controlling ever left. It’s very hard for stuff. We screen for
volatility. managers to hold all of their businesses that are
good people forever. Yet, inexpensive relative to
There are similar no one ever left the Madoff straightforward criteria.
constraints running a hedge organization to set up We try to find businesses or
fund, but they are less acute. “Madoff Light.” It was very industries that are becoming
In that sense, I find it an anomalous. The attraction somewhat cyclically
easier process, partially of Madoff was that he was depressed. We also try to
because I can focus on the purportedly doing what we find good businesses that
intrinsic attractiveness of were supposed to be doing; are down considerably
the underlying securities and but much better. In other because they’ve
not worry so much about disappointed people.
what might happen to them Sometimes it’s related to a
over the short run. “Any investment broad development within a
particular field. For
G&D: At the fund of funds, decision should be example, we’ve decided that
you managed to completely the increase of compliance
avoid all investments in made on the basis and regulatory burdens on
Bernie Madoff’s funds. How community banks is going to
you were able to do that?
of your enthusiasm
make community banking
for that investment. relatively difficult to conduct
PI: Any investment profitably, particularly in a
decision should be made on It shouldn’t be low-interest-rate
the basis of your enthusiasm environment. So we’re
for that investment. It made because you interested in acquiring
shouldn’t be made because shares in banks with
you can’t think of a reason can’t think of a reasonable footprints that
not to be in that investment. are relatively clean trading
Anybody who did any
reason not to be in
at significant discounts to
serious due diligence on the that investment.” their tangible book value. If
Madoff funds rapidly the discount is great
discovered that you couldn’t enough, the lack of
figure out what they were words, he was running with profitability is not a
doing. Plus, from the low volatility and reportedly deterrent – it’s actually an
scuttlebutt, it seemed very moderately high returns. incentive because chances
unlikely that anybody could There are lots of funds are they’re more likely to
deploy the amount of where if you’re willing to give up the ghost.
money Madoff was widely accept somewhat higher
reputed to be running in the volatility, you were likely to We also look at industries
strategies that people earn a Madoff-like return, that are undergoing
believed he was using. In and you could be perfectly consolidation. We try to
addition, there were other comfortable with them. So, find things that would have
people who were trying to why invest with Madoff? asymmetric payoffs in terms
do the same thing, and of financial market fashions.
weren’t doing it nearly as G&D: Can you talk about I confess that I’m always
successfully as Madoff was. your search process? interested in following what
There were other red flags
Page 50
Paul Isaac
(Continued from page 49) portfolio. It's not like I'm wonderful job of building a
really smart people do in going to call up Jeffrey large number of businesses,
this business and the stuff Immelt and say, "Let's chew and NAV discounts in
they’re most frustrated in. the fat over what you're Malone vehicles don't seem
There’s an old Marty going to do at GE." So in to survive very long. So in
Whitman line that says, that sense, no, we don't that particular case, I think
“You should do what I do, really talk to management in the management matters a
Pictured: Paul Orlin of Ami- but just do it two years most cases. However, with lot.
ci Capital at the Moon Lee later.” I’m perfectly happy smaller companies, we may
Prize Competition in March to listen to Marty. I’ll look talk to them, especially if the We won't buy something at
2013. at what he bought a couple leadership or strategic view a premium just because it’s
of years ago that hasn’t of the company is a particular manager or
worked that he still owns, particularly important. We promotional guy. There are
particularly if he’s adding to want to understand how certain people where, if
it, and see if we agree. they look at the business their stock is trading
and determine if that’s a relatively inexpensively and
We also look for reasonable strategy for they have a track record,
commodity businesses that them to pursue. Also, if we're more inclined to get
are cyclically depressed that they come in and their eyes involved.
may undergo a long-term are rolling in alternate
reversion to the mean, directions in either socket, In certain types of
especially if the replacement you might want to avoid the businesses, the management
cost is a lot higher for company. If they seem to has a much bigger effect on
capacity that is currently be really knowledgeable and operating effectiveness, and
embedded in the producers. engaged in the business, and when we get involved we
We try to determine how if they function well with the want to talk to them about
long it’s likely to take and other senior members of strategy. A lot of
how cheap these things are, the management team, then managements really try, and
and what their earnings that's a plus. they try hard. Most
power is going to be at the businesses are more
peak. Can we see ourselves There are people who say, complex and more difficult
getting an attractive IRR "I want to have a great than they ever seem to
making some moderately capital allocator," and within outsiders. If senior
unfavorable assumptions? limits I understand that. management is intelligently
Occasionally we will follow engaged with the business
Sometimes it’s sum-of-the- that, too. So, for example, and has a plausible plan for
parts stuff. Sometimes it’s our largest position is in the dealing with the issues that
relatively complex Bolloré Group in France. we see and the stock is
structures that occasionally That is partially the result of cheap, then that’s a big plus
fall out of favor. There are Vincent Bolloré and his for us.
fashions in this business, and talents, although it happens
the things that are out of to be very cheap statistically But we’re not looking for
fashion may well be worth and is a complex situation as Sir Galahad. We’re not
looking at. well. necessarily going to find
him, and we certainly don’t
G&D: How do you assess Anytime John Malone comes have the ability to identify
management? Many up with yet another fanciful him better than others. On
investors spend a lot of time creation, and it seems to be the short side, there is a bit
with management while trading at a thirty or forty of a tension because I react
others tend to avoid them. percent discount to NAV, viscerally negatively to
we're inclined to get highly promotional
PI: I started out with a involved. He's done a (Continued on page 51)
relatively small personal
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Issue I, Issue 2
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Paul Isaac
(Continued from page 50) was also the largest G&D: You’ve said in the
managements, yet those shareholder, had decided past that you don't
people are extremely that he wanted to do the necessarily look for catalysts
talented in getting the stock best impersonation of and that allows you to have
up. So you have to Corporate King Lear ever a longer-term holding
recognize that the seen in the Hudson Valley. period. Could you explain
promotional guy you dislike We thought that could the rationale behind this
may actually be very good at destabilize the company. So strategy?
causing you a lot of pain in one of our analysts, not me,
something that you think is went on the board and PI: Many times, what's
a natural short. contributed clarity to the happening is that we're
strategic process, and I think buying into something that
G&D: Have you this really did a lot of good has gone down a lot
considered taking activist for shareholders. recently. And it's going
positions where down for good reasons;
management is not In another case, we invested there are people who are
extracting full value? in a real estate company disenchanted, there have
that was extremely been cyclical problems,
PI: The presence of other inexpensive and had some, there may be a general
people who we think are frankly, incompetent second economic problem, or there
competent activists is a -generation family may be product or business
positive, especially if we leadership. The family transitional issues. We try
think the stock is attractive. managed to get itself into to figure out what the
It won’t cause us to buy the trouble financially in the company is worth if it's
stock, but a “make your crisis, and we had someone competently run under
own catalyst kit” is a go on the board to help normal future conditions.
positive to a lot of value with the strategic effort. Maybe it's not attractive
situations. I prefer to have When management did a today, but if it continues to
someone else do the work. deal that we thought was go down, you may start to
We do a pretty good job extremely unfavorable for see an attractive IRR on a
looking for value and shareholders, we went to weighted-average basis.
sometimes finding it amid the acquirer and said, “If There are a couple of points
complexity. But what I you don't let us in the deal, here that I think are a bit of
ideally want to do is just buy we have to consider putting an advantage for us.
T-bills at 120% a year in a in a competing bid for the
non-inflationary company.” This was after First, we don't have a stop-
environment. The problem our guy was off the board, loss discipline, and second,
is that the market won’t do but we came to terms and we don't require a catalyst.
that for me. participated in the buyout Many hedge funds have a
vehicle. So if we can make a stop-loss discipline, so they
So we generally do not seek difference, we will push for really aren't buying a stock –
to be activists. Doing it well change. We can't always in some ways, they’re
is a lot of work, and we make a difference though I buying a knockout option,
have a limited number of don't want to rule anything creating an inherent,
people to spread over a out. I think our role is inflexible whipsaw risk in
moderately large number of rarely activist, but when we the financial proposition.
positions. However, we get involved, we try to be as These stops are often pretty
have had two activist positive as possible and act tight and it is easy to lose
positions in the past. First, for the benefit of all your acceptable loss, plus it
we invested in an insurance shareholders as much as becomes difficult to get
company undergoing possible. involved again.
turmoil because the (Continued on page 52)
nonagenarian founder, who
Page 52
Paul Isaac
(Continued from page 51) to help determine sheet, and investor
We have the problem that allocations? sensitivity.
we may have to revisit our
assumptions, but if we do PI: It is a bottom-up G&D: How you think
and decide that it’s even proposition. If you can’t about position sizing when
cheaper, we can buy more. find enough bottom-up you initiate a position?
We have sense of certainty ideas, it gets harder to fill
of what’s going to happen the portfolio. A target-rich PI: Different funds will size
from here. We’re environment probably positions in different ways,
competing against a lot of means that you’re running partially because they have a
really smart people. If your gross lower because different implied volatility
there’s an obvious catalyst, volatility has gone up pretty target that they’re shooting
other people will jump on it sharply. You may be in for so as to not to rattle
and the price will go up. some particularly difficult their investors.
But we’re more inclined to macroeconomic
play out these multiple circumstances where you We are all running
possible path opportunities. may have had a draw-down portfolios that have a sort
In practical terms, that and have to be sensitive to of leverage – where we
means that we’re not what your investors are have participating capital, it
looking at shorter-duration doing. can be withdrawn. There’s
transactions or positions. probably an absolute
Many of the things that we So, ironically, a lot of guys at drawdown level where
get involved with can take really low market bottoms money tends to flow out,
one to several years to are trying to be substantially but there’s also a relative
work out. We therefore net long, managing their performance level where
generate most of our return gross, and biting their money tends to flow out.
in the form of long-term fingernails that their That is based upon your
capital gains. That’s investors will give them investors’ expectations,
attractive for most of our enough time for the surprise, and the
investors who are taxable recognition of value. When temperamental population
individuals. stocks are expensive, there that you’ve targeted and
is more of a tendency to try have accumulated.
G&D: Is it the same on the to find shorts against them
short side? to control the aggregate size I take chunkier positions
of the net, which pushes up than most other hedge fund
PI: No. Short investing is your gross. That also managers. Our history has
not the opposite of value means you’re probably been relatively volatile, and
investing. Short investing is trying to find securities that it’s worked out well for our
actually the opposite of are more liquid, so you can investors. So my limited
growth investing. It is much adjust the portfolio more partners have been more
more dependent upon quickly if circumstances tolerant (so far) than many
continued checks of the change. Volatility also acts others, which is very
growth story. Shorting is a as a constraint on gross fortunate.
challenge for us just as it is because you want to limit
for almost every other how much your portfolio That said, I’m very
hedge fund manager. bounces around. conscious of any binary risk
in a security. Some things
G&D: How do you You’re trying to find the may seem tremendously
determine your long-short best bottom-up situations attractive, but you’ve got to
allocations? Is it just based that you can and manage be honest about them. If
on the attractiveness of them against the constraints the wrong court case arises,
your current ideas, or do of liquidity, volatility, balance (Continued on page 53)
you use the macro picture
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Paul Isaac
(Continued from page 52) I like the business. It's a inexpensive again,
if foreclosures continue to perfectly reasonable particularly the Class B
cascade down, or if there business. We're not long shares, in the aftermath of
are serious business the Class A shares. We the 2002 bear market and
transition problems, you bought the Class B shares started building a position.
could have a substantial loss. because they were very
There also may be too inexpensive. We have There were a number of
much leverage and the accumulated a large position things about it that we liked.
enterprise could become in Class B shares relative to They had a CEO who did a
financially fragile because of us. Now it’s a 6%-7% wonderful job of
covenant violations, for position. rationalizing the business
example. Under those and making it more
circumstances, I will restrict I first encountered the profitable. There was an
the position size to about company in the 1970s when octogenarian granddaughter
half of the maximum for a Tweedy, Browne had of the founder who
security that has all of the bought Greif in a vehicle controlled a lot of Class B
attractive elements. they took over, a small stock. She subsequently has
passed away. The family is
There’s no magic formula to no longer involved in the
it, but securities with a fair “I’m very conscious business, and they seem to
amount of binary risk are disagree with each other
going to have higher rates of of any binary risk in about enough things that it's
return when they work. It’s not impossible that
important to be in a a security. Some something could happen to
position where you’re not the business. You now see
under a lot of pressure to
things may seem
a pattern where
get out of a position just tremendously management in the company
because it’s not working for is buying back Class B
a while. attractive, but shares much more
aggressively than they're
G&D: Can you talk about a you’ve got to be buying back Class A shares.
stock that you think is
attractive? honest about They also have some
them.” interesting diversification
PI: We have a sizable initiatives, notably into
position in the Class B flexible packaging, where
shares of Greif, Inc. The closed-end fund called they're manufacturing all
company is a packaging Cambridge Fund. My uncle, sorts of bags for bulk
manufacturer with two Walter Schloss, had offices transport. Where we
classes of stock, Class A and with Tweedy. I knew a little currently have it, it's trading
Class B. The Class A stock bit about them and thought at about ten times earnings
is liquid and is in several they were talented people. on the Class B shares and
indices. The Class B stock So I bought some of pays about a five and change
has all the voting rights and Cambridge Fund because it dividend. This is with
is entitled to 150% of the was trading at a 25% or 30% depressed profitability in a
per-Class-A-share dividends discount from NAV. I business that we think is
and earnings. Yet, it often eventually got a little bit of growing. Greif
trades at a discount to the Greif A after the liquidation Manufacturing has 240
Class A shares. The Class B of the Cambridge Fund, and plants that manufacture
shares currently trade at so I gained some familiarity containers for people
about 105% of the Class A with it. I later saw that it making stuff, so it's hard to
share price. had become quite (Continued on page 54)
Page 54
Paul Isaac
(Continued from page 53) Street. people tend to think of it as
imagine that it’s going to get a top-down organization,
supplanted anytime soon. What should a well-run the real locus of power
It's been a nice stock for us investment banking firm within the organization is
over time. Between the applying moderate leverage the board of the holding
dividends and the with a lot of fee-based company of the regional
appreciation, it's been a mid businesses be able to banks. The regional banks
Pictured: Meryl Witmer
-to-high teens IRR. We generate? A ten-to-twelve needed capital in the 1990s,
at the 2012 Graham &
Dodd Breakfast
have traded around the percent ROE seemed pretty so they issued a class of
position occasionally, either reasonable. If that's the share which is effectively a
by doing “buy-writes” selling case, Goldman should trade non-voting economic share
calls on Class A shares, or at 1.2 to 1.4 times tangible that, for dividends and
in some cases shorting the book value in this earnings purposes, ranks
A outright when the A environment. Buying in at pari passu with the 25%
really significantly outran the 0.8 to 0.9 times tangible holding in each of the
B. book, with an underlying regional banks owned by
rate of accretion in the mid- the corporate and
G&D: Is six or seven to-high single digits, given investment bank.
percent generally your the earnings that they were
largest position size? generating, seemed So there are 13 of these
reasonable. non-voting shares in these
PI: No. In fact our Bolloré various regional banks,
-related positions are now Our second-largest position which are decent regional
in the high-teens of capital. is more esoteric. It’s in the banks. They have non-
The stock has done very regional affiliates of Crédit performing assets of 1% to
well. We still think it's very Agricole. Crédit Agricole is 4% of assets. They usually
cheap, so we have not sold a bit like the federal farm have loan loss reserves of
any. credit system. The majority 70% to 150% of the non-
ownership is a pyramid with performing assets. The
We also have a sizable several thousand local tangible common equity to
position in Goldman Sachs. mutual societies at the assets runs 8% to 15% on
There was no particular bottom. They own, through the outside. The ROE runs
insight there. I was in too a special class of stock, the in the mid-single digits to
early when it was trading at majority of each of 40 about 10%. The efficiency
a substantial discount to regional Crédit Agricole ratios are around 45% to
tangible book value, and banks. Crédit Agricole Sud 60%.
then it traded down to a Rhone Alpes, Crédit
level where we re-upped. Agricole d’lle de France, and These are not bad regional
It's by far the most so on. banks, and as they have
productive investment assets between $8 and $60
banking organization in The regional banks billion apiece, they're also
terms of revenues per head. collectively own all of a not tiny, either. You can
The company still does a holding company called Rue get information on them if
really good job of recruiting La Boétie, which owns 56% you speak French or can use
and developing a culture of the listed Crédit Agricole Google Toolbar. Just go to
internally, so they have a vehicle, which in turn the website of each of the
deep bench. The controls their foreign regional banks. They don’t
combination of a deep holdings, the insurance make it easy for you. You
bench and higher comp than companies, the asset have to go through the site
all of their competitors management division, and and find the required legal
indicated that they are going about 25% of each of the filings, and then they’ll show
to have a leg up in adjusting regional banks. While (Continued on page 55)
to the new ways of Wall
Volume
Issue I, Issue 2
XVIII Page 55
Paul Isaac
(Continued from page 54) are not entirely rational for concerned about it. In
you the annual and an essentially mutual 1994, I was working in a
trimestral reports. institution to have brokerage house that was
outstanding indefinitely, and primarily in the fixed
These things are trading at we may get some buybacks income business. We were
25%-40% of tangible book, of whole issues. These clearing for some people
with somewhat depressed positions are not terribly who were small mortgage
earnings this year, partially easy to buy – they typically securities dealers out of
because of economic trade between twenty town, and a couple of them
conditions in France, thousand and a couple vaporized in the experience.
partially because of hundred thousand dollars a Anybody who went through
incremental taxes, and day each, so accumulating the Granite Capital
partially because of the lack them took a long time. meltdown and its associated
of flow through of any mortgage bond debacle or
earnings from the holding G&D: What is the anyone who experienced
entity where they take the composition of the assets at the second quarter of 1994,
dividends into their income the regionals? Is it what we which was the worst
statement when they pay would expect from quarter on record for the
them. traditional banks? treasury market, went
through a very painful
These entities are trading at PI: Yeah, it's small experience. At one point
five or six times earnings. commercial, consumer, and treasuries were down more
They're paying dividends of municipal loans. The one than 20%.
five to seven percent. Most thing that really concerns
of them have buyback me is if interest rates were Everybody has to be
programs. There have been to go up moderately, it concerned. With the
buybacks of whole share probably would help their degree of debt that’s out
classes of these entities. profitability. But if interest there, the authorities are
When they've occurred rates were to go up a lot, likely to lean very heavily on
they've been at significant there is an inherent a really sharp increase in
premiums to what these are duration mismatch because interest rates. Otherwise,
currently trading for. they do some term lending, given the very short average
particularly to municipalities. duration of treasury debt,
We had some misgivings So I think that is probably it's just inconceivable to me
about the French economic the biggest risk if you're that they would let Treasury
situation and the value of looking for an outlying bill rates go up to 6%, 8%,
the Euro, so we neutralized structural risk. or 10%, almost regardless of
a large chunk of our Euro how stupid the policies
exposure by shorting ten- G&D: Seth Klarman in his would be that would be
to fifteen-year French 2012 letter to investors needed to suppress rates.
sovereign treasuries against commented that the end of At high rates, it’s much
the position when the Euro the “free lunch” of low more difficult to manage
was at $1.30. If these banks interest rates and high your government budget
are going to get into serious government spending could because of the increase in
trouble, it’s unlikely that come to an end, which the cost of debt service.
France will continue to have would push interest rates
a bond market that's trading up significantly and could The United States and other
at two percent in fifteen cause significant financial countries have experienced
years. We're getting a nice pain. Are you preparing for sharply negative real returns
current income on the that moment? on fixed income
position, and there is some instruments. So, yes, I am
accretion to book value. PI: You have to be (Continued on page 56)
My hope is that these things
Page 56
Paul Isaac
(Continued from page 55) If I look at Merck versus there are international
concerned about what will Sanofi, what’s the real valuation parameters, can
happen when interest rates difference of the geographic make a difference.
go up. It could have a allocation of their business
pronounced effect on base? Sanofi is doing I know a great investor in
financial markets, and it's something like 60% of its London. He buys breweries
not going to be any fun to business in Europe, 30% in partially based upon the
go through. We’re not North America, and 10% in cost per hectoliter of
even talking about rates Asia. Merck is doing 15% in capacity, and when he finds
going to 10% – it will be Asia, 40% in Europe, and a ten-to-one disparity
pretty ugly even if the 5- 45% in North America. Just between his longs and
year goes up to 3% or 4%. how much of a home shorts, he figures he has a
“My father, and to That's one of the reasons country bias can you justify pretty good trade. I’m not
why what the Fed is doing is when you have truly nearly that sophisticated or
a lesser extent, progressively less effective. international businesses? intrepid, but there is a price
Walter [Schloss], In other words, people at which things become
aren't stupid. They are Nevertheless, for us to go attractive, and then you’re
had a saying that anticipating that at some overseas, the opportunity looking for some indication
point this is going to have to must be very compelling. that you’re likely to make
he almost never end. Therefore, I think it That may be because we money.
has a major effect on the can’t express the idea
invested outside the willingness of people to lock through an American In Sri Lanka we got involved
up long-term commitments. security, or because the because it was extremely
United States
valuation disparity is simply inexpensive. The Civil War
because he’d always G&D: How do you get enormous. Then we have had also ended recently.
comfortable with the to be reasonably The country has a history of
found plenty of regulatory and general comfortable that the legal British-based accounting and
investing environment in system works for us. I commercial law, which gave
opportunities to more esoteric countries don’t relish the idea of being us some comfort. Some of
such as Sri Lanka, where an unsympathetic hedge the situations that we were
lose money in the you have invested in the fund investor in France, but involved in had substantial
past? I can tolerate it, particularly foreign shareholders from
American markets.”
if we like the management. countries with good
PI: Well, greed helps! My corporate governance
father, and to a lesser But on the other hand, we standards, which gave us
extent, Walter, had a saying really don’t do anything in comfort with that sort of
that he almost never Russia or China because we J/V partner. It wasn’t
invested outside the United don’t have any real comfort necessarily favorable for
States because he’d always in the accounting, the legal outside shareholders, but it
found plenty of system, or the culture. And was unlikely there were
opportunities to lose money if we make a lot of money, going to be a tremendous
in the American markets. there’s a chance that number of self-interested
There have been some someone will try to take it deals on the part of
changes that make it easier away. So that skews the principals that were going to
to invest in places like Sri risk-reward ratio in a way take out value.
Lanka, most notably the that we don’t get involved.
ability to control execution But in a lot of other If we can get comfortable
and risk, and the ability to countries, there are with the institutional risks,
get information. Changes in intermediate positions. You and there is enough of a
corporate governance lose the color, the context, valuation disparity, we will
standards in foreign markets and the familiarity, but get involved. That does
have also helped. valuation, particularly if (Continued on page 57)
Volume
Issue I, Issue 2
XVIII Page 57
Paul Isaac
(Continued from page 56) inclined to be aggressive in and opening up potential
carry the risk that we get the region after Chávez’s competition from a
involved in a perma-cheap death, and the FARC will multiplicity of sources. I
or in something where we probably get less support. look at the Kindle, and it
don’t understand the Pacific Rubiales, which has a strikes me that it's an
principals’ motivations. But good record of developing intermediate step to better-
if you’re falling out of a reserves, is trading quality screens on tablets
basement window with inexpensively relative to with other types of services
something that is very North American analogs. that can be linked more
inexpensive, chances are It's a company of some size broadly with how people
you’re not getting hurt all and we're willing to make a manage their media intake.
that badly, and you pick bet. So, it doesn't strike me that
yourself up and hopefully the Kindle is a long-term
you have some G&D: You’re a noted bear moat for Amazon within
disproportionate winners on Amazon. What is your that sector.
that compensate for the short thesis on the stock?
incremental uncertainties. Amazon does not have an
PI: I am bearish. It's not a asset-light model. Amazon
G&D: Do you have primary driver of the now has a depreciation rate
analysts that only look at portfolio, and it's one where that is slightly higher last
international deals? I've been wrong in P&L year than Aéropostale’s and
terms. We actually short somewhat lower than Gap’s.
PI: No, if an idea takes us Amazon by essentially doing They've got 50 million
overseas, then we’ll look at a naked buy-write. We sell square feet of these vast,
it. Personally, I like smaller calls on Amazon and roll dystopian warehouses that
markets that have natural them and alter the exposure have been Taylorized with
oligopolistic tendencies somewhat based upon monitored guys walking
simply because of the certain valuation criteria. around fulfilling orders. It’s
limited size of the markets. very difficult for them to
So, I have personal holdings The question of what automate that. They are
in places like Mauritius, Amazon’s business model losing the sales tax
Bermuda, and Sri Lanka. will be when it grows up is advantage that they had
still not proven. Amazon progressively, and it will
At Arbiter, which has a had developed a terrific eventually go away
greater liquidity business, and may still have completely.
requirement, we follow a terrific business in physical
investment themes in liquid media – books and physical It’s true that they can
markets in industries that things like DVDs – because deliver a lot of goods to a
we understand reasonably originally about 20% of the lot of people, but they are
well. For example, we have U.S. population was not competing against the
a small long position in near a media superstore. implied untaxed labor costs
Pacific Rubiales, which is a Now that you don't have of people going to the store
sizable Colombian oil many bookstores any more, and picking up their own
company that was started that physical market may stuff. Amazon has delivery
by one of the teams of have grown, and Amazon expenses. We are long this
Petróleos de Venezuela clearly dominates it. trend via UPS, because we
engineers that fled the could buy it at a 6% or 7%
Chávez politicization of the However, they've got the free cash flow yield. UPS’s
company. Colombia is a problem that an increasing network would be difficult
petroliferous area, and the amount of media is being to replicate and is already
politics of Colombia have digitized. This is changing quite profitable. A lot of
been getting better. Amazon’s business model (Continued on page 58)
Venezuela will be less
Page 58
Paul Isaac
(Continued from page 57) You can also have shopping I'm not sure that's really the
the hopes of what people bots that can intermediate same thing.
want to get from of Amazon among vendors very, very
are ultimately going to be quickly. In other words, Businesses have to make
indissolubly associated with people argue that Amazon profits to justify their
a guy in a brown suit and a can aggregate things from valuations. It’s a critical
brown truck. everywhere, and they have mass issue for many
tremendous economies of businesses, which should
Amazon has been scale. But when you're up result in a higher degree of
spectacular at being able to to $50 billion of sales, what profitability going forward.
find new areas to go into kind of scale do you need to But how large does a
unprofitably. It will be become profitable? company have to be before
difficult for them to develop they start making money in
their third-party business I'm a great admirer of some aspects of their
because it’s really a people who can find Phil business? And the fact that
“Amazon has been fulfillment operation. Fisher-like growth Amazon isn’t profitable at
spectacular at being Where they’ve become a situations. I'm not good at their current scale makes
merchant, they are rapidly doing that. But the essence me wonder whether it’s all
able to find new becoming competitors to of a Phil Fisher growth that profitable in any
companies that they serve, situation is that it's a rapidly material portion.
areas to go into which limits Amazon’s growing business that does
ability to be a preferred such a good job of fulfilling It’s interesting because
unprofitably. … As vendor of choice on that customers' needs that it is we’re focusing on Amazon.
kind of platform. E- profitable enough to fund its It’s a decent-sized short for
an investment commerce is not a unique own more-rapid-than- us. It’s really not going to
proposition, I don’t skill. Amazon does it well, normal growth. Amazon be a major driver of the
but other people also do it funds its growth through a portfolio. But it’s also an
get it.” well. combination of anti-dilutive indication of a failing that we
stock offerings through all have in our business –this
Amazon has a negative options and its negative tendency to look for the big
working capital model. working capital model, and I controversial name and then
They have actually used a don't think that's the same have an opinion. Often the
portion of that negative thing. big controversial name is
working capital to fund their controversial for legitimate
very large capital plan. They I've got one guy who told reasons, and you don’t have
have to continue to grow, me today, "Hey, look, given to get involved. You can get
because if they ever stopped the rapid growth of the involved in names about
growing, they would no number of searches on which any sane person is
longer be able to keep their Amazon for goods that get going to basically say, yeah
expenses down by paying a sold through Amazon, if I that’s cheap, and I just want
substantial portion of their value that relative to the to know why it’s going to
wage bill in stock options. valuation of Google based get un-cheap? Or, yeah
When you put all that on its search and advertising that’s really expensive, but
together, there’s a good business, I can justify a why do you think they
chance Amazon is a substantial portion of the won’t be able to keep the
perpetual motion machine. market cap for Amazon promotion going?
I am a happy Amazon based on what it would be
customer. If somebody is able to do if it turned it into It's fun to have a debate
willing to sell me stuff at a local advertising business." about something like
cost or below, why not? Instead, Amazon manages to Amazon because it’s a “how
They do a very competent advertise itself for goods do you like those Yankees”
job. But as an investment that it sells at no profit. So (Continued on page 59)
proposition, I don’t get it.
Volume
Issue I, Issue 2
XVIII Page 59
Paul Isaac
(Continued from page 58) somebody looking to Icahn when you're eighty
topic? It indicates that a lot maximize their own capital. because, by that time, the
of us are spending time on I think targeting investment world could be a very
things where it's very products is perfectly valid different place. It's going to
difficult to have more than a work. Products are be very path dependent as
moderate incremental designed for institutional to how you get there.
advantage. You have only a contexts and they conform “You should be
limited amount of time, to popular preferences. You should be personally
attention, and analytical personally and
These can be enormously and financially conservative
resources. This whole lucrative jobs, you can build for a few reasons. First, it is financially
exercise that we've got is up tremendously attractive a cyclical business, as people
one of 'applied businesses out of them, and have now rediscovered. conservative for a
epistemology': what do we some people make a lot of Second, it's a lot more fun if
know and how do we know money doing it. I don't see you have some of your own few reasons. First,
it? Try to look at things on anything wrong with that money to invest. And third,
a scale where you can have even if I think it is sub- it opens up a lot of flexibility it is a cyclical
a relative information optimal for my investing to you, particularly in the
advantage compared to the business, as people
preferences. intermediate stages of your
rest of the world. We are career. have now
in an intermediate stage But it's important to
where that's getting harder distinguish that type of Enjoying the ride is really rediscovered.
given our size, but I'm investment approach from important. Too many
always a little bit surprised one that fully reflects your people have a fixed star of Second, it’s a lot
that individuals, particularly temperament and style. what they want to become.
for their own account, don't Figure out who you are, Frankly, I started in some more fun if you
do that more. what you're trying to very different areas, and I
have some of your
accomplish, and what your had several sub-specialties
G&D: Do you have any temperament is. shot out from under me in own money to
advice for students looking Otherwise, you may find the course of various types
to get into investment yourself as a square peg in a of technological or invest. And third, it
management? round hole. On the other regulatory changes. Be
hand, I'm a great believer open to where this will take opens up a lot of
PI: It's a very long race. that there is not one right you or what opportunities
You've got half your capital slot. You're going to learn a you will have. You could be flexibility to you,
from the last doubling, lot about investing, no a great growth stock guy;
which is one reason why particularly in the
matter where you wind up. but if you find yourself in
you have all these elderly the middle of the TMT intermediate stages
guys tottering up and giving Most of you are going to bubble maybe you're
you advice at Columbia. have careers that are supposed to shift your focus of your career.”
Time really matters. twenty-five to forty years for a while, if you have the
Compounding really long. And by the way, the ability to do so.
matters. The investing investing world will be very
process really matters. different. You will have G&D: It was a pleasure
What are you doing for been through several speaking with you, Mr. Isaac.
whom? economic cycles and there
will, undoubtedly, have been
There are an awful lot of a number of important
investment products out agency and regulatory
there that are targeted for changes, none of which
specific agency needs of you'll be able to forecast
particular types of investors. with precision. So don't
They are not necessarily decide you want to be Carl
ideal ways of investing for
Get Involved:

New York, NY 10027
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jhedstrom13@gsb.columbia.edu
jlubel13@gsb.columbia.edu
fixed income research for Fidelity Investments. He can be reached at
jhedstrom13@gsb.columbia.edu.
value fund. Prior to Columbia Business School he worked under Preston Athey on the
Graham & Doddsville
Issue XIX Fall 2013

Inside this issue:
Guy Spier P. 4 Guy Spier is the founder and managing partner of
Guy Spier — Aquamarine Capital, an investment partnership styled
Homex (HMX) after the original 1950’s Buffett partnerships. In 2008
9.75% 2020’s P. 16 Build Your Life Mr. Spier, along with Mohnish Pabrai, had lunch with
in a Way That Warren Buffett after submitting the winning bid for
Wabash National Buffett’s annual Glide charity auction. Mr. Spier
(WNC) P. 18
Suits You completed his undergraduate studies at Oxford and
earned an M.B.A. from Harvard Business School.
Active Network Graham and Doddsville (G&D): How did you first become
(ACTV) P. 20 interested in investing? What drew you in and what keeps you
going?
Koch Industries P. 22
Guy Spier (GS): I guess there are some natural proclivities
that I have. One is that I don’t like managing people and I’m
really bad at executing on stuff. Getting Mr. Guy Spier to have
the ambition of building Starbucks like Howard Schultz did
would never happen. Guy would still be running some crummy
Editors coffee shop because I’m just not very good at execution. I
Chris Brigham know that I’m an extrovert, I enjoy meeting people but on
MBA 2014 Guy Spier (Continued on page 4)
Jackson Thies, CFA

MBA 2014
Jason Yang
Koch Industries — Creating Value in Society
MBA 2014
Koch Industries is an industrial
Matt Ford conglomerate headquartered
MBA 2015 in Wichita, Kansas. It is the
second largest private
Mike Guichon company in the U.S. with $115
MBA 2015 billion in sales. Its businesses
range from petroleum
refineries and fertilizers to
chemicals and fibers, as well as
Visit us at:
Georgia-Pacific, which Koch
www.grahamanddodd.com Dave Robertson Steve Feilmeier
www.csima.org acquired in 2005 for $21
billion.
Koch’s recent investments include a $1.5 billion minority stake in Guardian

Industries, an architectural glass manufacturer; an investment in Colfax
Corporation, a diversified manufacturing and engineering company; and a $240
million preferred stock investment in American Greetings Corp.
Richard Hunt, Graham and Doddsville’s former AVP and a summer business
Page 2

It is our pleasure to bring you We also sat down with Koch as to some of the newer and
the 19th edition of Graham & Industries Executive Vice less-familiar faces in the
Doddsville. This student-led President and Chief Financial investment community. We
investment publication of Officer, Steve Feilmeier, as also have a few other ideas in
Columbia Business School is well as President and Chief store, so stay tuned for our
co-sponsored by the Heilbrunn Operating Officer, Dave upcoming editions.
Center for Graham & Dodd Robertson. They discuss their
Investing and the Columbia approach to finding investments As always, we thank our
Student Investment Management that are not only great interviewees for contributing
Association (CSIMA). standalone businesses, but also their time and insights not only
ones that can be integrated to us but to the investment
As students return to campus into their existing operations. community as a whole, and we
here at Columbia Business thank you for reading.
Pictured: Heilbrunn Center School, we are reminded and We continue to bring you
Director Louisa Serene implore our readers to continue pitches from current students - G&Dsville Editors
Schneider. Louisa skillfully the search for what Charlie at Columbia Business School.
leads the Heilbrunn Center, Munger has called “worldly CSIMA’s Investment Ideas Club
cultivating strong relation- wisdom.” By dedicating our lives meets regularly throughout the
ships with some of the to continuous learning, we year, including during the
world’s most experienced become not just better summer, and provides CBS
value investors and creating investors, but better thinkers students the opportunity to
numerous learning oppor- and contributors to the world in practice crafting and delivering
tunities for students inter- which we live. investment pitches. Three of
ested in value investing. the best ideas from this
The classes sponsored by Our first interview is with Guy summer are contained for your
the Heilbrunn Center are Spier, the founder and portfolio perusal—long the 9.75% senior
among the most heavily manager of Aquamarine Capital. guaranteed 2020 USD notes of
demanded and highly rated In a candid discussion with Gra- Homex (EJ0116982), long Wa-
classes at Columbia ham & Doddsville, Mr. Spier bash National shares (WNC),
Business School. discusses everything from his and long Active Network
use of checklists to several of his shares (ACTV).
recent investments. Insightfully,
he points out that it does little Looking forward to the coming
good to aspire to be a different academic year, we are working
investor, but instead suggests to to bring you even more
focus on creating an investment fascinating interviews; we plan
philosophy and portfolio that is to expand our gaze to
consistent with who you are. international investors as well
Pictured: Professor Bruce

Greenwald. The Heilbrunn
Center sponsors the Value
Investing program, a rigor-
ous academic curriculum
for particularly committed
students that is taught by
some of the industry’s best
practitioners.
Bill Ackman and David Winters at the Students waiting to hear the final
Omaha Dinner in May presentations at the 2013 Pershing
Square Challenge
Volume
Issue XIXI, Issue 2 Page 3
SAVE THE DATE
17th Annual Columbia Student Investment

Management Association Conference
February 7, 2014

investors in the industry, presented by:
and
Visit our website for updates: http://www.csima.org

Taylor Davis TDavis14@gsb.columbia.edu
Ivan Dias IDias14@gsb.columbia.edu
Joe Fleury JFleury14@gsb.columbia.edu
Page 4
Guy Spier
(Continued from page 1) think that at the end of the People who go to Oxford
some level I lose patience day, it suited my internal are great thinkers, they just
with humanity as well. Being wiring. I think I’m aware of can’t get anything done.
in a situation where I don’t some of that wiring but I’m That’s a broad
have to deal with too many not aware of all of it. generalization. Oxford
people if I don’t want to, brought out my proclivity
and I don’t have to manage for discussing, writing
them is a big plus. So I think essays, all of those things.
there are very specific ways Harvard Business School on
in which it was natural for “I sometimes ask
the other hand, is much
me to go into investing. I myself, ‘If you had more practical. It would
think it’s something that is have been very hard to
suitable for me, but at the the choice between choose between those two.
Guy Spier same time the world of
investing is broad so you either Oxford/HBS Then I sometimes ask
still want to find a niche or a myself, ‘If you had the
place in it that suits your and the education choice between either
own particularities. Oxford/HBS and the
that you get around
education that you get
Five years ago I asked Warren Buffett, around Warren Buffett,
Warren, ‘Berkshire Charlie Munger, Ben
Hathaway is structured a bit Charlie Munger, Graham, etc.’ I think hands
like the starfish versus the down Charlie Munger, Ben
spider?’ The idea is that a Ben Graham, etc.’ I Graham and all of that is
starfish, if you cut off a leg, much better, for me at least.
it regenerates. A starfish is a think hands down
decentralized organism and At Oxford, for example, I
a spider is not – you pick off Charlie Munger,
studied the Rudi Dornbusch
a leg and it doesn’t grow Ben Graham and all exchange rate overshooting
back a new leg. model. It’s a beautiful thing
Decentralized organisms are of that is much and it might describe some
more resilient to having measure of reality. But it’s a
their legs cut off and better.” very powerful idea that
Berkshire Hathaway is the grabbed hold of the whole
same way. It’s very resilient of academic economics, this
as opposed to a command idea that you could solve
and control organization. I G&D: Can you talk about equations representing the
asked Warren, ‘That’s really your background at Oxford economy through time by
smart. Did you figure that where you studied assuming rational
out twenty years ago?’ And philosophy, policy and expectations, which is now
he said, ‘No. I absolutely economics? Did that affect an important part and parcel
had not figured any of that your investment of the neoclassical model of
out. Berkshire Hathaway is methodology or philosophy? economics. Now you’ve got
the way it is because it suits a way of moving things to
me. It suits my particular GS: I was lucky enough to equilibrium through time
personality.’ I don’t know if attend both Oxford even if people don’t know
he actually said it, but he University and Harvard what the outcome is
clearly implied that if he had Business School. But I because somehow all the
Jack Welch’s personality and sometimes ask myself which actors in aggregate are
abilities and internal wiring, I would have chosen if I moving the market price to
Berkshire Hathaway would could only do one. Two their rational expectation of
have looked very, very very different educations. (Continued on page 5)
different. So why investing? I
Volume
Guy Spier
(Continued from page 4) things aligned right I could Intelligent Investor – Mr.
what it should be. make billions and live this Market, things having
incredible life.’ And many intrinsic value, stocks
I think that it handicapped people who do value representing part interest in
me in a profound way. investing end up living these businesses – are fantastic.
Because there I was at incredible lives. And we live But I was in a position ten
Harvard Business School long lives is what we’ve years ago not to charge a
and Warren Buffett shows figured out. We know from management fee the way
up and I have no interest in Warren Buffett that it’s not Warren Buffett did, but I
him. I also have no interest was charging a management
in the financial markets fee. Why on earth was I
because in my rational doing that? I don’t know
expectations view, there are how many years ago I met
no dollar bills on the “It took me a long Mohnish [Pabrai]. He was
ground; they would have not charging a management
been picked up by this time to figure out fee. I was an example of the
spectacularly efficient guy sitting on the other side
market. Now I’m sure I that my job is not of the road at the gas
learned plenty at Oxford station. You know the Tom
and at HBS, but I don’t think
to be Warren
Peters story? Mohnish talks
they helped me much Buffett or to be Bill about cloning and seeing
professionally. I’m sure I’m a whether people are willing
better human being but they Ackman. My job is to clone or not. I’m sitting
did not help me with there, laughing at all those
investing, I don’t think. And to be Guy Spier.” idiots who don’t clone. At
I don’t know one person I some point I realized, ‘Wait.
studied with who even I’m the guy on the other
understands what I do or side of the road who is not
understands the basic got to do with intelligence - cloning what is obviously
philosophies of value he says some people get it, working.’ There are so
investing. They just think, some people don’t. many things that I lost time
‘Whatever. He’s just a with and didn’t learn
finance guy.’ I got it, but my God, have I because I had too narrow
strayed from the path in so an understanding of the
G&D: Not even David many different ways. I had wisdom that was to be
Cameron gets it? such a narrow imparted.
understanding of the
GS: David Cameron is a wisdom that Warren Buffett G&D: You went straight
very, very, very smart guy had to impart. If my from being in investment
and he understands British investment career is the banking to managing money
politics and understands only thing we’re talking raised from friends and
what can and cannot be about, I definitely lost at family. What caused you to
done with Britain in a way least five years, perhaps do that?
that I could be living in more, getting started on it
Britain 100 years and not because my head was filled GS: A few things. It took
understand. But we with all these ideas of me a long time to figure out
underestimate how many efficient markets. But I’ve that my job is not to be
people have any clue about lost more time by not fully Warren Buffett or to be Bill
the way we feel, which is, learning the lessons that are Ackman. My job is to be
‘Oh my God. This is so available there for all to see. Guy Spier. I’m not going to
exciting. There are market do a very good job of being
inefficiencies that I can The basic tenets of The (Continued on page 6)
exploit. If I just get a few
Page 6
Guy Spier
(Continued from page 5) If the first tier is Morgan guy that I should not have
Bill Ackman or being Stanley, Goldman Sachs, associated myself with, and
Warren Buffett but I’m Credit Suisse, globally in finance especially, your
going to do a damned good recognized brand names and associations count. People
job of being Guy Spier, then you have a second tier don’t have the time, the
better than anybody on the of Robert Baird and energy or the interest to
planet. Associates and regional really dig deep to find out if
investment banks. Then you this is a good guy or not.
Everybody’s path is unique have this third tier doing You don’t have to get
and I think it’s really, really things like taking penny yourself burned. If you see
“Something I important that we find our stocks public or venture there’s smoke you don’t
own path. If I look back at investment banking where have to put your hand in the
believe quite the path that I took, there you would take a company fire. The good news is that
are many mistakes that I that didn’t have any earnings when you make mistakes
strongly is that if made. Many things I would and take it public. After I you want to make them
have done differently. But joined, I discovered that early. You want to make
you want to that’s yet another thing we there were people engaging those mistakes when you’re
have to learn, to own our in practices which were on 25 and not when you’re 40
understand who an path with its mistakes and the borderline of legal. In or 50 or 60.
investor is, you need to be accepting that every fact, five years after I left,
single person has massive the SEC shut down half of In my case, I was very
to understand their mistakes in their path, and the firm. I knew that to go interested in this investing
that’s part of life. and join Goldman Sachs I stuff. I started putting
relationship to would have been a glorified together mock portfolios. I
Leaving business school, I photocopier or something met some great people on
money in general, had this pristine resume. I’d like that. I didn’t care what the way, Carley Cunniff was
worked for a consulting brand name I had, I wasn’t very generous. That’s when
their relationship to
firm, had a great doing that. I was doing I started going to the
the money that undergraduate degree, something real. That said I Berkshire meetings. I didn’t
Harvard Business School should have left that place know anybody, but just
they specifically and I wanted to throw up all three months into it started showing up. Then in
over anything that had to do because it was a snake pit. my case what happened is
manage, and what with the establishment. I that my father notices this.
just had no interest. I did What happened to me, and There’s a family business in
the money means not pursue interviews with again I’m just describing my London trading agricultural
Goldman Sachs and all of path, was I was reading all chemicals. He had made
to them.”
those people. Which I think sorts of books. I pick up The some money and he started
was a mistake. I was feeling Intelligent Investor and a light investing that with me.
rebellious and had to break goes on in my head. An aha! From my father’s
out of these straight and moment happens and now perspective he wanted me
narrow tracks. However, I I’m applying for jobs as an involved, whether
think that there’s so much analyst doing what you guys consciously or
to be said for being on the do, except that I’d gone to subconsciously, he realized
corporate bandwagon for a work for DH Blair. I was that by getting me to invest
while and not getting off it interviewing with a number the family wealth he was
right away. of places but I wasn’t having getting me back involved. I
an easy time of it and these didn’t realize but at that
I started working for a guy question marks arose. I point, on some level, I had
who was also a graduate of made a very, very, very bad re-joined the family
Harvard Business School judgment call in terms of my business.
who had his own banking/ own personal reputation. I
investment firm, he was had associated myself with a (Continued on page 7)
very solidly in the third tier.
Volume
Guy Spier
(Continued from page 6) different people. people just go, ‘You know...
G&D: How did you feel Warren owned Coca Cola
comfortable starting out on I don’t understand some during the period when
your own and managing peoples’ approach to Doug Ivester was messing
close relations’ money? money. I don’t understand up completely but it didn’t
why they love it so much. get under Warren’s skin.’
GS: My father is the kind of Now contrast that with People had to practically
person who doesn’t do somebody that we all know read the Riot Act to him
things half measure. He pretty well—Mohnish. before he acted to remove
doesn’t say, ‘Here’s 10% of Mohnish is on record as Doug Ivester. You have one
my wealth and if you do saying that his dad went extreme there and then you
well with it I’ll give you bankrupt a number of times have Bill. I think
another 10%.’ He dumps all so he’s very familiar with understanding those
his liquid wealth on me, having money and not personality traits and
which was pretty much having money. And he’s very realizing they are “The investors that
everything, which instantly familiar with seeing how his unbelievably idiosyncratic in
made me unbelievably risk parents were unchanged each one of us is really we appreciate and
averse because I knew through that. His core important to do.
exactly what I was dealing family circumstances actually do well somehow
with. Then again, I’ve gone didn’t change that much. He G&D: Clearly you’re
back and said to myself, ‘If has a much lower fear of heavily influenced by
have found a way
he would have dribbled it loss of money I think Benjamin Graham and
out to me, I think I would
to reflect their
because of that. The other Warren Buffett, value
have been much more thing is when he started investing legends. But what inner life in a very
willing to take big gutsy Pabrai Funds it wasn’t Guy’s do you think sets you apart
bets.’ In that period I had dad saying, ‘Here’s some from those guys that gives fundamental way in
really great investments. money that I’ve made. Invest you an edge in investing?
One was Duff & Phelps it.’ It was Mohnish having their investing
which is one of the credit sold his business and taking GS: I’m dumber. The
rating agencies. It’s now part a portion of that and Aquamarine Fund is open
moves.”
of Fimalac and that was a investing it. That again is a but I’m not really trying to
7X over three or four very, very different raise money and it’s a
years, just a wonderful, psychological relationship to wonderful release because I
amazing situation, but I money and I think that don’t care about
didn’t invest very much. I drives a huge amount of distinguishing myself and
was scared stiff. One thing investment behavior. differentiating myself and all
that I’m adamant about is I’ll of those things. Warren
leave with one track record I would love to do the Buffett has a 180 IQ, maybe
and all of those things go analysis on Bill Ackman on higher. Mohnish has a way
into the track record. that front. I don’t have higher IQ than I do; it’s 160
enough information, but Bill or more. If you ask me, I
Something I believe quite I think, like me, came from think Mohnish’s IQ is not as
strongly is that if you want an environment where high as Warren’s but I tell
to understand who an there was established you they’re both streets
investor is, you need to wealth. For Bill, money, it ahead of me. Warren runs
understand both their seems to me, is the around saying that you don’t
relationship to money in opportunity to play out stuff need a high IQ, he’s just
general, their relationship to that on some psychological being nice. Having a high IQ
the money that they level he cares about. really helps. He says it’s
specifically manage, and Misgovernance in the better to be sensible than to
what the money means to companies that he follows be super smart – he’s
them. Money means very gets under his skin. Some (Continued on page 8)
different things to very
Page 8
Guy Spier
(Continued from page 7) Buffett has deep respect for particular commodity. I
absolutely right. But if you John Bogel. In many ways never thought that I would
can be sensible and super John Bogel is not an understand banks and I
smart that is definitely investor; he’s just a guy who know that I nailed banks
better. runs a machine. two years ago but it was
really specific—large
The investors that we G&D: How do your American money center
appreciate and do well personality and your life banks were unbelievably
somehow have found a way experiences manifest underpriced and a really safe
Pictured: Bill Ackman and to reflect their inner life in a themselves in your investing place to put lots of money.
Louisa Serene Schneider at very fundamental way in
the Omaha Dinner in May decisions? What do you
their investing moves. At look for? People jeeringly said to me,
2013.
the end of the day, every ‘You don’t understand Bank
successful investor ends up GS: I don’t like situations of America’s balance sheet.’
differentiating themselves on where there’s a lot of public I’d come right back and say,
the unique aspects of their controversy. I get ‘Neither does Brian
personality and who they particularly scared when I Moynihan but it doesn’t
are. I’m not trying to be the see very smart people on matter.’ I think that what’s
best investor. I’m just trying both sides of the equation. I interesting is I have a much
to be Guy Spier. If you give know that I’m much more better sense of when
me a path in life that comfortable in a place something is in my circle of
involves higher returns to where people just aren’t competence and I’m much
my limited partners and/or paying attention. That feels more willing to define stuff
high returns to me, but it much, much better to me. I outside of my circle of
makes me less Guy Spier, I figured out I know competence.
wouldn’t take it. So in a absolutely nothing about
certain way I guess I retail, that retail is just a In reverse engineering the
disagree with the premise of dumb place for me. I’ve Berkshire Hathaway 13-F
the question, which is I’m realized that it would not be filing, one of the positions
different to all those smart for me to invest in they have is a company
investors because I’m Guy the healthcare sector, but I called VeriSign. VeriSign is a
Spier and I’m not Ben think I can get through life beautiful, beautiful business.
Graham and I’m not without investing in the It’s probably not cheap but I
Warren Buffett. I shouldn’t healthcare sector. never thought that a
try to out-Warren Warren. company that is in the tech
G&D: Which industries space would be within my
To compare myself to any attract you more? circle of competence. I gave
of those other people is a up doing the work because
very dangerous thing to do GS: The core home base it’s too expensive and
and probably not helpful for me is branded consumer because allocating one’s
actually. But they are all goods. It’s really hard to find time to the stuff that’s
smarter than me and they’re something that’s super cheap rather than spending
all better investors and attractively cheap but I just all this time studying great
that’s okay. I’m comfortable know that I’m on safe businesses is smarter. But I
with that. It’s about being territory there. I actually think I would have been
the best version of yourself. now feel I’m in a lot safer ready to define VeriSign as
That may be investing in low territory in terms of natural being within my circle of
cost index funds because resources. They have to be competence.
that’s where you’re at in the lowest cost producer,
terms of your ability to for example, and we have to G&D: Would you by any
analyze and your understand the supply and chance be willing to discuss
relationship to money, and demand dynamics of a (Continued on page 9)
that’s perfectly fine. Warren
Volume
Guy Spier
(Continued from page 8) lot to lose you can counter- This is a huge cost to
any current ideas you have? sue each other and you can American industry. On the
say, ‘If you’re going to get one side they’re hated by
GS: I will tell you that, me on violating this set of people like Apple and the
where I am right now, I patents I’m going to get you other large companies and
have not found something on others so why don’t we on the other side they’re
that I want to put in the just call it a day? You get on the champions of inventors
portfolio for quite a long with your business and we’ll who often feel they’ve been
time. There’s been quite a get on with ours.’ This is screwed over by big
dry spell; it’s not like we’re what usually happens. industry. What Reciprocal
not looking. I’m happy with Patent Exchange does is
my portfolio the way it is so Then there are these things they go to all these
I haven’t done a lot recently. called patent trolls. They companies that are basically
I’ll tell you one that I just sue people for settling at the court’s door
rejected, but I think it is an violations of patents and or they’re paying these “The idea that
interesting business and is collect some kind of companies to go away and
such a puzzle. reward. If I’m a patent troll, they say, ‘Why don’t we we’re managing
I will acquire a pool of pool our resources?’ To cut
The one that came up was patents from somebody and a long story short, it’s some finely tuned
Reciprocal Patent Exchange haul Apple into court and I fractional ownership of
(RPX). So I was introduced machine is just not
say, ‘You’re violating this set patents. Like fractional jet
to the whole world of of patents.’ I didn’t invent it, ownership, fractional patent the case. I’m just
intellectual property. First of and I don’t have a business ownership. You pay a
all, IP is a big deal. What I off it, but I own the IP. The subscription to us, we’ll trying to get it right
learned is that 200,000 or law is if you own the IP, acquire all this IP and you’ll
300,000 patents get granted you’re the inventor. The never get sued on account 55% of the time or
every year and nobody problem that Apple has is of this IP. It doesn’t take
completely knows what the Apple has to go and defend away the legal risk entirely, get it slightly better
patent covers or doesn’t that. Now if I was some but it massively reduces the
cover. But in the US and 55% of the time.”
other operating business legal risk and they now have
Western countries, the Apple would say, ‘Let’s sit much more buying power
policy is, we grant people down and talk. Let’s see because it’s on behalf of all
patents. A patent lasts 25 what you’ve got. Let’s get of their clients and they
years. What does that some arbitration, we don’t have something like 200
patent give you the right to really want to go to court. clients. It is a really
do? It gives you the right to We can see you’re a small interesting business and it’s
pull somebody to court and business, you’re trying to cheap and they generate
say, ‘You’re violating my grow this division. Why massive amounts of cash.
patent.’ It’s an interesting don’t we buy a whole bunch Really, really interesting, but
right and it becomes a lot of stuff from you? Why at the end of the day I put it
more interesting or don’t we license you?’ in the ‘too hard’ pile.
uncertain when you realize There’s some kind of
the scope. At the end of the business arrangement that G&D: What about Fiat,
day a judge has to decide settles it out. Not with the would you be comfortable
was the patent being patent trolls. The patent discussing that investment?
violated or not? What trolls say, ‘We don’t have a
happened with Apple versus business. We are secure. GS: What I’d say about Fiat,
Samsung is extremely You can’t sue us for I don’t want to talk too
unusual because what anything but we can sue you much about it because of
happens is like nuclear for that.’ So at the end of commitment, consistency
warfare between two the day Apple settles. and all of those things but it
countries, when you have (Continued on page 10)
two big corporations with a
Page 10
Guy Spier
(Continued from page 9) about the money being facts change I change my
really is an interesting made or lost. They cared mind. What do you do?’
situation. What I think is about saving jobs. You want to be in a position
interesting about Fiat is that to do that. The more
what the Italians and the I think there is space on the people who know what
Europeans see is some also- planet for one Italian brand. your opinion is on Fiat, the
ran European automobile We have four or five less easy it is to change your
manufacturer. They see a German brands, global mind. Dangerous stuff.
Pictured: Rahul Raymoulik, company that is a much German brands. The only
Richard Hunt, and Stephen smaller automobile company that has a chance G&D: How do you make
Lieu at the 2013 Pershing manufacturer with sales of being a global automobile your sell decisions?
Square Challenge. skewed to Southern brand from Italy and not just
Europe, which has been in the high end like Ferrari is GS: Very badly. The idea
much worse hit than Fiat. Chrysler does an that we’re managing some
Northern Europe. They amazing thing for Fiat. Fiat’s finely tuned machine is just
don’t have a clue what business has already not the case. I’m just trying
Chrysler is but people here improved dramatically to get it right 55% of the
in the United States because they now have the time or get it slightly better
understand that Chrysler is ability to allocate costs and 55% of the time. What has
a substantial business, they production around the worked for me is first of all,
have some blockbuster planet. do not touch the portfolio
brands, and it has a real unless you have a clear
franchise value. But they Fiat used to be very heavily reason for action. One of
can’t invest in Chrysler under the thumb of the the things that I do is I don’t
because it’s all owned by Italian government and want to look at the
the VEBA, this voluntary Italian unions. Now Fiat can portfolio too often. I know I
employee benefits say, ‘Yeah, we’re will perform better if I can
association, and Fiat. I think headquartered in Turin but do this.
that is one of those unusual we don’t have to
situations. manufacture cars in Turin. A lot of the time what
We’ll produce them in happens to me is I’m
The whole way in which Fiat Brazil and we’ll import them cleaning positions out for
acquired Chrysler is very to you...’ Chrysler has given something else. I look at the
interesting. Sergio them a global base from investment more as a
Marchionne, the CEO of which to really allocate source of performance or as
Fiat, comes to the production across different a source of cash. When I
negotiating table. They’re factories. I think that takes have a great new idea I’m
close to doing a deal for an three or four years to play saying, ‘Where am I going to
undisclosed sum of money, out. raise money for it?’ and I
but the day before Barack will sell the thing that I
Obama says, ‘we’re going to I got the permission from believe is the least
save Chrysler as well.’ So the people I did the work undervalued or the least
Sergio says to the people with on Chrysler to talk to likely to contribute to
negotiating on behalf of the Forbes about it but I think performance going forward.
government, ‘Do you really that for me, investment But I’ve been surprised a
want to go back to your theses are fragile. I don’t number of times by things
president and say that want to say what I just said that I’ve had in the portfolio
actually there is no deal and too many times; the more that have gone up anyway. I
what the president said to times I say it the more will tell you, an experiment
the American public isn’t difficult it becomes should I that is really worth running
true? It’s that or you’re want to change my mind. is to pick portfolios by darts
giving it to us for free.’ The Keynes said, ‘When the (Continued on page 11)
US government didn’t care
Volume
Guy Spier
(Continued from page 10) to me made that I from the sugar and sweets
or by any other system and understand, and am I to the meat and potatoes.
then you just leave those repeating these mistakes? Sugar and sweets is most of
portfolios alone, and it’s It’s a bit like the common the stuff that comes up in a
often only one or two law. You’re not trying to Google search. It’s designed
companies that provide talk in generalities. You’re to get that instant response.
most of the performance. I saying, ‘I remember when I Meat and potatoes is down
think that meddling just invested in EBC oil and in the 10-K. Reading the 10-
ends up reducing returns so someone in management K or reading something
I really try to leave it alone was going through a divorce that, because of the process
until there’s a compelling and it really messed up the through which it went
reason for action. investment. Is anybody here through – e.g. in the case of
going through a divorce I the 10-K, legal checking by
I’d like to be optimal, I just need to know about?’ I lawyers – to make sure the
don’t know how to be remember when I invested claims being made are
optimal. I have two barriers, in Lab Corp of America it correct. That’s where we
or two difficulties, in doing was over-leveraged. We really want to start. Then
that. One is I don’t actually “What has
didn’t realize it was over- once we’ve got the solid
know if the conclusions that leveraged. It was a great diet, the meat and potatoes,
I’m drawing are accurate business but the investment we can move on to the
worked for me is
conclusions. I don’t know if went down by 80%. Is that sugar and sweets. But if we
the information that I have the case here? That’s allow the sugar and sweets
first of all do not
is the right or the full and definitely one thing. in first, there’s no space for
complete information or the meat and potatoes and touch the
whether I have enough I will tell you that other we know that what comes
information. I don’t know if things I’ve picked up from into our brains first affects portfolio unless
I’m analyzing it correctly. Mohnish that are just smart us massively. If I favor the
Then there’s overcoming moves. Don’t buy when the meat and potatoes sources you have a clear
my bias towards inaction market’s open. Don’t trade of information before other
and overcoming all the when the market’s open. I sources of information, over reason for
personal psychological don’t like to talk to the a lifetime of decision-
biases about endowment traders. I just want to send making, my decision-making action.”
effects and all of those them an e-mail. I don’t want will be a little bit better and
things - fricking nightmares. any feedback from the that little bit better is what I
market or any of those need.
G&D: I think there’s an things.
investor presentation I Another simple thing is how
looked at that had a litany of Sequencing the information one communicates with
biases that humans have in that I get is another way. A management, which is part
decision making. So what do sales person will get in of this information diet idea.
you do specifically to make touch and say, ‘Hey, I want Company visits are a very
sure you don’t fall prey to to call you up and talk about dangerous thing. I haven’t
those biases? something.’ The standard done a company visit in
response is, ‘Please put it in quite a while, but my goal is
GS: Suffer. writing.’ Make people not to make a buy or sell
submit stuff to you in decision within three days
G&D: And use a checklist? writing first because we of visiting a company
know that we’re less biased because there are all sorts
GS: That’s a great one. A when we get the of influences.
checklist is a very personal information in writing.
thing for me. It’s what For instance, a company
mistakes have I made, what Our information diet goes (Continued on page 12)
mistakes have people close
Page 12
Guy Spier
(Continued from page 11) cost of production and ‘I’m trying to find out about
called Quicksilver some wells are lower cost Quicksilver,’ or ‘I’m trying
Resources. I’ve no idea how and obviously you decide to find out about RPX.’
and why it came onto my where to go based on those Instead say, ‘I’ve been doing
screen. Another reject. costs. I knew I didn’t have some work on RPX. Looks
Very good reputation, family to go any further. like an interesting business.
controlled, natural gas, Here are three articles that
making a lot of money on The other thing that I would I think are the best articles
their hedges. I e-mailed the say is unbelievably critical is I’ve found. Here are some
investor relations guy and to have relationships with links. Here are some of the
he said, ‘I’m happy to get on the right people. How does things that I’ve learned but I
the phone and talk to you one practically do that? I would love to see if you
about the company.’ I said, think that this really works; might be willing to
‘That will be great. But if somebody I know is not a contribute to my knowledge
before we do that, I just healthy influence on me for or point me in the right
have two questions. Maybe decision-making, I’ll respond direction.’ It’s giving value in
you have an e-mail answer to their e-mail three or four the e-mail at the same time
for me which would be days later. Maybe I’ll leave it as asking for something. If
quicker.’ Again, wanting to in my inbox for a month. So anything, you develop your
have the written they’ll get a response, but network.
communication before the I’m simply prioritizing and
verbal communication being mindful and conscious G&D: Honestly, as a
because I know this guy can about how and why I’m student you get an almost
sell the pants off me. ‘I’m prioritizing. 100% response rate.
having trouble
understanding how you have In fact, take the people with GS: I would still develop
been so successful at whom one can have healthy the habit of adding value to
hedging over so many conversations and write them and not just saying ‘I’ll
years.’ The price at which them a thank you note be really grateful to you and
they’re selling the natural every now and then or send happy to do something for
gas is at $2.60 or $2.70 but them something or find a you in the future.’ What
it’s coming in with the reason to deepen that you’re doing is building up
hedges at $5. But if you’re relationship, even if it’s just your analyst franchise. In
doing that year after year a little bit. Over a short five years’ time you want to
after year these hedges period of time there’s no be in a place where there
must cost a lot of money obvious change but over a are so many people who
and I just couldn’t figure out long period of time that can just love you because every
where the cash was coming make a massive, massive time you have had a
from. And I said, ‘Could you difference. conversation about some
tell me what your all-in cost company you have found a
of production is?’ No G&D: What other ways way to add value back in
response. That shouldn’t besides through your their lives. Your information
take more than a paragraph network do you find the flow will be that much
to answer. My conclusion right contacts? better than other people
was that their cost of who weren’t doing that.
production was way higher GS: Something I’ve tried You don’t have much of a
than they’d like it to be. If without much success, but way to distinguish yourself
you’re doing anything, if is really interesting, is now from many other
you’re half doing stuff right, LinkedIn. So pull up the people but over five years
you know that number and company, see who’s that makes a big difference.
you’re trying to allocate connected to it, e-mail 20 How did I learn this?
resources based on it people. But don’t just say, (Continued on page 13)
because some wells are high
Volume
Guy Spier
(Continued from page 12) idea from Robert Cialdini, and the average person in
G&D: Mohnish Pabrai and right? my set of friends is
the practice of cloning? incapable of giving it the
GS: There’s a huge amount attribution it deserves.
GS: What’s so beautiful of wisdom there. I told They’ll say, ‘You’re lucky.
about cloning is that it’s not somebody 10 years ago, ‘I’m You’re smart. You’re in the
mutually exclusive. The writing 20 thank you notes a right place at the right time.’
more you do it, it’s helpful week.’ And they say, ‘How And I’m like, ‘No, no, no.
for the whole community ridiculous. Who are you It’s because I was doing Pictured: Mario Gabelli ’67
and enough of humanity will writing thank you notes to?’ Cialdini for the last five speaking at the 2013
never do it. I’m at the I say, ‘The doorman, years. You can do it too.’ Omaha Dinner.
Berkshire meeting with anybody I can put my hands You know, in some way that
Mohnish and all of these on really, the person who is even more surprising to
people are coming up to served me at the shop. You me than value investing
him. He has spent the last name it, left, right and because value investing is a
twenty years making people center.’ They’re like, ‘How’s very narrow thing. All we’re
feel glad that Mohnish that working for you? Have talking about now is a
Pabrai’s on the planet. In you seen any changes?’ Not strategy for anyone to
small ways and in big ways, really. They say, ‘What a improve their lives. Finally,
just doing it as a habit. So if dumb idea.’ I say, ‘Well, the after ten years of being
you’ve been handling people doorman was really nice to married and five years of
right for 20 years, you me this morning.’ doing this, my wife gets it.
become a very real asset to
whatever business you’re a So say I’m writing thank you As you can see, in a certain
part of because you’re just notes like that and I attend way I’m more enthusiastic
going to get lucky more the Pabrai Fund Annual about this than value
often. I’ve experienced that Meeting and I write him a investing. Having read Ben
over the last five years. I’ve thank you note, one of Graham would not have
gotten luckier with people twenty I wrote that week, helped me if I was a poor
more and more often and but that may have been the boy in Bangladesh, but this
it’s just a lovely thing. I had only thank you note Cialdini reciprocity stuff is
to realize I was not put on Mohnish received from the much more basic and would
earth to help Guy Spier. I meeting he held in Chicago. have helped anyone.
was put on earth to help And when he was in New Warren has this famous
humanity. York for some reason he saying about how he was
had the idea to call or to e- very lucky as to where he
I’ll give you an example. Bill mail me and to say, ‘Would was born. If he was born in
Ackman got into doing this you like to get dinner?’ Bangladesh those good
a year or two before me. I These simple changes in business practices wouldn’t
knew him; he was a year behavior make such a have made a big difference.
above me in business massive difference because
school. They had offices in at the time my derisive It’s like Wal-Mart. Sam
245 Park Avenue and he just friend is asking me how my Walton figured something
said, ‘Come here, use relationship with the out with Wal-Mart: stack it
Bloomberg, spend as much doorman is going, the thank high, sell it cheap, keep
time as you like. Really you note to Mohnish Pabrai delivering massive value to
happy to have you here.’ I hadn’t been written. the consumer, always give
remember that and I would them better value than they
leap at the opportunity to I’ll tell you something else. can find elsewhere, work
help him out in some way if It’s made me more really hard to negotiate with
he asked me to. successful that the average your suppliers to give
member of Joe Q. Public (Continued on page 14)
G&D: Mohnish got that
Page 14
Guy Spier
(Continued from page 13) people that you want to get to be in the room with you
[customers] great stuff at close to? The first natural to mentor to you.
low cost. Who would have response is, ‘Nothing.’ But
thought that piling it high we can. First of all, thanking Before our meeting with
and selling it cheap would people. Every human being Buffett, we sent our bios
have developed into the wants to feel thanked. We over. I sent this bio, ‘I grew
amazing business franchise were there to say thank you up in South Africa and
that Wal-Mart is now. and we were there to Israel, lived in London, and
Where I started off on this appreciate him, not just moved to the United
little reverie is that we can some idiot on the street, States.’ My wife Lory, the
do the same things. I can’t but as people who had only thing her bio says
be Wal-Mart and I can’t be studied him really closely. pretty much is ‘born in
Sam Walton but my God, I Salisbury, North Carolina.’
have the tools to develop a I sent my most recent Warren had no interest in
“My goal is not similar unique Guy Spier annual letter to Debbie the fact that I’d lived in Iran,
franchise just by getting Bosanek. Here’s what I said Israel, whatever, but he
to make a buy or mind space and getting to Debbie. I said, ‘Debbie, liked the fact that Lory grew
people to feel a certain way there’s no wisdom in here up some place. That’s his
sell decision about me. It’s just caring Warren’s going to glean, mind-set. He’s not just an
about them, caring about nothing about the world American guy; he’s a guy
within three days the outcomes in their lives, that he doesn’t already from the American mid-
and figuring out a way to know, but I think he might west and he knows what he
of visiting a help them. That’s the ideal, enjoy seeing what a likes and he likes what he
actually helping them, but powerful impact he has had likes and he’s not interested
company the second best is to let on me. This thing has got in experimenting very much
them know you would have ‘See what Warren Buffett with other stuff.
wanted to help them. That’s
because there effectively what a card does.
inspired me to do’ written
all over it and he might The starfish and the spider
I have a rule—every single enjoy it on that level’. that I talked about was
are all sorts of person who sends me a job really an awakener for me.
application gets an e-mail I think the mentors that you It was not just what he said,
influences.” back. It’s particularly and I want, we can’t but the way he said it
important for people who necessarily spend every day because he knew exactly
apply as analysts because with because they don’t where I was coming from. In
they’re likely to go on and have time and you may not a certain way he was
do great things so I want know them and they may teaching me a really
them to like me. I want to not even be alive. So important lesson. ‘Don’t try
help them. studying them really closely to build the best business
to get a good sense of the you can build. Build the
G&D: Could we talk about answers they would give to business that suits you the
the lunch you had with the questions we have is best. Build your life in a way
Buffett? Can you give us totally the right track and a that suits you.’
some questions that you very, very smart thing to do,
asked him and were you especially with people who Realize you only have one
surprised by any of the are not alive. What would life to live on the planet.
answers to his questions? Shackleton say? What would ‘Yeah, Berkshire Hathaway
Ben Graham say? What is this wonderful big
GS: One of the things that would Franklin say? You can company, but it suits me.’
Mohnish did is he set the go to Seneca. You can go to That’s the most important
tone of the lunch in the Marcus Aurelius. They’re all thing about Berkshire to
right direction. We were available the minute you Warren. So in a certain way
there to say thank you. drop the idea that they have (Continued on page 15)
What can you guys give the
Volume
Guy Spier
(Continued from page 14) she is that she doesn’t mind don’t know. I don’t think
I came away with a renewed being perceived as Warren Warren could be who he is
appreciation of how unusual Buffett’s assistant. She’s so if Debbie wasn’t who she is.
Warren is. Given the choice
between building a bigger Something I’ve learned is
Berkshire and building a that to say I have a
Berkshire more suited to relationship with Warren is
him, or building a Berkshire “In five years’ to say he knows who I am.
with higher returns, he But if I want a good
takes the Berkshire more time you want to relationship with people like
suited to him. He said, Warren, the key is to have a
‘We’re not going to make be in a place good relationship with their
any decision that would get assistant. And it’s not trying
us more money if it means where there are to manipulate them into
we lose one night of sleep.’ doing right for you. It’s
That’s effectively saying, ‘I
want this to suit me. I don’t
so many people really genuinely caring about
who they are, caring about
want to be the best, biggest, what their job is, and trying
fastest.’ who just love you
to help them to do a good
because every job for the guy that they’re
That’s just a profound working for. When you get
insight and I can tell you it’s them as allies it’s a huge
scary for me to stand up in time you have amount of fun and joy. I
front of my investors and don’t even address anything
say, ‘I’m not trying to have had a to Warren anymore. I
the highest possible returns. address it to Debbie. I say,
I’m trying to run this in a conversation ‘Dear Debbie dot dot dot.’
way that fundamentally Or I might say, ‘Warren
really suits who I am.’ Half about some might want to see this, but
your investors leave the only if you’re printing it out
room. company you for him and giving it to him
at the right time when he’s
I’ll just give you one final have found a not busy, when he’s ready
thing. We talked about the for a bit of a laugh.’
limits to the size of way to add value
Berkshire. For some reason G&D: Guy, thank you for
we haven’t had a company
that’s broken through a
back in their your time.
trillion dollars in market cap

and somehow that seems to lives.”
be the limit to size. The
fierce pride with which
Warren asserted that much more than that. She
Berkshire wasn’t subject to knows everything that’s
that was fascinating. going on. It’s impossible for
Warren to function if she
G&D: What did you learn doesn’t. She’s a repository
from Debbie? of a huge amount of
knowledge at Berkshire
GS: Let me tell you how Hathaway. She’s a
special a person Debbie is. repository of many things
She’s somebody who’s so that managers at Berkshire
self-confident about who
Page 16
Homex (9.75% Sr. Guaranteed 2020 US$ Notes) - Long @ 36.94 (5/28/13)
Peter Bowley
PBowley14@gsb.columbia.edu
Peter is a second year MBA

student participating in the
Value Investing Program.
During the summer, he
worked at Perry Capital
researching high yield and
distressed debt Recommendation:
opportunities. Prior to BUY Homex (“HMX”) 9.75% Senior 2020 Notes. Even assum-
Columbia Business School, ing aggressive down-side scenarios (30% of face tender offer/
he worked at a farmland restructuring or liquidation), making money (on prob.
investment fund based in weighted avg. return basis) requires only a 5% probability the
Argentina. Peter holds a BS notes remain performing. I estimate this probability as at least
from Boston College. 30% due to HMX’s market leadership, relationships with government/domestic and international
banks/suppliers, non-core assets available for sale, Mexico’s significant remaining housing supply defi-
Peter was part of the 1st cit, continued government subsidy support to subsidize housing demand and Mexico’s favorable mac-
place team in Columbia’s roeconomic outlook. Restructuring is a much more likely outcome than liquidation, due to family-
2012 Restructuring Case controlled nature of the company, as well as the significantly larger value of land bank as an on-going
Competition. He was a semi concern versus liquidation value.
-finalist in Origami Capital’s
2013 Global Investment Background
Idea Competition for his HMX is a vertically integrated homebuilder focused on affordable entry-level and middle-income
research on water rights. housing in Mexico, as well as a small operation in Brazil. Its tourism development division targets high-
Peter is co-President of the income foreigners, and its infrastructure division constructs/operates public-private partnership pro-
student-run Commodity jects like prisons. In 2012, HMX operated in 35 cities/22 states, building 46,357 homes (#3 player with
Club. 2.0% market share), 91% in the affordable entry level segment. In 1Q13, HMX had a land reserve of
76.7 MM m2 in Mexico, 2.3 MM m2 in Brazil, as well as 0.3 MM m2 tourism-related land bank and a
The student pitches hotel. Customer price/sale risk has historically been reduced through federally-subsidized mortgages
featured in this issue are a (INFONAVIT/FOVISSSTE) for low-income earners (financed via obligatory payroll taxes), to reduce
selection from Columbia Mexico’s 4.3 MM housing unit deficit (+2.5 MM fed/state/muni. formal-sector employees alone).
Business School's
Investment Ideas Club During 2011-12, leading Mexican homebuilders expanded land banks into 2nd/3rd tier regions. Simul-
(“IIC”). If you are taneously, their horizontal row-house building model generally failed as suburban locations lacked
interested in hearing more transportation infrastructure for residents to reach workplaces. Many homeowners “mailed back
pitches by serving as an IIC keys” (100% LTV purchases from government-subsidized mortgages), turning some developments
judge, please contact Ben into abandoned ghettos. Government payments of receivables to homebuilders slowed significantly in
Isaac (bisaac14@ 4Q12-1Q13 as ministries transitioned for newly elected President Peña Nieto. To address the failed
gsb.columbia.edu) or suburban row-house building model, the government announced homebuilders will be required to
Charles Buaron (cbuaron14 build urban vertical developments (more costly; less land available). These factors created a liquidity
@gsb.columbia.edu). crunch for Mexican homebuilders, including HMX, which burned (MXN$6.1 BN) and (MXN$3.2 BN)
in operating cash flow in 2012 and 1Q13. HMX has MXN$20.6 BN in debt (incl. 1Q13 Inbursa bank
debt), of which 56% is Senior Unsecured notes. In April 2013, HMX breached a covenant on US$70
MM of swaps with Credit Suisse and Barclays (who are taking HMX to court for payment remedies),
as well as on a loan from a Brazilian bank for HMX’s Brazil operations. Both events could qualify as an
event of default for HMX’s Senior Unsecured Notes, including the 2020 Notes. Further contributing
to the homebuilder liquidity crunch, in late-May 2013, INFONAVIT (the Mexican government mort-
gage credit agency; issues 2/3 of housing sales by HMX) was ordered by courts to suspend payments
to homebuilders due to legal actions of foreign/local creditors to the homebuilders.
Volume
Desarrolladora Homex (Continued from previous page)

Investment Thesis:
A. HMX selling non-core assets and focus on cash flow generation: MXN$4 BN sale of prison assets;
MXN$2 BN for debt repayment, MXN$2 BN for working capital; actively marketing tourism land bank
(MXN$750 MM market value); owns 2.3 MM m2 Brazil land bank, a 150 room hotel and 2 airplanes
B. HMX has sufficient liquidity through 2013E, even in a downside scenario: +MXN$2 BN in new work-
ing capital to unlock value from current construction in progress; low capex needs (<MXN$100 MM);
13E debt amort + interest of MXN$3.0 BN; (MXN$1.4 BN) financing gap can be met by non-core asset
sales (high demand for tourism assets as constitutional ban to be removed for foreigners to own beach
front land; large real estate fund believed Brazil land bank could be developed for industrial use).
C. Federal government and domestic banks need top homebuilders to survive: still +2.5 MM home unit
deficit for salaried police/army employees alone; Top 4 homebuilders build +150k new units/year (20% of
affordable homes in 2012); President announced +MXN$7 TN in public infrastructure spending; HMX
CEO has strong relationship with new president and helped get elected, should benefit from new, high-
ROIC infrastructure deals; domestic banks are large creditors to homebuilding sector with symbiotic
relationship (uninterested in foreclosing on land bank/work-in-progress construction creating price col-
lapse; also repackage mortgages into CMBS).
D. Vertical Building Model: Gradual and Subsidized Transition: government mandate for vertical home-
building won’t take effect until 2014-2015; new government subsidy program to guarantee first 30% loss
on new loans for vertical construction (HMX already received US$12 MM bridge loan from ABC Capital/
Cemex); HMX increased to 55% vertical construction in 2012 (from 5% in 2010).
E. Mexico Macroeconomic Tailwinds: balanced budget since 2006; 27% debt/GDP; increased tax collec-
tion and energy/PEMEX reform to drive 13E/14E GDP growth of 3-4% p.a.; May 2013 Fitch upgraded
Mexico to BBB+ (if fiscal/energy reforms passed could go to A-level).
Valuation/Recovery Analysis:
 My liquidation valuation: (i) 70% discount to homebuilding land banks, (ii) 30% discount to tourism land
bank, (iii) 40% discount to other assets, (iv) no value assigned to infrastructure division other than the
prison service operation.
Investment Risks/Considerations:
 Distressed sale of competitor’s land
bank/home inventory: could cause land
bank and housing prices to drop
 Extended suspension of payments from
INFONAVIT: past 3-4Q13 could impair
HMX liquidity (post non-core asset sales)
 Collateral value expropriation in a
liquidation: CEO/family is controlling
shareholder
 Weak bankruptcy laws/institutions:
judgments in pesos; subsidiary guaran-
tees/fraudulent conveyance;
intercompany debt (Vitro case)
Page 18
Wabash National Corp. (WNC) - Long

Adam Trivison
ATrivison14@gsb.columbia.edu
Ticker: WNC (NYSE) Market Cap: $717mm

Current Price: $10.47 (7/19/13) Enterprise Value: $1,088mm
Shares Outstanding: 68.5mm ROE: 51% (FY2012)
Price Target: $14.50 ROIC: 12% (FY2012)
Target Time Horizon: One year EV/EBITDA: 6.8x (Consensus NTM)
Target Return: 40% NTM P/E: 11.9x (Consensus NTM)
Adam is a second year MBA
Wabash National Corporation is a leading manufacturer of truck trailers in the US. Headquartered in
student focused on
Lafayette, Indiana, the company has leading positions in the Dry Van and platform trailer markets, and
investment management.
also has top 3 positions in the market for Refrigerated and Dump trailers. The company's customer
Prior to enrolling at
base is primarily comprised of large trucking fleets (e.g. UPS, Werner Enterprises and Knight Trans-
portation) and large corporations that own trucking fleets (Dillard’s and Safeway). WNC also pro-
he was an investment
vides parts and support for its products through a dealership network. With the acquisition of Walk-
analyst at Mont Pelerin
er Group (specifically its liquid storage business), WNC gained exposure to the chemical, energy,
Capital. Adam holds a BS in
aviation, and food industries.
Finance from California
State University.
Investment Thesis
North American trailer cycle is still in early innings with strong secular and structural
supports: Significant underinvestment by trucking fleets during the 2008-2010 time period has lead
The student pitches
to an elevation of the average truck trailer age to record levels. Currently, the system wide trailer age
featured in this issue are a
stands at near 8 years old, versus an average long-haul life of 10 years. As trailers age, maintenance
selection from Columbia
costs increase and the economics of a new trailer purchases improve. Moreover, the US trailer popu-
Business School's
lation is 10% lower than pre-2008 levels despite the fact that aggregate truck tonnage has recovered
Investment Ideas Club
to (and exceeded) pre-2008 levels. Purchases thus far in the cycle have only served to replace old
(“IIC”). If you are
trailers, thus trailer purchase volumes will need to outpace current levels (and expectations) to grow
interested in hearing more
the trailer population as tonnage continues to increase. Industry organizations currently expect vol-
pitches by serving as an IIC
umes to remain flat at just under the 250k level; the two most recent cycles have had multiple years
judge, please contact Ben
above the 250k level. Regulatory pressures, specifically Hours of Service rule changes and CSA 2010,
Isaac (bisaac14@
are forcing truckers to increase trailer purchases. The compliance date for the Federal Motor Carrier
gsb.columbia.edu) or
Safety Administration’s final regulations governing Hours of Service for commercial drivers was July 1,
Charles Buaron (cbuaron14
2013. The rule changes reduce a driver’s maximum work week by 12 hours to 70 hours from 84.
@gsb.columbia.edu).
WNC management has stated that customers have indicated that they will increase the use of drop-
and-hook activity (i.e. when a driver simply "drops" his trailer at a customer location and "hooks" to
another trailer), which will increase trailer demand. Also, the Compliance, Safety, Accountability
(CSA) program, instituted in 2010, has created incentives for equipment replacement through a scor-
ing system that is partially based on the fleet condition. The environment for truckers is fairly positive
as tonnage has grown consistently since its 2009 trough and diesel fuel prices have stabilized near
$4.00. Increased home building activity has added another vector to the growth of tonnage, particu-
larly in the flatbed segment of the market, in which WNC has a leadership position through its acqui-
sition of Transcraft and Benson in 2007 and 2008, respectively. NTM consensus revenue growth ex-
pectations for public trucking companies sit in the mid-single-digit range and NTM EBITDA growth
expectations in the mid-teens.
Efforts to diversify the business have transformed the firm, creating a more stable cash
flow stream: Historically, WNC’s business has been almost entirely reliant on dry van trailer sales.
Dry van cycles are extremely volatile and, in the past, the Company regularly incurred large losses
during cycle troughs. In 2007, WNC’s management instituted their Next Steps initiative, a plan fo-
cused on diversifying the business and improving operations. Since then, the Company has expanded
outside of their traditional dry van trailer business through organic initiatives and the acquisition of
four businesses. These new businesses create value through synergies that can be broken down into
several buckets, including supply chain optimization, commercialization and distribution of new and
existing products, back office and administrative consolidation. Moreover, these acquisitions and initi-
atives represent significant growth opportunities as they are levered to secular growth drivers (i.e.
fuel efficiency, US energy production). Most notably, the acquisition of Walker Group in May 2012,
gave the Company a leadership position in liquid transportation systems and relationships with a Blue-
chip customer base. Moreover, Walker’s +25% gross margins helped to raise company-wide gross
margins. The acquisition should create more than $10mm of annual synergies over the next year.
Volume
Wabash National Corporation (Continued from previous page)

Profitability will continue to improve as multiple factors drive margin expansion: The Com-
pany has also been more selective in terms of the orders they are taking on, raising prices at a mid-single
-digit rate. Volumes initially decreased with the price taking, but management has stated that they are
beginning to see those customers who initially walked away from the higher prices come back. The price
taking has helped to expand their Commercial Truck segment’s margins from the low single-digits in late
2011 to the high-single-digits in the most recent quarter. Ultimately, Commercial truck margins should
reach the low-teens later in the cycle as volumes and prices continue to increase. Moreover, aluminum
(one of WNC’s primary raw materials) prices have fallen from $0.95 per pound in January to $0.80 in
July. The benefit of the decreased cost should be evident in 3Q12 results. The Company has mitigated its
exposure to wood and rubber prices through escalators in customer contracts.
Competitive Dynamics:
The truck trailer market is an oligopoly (four-firm concentration ~65%). Players in the industry offer
marginally differentiated products, thus only two criteria matter: Price and Relationships. Scale is im-
portant as it drives down cost and allows for profit at market prices, thus all small players focus on a
market niches. The largest players include Wabash Nation Corporation (20% of industry market share),
Great Dane (20% of industry market share), Utility (15% of industry market share), Hyundai Translead
(10% of industry market share), and Stougton (5% of industry market share). Wabash dominates in the
dry van, flatbed, and liquid tank categories, while Utility leads in the refrigerated segment.
Industry Outlook:
Despite popular belief, the amount of tonnage transported by trucks is growing and rail transport is not
a threat to trucking volumes. If anything, intermodal transport will cannibalize rail volumes over the next
10 years. According to the American Trucking Association, Truckload volumes will grow 3.2% through
2018 and 1.1% annually between 2019 and 2024. Less-than-truckload volume should grow 3.5% annually
through 2018 and by 2.4% until 2024. In general, US Trailer fleets are in decent financial shape in terms
of leverage and business outlook.
Valuation:
WNC offers a compelling risk/reward payoff at current levels as the market currently underestimates
future trailer order volumes and thus WNC’s future revenues and profit. WNC can earn an EPS of
$2.50 in 2017 based on mid-single digit revenue growth, gross margin expansion in the commercial trail-
er segment to prior cycle levels of 11%, and lower interest expense as the Company pays down debt and
buys back shares with free cash flow. My price target for the stock is $14.50 based on an 8.0x P/E multi-
ple on 2017 earnings, discounted to the present at a discount rate of 10.8%. The 8.0x multiple sits rela-
tive to historical peak earnings multiples of 6.0x; the higher multiple reflects the high quality of WNC’s
business relative to prior periods. The peak earnings valuation is confirmed by free cash flow valuations
as they produce price targets that bracket the peak earnings price target.
FCF Valuation
In $mm Actual Company Projections Terminal
FCF Calculation: 2012 2013 2014 2015 2016 2017 2018
EBITDA 118.4 168.8 205.6 241.5 271.3 295.2 295.2
EBIT 87.7 129.5 167.6 204.6 235.5 260.3 -
NOPAT 54.8 84.2 108.9 133.0 153.1 169.2 169.2
NWI 116.8 130.9 142.7 151.6 154.7 159.4 -
Change in NWI - 14.2 11.7 9.0 3.1 4.6 -
NFA 132.2 128.9 122.2 115.3 108.2 100.8 -
Change in NFA - (3.3) (6.7) (6.9) (7.2) (7.4) -
Deferred Taxes 64.2 64.2 64.2 64.2 64.2 64.2 -
Change in Deferred Taxes - 0.0 0.0 0.0 0.0 0.0 -
FCF - 73.3 103.8 130.9 157.2 171.9 171.9
FCF Yield - 10.2% 14.4% 18.1% 21.8% 23.8% 23.8%
Discounted FCF - 64.5 84.7 96.4 104.5 103.2 -
Tax Rate 37.5% 35.0% 35.0% 35.0% 35.0% 35.0% -
WACC 10.8% Competitive Markets EBITDA Exit Multiple

PV of yr. 1-10 $453.2 NOPAT for 2017 169.2 EBITDA Multiple 5.0x
Peak P/E Multiple TV at 2017 1,573.5 TV at 2017 1,476.0
2017 Earnings $2.55 TV PV 944.3 TV PV 885.8
Peak P/E Multiple 8.0x Firm Value 1,397.5 Firm Value 1,339.0
2016 Equity Price Tar- Equity Val-
get $20.40 Equity Value 987.5 ue 929.0
Current Equity Value PS $14.56 Equity Value Per Share $14.74 Equity Value Per Share $13.87
Page 20
Active Network, Inc. (ACTV) - Long on 7/21/13

Wes Aull, CPA
WAull14@gsb.columbia.edu
Recommendation:
Active Network, Inc. (ACTV) has significant upside potential
with catalysts in the coming year to realize EBITDA expansion
and improved performance. The main catalysts are reduced
R&D spend, due to end of a new cloud-based platform imple-
mentation, along with improved management after the found-
ers’ overdue departure. Increased EBITDA and improved man-
agement should further catalyze multiple expansion to valua-
tion more in-line with peers. The downside to Active Net-
work’s current base revenue is small due to its leading market
position and competitive advantages (e.g. sticky customer
groups).
Wes is a second year MBA
student focused on Business Description
investment management. Leading provider of SaaS, cloud-based event/organization man-
Prior to enrolling at agement in four activity segments: sports, communities, out-
Columbia Business School, doors, and business. It’s solutions help over 55K organizations
he worked in public process ~90M transactions for 200K+ activities. ACTV’s plat-
accounting, beginning at form provides operations management, analytics, marketing,
BDO Seidman in assurance. registration, and payment tools.
He went on to found his
firm (now Aull & Cooper, Investment Thesis
CPAs PLLC).
Strong Base of Revenue With Leading Market Share in Its Activity Segments, Solidi-
fied by Competitive Advantages.
He graduated magna cum
laude from the University of
Kentucky with a BS ACTV has established customers with multi-year contracts in each of its segments: Sports– Iron-
Mathematical Economics. man, Little League Baseball, USA Triathlon; Communities–60 of top 100 North American park
He also earned his Master’s dept.’s; Outdoors—National Park Service, California State Parks; Business– CISCO Live!, Oracle
of Public Accounting at the OpenWorld, Macworld. 25% of revenue derived from corporate conference platforms, seeking
University of Texas— best in brand. 25% of revenue derived from state and federal government agencies with sticky
Austin. contracts.
The student pitches Customer captivity created because of ease in using existing marketing/operational functionality
featured in this issue are a for event organizers and their end users year-on-year. Database and tool conversion creates
selection from Columbia painful switching costs.
Business School's
Investment Ideas Club ACTV has a leading market share amongst a fragmented industry. Because of ACTV’s research
(“IIC”). If you are and development spend (~20% of sales) with its superior market share, the company has a R&D
interested in hearing more lead over most competitors. ACTV’s R&D spend is nearly 2x of Constant Contact, a significant
pitches by serving as an IIC competitor.
judge, please contact Ben
Isaac (bisaac14@ Bar Lowered for ACTV Over FY ‘12 and 1st Half FY ‘13: Expectations That Can Be
gsb.columbia.edu) or
Beat Based on Founding Mgmt.’s Departing Performance
Charles Buaron (cbuaron14
@gsb.columbia.edu).
From mid-2012 to mid-2013, ACTV disappointed investors and anchored low expectations be-
cause of:
 Progressively lowered guidance on sales growth from 20-30% to 10-20% YOY.
 Longer-than expected spend and implement. of new cloud-based ActiveWorks platform,
resulting in significantly higher R&D spend over past 2-3 yrs.
 ACTV founders (chairman and CEO) both resigned in May ‘13 after leading the organization
for over 12 years. The stock price has seen a 60% drop during their tenure after ACTV’s
IPO in 2011.
 Poor performance in outdoor (due to cold spring) and one-time marketing svc.’s in Q1 ’13
were outside of normalized earnings.
Volume
Active Network, Inc. (Continued from previous page)

ACTV substantially undervalued against its peers despite its higher quality earnings.
While ACTV has a lower gross margin versus its peers, its EBITDA margin of 7% (vs peer avg. of
2.9%) stands notably higher despite ACTV’s greater R&D spend. Because of ACTV’s scale and lean
SGA, it is able to operate with a much lower sales & marketing (as % of sales) versus its peers.
In spite of the higher EBITDA margin, the market gives ACTV’s earnings a lower valuation (EV/
EBITDA—9.2 versus 20.3 peer avg.; EV/Sales—1.0 versus 2.3 peer avg.). While sales growth has
slowed, it does not justify the dramatic valuation difference.
EBITDA expansion and improved management to catalyze stock appreciation.

 R&D expense will be significantly reduced following implementation of cloud-based Active-
Works (end of 2013). Reversion of R&D as % of sales to forecasted 16-17% in ‘14 re-
sults in a 23-33% increase EBITDA.
 New management will improve Active Network, Inc. where prior ‘founding’ leadership was
limited or lacked vision/execution. Ripe for a turnaround? Founding chairman and CEO
both unexpectedly resigned together, signaling a potential board move after disappointing re-
sults in prior years. After their resignation, the stock price did not retreat but celebrated man-
agement’s departure.
Page 22
Koch Industries
(Continued from page 1) key to unleashing those buyer who can do big deals
development intern at pent-up ideas and quickly. What sets you apart
Koch Industries, sat innovations. The system from not only Berkshire
down with Steve allows all of our employees Hathaway, but also other
Feilmeier and Dave to share in a portion of the financial or strategic buyers
Robertson at Koch’s value that they are creating. when it comes to investing
headquarters. Steve It doesn't matter what your in businesses?
Feilmeier is Koch’s role is—if you can find ways
executive vice president to help us better serve our SF: It’s our ability to tailor
and chief financial officer customers so that we profit our investment to the very
Dave Robertson and has been with the more, we want you to share specific needs of our
company since 1997. in some of that profit. You counterparty to solve the
Steve earned his are rewarded like an problem they’re trying to
bachelor’s and master’s entrepreneur is rewarded. If solve. A typical hedge fund
degrees in accounting you're successful at that, or private equity fund is
from Wichita State you’ll do better and if you limited in the types of things
University. Dave is fail, then you won’t do as they can do, types of
president and chief well. securities they can invest in,
operating officer of Koch or the duration of the
and started his career Steve Feilmeier (SF): It's investment because they are
with the company in also the incentive to speak beholden to their own
1984. Dave earned his up when you think investors who may
bachelor’s degree in somebody else’s idea has prescribe certain mandates
business administration some limitations—what we or rules.
and marketing from call our challenge process.
Emporia State Not only do we incentivize We try to listen and will
University. people to speak up, but we adapt to meet our
also expect the recipient of counterparty’s needs. The
Graham and Doddsville that information not to be key is to make sure we’re
(G&D): Koch Industries defensive so he or she is being compensated for the
has one of the best long- open to incorporating risk that we’re taking.
term compounding records, different viewpoints. We'd
with mid-teens compound much rather limit the G&D: Koch is in a unique
annual growth for over 50 mistake rather than invest in position to allocate capital
years. Why do you think it—then you’ve really got a given its diverse set of
Koch has been so successful mess on your hands. businesses and significant
over the years? capital to invest in new
Having an open and honest opportunities. Can you
Dave Robertson (DR): culture where we trust each explain Koch’s overall
Our management other is key. A lot of capital allocation
philosophy, Market-Based companies think they do a philosophy?
Management®, is what good job at incentivizing
allows us to achieve those people, then they get in SF: First, you have to be in
types of returns over time. here and say, “Wow, it's the right businesses where
When we acquire a new night and day.” you have the capability to
company, Market-Based create real value. Then,
Management® unleashes the G&D: A recent article in don’t try to optimize and
knowledge and ideas that the Wall Street Journal trade in and out of them
people in that firm have to talked about how Koch like a private equity firm has
innovate and to make their Industries wants to be to do.
product or process better. considered alongside
Berkshire Hathaway as a (Continued on page 23)
Our incentive system is very
Volume
Koch Industries
(Continued from page 22) trying to pick the ones that typically constrained by
As Charles [Koch] likes to provide the best return on whether or not the markets
say, it’s hard enough to find the risk that we’re taking. are offering an appropriate
good businesses. Why return or whether or not
would you want to sell one It’s a little bit of first-come, we’ve got the capabilities to
once you already own it? first-served in that when we manage the investment.
That is a very important key see good opportunities that When we have more ideas
to how you compound—get present an attractive return or good opportunities than
good businesses, and then on the risk, then we go after capital, we could always use
invest in them for the long them. debt capital but this is rare.
run. Our goal is to finance Steve Feilmeier
everything with equity.
Another critical dimension
is to stay very rigorous in DR: Our transaction
your discipline. All too excellence capability is the
often, you’ll hear public “As Charles [Koch]
discipline that Steve’s talking
companies acquiring likes to say, it’s hard about. We can evaluate
businesses for “strategic each of these opportunities,
reasons.” For us, if we’re enough to find good whether it’s a project to add
not earning an appropriate on to an existing facility, an
rate of return, it’s never businesses. Why acquisition, or an equity
strategic. Strategic should investment. We’re putting
mean that you’re creating would you want to each of those through the
real value in society. If same rigor and analysis to
you’re not earning an sell one once you
determine the expected
appropriate return on your already own it? risk-adjusted return.
investment, by definition,
you’re not creating value. That is a very G&D: You have said in the
past that Koch is not
So we stick to our important key to bounded by any industry—
disciplines and make sure instead, it’s bounded by its
that the returns on risks are how you capabilities. Could you
appropriate each and every describe Koch’s capabilities?
time. Then we look at things compound: get
And given how fast the
not through a filter of good businesses, world changes, how do you
“who’s going to get how think about developing new
much capital this year.” and then invest in capabilities?
We’ll fund any and all
projects in each of the them for the long SF: Most of our businesses
businesses we have that have more in common than
meet these criteria. run.” might meet the eye. We
take some form of
DR: A lot of firms have a commodity and we’ll
budget mentality where they process it through a very,
say “we’ll give this business very large plant that
this much capital,” and SF: We’ve never been in a requires sophisticated
we’re not doing that. We situation where our internal technology and analysis to
have shareholders who funding hasn’t generated ensure that we have a
historically have reinvested enough capital where we’ve competitive advantage and a
90% of the earnings back in been constrained. So we’re capability to go to market in
the company. So we’re not constrained by the fact scale. Then we’ll optimize
looking at any and all that we’re private. We’re (Continued on page 24)
opportunities and then
Page 24
Koch Industries
(Continued from page 23) money by being excellent at requires looking forward
around that processing or getting product to the store and trying to understand the
manufacturing process and having the right trends that might really
because there is raw inventory at the right place matter, for example, energy
material risk, commodity at the right time. And they and agriculture products
risk, and counterparty risk. have the scale to do so at should continue to be in
low cost, too. high demand. The world is
We also have the capability going to need more of the
to be very efficient and products from these
Pictured: Leon Cooperman effective from a cost
’67 speaking at the 2013 industries in the future.
perspective and the “A great business is
Omaha Dinner.
capability to constantly G&D: How would you
innovate because the one where you
define a great business?
technology changes in these What are some examples of
big plants. We must be
have a significant
great businesses that you
adaptable to ensure that we competitive admire?
don’t fall from the first
quartile to the second, advantage with DR: A great business is one
third, or fourth quartile in where you have a significant
cost advantage. offshoots that competitive advantage with
offshoots that allow that
Our other core capabilities allow that business
business to grow. That
besides innovation and advantage could come from
operations excellence are
to grow. That
a raw material advantage,
Market-Based advantage could technology advantage, or a
Management®; trading; number of other sources.
transaction excellence; and come from a raw
public sector, which Take our Pine Bend, MN
encompasses legal, material refinery. It's a great
communication, community business. We buy
relations, and government advantage,
advantaged feedstocks,
relations. convert those into very
technology
high-value end products, and
So, whether it’s crude oil advantage, or a sell them in one of the best
going into refined products, marketplaces in the country.
natural gas going into number of other That has propelled us into
fertilizer, naphtha going into other businesses, like our
chemicals, trees going into sources.” petroleum coke business in
pulp, metals going into our Koch Minerals.
manufacturing businesses—
each of these businesses fit SF: When we say
the capabilities described We don’t have that “competitive advantage,”
above. capability. So there are that does not mean an
certain things that we advantage over our
Certain businesses simply couldn’t envision—that customer where we can
do not benefit from these doesn’t mean that we profit at their expense. It
capabilities. We’re not a big, wouldn’t build the capability. means that we have created
multi-unit retailer. The We would consider building something that creates a
capabilities of the largest capabilities whenever it’s great advantage over the
retailers are being very, very evident that society is not way things used to be done
sophisticated at information effectively allocating capital or over the way our
technology management and to an industry. That (Continued on page 25)
logistics. They make their
Volume
Koch Industries
(Continued from page 24) that Koch often has more to find actionable
competition does it today. than 100 companies on its opportunities that would fit
As a consequence of that, investment watch list. How our capabilities. We have
we're using fewer resources does Koch go about well over 100 business
to produce goods or generating these investment development personnel
services that somebody will ideas? across all the companies.
value. And that's good for
society. Everybody wins. DR: We have business SF: We must be able to do
Our customers win because development (BD) something with a business
they'll participate in that personnel in all of our that the incumbent owners
value creation. different businesses. So for cannot, or else we’re not
example, Georgia-Pacific has creating any value—they’re
We stress this idea to all of a better owner than we are
our employees that we’re otherwise. It doesn’t make
not seeking the type of sense for us to own
advantage where you win anything unless we add
and someone loses. Not value to it.
every business thinks of it “We must be able
this way. We think of this as I’ll give you two examples
subsidization or cronyism to do something out of our fertilizer
which distorts markets and business. Agrotain, which
is not good for society. with a business that produces a specialty
molecule that, when
DR: It’s a great point the incumbent combined with straight-run
because win/lose is not commodity fertilizer, makes
sustainable over time. You
owners cannot, or
a much better product for
can’t do what Koch has else we’re not the farmer. With Agrotain
done over 50 years by us applied, the amount of
winning and our customers creating any fertilizer that actually
losing. Competitive reaches the plant goes way
advantage assumes that we value—they’re a up, and that creates value
can provide goods and for everybody. J&H Bunn in
services to our customers better owner than the UK is good at fertilizer
and be their best alternative. distribution, blending, and
The spread in that equation
we are otherwise. It
warehousing and dealing
is profit, and we believe doesn’t make sense directly with the customer.
profit really is the measure
of how much value we are for us to own Koch Fertilizer’s core
adding in society. competency before
anything unless we acquiring these two
The only reason a business businesses was having a
exists is to make people’s add value to it.” global breadth and depth of
lives better. We use manufacturing commodity
resources more efficiently fertilizers, and then getting
to produce goods and them to market through our
services that people want to terminal system and
buy. If we do that a BD Team and Flint Hills marketing capability. The
effectively, then we are has a BD team. Within Agrotain and Bunn business
creating value in society. It’s Steve’s group at a corporate lacked the capability that we
an important backdrop to level, we also have a have to reach global
this discussion. business development team. markets.
Those teams’ daily activity is (Continued on page 26)
G&D: Dave, you’ve said
Page 26
Koch Industries
(Continued from page 25) easy to make a mistake. We You learn a lot about how
These businesses came know that our culture is the company treats them.
together synergistically unique—we talk about that
where we could take a lot. So we’re not going to DR: If we thought a
Agrotain, use J&H Bunn’s find someone whose culture company’s culture was one
knowledge of blending, fits exactly. that lacked integrity and
storing, distribution, and compliance, we'd back away.
customer service, and do We try to make sure that We wouldn't do the deal;
that globally. their culture isn't so it's not worth it. And that
antithetical to ours that we has happened more than
That’s what we brought to wouldn't be able to, over once.
both of these businesses and time, meld it or blend it into
why transactions made our culture. But it's G&D: Given that gasoline
sense for all three something that we haven't consumption in the U.S. is in
businesses. really been great at. We're structural decline from
trying to get better by increases in fuel efficiency
DR: We can’t just dream up spending more time and and the shift toward hybrid
or manufacture these energy assessing it and and electric vehicles, is the
opportunities amongst understanding how different refinery business still a good
business development they are, what those business?
people. They have to have differences are, and what
contacts and relationships in we need to do to bring DR: Yes, depending on the
the industry to have the them into our culture. asset. We look at these
opportunities shown to us. businesses on a supply stack
So it requires a lot of SF: Culture is many from who we think is most
different interactions to be different things. For us, it competitive to who we
able to size up, screen, and starts with our ten think is least competitive. As
think about where the principles. They are each volume shrinks in a market,
opportunities might be. important because they you move closer to the
work together, but there is more competitive players to
G&D: How do you judge one in particular that I pay be able to meet the demand
whether or not the culture attention to when we're in the marketplace. As long
of a potential acquisition will looking at another company, as you're far left in the
be a good fit for Koch? How and that is humility. supply stack, then it can be a
do you prevent mistakes? very attractive business. If
Being open to challenge is you're far right—if you're a
DR: It’s very difficult to do, really important. The way high-cost producer—and
and it depends on the type people treat each other is the market is shrinking, then
of deal. If it’s a public also really important. I was it's a bad place to be
company deal, you get very with a company yesterday because you're going to be
little due diligence. You’re where the CEO knew every less profitable, or
not going to get a full single person's name that he unprofitable.
picture of the culture, other passed by. It tells you a lot!
than the feel you get from We feel good about our
the handful of leaders that Understanding culture position in the refining
you meet. before we acquire a business, but for those with
business could be the most marginal assets, it's probably
If you’re doing an asset- important thing we do. And not a good place to be.
based deal or carve-out, you it's been the one of the
may get a lot more time to hardest to do. You have to SF: Having the correct
work with the counterparty talk to the employees, vision for the business is
to find out what their customers, and suppliers. (Continued on page 27)
culture is like. But it is very
Volume
Koch Industries
(Continued from page 26) engines need higher octane. today, even without
key. For example, Flint Hills subsidies or mandates.
used to view themselves as A blend of gasoline with
strictly a crude-oil-based ethanol to increase the SF: Here are some
refined products business. octane level makes sense to numbers to put with that.
Now they view themselves feed those engines. So You can buy 87, 89, or 91
as a transportation fuels ethanol has a place in the octane gasoline. That is
business. These visions are transportation fuel industry regular unleaded, mid-grade,
very different. or premium. One way to
achieve 89 or 91 is by
When you make that shift in blending a higher-octane
how you think about the “We don't spend a component with regular
world, suddenly you will gasoline.
look at ethanol, biodiesel, lot of energy trying
and hybrid vehicles Ethanol has a high octane
differently. It's changed the to predict the value of about 99 or 100.
way we invest in those When you blend it with
assets. Time will tell how future. That goes
carbon-based motor
good the vision is, but we'll back to getting into gasoline it has the equivalent
adapt it again as we need to. of 120 octane value because
businesses where of the chemistry. So as the
G&D: How do you think engine manufacturers
about investing in areas you have increase their compression
boosted by big government ratios to get higher fuel
subsidies such as ethanol, competitive efficiency, we're going to
especially given Charles need more octane in the
Koch’s free-market views? advantages, where
future.
you can build out a
DR: We're not in favor of People often look at us and
any subsidies or mandates platform, and say, "You guys are
where the government picks hypocrites because you're
winners and losers. We're where you have investing in an industry that
opposed to all of that, even has a subsidy or a mandate."
if it’s detrimental to us. The optionality in what That's not why we're
ethanol industry is not invested. We're invested
subsidized anymore today, you do. Then you
because it will be an
but it is mandated. It's great can adjust as things important fuel of the future.
that the subsidy went away, The industry survives just
and we'd like to see the change in the fine without subsidies or
mandate go away and let mandates and we advocate
ethanol compete on its own economy. We’re for such policies.
merits.
much more G&D: Given your diverse
If you look at the energy set of businesses, it seems
content in ethanol, it's not effective at doing
like you’d have a lot of
as good as gasoline or diesel that than spending insights into the current
fuel. But ethanol is a very state of the U.S. economy
cost-effective way to get time trying to and where it’s headed. Are
octane. To meet the miles there any unique or
per gallon requirements, predict the future.” interesting data points you
engine manufacturers are look at to get a read on the
making smaller engines with (Continued on page 28)
higher compression. Those
Page 28
Koch Industries
(Continued from page 27) perspective, the EPA is measures like rail loadings
health of the economy or to promulgating policies might help us manage
help you make investment through regulation that they working capital levels or
decisions? For example, can't get done through something of that sort, but
Warren Buffett often legislation, in my opinion. It long term fundamentals are
mentions railcar loadings as makes it very difficult to what matter most.
a good indicator of the meet the immediate
health and direction of the demands of consumers DR: Many companies
economy. when this happens. So, we embark on those things to
look at the implications of try to predict the future,
SF: We look at our those policies. Do we want but we think the future is
business over the next 20 to be an industry like that? If unknown and unknowable.
years. We do not worry we can't get a permit to So we don't spend a lot of
too much about short-term evolve our assets in a energy trying to predict the
data points that might help productive manner, it’s a future.
explain our quarterly hard industry to be involved
earnings. We worry about with. That goes back to getting
the long run and I will give into businesses where you
you two examples. have competitive
advantages, where you can
First, many policies coming build out a platform, and
out of Washington are going where you have optionality
to distort the economy in a in what you do. Then you
big way. For example, the can adjust as things change
“We take some
very artificially low interest in the economy. We’re
rates that are being pushed form of commodity much more effective at
on us by the government doing that than spending
and the Federal Reserve are and we’ll process it time trying to predict the
causing artificially higher future.
asset values. through a very, very
large plant that G&D: Going back to your
It’s interesting to me that comment on the Fed. Steve,
they’re doing it as a how do you see the
requires
response to a problem that unprecedented Fed
they created in the first sophisticated intervention ending, and
place with the exact same what do you do as CFO of
low interest rate policy that technology and Koch Industries to prepare
was there throughout the Koch for that eventuality?
beginning of this decade. analysis to ensure
We now know that much of SF: There are lots of ways
the investment following that we have a
to manage risk. One way to
these low rates was manage risk is simply not to
competitive
unproductive and take the risk. Here’s an
unprofitable. The Fed is advantage.” example. If you invest in an
making the same mistake asset, you need to look at
over again. what the source of return is
from that asset. If you're
We are very wary of assets investing in a 10-year
with sky-high valuations. We treasury, your source of
are not tempted to invest in Those are the return is almost 100%
them because it’s going to macroeconomic things we attributable to the duration
end badly. look at. Short-term (Continued on page 29)
Second, from a policy
Volume
Koch Industries
(Continued from page 28) them. It is the most from them?
of that security and very profitable single item that a
little attributable to credit grocery store sells on a per- SF: Well, this is going to
risk. If you believe there’s square-foot-of-retail-space- use the rest of the time!
much more downside than required basis. (Laughs.)
upside because of all the
manipulation, don’t try to That’s why the greeting card I think our single biggest
time it—just don’t do it section still has massive mistake was the polyester
because you can’t time it. amounts of square foot business that we acquired
allocated to it, and it is from Hoechst, a German
We would rather invest prominently featured so company. We probably got
where the source of the you’re likely to walk by it back about 80% or 90% of
return comes from the before you leave the the capital we put in the
capability or the innovation grocery store. business. That’s definitely a
of a project or business. If mistake when you don’t get
that means taking on more A reporter commented to your capital back. In this
illiquidity or duration risk, me on the day the deal was case, we did not understand
those risks are much more announced, “I still don’t get how significantly the
palatable in this it. The internet is taking Chinese economy had
environment than taking on over this whole space.” And invested in polyester.
interest rate risk. That’s I said, “Not really, I don’t
how we look at it. That’s think you’re right. The facts
how we’re trying to do it don’t bear that out. Let me “The number one
anyway (laughs). ask you a question. Are you
married?” And the reporter thing that appeals
What we’re doing with the said, “Yeah, but what does
American Greetings to the companies
that have to do with this
investment ties into this interview?” I said, we talk to is our
idea. Although it is an “Everything. Try sending
interest-rate-sensitive your wife a text on her next focus on the next
security, the valuation of the birthday. Tell me how that
investment will not move works out for you!” And he twenty years, not
around very much because said, ” I kind of get it
the primary source of now!” (laughs) on the next ninety
return comes from the
capability of the equity days.”
When we see the value
investors that we’re that’s being created for their
supporting and the customers and the capability
capabilities within their of the company to continue When the treaties between
industry. to create value through the United States and the
innovation, we’re very other WTO countries were
G&D: What is the thesis comfortable supporting that put in place, a lot of
behind the American investment and earning a polyester started coming
Greetings investment? return that’s not 100% tied over to the United States.
to the discount rate, but We had no idea how
SF: Even though the more tied to the capabilities sophisticated these Chinese
industry demand trends are that they have. producers were and how
flat, they still create much volume would actually
tremendous value for their G&D: Can you share some land on our shores. It
customers. They have very of the biggest investing displaced a lot of capacity
strong relationships with mistakes Koch has made that existed here that we
their retail partners and and what you’ve learned (Continued on page 30)
long-term contracts with
Page 30
Koch Industries
(Continued from page 29) a deal. We don't want to be example, then it's hard to
had just purchased. handcuffed in our ability to make the investments in
We also didn’t understand invest and do the right new capacity that would get
that the rate of learning things for the long-term supply and demand back in
within the industry had benefit of the business. balance. This puts upward
substantially accelerated. pressure on prices in a
For example, a plant that G&D: Corporate profits in supply constrained industry.
once cost $500 million to the United States as a
build fell to $250 million percentage of GDP are So ironically, the very
within three years. currently around 11%, policies that the federal
Pictured: Professor Tano
Santos at the 2013 Omaha
which is at all-time high and government is promoting
A couple key lessons came well above the average over are causing the opposite of
Dinner.
out of that acquisition: one the last 20 years of about their intended effect on
was that we must have 7%. Do you guys expect a employment and wages.
global knowledge systems, reversion to the mean, and And, when supply and
not just regional knowledge how do you think about demand stay imbalanced,
systems, and have a much investing in an environment you're going to have higher
greater awareness of how when asset values probably profits by definition.
globally fungible our reflect these record-high
products are. Second, we profits? So that's why we're where
must talk to customers, we are as a country and
suppliers, and vendors SF: In this part of the corporate America. Will
before we do an acquisition business cycle, labor that change? Well, we hope
so we can be attuned to the normally starts getting a so. We want less non-value-
speed of the technological bigger piece of the overall added bureaucratic
change within the industry. GDP via expansion of regulation. We want the
employment and wage rates. ability to take care of our
DR: Another thing we've customers.
learned the hard way is how There are a couple things
much debt we are willing to happening that are different This doesn't mean that all
put on a deal. Too much than in previous cycles, regulations are bad. But
leverage not only stresses a which have caused profits to when you layer on
deal, but the associated debt be higher. First, U.S. regulation after regulation
covenants also limit your companies aren't just after regulation, it becomes
ability to invest for the long competing with U.S. extremely
term. During downturns, companies anymore; they're counterproductive. We
you start to bump up against competing with global have a lot of that right now.
those covenants, and then companies. Even though
you become very restricted U.S. workers are much Higher profits will reverse
in making good long-term more productive, there is over time as new
decisions. still a cap on our ability to economies emerge and
pay more to stay compete. Exchange rates
So you start making short- competitive globally and to will also eventually adjust
term decisions just to make expand employment. and our prosperity will be
it through the next quarter challenged without change.
to meet those debt A second reason is the
covenant metrics. We've uncertainty caused by public DR: Uncertainty is one of
learned that it's just policy coming out of the biggest factors as to why
inconsistent with our long- Washington. If you don't you see these profit levels.
term philosophy, so we're know what the Affordable For example, if you want to
going to be relatively Care Act is going to do to get a permit to build a
conservative in how much your healthcare costs, for (Continued on page 31)
debt we're willing to put on
Volume
Koch Industries
(Continued from page 30) DR: It hurts the poor. The this company is being forced
greenfield facility or to consumers are the ones to let go very highly skilled,
expand capacity, you may be who suffer the most great-culture-fit engineers
in the permitting process because the goods they within their company—
for five, six, or seven years. need just for necessities are people that in the long run
more expensive. would create much more
To start committing capital value staying employed with
to something which may not SF: Any form of a price the company than not. Yet
start for seven or eight control causes this they’re letting them go
years from now is a very, imbalance. In Venezuela, the because their investors are
very high-risk bet because former Chavez putting so much pressure
you don’t know what the administration stipulated on the management team
environment’s going to be. that, “The price of milk that they have to reduce
You don’t know what the cannot exceed X.” Guess their costs to meet short
supply and demand balance what happens? There’s no term objectives.
is going to be. You don’t incentive for people to
even know whether the create milk. And there’s no So they’re making poor
product is going to be milk. It leads to scarcity. decisions for the long run.
needed that far in the When you have scarcity, Look at how disruptive that
future. you have very high profits is. It's disruptive to the
for the people that are left company because it is
So that dampens additional in the business, and that’s getting rid of capability that
investment, which keeps happening on a much larger, it needs. It's disruptive to
capacity low and margins more discrete scale here. the family of that employee
high. If only the U.S. does that is being let go. We
that, then all the G&D: Is there anything else don't need to think that way
manufacturing and you’d like to add about here. We look at an
production will eventually Koch Industries’ strategy in investment in that kind of an
go to other countries that acquiring businesses? employee as an investment
are more advantaged, and in the long run. Let’s find
we’ll be an importer. SF: The number one thing something that he or she
that appeals to the can be working on until the
SF: Look what happened to companies we talk to is our market comes back. That is
Wal-Mart just recently in focus on the next twenty the number one thing that I
Washington, D.C. where years, not on the next talk to people about, and it's
the city council tried to ninety days. That unleashes pretty compelling to them.
impose upon them a $12 companies to make different
minimum wage. So what decisions that they don’t get G&D: Dave and Steve,
happened? When that kind to make when they’re a thank you for your time.
of regulation came in, Wal- public company under the
Mart said, “We’re not scrutiny of an investor base
building.” that’s trading, not investing,
in their shares.
Is that good for the
consumers? The rest of the We’re talking to a company
retailers have less right now that is in the
competition, and prices will trough. Their industry is
be higher. So profits are being significantly
higher and labor is constrained because there
constrained. Those kinds of was overbuilding and
regulations are causing demand is weak. As a result
these high profits. of this temporary condition,
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Chris Brigham is a second-year MBA student and a member of the Heilbrunn Center’s
Value Investing Program. Prior to Columbia Business School, he worked as an equity
trader for Bank of America Merrill Lynch and as a research analyst for Tiresias Capital,
an event driven hedge fund. Chris graduated Phi Beta Kappa from Claremont McKenna
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cbrigham14@gsb.columbia.edu.
Jackson Thies is a second-year MBA student and a member of the Heilbrunn Center’s
Value Investing Program. During the summer he interned at PIMCO as a high yield credit
analyst. Prior to Columbia Business School, he worked in the research department at the
Federal Reserve Bank of Dallas. He received a BS in Economics and Engineering from
Southern Methodist University. He can be reached at jthies14@gsb.columbia.edu.
Jason Yang is a second-year MBA student and a member of the Heilbrunn Center’s
Value Investing Program. During the summer Jason interned at Development Capital
Partners, a concentrated, value-oriented fund investing in sub-Saharan African equities.
Prior to Columbia Business School, he worked as a consultant in PWC’s Transaction
Services Strategy practice. Jason received a BS in Economics and Mathematics from Yale
University. He can be reached at zyang14@gsb.columbia.edu.
Graham & Doddsville
Issue XX Winter 2014

Inside this issue:
Ken Shubin Stein P. 3
Lee Ainslie—No Holds Investing
Lee Ainslie P. 18
Lee S. Ainslie III is the head of Maverick Capital, which he formed
Geoffrey Batt P. 28 in 1993. Prior to founding Maverick, he worked at Julian
Robertson’s Tiger Management. He holds a bachelor's degree
Investment Ideas P. 42 from the University of Virginia and an MBA from the University of
North Carolina’s Kenan-Flagler Business School.
Jim Grant P. 52 (Continued on page 18)
Lee Ainslie
Justin Muzinich P. 60
Ken Shubin Stein—A Study Geoffrey Batt—
in Investing Perception and Reality
Dr. Kenneth Shubin Stein Geoffrey Batt is the
is the Founder and managing partner
Portfolio Manager of and founder of the
Editors Spencer Capital Euphrates Iraq
Chris Brigham Management and the Fund. He has been
MBA 2014 Chairman of Spencer investing on the
Capital Holdings. Iraq Stock
Jackson Thies, CFA Spencer Capital is a value Exchange since
MBA 2014 -oriented investment January 2008. Mr.
Ken Shubin (Continued on page 3)
Geoffrey (Continued on page 28)
Jason Yang Stein Batt
MBA 2014
Matt Ford Jim Grant—Lifelong Justin Muzinich—Find
MBA 2015 Observer Good Businesses
Mike Guichon James Grant is the Justin Muzinich is a
MBA 2015 founder and editor President at Muzinich
of Grant’s Interest and Co. Inc., a pri-
Rate Observer, a vately owned invest-
twice-monthly ment management
Visit us at: firm with a focus on
www.grahamanddodd.com journal of the
www.csima.org financial markets. rigorous credit analy-
After graduating sis. Prior to joining
from Indiana Muzinich, he was a
University with a Managing Director at
Jim Grant degree in economics EMS Capital and Justin
and Phi Beta Kappa worked in the mer- Muzinich
accolades and earning a degree in gers and acquisitions
international affairs from Columbia group at Morgan Stanley. Mr. Muzi-
University, he began his journalistic nich holds a Juris Doctor degree from
Yale Law School, where he was an
Page 2

We are pleased to bring you running a credit-oriented nancial system, and discuss-
the 20th edition of Graham & asset management business. es how skepticism shapes
Doddsville. This student-led He also talks about the op- both better journalists and
investment publication of portunity he sees in the investors.
Columbia Business School is European debt markets.
co-sponsored by the Heil- This issue also contains pic-
brunn Center for Graham & Geoffrey Batt shares his tures from the 23rd Annual
Dodd Investing and the Co- unique transition from a Graham & Dodd Breakfast,
lumbia Student Investment philosophy student to a which took place on Octo-
Management Association frontier markets investor ber 4th at The Pierre Hotel
(CSIMA). focused on Iraq. He ex- in New York, and featured
plains his interest in the Neil Petroff of the Ontario
Heilbrunn Center Director
Louisa Serene Schneider. We were lucky enough to Iraqi markets and describes Teachers’ Pension Plan as
Louisa skillfully leads the speak with five great thinkers his process for searching for the keynote speaker. Lastly,
Heilbrunn Center, cultivat- and investors who provide a equity markets that are on this issue includes the win-
ing strong relationships range of different perspec- the verge of a significant re- ning pitch from the 2013
with some of the world’s tives and investment rating. Mr. Batt also shares Darden @ Virginia Investing
most experienced value approaches to this issue. some interesting ideas he Challenge, and the four
investors and creating nu- Lee Ainslie recounts how currently sees in Iraq. finalist pitches for the 2014
merous learning opportuni- he founded Maverick Capital Moon Lee Prize Competi-
ties for students interested
and shares his thoughts on Ken Shubin Stein discuss- tion.
in value investing. The clas-
ses sponsored by the Heil- hiring analysts and structures the structural and behav-
brunn Center are among ing his team. Mr. Ainslie also ioral elements of investing We would like to thank our
the most heavily demanded describes what he looks for and describes the methods interviewees for sharing
and highly rated classes at in a good investment, shares his firm employs to improve their time and insights with
Columbia Business School. an idea that he likes, and its investment process. Mr. our readers. As always, we
candidly recounts past mis- Shubin-Stein also shares invite you to contact us if
takes that he has learned some present and historical you have any comments or
from. ideas. suggestions, and we thank
you very much for reading.
Justin Muzinich talks James Grant discusses his
through his perspectives as a career in investment jour- - G&Dsville Editors
credit investor—both in nalism, argues for significant
looking at credit ideas and overhauls to the global fi-
Professor Bruce Green-

wald. The Heilbrunn Center
sponsors the Value Invest-
ing Program, a rigorous
academic curriculum for
particularly committed
practitioners.
Neil Petroff speaking at the 23rd annual Bruce Berkowitz speaking at the 2013
Graham and Dodd Breakfast CSIMA Conference
Volume
Issue XXI, Issue 2 Page 3
Ken Shubin Stein

(Continued from page 1) it's difficult. approaches that people
management firm with a follow is wider. There are
successful long-term But he makes it accessible certainly lots of debates in
track record investing in and that's how I became health care but, in finance,
undervalued securities interested. I started we have different views on
and special investing early, and quickly fundamental concepts about
situations. He is also an took over handling the way the world works
Adjunct Professor at investments for my family. I and there are conflicting
Columbia Business was investing concurrently ideas accepted at business
School, where he schools—an obvious one is
teaches the Advanced the efficient market
Investment Research hypothesis, another is the
course. Dr. Shubin Stein question of whether
is a graduate of the volatility is risk. These
Albert Einstein College simple, core questions are
of Medicine where he debated decades after first Ken Shubin Stein
completed a 5-year “We think about being asked and I find that
medical and research interesting.
program with a focus on process a lot, and
molecular genetics. He G&D: Are you still involved
has a B.A. from
we’ve tried to
in healthcare other than
Columbia College, create a process investing in it?
Columbia University
with a dual that maximizes our KSS: I still have a passion
concentration in for healthcare and a strong
Premedical Studies and chance for great network in that
Political Science. world. Many members of
outcomes.
my family are doctors and
Graham & Doddsville scientists, and I am on the
(G&D): You have a fairly Board of Advisors at the
non-traditional background For us, a process Hospital for Special Surgery,
for a value investor. How so I regularly speak with
did you become interested needs to be explicit, doctors, scientists and
in investing and how did you healthcare executives.
make the transition from repeatable, and Additionally, I am involved
getting your M.D. to from a public health
investing? flexible.”
standpoint through
Crutches 4 Kids, a charity
Ken Shubin Stein (KSS): that I co-founded to help
From an early age, I've collect crutches from
always had an interest in people who have and don’t
both health care and need them any more, and
investing. My mom with my science and medical distribute them to children
introduced me to investing training, and eventually who need and don’t have
when I was a kid and she is made a decision that I them.
the first one who taught me wanted to make investing a
about buying stocks. I was career. G&D: How has your
exposed to Warren Buffett medical and scientific
in the early '80s, and that One of the things about background helped you as
was pure luck. Buffett is so investing that is different an investor?
good at writing about it that from a field such as health KSS: It's been helpful in
he makes you think you can care is that the spectrum of (Continued on page 4)
invest well too, even though
Page 4
Ken Shubin Stein

(Continued from page 3) Murrell, both at the on this topic. Dan Coyle’s
terms of understanding how Hospital for Special Surgery, book The Little Book of Talent
to perform research, how and they both epitomized has a great list of tools
to think about a question, lifelong learning and people can use to accelerate
how to think about what continuous improvement. learning. The Art of Learning
are the critical factors, and They take it seriously and by Josh Waitzkin is another
how to collect the data and they're both very good at it. good book on this topic.
analyze the results. We We do active literature
think about process a lot, G&D: You have spoken searches where we assign
Columbia Business School and we’ve tried to create a
students visited Warren before about learning to researchers 10-50 hours to
process that maximizes our learn, can you elaborate on go through basic and clinical
Buffett in Omaha in the fall
of 2013.
chance for great outcomes. this topic? science articles, as well as
pieces on other fields, such
For us, a process needs to KSS: Sure. Thinking about as art, professional sports,
be explicit, repeatable, and coaching, and all sorts of
flexible. If it's not explicit, things. We try to be
then the process can't be effective in this process
studied and used by even though it’s not always
different people and, if it's “We borrow tools efficient.
not repeatable, then you
can't iterate and improve from other fields. We think about efficiency
the process. Lastly, a and effectiveness a lot too.
process needs to be flexible We look at what's “Efficiency” is getting a lot
because there are many of units of output for a unit
different situations in life. available in the of input. But you could be
Things change. The credit efficiently running in the
markets change and science of cognition
wrong direction and it
attractive opportunities or decision-making. would not be effective.
change. You may be Sometimes, we know we're
evaluating a hard asset that We think about engaging in a process where
is not producing cash flow, there’s no way to be
but has the potential to how to apply to our efficient and maximize
generate significant cash in effectiveness. A good
the future. Or you may be circumstances work example of this is looking
evaluating a high return on for certain types of
capital business, like an asset that's being done
acquisitions. There isn’t a
management firm, that academically about really efficient way to do
produces significant cash this. You can't completely
flow, but the important human thinking.” screen for it and, if you're
assets of the firm walk out looking for something that
the door every night. So you can't screen for or
the process has to be develop an efficient search
explicit, repeatable and thinking, or metacognition, process around, it means
flexible to allow it to be has been around for a while that, although you're going
improved over time. and the field keeps to try to head in the right
improving. Something we direction and be effective,
I learned to be a lifelong try to do well is to think you are going to have to
learner from my parents about what we are doing, turn over a lot of rocks to
and from my medical and what we are trying to learn, find what you are looking
scientific training. Early in and how we can best learn for. Another example of this
my career, I worked for two it. There are some great is literature searches. We
fantastic surgeons named articles and books out there (Continued on page 5)
Russell Warren and George
Volume
Ken Shubin Stein

(Continued from page 4) process. Additionally, we hypothesis. We iterate this
will read broadly with an are fortunate to have some four-step process over and
idea of what we're trying to leading investors visit the over again.
accomplish, but it's not class and answer questions
always efficient. We think in a small, off-the-record We borrow tools from
about efficiency and environment, which is very other fields. We look at
effectiveness separately. educational for both the what's available in the
students and me. science of cognition or
G&D: You’ve taught the decision-making. We think
Advanced Investment G&D: Can you share your about how to apply to our
Research course at circumstances work that's
Columbia for the past five being done academically
years. What motivates you about human thinking. We
“We think we can
to teach and has it affected put effort into applying
your investing? have four possible these ideas; this requires
some creativity and some
I love teaching and have had edges and we try to guesswork. We make
an especially great educated guesses about
experience teaching at understand whether how to apply something. I'll
Columbia. Bruce give you a specific example.
Greenwald and Louisa one or more is
Charlie Munger famously
Serene Schneider have been has his list of 25
present in a given
terrific in helping me grow psychological tendencies of
as a teacher. They have situation. The four human misjudgment—25
been supportive and helpful mistakes we make in how
as I learned how to organize edges are: we think. We went one by
the class and communicate one through each cause,
effectively with students in informational, rephrasing it in our own
the business school words, and tried to figure
environment. One great analytical,
out how we could apply it
aspect about teaching for to our checklist process to
the past five years is that
behavioral and
improve our decision-
most of my former students structural.” making.
are now analysts and
portfolio managers, or doing Whether you call it
other interesting things in process for evaluating a behavioral finance or
the world. I actively stay in prospective idea? neuroeconomics or innate
touch with the class alumni and acquired cognitive
and I get a tremendous KSS: We use a four-step biases, these terms are
amount of satisfaction process for evaluating ideas. circling around the same
seeing them progress in life. Step 1 is to form a basic issue: how do our
hypothesis. Step 2 is the brains make decisions under
Teaching has also been great study design, or, said different circumstances? For
for me as an investor. The another way, identifying the decades, people have been
process of taking what I do important questions and trying to describe this idea
and making it explicit, of developing a plan to answer academically. Now there's
breaking it down into them. Step 3 is doing the diverse vernacular in that
discrete, teachable steps, work to answer the world because it hasn't
and of answering challenging questions; this is analogous coalesced into one unified
questions from smart to running the experiment. field yet, but what's really
students has refined my Step 4 is analyzing the data interesting to me is how to
thinking about every aspect and then refining our (Continued on page 6)
of the investing
Page 6
Ken Shubin Stein

(Continued from page 5) circle of competence.
take that learning and Having an analytical edge
specifically apply it. How do Behavioral edges are central
we develop de-biasing to value investing. It's being
techniques? How do we greedy when others are
develop standard operating fearful and fearful when
procedures that can help us others are greedy. It is
make better decisions? It's understanding the lessons of
all very humbling because behavioral finance and
it's complicated and “This is where neuroeconomics, and then
nuanced; applying it is applying them to the idea at
difficult and, to a degree, having deep hand. These opportunities
personal. So it’s going to come up regularly. There
work differently for industry expertise will always be the
different firms and different opportunity to gain a
people, but we work hard sometimes helps behavioral edge because
on applying it and making it most innate cognitive biases
practical.
because certain
are Darwinian. Evolutionary
information will forces caused these
G&D: How do you think behaviors to evolve because
about getting an edge? Is it mean more to us they were useful at a prior
different from situation to point in history even though
situation and is there a than to the they are not useful in
common thread? modern, complex markets.
market.” They are hardwired into all
KSS: There is a common of us.
thread. We think we can
have four possible edges and With a structural edge, you
we try to understand know exactly why
whether one or more is something is cheap or
present in a given situation. expensive. For example, if a
The four edges are: means taking available bond is downgraded from
informational, analytical, information and arraying it investment grade to non-
behavioral and structural. so that we can glean better investment grade, there are
insights. This is where certain holders who have to
The first two edges, having deep industry sell it. If a stock is kicked
informational and analytical, expertise sometimes helps out of, or included in, an
are necessarily related and because certain information index, this will cause buying
sometimes overlap. will mean more to us than and selling transactions that
to the market—either we are not based on the price-
We work hard to find are more aware of the to-value relationship. Spin-
information that is helpful history of the industry or off and distressed situations
and legal to use. Sometimes we have experience with also regularly have these
we are able to find great the industry players and forces at work.
pieces of information that, have a better behavioral
combined with other insight into those people. G&D: Do you try to
information, increase our Analytical insights are create structural and
understanding of an frequently possible and it's a behavioral advantages inside
opportunity. This is often matter of arraying of your own structure and
referred to as the mosaic information in a creative process?
approach, and it is the link way and deeply knowing KSS: We do. There are
to the analytical edge we something—having a good (Continued on page 7)
regularly seek.
Volume
Ken Shubin Stein

(Continued from page 6) things all the time; it’s an an example. Even once
plenty of managers who may overarching theme of our they're at the top of their
have a long investment firm. We don't do what field and at peak
horizon, but their clients do Google does where we take performance, they still use
not; therefore, they don't 20% of our time to pursue coaches. They go over the
have strong hands for a true pet projects—it’s not that basics. They use the
long-term perspective. structured. We are always psychology of visualization.
There are few investment talking about these things They think about nutrition
firms that can execute on a and asking ourselves, How and rest in order to
long-term horizon. There’s can we be better? What can perform better. The system
an enormous amount of we do? What are other built around professional
institutional and retail people doing that we can athletes is impressive and
capital that has high liquidity learn from? robust because the stakes
and, as a result, the manager are high and measurable. So
doesn't have that much There's a quote by Picasso, we are always thinking
staying power or ability to about how to improve and
invest in things that may it permeates our firm.
take three, four, or more
years to work out. So firms G&D: Is there a particular
that have patient capital “There are plenty strategy or type of
definitely have a structural investment that you are
advantage. of managers who comfortable with or have a
particular expertise in?
We think about the may have a long
application of psychology We're not dogmatic about
and the science of cognition investment horizon, investing in a cheap,
to both our analysis and our mediocre company or a
portfolio management, and
but their clients do
non-earning, but
we have multiple checklists not; therefore, they undervalued asset, or a
and processes in place to profitable company with
try to improve how we don't have strong sustainably high returns on
think and make decisions. capital. We’ve done all of
It's not perfect. This is hands for a true them. What we are very
rough work, so while we careful about is reflecting on
might use specific scientific long-term past mistakes and thinking
terms to describe about what works best in
everything, the work itself
perspective.”
our hands. We have a
doesn't go out to the pretty good idea of what
second decimal place. It's works best for us, and part
really “best efforts” and of the reason is because I
we're constantly trying to which basically says good really wanted to understand
improve. We’re constantly artists copy and great artists our difficult experience in
finding mistakes and fixing steal. There's been a great 2008. Different techniques
them. deal written about looking work differently in different
at what other investors do people's hands. We all have
G&D: How do you balance that works and copying it. different life experiences,
your time between doing We look at other investors different training, and
investment analysis and and we also observe other different brains. So
thinking about the fields to see how star something that works for
behavioral and process performers do their jobs someone else, I may not be
elements? and continue to improve. able to do well. What I
Professional athletes offer (Continued on page 8)
KSS: We think about these
Page 8
Ken Shubin Stein

(Continued from page 7) employees to review every manager. While these red
really want to know is what investment decision we’ve flags don't mean we'll never
I can do well, so I do more made. We went through repeat mistakes, they are
of it, and what do I not do cautionary flags. The red
well, so I do less of it. flags slow me down and
make me think about a time
After 2008, we did a one- when I was confident that
year project looking for something similar to the
mistakes we could learn idea in front of me was a
from. The challenging part great idea, and then I made
of this process was a mistake and lost money. I
differentiating between a would say this is one of the
true positive and a false “If we're doing the most helpful things we've
positive and a true negative implemented as a firm. To a
and a false negative. It's right thing, but
degree, it comes out of
important that you separate Daniel Kahneman’s work
process and outcome.
occasionally it
detailed in his book, Thinking
doesn't work, it Fast and Slow. The
The best situation, a true framework that he
positive, is when you have a doesn’t make sense describes says that the brain
good process and you have has these two mechanisms
a good outcome. If you have to abandon that of thinking—fast and slow.
a bad process and a bad
outcome, that's a true process, because
Basically, the idea is that, for
negative. The tricky part is the work we do, fast
what happens if you're
over time it will do
decisions don't help. So we
unlucky and you have a well.” try to slow down. For
good process, but a bad example, we explicitly put
outcome—a false negative. circuit breakers into our
It is important not to be checklists now so that we
fooled by false negatives. If sleep on decisions. We have
we're doing the right thing, taken some of the learning
but occasionally it doesn't from the literature on
work, it doesn’t make sense decision-making and
to abandon that process, creativity research, and
because over time it will do this obsessively for a year lessons from great creative
well. and we came up with a list thinkers and investors, such
of about two dozen red as John Griffin, who taught
The riskiest thing is getting flags of places where we've the Advanced Investment
lucky—a false positive. You lost money in the past and Research course for a long
have a positive result, but where, after much analysis time. One take-away from
your process was poor. and debate, we decided it this is the idea that putting
That's the most dangerous was because of a bad yourself in different
because, after a few false process and not just bad situations, sleeping on ideas
positives, you typically go luck. and letting yourself be
bigger, and that leads to the creative lets you engage
old saying of “succeed small, This review has been your subconscious to
fail big.” So we think about tremendously helpful to our process information.
this pretty carefully. investment process, it has
helped make us better In medicine, there is an
We engaged an outside analysts, and it has helped acronym, HALT—hungry,
analyst to help us and we make me a better portfolio (Continued on page 9)
invited back former
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Ken Shubin Stein

(Continued from page 8) actually is good for an idea that hit a couple of
angry, lonely, and tired— investment decision-making? the edges we talked about.
and, under these conditions, It was a post-bankruptcy,
decision-making worsens. KSS: It seems to work for small company that
For example, under these Buffett, but not many provided reagents and other
conditions, people who are others. important things to
addicted to drugs will have a laboratories. It was a
higher rate of recidivism, G&D: Can you share a straightforward investment
meaning they'll fall back on couple of past investment if you understood it,
their old patterns of ideas, including an activist because, coming out of
behavior even though they Bill Ackman at the 2013
idea? And any current ideas bankruptcy, there were
know it is ruining their lives. Pershing Square Competi-
you would be willing to talk structural issues of why tion.
I've added a P for pain, about? people couldn't buy it. It
which also has a direct was inaccessible to some
impact on emotion and firms due to its small size or
decision-making. So with to firms without stable
HALT P, we try to think capital. It required an
about both the understanding of how
psychological and laboratories and the FDA
physiological framework for “We tackle things approval process works
making decisions. We ask because some of the
ourselves, as we're making not by trying to
reagents that they provide
decisions and as we're were actually written into
thinking about things, are
prove them, but by
the FDA approval process
any of these conditions trying to disprove for the test kits using their
present? Are we hungry, reagents.
angry, lonely, tired or in them. Falsifying a
pain for one reason or When you run a laboratory,
another? And, if so, realize thesis is the you want to minimize
that it's suboptimal for variation in processes so
decision-making and, if fundamental
that your results are
possible, don't make the reliable. So what can you
decision.
approach of the
control in a laboratory?
scientific method What are the variables?
Something else that's really Well, the things that change
important is nutrition. and it’s an in a laboratory are your
Blood sugar levels and inputs such as your
general nutritional states approach we use reagents, so you usually
have an impact on cognition have complete control over
and, I think, this is one of and like.”
that, and you don't want to
the areas that is change them if you don't
underappreciated. Our have to.
nutritional levels directly
impact our decision-making. So, understanding that, you
Buffett talks a lot about fear KSS: Sure. We have a appreciate the durable,
and greed as frameworks or concentrated portfolio and competitive advantage of
contexts within which we often hold investments selling things that are small
decisions are made, I would for several years. I'll talk and relatively inexpensive,
add to that HALT P and about a couple of past and but critical to a large
nutrition. present ones. process. We invested in the
company at around $3 per
G&D: So what you're SeraCare Life Sciences was (Continued on page 10)
saying is that Cherry Coke
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Ken Shubin Stein

(Continued from page 9) need to have a strategy to insurance industry is AIG.
share. We expected it to be create value, but even with What was interesting about
worth $6 in two to three that, you can lose an activist AIG when we invested
years and it was bought out campaign if you dot your several years ago was that, I
in less than a year at $4. It “i's” and cross your “t's” think, it was one of the
was good to be paid $4, but incorrectly. most hated companies in
I would have preferred to America. When we were
wait another year or two The company makes the making our investment,
and been paid $6.These gold-standard demineralized there were bus tours in
bone matrix product called Connecticut taking people
Grafton, which is frequently to the homes of executives
used in orthopedic and who worked at AIG so they
other types of surgery. could see where the “evil”
Osteotech spent a AIG people lived.
significant amount of capital
on research that was Think about that for a
partially productive. They minute. These executives
had a dysfunctional sales likely had nothing to do
effort; they had a misaligned with what happened; AIG is
“What was management team, and they a large global company.
put much of the money they Think about the implication
interesting about generated into various of people paying to get on a
things that weren't bus to come see the home
AIG when we productive. The latter is where an executive who
invested several common in healthcare— works for this hated
often a company has company lives. This is a
years ago was that something, a drug or device, great example of behavioral
that generates significant bias. People were
it was one of the cash and management embarrassed to say they
invests it all in risky ideas worked at AIG, and many
most hated rather than returning the portfolio managers were
profits to shareholders. reluctant to own the poster
companies in child for the financial crisis.
America.” So we got involved. We
analyzed the situation and Half a dozen government
we went through our pre- agencies had been living
investment checklist for inside of AIG, going through
activism. Osteotech passed. their books, and the
We ran a campaign to government owned the
replace the entire board. majority of the company.
We met with ISS and a We had the following thesis:
number of large over five years the stock
shareholders, and we made would be at least a triple
the case that our plan would because we were investing
things happen. create shareholder value. at half of stated tangible
book value, investment
Osteotech was one of our It was a good investment. income was below normal
activist ideas. Osteotech Shareholders made a due to artificially depressed
was a situation where a 100% return in less than a bond yields, and the
large institutional investor year from the time we company was buying back
asked us to partner with became involved. significant amounts of stock.
them. Activism is about An example from the (Continued on page 11)
strategy and tactics. You
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Ken Shubin Stein

(Continued from page 10) made phone calls, we spoke this case, and then trying to
We thought book value was to people who work at the understand a low case
conservatively stated laboratory—the end- earnings power analysis was
because the government users—we spoke to the possible, especially if you
agencies had a bureaucratic buyers, and we investigated understood health care as
incentive to come up with a the regulatory framework. an industry and where the
conservative number. There Some of the information we trends were going.
was new management in knew already because it's a
place and their incentives— health care idea. With health care, often, the
like the incentives of most problem is that, since we
new management in a turn- One of the benefits of our have a fundamentally
around situation—were to business is that, once you challenged industry, there
state all the problems up develop expertise in an will be a lot of changes to
front because none of it was area, you don't have to start reimbursements and the
their fault. Additionally, from scratch every single way margins are going to
bond yields were kept low time. So, in this respect, work in the future. That is a
by the Fed and we didn’t SeraCare was both problem for many health
believe that would last care-related ideas. In the
forever. And lastly, case of SeraCare, we
management was buying understood how the issue
back large amounts of its applied to the company and
stock, which was a powerful why it was protected from a
signal that they believed the lot of it. And it was
stock was significantly “Another red flag is undervalued enough that it
undervalued. was okay.
investing in an
G&D: Could you share With AIG, there were some
your analytical process or average or less- similarities and some
the research that you did on differences. We have
the idea? What kind of work than-average invested in insurance for a
did you do to prove some long time and this helps in
of the key points you business without
understanding the industry
mentioned? multiple ways to and the basic transaction.
We always try to
KSS: We tackle things not win.” understand deeply why
by trying to prove them, but someone buys or sells. Why
by trying to disprove them. does someone buy this
Falsifying a thesis is the product or service from this
fundamental approach of the company and why would
scientific method and it’s an they not buy it from that
approach we use and like. interesting and relatively company? These are basic,
straightforward in terms of but important, questions.
I'll compare and contrast the work, and we tackled it And, in the case of AIG, we
SeraCare with AIG. One using all the tools from felt comfortable in our
was small, the other was Advanced Investment understanding of the
large. One was post- Research and really tried to components of the business
bankruptcy and a special understand the specifics of and industry. Even though
situation, the other was a the buyers and sellers, the we were not experts in
large, out-of-favor company. industry, the trends, and the some of the non-core
Thus, the processes were supply/demand issues. assets, we had a sufficient
different. With SeraCare, all Understanding the switching margin of safety and we
the research techniques that costs became important in (Continued on page 12)
I teach are what we did. We
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(Continued from page 11) How do you think about the or not additive to the key
were comfortable with the trade-off between the time investment factors that are
liability analysis and the spent and the knowledge driving the investment
liquidation value, which gained? decision. We also learn a lot
were significantly higher from publicly available
than where we purchased KSS: The general reading materials that are not so
our stock and where it still and research we do is the obvious. For example,
is today. same for all ideas but, government databases can
David Winters at the 2013 beyond that, we use our offer very useful data, but it
Omaha Dinner. When we think about process to guide us in which usually needs be carefully
intrinsic value, it is always a research tools to use. analyzed to gain insights
rough guess, a range. In my Once we begin formulating from it.
mind, if I throw out a the questions we think are
number to you, such as, “I important, then we figure G&D: Have you
think intrinsic value for this out what needs to be done experienced any anchoring
stock is 100,” what I'm to best answer those effects in processing new
really saying, and the way questions. information where, because
we internally use that of the previous knowledge,
statement, is, “It's 100, give Often, making research calls you don't necessarily fully
or take 10 to 15%. It might incorporate updated data?
be 85, it might be 115.” It's
100, with implied error bars KSS: Yes, and AIG is an
around the statement. example of that. AIG is a
company that I had followed
We are cautious about our “We think about for well over a decade, and
ability to really know what there were a lot of things
something's worth, and we risk as ‘How much about the old way AIG was
only invest in situations run that I didn't like. After
where the price is well money can we lose the credit crisis, I really had
below that range. With AIG, to force myself to drop my
it was with the benefit of a and what's the prior thoughts, good and
political analysis, which we bad, about the company and
do sometimes. And I don't probability of losing
look at it fresh because it
mean “political” in the sense it?’ It’s a private was a different situation—
of “who's going to win the different management,
election,” I mean “political” business way of different balance sheet, and
in understanding how different asset collection. So
Washington works, because thinking about risk much was new that I, in a
that’s something you can forceful way, had to take a
sometimes understand. and it's simple, but clean approach to it.
Washington works in a
specific way, with different not easy.”
G&D: While we're on the
parts of the system having topic of mistakes and biases,
different incentives and, if are there any big red flags
you understand these from the self-analysis you
dynamics, you can analyze conducted that you would
situations as to how they're to industry participants, be willing to share with our
likely to work out. employees, customers, and readers?
others, is helpful, but there
G&D: How do you balance are certain ideas where the KSS: I'll throw out a couple
just reading the public information those calls can that we are now more
materials versus really going give may already be known, (Continued on page 13)
in and kicking the tires?
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(Continued from page 12) for them personally and his or her own self-interest
sensitive to than before the their ability to keep their might not be in your best
credit crisis. We are extra elected position in the interest. It’s important to
cautious if the company is in union. One of the things I've align incentives to ensure
a dynamic industry. If things developed a greater you’re operating toward a
are changing rapidly in an appreciation for is that, common goal. That's a
industry, it calls into sometimes, I'll look at a lesson that we’ve learned
question the durability of a situation and think, “Oh, the hard way.
competitive advantage; for that person's not acting
example, maybe the buying rationally.” However, what's One last one that can be
transaction is changing. In actually happening is they're more subtle is the red flag
retail, Amazon is that goes up when a
fundamentally changing the company is either acquiring
way buying occurs and, if other companies or
you're a retailer, you have investing in capex projects
to think about the impact of that are different from what
this trend. Some industries they have done in the past.
are more difficult to “Building a firm is a The new acquisitions or
understand than others and, projects may be different in
if they're changing, they're combination of
size and scope, or may be in
often too tough to analyze. new areas but, either way,
timing, skill and
they pose a risk that needs
Another red flag is investing luck, and what I to be considered carefully.
in an average or less-than- This is especially true if the
average business without have learned is that new large project is causing
multiple ways to win. For the company to incur more
good businesses, sometimes, it's a different thing debt.
we have a clear thesis. We
understand what our edge from just being a
G&D: Are value traps on
is, and we have a clear idea your list of red flags?
of the way it will work out.
good investor.”
We think there's one highly KSS: I don’t use the term
probable future path. In “value trap.” I find it more
contrast, for average or helpful to say, “Okay, I
below average quality made a mistake. I didn’t
companies, more can go understand a component of
wrong, so we prefer to have acting rationally for their this, so it’s not working
the potential for more than circumstance, but we may out.” Generally, if you’re
one thing to go right to not know enough to right in your analysis,
unlock the value we see. appreciate the various including understanding the
This “more than one way to forces at work. In incentives of the company’s
win” approach works better Washington, you see this a leadership, then most of the
for us than investing in such great deal and you see it time the market will agree
companies solely when they with unions as well. You with you in two to three
are available for purchase at also see it with leaders of years.
a low valuation. organizations.
An additional red flag is the G&D: Could you talk a
presence of unions. Union This is why aligning little bit about your process
leaders don't always act in incentives is so important, for sourcing ideas and
ways you would think are because, if you don't align figuring out what’s worth
best for their incentives, the rational thing your time to analyze?
constituencies. Sometimes, for a leader to do based on (Continued on page 14)
they act in a way that's best
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Ken Shubin Stein

(Continued from page 13) fantastic CEO, David think it’s worth, and if it is a
Weinreb, and an excellent, great asset or company,
KSS: Sure, Charlie Munger shareholder-friendly board, then we are going to hold
has spoken about there led by Bill Ackman. I think on longer. That’s our rough
being three good ways to that, even though the price guideline, but we don’t have
identify ideas. The first is to has meaningfully a mathematical rule. The
look for companies that are appreciated, its assets are selling decision is also in the
cannibalizing themselves by going to continue to context of what else is going
doing significant share improve for the next five to on in the portfolio.
repurchases. We look at ten years and intrinsic value
those and we think about per share will increase. I am also specific about the
share repurchases, not in way I phrased my earlier
dollars or share count, but G&D: How do you think statement—if it’s not great,
in percentage of shares about the selling decision? then we sell. That “if/then”
outstanding. The second is statement helps because, if
in spinoffs, and we broaden KSS: Selling is specific to you put it the other way, it’s
that to corporate situations just too easy to take
or special situations because something that’s a little
they have similar dynamics. better than average and put
And the third is cloning or it in that bucket of, “Oh, we
looking at other investors. should hold it longer.” I
We read what people do have certainly made that
and try to reverse engineer mistake, so now I just think
why someone bought “If things are about it as, “Is it great? Yes
something. or no?” If it’s great, fine,
changing rapidly in we’ll probably hold it longer,
In addition to those three but if not, if it’s anything less
areas where we actively an industry, it calls than great, then we’re going
look for ideas, we also to sell it early.
receive inbound ideas from into question the
investors we know or who G&D: What are your
are part of the Columbia durability of a
thoughts on shorting and its
community. Generally, we competitive relationship to portfolio
have more ideas than time management?
and we are usually trying to advantage.”
triage them and decide KSS: We generally don't
which ones to work on. short. We have in the past
and we have a good track
G&D: Are there any ideas record of doing it, but the
that you’re particularly reason for that record
excited about right now? might be because we've only
done it occasionally. We've
KSS: Howard Hughes is the security and what we done it in two situations—
going to continue to want in the portfolio, so, both where it's been
develop its assets and add again, it’s rough work and incredibly obvious and
value over a long period of we are constantly trying to where there was a security
time. We have owned it get better at it. The way I that lent itself to doing it,
since it was spun-off from broadly think about it is, if like a very long dated put or
General Growth Properties it’s not a great asset or a it was part of a cap
when GGP was in great company, then we are structure arbitrage where
bankruptcy. In addition to going to sell at the low end we bought the parent and
its tremendous assets, of our range of what we (Continued on page 15)
Howard Hughes has a
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(Continued from page 14) is inversely proportional to of things we do are that
shorted out the subsidiary. how challenging the way.
But the latter case is not environment is.
really shorting; it’s just We will make something a
setting up a trade to isolate G&D: Given your large position if we think
the asset that we wanted to framework and portfolio there is an extremely low
own. chance of losing money on a
permanent basis. Even if we
After the credit crisis, we think it might be a 4x
raised our standards and it’s return, if the idea could be a
helped us, I think, be better zero, it'll be a small position.
investors. Our current For something to be a
framework for managing the “I think it's actually significant position, such as a
portfolio is: for the first 10-15% position, it has to be
80% of our capital, we'll an aggressive very safe, for example, a
only invest in something if low-levered real estate
we think it's a double in two strategic asset opportunity such as Howard
to three years; for the next Hughes.
10%, we raise the bar and because it's one of
will only invest if we think One of the reasons we
it's a three to four multiple
the few things that
invest in real estate, along
return in two to three rises in value as the with healthcare and
years; and then, for the last insurance, is because it has
10%, which rarely gets market plunges.” distinct points of value
invested except during creation. If you take raw
extremes, we'll only invest if land and put in sewer and
we think it's a four to five power, you have improved
multiple return in two to it and it's a more valuable
three years. By following asset. It's a step function. If
this simple portfolio concentration, how do you you then get easements and
management structure, think about position sizing? get permits to build big
we’re safer because if 2008 buildings and you land an
happens again (and surely KSS: For us, position sizing anchor tenant for a 20-year
another crisis will happen) has to do with absolute risk. lease, you've improved the
we'll know how much We take the perspective real estate again. So, if you
capital we can invest at that, if you are not levered, understand how real estate
those lower prices. and your companies are not development works, you
too levered, then volatility is can track these things.
On that topic, I'd like to talk not risk. This isn’t always Howard Hughes has made a
about cash for a second true because of reflexivity lot of improvements in
because I think it's an and some other things but, recent years, and they're
underappreciated, for our purposes, volatility going to do a lot more, and
aggressive asset. Most of a security price is not that's why we think it's a
people say it's defensive, for intrinsically risk, although five or ten-year idea.
the obvious reason that, in the two can occur together.
most normal environments, We think about risk as G&D: Let’s talk about the
if you're holding cash, it's “How much money can we experience of running your
earning close to nothing. I lose and what's the business. You've co-founded
think it's actually an probability of losing it?” It’s a couple of partnerships
aggressive strategic asset a private business way of along the way. How have
because it's one of the few thinking about risk and it's these experiences built on
things that rises in value as simple, but not easy. A lot (Continued on page 16)
the market plunges. Its value
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Ken Shubin Stein

(Continued from page 15) while I was holding onto interested in buying a
each other and compared to their capital. I made what I business. So I, along with
each other and what have thought was the right ethical some of our former
you taken away from each decision, although it did hurt investors, bought a
of them? our business, to open up reinsurance company, and
the fund and, basically, that reinsurance company,
KSS: Building a firm is a release the capital. We Spencer Capital Holdings, is
combination of timing, skill became a funding source at a client of our investment
and luck, and what I have a time when many hedge management firm.
learned is that it's a different funds were gating their
thing from just being a good G&D: The reinsurance
investor. Something I business seems like a great
appreciate more now than I source of long-term capital,
did 10-15 years ago is how but if you underwrite poorly
important communication is you can certainly lose
with your partners, your “Be explicit about money. How do you think
investors, and all of your about running and managing
stakeholders. learning and that business and acquiring
the right talent for it?
The second thing I would progressing.
say is that it is a much KSS: It is important to
different environment today Constantly trying to
understand that our
than it was 15 years ago. improve and reinsurance company is a
The industry has changed frequency business, not a
quite a bit in terms of the designing systems severity one. A frequency
investor base. It used to be business underwrites
a business of mostly for yourself to generally predictable losses
individual investors, and and a severity business
now it is a business of accomplish goals underwrites risks that don’t
mostly institutional happen often or predictably,
investors. So if you want to yields significant
but when they do occur,
build a business today, it's rewards over time.” they are usually severe and
more challenging unless you expensive. We can still lose
come from a brand-name money, but it's less often
firm or you start at a certain and less extreme than with
size. Being small is great for a severity business.
investing but a challenge for
building the business. capital. The benefit of Given the nature of our
making that decision is we losses, we have the latitude
In our case, we have $80 had a lot of grateful clients, to invest much of the float
million in assets under although we didn't have in equities, which helps our
management. We had their assets. returns most of the time. It
$400 million before the also makes us an attractive
credit crisis and we made We had to rebuild the firm employer for someone
the decision during the after that happened. One of interested in investing
crisis to give cash back to the ways I did it was by because we have a lot of
our clients who were under putting a lot of thought into flexibility in how we deploy
extreme distress, even trying to get more stable, capital.
though we had some capital long-term capital, perhaps,
locked up. I made the in a different structure than G&D: Did you decide to go
decision that I didn't want a hedge fund, or in addition into reinsurance because of
people to experience to one. This led me to get (Continued on page 17)
extreme financial stress
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Ken Shubin Stein

(Continued from page 16) list. It is composed of ideas are interested in a career in
your past experience? we might want to own if the investing?
price changed, or a risk
KSS: Yes, I specifically issue was resolved. KSS: I would say only do it
wanted to be in reinsurance, if you really enjoy it. If you
so I spent time looking at When doing a deep dive have a passion for the
ideas and deals before into an idea, we sometimes work—for solving
finding one that worked. use external consultants to problems, for constantly
That's an example of help us deepen our research learning, and for the
something I would say was by focusing on one key area psychological aspects of
effective but not efficient. we want more information investing—then try to get a
on quickly or to help job at a firm where you can
G&D: Do you have any broaden our research by learn from someone else’s
words of advice to investors aggregating large amounts of experience. This isn’t a
who are thinking about information from diffuse requirement, and I didn’t
starting a fund today? sources. We’ve spent ten have that experience but,
years getting better at generally, I think working at
KSS: My advice to anyone working with outsourced a place where you can learn
who wants to start a research providers and now from a more experienced
business is to have at least a we can take virtually any investor can accelerate your
five-year timeline. If you're topic and find people with development early in your
predicating your decision on the appropriate technical or career.
being profitable in the first science or general
two to three years, I think investigative journalism The other suggestion I have
that's more challenging of a backgrounds and outsource is to get serious early in
choice. a research project to them. your career about mastery.
Our experience also enables Be explicit about learning
G&D: How do you us to use research assistants and progressing. Constantly
allocate time and how has to do robust literature trying to improve and
that fluctuated as the searches. It is time designing systems for
business evolved and consuming and it lends itself yourself to accomplish goals
developed? to outsourcing once you yields significant rewards
learn how to manage the over time.
We use four lists to process.
organize our ideas and G&D: Ken, thank you very
prioritize our time. List #1 I try to receive information much for your time.
is the ideas we currently the same way every time
have capital at risk in—our because it makes it more
current investments—and efficient for me to go
this takes priority over through large amounts of
everything else. List #2 is a data, articles, and videos. It
small list of one to three takes a lot of work on
ideas that we're actively someone else's part to
doing deep research on. collect and organize the
List #3 is a list of ideas we information, but then I can
might do research on. We get through it efficiently.
collect interesting ideas and This has all been worked
put them on List #3 and, out over ten years, but we
when space opens up on still work to improve the
List #2, we'll discuss all the process.
ideas on List #3 and decide G&D: What advice would
which one to promote to you give to students who
List #2. List #4 is our watch
Page 18
Lee Ainslie
(Continued from page 1) developed many friendships, or books that you've read
Graham & Doddsville which have lasted the that have really influenced
(G&D): How did you get twenty years since I left. you?
interested in investing? We all had different pockets
of knowledge about LA: At one point in time, I
Lee Ainslie (LA): When I investing, not only in terms read every single investing
was in eighth grade, my of sectors and industries, book I could get my hands
father was the headmaster but also different ways of on. Then Amazon came
of a boarding school, and looking at and thinking along, and the number of
the school decided to start about stocks. We spent a investment books has
an investing club. I thought lot of time comparing notes grown exponentially! In
that sounded fun and and playing devil's advocate terms of who influences me
interesting, so I asked if I to each other, and so the now, I would really point to
could join that club, which collective talent of the team my peers at Maverick. We
they let me do. I started ended up being a great have worked hard to
Lee Ainslie keeping a paper portfolio, benefit to my investing recreate that part of the
and my interest developed education. culture of Tiger in that I am
from there. surrounded by extremely
talented investors. If a
G&D: It's well known that week goes by that I haven’t
you got your start under learned something new,
Julian Robertson at Tiger “If a week goes by then that is really a wasted
Management. Was there week. Sometimes, I’ll
anything that was markedly that I haven’t discover another way of
different than the public evaluating a particular stock
perception about the way learned something
or hear about a decision by
things were run at Tiger? a management team that
new, then that is
could be interesting. Other
LA: I'm not sure I have a really a wasted days, I’ll learn about a
strong understanding of development in an industry
what the public perception week. Sometimes, that changes my perception
is, so it's hard to say if of the competitive dynamics
anything was markedly I’ll discover another in that industry or recognize
different. When I was a certain macro
there, it was a smaller firm. way of evaluating a
development may have a
When I accepted the offer, meaningful impact on the
particular stock or
they were managing around environment. Whatever it
$500 million. I was only hear about a is, I’m hopefully learning
there for three and a half every day. We have tried
years, but by the time I left, decision by a to develop a culture where
the firm had grown pretty we have a group of people
dramatically, both in terms management team who view themselves as
of assets and in terms of peers, who are not afraid to
people. I certainly learned a that could be
challenge one another, who
great deal from Julian but enjoy working together and
interesting.”
also from my peers there. who are driven by common
What truly made Tiger a goals and values. I believe
special place was that you I’m a much better investor
were surrounded by so today than I was twenty
many individuals who were years ago, and I really have
not only very talented and G&D: Since that time, have my colleagues to thank for
dedicated investors, but also there been other investors (Continued on page 19)
just really nice people. I
Volume
Lee Ainslie
(Continued from page 18) how critical integrity and investor should know more
that more than anything reputation are in the about those companies than
else. investment business, and you did. This objective was
those are lessons I certainly possible because most folks
G&D: What led you to took to heart. were responsible for
your decision to leave Tiger anywhere from a handful to
and start Maverick Capital? a couple dozen positions in
the portfolio. However, an
LA: That was an extremely appropriately diversified
difficult decision because I portfolio requires more
had been treated extremely “There's a trade-off
than a handful of stocks, so I
well at Tiger and had so with having very needed a different approach
much respect for Julian. I when starting Maverick.
was approached by a family narrow expertise. If Likewise, a properly
in Texas who were sort of diversified portfolio is not
serial entrepreneurs and one focuses on just just focused on one sector
had decided that they or on one region, and so
wanted to help launch a a very small number there was a period of time
hedge fund. I declined their when I was more dependent
offer to work with them of names they can
upon sell-side analysts and
more than once, but they develop a deep friends than I was
were persistent. I finally comfortable with. For
recognized that even though understanding of someone who was very
I was not sure I was ready accustomed to being
to take on such certain companies extremely close to each
responsibility, that when I investment I was
would finally be ready, the but may lose responsible for that was a
odds of finding this kind of bit of a scary feeling. That
opportunity would be slim perspective of how
drove a very early effort to
to none given their track that opportunity set expand the internal
record of success in a resources at Maverick, but
number of different fields compares to a initially during the first
and their willingness to be couple of years, that was
so supportive of this new broader universe.” the biggest transition.
venture. I am very thankful
to them. While they have G&D: That was a
not been actively involved in concerted effort when you
the business for many years, started to have analysts
they remain good friends covering a smaller number
and significant investors. G&D: What was the of names. A lot of analysts
toughest part of the we talk to have pretty
G&D: What was Julian’s transition going from broad coverage universes,
reaction to it? Did he give working for Julian as an so your goal was to have
you any words of advice? analyst to running your own the depth of knowledge that
fund? comes with having a smaller
LA: His reaction was number of names.
understandably mixed. I LA: At Tiger you were
don’t recall his giving me essentially expected to be LA: There's a trade-off
any particular advice when I the foremost authority on a with having very narrow
told him about my decision. small number of stocks. For expertise. If one focuses on
However, by that point I the investments you just a very small number of
had already had three plus oversaw, no other public (Continued on page 20)
years of hearing from him
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Lee Ainslie
(Continued from page 19) universe and are attuned to money in the short term in
names they can develop a developments that may the hope that together, as a
deep understanding of impact different industries team, we would be
certain companies but may we established a stock successful over time. They
lose perspective of how that committee that usually had to have confidence in
opportunity set compares meets several hours each our effort.
to a broader universe. So week. This group includes
how do you have your cake every sector head, our Today, the majority of our
and eat it too? We Chief Risk Officer, and investment team joined
addressed this issue by myself, and is chaired by Maverick as an analyst.
hiring what we refer to as Andrew Warford. These Typically, our analysts have
sector heads who oversee meetings are focused on worked for two years at a
our efforts in each of the six evaluating and reviewing Wall Street firm or a
broad industry groups in potential and current consulting firm before
which we invest. By 1998, investments, and under joining us. We make a two-
we had heads for each Andrew’s leadership we year commitment to them
sector so there was finally have done a wonderful job and expect the same in
no stock in the portfolio of maintaining a very return, and some are asked
where I was the only consistent and very high to stay longer. We usually
individual tracking the hurdle for including a stock hire one to three analysts
investment. The next five in the portfolio. each year, and it’s a highly
years were spent building selective process. We
out the depth and talent of There's also a weekly review hundreds of resumes
those teams. Now we portfolio management from extraordinarily well-
typically have three to six meeting that I lead in which qualified individuals. Our
people on each sector team. we consider our portfolio selection process has
Over the last decade, the exposures and risks in light improved meaningfully over
incremental growth of the of different developments the last few years. First, we
investment team has been around the world. We have changed our interviewing
driven by developing tried to find a balance that process to make it very
expertise that is beneficial allows our sector teams to targeted on evaluating
to all the sector teams. be quite focused on the different skills and attributes
Today, we generally hold industries they cover and that we believe are essential
about four investment yet to be fully informed to success at our firm.
positions per investment about factors outside of Secondly, we introduced a
professional. At most their universe that could third-party testing
hedge funds, this ratio play a role in their decisions. component which measures
seems to average characteristics that the
somewhere between 10 and G&D: As you were interviewing process may
20. This gives us a building your analyst team, not reveal. Thirdly, we
significant advantage in what did you look for in the spent time analyzing the
terms of the quantity and people that you hired? success of past
depth of our due diligence recommendations of the
behind each investment LA: The initial group folks on our team who
decision and how familiar consisted of people whom I conducted our interviews to
we are with the companies had known for a long time understand who in the past
in which we invest. and had great confidence in was adept at predicting
their abilities. However, good candidates—evaluating
To ensure that our sector each of these individuals people and evaluating
heads have a strong were being asked to take a securities are two different
understanding of the relative risk in that they would skills.
attractiveness of their almost certainly make less (Continued on page 21)
investments to a broader
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Lee Ainslie
(Continued from page 20) can do to improve your LA: Not really, I think
ability to recognize signals every business in the world
The most important that can help you determine continually becomes more
components we gauge whether someone is not competitive. I'm sure that's
include competitiveness, being forthright or honest. true for the dry cleaner
mental flexibility and This can come in handy down the block—I bet their
emotional consistency—that when you’re talking to a business is more challenging
last trait is surprisingly management team and than it was a decade ago.
important. This is a very asking difficult questions. That's certainly true in our
stressful business. We are We haven't found that these field, and so you constantly
all human, and we all make have to find ways to
mistakes. How one improve. If you’re not
responds to those mistakes improving you eventually get
and whether someone can left behind. So this training
keep a level head and make really was a result of trying
thoughtful decisions is “This is a very to find ways to improve our
critical. Conversely, how abilities. I heard about this
does one respond to a few stressful business. group of ex-CIA officers
big wins? With some folks, who conduct this coaching
early success leads to We are all human, from one of our investors
inflated confidence that may actually, and I think it's been
slow the recognition of a and we all make
helpful.
mistake.
mistakes. How one
G&D: How have your
At the end of the day, responds to those responsibilities as a
investing is not rocket portfolio manager evolved
science. Most of the folks mistakes and over the years? Are you
we're interviewing are still close to every
certainly bright enough to whether someone investment decision you
discount a cash flow stream make?
or calculate a P/E multiple. can keep a level
Productivity and dedication LA: Over the years it's
can be much more
head and make
been a bit cyclical. If you go
important differentiators thoughtful decisions to the very beginning, we
than just raw brain power. had one investment
Intelligence helps, but is critical.” professional, so I was very
whether you’re driving a close to every decision we
Porsche or a Ferrari doesn’t made, for better or worse.
matter too much if the There have been periods
speed limit is 65 MPH. where the business itself has
techniques provide some required a larger investment
G&D: One thing we read magical ability, but they can of time as we were going
about was that your team is help you understand through changes in our
trained in lie detection and whether someone is process or rough patches in
interview techniques. Is addressing a topic that gives performance so investors
that an important process them discomfort. want to speak with me
when you are interviewing a more. Other times, I end
management team or G&D: Was this training a up investing more time in
conducting channel checks? result of you having been evaluating and managing our
lied to by a management investment team—these
LA: I'd say it's helpful but team in the past? responsibilities tend to ebb
not extremely important. (Continued on page 22)
There is some training you
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Lee Ainslie
(Continued from page 21) is different from our average portfolio reflects the riskier
and flow. Over the past holding periods, as often nature of these investments
couple of years, the amount others begin to recognize and that these positions
of time I have had to invest some of the elements of the turn over more frequently,
in running the business has investment that we have so having a deeper bench of
been relatively light. been focusing on and the such investments is helpful.
position becomes
We typically have about 150 incrementally less attractive,
Professor Tano Santos at stocks in the portfolio, and I and of course other times
the 2013 Moon Lee Prize am familiar with all of them, we recognize that we’re
Competition. but I am closer to our larger wrong. Nevertheless on
positions and investments the long side, our typical
that have not worked the holding period is still over a
“We believe that
way that we had expected. year, and on the short side
So when I'm doing a deep
having
it is closer to nine months.
dive or going to visit a Although our investment responsibility for
management team, often the horizon is similar for longs
P&L of that position has a and shorts, our holding both longs and
minus sign in front of it. period ends up being longer
With Andrew’s role as chair on the long side because we shorts sharpens
of the stock committee, have often been fortunate
both he and the relevant analytical judgment
to identify great businesses
sector head are very close run by talented managers.
to each investment, and to
and helps a team
When a business is
me it’s reassuring to know generating a strong return build a more
that we have at least two on capital and the cash flow
senior, proven investment stream can be reinvested complete
professionals very attuned effectively, then we may able
to the potential return and to own that stock for understanding of a
risks of each stock in the several years. The short
portfolio. particular industry.”
side typically doesn’t work
that way because when a
G&D: Can you talk a little company has significant
bit about the difference in issues, these flaws usually
how you think about the come to light sooner rather
timeframe and the sizing than later. So on the short
between long and short side, you often end up
ideas? How you think about having more of an event G&D: We've interviewed
the similarities and orientation. investors who have said that
differences in regards to it’s rare to find people who
portfolio construction? In terms of sizing, our are adept at both long and
average long is roughly short investing. Have you
LA: I think compared to twice the size of an average found that to be the case?
many other hedge funds, we short at Maverick, and our
may have a longer term long portfolio is more LA: I disagree with that
timeframe and tend to think concentrated than our short thesis. We believe that
very strategically when portfolio. This construction having responsibility for
evaluating different allows us to maintain net both longs and shorts
industries and companies. long exposure typically sharpens analytical judgment
We are typically looking to between 30% and 60%. The and helps a team build a
understand where a greater level of more complete
business will be in two to diversification of our short (Continued on page 23)
three years. However, this
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Lee Ainslie
(Continued from page 22) balance supports our investment.
understanding of a particular approach.
industry. In my experience, G&D: Can you talk about
people that are solely G&D: You said in an your idea generation
focused on shorts tend to interview a few years ago process? Are you finding
become extreme pessimists. that classic value investors yourself looking more at
They look at any situation often invest purely on new ideas or at ideas that
and immediately start to valuation and that was you’ve been tracking for
find all of the things that something that you just many years?
may go wrong, while quickly weren't comfortable with.
overlooking important How much weight do you LA: We have always
potential positives. place on valuation? considered our universe to
Furthermore, shorting is be every stock in the world
more challenging for several LA: To be clear, I think that trades more than $10
reasons, one of which is that valuation is a critical million a day and has a $1
that the market tends to component of billion market cap. As we
appreciate over time. So understanding where speak, there are almost
even talented short-sellers investment opportunities 3,000 such stocks—this
who are generating alpha may lie. But I think many excludes A shares in China
tend to get rather frustrated “value investors” purely as US investors only have a
over time. These issues focus on that metric and limited capacity to invest in
may be even more acute at may ignore other important these stocks today. If we
Maverick than many firms considerations. It’s one did, it would add several
because all of our short thing if you have a very hundred stocks to our
exposure is achieved by cheap stock and reasons to universe. At Maverick, our
shorting individual stocks, as believe that the cheap investment process is driven
opposed to using ETFs, S&P valuation will not persist: by our six industry sector
puts, or other market- there's a new management teams, which have global
related instruments. team, there's an activist responsibility. Each sector
shareholder, they’re team has between three and
We have always held our restructuring, they just five people.
sector teams responsible for made a decision to buy back
both long and short stock, and so forth. I Idea generation almost
investments, and our believe it is important to always takes place in these
investment process is pretty identify a catalyst that sector teams. There are
similar for each. To should benefit the valuation. times I have an idea that
dramatically oversimplify, The approach of simply merits further evaluation,
we are trying to identify the identifying a very cheap but most of our sector
winners and losers in each stock that often has been heads have spent their
industry in which we invest cheap for a while and then entire careers focusing on
and then evaluate the just crossing your fingers one industry, and they have
discrepancies between our and hoping the world will each proven that they are
conclusions and consensus wake up and be willing to very talented investors—so
views, and I believe that is assign a higher valuation one we would never move
an effective approach for day soon is not a very forward on an idea without
both longs and shorts. effective approach in my their input. Our sector
While many firms seem to judgment. So while we heads are probably
be markedly better on place great emphasis on responsible for the majority
either long or short valuation in our investment of new ideas, but even our
investments, at Maverick we decisions, valuation alone junior analysts are expected
have added 6% of alpha per should never be the driver to develop actionable
year on both longs and of either a long or a short (Continued on page 24)
shorts, so I believe this
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Lee Ainslie
(Continued from page 23) Of course, we also want to important consideration for
investment theses. From have a very deep us. I believe that a
that spark of an idea, if it’s a understanding of the successful investor must be
company we know well, one businesses in which we very comfortable with a
little data point can be invest: the sustainability of number of different
enough for us to move the business, of the growth valuation methodologies and
quickly. However, if it’s a and of the cash flow. The have the wisdom to
company we have not recognize which valuation
analyzed before, it typically approach is going to be the
takes months before a stock most relevant in different
can make its way into the situations. The most
portfolio because we will do commonly used valuation
a deep dive not only on the metric at Maverick is
company in which we’re sustainable free cash flow in
considering investing, but comparison to enterprise
also on the competitors, “The most critical value. But we may also
customers and suppliers of consider metrics such as
that company. For better factor that we’re enterprise value to
or worse, this process can revenues, book value, free
take a very long time. trying to evaluate is cash flow yield, P/E ratio,
the quality of dividend yield, and so forth.
G&D: What do you look Different metrics will be
for in these deep dives? management—their more or less important in
What qualities make for a different situations.
good investment? intelligence, Finally, as I mentioned
earlier, we consider how
LA: By deep dive, I mean competiveness and, differentiated our view is;
we typically have extensive not to say that we will only
meetings with as many most importantly, invest in things where we
different members of have a contrarian
management as possible as their desire to
perspective. For example,
well as managers of different create shareholder Microsoft in the early 1990s
regions or product lines if and Wal-Mart in the early
possible. The most critical value.” 1980s were consensus buys
factor that we’re trying to among virtually all Wall
evaluate is the quality of Street firms, and yet they
management—their were among the most
intelligence, competiveness successful stocks of their
and, most importantly, their day. So it's not impossible,
desire to create shareholder but the odds are against you
value. At the end of the if your view is the same as
day, businesses are run by primary point of our everyone else's because that
people, and different extensive conversations view is probably already
management teams have with customers, suppliers reflected in a stock’s
different motivations and and competitors is the valuation. Our most
different abilities. As evaluation a company’s successful investments tend
investors, it is critical that strategic position and the to be those where our
we have a strong strength of a company’s research process has led us
understanding of the quality moat or competitive to a conclusion that is
and the objectives of every advantages. As we different than the
management team in which discussed a few minutes ago, perspective commonly held
we invest. valuation is also an (Continued on page 25)
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Lee Ainslie
(Continued from page 24) against and have found or sell securities to get to
by most investors, and these insights gleaned through the portfolio that I believe
deep dives allow us to those conversations very represents the optimal use
develop significant helpful over the years. of capital once again.
confidence in these
differentiated views. G&D: You have been This is exactly why we
quoted as saying there are primarily invest in liquid,
G&D: You've met a lot of no “holds.” You either public equities—so we have
management teams over “buy” or “sell”. How do the ability to improve our
your career. Have you you implement that portfolio every day. If we
found more often than not practically in your portfolio? conclude that a 3% position
that they are thinking the in stock X would be the
right things in regards to LA: I think I have read ideal position size, then we
creating shareholder value, almost everything that should try to get to that
or is it kind of the Warren Buffett has written, position size that day.
alternative where you're and I agree with more than Whether stock X is new to
generally disappointed? 95% of his thinking, but this the portfolio or it’s a
is one area where I disagree. position we’ve held for
LA: One of the things we I understand the tax impact years is not horribly
really try to make sure our of turnover, but relevant. Likewise, whether
team understands is that if nevertheless, I would argue we entered that day with a
someone is able to become that an investor should be 2% position or a 4%
the CEO of a Fortune 500 able to overcome the position in stock X should
company, the odds are that negative tax consequences not play a role in our
individual is going to be of shorter-term holdings determination of the most
pretty impressive across the through more efficient use appropriate position size. I
conference table for 45 of capital. For example, if I think too often investors get
minutes. These executives am starting a new fund, and wed to certain investments
are not dumb; they know my portfolio is a blank sheet that have worked well or
exactly what you're trying of paper then I will evaluate perhaps because they’ve
to get at, what you want to the potential return of every developed a nice
hear, what Wall Street potential investment from relationship with
thinks the right answers are, the prices the market is management that they don’t
and like all good politicians offering that day. I can want to disrupt, and so
they will do their best to decide how much risk I am investors often get
highlight the strengths of willing to take to achieve complacent and comfortable
their business. When you expected returns, and I can with their current portfolio.
delve into the potentially evaluate how each In my judgment, it is critical
weaker aspects of their opportunity compares to to attempt to identify the
company, they will typically every other opportunity to best possible use of capital
try to gloss over your develop a portfolio which I continuously.
concerns or even obfuscate believe represents the
the issues. So when we optimal use of capital. In my The “no holds” concept
evaluate a management view, tomorrow, I should go simply reflects the approach
team, we’re much more through the exact same that every investment
focused on analyzing past process taking into account should represent a very
decisions and actions than any new information compelling risk/reward
simply reviewing their including changes in the opportunity from current
responses to our questions. price of securities. If I prices, and if that’s not the
We also invest a lot of time conclude that a different case then that capital should
in trying to interview people portfolio would be be redeployed into positions
they've worked with before preferable then I should buy (Continued on page 26)
or people they’ve competed
Page 26
Lee Ainslie
(Continued from page 25) balance of longs and shorts which was a result of a
that are viewed as very in every industry and in merger between Software
compelling at current prices. every region in which we Etc. and Babbage's in late
In the perfect world, every invest. We try to avoid 1994. The companies were
member of our investment market timing or sector the two largest sellers of
team is pounding the table rotation calls. Our returns computer software and
to increase the size their are driven by our ability to operated in malls around
positions every day until generate alpha within the US. On paper, NeoStar
they are at a maximum size industries and regions. was very attractively
in terms liquidity or risk positioned. By merging,
contribution. When G&D: Can you talk about a these two competitors
somebody tells me that they mistake that you've made would enjoy economies of
don’t think we should sell a on an investment that has scale and could improve
stock, but that they changed the way you think pricing. As this merger was
wouldn't buy more at the about things? taking place both Sega and
current price either, then Nintendo had roll-outs of
that investment probably LA: Unfortunately, I can go their new game platforms,
does not represent one of through many examples of both of which ended up
our very best uses of mistakes that we’ve learned being bigger than people
capital—unless the size of from. In terms of risk/ expected. At the same
the position is already at a return management, we time, Windows 95 was
maximum from a risk develop a risk case that we coming out, so you had
perspective. We want our think has a 10% chance of huge drivers to both PC and
portfolio invested in the taking place—so a case that gaming software sales as
most attractive use of is not highly likely, yet well as very significant
capital today at current certainly in the realm of synergy opportunities.
price points, and if a certain possibility—and we These businesses should
position no longer vigorously debate the enjoy meaningful operating
represents that then we assumptions behind these leverage, so just improving
should sell. Sometimes, risk cases. In measuring comp store sales a few
people have a hard time potential downside, we have percent should have had a
with this because this often used historical nice impact on operating
philosophy often means we dynamics, such as trough margins. Putting all these
are reducing or exiting a book value or revenue factors together, we
position before it’s reached multiples. One of the concluded that the company
our expected price. For lessons of 2008, and even would earn significantly
example, if a stock is 10% more so in 2011, was that, more than investors were
away from our original in certain environments expecting. And we were
target price, we are likely to those historical patterns can wrong. We were wrong
sell because we think there collapse. We took too because management just
are many other much comfort in the blew it. When you asked
opportunities with greater thought that many stocks me about characteristics I
upside. Conceptually, our were sitting at levels where look for in stocks, I
team has to accept this the downside risks appeared mentioned quality of
concept of “no holds.” very limited given they were management is the most
so close to the historical important. While our
G&D: Are there industries lows on such metrics, and investment case for NeoStar
or countries that you have a we were proven wrong. was extremely compelling,
different view on versus the we were doomed by
market? In terms of a specific horrific execution. In doing
company, we invested in a a postmortem, it became
LA: In our core hedge company called NeoStar, (Continued on page 27)
fund, we try to maintain a
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Lee Ainslie
(Continued from page 26) Secondly, the path to an Not that a poor record
clear the merger was a investment career is not can't be overcome, but it's
disaster. The companies necessarily to work at a certainly going to make
continued to be run as hedge fund or at a large raising capital harder. You
separate entities and mutual fund complex. You can’t just tell people not to
continued to compete can start your career by count your past record
viciously. There was huge simply improving your because you didn't know
in-fighting about who was understanding of how what you were doing. So
going to get what different industries or the first couple of years Professor Bruce Green-
responsibility. Instead of companies work or how become a make or break wald and Heilbrunn Center
taking advantage of the Wall Street works. Any period. If it were me, I Director Louisa Serene
obvious synergies, they had brokerage firm or Wall would want to stack the Schneider at the 2013
duplicate efforts on many Graham and Dodd
Street firm can be a path to deck in my favor as much as
different fronts. One large Breakfast.
an investment career. A lot possible. When I decided
vendor told us that two of people move from the to launch Maverick, I had
different people each sell-side to the buy-side been with Tiger for three
thought they were ordering over time. We probably years, and I was still scared
for all the stores and as a have as many former to death. I was young, naive
result, important orders McKinsey consultants as we and probably a touch
were placed twice, and they do former Morgan Stanley arrogant in hindsight. If I
literally ended up with twice investment bankers. had a better understanding
the expected inventory. It of the challenges of
was just an unmitigated G&D: A lot of our successfully starting a fund,
disaster. We bought the students are also interested I’m not sure I would have
stock right after the merger in starting their own funds. departed Tiger. Also,
in early 1995, and by 1996 it Assuming they can raise today's world is far more
was all falling apart. Our capital, would you competitive. The odds of a
strategic analysis proved recommend that they spend small group of people
correct—both the gaming the first few years trying to launching a small fund and
platforms were huge and get training somewhere growing that fund into a
Windows 95 became the first, or do you think it is large entity are just much
best-selling operating okay to start right after smaller today. When I
system of all time. Realizing business school without any started, there were
the potential synergies formal training? probably about 100 hedge
seemed straightforward as funds in the world. Today,
well. But the important LA: The capital is there are over 7,000.
lesson was that such important, but the know-
considerations are not how is even more
relevant if the management important. The fear with G&D: Lee, thank you for
team is subpar. starting right away without a your time.
great deal of experience is
G&D: What advice would you don't get many
you give to the students mulligans in this field. If you
who are interested in a launch a fund that has
career in investing? disappointing performance,
then go to work for another
LA: Two things: first, read firm for a few years and
a lot. Read as many eventually try to launch
investment books as you another fund—potential
can get your hands on. I've investors are still going to
been able to learn want to delve into the
something from almost returns of your initial effort.
every book I have ever read.
Page 28
Geoffrey Batt
(Continued from page 1) because I couldn’t renew my than cover my tuition and in
Batt launched the student loans. the meantime I’d get to
Euphrates Iraq Fund in learn about the world. He
October 2010. Prior to I revealed this to him having said something along the
his Iraq investments, Mr. really no idea who he was. lines of, “the last thing the
Batt was an analyst at But then he started telling world needs is another
Quantrarian Capital me this story of how, philosopher with no real
Management. He before school, he was experience.” He was of the
studied philosophy at running a fund that was one opinion that philosophy
Columbia University. of the first to invest in post- provides a good training for
Soviet era Russian equities financial markets.
Graham & Doddsville during the 1990s. Russia
(G&D): Let’s start with turned out to be one of the I actually thought he was
your background—what best places in the world to nuts. He didn't fit my
Geoffrey Batt drew you to investing, and invest in at that time so it conception of what an ultra-
in particular, to investing in was quite successful, but he high net worth individual
Iraq? also had a lifelong dream of looked like. But I went to
the library and looked him
Geoffrey Batt (GB): I up and it was all true. His
studied philosophy at name was Dan Cloud. You
Columbia as an undergrad couldn't bring up good
and had absolutely no pictures on the internet at
intention whatsoever of the time but I saw there was
getting involved in finance. I a Barron’s article on him
didn't know anything about that I had to look up on
the stock market. I honestly “Philosophy teaches microfilm. Everything he
didn't know the difference said was there. So I decided
between a stock and a you to take to give it a shot. I went to
bond. I was strictly work for him, with his
interested in academics and whatever the family office, and learned
very much wanted to about East Asia and the
pursue a Ph.D. in
prevailing wisdom is
markets that they were
philosophy. I took a and challenge it.” investing in—Thailand, Hong
graduate seminar in my Kong, South Korea,
junior year and there was a Singapore, Indonesia,
third year Ph.D. student in Vietnam, et cetera. Dan was
the class who was much very much a macro driven
older, maybe in his forties. investor, looking at things
But he was, in my opinion, from a top down point of
clearly the smartest guy in view. What he had me
the room, probably smarter looking for were countries
than the professor. He was pursuing a philosophy that seemed to have the
also a bit eccentric to put it doctorate. It turned out best potential to grow very
politely. He seemed very that he was in the process rapidly and had the most
interesting, though, and one of starting a new family interesting demographic
day we bumped into each office to focus on investing profiles.
other on campus, started in East Asian emerging
talking, and a friendship markets and asked if I’d be I more or less just tried to
developed from that. After interested in working for learn on the job, and I
knowing him for a while, I him during the time off. If it would say after six months
mentioned that I was going went well, he told me I’d get or so I started getting very
to have to leave school for a a bonus that would more (Continued on page 29)
year to save up money
Volume
Geoffrey Batt
(Continued from page 28) And so I went back to focus going to be initially?
interested in companies school and had enough
themselves. I didn't have the money left over to invest on GB: Several different stock
slightest clue about how to my own. And you know, markets over time have
analyze or value them so I before I started working for gone through these historic
spent the next six months him, my focus was 100% equity re-ratings and what I
trying to learn. The first philosophy. When I came was really taught to do
thing I read was The back, it was 50/50—50% when I was working for
Intelligent Investor. I felt philosophy and 50% Dan, and what he was
pretty confident that I markets. And as that year taught to do when he first “I'm not a value
understood it, so I went on progressed, it gradually got involved in the business,
to Security Analysis and read shifted to 0% philosophy was to find opportunities purist in the sense
that. I still read it—to this and 100% markets. Toward for historic re-ratings.
day, I think I’ve finished it the end, I was sitting in class that I altogether
seven or eight times. Security with my laptop open reading Let me try to define what
Analysis gave me a basic shun macro
10-Qs and 10-Ks rather that is. It’s a type of secular
framework, however than paying attention to the bull market that tends to
imperfectly I understood it,
considerations. But
professor. I was two classes last for seven to fifteen
that I could use to approach short of graduating and years, In the case of Japan, to me, the real
valuing companies on an decided that I had enough. their bull market started in
individual level. And that's 1950 and lasted until 1989. interesting work is
when it became very In retrospect, it was an That is one of the longest
interesting to me. The unwise decision because I ones that I am aware of. in finding the next
macro stuff, it has its place, I didn't have as much money Russia was fourteen to
suppose. I'm not a value big company, the
as I thought I did. Maybe I fifteen years. You can get a
purist in the sense that I was a bit delusional in secular bull market that lasts
altogether shun macro
kind of deeply
thinking it, but I was for seven to fifteen years
considerations. But to me, determined to just go out and during that period undervalued
the real interesting work is on my own and become an companies on the exchange
in finding the next big independent investor. I still can see their profits go up company that has
company, the kind of deeply had library access at 20x. Initially they might be
undervalued company that Columbia and there was a trading at 2-4x earnings and the potential to
has the potential to Bloomberg there so I by the end of the bull
appreciate ten, twenty, appreciate ten,
thought it would be perfect. market, they are trading at
thirty times over a ten year I told Dan my plans and he 15-20x earnings. There’s an
period.
twenty, thirty times
said, “Look, you can't just improvement that gradually
go out on your own and not gets recognized. Initially, the over a ten year
G&D: How did that year have structure. You really market goes up but the
working for Dan turn out? need to have a mentor for moves are commensurate period.”
this process, somebody who with profit growth. If profits
GB: The year went really can help guide you if you're grow 40% and the company
well. We were mostly going in the wrong direction is trading at 8x earnings,
invested in Thailand and I or to provide you with then the stock goes up 40%
think the market was up advice and support and but still trades at 8x
110% or so in 2003-04. I got criticism.” So I decided to earnings. But towards the
a bonus, which at the time strike up that relationship end, people get really
seemed quite large. In with him informally where I exuberant and assume that
retrospect, it wasn't, but would start on my own but the good times are going to
when you're approaching he would serve as my last forever and that’s when
things from the perspective mentor. you see multiple expansion.
of what you're going to earn So it’s when you get
in philosophy, it seemed like G&D: And what was the (Continued on page 30)
quite a lot of money.
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Geoffrey Batt
(Continued from page 29) thing. He found it in Russia is followed by a move away
significant profit growth and launched his fund in from whatever was plaguing
over a long period of time 1994. Russia from 1992- it before to something more
coupled with multiple 1994 was also a basket case. positive, more market and
expansion that you can get Yeltsin lost an election in capitalist oriented. If you
these spectacular stock 1993 but decided it wasn’t can find that kind of
market moves. valid just by decree and situation, that's a potential
suspended the constitution. candidate for a historic
When Dan first got involved Parliament was obviously equity re-rating.
“Several different in the business, it was in very upset about that so he
China in the 1980s. He sent tanks in to fire on G&D: What else goes into
stock markets over finished school and went off Parliament in 1993. Literally, it?
to China to work for a the President of Russia was
time have gone British brokerage firm. The using the military to fire on GB: There's a lot more but
guys who taught him made the Parliament building and that's the first thing you
through these their fortunes investing in kill MPs. But it turned out want to look for. It seems
historic equity re- Hong Kong and South that was the ideal time to to me at least, the greatest
Korea in the 1960s and get involved in Russia. These opportunities in any market,
ratings and what I 1970s. South Korea was sorts of alarming states of any asset class, any
socially and politically an affairs, they really, it turns investment generally that
was really taught to utter basket case at that out in retrospect, don't you're going to make, are
time. It was ruled by a matter much. They're those in which there's a
do when I was dictator, Park, for around terrifying and for that very wide gap between
19 years. He was a guy who reason most investors don't perception and reality. So
working for Dan, had suspended the get involved in their the perception of a country
and what he was constitution two or three markets. When it's most that has these
times, murdered the opportune to invest in a characteristics is obviously
taught to do when opposition. Park was brutal market, most people are going to be very negative
but this was also the period doing anything but investing because there's political
he first got involved that is referred to as the there. They stay very far instability, social instability,
South Korean economic away. and so on. But if the
in the business, was miracle. So despite the fact economic situation is
there was quite a lot of But he was there and positive, if the country has a
to find political and social instability started a fund, Firebird. And couple years of very high
opportunities for in that country, it happened I think that fund was up 50x, GDP growth, inflation is
contemporaneously with an net after two and twenty, so relatively stable and they
historic re-ratings.” economic miracle. These it was an extraordinary run. have price stability, then this
guys recognized that and I think it was one of the is where I think the macro
they believed that many of best performing emerging very much comes into play.
the things that typically keep market funds in the world
people away from during that period. So that's You want to look at things
markets—bombings, really what I was taught to like, are deposits in the
violence, general look for—these types of banking sector growing? Is
instability—really don't really alarming and chaotic the currency relatively
matter that much. As long transitional situations in a stable? Generally what
as it's not related to the country that, for whatever you're looking for are signs
economic development of reason, was living in the of macro stability and
the country, it doesn't stone ages or had some economic growth. If you can
matter. That was what Dan kind of very flawed find these things, then that
was taught. economic system in place implies there are institutions
for decades. Something in place that are capable of
So he later went off and was transformative occurs that (Continued on page 31)
searching for the next big
Volume
Geoffrey Batt
(Continued from page 30) countries where there is Dictatorships can be very
achieving this stability. If you perceived political risk, how stable, but, by their very
have price and currency do you separate out the nature, they're stable until
stability, that presupposes a noise from true risk? Take they're not. If there's an
central bank exists that is Yeltsin for example, if you issue, if suddenly the
capable of imposing stability have a leader or autocrat dictator can no longer rule,
on the system. And that also who is willing to go and fire what follows? Also if the
presupposes that you have on Parliament, how do you dictator goes crazy, there's
some sort of technocrat get comfortable that he also no mechanism to easily
running the institution. So if isn’t also willing to devalue remove him and then you
you have credible the currency? can get a dangerous
institutions at the financial scenario where he just
and economic level that are starts printing money or
able to achieve macro devaluing the currency—
stability, then whatever has you could have a revolution
been holding back that or other undesirable
country from realizing its developments follow. Still,
potential, if they can the South Korean example
transition away from it, under Park demonstrates
macro conditions aren't that economic miracles and
going to interfere with historic equity re-ratings can
development. “The South Korean happen even in iron-fisted
dictatorships.
If you look at countries that example under Park
had the potential to do this That said, I have a
demonstrates that
but failed, like any South preference for transitional
American country in the economic miracles countries where there is a
1960s, what destroyed them democratic political system
is that they had chronically and historic equity in place. Taking Russia and
high inflation, they had Yeltsin, you could make an
persistently weak re-ratings can argument that what Yeltsin
currencies, and they lacked was actually doing was
the institutional framework happen even in
establishing legitimacy of the
that was vital to achieve the state itself—that the state
iron-fisted
stability that you needed to itself was being undermined
get that kind of economic dictatorships.” by a group that was trying
take-off. If you're a business to take control, the former
person, how do you plan for Communist party, and
the future if the currency is Yeltsin was trying to
devalued by 80% and there's prevent that. So you could
prospect for further argue his aims were noble
devaluation? How do you and he was actually trying to
plan for the future if you install a capitalist,
cannot estimate what your democratic framework, and
real returns are going to be GB: Right. So this is that action, though
because the currency and obviously a key autocratic, was directed
prices are so unstable? It consideration and a great toward something that was
leads to a very short term question. In South Korea, ultimately in the country’s
outlook. That is what I'm not so sure I could ever best interest.
prevents an economy from have gotten comfortable
realizing its potential. with the fact that Park ruled When you look at a country
the way he did. (Continued on page 32)
G&D: In some of these
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Geoffrey Batt
(Continued from page 31) enrichment. In the case of die for it. Or you could stop
that has a great deal of Russia and also in the case short and compromise and
violence and where the of Iraq, what you find is that admit that some parts of
political leaders have a what these guys are really your arguments are wrong
reputation for ruling with an doing is attempting to or you’re not going to push
iron fist, even if democratic, establish the state’s for certain parts of
monopoly on the just use of whatever you were striving
force. That is a critical part for. In Iraq, this is what we
of establishing the legitimacy tend to find. The various
or sovereignty of a country. political actors that are
In these transitional constantly feuding with each
“I had thought of situations, what seems to other use heated and often
matter most is that the alarming rhetoric, but at the
Iraq as a failed
state demonstrates to the end of the day, when
state in the middle people that only it has the they’re on the brink, they
authority to use force justly. always pull back and make
of a civil war. I Really what the state is some kind of pragmatic
doing is demonstrating it has compromise. And it tends
knew nothing about the capability and willingness to be compromise that is
to establish law and order. rationally self-interested.
it beyond what I Sometimes that can be That, to me, is very
brutal. But if it’s done to encouraging because you
read in the New
ultimately achieve see the same, or similar,
York Times or saw democratic ends, then it sorts of behaviors in
seems like it’s justifiable and democracies throughout the
on TV. And so I something that at least I can world, including the West.
get comfortable with. So I
thought the article think that probably applies G&D: For instance, in
to what Yeltsin did. And raising the debt ceiling?
was odd because when I look at Iraq, I think it
very much applies to what GB: Right. And that to me
how on earth is a
has happened in Iraq since is even more insane in a way
failed state in a civil 2008. To the extent there because, and I guess this is
has been political violence, contentious, at least in the
war increasing oil it’s been done for reasons Iraqi political system they
that are almost always tend to be arguing about
production?” justifiable in those terms. things of great significance. I
We observe the behavior of mean this is a country in the
the Iraqi political elite very very early stages of its
closely. What we ask is development, ten years
this—are they behaving in a removed from Saddam, and
the key is this: why are they pragmatic way? Is there a they have quite a lot they
doing it? Are they doing it rational self-interest to what need to work out. In our
to enrich themselves? Or is they’re doing? Are they country, this seems
it mixed motives—maybe able to make pragmatic completely unnecessary—
partially to enrich compromise? Rather than to put a gun to our head
themselves but also to help drive the car off a cliff, do when we don’t really need
the country? No one is they actually stop short to. So I would say, in a way,
entirely acting out of before they go over the politicians in Iraq operate
altruistic motives but in edge? I mean, if you want more rationally than
dictatorships that lead to to prove a point, you can politicians in the US. This is
disaster, it is often purely prove a point and ultimately (Continued on page 33)
just corruption and self-
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Geoffrey Batt
(Continued from page 32) and so by that summer, enough to convince you?
a sad state of affairs I violence was about 75%
suppose. below its peak. Deposits in GB: I went back to Dan
the banking sector were with the idea and he said
But getting back to how I increasing, electricity something like, “You’ve
found Iraq, I was searching generation was increasing, come to me with 100 ideas
for that next thing. In 2007, and the economy was and 99 of them were bad or
every market in the world starting to grow pretty okay, but I know this one is
was in a bull market. It’s rapidly. When I looked at good because the very first
hard to think of any asset these macro variables, what thought that I had when you
class that didn’t produce a I found was that the mentioned it to me was
fairly spectacular gain over consensus view was very how can I steal it from “I went back to
the prior five-year period. much at odds with reality, you?” But he said he would
Equity markets around the that what you were seeing help me pursue it. I should Dan with the idea
world were strong, on television was about as study it for the next six
commodities were strong, and he said
far removed from what was months and see if I could
even certain currency actually happening in Iraq as confirm that the data is
markets had produced very
something like,
it could be. Yes, things were accurate. So I studied the
strong returns. It was hard awful but the media was not country, its markets, its ‘You’ve come to me
to find anything that fit into making the distinction. They political situation, and its
this category of deeply weren’t showing you any history for the next six with 100 ideas and
distressed, transitional improvements that took months. And by the end of
situation. And it was right place over that year. But it 2007, I was convinced that 99 of them were
around that time that I read looked to me like there was there was a legitimate
an article about how Iraq bad or okay, but I
pretty compelling objective change taking place and that
was increasing its oil evidence that Iraq had the country had turned a
production, which I thought
know this one is
reached a turning point. very important corner in its
was very strange. development. Then the good because the
I had thought of Iraq as a This is exactly the sort of question became, how do
failed state in the middle of situation that you want to you take advantage of that? very first thought
a civil war. I knew nothing look for when you’re It just so happened that
about it beyond what I read searching for these potential there was a stock market. It that I had when you
in the New York Times or historic equity re-ratings. was very small and I was
saw on TV. And so I mentioned it to me
There is objective data that shocked to find it. I think at
thought the article was odd portrays a positive picture the time the whole market
because how on earth is a
was how can I steal
yet there is a perception had a capitalization of about
failed state in a civil war that none of that is $2 billion, which was smaller it from you?”
increasing oil production? happening, there is a than the Palestinian stock
You can’t reconcile those perception that quite the exchange which had only
two data points. Increasing opposite is happening, that launched in the summer of
oil production implies there there is capital flight, 2007.
is a functional state that is hyperinflation, chronically
capable of achieving this. weak currency, falling oil I e-mailed every broker that
One of those two points of production, economic was on the stock exchange
view had to be incorrect. So depression, and so on. That website, maybe 50 brokers,
I looked into the matter was the image that I had in and I got 5 or 10 replies.
more closely and saw it my head; I think that was a Only a few of them were in
wasn’t just oil production, fairly representative view in English and only one of
but that they had a the West at that time and them was in coherent
hyperinflation that started in still is. English, so I chose him. I
1990 and ended in 2006. wired $2,000 there, bought
They did have a civil war but G&D: And was that (Continued on page 34)
it had ended by early 2007
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Geoffrey Batt
(Continued from page 33) what I thought was the next about a lot of Africa right
a stock, sold it the next day historic equity re-rating, and now, which is interesting.
and wired the money back only found it after I thought Take Nigeria for example.
out of the country to see if I I had pretty much exhausted Nigeria has a serious and
could complete the whole all of the options. It was a growing problem with Al-
cycle. It turned out that it complete shock that it Qaeda. They don’t control
was very easy to do. So with turned out to be Iraq the northeast part of their
that, I put most of my because it was the very last country and it’s in a state of
investable assets into Iraq, place that I would have emergency. But if you look
Louisa Serene Schneider and then around January
and Marty Whitman at the anticipated. But that’s the at the valuations in Nigeria,
2008, Dan gave me a key, take some country with consumer products
2013 Graham and Dodd
Breakfast.
managed account and put a stigma like North Korea companies are trading for
me in touch with his two or Myanmar—people are 30x earnings. They might be
partners at Firebird. I really excited about growing fairly rapidly but
presented the idea to them Myanmar now, so maybe the multiples being assigned
and they each gave me a that’s not such a good to their earnings are
managed account as well. I example—and see where it absurdly high and certainly
had my own money there leads. don’t price in the risks.
and three managed accounts
for two years. G&D: Zimbabwe? Iraq, on the other hand, is
actually quite similar if you
Back then, I was probably just look at the data. Iraq
one of the few, if not the produces more oil and its
only person, in the West oil production is increasing
who was investing in this while Nigeria’s is flat. Iraq
market. I thought there has substantially greater
could be demand for this foreign exchange reserves.
kind of frontier investment “Having him made They produce more
and I was credibly in a electricity with a smaller
position to create a fund to it pretty easy to population and their
capture what I thought was electricity generation
untapped demand. The one
market. People
increases each year. GDP
problem was that I didn’t thought, ‘The guy per capita is higher and
have a track record and I GDP itself is higher. Relative
had a very unorthodox who found Russia is to every development that
background so I needed you can think of, Iraq has
someone with a pedigree. now looking at Iraq, the edge. Both have a
And that was Dan. I started problem with Al-Qaeda and
the company and sold him so there must be the levels of violence are
20% of it, with the somewhat comparable—
agreement that he would be
something
Iraq is worse but it’s not
a partner but not be interesting there.’” that much worse. But you
involved in day-to-day can buy a branded
operations. Having him consumer products
made it pretty easy to company for 7x earnings in
market. People thought, Iraq whereas in Nigeria it’s
“The guy who found Russia trading at 30x earnings.
is now looking at Iraq, so
there must be something So it’s fascinating when you
interesting there.” GB: Actually, people are look at the interest that
excited about Zimbabwe, people have in Africa that
So that is how I got too. They’re enthusiastic (Continued on page 35)
involved. I was looking for
Volume
Geoffrey Batt
(Continued from page 34) price risk. The places that evaluating countries?
they completely disregard you would last think you’d
the risks that are attendant want to put money can turn GB: Does the country
in those countries and take out to be the most have the ability to become
those very same risks and interesting. That’s how I much larger in the future
exclusively focus on them in found Iraq and it was quite a than it is in the present? So
Iraq. The same is true in surprise. But after I studied in the case of Russia after
Mexico. Sixty thousand it closely, it fit the narrative the collapse of the Soviet
people died in Mexico from beautifully. That’s why I am Union, Germany and Italy
2007 to 2011 in what was there. after World War II, and
very much a civil war. The South Korea after the war
government still does not G&D: You mentioned a there, you were looking at
control parts of western couple key indicators about countries where the
Mexico. The police and economies were quite small
military have given up. Look for various reasons, but
at their consumer product they had the potential to
goods companies—they become orders of
trade at 40x earnings. This magnitude larger. When you
actually illustrates quite look at a country like Sri
nicely the irrational “So it’s fascinating Lanka, what do they really
extremes that markets go have? How much tea can
to. Do they teach efficient when you look at they actually export? How
markets theory at Columbia much is that going to drive
these days? the interest that
their economy in the next
people have in twenty or thirty years?
G&D: It depends. In some There are markets that can
classes, they do, with limits. Africa that they be interesting for a year or
two, maybe up to five years,
GB: But efficient markets completely but you want more than
theory is completely that.
incompatible with value disregard the risks
investing and I would Does it have economic
imagine that for business that are attendant
scalability to it? You want to
schools generally, it is a part look for the presence of
of the curriculum. Just look
in those countries
credible institutions that are
at the behavior of market and take those very capable of achieving the
participants and how they macro stability that is
appraise value where the same risks and necessary for the country to
conditions are almost grow over time.
identical, but the only exclusively focus on
difference is geography or And you want to look for
the name of the country. In them in Iraq.”
cheap assets. You must have
one situation the perceived a mispricing. If Iraq was
risks are very low and the already pricing all this in
valuations are quite high and during 2007-08, if everyone
in the other country the was optimistic about the
perceived risks are very high future and stocks there
and the valuations are quite Iraq, like power generation were trading at 30-40x
low. It shows how far the and natural resource earnings, then you weren’t
investing community departs production. Is there a being compensated for the
from a rational assessment standard set of data that risk. After the other
of value and how difficult it you look for when you are (Continued on page 36)
is for a market to accurately
Page 36
Geoffrey Batt
(Continued from page 35) stayed away from Japan until world has ever seen outside
conditions are satisfied, that the 1970s. During the 1950s of Myanmar and North
last factor is vital because and 1960s they had capital Korea. It was dreadful. By
it’s your margin of safety. controls in Japan so if you the time Saddam was
invested you couldn’t take overthrown, GDP per
G&D: Do you need foreign your money out for two capita was back to $500
institutional investors to get years and that kept a lot of again. Oil production is right
people away. Emerging around the same level it was
markets were something at in the mid-1960s. The
very few people went near country was on a trajectory
prior to the 1980s. So the that was going to have it
historic re-ratings that have rival Saudi Arabia in terms
“I think they have taken place since then, I of oil production and
think, have had a foreign exports, and have an
an ability not only component to them. But I economy that was almost as
don’t think it is essential. large, but it was derailed. It
to matter History shows that they’ve was taken off course by the
happened without foreign mismanagement of a
economically, not money, particularly in a dictator. That actually made
petro-state. Take Saudi Iraq stand out much more
only to be orders of Arabia—you can’t invest than South Korea or, say,
magnitude larger in there directly and they’ve Hong Kong. South Korea
had spectacular bull markets never really had a history of
the future than they that were driven entirely by growth before the 1960s
petro dollars and the oil and 1970s. It was mainly
are today, but to be cycle. subsistence level agriculture
with no real history of
one of the most G&D: How did Iraq fit into modern economic
that framework? development. Iraq had that
important and they lost it. It was just a
economies in the GB: Iraq is a neat case. It matter of whether they
was a country that, in the could get it back. When you
world in 20-25 1960s and 1970s, was on look at their oil industry,
the verge of becoming one they have the ability over
years.” of the most powerful petro- the next fifteen to twenty
states in the world. Oil years to rival Saudi. They
production was around could conceivably become
500,000 barrels a day in the the second swing oil
1950s. By 1979, the year producer in the world.
Saddam comes into power, Saudi would no longer be
it was 3.5 million barrels/ the only country that has
involved for a country to re- day. GDP per capita went enough spare capacity to
rate? from $500 in the mid-1960s meet unexpected demand
to $3,500 by 1979. They for the world. So I think
GB: It depends. You would had this extraordinary they have an ability not only
think that you absolutely economic transformation to matter economically, not
need foreign money to fuel taking place and Saddam only to be orders of
it but South Korea, to the destroyed it all. For the magnitude larger in the
best of my knowledge, next two and a half decades, future than they are today,
didn’t have that much it was really one of the but to be one of the most
foreign money and neither single greatest episodes of important economies in the
did Germany or Italy in the wealth destruction the (Continued on page 37)
1950s. Most foreign money
Volume
Geoffrey Batt
(Continued from page 36) gives you an idea. And it’s be the classic Ben Graham,
world in 20-25 years. And very rare to find a market in deep-value kind of
that’s not an overstatement; a country that has that investment. It's far from a
if they are producing 9-10 much scope for growth. franchise. It's just simply
million barrels of oil a day, That’s what I think makes that net current assets are
that puts them right up Iraq unique—it has more “x” and the stock market
there with anyone else. scope for growth than any appraisal of that is 0.1x, so
And when you look at the country I am aware of in the you're buying a dollar for
tiny size of their banking world today. ten cents. Most of the
sector, the tiny size of their investments we make are
“What I've learned
consumer product sector, G&D: Once you found an the first category.
the valuations that we found from making
interesting situation like
in their real estate markets Iraq, how did you think When I first started to investments in
in 2008-09 and even about efficiently screening invest in Iraq, I went more
present, it was a country the opportunity set there? towards the latter category, companies that
which was stunted. It was which I think was a mistake.
like a giant stuffed in this GB: Well, thankfully there What I've learned from seem very cheap
tiny little cage. It is very are only about 90 making investments in
difficult to tell when it is companies on the exchange companies that seem very
based on net asset
stuffed inside but once you and I would say about 20-30 cheap based on net asset
take it out, it stands fifty value is that it’s
of them are what I would value or net current asset
feet tall. call investable. It is a very value is that it’s very easy to very easy to
narrow set of companies. So underestimate
Take their banking sector as a lot of this is simplified by management's ability to underestimate
an example. In 2003, there the small size of the destroy value. Even slightly
were $300 million of assets exchange and its limited sub-par management can management's
in the private banks. Now number of offerings. make a series of decisions
the private banks have that will wipe away your
ability to destroy
about $16 billion. They’ve We are really making two initial margin of safety.
gone from $300 million to value. Even slightly
types of investments. We're
$16 billion in ten years. investing in emerging Then there's still the sub-par
GDP in 2004 was $25 franchises, which are question of how you realize
billion. By the end of 2012, companies that are outside the value. Graham was of management can
it was $210 billion. So even the oil space and tend to be the opinion that the market
though they have managed by entrepreneurial would eventually correct make a series of
experienced extraordinarily people. They're very much itself, that the market in the
rapid growth, banking assets profit-driven. They're short run was a voting
decisions that will
are still less than 10% of owner-managers, so they machine and in the long run
GDP. The top five banks in wipe away your
have significant stakes in the was a weighing machine so
Saudi Arabia have assets business themselves. that eventually, it will be initial margin of
that are about 50% of GDP. They're transparent and valued correctly. That’s
So let’s say Iraq has a $600 they appreciate the probably true in the West, safety.”
billion economy by 2030. If importance of reputation, but less so in a frontier
the top five banks were to brand, and establishing market, where you're going
equally split half of that, it dominance in their to have to be very careful
would be $60 billion in particular industry. Because about assuming an activist
assets for each bank. The they’re able to achieve that, role and you can't rely on
biggest bank right now has it gives them pricing power, the market to be even
$1.5 billion in assets and a it gives them scale, and it slightly efficient over a long
market cap of $300 million. gives them all these other period of time. It could stay
So when I talk about benefits. Another, second inefficient and undervalue an
scalable economic growth category of company would (Continued on page 38)
and scope for growth, this
Page 38
Geoffrey Batt
(Continued from page 37) a few years. And after you loan to deposit ratio go
investment for a decade and travel there and meet the from 5% to 40%. They have
you could end up in a value people, you're in a much a very low NPL ratio, ROE
trap for ten years. So it’s better position to say with has been trending up. All
difficult to realize the value confidence if you should the metrics that you would
if it's not destroyed, and trust them. use to analyze a bank are
there's a high probability not only looking positive,
that sub-par management I think this is, again, the but they're really strong,
will destroy it anyway. market benefiting us. and yet it's trading for just
Because there's such a small 5x earnings. If you see a
G&D: How do you group of companies that we bank that is growing
approach portfolio think are investable, it gives earnings at 40% or 50% a
management given that us the ability to concentrate year, trades at 5x earnings
“The largest there are only 20 to 30 rather than look all over the and a discount to tangible
companies you would call place. There are some book, and has a ROE of
position is 30% of investable? frontier market funds that 30%, that looks really
the portfolio, so we have investments across interesting, right? Then you
GB: We have twelve twenty countries. How on meet the management, get
obviously don’t companies in our portfolio earth could you possibly to know them over a period
and the top ten make up know the management in of years, and that's what lets
define risk as price 95% of it, so it's very each country? And they you build the confidence
concentrated. The largest have fifty or more there is something real
volatility. We're position is 30% of the investments! How can you behind those numbers.
portfolio, so we obviously possibly know if you can
thinking about it in don’t define risk as price trust these guys or not? G&D: How long did it take
terms of probability volatility. We're thinking Even a team of ten or fifteen you to get comfortable
about it in terms of people can't pay enough enough to make your first
of permanent loss probability of permanent attention to each company investment in Iraq?
loss of capital. to establish that.
of capital.” GB: Initially, I wasn't
The most important thing I think trust in the people comfortable with any
we look for is a business managing the business is particular company. In
where we can trust the paramount, because it's January 2008, when I
people who are running it. pretty easy to spot a good started, I bought everything
By definition, trust is company. So, if you see a that traded, so it was the
something that's built over bank in a country like Iraq exact opposite strategy.
time. For the first few years that is experiencing its first Back then, it was very
that I was involved in Iraq, private credit cycle and has difficult to find information
that's more or less what I an economy that is growing about these companies from
was learning—who I could pretty rapidly, you’d expect a distance. Quite a lot has
trust, what companies were to see the balance sheet changed since that time.
putting out financial grow very rapidly. You look Now, quarterly reports are
statements that faithfully at the balance sheets over published in a timely
represented the condition time and it's pretty obvious manner, sometimes even
of the business, which which companies look ahead of when US
companies seemed like they interesting and which ones companies file. It’s not
were doing well but may don't. This one is growing unusual in a very early stage
not have been accurately but puts all its money into frontier market to have
reporting performance, T-bills. It's completely risk- extremely limited data that
which companies had averse. OK, that's not very you can use to conduct due
unsavory people running the interesting. However, this diligence. The rational
business, and so on. You one over here has seen its (Continued on page 39)
start to figure that out over
Volume
Geoffrey Batt
(Continued from page 38) history of philosophy, what markets, or in business
strategy if you're going to you find is that many of the generally, you find they tend
invest in that setting is to great philosophers were to be people who are
have smaller positions. How deeply skeptical people. skeptical of whatever the
can you have conviction They were like Steve Jobs in prevailing convention is and
about something like that? a way, iconoclasts who will challenge it and try to
It's more of a macro looked at convention as if it change it. To get involved in
investment. was something to be Iraq, you had to be very
broken. Socrates is a perfect open-minded and had to
What I've found is that example of this. He walked have a very skeptical view
having my own money around Greece and about the ability of the
invested in these companies challenged any kind of media to provide you with
is really what makes the convention or power an accurate portrayal of
difference. When you have structure he saw. And I reality. If I were not
money invested in a bunch skeptical, I would have seen
of companies that you don't the data, and I would have
know much about, you said even if Iraq were
suddenly have a very strong increasing oil production,
motivation to know as much the country's still just a
about them as you possibly basket case because that's
can. And so once the money “What I've found is what I read in the New York
was invested, I had to find Times. Philosophy is useful in
out everything I could. And that having my own a general sense because it
that really was what the can give you a skeptical
next two years were about. money invested in
world view.
It took about two years
these companies is
after I made my first Then you can take that
investment before I felt really what makes skepticism and apply it at
confident that I really did the company level.
understand which the difference.” Thousands of years ago,
businesses were legitimate, philosophers were asking
which ones should be questions like how would
avoided, which ones could you define a table? And if
go either way. And that's you went around the room,
also why there wasn't a fund each one of us would come
initially. I didn't feel as if I think the general idea that up with a definition of a
had the requisite you learn from studying table and everyone else
understanding of the these historical philosophers would poke holes in it. The
companies and the market is that there's a lot to be smartest philosophers in the
until I was involved for gained from a skeptical world have struggled with
more than two years. So world view. If you simply these very basic ideas and
initially it was just a very accept what you're told, if they can't find a satisfactory
broad bet on the market you are simply a receptacle way to treat the problem.
and that later became a very that takes in whatever You realize that about
concentrated set of value information is provided to 99.9% of everything you
investments. you without critically hear is complete and utter
accessing it, it's going to be bullshit. Take the
G&D: What do you think very hard for you to do convention that markets are
makes philosophy a good anything other than live a efficient. Approaching it
training ground for conventional life. If you look from a philosophy
investors? at the people who have had background, it was very easy
the most success in (Continued on page 40)
GB: When you study the
Page 40
Geoffrey Batt
(Continued from page 39) situation like that, then Coke has struggled in Iraq
for me to take that idea and there's typically an for a number of identifiable
reject it. opportunity to profit from reasons.
it.
I remember Caterpillar in Baghdad Soft Drinks
2010 or 2011 printing a five- G&D: Would you mind received its Pepsi license in
year earnings forecast. 1984 and lost it in 1991
We’re talking about when sanctions were
construction and mining imposed on Iraq after the
equipment, which are as first Gulf War. By the time
cyclical as anything can be. Saddam was overthrown in
How on earth can the CEO 2003, Pepsi was eager to
know what their earnings return to Iraq so they
situation is going to look
“The stock was
reached out to Baghdad Soft
like five years from now? trading at about 3x Drinks in order to
And to the extent the reestablish the relationship.
market actually believes earnings and had a Some of their factories had
what he is putting out and been severely damaged by
pricing it into the shares, 10% dividend yield. the war. What hadn’t been
that is an extraordinary damaged was obsolete
mistake. When I looked at To give you an idea,
because, while the sanctions
the sell-side, they were were in place, they couldn't
pointing out just how bullish
in 2012, the
import equipment. So the
they were on CAT. Since company’s earnings equipment from the 1980s
then the stock has just gone was still there in 2003. The
sideways and now of course actually grew over company was just a mess.
we're approaching 2015 and Pepsi floated a $30 million
they're guiding down 400%. We were just loan to help rehabilitate
because it's just not the operations.
market or economy they scooping up as
thought it was going to be. The management at that
much as we possibly
point in time were ex-
So when you apply could.” Baathists. Saddam was from
philosophy to your analysis the Baath Party, and the
of individual companies, it party’s economic ideology
makes you much more was basically Arab socialism.
skeptical of management's You had 3,000 employees
ability to forecast into the when you needed just
future. To the extent a 1,000. Pepsi, in one of the
manager or a company is talking about a specific hottest places on earth and
going to get your trust, investment idea within Iraq? where people don't want to
they're going to have to drink Coke, pretty much
earn it and that's going to GB: Sure, I can discuss sells itself. You could put a
take quite a long time. Baghdad Soft Drinks, the dog or a five year old kid in
Philosophy teaches you to Pepsi bottling and charge and sales would
take whatever the prevailing distribution company there. grow. The question is what
wisdom is and challenge it. Pepsi has 80% market share part of that is going to fall to
Sometimes it turns out the in Iraq. It's one of the few the bottom line. What I
prevailing wisdom is right, countries where it’s found was that most of the
so you should accept it; dominant. Normally it's the revenue growth in the
other times it turns out the reverse—Coke is closer to company from 2003-2007
prevailing wisdom is way off 80% and Pepsi is 20%—but (Continued on page 41)
the mark. If you find a
Volume
Geoffrey Batt
(Continued from page 40) Soft Drink’s margins so trading at about 3x earnings
was being soaked up by they’re now about 15.5%. and had a 10% dividend
these inefficiencies. By the yield. To give you an idea, in
time you got to the bottom The new owners spent a lot 2012, the company’s
line, there was nothing left. of money up front to put in earnings actually grew over
By 2007, the company was a direct distribution system 400%. We were just
unable to service the loan and it’s now paying off. The scooping up as much as we
from Pepsi. It contacted two public electricity grid at the possibly could. That's why
local businessmen for help. time was unreliable, so they it's 30% of the fund. It was
The two guys looked at the built their own generator to 15% but with the total
situation and eventually make sure they could run return, it’s since doubled.
approached Pepsi about 24/7. They made the We haven’t sold a share. It
selling them the loan. Pepsi company much more still trades for around 6-7x
agreed and the businessmen efficient and with a company earnings and remains deeply
immediately converted the like this, it's about volume undervalued.
loan into a controlling stake
“Iraq was the very
growth and efficiency.
in the company, firing the G&D: Before we finish, do last place I thought
managers who had initially Iraq consumes about 21 you have any thoughts on
asked for their help. They liters of soft drinks per where the next Iraq-type I would find an
also fired 2,000 of the 3,000 capita. If you look at other market opportunity may be?
employees and instituted a emerging market countries, opportunity like this
performance-based it's anywhere from 60-100 GB: It’s hard for me to
compensation scheme for and I don’t know if
liters. You have a growing think of a place now. Maybe
the remainder. A year later, population, growing GDP Afghanistan? Five or ten
revenues had tripled and
there is a similar
per capita, and each year years from now, maybe it
they turned their first profit. they're consuming more will be Iran. Iraq was the place today.
They became fully certified Pepsi. It's the dominant soft very last place I thought I
by Pepsi for quality control drink company there so would find an opportunity Maybe it’s still
and quality assurance for there are compelling like this and I don’t know if
the first time and the reasons to believe that sales there is a similar place Iraq.”
thousand remaining will continue to grow. today. Maybe it’s still Iraq.
employees were paid double Management has
what they made under their demonstrated its ability to G&D: Thank you so much
previous salary. improve operating for sitting down with us, Mr.
efficiency. If sales can grow Batt.
Starting in 2007 and at the 20%-35% rate we
continuing to the present, expect and margins expand
the new management really by 200-300 basis points,
focused on streamlining the then suddenly earnings
operations and making them could be up 100%. It's that
much more efficient. If you kind of story.
looked at their EBITDA
margins under the old We own 11% of the
management, they were company. According to the
typically either negative or CEO, we're the only
1%-2%. If you look at Coke Westerner to ever visit the
and Pepsi bottling and bottling facility. In 2012,
distribution companies in there was a bear market in
comparable emerging Iraq, with the market low
markets, the EBITDA occurring sometime in the
margin range is normally summer of that year. At
15%-20%. We've seen a that time, the stock was
normalization of Baghdad
Page 42
Rocket Fuel Inc. (Nasdaq: FUEL) - Short

Winner - 2013 Darden @ Virginia Investing Challenge
Matt Bracewell, CFA; Patrick Enriquez-Fischer; Brian Waterhouse
MBracewell15@gsb.columbia.edu; PEnriquezFischer15@gsb.columbia.edu; BWaterhouse15@gsb.columbia.edu
Capitalization Summary Ownership Structure Share Price Performance
Share Price 65.37 Holder % TSO ($MM) Sh. Price($) Vol (000)
$75 3,000
Diluted Shares (MM) 39.5 Mohr Davidow Ventures 33.4 716 +125.4%
Market Cap ($MM) 2,579.4 Nokia Growth Partners 8.2 176
Net Cash ($MM) 98.4 Northgate Capital 6.3 135
$50 1,500
Enterprise Value ($MM) 2,481.0 Labrador Ventures 4.6 99
+7.5%
EV / Sales 2014E 5.92x Total VC Holdings 52.5 1,126
Target Price 29.00 $25 0
Matt is a first-year MBA % Return 55.6% Insiders 17.7 379 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14
student at CBS. Prior to Short Interest % of Float 28.6% Float 29.8 639 Volume (000) FUEL S&P
CBS, he worked in private
equity at Navigation Capital Recommendation: EV / 2014E Sales
and in healthcare Short FUEL with a price target of $29.00. As a demand side 5.9x
investment banking at platform (“DSP”) operating in the ad tech space, FUEL is a recent 6x 4.9x
SunTrust Robinson IPO issue enjoying substantial top-line growth and as a result, 4x 3.2x
2.9x 2.4x
Humphrey. currently trades at a high-flying valuation. At 5.9x 2014E reve- 1.6x1.5x
2x 1.0x 1.0x
nue, FUEL trades at a premium to the broader ad-tech space,
where the average comp trades for 2.2x 2014E revenue. How- 0x
Patrick is a first-year MBA ever, after speaking with an array of industry participants, we
student at CBS. Prior to believe FUEL is nothing special in an increasingly commoditized
CBS, he worked in and competitive marketplace. We expect continued revenue
investment banking at growth, but the street’s expectations of long-term growth with-
Morgan Stanley covering out margin compression are reflective of exuberant irrationality. Because FUEL’s venture firm-
Latin America. concentrated investor base is well in the money, we expect selling pressure in conjunction with these
firms’ lock-up expiration in March 2014. Our target is 56% below a recent closing price of $65.37.
Company Description
Brian is a first-year MBA FUEL is a DSP that leverages big data through artificial intelligence (“AI”) technology to optimize ad
student at CBS. Prior to buying in a real-time buying (“RTB”) environment. FUEL’s predictive modeling solution is built on its
CBS, he worked at optimization engine, which utilizes significant computational infrastructure to deliver automated,
Millennium Technology measurable digital ad campaigns. Its solution is designed to optimize direct-response campaigns, as
Value Partners. well as brand campaigns geared towards lifting brand metrics. FUEL primarily sells its solution to ad-
vertising agencies and advertisers. FUEL was founded in 2008 and IPO’d in September of 2013.
Matt, Patrick, and Brian Investment Thesis
defeated 14 other top FUEL is not a broken business, but our channel checks revealed that it is a much worse business than
business schools at the valuations imply, and participants in the industry know this is true. The ad-tech space is an extremely
Darden @ Virginia Investing crowded and competitive category, with participants ranging from massive, fully-integrated solution
Challenge. providers such as Google, Yahoo, and AOL, to digital ad agencies such as IPG and Publicis / Omni-
com, to scaled single-solution providers such as FUEL and Criteo (public) as well as Turn and DataXu
(private). Our original thesis is that FUEL could be instantly disintermediated by large providers such
as Google that operate on all sides of the ad tech ecosystem, or could be marginalized over time by
similar, scaled single-solution providers competing on the basis of price. To back up the thesis, we
conducted detailed interviews with 15 industry participants, including major FUEL customers, former
FUEL leadership and investors, ad-tech investors, and industry experts. The interviews confirmed our
margin compression thesis, but we were shocked at how cynical industry participants are towards
FUEL and DSPs in general. While we believe the entire DSP category is highly overvalued, FUEL
stands out, trading for 5.9x 2014E revenue versus 2.2x for the category, even though FUEL will not
generate any earnings or positive cash flow until 2016 at the earliest.
Undifferentiated provider in a crowded and competitive marketplace. We estimate that
FUEL is one of over 90 DSP solution providers, and we expect the continued commoditization of the
market to impact margins over time. One interviewee, who is an advertised FUEL “success story”
and CEO of a top-50 marketing firm, equated DSPs to the ad networks, whose gross margins have
been compressed from 40%+ in the 1990’s to less than 10% today. Channel checks reveal that there
is little differentiation across the industry, although everyone claims to have the same technological
advantages. For example, FUEL advertises itself as “AI, Big Data Driven Real-Time Programmatic
Buying,” virtually identical to competitors Turn and DataXu’s claims of “Data Driven Advertising Us-
ing Programmatic Solutions,” and “Programmatic Optimized Real Time Buying Leveraging Big Data.”
Volume
Rocket Fuel Inc. (continued from previous page)

Poor competitive position. In addition to scaled single-solution providers, FUEL faces competition
from a who’s who list of media companies with fully-integrated platforms. FUEL generates the bulk of its
revenue by selling to marketing firms that own the client relationship; however, many of these firms
either have their own similar solutions, or have chosen to outsource the solution based on the view that
this portion of the value-chain will be commoditized. In addition, FUEL competes for ad dollars against
large media businesses such as Google that have their own DSP solution in addition to high value-added
offerings such ad networks and exchanges. These competitors have exhibited an increasing propensity
to internalize ad spending via large upfront ad buys on owned, high-value properties such as YouTube.
Unsustainable business model. We believe that FUEL’s current 40-50% gross margins are a result of
the industry’s nascence, but will be pressured over time. Industry experts agreed, by suggesting that
because gross margins result from taking advantage of an evaporating arbitrage on media costs, they will
get squeezed from both ends of the value chain. One customer noted, “DSPs are an arbitrage game and
this game is coming to an end. The technology is being commoditized...These companies try to capture
market share by losing money… their business model is not viable in the long-term.” The industry is
also plagued by low customer switching costs, and most advertisers utilize multiple DSPs to generate
price competition. We believe that the best positioned DSPs will be those that provide platform SAAS
solutions, such as DataXu. FUEL recognizes this and is currently working on a SAAS offering. Finally,
interviews with customers reveal their displeasure with certain FUEL business practices. These practic-
es, which included FUEL communicating a lower media margin than they were actually getting, did not
become known by a certain customer until he obtained detailed access to data on the campaign that
FUEL was running. We believe that increasing transparency from SAAS solutions will pressure margins.
Ad-tech mean reversion and a clear catalyst. Ad-tech Reversion to the Mean of Comparables
companies have IPO’d with high valuations due to substantial 6.0x
MM
growth prospects; however, multiples tend to compress to- 5.0x
EV/ NTM Revenue
MRIN
wards 1.0-3.0x NTM revenue over time. We analyzed multiples 4.0x
TRMR
post-quiet period expiry on pure-play ad-tech businesses, and 3.0x
YUME
found that each firm traded down, with an average reduction of 2.0x
2.2x NTM revenue. This is due to the street’s tendency to 1.0x
reduce expectations from the lofty levels. To illustrate, most 0.0x

0 30 60 90 120 150 180 210 240 270 300
FUEL initiation pieces assumed 42%+ 2012-2018 sales CAGRs Days from Quiet Period
with no margin compression, and one DCF valuation assumed a
30x terminal multiple on 2023 FCF. CRTO and MM, the closest comps, trade for 3.2x and 1.6x 2014E
sales with their 33% and 32% 2012-2018 CAGRs, exhibiting the downswing in multiples even with still
high expected growth. We also believe that the lock-up expiry on 3/19/14 will serve as a catalyst. ~33%
of shares O/S are held by venture firm Mohr Davidow (~40 days of trading), and ~19% are held by other
venture backers. We expect significant selling pressure in conjunction with the lock-up expiry as MD
stands to generate a much needed 30x+ return on its investment at our $29.00 target. Channel checks
reveal that the MD fund that holds the FUEL stake has not yet had a big exit, and due to its 2007 vintage
and fund-raising cycle, we expect the firm to liquidate its FUEL holdings ASAP.
Valuation Base Case vs. Analyst Estimates
Our valuation used 2014E and 2015E revenue multiples, and a DCF Metric Base Street
2014E Sales 388.9 419.8
assuming a 10-12% cost of equity. We believe that FUEL will have im-
2015E Sales 555.9 679.0
pressive top-line growth in the coming years with a CAGR of 66% be- 2016E Sales 810.7 1,000.3
tween 2012-16, comparing favorably to the industry’s 40%. However, 2014E EBITDA Margin (0.8%) 0.8%
analysts are expecting a CAGR of 75% mainly from much too aggressive 2015E EBITDA Margin 2.9% 5.7%
assumptions on customer and ARPU growth (ARPU has remained flat in 2016E EBITDA Margin 7.8% 10.2%
recent qtrs, supporting our thesis). In addition, we expect competition LT EBITDA Margin 15.0% >20%
to keep EBITDA margins to ~15% at best (CRTO disclosed in its in Target Price 29.0 63.0
Implied EV / 2014E Sales 2.5x 5.7x
roadshow that ~15% margins are its long-term target) vs. margins of
20%+ from research analysts.
Summary of Key Financials
2012A 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E
Active Users 536 1,018 1,579 2,131 2,813 3,572 4,394 5,273 6,064 6,670 7,004
Growth (%) 90.0% 55.0% 35.0% 32.0% 27.0% 23.0% 20.0% 15.0% 10.0% 5.0%
Sales 106,589 231,981 388,882 555,860 810,680 1,039,859 1,291,816 1,565,681 1,818,539 2,020,397 2,142,631
Growth (%) 138.7% 117.6% 67.6% 42.9% 45.8% 28.3% 24.2% 21.2% 16.2% 11.1% 6.1%
EBITDA (2,981) (5,244) (3,025) 16,220 63,423 103,190 144,986 192,946 235,018 271,207 319,754
Margin (%) (2.8%) (2.3%) (0.8%) 2.9% 7.8% 9.9% 11.2% 12.3% 12.9% 13.4% 14.9%
Unlevered Free Cash Flow (27,566) (28,559) (40,919) (29,126) 7,524 24,192 47,957 71,933 97,087 115,074 142,952
Page 44
XPO Logistics (NYSE: XPO) – Long

Stephen Lieu
SLieu14@gsb.columbia.edu
Investment Recommendation As of 1/29/14; in USD m except per share data
Buy the common shares of XPO Logistics with a three-year target Current Capitalization
share price of $49, which represents 87% total upside (23% IRR over Stock Price $25.96
three years). There are three main points to my thesis: Dil. Shares Outs (M) 57.9
Market Cap $1,503
1) Industry characteristics, which include a large and growing Plus: Debt 1
market size, high fragmentation, long runway of acquisition Less: Cash (67)
opportunities, and significant competitive advantages to scale, Enterprise Value $1,437
provide for an attractive consolidation opportunity.
2) Acquisition benefits, which include private/public multiple arbi- Trading Statistics
52-Week Range
trage, revenue synergies, cost synergies, and strengthening of $15.48-$30.90
moat, are highly compelling. Dividend Yield 0.0%
Stephen is a second-year
Avg. Daily Volume (M) 435.0
MBA student, participant in 3) XPO has everything in place – a CEO with a phenomenal track
Short Interest as % of Float 20.7%
the Heilbrunn Center’s record of consolidating industries, management team with
Value Investing Program, substantial industry experience, significant insider ownership, Share Price History
and Co-President of the and easy access to capital – to successfully execute its consoli-
dation strategy. 41% IRR since CEO Brad Jacobs took over
Columbia Student $35
$30
Investment Management Business Description $25
Association (CSIMA). Prior XPO is one of the largest third-party logistics providers (3PL) in $20
to Columbia Business North America, offering freight brokerage, intermodal, expedited $15
School, he worked for four transportation, and freight forwarding services to companies in a $10
years in investment banking wide variety of industries. The company essentially serves as a mid- $5
$0
and private equity. Stephen dle man, connecting shippers (customers) with carriers Sep-11 Apr-12 Nov-12 Jun-13 Jan-14
holds a BS from the (transportation providers), and collects a fee for brokering the trans-
actions. XPO has a network of ~12,000 active customers and ~24,000 transportation companies, and operates
Wharton School, University
124 offices in North America.
of Pennsylvania.
XPO is pursuing an aggressive roll-up of the industry. Since CEO Brad Jacobs joined the company in September
2011, XPO has made 11 acquisitions, increasing revenues from $175 million to a run-rate of ~$2 billion. Manage-
Stephen was a member of ment has stated that its goal is to reach $5 billion in revenues and $300 million in EBITDA by 2017.
the team that placed 1st in
the 2013 Pershing Square Investment Thesis
Challenge and a member of 1) Industry characteristics, which include a large and growing market size, high fragmentation, long runway of acquisition
the team that placed 2nd in opportunities, and significant competitive advantages to scale, provide for an attractive consolidation opportunity.
the 2012 UNC Alpha Large and growing market: U.S. trucking is a $350 billion market, of which only 15% (~$50 billion) is intermediated
Challenge. through 3PLs. The 15% penetration rate is expected to increase significantly over the next decade as more compa-
nies realize the economic benefits of outsourcing to 3PLs. Over the past five years, trucking brokerage has grown
Stephen is a finalist in the at 2-3x GDP and is expected to continue at this pace.
5th annual Moon Lee Prize High fragmentation and long runway of acquisition opportunities: The U.S. truck brokerage industry is highly fragment-
Competition. ed, with over 10,000 licensed truck brokers in the U.S. The majority of truck brokers are small: more than 99%
generate less than $10 million in EBITDA. With smaller brokers facing intense competition from increasingly larger
competitors (as XPO and others look to consolidate the industry) and operational headwinds (increased IT so-
phistication and working capital requirements), they are becoming more willing to sell their businesses.
Significant competitive advantages to scale: Potential customers are attracted to providers with a large network of
existing carriers, while potential carriers are attracted to providers with a large base of existing customers. This
benefits the large 3PLs as it creates a virtuous cycle of increasing customers and carriers, and creates an impedi-
ment to growth for smaller 3PLs.
2) Acquisition benefits, which include private/public multiple arbitrage, revenue synergies, cost synergies, and strengthening
of moat, are highly compelling.
Public/private market arbitrage: Large 3PLs (of XPO’s size) currently trade at an average 13x LTM EBITDA, in-line
with their 10-year historical average. XPO acquires mid-sized 3PLs at 8-11x LTM EBITDA, and smaller 3PLs at
5-7x LTM EBITDA, resulting in acquisitions being immediately accretive.
Revenue synergies: There are substantial cross-selling opportunities between XPO and acquired companies’ custom-
er bases. Further, the aggregation of the acquired companies’ route history data allows XPO to improve its pricing
algorithms and price more effectively, helping to increase both margins and customer satisfaction.
Cost synergies: XPO eliminates duplicative back-office functions, such as legal, IT, and accounting.
Strengthening of moat: XPO’s competitive positioning increases with each acquisition. As XPO gains scale, the com-
pany’s ability to attract new customers and carriers strengthens, and there is a virtuous cycle of growth. Scale
begets further scale.
Volume
XPO Logistics (continued from previous page)

3) XPO has everything in place – a CEO with a phenomenal track record of consolidating industries, management team with
substantial industry experience, significant insider ownership, and easy access to capital – to successfully execute its consolidation
strategy.
CEO with a phenomenal track record: Over his 35-year career, Brad Jacobs has built four separate billion-dollar businesses
from scratch. At his two most recent companies, United Waste Systems and United Rentals, he successfully executed
roll-ups in the waste and equipment rental industries, respectively. During his tenure at United Waste Systems, the
company outperformed the S&P 500 by 5.6x. During his tenure at United Rentals, the company grew to become the
largest equipment rental company in the world, and outperformed the S&P by 2.2x.
Management team with substantial industry experience: Brad Jacobs has assembled a team of experienced transportation
industry veterans from large competitors like C.H. Robinson and Echo Global Logistics, as well as from investment
banks. For example, the Chief Strategy Officer was formerly the lead transportation analyst at Goldman Sachs, while
the CFO was formerly the lead transportation analyst at Stifel Nicolaus. The entire management team has a wealth of
experience, knowledge, insight, and contacts in the transportation industry.
Significant insider ownership: Management and the board own 41% of the company and Brad Jacobs has personally invest-
ed $75 million into XPO. Incentives are aligned with shareholders.
Access to capital: Given Jacobs’ strong reputation on the street, XPO has easily been able to raise capital for acquisitions.
Financial Projections and Valuation
I believe management’s goal to reach $5 billion in revenues and $300 million in EBITDA by 2017 is achievable, given
that XPO has already reached $2 billion in run-rate revenues in just over two years. I apply an 11.5x forward EBITDA
multiple (in-line with current average 3PL multiple) to 2017 EBITDA to arrive at a 2016 target share price of $49 for
87% total return, or 23% IRR over three years.
Total
2013A 2014E 2015E 2016E 2017E ('14-'17) Bear Base Bull
Revenue (run-rate) 1,000 2,500 3,500 4,525 5,478 Revenue (2017) 4,382 5,478 6,573
Organic 250 500 525 453 1,728 EBITDA (2017) 219 329 460
Acquisitions 450 1,250 500 500 500 2,750 Margin% 5.0% 6.0% 7.0%
EBITDA 10 50 117 211 329 Fwd. EBITDA Multiple 10.0x 11.5x 13.0x
Margin% 1.0% 2.0% 3.3% 4.7% 6.0% Enterprise Value 2,191 3,779 5,981
Less: Debt (2016) (242) (242) (242)
Acquisition Price 396 200 200 200 996 Equity Value 1,949 3,538 5,739
EV/EBITDA 10.3x 8.0x 8.0x 8.0x
FCF 20 52 106 181 359 Shares Outstanding (2016) 72.9 72.9 72.9
% of Revenue 0.8% 1.5% 2.3% 3.3% Curr. Shares Outstanding 57.9 57.9 57.9
Debt Issuance 0 148 94 19 261 New Shares Issued 15.0 15.0 15.0
Total Debt 0 148 242 261
Leverage 0.0x 1.3x 1.1x 0.8x Share Price $27 $49 $79
Equity Issuance 376 0 0 0 376 Current Share Price $26 $26 $26
Shares Issued 15.0 0.0 0.0 0.0 Upside 3% 87% 203%
IRR 1% 23% 45%
Investment Risks and Mitigants

1) Acquisition integration: XPO has been executing acquisitions at reasonably attractive valuations. Integrating them is the
single biggest risk, and the key to the company’s success.
Mitigant: Before closing any acquisition, XPO mandates all of its acquired companies’ employees to sign non-compete
agreements, helping to ensure that salespeople and their customer relationships remain with XPO. Additionally, Jacobs
stated that he deliberately delayed acquisition activity initially while he established the infrastructure to support signifi-
cant scale, showing that he understands the process of building large companies. Furthermore, Jacobs has done this
before, having acquired and integrated over 450 companies during his time at United Waste Systems and United Rent-
als. Finally, Jacobs and his management team have significant skin in the game (41% ownership stake) and are highly
incentivized to do well.
2) Competition for acquisitions: Other truck brokerage firms have recently been making acquisitions. XPO could be bid-
ding directly against its competitors for the same targets.
Mitigant: The U.S. truck brokerage market is very large and highly fragmented, with over 10,000 truck brokers. Further-
more, XPO has easier access to capital (given Jacobs’ prior track record) and an M&A team with significant experience
in executing acquisitions.
3) Shift from trucking to intermodal (rail): Improving reliability and timeliness of intermodal, rising diesel prices, increased
highway congestion, and a shortage of truck drivers are causing a secular shift away from trucking towards rail.
Mitigant: Increasing penetration of trucking logistics outsourcing will help drive organic growth. Additionally, XPO’s
recent entrance into intermodal through the acquisition of Pacer (third largest provider of intermodal services in North
America) helps hedge this risk and provides an additional avenue for growth.
Page 46
World Acceptance Corp. (Nasdaq: WRLD) - Short

Patrick Stadelhofer, CFA
pstadelhofer14@gsb.columbia.edu
CAPITALIZATION ($M) CURRENT
CURRENTVALUATION
VALUATION $120
$100
Share Price - as of 1/22/14 $88.97 LTM $80
Total Diluted Shares (m) 12.478 TEV / Sales 2.3x $60
Market Cap $1,110.1 TEV / EBITDA 7.3x $40
Less: Cash and Cash Equiv. (14.5) TEV / EBIT 7.6x $20
$0
Plus: Senior Notes Payable 486.9 Price / EPS 10.3x
Enterprise Value $1,582.5 Price / Book 2.7x
Recommendation
Short World Acceptance Corp. (NASDAQ: WRLD) with a target price of $46, a 48% short up-
side from its current level. WRLD provides a highly attractive risk/reward profile, as a lot of the short
downside is already priced into the stock, with limited potential for large value creation by the com-
pany but a significant potential for dramatic value destruction.
Background
World Acceptance issues and refinances installment loans to primarily subprime borrowers in the
Patrick is a second-year U.S. and Mexico. WRLD has benefited from the weak economic climate since the recession, with the
MBA student and the stock up over 430% over the past five years as the company’s portfolio and footprint have grown.
recipient of the Heilbrunn Investment Thesis
Fellowship. While at Core business continues deteriorating, with lower credit quality and interest rates:
Columbia Business School, WRLD’s loans have increased nearly 95% since FY08, concurring with higher delinquency as it reaches
he has worked at VGI more (and perhaps lower-quality) borrowers. 9.3% of the loan portfolio is currently delinquent (>30d
Partners, a high conviction overdue). At the same time, WRLD has seen interest rate erosion due to regulatory pressure, com-
global equity manager, petitive factors, and an increase in average balances. Many jurisdictions have usury laws regulating
which he will join after maximum rates that can be charged; if states and courts impose or tighten rules, interest rates will
graduation as an Investment come down further (e.g., there are ongoing efforts to impose a federal 36% interest rate cap).
Analyst. Prior to school, he
Delinquent Loans (>30d) as % of Gross Loans Interest Income / Average Gross Loans
was an investment banking
10% 9.3%
Associate at Lazard. Patrick 9%
7.9%
8.4% 8.2%
7.9%
8.4% 60%
59.8%
57.7%
holds a BBA from the 8% 7.3%
6.5%
7.1% 7.4%
6.5%
7.0% 55.2% 54.8%
7% 55%
George Washington 6%
52.0% 51.8% 51.4%
50.2% 49.7%
University and is a CFA 5% 50%
4%
charterholder. 3%
45%
48.4%
2%
1%
Patrick is a finalist in the 5th 0%
40%
Mar-09 Mar-10 Mar-11 Mar-12 Mar-13
annual Moon Lee Prize
Interest Rate - U.S. Interest Rate - Mexico
Competition.
CFPB cracks down on “add-on” sales of
high-margin insurance: WRLD distributes
insurance for a third party (see its confusing
form at right). It earns high-margin commis-
sions for distributing this insurance ($51.3m in
FY13, nearly a third of pre-tax income). While
there are clear legal requirements for proper
disclosure, former employees are saying that
“they were instructed not to tell customers
the insurance is voluntary” (WLRD denies
this). If it makes it appear to consumers that
they are required to sign up for insurance, this
“deceptive” marketing might be illegal. The
Consumer Financial Protection Bureau has begun cracking down on deceptive practices, including
against so-called “add-on” products. It considers the following factors in evaluating the effectiveness
of disclosures at preventing consumers from being misled, including those related to add-ons: “Is the
statement prominent enough for the consumer to notice? Is the information presented in an easy-to-
understand format and at a time when the consumer’s attention is not distracted elsewhere?” A re-
cent CFPB White Paper on payday loans and deposit advances concluded “that further attention is
warranted to protect consumers” and that “the CFPB expects to use its authorities to provide such
protections.” There is even legislative pressure, with Sen. Ron Wyden (D-OR) asking the CFPB at a
July 25, 2013 committee hearing: “So what can be done about World Acceptance?”
Volume
World Acceptance Corp. (continued from previous page)

Investment Thesis (continued)
Loan rollover model and capital structure present risks of a liquidity crunch:
Loan rollovers issues. Nearly 80% of WRLD’s loans outstanding are refinancings of existing loans (including
delinquent ones) or represent relationships with “former” borrowers; only 12% are completely new
customers. A loan that is constantly refinanced does not need to be paid back, becoming a permanent
part of the borrower’s “capital structure.” There is significant discretion in which loan gets refinanced or
charged off, which could mask deteriorating quality and lead to understated provisions. Currently the
new customers create inflows that continue the refinancing circle, but if WRLD were to run out of new
borrowers or if repayment patterns were to deteriorate, it could find itself in a liquidity crunch. Some
states (e.g. WA) have begun limiting the number of allowed refinancings per year. If WRLD left a state, it
could also create liquidity issues (e.g., TX, TN, and GA each contain more loans than all new borrowers).
Capital structure issues. Despite its large regulatory and economic risks, WRLD utilizes meaningful debt in
its capital structure and intends to continue to increase leverage through share repurchases. In fact, its
net debt balance has risen from 17% of net loans in March 2011 to 61% currently. WRLD is drawing on a
revolving facility that has been extended several times, most recently in September 2013, and expires in
November 2015. While the lenders were recently willing to extend this facility, such a willingness is not
guaranteed for the future, especially if WRLD encounters regulatory or operating headwinds.
Recent management disruptions might be a harbinger
of bad developments:
Departures. November’s unexplained departure (“personal
reasons”) of Mark Roland, COO, raises significant questions
about management. Additionally, CFO Kelly Malson announced
her “retirement” (at age 43) in September 2013; she had been
CFO since 2006 and is “pursuing other life objectives.”
Internal Controls Warning. Auditor KPGM identified a “material
weakness” in internal controls, concluding that WRLD “has
not maintained effective internal control over financial reporting.” WRLD did not have a documented
policy for establishing loan loss allowances. It also did not have a control to assess whether the account-
ing treatment of renewals was in accordance with GAAP and what impact renewals would have on the
estimate of the allowance for loan losses
Insider selling. Significant insider sales (chart above, sales are red) are also a negative signal for WRLD.
Valuation
For the base case, modeling most of the business conservatively, with TARGET PRICE - BASE CASE
key drivers being: continued office openings, continued growth in DCF (10% WACC, 3% g) $36.70
loans per office, interest rates continuing to decline, charge-offs and EBIT Multiple (8x FY18) $43.61
provisions increasing, and the insurance commission business shrink- EPS Multiple (10x FY18) $58.78
ing to a fraction of its size under a regulatory crackdown. Target Today (Rounded) $46.00
The target price of $46 is an equal blend of three valuation methods Current Share Price $88.97
(see right). A more aggressive bull case (disappearance of insurance Short Upside/(Downside) % 48.3%
commissions by FY15) yields a target of $22 (75% short upside).
SUMMARY FINANCIALS ($M)
Actual Actual Actual Model Model Model Model Model
Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
U.S. Offices 972 1,032 1,084 1,134 1,179 1,221 1,257 1,295
Mexican Offices 95 105 119 134 150 167 183 202
Total Offices 1,067 1,137 1,203 1,268 1,329 1,387 1,441 1,497
Average Gross Loans $822.7 $923.9 $1,019.9 $1,115.1 $1,212.3 $1,311.0 $1,409.2 $1,508.6
Per Office ($k ) $771 $813 $848 $879 $912 $945 $978 $1,008
Average Interest Rate 51.6% 50.5% 49.6% 49.1% 48.6% 48.1% 47.6% 47.1%
Interest and Fee Income $424.6 $466.5 $505.5 $547.1 $588.9 $630.5 $671.0 $711.3
Insurance Commissions 41.7 47.2 51.3 57.5 29.3 22.3 23.9 25.5
Other Revenue 25.2 26.5 26.9 27.9 28.9 30.0 31.1 32.2
Total Revenue $491.4 $540.2 $583.7 $632.5 $647.0 $682.8 $726.0 $769.0
Change 11.5% 9.9% 8.1% 8.4% 2.3% 5.5% 6.3% 5.9%
Operating Income $158.0 $173.8 $183.7 $201.7 $183.4 $183.4 $189.9 $195.1
Margin 32.2% 32.2% 31.5% 31.9% 28.3% 26.9% 26.2% 25.4%
Diluted EPS $5.63 $6.59 $7.88 $8.61 $7.80 $7.93 $8.46 $9.03
Risks and Bear Case

Ongoing growth in lending and office openings could increase WRLD earnings.
Mexico (7% of revenues in FY13) could become large and drive future growth and profitability.
Short squeeze as 35% of CSO is currently sold short (mitigated by large passive institutional ownership).
CFPB could decline to investigate or investigate but not act, permanently validating the business model.
Without CFPB action, the base case still yields a 25% upside, implying CFPB is remaining 24% of upside.
The bear case of continued growth and improving rates and credit quality yields a $106 price target (19%
downside), indicating an attractive risk-reward versus the 48% base case upside and 75% bull case upside.
Page 48
Pandora (NYSE: P) - Long

Akhil Subramanian
asubramanian14@gsb.columbia.edu
Capital Structure
Recommendation: Price (12/12/2013) $26.82
Buy Pandora ($26.82 as of 12/12/2013) with a probability- Shares outstanding 192.15
Market cap 5,153
weighted price target of $38 (40% upside)
Cash (437)
Debt 0
Background: EV 4,716
- Internet radio company with 72MM active users Consensus estimates 2013E 2014E 2015E
- Pandora makes money via a) Subscription ($36/year, no Revenue $628 $821 $976
ads) or b) Ad-supported listening % growth 31% 19%
- Available on many platforms (PC, mobile, tablet, cars, EBITDA ($2) $41 $85
EPS $0.02 $0.21 $0.32
Akhil is a second-year MBA TVs, etc.). ~80% listening is non-PC, primarily mobile EBITDA % -0.4% 5.0% 8.7%
- Steadily capturing US terrestrial radio share; 8% today
student in the Heilbrunn Multiples 2013E 2014E 2015E
(vs 5% in 2011). Importantly Pandora is only 3% of the
Center’s Value Investing EV/Sales 7.5x 5.7x 4.8x
Program. Over the summer, $17BN radio advertising market; they will close this gap EV/EBITDA NA 113.9x 55.2x
P/E 1,158.6x 130.1x 84.3x
he worked at Owl Creek.
Thesis:
He and his team (Eric Lai 1. Revenue inflection point. Pandora has found a way to monetize mobile listeners and they still
and Jeremy Colvin) were have many levers to pull. Furthermore, barriers to advertising are coming down
finalists at the 2013 Pershing 2. More and more ubiquitous. Advertiser ROI is favorable
Square Challenge, where 3. Relatively unfazed by competitor launches
they pitched LONG Dollar 4. Blue sky: Pandora could expand overseas or get acquired
Tree (DLTR). Akhil
graduated in 2008 from the 1. Revenue inflection point; barriers to radio advertising are coming down
University of Chicago; he - Pandora has guided to 3MM paying subs and 69MM nonpaying subs (i.e. ad supported)
majored in mathematics and - Mobile and PC RPMs were $34 and $58 respectively (RPM = revenue per 1,000 hours listened).
economics. Mobile RPMs have been increasing rapidly and this has been primarily due to a) Appointing a
new CEO in 2013 (Brian McAndrews) who is an advertising expert, b) mix-shifting from national
Akhil is a finalist in the 5th to local ads; local RPM = 3-4x national RPM, c) experimenting with ads (e.g. back to back spots)
annual Moon Lee Prize and surgically inserting more ads without increasing churn
Competition. - In September 2013 Pandora removed a monthly listening cap (40 hours) on mobile devices, a cap
that they put in place in May 2013 because they couldn’t monetize mobile listening. In my opinion,
this was a revenue inflection point
- Levers that Pandora can pull to increase Mobile listening: a) Ad minutes per hour (currently 2
mins/hr versus 13-16 mins/hr on terrestrial radio, mgmt. stated that they want to go higher), and b)
Revenue per minute of ads (breaking down unit economics => ~$11 per ad minute, this can go up
to ~$14)
Exhibit: How high can mobile RPMs go? Comparison of current ($35) versus Theoretical ($62)
Mobile RPM breakdown: Ad minutes per hour
Mobile - Ad minutes per hour 2.0 3.0 Upper limit from Q2 call $62 1 1.5 2 2.5 3 3.5 4 4.5 5
35% $16 $24 $33 $41 $49 $57 $65 $73 $82
Mobile hours listened (BN) 2.8 2.8
40% $17 $26 $34 $43 $51 $60 $68 $77 $85
# Mobile ad minutes 5.58 8.37
45% $18 $27 $36 $45 $53 $62 $71 $80 $89
50% $19 $28 $37 $46 $56 $65 $74 $84 $93
% Local
Mobile Ad RPM per minute $17.66 $20.81 Mix-shift toward local ads 55% $19 $29 $39 $48 $58 $68 $77 $87 $97
% Audio 60% 66% 60% $20 $30 $40 $50 $60 $70 $80 $90 $100
Mobile Ad RPM per minute (Audio) $10.59 $13.75 Q3 call: "$9-$12 range" 65% $21 $31 $42 $52 $62 $73 $83 $94 $104
70% $22 $32 $43 $54 $65 $75 $86 $97 $108
Local RPM $19.00 $19.00 High teens 75% $22 $33 $45 $56 $67 $78 $89 $100 $112
National RPM $4.00 $4.00 Low-to-mid s.d.
% local 44% 65% 74% of radio is local ads
Mobile Ad RPM per minute (Audio) $10.59 $13.75

Mobile Ad RPM per minute (Display) $7.06 $7.06 No increase
Mobile RPM $35.31 $62.44
- Pandora needs a local salesforce if its going to sell local ads. These salesforces are being rolled out;
Pandora is currently in 29 markets (50% of listeners) and my model assumes 50% increase in SG&A
over next couple of years
- Barriers to radio advertising are coming down. Pandora is now integrated into media-buying plat-
forms (i.e. media buyers can look up Pandora audience size and compare to radio in various markets)
- Furthermore, Nielsen recently bought Arbitron (the Nielsen of radio) and stated that it will now
start ranking Pandora. Previously Arbitron did not rank Pandora and this meant that buyers couldn’t
compare Pandora versus terrestrial radio ratings easily
Volume
Pandora (continued from previous page)

2. More and more ubiquitous. Advertiser ROI is favorable
- At launch, Pandora was PC only. Today listeners can consume Pandora on mobile, tablet, TV, car, etc.
At some point it is likely that Pandora will offer separate advertising solutions for each platform
- Advertiser ROI is superior to that of terrestrial radio because: a) Terrestrial radio tends to have 4-5
min ad blocks every 30 mins and users change channels during these blocks, b) an ad on terrestrial radio
is played to all listeners at the same time whereas an ad on Pandora is played to a user listening to a
custom-built station => advertisers can segment and tailor ads on Pandora, c) Pandora has untapped geo
-location potential, i.e. they could play you an ad for a store that you walk by (they don’t do this as of
today but they can) and these ads should have higher RPMs
- To sum it up: 8% of listening share but only 3% of advertising revenues + good ad product
whose ROI is higher than terrestrial radio ROI + many RPM levers to pull
3. Relatively unfazed by competitor launches

- Apple launched iTunes radio in September 2013 and claimed that they had 20MM users and 1BN songs
played in 1 month. 1BN songs = 4BN minutes = 67MM hours. 67MM hours / 20MM users = 3.3 hrs/mo
- Pandora users average 18 hrs/mo, i.e. 6x as much as iTunes radio
- The launch appears to have been quite underwhelming. Pandora’s active user count dropped from
72MM to 70MM but they made it back up 1-2 months later
- Spotify launched an ad supported radio service in December 2013. They only have 24MM users (6MM
paying) so the impact on Pandora should be minimal. Pandora was down 7% on the day of the launch and
I think that this could be a buying opportunity
4. Blue sky: Pandora could expand overseas or get acquired

- Pandora has 200MM users of which 72MM are active (streamed in the last month)
- Competitors have chosen to build versus buy, but Pandora ($5BN market cap) would be a tuck-in deal
- Gross margins are 44% so Pandora is worth a lot to a buyer who has a large salesforce (they could buy
the company and wipe out SG&A)
- Potential Catalyst: Outcome of royalty negotiations. Pandora will negotiate post-2015 royalty
rates in 2014, its possible that a buyer could emerge after those rates are set. Furthermore, Pandora
could strike a deal with music labels directly for royalties (currently it pays royalties under a federal stat-
utory license... but it could pay them directly to labels) and this could be another catalyst if the rates are
favorable
- Pandora could also move overseas if it strikes a direct royalty deal with labels. Currently Pandora is
only available in Australia, New Zealand and the U.S. (as those countries have federal statutory licenses)
- September 2013 equity raise could be catalyst for a direct deal with labels followed by overseas
expansion. Direct deals require upfront advances to labels and management stated that the equity raise
would allow them to address such opportunities “from a position of strength”
Valuation:
(MM)
Users and # hrs/mo
Valuation (2016E) Bull Base Bear
80.0 25.0
Probability 30% 50% 20% 70.0
20.0
Hours listened (BN) 25.3 23.8 19.8 60.0
Mobile RPM $73 $63 $54 50.0 15.0

40.0
PC RPM $96 $89 $78 10.0
30.0
Content acquisition costs % Revenue 38% 42% 47% 20.0
5.0
10.0
Revenue 1,870 1,566 1,144 0.0 0.0

Jan-2011
Jul-2011
Jan-2012
Jan-2013
Nov-2012
Nov-2011
Jul-2012
Jul-2013
May-2011
Mar-2012
May-2012
Mar-2011
Sep-2011
Sep-2012
May-2013
Mar-2013
Sep-2013
Operating profit 574 372 122

Operating margin 31% 24% 11%
EBITDA 619 410 150 Active users Hours / Active user
EBITDA margin 33% 26% 13%

$30.00 Gross profit per sub per year (at Current RPMs)
EPS $1.98 $1.55 $0.66 $25.00
Multiple 25.0x 25.0x 25.0x
$20.00
Target price $50 $39 $16
% upside 85% 45% -39% $15.00
IRR 36% 20% -22% $10.00
$5.00
Probability-weighted Price $38
% upside 40% $0.00
10 20 30 40 50 60 70 80
IRR 18%
Hours listened / mo
Paying Nonpaying
Page 50
Post Holdings (NYSE: POST) – Long

Jackson Thies
JThies14@gsb.columbia.edu
Capital Structure
Recommendation
Share Pr. 1/27/14 $54.80
Purchase shares of POST. My target price of $105 implies 90% upside over three
Shares Out. (mm) 33.0
years, or a ~25% IRR. Mkt. Cap. ($ mm) 1,808.4
+ Debt + Pfd. (PF) 2,452.0
Business Description / History
- Cash & Equiv. (PF) 359.1
POST is a consumer packaged goods company which manufactures and distrib- Enterprise Value 3,901.3
utes ready-to-eat cereals in the U.S. with 10.4% market share (3rd largest). Addi-
tionally, POST has created two new platforms—active nutrition and private la- Key Stats
bel—to capitalize on secular growth in the health and wellness category and in 52 Wk. hi/lo 55.9 / 36.7
organic and gluten free foods. Notable brands include: Grape Nuts, Honey Bunch- Dividend Yield 0.0%
Short Interest 8.2%
es of Oats, Honeycomb, Pebbles, Raisin Bran, Premier Protein, Dymatize Nutri-
Avg. Dly. Volume (mm) 0.4
tion, and Dakota Growers among others. Est. Intrinsic Val. $105
Jackson is a second-year Upside (downside) 92%
MBA student, participant in POST became a publicly traded company in early February, 2012 when it was
the Heilbrunn Center’s spun-off from Ralcorp. POST was initially spun-out of Kraft Foods and merged into Ralcorp in 2007 for a total
Value Investing Program, consideration of $2.6bn (including $950mm in debt), the TEV post spin-off from Ralcorp was roughly 2bn based on
a share price of ~$30. Shortly after the spin-off, in November 2012, ConAgra agreed to purchase Ralcorp (made
and Co-Editor of Graham &
Doddsville, the Columbia the offer in 2011 before the spin and closed in 2013).
Student Investment Investment Thesis
Management Association I) The POST management team lead by Bill Stiritz is best in class
(CSIMA) newsletter. Over A critical aspect of investing in POST is that William Stiritz became chairman and CEO of the spin-off. This is the
the summer, he interned at same William Stiritz profiled in The Outsiders for his stellar performance running Ralston Purina. Over his 19-year
PIMCO in the credit tenure at Ralston Purina, he delivered a 20% compound return through intelligent acquisitions, divestitures, and
research group. share repurchases (ultimately repurchasing 60% of the shares outstanding). Also relevant is that Stiritz pulled a
cadre of business managers from Ralston Purina to POST (CFO Vitale, COO Block, and EVP of Marketing
Holbrook), deepening the management bench and giving comfort that the right team is in place and focused on
Prior to Columbia Business
creating shareholder value.
School, he worked for the
Federal Reserve Bank of In The Outsiders, Thorndike states: “Under Ralston’s management, distribution was expanded, redundant costs
Dallas. Jackson holds a BS in were eliminated, new products were introduced and cash flow grew significantly...pretax profit margins grew from
economics and engineering 9 percent to 15 percent.” Stiritz is repeating the process. For example, he re-launched the Great Grains brand
from Southern Methodist and grew volume 7.4% in 2012 and 9% in 2013.
University.
Stiritz’s incentives are well aligned with shareholders – he currently receives an annual salary of $1 and all other
compensation in the form of stock options / share ownership. He currently has 1.55 million options with a strike
Jackson is a finalist in the
price of $31.25 and 600,000 options with a strike price of $40.30. In addition, he directly owns ~370,000 shares.
5th annual Moon Lee Prize
Competition. II) Acquisition strategy through platform expansion and increased attention to the historic Post cereal business
Stiritz made his intentions known in POST’s pre-spin S-1, “As an independent company, we will be able to allocate
capital more efficiently and have direct access to debt and equity capital markets. We anticipate that these charac-
teristics will improve our ability to continue to develop innovative new products, pursue acquisitions and other
growth opportunities, extend our brands into adjacent categories and increase our ability to motivate employees
by providing compensation that is tied directly to our business results.”
And in the 2012 annual report, “Post received less and less attention as it became part of an ever larger conglom-
erate…historical “best in class” margins reflected an insufficient amount of support for the portfolio…We believe
Post requires a top notch in-house sales force…Our business generates attractive cash flow and we intend to use
that cash to reduce debt, repurchase shares, and/or make acquisitions…We intend to expand our platform of
iconic brands by identifying organic opportunities to extend those brands into new product lines or markets. In
addition, we intend to pursue acquisition opportunities that can strengthen our current portfolio of branded prod-
ucts or enable us to expand into complementary categories, geographic regions or distribution channels.”
With Stiritz at the helm POST has been very acquisitive over the past two years – acquired roughly 50% of
POST’s pro-forma revenue – using FCF and leverage to purchase companies that now form the base of their
active nutrition and private label platforms. These platforms will enable management to rapidly drive efficiencies in
future acquisitions and fold new products into their existing distribution network. After accounting for synergies
and the NPV of tax benefits the average acquisition price has been 8.2x EBITDA. Not counting the NPV of tax
benefits I estimate POST is achieving an 8-9% levered free cash flow yield on its acquisitions. The historic POST
ready-to-eat cereal business has also benefitted from additional focus since the spin-off and has stabilized with
growth of 2.5% in 2013 compared to a category decline of 2.2%.
Volume
Post Holdings (continued from previous page)

III) POST closely resembles a publicly traded LBO providing significant upside for the equity
Indeed this is Stiritz’s intention, in the 2013 annual report he states, “Post Holdings competes for your capital alloca-
tion. To earn it we must deliver risk adjusted returns commensurate with your assessment of risk and your alterna-
tives. Perhaps uniquely, we view Post as a hybrid of a traditional public company and a private equity fund. We use
many of the same tools as a private equity company – relatively higher leverage, investment analysis and adaptive
management. We also view our portfolio as dynamic, reacting to opportunities as they develop. However, unlike most
private equity firms, we also provide Centers of Excellence to create competitive advantages for our operating com-
panies. And we do this in the public forum allowing our investors greater transparency and, most importantly, the
ability to act on their own accord.”
POST has undertaken six acquisitions since being spun off and financed a significant portion of the cash consideration
with debt. The leverage employed, while increasing risk to a degree, results in significant upside to equity holders and
is accomplished in a prudent manner as the consumer staples product is less cyclical. Added comfort is gained from
the significant cash flow generated by the historic POST cereal business as well as the newly acquired businesses.
Valuation
POST is currently trading at 11.4x forward EBITDA after adjusting for recently completed and announced acquisi-
tions. While valuation is contingent on management actions and the opportunity for attractive acquisitions, recent
activity and comments on the latest earnings call regarding deal flow are encouraging. I assume POST will continue to
make acquisitions at a pace that keeps net leverage near current levels (roughly 5x) and that acquisitions are done at
8.5x. Holding net leverage
Financials 2010 2011 2012 2013 2014PF 2015E 2016E 2017E
roughly constant I derive reve-
Revenue 996.7 968.2 958.9 1,034.1 1,866.8 2,478.4 3,163.9 3,925.4
nue and EBITDA acquired based
Growth -7.0% -2.9% -1.0% 7.8% 80.5% 32.8% 27.7% 24.1%
on the assumption that the EBITDA 265.6 256.6 202.3 191.3 341.3 459.3 594.2 747.1
EBITDA margin of future acqui- Margin 26.6% 26.5% 21.1% 18.5% 18.3% 18.5% 18.8% 19.0%
sitions will be similar to the FCF 111.3 128.9 113.1 86.4 152.1 215.3 288.4 372.0
recent average (~18%). I esti- as a % of Sales 11.2% 13.3% 11.8% 8.4% 8.1% 8.7% 9.1% 9.5%
mate organic growth at 3% and
modest EBITDA margin expan- Acq. Revenue nm nm nm nm nm 555.6 611.1 666.7
sion of 25bps annually. The Acq. EBITDA nm nm nm nm nm 100.0 110.0 120.0
result is $750mm in 2017 Total Debt 716.5 784.5 945.6 1,408.6 1,900.0 2,400.0 2,950.0 3,550.0
EBITDA to which I apply a 10x Gross Leverage 2.7x 3.1x 4.7x 7.4x 5.6x 5.2x 5.0x 4.8x
forward multiple
Recent Acquisitions Hearthside Premier Dakota Golden Boy Dymatize Total
resulting in a $105
Purchase Price 158.0 180.0 370.0 300.0 380.0 1,388.0
share price in
Multiple 8.8x 9.7x 8.4x 8.6x 9.0x 8.8x
2016, yielding a Multiple adj. for tax benefits 7.4x 8.4x 8.4x 8.6x 8.0x 8.2x
~25% IRR over Revenue 70.0 135.0 300.0 220.0 195.0 920.0
three years. EBITDA 18.0 18.5 44.0 35.0 42.0 157.5
Investment Risks
I) Capital markets become less accommodative
Mitigant: While accommodative markets aid POST’s current strategy, and help the incremental upside, it isn’t the
whole story. Stiritz and his team operated Ralston for 19 years in varying market climates with great success. Ulti-
mately Stiritz repurchased 60% of Ralston’s shares and spun-off or divested multiple businesses in his quest to create
shareholder value.
II) Management becomes overly focused on the story and stretches on price for acquisitions
Mitigant: While at Ralston Stiritz was very calculated in his capital allocation decisions and would look at the prospec-
tive return on repurchasing stock as a benchmark against which other investments were compared. They also avoided
competitive auctions and only pursued acquisitions that were attractive using conservative assumptions.
III) Key man risk – Bill Stiritz is 79 years old
Mitigant: This is a concern but as noted previously,
POST Historical Share Price multiple members of the top management team
60
worked with Stiritz at Ralston with great success.
55 Additionally, you’re paying 11.4x forward EBITDA for
50 POST when General Mills is at 10.7x and Kellogg is at
45 10.6x, so the risk of loss looks fairly minimal. You still
40 have a very good management team in place but you
35 may lose some incremental upside. That said, Stiritz
30 looks like he is in good shape and purportedly drinks
25 protein shakes (which POST now sells) on a regular
20 basis.
Page 52
Jim Grant
(Continued from page 1) The Baltimore Sun—this was the courage I needed. She
career as a reporter for in 1972—where I met my said, “Well, let’s persist,”
The Baltimore Sun and wife, Patricia, and and we did. We were lucky
Barron’s. In 1983, he set discovered my vocation. enough to find an angel
out on his own, founding Financial news at The investor named John
Grant’s. He has written Baltimore Sun was the least Holman, now known on
several financial prestigious job on the these premises as St. John.
histories, biographies, paper, a sure dead end. I He invested $35,000 and
and collections of Grant’s didn’t know the phrase that was all we needed. I
articles, as well as the “contrary opinion” but I must say, he made a pretty
Jim Grant introduction to the Sixth seemed to have had a bent good investment. That was
Edition of Security for it. I took that job and a in 1984.
Analysis. In 2013, Grant couple of years later went
was inducted into the to Barron’s. That was in My friend Lew Lehrman, a
Fixed Income Analysts 1975. I was there about successful entrepreneur and
Society Hall of Fame. eight years. I wrote some a good investor, says that
He is also a member of editorials and originated the you’re not a true
the Council on Foreign credit markets column, entrepreneur unless you
Relations and a trustee “Current Yield.” I quit in nearly go broke twice. I’m
of the New York 1983 to found Grant’s. still waiting for number two,
Historical Society. but the first time was
G&D: What prompted you enough for me.
Graham & Doddsville to start Grant’s?
(G&D): What first drew G&D: Who do you
you to the world of JG: I picked the wrong side consider to be some of the
economics and what led you in an intramural argument at main influences in your
to pursue a career in Barron’s. I had to leave. The economic philosophy?
journalism? question was, Where could
I go? I decided to start my JG: In college, I loved the
Jim Grant (JG): own paper rather than writing of John Kenneth
Circuitously, is how I working for someone else’s. Galbraith. My junior year at
arrived here. I was a serious I had no idea what a brave Indiana, I went to the
teenage French horn plan that was. I started American Economics
player—serious and almost Grant’s with the $75,000 I’d Association annual meeting
good enough to play accumulated in my Dow in Manhattan. I walked into
professionally. Using a Jones profit-sharing plan. a room and at the end of
baseball analogy, I was just That lasted just about 8 the room was an elevator.
good enough to play in the months. Subscribers were And in that elevator stood
Cape Cod League. scarce, very scarce. It seems John Kenneth Galbraith
the world had enough to himself, about seven feet
So I went to Ithaca College read even without Grant’s. tall. I was awestruck. Before
to become a music teacher. I’d just published my first very long, I am pleased to
I quit after one semester, book, a biography of the say, my tastes matured. I got
served in the Navy, investor Bernard Baruch, interested in free market
returned to civilian life as a which did not set the world literature, laissez-faire
clerk on a Wall Street bond of literature on fire. Nor did literature, the Austrian
desk, and went back to Grant’s set the world of approach—Hayek, Mises,
college, this time to study journalism on fire. Nothing Röpke, and the rest.
economics at Indiana was going well. We had two
University. kids and not much money. Good financial writing, to
My wife, a banker at me, is good writing. I have
When the time came to get Lehman Brothers, had all (Continued on page 53)
a job, I joined the staff of
Volume
Jim Grant
(Continued from page 52) freedom and the price you are Graham’s lessons
tried to emulate the mechanism, each of which is and how do they apply in
masters. Walter Bagehot, a fine cause. Then, too, the modern world?
the great Victorian editor of
The Economist, is one. I used JG: Graham reminds us
to read old bound copies of that markets are just as
The Economist in the New efficient as the people who
York Public Library, just operate in them. They—the
glorying in Bagehot’s people—overreact. They
writing. Another is Frederic underreact. They try to
Bastiat, who urged his “My friend Lew
follow their heads but they
readers to look beyond that often follow their hearts.
“which is seen” to that
Lehrman, a
They ought to buy low and
“which is not seen”—in successful sell high, but they tend to
other words, to imagine the wind up doing the opposite.
unintended consequences of entrepreneur and a
human action. I have learned Graham knew all about the
from Henry Hazlitt, who good investor, says emotional side of investing.
wrote free-market editorials Between the top of the
for The New York Times, if that you’re not a
stock market in 1929 and
you can imagine that; John the bottom in 1932, his
Brooks, author of Once in
true entrepreneur
hedge fund was down by
Golconda; and Bray unless you nearly go 70%. He picked himself up,
Hammond, author of a dusted himself off, and
wonderful history entitled broke twice. I’m still wrote his magnum opus,
Banks and Politics in America. Security Analysis. He might
waiting for number have given up, but he didn’t.
Then there’s the great Fred By the way, Graham was a
Schwed, Jr., author of Where two, but the first
wonderful writer as well as
Are The Customers’ Yachts? an analyst. Security Analysis is
It’s delightful, word for
time was enough
a model of expository
word among the wisest for me.” prose.
books ever written about
Wall Street. G&D: A lot of value
investors have begun to
G&D: You mentioned fancy themselves
Hayek and Mises. Why do macroeconomists of late.
you think the Austrians What do you think about
seem to be a source of Austrian doctrine puts value investors who are
controversy these days? interest rates at the center trying to be
Mainstream academia seems of the theory of the macroeconomists?
to write them off while business cycle. Certainly,
others take them very that rings a bell for JG: Let me tell you first
seriously. What’s your take someone whose publication about the ones who refused
on Austrian economics and has “interest rate” in its to fancy themselves
where do you think it is name. macroeconomists. Investors
better or worse than who turned a blind eye to
traditional economics? G&D: In your “increasingly credit—to monetary policy,
famous” cartoons, you to the Federal Reserve—
JG: First, let me say that no frequently reference Ben didn’t notice the stupendous
single canon of economic Graham’s concept of Mr. buildup of bad debt through
thought has all the answers. Market. How important to (Continued on page 54)
The Austrians preach
Page 54
Jim Grant
(Continued from page 53) specifically, the seasonally- by no means generate all of
2007. They tended to own a adjusted and hedonically- the ideas.
lot of optically cheap adjusted ones in the index.
financial stocks that got It’s no easy thing to build a Our readers contribute
cheaper and cheaper until price index—the compilers some of our best ideas. In
they weren’t there must make all kinds of 2006, Alan Fournier,
anymore. choices that may or may not managing member of
comport with your own Pennant Capital
Seth Klarman, a renowned ideas of relevance and Management, suggested that
value investor, says that fairness. It’s no easy thing to we look into mortgage
run-of-the-mill talk about interpret a price index, derivatives. We did, under
the macroeconomic future either. We shouldn’t be so the somewhat uninviting
reminds him of sports radio. quick to accept these figures page one headline, “Inside
Everyone has an opinion, at face value. ACE Securities’ HEL Trust,
and every opinion is equally Series 2005-HES.” It was the
valid, or invalid, or vapid. G&D: Howard Marks first of what proved to be
emphasizes not forecasting many bearish stories on
We can’t know the future. but simply knowing where structured finance,
But we can observe the you are in the economy. mortgage derivatives and
present. Sometimes interest the like. By 2008, our
“No single canon rates and credit and the JG: Exactly! We should be readers were awfully glad
cycles of credit are more more like Henry Singleton, we’d published them.
of economic important than stock the CEO of Teledyne in the
thought has all the selection. That was true in 1950s and 1960s. Singleton I’ll be forever grateful to
2007 and 2008, and it will baffled his critics by doing Alan for the idea and to Dan
answers.” no doubt be true again at what hadn’t been done Gertner, a Grant’s analyst at
some point. before. For instance, he the time, for doing the hard
would purchase his own work. Dan was a chemical
Allow me to suggest a book stock in the market when engineer by training. He had
on a related subject. It’s he judged it was no experience with
Oscar Morgenstern’s On the unreasonably cheap. His mortgage-backed securities.
Accuracy of Economic critics demanded that he But he knew a bad idea
Observations. The second present a long-range when he saw one.
edition came out fifty years corporate plan. Singleton
ago. In it, Morgenstern replied that he had no plan It actually helped, I think,
exposes the errors and and wanted none—the that he was not an expert in
fallacies that riddle future was too full of derivatives or structured
macroeconomic data. Don’t surprises. His only plan, said finance. It was the mortgage
settle for what the data say, the visionary, was to come experts who tried to tout
urges Morgenstern in so to work in the morning with us off the story. Nobody at
many words; ask what they an open mind. Grant’s is an expert. We’re
mean. Marty Whitman, all generalists.
founder of the Third G&D: You have a whole
Avenue funds, has the same team of analysts at Grant’s. G&D: Do you prefer team
message for users of How is the work organized members who come from
corporate financial and how does an issue of economics or finance
information. Grant’s come together? backgrounds?
To take an example, the CPI JG: I sometimes wonder JG: Yes. Smart people fit in
says that prices are rising by myself. Ideas come into the well, too, as do those who
a little less than 2% a year. office; finished copy goes are curious and tireless and
Which prices? The ones in out. I write all the copy but (Continued on page 55)
the index, of course. More
Volume
Jim Grant
(Continued from page 54) your office, how much time Warren Harding balanced
can write good, sound do you devote to reading? the budget and, through the
sentences. We publish every Federal Reserve, raised
other week and have for 30 JG: I read when I’m not interest rates. No
years. I’m no longer writing. As far as that goes, I “stimulus,” no TARP, no
surprised that we actually read to write. I’m usually QE, no ZIRP. Yet the
manage to produce a 12- working on a book—a depression did come to an
page issue of Grant’s, though hobby, not a profit center, I end (from top to bottom, it
I am always grateful. can assure you. My new lasted for 18 months), after
book is a history of the which the 1920s
I’ve got to say that ours is depression of 1920-21. It proverbially roared. There,
not the most electrifying was the last laissez-faire I’ve given away the plot.
newsroom you’ve ever depression in America. In Simon & Schuster will
walked into. It’s more like publish it in the fall.
the reference room of a
public library. G&D: Do you have any
“Investors who
favorite books that you
There are seven of us, not would recommend?
including the copy editor or
turned a blind eye
the cartoonist, who work to credit—to JG: Besides the titles listed
only on the days we go to on the Grant’s website, I’ll
press. There are three monetary policy, to mention two. One is James
analysts: Evan Lorenz, Boswell’s 1791 Life of
David Peligal and Charley the Federal Samuel Johnson, a book
Grant (the last-named being about life and therefore
my son). Del Coleman Reserve—didn’t
about investing, although it
handles circulation, John contains no actionable stock
McCarthy is the production
notice the
ideas. A true category killer,
chief and Eric Whitehead is stupendous buildup Boswell managed to write
the general administrator. If the best biography in the
a subscriber needs a little of bad debt through English language that was
encouragement to renew also the first biography in
his subscription, he will hear 2007. They tended the English language. I read
from our discreetly it over and over.
persuasive marketing man, to own a lot of
John D’Alberto. The other—a little
optically cheap
different—is Banking and the
A proper issue of Grant’s is financial stocks that Business Cycle, by C.A.
a little like a bride on her Phillips, et al. To my mind,
wedding day: something old got cheaper and it’s the best contemporary
(a little history), something analysis of the Great
new (never hurts in cheaper until they Depression.
journalism), something
borrowed (credit is our weren’t there
G&D: Given your thoughts
main subject) and something on the Fed and the gold
blue (we’ve been known to
anymore.”
standard, what did you think
be bearish). The analysts when Ron Paul suggested
submit memos, from which I response to a collapse in that if he were elected, he
write articles. prices and a surge in would name you Chairman
unemployment, the of the Fed?
G&D: Given the extensive administrations of
research in your memos and Woodrow Wilson and (Continued on page 56)
the very large bookshelf in
Page 56
Jim Grant
(Continued from page 55) government and Wall Street Here at Grant’s, we call it
JG: Wise choice. And I can have a vested interest in not the Ph.D. standard. The
tell what I’d do. Day One, I changing things. These are FOMC has become a kind
would open the Fed’s very potent constituencies. of seat-of-the-pants
first Office of Unintended economic planning bureau.
Consequences. Laura Ingalls Wilder The gold standard, by
illustrates the moral side of contrast, operates through
G&D: If you were the monetary question in the price mechanism.
president and could not one of her Little House Money is defined in law as a
nominate yourself as Fed books. This one, entitled weight of gold. Paper dollars
Chairman, who would you Farmer Boy, is set in upstate are convertible into gold,
Alex Porter at the 2013 nominate? New York. One day, the and vice versa, at the fixed
Moon Lee Prize Competi- protagonist is at the fair, and statutory rate.
tion. JG: My friend Lew and his father gives him a
Lehrman, whom I 50-cent piece. The father Is that a good idea? It was a
mentioned a moment ago. asks him, “You know what good and serviceable idea
He made a lot of money by this is?” Silence. “Well it’s for most of American
building up Rite Aid, which money. Do you know what history and, as far as that
others subsequently unbuilt. money is?” Again, silence. goes, for most of the
He has devoted much of his “Money, son, is work.” modern commercial history
life to studying monetary Here’s the question: Is of the West. You asked
questions. He is the most money work? Or is it an about the “financial system.”
knowledgeable and world- instrument of public policy? Under the gold standard,
wise exponent of the gold The voters will ultimately banks were the property of
standard in America. have to decide. the stockholders, not of the
taxpayers. If a bank became
G&D: What do you think G&D: What would happen impaired or insolvent, the
it would take to move back in the economy if the US stockholders got a capital
to the gold standard? and presumably at that call (that arrangement,
point, the world, moved called “double liability,” was
JG: A clear demonstration back to a gold standard? phased out in the 1930s). I
that the non-gold standard There are a lot of believe that that is the
isn’t working. For me, I’m arguments that it would direction in which our
already persuaded, though throw a wrench in the financial reforms should be
many seem not to be. The financial system, but in your headed, not toward more
system in place is a system opinion, what would that regulatory
of price control and market scenario look like? micromanagement and not
manipulation. The Fed sets more monetary
interest rates. It manipulates JG: If I were king, or improvisation, or “learning
the stock market. It chairman, I would present by doing,” as Chairman
materializes trillions of new the gold standard to the Bernanke candidly styled
dollars. nation as a monetary system QE, zero percent interest
grounded in free markets rates and the rest of it.
Unsound, I would call it, but and individual responsibility.
the system does have its The system we have is one G&D: If you were to grade
beneficiaries. Washington, of command and control. Ben Bernanke’s
D.C., is one. Greenwich, Sitting at the control panel performance as Fed Chair,
Connecticut, is another. are former tenured faculty how would you evaluate
Ultra-low interest rates and members—the cream of the him?
fast-paced money printing economics departments of
facilitate federal borrowing the top universities. They JG: I would say A for
and lubricate leveraged do what they think is best. (Continued on page 57)
finance. Ergo, both the
Volume
Jim Grant
(Continued from page 56) risks in the economy at environment, it sounds like
intentions, F for theory, C large. How do you think you perceive risks that
for short- and intermediate- investors should look at risk others do not. What facts,
term results. By results, I and reward and how does measures, or indications
mean that the world turns that compare to how bother you most?
on its axis; America is more central bankers should think
prosperous than, say, about it? JG: Here’s a fact: China’s
France; and most people banking assets represent
who want work seem to be JG: The manager of one of one-third of world GDP,
able to find work. It’s a far the world’s biggest hedge whereas China’s economic
cry, though, from dynamic funds looked into the output represents only 12%
American prosperity. As for CNBC cameras the other of world GDP. Never
the long-term costs of this day and said that risk is the before has the world seen
extraordinary monetary volatility of returns. I would the likes of China’s credit
experiment, I expect them say—many value investors bubble. It’s a clear and
to be sky high. would agree—that risk is present danger for us all.
the likelihood of the
I say that because price permanent impairment of And here’s a sign of the
control doesn’t work. As far capital. times: Amazon, with a
as I know, it has never trailing P/E multiple of more
worked. By controlling than 1,000, is preparing to
some prices, e.g., interest build a new corporate
rates, you invariably distort headquarters in Seattle that
others. The Fed is trying to may absorb more than
fool Mother Nature. 100% of cumulative net
income since the company’s
G&D: Being a proponent “We can’t know the founding in 1994.
of the gold standard, what
do you think of Bitcoin? future. But we can
Now, there are always
observe the things to worry about.
Bitcoin is a monetary cry for Different today is the
help by the technological present.” monetary policy backdrop.
elites. They don’t like the Which values are true?
idea of government money Which are inflated? In a
in general, and they time of zero percent
disapprove of QE and zero interest rates, it’s not
percent interest rates in always easy to tell.
particular. Their solution is
a crypto-currency that G&D: Where can the
governments can’t print. As In the case of a central average investor find
an alternative, allow me to banker, risk is a little income?
suggest a tangible monetary different. As Ron Paul’s
asset that governments can’t prospective Fed chairman, I The average, risk-averse
print. One which has been would define risk as the investor can’t. There’s none
accepted as money for chance that market to be had, at least none in
millennia, which is scarce, intervention in whatever natural form. To generate
fungible, ductile, beautiful, form winds up doing more yield, you must apply
and universally accepted as harm than good. leverage. This is the stuff of
money. Hey, Silicon Valley: businessman’s risk. A pair of
You’ll never lose gold on G&D: Given the current examples: Annaly Capital
your hard drive. state of the economy and Management (NYSE:NLY), a
the low interest rate (Continued on page 58)
G&D: You focus a lot on
Page 58
Jim Grant
(Continued from page 57) They inflate something—and debt formation. The trouble
mortgage real estate that something, these days, with debt is that it tends to
investment trust, which is investment assets. The be deflationary. Leveraged
changes hands at 83% of Fed doesn’t seem to mind; firms tend to overproduce
book value to yield 11.4%; higher stock prices are part in order to generate the
and Blackstone Mortgage and parcel of the central revenue with which to
Trust (NYSE:BXMT), a new bankers’ recovery program. remain solvent.
real estate finance company, But when markets crash, Overproduction presses
which trades at 113% of the Fed returns to do more down on prices. Easy access
book value to yield 6.43%. of what levitated those to speculative credit
We judge both to be markets in the first place. prolongs the life of marginal
reasonable risks. More firms. They don’t go broke
speculative, but—we think, but continue to produce,
also priced appropriately for thereby adding to the
the risk—are long-dated physical volume of
Puerto Rico general “A proper issue of
production and so to the
obligation bonds. The 5s of overhead weight on prices.
Grant’s is a little
2041 trade at 65.40 to yield Debt is deflationary the
a triple tax-exempt 8.18%. like a bride on her more it drives production
Widows and orphans stand or the more it inhibits
clear. wedding day: consumption.
G&D: What about the something old (a You see the problem. The
great debate over tapering? Fed is egging on inflation
little history),
with one hand but
JG: Grant’s is on record as suppressing it with the
something new
saying that the Fed won’t other. It materializes the
taper. Or, that if it does (never hurts in dollars that drive some
taper, it will likely de- prices higher. It fosters the
taper—i.e., reverse course journalism), debt that drives other
to intervene once more— prices lower. What it
because the economic something refuses to do is let markets
patient is hooked on clear.
stimulus. borrowed (credit is
our main subject), G&D: Do you think
The source of the Fed’s there’s a multi-year
problem (which, of course, and something blue playbook that they’re
is everyone’s problem) is following or is it more day-
that there ought to be (we’ve been known to-day?
deflation. In a time of
technological wonder, to be bearish).” JG: Well, if they’re “data-
prices ought to fall, as they dependent,” as they insist
fell in the final quarter of the they are, they’re just as
19th century. As it costs The central bank did it in good as the quality of their
less to produce things (and the early 2000s to bind up data. And they’re just as
services), so it should cost the wounds of the dot-com good as the soundness of
less to buy them. In an crash; and, of course, it’s their theories. In short—by
attempt to force the price repeated the treatment, my lights—they’re not very
level higher by an arbitrary only with much heavier good.
2% a year, the central bank does, from 2009 to date.
inevitably creates too much Observe that ultra-low G&D: Where in the world
money. Those redundant interest rates encourage (Continued on page 59)
dollars don’t disappear.
Volume
Jim Grant
(Continued from page 58) no currencies. I don’t track late 1980s and very early
do you see there being our returns because they 1990s. Then he turned
attractive investment wouldn’t be returns. They bullish, did very well, and
opportunities right now? would a journalist’s idea of became much happier. His
returns. mother was the inspiration
JG: We are finding it for one of my favorite
harder to find good long G&D: There are some Grant’s cartoons. A married
ideas, easier to find good who compare journalism couple is seen in the family
short ideas. Years ago, and investing. In fact there’s kitchen. They happen to be
when I believed I could the notion that being an bears. She is laying a paw
predict the future, I would investor is like being an consolingly over his
have answered your editorialist because you shoulder. Obviously, the
question by declaring that have to find the facts and market has been soaring.
the top is in: Sell then connect them to form “Don’t worry cupcake,” she
everything! Older and— “Here’s the
an argument or opinion. is saying. “I just know
maybe—wiser, I know that I something terrible is going
don’t know that the top is
question: Is money
JG: Plenty of people leave to happen.”
in. What I think I know is journalism to go to Wall work? Or is it an
that risk increasingly Street and find that investing I am cyclically bearish and
overshadows reward in is not as easy as it seemed permanently— instrument of public
stocks and bonds alike. while they were writing temperamentally—skeptical.
about it. And there are But one has to navigate this policy? The voters
G&D: Have you tracked plenty of people who invest terrain between cynicism
the returns of the will ultimately have
for a living whose annual and skepticism. One cannot
investment ideas that you letters are fun to read only be bearish on life, and I’m
include in Grant’s?
to decide.”
because the first paragraph happy to say that I’m not.
says, “Dear investor, we
JG: No. I’m not sure which were up 46% this year.” G&D: What advice do you
is harder, investing or Beautiful prose. have for students or
writing about investing. investors in the early stages
What I do know is that they G&D: How do you manage of their career?
are different. For a decade to maintain a healthy
and more, Alex Porter and I skepticism without JG: See the older gent
were the general partners becoming overly cynical? walking down the street,
of Nippon Partners, a long- the one not checking a
only partnership that JG: It can be hard. To mobile device? He has
invested in Japan. We anyone who was bearish on money, security, position. In
worked hard at securities the dot-com mania, as I was, short, he possesses
analysis and portfolio the year 1998 lasted for everything you don’t have
management, but we didn’t about 6 years; 1999 dragged and desperately want. But
have to publish our findings, on, seemingly, for another do you know something?
in scintillating prose 15 years. But then, The elderly gent would give
(complete with a funny blessedly, came the year his money, security and
cartoon) every two weeks. 2000. You start rooting for position for your bounding
bad things. energy, full head of hair and
At Grant’s, we analyze limitless prospects. You
securities and we comment A friend of mine and a fine should enjoy them!
on credit and on China and investor, Frederick E.
on the prices of modern art “Shad” Rowe, calls himself a G&D: Thank you very
and on anything else that recovering short seller. Shad much for your time, Mr.
strikes our fancy. But we was bearish with the rest of Grant.
manage no portfolios. We us skeptics and cynics in the
size no positions. We hedge
Page 60
Justin Muzinich
(Continued from page 1) side of investing? insight into how the law
Olin Fellow in Law, Eco- actually worked.
nomics and Public Poli- JM: Post-college, I worked
cy, and an MBA from at Morgan Stanley in their G&D: You started out
Harvard Business mergers and acquisitions doing equity investing and
School, from which he group and there I learned a moved to fixed income.
graduated with highest lot about finance. That can Why did you make the
honors as a Baker Schol- be a good or a bad thing, as move and what do you see
ar. an investor, because as a as the primary differences?
banker you can end up solv-
Graham & Doddsville ing for an outcome as op- JM: I was very lucky out of
(G&D): Can you tell us a posed to taking an unbiased graduate school to work for
little bit about your back- view as to what a company a fund that had been spun
ground and how you got is worth. out of a family office with a
interested in investing? lot of capital. It was a very
Justin I went to business school to small group of us and we
Muzinich Justin Muzinich (JM): round out my banking expe- could think with a very long
Sure, I’ve always been inter- rience. I enjoyed finance, horizon and look for good
ested in investing. When I but I also wanted to think businesses. We did mostly
was in college I ran a stu- about businesses more ho- equities, and I really enjoyed
dent investment fund and listically, learn how busi- it.
enjoyed it. I didn’t know nesses think about sales,
anything really about fi- product development and But there was something
nance, which in some ways management. especially stimulating to me
was an advantage because about fixed income. On the
we thought more about the I went to law school be- credit side, whether you are
companies—their business cause I thought law was a looking at senior loans, or
model, products—than very stimulating field. In law high yield or emerging mar-
about numbers in a spread- school you get to think ket debt, you have to do all
sheet. about big questions and you the analysis you do for equi-
don’t get that opportunity ties. You have to under-
As your career progresses, often in your career. Once stand the companies to en-
you understand how im- you are working full-time, it sure you are going to get
portant thinking about com- can often be more difficult your coupons and principal.
panies is as opposed to just than you’d like to step back. But there is also a much
thinking about numbers. In I was lucky enough to go to broader analysis you have to
college you take that ap- Yale, which is a place that do in terms of reading the
proach out of naiveté. We gives you lots of flexibility to debt contracts and under-
thought we had a compara- follow your interests. It also standing covenants; it’s
tive advantage understand- ended up being very helpful more complicated and in
ing technology stocks be- in fixed income, since you some ways that’s very ap-
cause we were the genera- deal with contracts and oth- pealing.
tion using their products er legal and regulatory is-
and we were more in the sues all the time. Another difference is that in
flow of what was popular credit, you can be more
than someone sitting behind G&D: Did you ever think certain of the outcome. You
a desk in New York all day. of practicing law? buy a bond and you have
three or four years left of
G&D: You have both an JM: Never very seriously. I its life, either it’s going to
MBA and a JD. What was spent a summer practicing pay you $100 or it’s going
the rationale for pursuing law to get a sense for what to default. So the market
both and has it helped you it was like. I wanted more (Continued on page 61)
being on the fixed income
Volume
Justin Muzinich
(Continued from page 60) ness model and making sure and Dodd emphasized fixed
can move against you for six you are going to be paid in income investing being a
months or a year, but if that almost any circumstance is negative art in that you
bond is money good it’s really important. In some don’t always have to pick
going to move back pretty ways it is similar to the mar- the right ones but you really
quickly because you have a gin of safety concept on the need to avoid picking the
pull to par. equity side. bad ones.
In that way you are reward- There are two ways of JM: It’s absolutely the case
ed quickly if your analysis is looking at the bond market. in fixed income because the
right. In equities something One is to look at it as a historical recovery rates in
can trade from 15 times to securities market. Securities the high yield market, for
10 times and can stay there prices go up and down, and instance, are typically forty
for years and years. Eventu- you try to buy a bond today cents on the dollar. So if
ally if you buy at a low because you think in a you make a mistake you are
enough valuation and you month or a quarter it will getting 40 cents back. That’s
are actually collecting divi- be worth more. The equiva- a lot of coupon you are “As your career
dends you’ll be fine, and lent on the equity side is giving away if you have a
that’s what value investing technical investing or mo- default. It is a negative art in progresses, you
is, but it can take a really mentum investing or some- that sense. You’ve got to try
long time to be proven thing like that. to make sure the business understand how
right. Whereas in credit if can withstand everything
you are right, generally you important thinking
Alternatively you can ap- that’s happening around it in
see that in a shorter period proach bonds as a market in order to minimize your de-
of time. That’s, I think, an
about companies is
which you are lending mon- fault rate.
important difference. ey to companies. What you as opposed to just
care about is that the com- G&D: Corporate credit
G&D: When looking for pany and the business model markets are very broad; thinking about
investments your criteria are strong enough to pay how do you narrow the
sound very similar to Buffett you interest and principal opportunity set? numbers.”
-style equity criteria, really over the life of the bond. If
looking for a strong busi- that is your approach you JM: We segment the world
ness with competitive have to be sure that regard- by industry at an analyst
moats. How do you find less of all the things happen- level and do a first cut to
that working from the cred- ing to a company that they eliminate issues or compa-
it side? It gives you better can’t control, that they can nies that we aren’t going to
principal protection but it still pay you interest and pay spend time on, either be-
seems like an equity way of you principal because you cause they’re too small or
thinking. understand the drivers of they’re just too illiquid. You
their business well enough. can cut the universe down
JM: That is something we That approach is the equiva- by one third—to one half—
think about a lot in fixed lent, on the equity side, to a depending on exactly what
income. Unless you are do- margin of safety or value you are looking for. From
ing distressed investing you investing concept. That is what’s remaining, we try to
are paid just for sitting the approach we take be- do work on most compa-
around—whatever the cou- cause we take uncertainty nies.
pon is, 7%, 8%, etc. What very seriously.
you need to ensure is that What’s really important in
you are going to be paid G&D: That’s interesting. narrowing the opportunity
back and avoid losses Howard Marks spoke to set is that you have a sense
through default. our class last week and of what happens with com-
talked about how Graham (Continued on page 62)
So thinking about the busi-
Page 62
Justin Muzinich
(Continued from page 61) business. Here it’s attention makes us better investors
panies during difficult peri- to protecting on the down- with a broader opportunity
ods. We think one of the side and having the experi- set to be able to invest in
best ways to have that sense ence to know what happens European and emerging
is to have experienced peo- to companies in difficult market credit, not just US
ple on the team who have times. credit.
seen a number of cycles. It’s
fine to think in the abstract The other decision we’ve G&D: Muzinich & Co. flies
about what happens when made is to stay focused on under the radar more than
the economy deteriorates. corporate credit. Lots of we would expect from a
But when you actually know asset managers, for a variety firm with your AUM. Is that
how companies behave and of reasons, start with a fo- a strategic decision or is
what management teams cus but then want to get that just the fact that we
have done, what companies into a lot of different verti- come from a non-credit
try to do with covenants, cals from a diversity of busi- background?
what happens to cash flows ness perspective. So they’ll
in cyclical industries—having start in growth equity and JM: It is a strategic deci-
a team that has lived these then move to value equities, sion. We think what is going
issues gives you a lot of and maybe from value equi- to matter over the long
comfort as you go into a ties move into converts and term is doing a great job for
downturn. credit. our investors. It doesn’t
help us to do a great job for
G&D: It would be interest- I can see why people do our investors by appearing
ing to talk about the busi- that, but we feel we have a on TV. Our view is that we
ness model of an asset man- competitive edge by doing just want to stay focused on
ager and how you view it nothing but credit. We are what’s ultimately going to
versus how some other very aligned with our inves- matter over the long run,
large asset managers ap- tors because we can’t do which is picking good com-
proach it. credit badly and then rely panies at the right valua-
on an equity team to per- tions.
JM: There are many sides form well. This focus also
to that question. How you generates robust debate, G&D: Do you find it af-
set up your organization is because credit is what peo- fects your investment pro-
really important for long- ple discuss all the time, and cess at all? There are some
term success and there are real debate is important to people who deliberately try
lots of decisions you can the investment process. to stay off the radar so that
make that might enhance Talking about credit all the it’s easier for them to do
short term profitability but time might sound boring, deeper due diligence.
are the wrong long-term I’m sure it does, but that is
decisions for generating what makes you good. So a JM: Some might keep a low
good returns, and ultimately big business model decision profile because their profile
that is what matters. has been to stay focused on is not one which companies
corporate credit. they invest in would like.
One decision we made on But we’re generally inves-
the business side is to have A third business model deci- tors that companies like to
senior investment profession has been to be global. have, because of our longer
sionals, with the goal of min- This requires investment term outlook, so we don’t
imizing defaults. While you teams in several countries, have a problem with access
may not make this decision and again is not something to management etcetera.
if you are focused on short you would do if you were For us it’s more just a mat-
term profitability, we try to focused on short term prof- ter of where we put our
keep sight of what’s really itability. But we think it (Continued on page 63)
important to success in the
Volume
Justin Muzinich
(Continued from page 62) We also don’t do a lot of 2000, and at times we’ve
focus and what consumes distressed investing. We been totally out of indus-
our time every day. Spend- have people who have done tries when we think it’s the
ing time on TV does not distressed, and we certainly right thing. There are peo-
help us earn good returns. can. But if you are going to ple in the investment world
Time management is one of do distressed full time, it’s who look at benchmarks,
the most important things in as much legal analysis as it is but benchmarks don’t drive
investing and we just want credit analysis and that is a our investment decisions.
to be focused on what will different skill set. Again, we
matter over the long run. want to be focused on what G&D: What kept you out
we’re really good at. of financials in 2008?
G&D: In terms of focusing
on corporate credit, you G&D: So if one of the JM: On financials, it wasn’t
“We were out of
primarily do high yield, but names you hold does move a great insight that financials
will you branch into invest- financials because
into a distressed situation were going to go through all
ment grade if you think will you work with them on the turmoil they ultimately we couldn’t
there is some type of dislo- a credit committee? did. We weren’t totally
cation? comfortable with what was evaluate them from
JM: Yes, if that is the right happening, but we didn’t
JM: The firm is not just thing to do for investors, make some great call that a credit perspective.
high yield; we define it as absolutely. there was going to be a fi-
global corporate credit gen- nancial collapse either.
The first rule of
erally. So we do a fair G&D: In terms of portfolio
amount of crossover invest- credit investing is
management, how do you We were out of financials
ing between, for instance, think about the number of because we couldn’t evalu- you don’t invest if
investment grade and high positions you have and in- ate them from a credit per-
yield because of structural dustry concentration? Are spective. The first rule of you don’t
reasons. When you make you managing to a bench- credit investing is you don’t
the transition from invest- mark in some instances and invest if you don’t under- understand, and
ment grade to high yield not others? stand, and that requires a
there are often a lot of lot of intellectual honesty.
that requires a lot
forced sellers and inefficien- JM: We don’t manage to a
cies. Over time that’s been of intellectual
benchmark. Certainly some They were such black box-
an interesting area for us to of our investors might be es. I remember talking to a honesty.”
focus on. more benchmark oriented very senior research analyst,
than we are; it’s just a reali- one of the most senior
We also invest in senior ty of the investment world. banking analysts on Wall
loans and we have a hedged The way the industry is set Street, at the end of 2007. I
vehicle which has a lot of up you have investment asked him, “Can you really
flexibility to put on arbitrage committees and consultants look me in the eye and tell
trades. We look at the who use benchmarks so you me that you understand the
whole credit universe, ex- can’t avoid it to some de- risks broker-dealers are
cept upper tier investment gree. exposed to or is this a black
grade, because that is driven box?” This guy who had
by interest rates. We don’t But we don’t make invest- made a career of financials,
think we can consistently ment decisions based on a who has been covering fi-
predict what’s going to hap- benchmark. For instance, nancials for 20 years and
pen to interest rates, which we hardly held any financials writes very long reports on
is a very liquid and efficient going into 2008, even these institutions, said that
market. So we try to be though they were part of at the end of the day, it’s a
very honest about that with the benchmark. We hardly black box.
our investors. held any telecom going into (Continued on page 64)
Page 64
Justin Muzinich
(Continued from page 63) good argument for diversifi- There are two areas where
We just didn’t know what cation. If you only have ten we generally find opportuni-
exposures they had on their names in an equity book and ties. One is intra-capital
own book and what they one triples, that’s great. structure arbitrage. One
had done to hedge out ex- That makes a lot of sense. In company might have senior
posures. There wasn’t credit you usually buy some- loans and high yield bonds,
transparency, which you thing at $100 or relatively and let’s say the market has
need for credit investing. close to par, unless it is a really rallied and they’re
Professor Bruce Green- distressed market, but you trading at about the same
wald speaking at the 2013 G&D: Has that changed are not going to get $300 levels. But senior loans are
CSIMA Conference. since then? Have you guys back; maybe you’ll get slight- floating rate instruments
moved into more financials? ly above par. and high yield bonds are
fixed rate, and the loans are
JM: In the case of broker- So you don’t get the payoff senior in the capital struc-
dealers for instance, we still from being concentrated. ture.
feel like we really can’t eval- On the flip side you can get
uate the risks to the point hurt if you hold ten names With interest rates so low
where we are comfortable. and something unexpected now it’s difficult for them to
There are times when you happens, and one position go much lower. So you
might get paid for that un- ends up being worth 40 should get paid more to
certainty. But you really cents on the dollar. One own high yield, because it
need to be paid a lot. That way to control that risk is doesn’t have a floating rate
said, there is a price where diversification and that’s feature and it’s lower in
taking on this uncertainty why banks and lending insti- capital structure. When
can make sense. We will tutions also have diversified credit markets rally it’s of-
invest in leasing companies books. ten because of technicals in
where there is actually col- the market, and the same
lateral you can understand When I was spending a lot when they sell off. Every-
and it’s much more trans- of time on equities I came thing will move up together
parent. But that’s just not to dislike the word diversifi- and often the price between
the case with the broker- cation as an equity analyst. these two securities in the
dealers. In fixed income I’ve come to capital structure will con-
appreciate it. verge substantially. When
G&D: Coming back to that happens we can arbi-
diversification, how do you G&D: Do you mind talking trage the two against each
think about it in the context a bit about what you do in other. We short the bonds,
of fixed income portfolios? terms of credit long-short for instance, and go long the
ideas and where you see loan. You largely offset your
JM: From the equity side most opportunities? cost of carry from shorting
there are pro and con argu- the bonds.
ments for diversification. JM: Sure, we see lots of
And there is certainly an opportunities. Generally Another area where we
argument to be made for what we try to do is look often find ideas are what we
just investing in a handful of for companies that are call intra-industry trades.
companies you know really yielding a similar amount but There will be two compa-
well, where you really un- have very different risk pro- nies in the same industry,
derstand what’s going on in files. Over time yields gen- one with a great business
the business. erally reflect risk profiles so model and one we think is a
the securities eventually very bad business model,
On the credit side, because should converge to fair val- more cyclical maybe or just
it’s a negative art, and be- ue. a different cost structure.
cause so much of it is risk (Continued on page 65)
control, I think there is a
Volume
Justin Muzinich
(Continued from page 64) trage those against names and the fact that interest
Again, in a strong market, that aren’t selling off as rates are going to have to
bonds often move within much, or aren’t as flow- go up from here at some
the industry in the same based. point, how are you thinking
way and then when there is about duration?
pressure on the market, G&D: Do you think the
bonds are differentiated. But rise of high yield ETFs exac- JM: For the more credit-
when everything is moving erbates that sort of behav- focused part of the market,
up the yields get pretty ior? duration doesn’t matter too
close. much. The long term corre-
JM: It exacerbates some of lation of the high yield mar-
G&D: On the opposite that behavior. ETFs—we ket to the ten year treasury
side, when spreads haven’t could talk for an hour just is zero. It’s actually very
“For the more
necessarily converged, when about this—create their slightly negative even.
they’ve diverged, how do credit focused part
own sets of inefficiencies
you go about identifying around the market because That’s because in a rising of the market,
attractive trades? they’re rule-based. They rate environment compa-
operate based on arbitrary nies are generally doing duration doesn’t
JM: Often what we’ve seen rules. Not rules that are well, and likely have some
happening, and this is partly based on the value of the pricing power from inflation, matter too much.
because the books of bro- underlying company, but so even if rates are moving
ker-dealers are smaller be- rules that say you can only up, spreads will often com-
The long term
cause they are not making own certain types of issues press at the same time.
markets in the way they correlation of the
or certain types of securi- That’s historically been true,
used to, is big liquid bond ties. So if there are out- but sometimes it doesn’t high yield market to
complexes, in periods of flows then that type of issue happen. But generally it’s
stress, will trade off more or that type of security gets not illogical that you would the ten year
than less liquid ones, be- sold, it has nothing to do be in a spread compressing
cause retail money is mov- with the underlying value of environment at the same treasury is zero. It’s
ing in and out of the market, the company, it’s just be- time that rates are going up.
and retail focused funds cause of some rule being However you may get to a
actually very
have to sell more liquid executed. So we spend a lot point where spreads can’t
bonds to satisfy redemp- slightly negative
of time trying to understand compress anymore and
tions. those rules and the pressure rates still rise. even.”
that those rules put on dif-
So we often see artificial ferent securities. Especially when rates are
pressure being put on big low and the curve is fairly
liquid complexes and often G&D: Based on that liquid- flat, we’ll be on the shorter
these are companies where ity aspect, will you typically duration side. However, we
there is no question that hold cash bonds or do you don’t have an in-house view
they are not going to de- consider using credit default of where rates are going.
fault. They have huge equity swaps (CDS) to gain expo- But we can have a view that
market capitalizations and sure? there is a lot of uncertainty
we know the business mod- about rates and we’re not
els very well. It’s just that JM: We’ll typically hold being paid for that uncer-
the flows are causing move- cash bonds. In our hedge tainty. Also, in our hedged
ments in security prices strategy we’ll use CDS, but strategy, we have the flexi-
within the markets. we typically transact in the bility to arbitrage out dura-
cash markets. tion. If you put on a trade
So we’ll often see opportu- going long loans and short
nities around flow-based G&D: Given the current the bonds you achieve this.
names when the market interest rate environment (Continued on page 66)
sells off and we can arbi-
Page 66
Justin Muzinich
(Continued from page 65) For a variety of reasons this the investors in our funds.
G&D: What about the is putting more pressure on We do have to match assets
duration needs of your in- small and medium size busi- and liabilities because these
vestors? nesses than on large busi- are private loans. You are
nesses. One of the ways not going to get your mon-
JM: Different investors banks make money is cross- ey back until the maturity of
have different duration selling. They don’t make the loan so you have to
needs. For instance, insur- that much money on the make sure your capital is
ance companies often match actual loans they make to long term. But we see some
asset and liability duration, companies, but on selling pretty good opportunities
whereas endowments foreign exchange services and have been spending a
sometimes do not. The du- and a variety of other ser- lot of time in Europe.
ration needs of our inves- vices to companies they
tors can drive whether they make loans to. G&D: What was it that
invest with us in duration- drew you to Italy? Was it
hedged strategies or not. Banks can do more cross- the fact that their financial
selling to large companies institutions have taken a
G&D: You are also in- because their businesses are particular beating or was it
volved in opportunities out- more international, there- some other reason?
side of the U.S., particularly fore they need these addi-
in Europe. Could you ex- tional services. So as banks JM: We’re looking at all of
plain the opportunity you are capital constrained, Europe. In Italy and Spain
see there? they’re focusing more and the banks are in more trou-
more on large companies. ble than other countries.
JM: The European debt While all companies in Eu- There are a lot of northern
markets are really interest- rope are feeling the pinch of Italian business we know
ing right now. The European the credit crunch, the small from experience are very
high yield market developed to medium size companies well run. There are lots of
after the U.S. high yield mar- are most impacted. great manufacturing busi-
ket. The private equity mar- nesses and a great manufac-
ket there developed after A lot of these businesses turing culture.
the U.S. private equity mar- are great businesses. We’ve
ket. On the debt side of been spending a lot of time We thought that in Italy,
things they often take their for instance in Northern because it was one of the
cue from the U.S. markets. Italy, where there are a lot powder kegs of Europe,
of well protected niche there was a good chance
Several decades ago, small businesses that have made it the baby was being thrown
and medium size businesses through multiple cycles in- out with the bath water.
in the U.S. got a majority of cluding 2008 and 2009. So People didn’t want to deal
their financing from banks. the businesses which remain with a company because it
That’s come down over the are often very good. They had an Italian flag, even if
last few decades to about 30 often have long-term inter- most of its revenue came
percent. In Europe, small national contracts. But if from outside Italy. Many
and medium size businesses they want to expand or they businesses in Italy were just
get about 90 percent of have an opportunity to win as solid as businesses in
their financing from banks. a new contract, they just Germany.
Banks in Europe are under can’t get financing anymore.
tremendous pressure, they You still have to be sensitive
are de-levering, and their So through our investment to the regulatory regime
banks did not restructure in funds we can provide financ- and the bankruptcy regime.
the way our banks did in ing to them, which we think But the different bankruptcy
2009. is a good risk-reward for (Continued on page 67)
Volume
Justin Muzinich
(Continued from page 66) guy. It was a privilege to talk about a mistake you’ve
regimes always existed, work together. On the first made, either in investing or
while the price that you paid part of the question, how in your career, and what
in 2007 versus 2008 or does that overlap with in- you learned from it?
2009 really gapped out vesting? I think investing is
when you looked at Germa- about being curious and I JM: Early in your career it’s
ny compared Italy. That’s think that leads very natu- easy to be overly focused
because companies were rally to writing. on numbers, especially if
being dismissed simply be- you are coming out of an
cause of their Italian flag. Investing is a never-ending investment bank or out of
stream of interesting ques- business school, and I made
G&D: How do you build tions. You can think about this mistake. Numbers are
that business out, do you business models, about the really important and you
set up an origination team world, about what other certainly have to understand
on the ground and how people are thinking and valuation, but the most im-
time intensive is it? where there are opportuni- portant thing is finding good “Numbers are really
ties. Often, thinking about businesses. I think it’s easy
JM: It took us a year and a companies leads to thinking early in your career not to important and you
tremendous amount of about some broader ques- appreciate what really
work to set up before we tion, because companies makes a good business. I certainly have to
were really comfortable inhabit a world around love reading Buffett’s letters
with it. If you are going do it them. and his discussions about understand
right, you’ve got to put the moats around good busi-
infrastructure in place and valuation, but the
I also believe it is important nesses, but until you inter-
hire a number of people in to try to contribute to the act with enough businesses most important
Italy. Now we’re seeing public debate if you have an and understand what a moat
strong deal flow and a de- idea, even if in just a small actually is, you don’t really thing is finding good
cent number seem to be way. appreciate it.
very good risk-reward op- businesses.”
portunities. They are good In terms of the Fed, we have G&D: Any parting words
business models with low some views in our article of advice to our readers,
debt to EBITDA that need about what the Fed can and and especially to any stu-
financing and we can be can’t credibly do. We think dents interested in careers
good long term partners it’s difficult given the way in investing?
because we have a long the Fed is structured right
term view of the world and now to credibly say they’re JM: I’ll come back to some-
want to help them grow. going to be very good at thing I said earlier in the
what’s called “macro pru- interview, which is to try to
G&D: We noticed that dential regulation,” which is be really stimulated by in-
you co-authored an article just a fancy word for trying vesting and to keep a sense
with Dean Hubbard recently to stop bubbles. of curiosity. I think that’s
and were curious what mo- what makes the best inves-
tivated you to work on that We should think about insti- tors. It allows you to have
and how it relates to your tutional reform rather than insights into where there
investing? And is there a lots of these small rules- might be opportunities and
particular area that you based reforms around the that’s a very important
think the Fed should be edges, which don’t funda- starting point for investing.
focusing on currently to mentally change the man-
address excesses? date or structure of the G&D: Thank you very
Fed. much for your time, Mr.
JM: We co-authored one Muzinich.
piece together and Glenn G&D: Could you briefly
Hubbard is just a terrific
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Graham & Doddsville
Issue XXI Spring 2014

Inside this issue:
CSIMA
Conference P. 3
Philippe Jabre—Following the Steps to
Philippe Jabre P. 4
Investment Success
Arnold Van Den Berg Philippe Jabre ’82 is the founder and Chief Investment Officer of
Jabre Capital Partners, which runs three investment funds – a
& Jim Brilliant P. 12 multi-strategy fund and two long-only funds. Prior to launching
his own firm in February 2007, he was a top money manager at
Pershing Square
GLG Partners. Jabre Capital Partners recently won
Finalist Pitches P. 22 Philippe Jabre (Continued on page 4)
Eric Rosenfeld P. 32
Women in
Investing P .37 Century Management—The Value of Discipline
H. Kevin Byun P. 38
Arnold Van Den Berg founded Century
Moon Lee Prize P. 45 Management in 1974. He is a principal of the
firm, the Chief Executive Officer, co-Chief
Editors Investment Officer, and a portfolio manager.
Arnold has no formal college education but
Chris Brigham
gained his market knowledge through rigorous
MBA 2014 self-study, tremendous dedication, and over 45
years of industry experience. Prior to starting
Jackson Thies
Century Management, he worked as a financial
MBA 2014 Arnold Van Jim
Jason Yang Den Berg (Continued on page 12) Brilliant
MBA 2014
Matt Ford Eric Rosenfeld—The H. Kevin Byun—Special
MBA 2015 Evolution of an Activist Situations Investing
Peter Pan Eric Rosenfeld is the H. Kevin Byun ’07
MBA 2015 President and Chief founded Denali
Executive Officer of Investors in 2007.
Crescendo Partners, a The firm employs
Visit us at: an opportunistic
www.grahamanddodd.com New York based
www.csima.org investment firm special situations
focused on activist and value oriented
investing. Prior to framework. Denali
forming Crescendo in seeks to identify
1998, he held the catalyst-driven
Eric Rosenfeld position of Managing situations that will H. Kevin Byun
Director at CIBC Oppenheimer and its unlock value. He
predecessor company Oppenheimer & was a triple major at Rice University
Co., Inc. for fourteen years. and has an MBA from Columbia Busi-
ness School.
Page 2

We are pleased to bring you Eric Rosenfeld shares his With this being our final
the 21st edition of Graham & evolution as an activist in- issue as editors of Graham &
Doddsville. This student-led vestor and how his firm, Doddsville, we want to
investment publication of Crescendo Partners, identi- reflect for a moment on our
Columbia Business School is fies potential investments. time shepherding this publi-
co-sponsored by the Heil- Eric also delves into cation. It has been a privi-
brunn Center for Graham & Canadian laws and how they lege to act as stewards of
Dodd Investing and the Co- facilitate shareholder the legacy of value investing
lumbia Student Investment activism. at CBS and to share the
Management Association insights of such talented
(CSIMA). H. Kevin Byun discusses investors with our readers.
the nuances of special situa- These interviews will be
Heilbrunn Center Director
Louisa Serene Schneider For this issue we spoke with tions investing and how he among our fondest memo-
’06. Louisa skillfully leads five unique investors cover- searches for opportunity in ries at Columbia Business
the Heilbrunn Center, culti- ing a range of different per- spin-offs, liquidations and School. We leave Graham &
vating strong relationships spectives and investment transformative M&A actions. Doddsville in the highly capa-
with some of the world’s styles. He also discusses some of ble hands of Matt Ford and
most experienced value the opportunities he sees in Peter Pan. Apparently we
investors and creating nu- Philippe Jabre recounts the market today. have to grow up now, but
merous learning opportuni- how he began his career in we look forward to reading
ties for students interested
convertible arbitrage and This issue also contains pic- the interviews they conduct
in value investing. The clas-
ses sponsored by the Heil- how his firm, Jabre Capital tures from the 17th annual in future issues. We are
brunn Center are among Partners, searches the world CSIMA Conference, which deeply grateful to those
the most heavily demanded for attractive investments. took place on February 7th investors we interviewed
and highly rated classes at at Columbia University, fea- during our tenure – none of
Columbia Business School. Arnold Van Den Berg turing Bill Ackman and Joel this would be possible with-
and Jim Brilliant emphasize Greenblatt as keynote out their willingness to
the value of discipline in speakers. share their wisdom. Finally,
investment management, and we thank you, dear reader,
explain the importance of Lastly, this issue includes the for your continued interest,
building a framework and finalist pitches from the Per- loyalty, and suggestions.
mental database around your shing Square Challenge
experiences to improve deci- which took place on April - G&Dsville Editors
sion making. 23rd.
Professor Bruce Green-

wald. The Heilbrunn Center
sponsors the Value Invest-
ing Program, a rigorous
particularly committed
practitioners.
Julia Kimyagarov, Louisa Serene The first-place team and judges at the 2014
Schneider ’06, and Marci Zimmerman at Pershing Square Challenge
the 2014 Moon Lee Prize Competition
Volume
Issue XXII, Issue 2 Page 3
2014 CSIMA Conference at Columbia Business School
The audience listens as Bill Ackman answers student Student conference coordinators Joe Fleury ’14, Taylor
questions with a mix of candor and humor. Davis ’14 and Ivan Dias ’14 deliver opening remarks.
Kyle Bass (L) of Hayman Capital speaks on the Best Mark Cooper moderates the Behavioral Investing Panel with
Ideas Panel with Tom Gayner (R) of Markel William von Mueffling ’95, James Montier, Michael Mauboussin
Corporation. and Kent Daniel.
Bruce Greenwald moderates a discussion with Joel Greenblatt. Bill Ackman discusses his GSE investments.
Page 4
Philippe Jabre
(Continued from page 1) G&D: When you were at when they start school. I
EuroHedge’s Columbia, were there any don’t even know if there
Management Firm of professors who were was an investment club
the Year award for 2013. particularly influential for when I was at Columbia in
Mr. Jabre received an you? Or any courses that 1980. Maybe there was...I
MBA from Columbia stood out in your mind? had no clue.
Business School in 1982
and serves on the Board G&D: And when you
Philippe Jabre of Overseers. graduated, where did you
start your career?
Graham & Doddsville
(G&D): Can you start by PJ: I joined JPMorgan in
talking about how you New York for an internship
became interested in “Today, students in asset management for
investing? nine months. And that was
are much more very useful because it was
Philippe Jabre (PJ): I was my first contact with the
at Columbia Business School prepared and real world of managing
from 1980-82 and part of equities, bonds, convertible
the interest came from focused when they bonds, and warrants.
classes I was taking in
international investments. I start school. I don’t
Then, after the nine months,
was also reading a lot of even know if there I went to Paris to work for
books which helped me a bank named BAII, which
grow into it. Of course you was an investment later became a subsidiary of
don't know at age 20 or 22 BNP. It was still in the very
that you're going to be club when I was at early days for investments.
successful, but gradually it In those days, the stock
evolved into what I'm doing Columbia in 1980.” market would open and
now. have only one quotation a
day. So I was in Paris
G&D: And were you managing money for
investing before Columbia? international clients while
the whole French domestic
PJ: I did invest. I lost my market was not allowed to
shirt. I borrowed money PJ: In the first two invest offshore. Those were
and told my investors I'd semesters, you don't know the early days in 1983.
share in both losses and all the classes that exist. Things have progressed a
profits. It's not like hedge And by the last two lot.
funds today where profits semesters, you try to catch
are for the manager and up as much as you can. G&D: You started in
losses are for the client. It There was a guy named convertible arbitrage – how
cost me a fortune. So when Francis Finlay, an Englishman would you say convertibles
I left Columbia Business who was teaching investing has changed since
School, I had lots of debt. investments. Professor when you started in the
But for me, the lesson Adler had a course on 1980s?
behind it was important. It international trade. I was
was a steep learning curve. fascinated by anything linked PJ: In the early 1980s,
My time at Columbia to international investments. people used to value
Business School was a great converts as a substitute for
learning experience in how Today, students are much stocks. Now people value
you can maximize your more prepared and focused (Continued on page 5)
losses.
Volume
Philippe Jabre
(Continued from page 4) of event driven, emerging what are our expectations.
them on implied volatility markets, foreign exchange,
compared to historical and fixed income. Then I'm I think the real game today
volatility and there is more running two long funds or becomes optionality. Where
of a credit markets aspect absolute return funds where we can make money is on
to it. In the earlier days, we I buy cheap stocks or the increase in volatility if
used to have broker loan convertibles. So the same the stock has sharp moves
rebates. If you put your trades that I do in the hedge up or down. One needs to
shorts and longs with them, fund, I can do in the long take a view. If you take no
they would give you a funds but I just don’t hedge view, you make no money.
credit. So let's say the two them.
year treasury was at 6%, G&D: How was it moving
they would give you 6% plus from convertibles into
the coupon on the bonds equities and other types of
less the dividend on the investments?
stock (if any). So we were
looking at convertible PJ: Convertibles are made
arbitrage with a 3-5% of four variables. On the
positive carry on the trade. fixed income side, it's made
Converts were excessively of credit and the interest
“One needs to take
cheap at the time. They rate. So one needs to know
priced in very little value for a view. If you take what is happening there on
optionality and didn’t the macro side. And on the
accurately price the no view, you make equity side, it's made up of
potential for the stock to an option on an underlying
explode or to collapse. no money.” stock. So basically when you
Black Scholes was very good look at convertible bonds,
at pricing short-term you have to be familiar with
options—three or six or what's happening with
nine months. It was not interest rates, credit
good at all for 3-5 year spreads of your underlying
optionality because you had instruments, the valuation of
a different set of data. And the stock, and the value of
so, for ten years, it was a The reason why I have the optionality.
very profitable environment those three products is
to invest in. Today you have because I always look for At times, the first two
convertible bonds coming the catalyst. If you fully variables, interest rates and
with 0-1% coupons and hedge a convertible bond by credit, get their days of
already pricing in large hedging the credit, selling glory like in 2008 or 2011
implied volatility. The the stock, and locking in the when interest rates were
market is just much more implied volatility, you make under pressure and credit
efficient. no money if you have a spreads exploded. But in
hedge. So people like myself eight years out of ten, all
G&D: How would you look for catalysts on you need to worry about is
describe your investment stocks – earnings, events, your stock valuation. Today,
philosophy? positive or negative companies have a lot of cash
surprises. This is why and interest rates are at
PJ: I’m currently running I've developed long-only zero, so there is nothing to
three funds. One is a multi- expertise. It brings hedge there. The real hedge
strategy fund which has a additional layers of is on the equity part. So
convertible arb portion, a information on why a stock over the years we
long-short equity portion, should go up or down and (Continued on page 6)
and then a smaller section
Page 6
Philippe Jabre
(Continued from page 5) concept that you learn with Today, you don't have that.
developed knowledge on time. Banks don’t really provide
the equity side. That's how that platform anymore. So
we became investors in to develop that track
stocks. record, you might go to a
long-only manager, which is
G&D: Can you talk about a very different world. Or
deciding to start Jabre “Before you start a you would need to go to a
Capital? hedge fund, spend 6-7 years
hedge fund you
doing analysis, and then
PJ: Before you start a have to follow the manage a pool of capital as
hedge fund you have to part of a larger hedge fund.
follow the right steps. I right steps. I always
always tell people it's the Ten or fifteen years ago,
same as if you are a doctor, tell people it is the you might need $20-40
architect, or lawyer opening million to cover the costs of
a practice. I first joined a same as if you are a starting a hedge fund.
bank, then after ten years I Today, that number is
joined Lehman Brothers.
doctor, architect, or
probably closer to $100
Then, with a group of four lawyer opening a million because regulations
partners, we spun off from and controls are much
Lehman Brothers and practice...You more intense and, as a
created GLG. And then result, you need a lot of
after that, I created my own follow the steps so people just for compliance.
fund. You follow the steps So it’s become much
so people will follow you. people will follow harder, which is good for
you.” funds that already exist
I remember after business because the barriers of
school I wanted to create entry are getting even
my own fund at age 25. My higher. We can maintain a
father told me if you want higher alpha because banks
to lose money, go lose don't really speculate
money at other people's G&D: What are the anymore, many hedge funds
expense. You can't become challenges for someone who have closed down over the
a fund manager unless might want to start their past five or six years, and
you’ve lost a lot of money own fund today? there are very few
and survived. So JabCap was newcomers. So whoever
a normal evolution when I PJ: It's getting much harder has survived in our industry
started it seven years ago. A for a number of reasons. is able to develop high
lot of clients followed First, banks used to be a margins, at least on stocks.
because I had a very good platform where you would If you look at fixed-income
track record at my prior get exposure to a variety of or at algorithmic traders,
funds over the previous areas. So you could do the performances are much
fifteen years and that made capital markets, M&A, you lower because there is a
it easier. But you need a could be a trader or an huge amount of money
track record and you need arbitrageur. It used to be there. Most became too big
to have clients. The barriers like a school. And then the and the market doesn't give
to entry are very high today brightest would have their them the same
and what people look for is own book and then after a opportunities. So it's a
a track record and the few years with a track rotation and, for the
experience of managing record they could set up moment, it is much harder
money unsupervised. And their own fund. (Continued on page 7)
that's a very difficult
Volume
Philippe Jabre
(Continued from page 6) There's always something people asked me if we were
for young people to create a happening or an area in investing in Russia. I told
hedge fund. I think people which the market is not them the fund had no
need to have at least 8-12 focusing enough attention. emerging markets exposure
years of experience, so This presents interesting and no intention to add any.
maybe by age 37-40 you opportunities, and our They asked what it would
start to think about setting agility can help us take to change my mind. I Students talk with Bill Ack-
up your own fund. But it outperform because in the said if you have a collapse in man at the 2014 Pershing
takes time and it’s much bigger investment valuation, then we will jump. Square Challenge.
harder than before. management firms, they Several weeks ago there
have fund managers was a collapse so I went and
G&D: Can you talk about specialized by area. They bought Russia. I put 10% of
how the Jabre Capital team have a value guy, a growth the fund there. Colleagues
is organized? guy, a mid-cap guy, or a guy who cover emerging
who only does oil and gas. It markets said you’re crazy.
PJ: I have an investment is hard for these guys to be But I said why? I told you I
team of 15-17 people up to speed on all areas. would invest when things
working with me out of a Things slip, and this is where collapse. They have
fund with about 50 people. I a hedge fund can be a bit collapsed. There are names
have analysts looking after faster – faster to recognize, that trade around 3x P/E.
certain geographies – one faster to buy, faster to sell, They said yes but everyone
looking at Asia and Japan, faster to understand. I think is selling. I said it is already
two looking at Europe, and that's what we do. in the price, just give it time.
one focused on the US. You can’t invest based on
Then I have product news stories of what
specialists. So I have a credit Obama and Putin discuss on
person, and a person who their phone calls. You need
trades converts and a something based on
research specialist for valuation and you need to
converts. Then I have an forget about the noise.
event-driven team with a “A hedge fund can
specialist in risk arbitrage, a be a bit faster – A second example would be
specialist in emerging our Japan investments. In
markets, and a series of faster to recognize, November 2012, I was
traders for the US, Europe, invited by a bank to make a
and Asia. These traders and faster to buy, faster presentation in Japan for
specialists bring interesting institutional investors. Two
situations to my attention to sell, faster to weeks after my visit, the
or to the attention of the parliament was dissolved
other fund managers. By understand.”
and there was talk of a new
organizing this way, and government. I’ve followed
covering different strategies Japan over a long period of
and products worldwide, we time so I knew what the
have great flexibility. implications of that might
Sometimes we buy value be, and thanks to that
stocks, other times we buy experience, I immediately
growth stocks. Last year, for G&D: Can you walk us went overweight a market
example, we bought a lot of through a past investment where I previously had no
Chinese internet stocks and that you think illustrates exposure. Japan was thought
gambling stocks in Macau. your investment approach? of as a market that was
These investments were going nowhere in those
quite new in our portfolios. PJ: Earlier in the year, (Continued on page 8)
Page 8
Philippe Jabre
(Continued from page 7) made 50% net of fees. The down 10% every month. For
days. In December 2012, main thing was to have eight months in a row, we
our equity book was up 10% Japan and Europe going had volatile moves up or
because I was quite early from an underweight to a down. So you either had the
compared to others in market-weight position feeling that the market was
understanding the changing during an extraordinary going to collapse or that the
dynamic in Japan. And that period. So you have to market was going to go up.
positioning worked out very recognize you are in that The S&P finished flat on the
well in 2013. type of extraordinary period year but it cost most active
and deploy money ahead of fund managers money
Another example: in 2009, others. because of the volatility.
everyone hated banks in
America. But I heard the But in addition to that, I had
CEO of Citigroup and the exposure to mining and
CEO of JP Morgan talk in inflation-protection stocks
Q1 2009 about how their in 2011. That cost the fund
banks were making money, a lot of money because all
not losing it. And that was the industrial materials,
the biggest signal to buy US mining, and gold stocks
banks that I ever saw. We “The key thing is to really struggled. It was one
bought a lot of them in the of those periods where you
US and we finished the year find things that had to experience your
up 80%. stock going to zero before
have done nothing it bounced back.
A similar thing happened in
Europe. Last June, European for ages and
Even though we will
banks were trading at suddenly there is an implement a stop-loss when
60% of book value and we have a bad investment,
suddenly the ECB came in event that you need 2011 became the worst
very strongly to support time to stop-loss you could
them. And so we bought a to be the first to think of because we would
lot of ETFs on the European stop-loss an investment and
financials and they ultimately understand or the market would go right
went up 60% or so. back up. But in 2008 when
appreciate how
we did stop-loss, the equity
Having the cash, having the things will change.” fund finished up for the year
openness of mind, not being because after I lost 10%, I
caught with bad invest- went out of the market in
ments – all of that was the equity funds. Then I
important. bought bonds the last three
months and the fund
So the key thing is to find finished up 2%. So as much
things that have done as that model of stopping
nothing for ages and your losses works in
suddenly there is an event G&D: Can you talk about extraordinary periods, it can
that you need to be the first any investments that didn't hurt you a lot when the
to understand or appreciate. work as well or where you market is going through
And this is where you have learned from a mistake? erratic moves but with no
a huge opportunity to definitive trend. And so the
outperform. Last year, our PJ: In 2011, I had a very conclusion is that when you
equity fund, which is difficult year because the start to lose money, you
unlevered and has a market was going up and (Continued on page 9)
maximum exposure of 130,
Volume
Philippe Jabre
(Continued from page 8) very disciplined. If we go period we ever had because
should get smaller and trade through a period where we had the cash and
less, because you can’t catch we’re down 10% in a stock, investors behind us.
the market properly. we're very disciplined about
cutting exposure because Take that strategy we
Over the past 15-18 there's something wrong followed compared to value
months, it's been a much that we don’t understand. funds which got very badly
easier market because every hurt in 2008 because cheap
dip was an opportunity to stocks got cheaper, and
buy. So one could increase some even went bankrupt. Scott Ostfeld ’02 of Jana
leverage and create great A lot of value funds got Partners speaks at the
performance. All of this was decimated by sticking to 2014 CSIMA conference.
exactly the opposite of their model of buying cheap
2011. The lesson is that you stocks like Bear Stearns,
need to identify the cycle Lehman Brothers, or
and the trend and try to Countrywide. So it was a
apply the right investment very difficult period and the
strategy according to the “The world is full of thing that helped was the
trends. stop-loss.
investors that miss
G&D: Aside from stop- But now we're okay, there's
losses how do you think the big move no more systemic risk in the
about risk management, market where we face
position sizing, and the because they
extraordinary dangers.
amount of cash that you
hold?
overreacted to
G&D: Would you rather
headline news or to hire someone who has a
PJ: The big difference trading type of background
between someone that short-term profits.” or a traditional asset
comes from asset management type of
management and someone background?
who comes from a trading
environment in a bank is the PJ: Asset management. An
sizing of the portfolio. I have asset manager will survive
met so many traders who cycles provided they have a
put too much weight on good trader behind them to
some ideas and if the idea protect them. I think finding
doesn't work, they find a good manager who
themselves either stopping The combination of these understands valuation is
them lower down or not constraints helps us survive much more valuable than
generating any return difficult periods and gives us finding a good trader
because they missed the the cash to take advantage because over the years,
more interesting ideas. of better periods. I took a that’s how you avoid buying
Since I come from a more stop-loss in my long fund in too early and selling too
traditional investment the summer of 2008 and early. The world is full of
management background, moved money into fixed investors that miss the big
we're more diversified and income bonds. And in early move because they
have very strict limits on 2009, the equity market overreacted to headline
how long or how stabilized and we had the news or to short-term
overweight we want to be cash to buy cheap banks and profits.
in some situations when we cheap growth stocks. It was
find great, cheap the most extraordinary (Continued on page 10)
opportunities. And we're
Page 10
Philippe Jabre
(Continued from page 9) AIG goes from 28 to 50 in a period to buy and hold
In 2013, for example, fund straight line in a year. When compared to that period.
managers of my generation that happens, you feel stupid The challenge now is to buy
were able to make 40-60% if you buy it at 28 and sell it the right stock, because if
type returns, because we at 35. But you need you bought a Cisco or Intel
had a price target for what experience to avoid making or an IBM, you went
that mistake. nowhere. So you have to
identify the right stock, the
So I think what you need is right sector, and the right
a good fundamental fund growth story so that you
manager and an excellent don't waste your money on
trader. You need both to underperforming names.
“The challenge now have experience because
the market is continuously G&D: What metrics do you
is to buy the right repeating and the key is to focus on when evaluating
figure out what type of stocks?
stock, because if period we are in and where
we are in it. That's the most PJ: First, you have to look
you bought a Cisco important challenge. at the macro because if you
or Intel or an IBM, buy a great stock in a
G&D: You mentioned the horrible environment, you
you went nowhere. cycle. What is your typical make no money. For
time horizon for example, Japan has the right
So you have to investments? environment right now
because you have central
identify the right PJ: Since the macro bank monetary stimulus and
situation stabilized in June a weakening of the yen. So
stock, the right 2012 when the ECB decided you need to have a macro
sector, and the right to do whatever it takes to view which will help you
stabilize the euro, we develop a micro view. What
growth story so that moved from a risk-on/risk- we do is look sector by
off macro environment sector and analyze which
you don't waste where correlation was very sectors to focus on and
high to a stock-picking which ones to avoid based
your money on environment where on where we are in the
correlation is very low. In cycle and the macro
underperforming the period before, it was backdrop.
names.” very hard because the
market was not reacting to Then each sector will have a
fundamental valuation. It different metric. If you want
was reacting to the possible to buy financials, you’ll want
breakup of the euro, to to understand Tier 1 capital
sovereign downgrades, to ratios and price-to-book
the shutdown of the US metrics. If you look at real
we owned and would stick government, to a possible estate, you need to
to it. The younger crisis in China. It was more understand cap rates, price
generation of managers, on of a macro, high-correlation to NAV, and trends in real
the other hand, would tend market. So it was very hard estate. If you look at export
to realize their investments to hold on to stocks before. companies, you need to
much faster, making 10- But since June 2012, people understand foreign currency
15% and then moving on. like us who pick stocks have exposure. So they will all be
But doing that, you miss the had a much smoother (Continued on page 11)
big move when a stock like
Volume
Philippe Jabre
(Continued from page 10) you have any parting words have to avoid being too
different and you have to of advice? scared to make the jump
know which ones matter for when the time is right. So
a given sector. you need to have a very
cool head and take advice.
G&D: Are there other Look around you – what are
current ideas you think are the right steps to create
interesting? your own best path? I think
a lot of people suffer from
PJ: Oh yes, you should buy leaping too early or too late
Japan. Nobody believes the into an area in which they
government can sustain “People have to want to work.
their current policies, so the
market puts a very small
make sure that
My advice is: work really
premium on the success of they're not ahead hard but don't be in a rush
their policy. Even the to create your own hedge
Japanese themselves do not of their own fund. A hedge fund is like
trust the government to finishing school. You first
sustain it. If they keep on experience and need to go to university to
trying, we could have the get practice, to get training,
Nikkei going to 16,000- then have to avoid to lose money at someone
18,000 with the Yen at 110 else's expense, to develop
to the dollar. A lot of
being too scared to
your own expertise, to
reforms that might happen, make the jump develop a track record, and
like corporate tax cuts, then if you're still interested
labor liberalization, or when the time is and motivated, you can try
pension funds redirecting to think how to start your
investment into stocks, right.” own fund.
could very easily help the
equity market there G&D: Excellent. Thank you
continue to do well. for taking the time to speak
Another one is China. with us, Mr. Jabre.
There are a lot of macro
funds that are short Chinese
shares. But if the Chinese
authorities stimulate, we PJ: If people want to join
could see the Chinese the hedge fund world, they
market up another 10%. need to really develop
fundamental analysis skills
A hedge fund has the and these skills should be
capacity to look ahead. We developed within large
could be wrong but if we're organizations. They
right, we can make a lot. If shouldn't be in a rush.
I'm wrong on Japan, I think Things happen when they
we’ll see the Nikkei go from should occur. If I had
14,000 to 13,000. But if I'm started my own hedge fund
right and they implement in 1996 instead of 2006, I
these reforms, I see it going would not have had the
from 14,000 to 18,000. So same success. So people
it's all a risk-reward have to make sure that
situation. they're not ahead of their
own experience and then
G&D: Before we end, do
Page 12
Arnold Van Den Berg & Jim Brilliant

(Continued from page 1) wrong. I was reading and first stock I ever bought was
advisor/consultant for researching and one day Commonwealth Edison
Capital Securities and something caught my eye when I was 15 years old.
John Hancock Insurance. that changed my whole way
of thinking. As I was
Jim Brilliant has been reviewing the companies “One day
with Century and the people who did well
Management for 27 and who did poorly in this something caught
years and is a principal market, I noticed that some
Arnold Van Den of the firm, the co-Chief of the better performing my eye that
Berg Investment Officer, firms and better performing
Chief Financial Officer, money managers all had a
changed my whole
and a portfolio manager. connection with Benjamin
Jim is a member of the
way of
Graham’s investment
Century Management approach. I thought, "Geez, I thinking...the better
Advisory Committee. wonder what this
Jim attended Pierce philosophy is all about?" performing firms
College where he I started studying and
studied Finance. eventually met a gentleman and better
named Mark Franklin who
Graham & Doddsville became a mentor to me,
performing money
(G&D): Can you each tell and he was a big Graham
us about your introduction
managers all had a
fan. After I felt that I
to investing and how you understood the philosophy, connection with
first became interested? I studied everything I could
get my hands on. I decided Benjamin Graham’s
Arnold Van Den Berg that rather than depend on
(AVDB): My introduction mutual funds, I would start investment
to investing began when I my own investment firm.
was working for a financial That was how I got involved
approach.”
firm, and they were selling in the investment field and it
insurance and mutual funds. eventually led me to start
I got very excited about the Century Management. I made money on it and that
mutual funds, as the market turned me in the direction
was doing really well in late Jim Brilliant (JB): My first of businesses, and
'68 and early '69. I thought introduction to investing understanding that my
that after all of my travels I was when I was a teenager. intellectual power is far
had finally found the field Every Sunday my dad would more profitable than my
that I'd like to devote my pull the stock tables out of labor power. I made more
Jim Brilliant life to. I started getting the newspaper, and his money on that stock than I
people, mostly friends of simple method was to chart did cutting grass. It certainly
mine and friends of people I the stock prices, tracking opened my mind to the
knew, involved in mutual the trading range of that importance of expanding the
funds. stock from high to low over mind and using that as the
time. At that time, I was way to wealth.
Just about the time I got shoveling snow and cutting
going, stocks and mutual grass and had kind of a G&D: Can you talk a bit
funds went into a bear neighborhood business about the founding of
market from 1969-74. I was where I'd saved some Century Management and
very, very distraught. By '72 money. I decided, "Well, why you started it?
and '73, I was doing a lot of that looks pretty good. Let
soul searching about what me try my hand at it." The (Continued on page 13)
was going on and what went
Volume

(Continued from page 12) down. While the management? Then we have
AVDB: I was able to get a environment eventually a strict quantitative
good grasp of the value created tremendous approach as well. The most
philosophy, but the problem opportunities, the sentiment important thing is to identify
was I didn't have any was extremely negative. the potential pitfalls – what
credentials or formal You had 12-15% inflation, are the flaws? How low can
education. I didn't have any you had a market that this stock go if things don't
money either, but I did have dropped 45%, and you had work out?
a dream. I was sitting with small cap stocks that
one of my clients and I told dropped 75%. Everybody G&D: Do you think
him about my dream of was bearish. People didn't
starting my own investment even want to talk about the
company. I was working out stock market because they
of my studio apartment at had been burned so badly. “The most
the time, and he said, "Oh My thought was that either
Arnie, you can't do this out the world was going to end, important thing in
of your apartment. You've and a lot of people thought
got to get an office. You've the market, as in
it would, or I was going to
got to get a business going." make a lot of money. People almost any
I said, "The problem is I are always predicting the
don't have much money." end of the world, but the endeavor, is
only things that end are the
Anyway, a long story short, people; the world keeps discipline.”
after lunch he offered to going. That was the founding
help me get my business of Century Management.
going, rent an office and buy
some furniture. It was about G&D: How has Century discipline is teachable or is it
$2,500 at the time; in evolved over time? Are something the people you
today's money that's about there particular processes hire inherently have?
$17,000. I decided I'd go out you have implemented that
and I'd get an office and you think lead to better AVDB: Oh no! I think
start my business. I do not results for clients? discipline is very teachable.
recommend that people If you don't learn it by
start that way. That's the AVDB: I think the most yourself the market will
way I did it, but I didn't have important thing in the teach it to you, but you will
much choice other than to market, as in almost any learn it one way or another.
continue selling products, endeavor, is discipline. It is It's kind of like what one of
and I didn't want to do that. one of the things I learned my favorite authors, James
It was many years of as an athlete when I was Allen, said, "You either learn
struggling, of building a young, and I became very by wisdom and knowledge,
clientele, of developing a good at it. Remaining or by suffering and woe, and
reputation and track record. disciplined is something that you continue to suffer until
I started in September of we try really hard to do in you learn."
1974 and the market this business.
bottomed three months G&D: Moving on to your
later, which gave me a boost One of the things we've investment philosophy, you
with the few clients I had. tried hard to implement mentioned Ben Graham,
here is that when we're you just mentioned both the
That six year bear market looking at a company, we qualitative and quantitative
leading into 1974 was just look at the qualitative risk. aspects of companies. How
torture. Every day we How good is the business? would you characterize
would come in and the How good is the (Continued on page 14)
market would just grind
Page 14

(Continued from page 13) the reasons why studying have a stock that has a
your investment philosophy? history is so important. worst case of $8 and a sell
point of $20, if it were a
JB: We have three primary Arnold kind of mentioned small cap stock, we'd want a
tenets to our investment this in terms of discipline, minimum of a 5:1 reward to
philosophy. The first one we that expertise in any field is risk. So in that case, we can
call recognizing and largely driven by a mental we can only pay $10 to buy
First-place winner Patrick capitalizing on value gaps.
Stadelhofer ’14 with Paul database of experiences and the stock. If it were a big
That's really just finding patterns that are recognized cap stock, then we're
Orlin and John Friedland ’97
at the 2014 Moon Lee Prize companies where the price by having lived through looking for a 3.5:1 reward-
Competition. of the stock is disconnected different environments. To to-risk ratio. These can be
from the underlying value of us, studying history is really slightly adjusted based on
the business. You're important. We go back industry and the nature of
probably familiar with Ben through 20 years of the the stock. Once we’ve done
Graham's quote, that in the company's history, or as far this, we take all of our
short run the market's a back as we can get the data. stocks and put them into a
voting machine and in the We look at all aspects of dashboard, which is just our
long run it's a weighing the business and we want to master Excel worksheet
machine. To us, what he understand its drivers, what that has all the valuations.
was really describing was makes it tick. In particular, Then we sort by reward-to-
how the prices of stocks we break down the risk, and this is what really
often get disconnected from company to see how each drives the framework for
their underlying value due segment performs during our portfolio. Sorting
to volatility in the market. the entire business cycle through that reward-to-risk
We are searching for and how the market will helps us make our buy and
opportunities where that price that company during sell decisions and portfolio-
price disconnect occurs. these extreme events, weighting decisions.
either during extreme
The other part of our downturns or extreme G&D: Are there particular
investment philosophy, as upturns. investors that have helped
Arnold mentioned, is that all form tenets of your
of our valuation is anchored At the end of all this, we put investing philosophy, besides
on what we call a worst together what we call our Ben Graham?
case analysis. The idea is valuation structure, where
that we handicap what we we have a worst case price AVDB: There are lots of
think the company's stock is based on the company being investors like Graham and
going to sell for during in extreme duress. Then we Buffett and people of that
times of extreme duress. look at a sell point, and that nature, most of them you've
The duress could be a is where we forecast a full heard of. There's one that I
recession, it could be an cycle recovery in earnings learned a great deal from,
industry problem, or it and multiples, and derive and pardon me for
could be a company our sales price based on mentioning his name in a
problem, but focusing on that. And finally we want a value-focused newsletter,
that worst case analysis margin of safety. That but that was T. Rowe Price.
helps us identify what we margin of safety is what He taught me three things
think is the proper margin drives our buy point. We'll that are really important.
of safety. What we have buy the stock based on a He was a growth stock
found over the years by margin of safety and we use investor, kind of like Phil
doing this is that companies a reward-to-risk ratio to Fisher. He was big on the
and industries tend to have determine that. qualitative aspects and he
repeatable patterns, in really made me stop and
terms of valuations, through By way of example, if we (Continued on page 15)
a cycle. That is also one of
Volume

(Continued from page 14) still associated with the seen multiple market cycles.
think about the value of a business. Did that frame of reference
business beyond the normal help you in 2008 and 2009
financial metrics. T. Rowe The third thing that I and how does it frame your
Price is an investor that is learned from him was the thinking now?
underappreciated in my value of having incredible
opinion, and I think anybody flexibility. He was a premier AVDB: I think the main
who's interested in this field growth stock investor, and lesson you get from being in
ought to study his life and in 1969, he decided that his different markets, and
his philosophy, because growth stocks were over- markets that go down quite
there are tremendous valued, as was the rest of a bit like the 1974 bear
lessons to be learned. the market. In addition, the market and the 2008-9 bear
government was printing market, is that when stocks
money to provide the social go down 40% or 50%, some
programs that were way or another, as a whole,
“Expertise in any established in the 1965 stocks always come back.
Great Society initiative, so Everybody who starts out in
field is largely he completely changed his this business knows that,
driven by a mental point of view. He opened up but until you go through
the New Era Fund that one of these markets and
database of consisted of the antithesis of you see things fall apart and
the stocks he always then come back, you don't
experiences and followed. He bought gold have total faith when you're
and silver stocks, oil stocks, going through it that it will
patterns that are cyclical and basic materials come back the next time
stocks, and real estate, around.
recognized by because he felt that inflation
having lived was coming. This proved to By going through these
be a very good call, given markets, it's given me
through the the environment, and he complete faith in America
provided a great return and the American markets,
different during difficult times. because when you look at
That was a very big lesson how low stocks get in these
environments. To and that really helped me bear markets and you see
during the 1970s when I got how quickly they recover
us, studying history started. In my early years once things clear, you
is really we bought Swiss francs and develop confidence that
claims on Swiss reserves. It when you have something
important.” was illegal to own gold at you believe is of value, you
the time but you could buy stick with it. You don't sell
collectibles (which I don’t and if you have the cash,
The second thing I learned normally recommend), so you buy more. That
from him is that he really we bought British confidence helps you to
regretted selling his sovereigns as they were navigate through these
business. His regret selling at a small premium to cycles and helps you sell
influenced me to make the gold bullion. This helped us stocks, like we've done this
decision that I would never a lot during the early '70s past year, and build up cash
sell Century Management, when inflation rose. knowing that another cycle
because when you sell, you will come and you will be
lose control over the way G&D: That leads to our able to redeploy the cash
the investment philosophy next question. You founded when the bargains appear.
and business are managed, Century in 1974 and have (Continued on page 16)
even though your name is
Page 16

(Continued from page 15) that was so disruptive - did source of ideas. We
Right now, out of four that change the way you certainly talk to other
hundred stocks, we only think about worst case investors and share ideas
have ten, maybe twelve analysis or is it viewed as an that way. One of the areas
ideas that we could buy aberration, a once in a that I find to be the most
today. We know this is not lifetime type of market? fruitful is identifying themes.
a good time to be very That's because if you can
aggressive and we're AVDB: No, I think that the identify a theme, you can
Louisa Serene Schneider ’06 building cash.
addresses the audience at 2009 market was very much leverage your research.
the 2014 CSIMA conference. like the 1974 market. It Instead of one idea at a
came a little quicker, but I time, a theme allows you to
think that the 1974 bear pick up five to ten ideas.
“We look for things market was even worse
because it lasted over six We look for industries that
like regulatory years. Just to give you an are undergoing some
example, the 2007-09 bear dramatic improvements in
changes, policy market went from an 18x their end markets that may
changes, or multiple to about a 10x not yet be realized in their
multiple. The 1974 bear price. To get to those, we
demographic changes market went from an 18.9x look for things like
multiple to an 8x multiple. regulatory changes, policy
… We find that often The median P/E for the changes, or demographic
provides ripe areas average stock in the Value changes. Probably the most
Line® composite of 1,700 prolific is technological
for further companies went to a 4x-6x change, and I don't mean
multiple. I still consider the the PC change, but changes
investigation and a
1974 bear market the in an industry due to
way to develop toughest one because it different kinds of technology
dragged out for six years. being used. We find that
themes.” Not that a down market of often provides ripe areas for
a year and a half to two further investigation and a
years is short; it is long way to develop themes. For
That kind of anchors your when you're living through example, in the energy
philosophy about what is it, but it's not as long as six industry, we've all heard
value. I think our 5:1 re- years. about the well publicized
ward-to-risk ratio on the fracking techniques utilized
small cap stocks came out G&D: How do you typically in onshore oil and gas
of going through these look for new ideas? You drilling. While fracking has
cycles and realizing that our mentioned earlier that you been around for decades, it
buy point probably shouldn’t keep a spreadsheet of the is the combination of
be much more than 15-20% companies you are tracking fracking and the relatively
above our worst case. That and their reward-to-risk. newer advanced drilling
has worked for us for many Will you also use screens technologies such as long-
years. During our first 30 and other methods of lateral horizontal drilling,
years we only had one sourcing ideas? and directional drilling that
down year, a loss of 9%, and has led to the tremendous
averaged more than 15% JB: We run a lot of screens. increase in the amount of
during that time. We subscribe to Value natural gas and oil produced
Line®, which covers several in the United States.
G&D: Did 2008-2009 thousand companies over
influence the way you think the course of a year. We G&D: With markets up
about your worst case find that to be a great (Continued on page 17)
analysis? It was a market
Volume

(Continued from page 16) implication for the chemical construction firm, and in my
significantly in 2013, are industry, because in the US, view one of the best run
there specific areas you we use natural gas to companies in the business.
think have become produce ethylene, which is I'm not recommending that
overheated or still find the primary/basic anybody buy it right now,
relatively attractive? And component for most value- but we see this being a five-
within that are there any added chemicals. A few to seven-year cycle. The
specific investment ideas years back, we saw this stock is around $63 now,
you would be willing to when we observed natural and should it sell off into the
share? gas prices declining rapidly. mid-$40s, we'd certainly be
One of the things we look buying more of it.
JB: As Arnold has at are structural shifts, so
mentioned, it is hard to find when a new technology Another company that is
value in the market today. comes in, we look to see if somewhat related is Orion
And it's hard to find cheap it is going to impact an Marine (ORN). They're a
stocks across an entire industry structurally. The marine construction
industry, so it's more of an production of natural gas company that specializes in
individual stock-picking became prolific and prices heavy construction projects
market at this point and it's fell dramatically, so we were that are around water.
tough to find good values. looking at those companies They're very big in the Gulf
We obviously keep digging that stood to benefit from Coast, the Pacific
for them and we try to look cheap natural gas and, of Northwest, and the
for those themes that we course, those that were Caribbean. They do marine
think are mispriced. In going to get harmed. Some construction and dredging.
particular, some of the areas getting harmed were coal It's a heavy construction
where we think there's companies, because natural business and coming out of
opportunity right now are in gas became very 2008-9, the industry was
sectors of the energy competitive from a cost peaking from the previous
market. Basic materials standpoint. The chemical construction cycle. Their
names have been beaten up, industry is one area in revenues, backlogs, and
so we're finding some value particular that would benefit profits were declining and
there and also in some areas because of lower input competition got very
of insurance. I think we've costs. difficult. Bidding became
all heard recently about the very competitive, so their
biotech industry and how We recognized that and earnings collapsed. It
that's gone crazy. We have believed there would be showed up for us on a
no circle of confidence in significant share gains by US tangible book value screen
biotech, so that doesn't chemical companies, which that we run, but it also
affect us. would require capital showed up in two other
spending. Well, it's coming ways: one was our chemical
One theme we previously to fruition, as there's about theme, and the other was
mentioned is natural gas. $70-100 billion dollars that's our Panama Canal
We believe the US is going to be spent over the expansion theme. It kind of
developing some very next five years. We bought gives you an idea how we
significant competitive a fair amount of these try to triangulate different
advantages in different companies that we believe things based on cheapness
areas, and one is the energy are going to benefit from and themes we're looking
market. That is evident with this capital spending binge. at.
the increased production One of my favorites in that
both in oil and natural gas. industry is Jacobs They're widening the
Engineering (JEC). They're Panama Canal, which
On the natural gas side, that an engineering and (Continued on page 18)
has a particularly positive
Page 18

(Continued from page 17) $800 gold. We've done justify that they're right. It's
requires deeper and wider what we believe is a really the down and dirty
ports in the United States thorough analysis on gold value guys that are buying
to be able to accept bigger and gold mining companies, some of these stocks at the
ships. The project has been which Arnold summarized bottom. What we often find
somewhat delayed by in two articles he and the is the longer the cycle, and
government budget issues, team wrote on this subject. the more that the earnings
but it looks like the Army We sent these write-ups to grow throughout the cycle,
Corps of Engineers will start our clients back in February the more that multiples
to release some projects and March but they are still start expanding and you
pretty soon. Additionally, available on our website at begin to attract growth
most of the chemical plants www.centman.com if you investors. Typically, by the
around the Gulf Coast will would like to read them. time those guys are in,
require marine we're out.
construction. Orion Marine We're not big buyers of
is in the very beginning gold miners right now and G&D: How do you think
stages of this and it's we're not buyers of gold about position sizing? If you
starting to have a positive itself. But we watch the have a buy target and a sell
impact on their backlog and companies individually target, is the position sizing
revenues. The stock has run because there are some that a sliding scale between
lately and is at roughly $13, are nearing our buy points those two ends?
or about 40% above our buy again.
point. I wouldn't buy here, JB: We're an all-cap
but at lower prices, we'd G&D: Some of the ideas manager, so we'll buy across
certainly add to that you mentioned play on the market cap spectrum.
position. Our target on that themes that develop over The smaller the company is,
stock is about $20. multiple years. How long do the more cognizant we are
you typically hold a about our ownership
G&D: Any others you position? percentage relative to float
would be willing to discuss? and the amount of average
JB: Our average holding daily trading volume. So
JB: As you know, over the period is usually three years, we're very aware of that
last couple of years, gold but it depends on a couple when we're taking our
went from roughly $700 to of things. One is the overall positions. A position
$1,800 and then back down market environment. typically ranges between 1%
to $1,200. Well, even more Second is how quickly the and 5% of the portfolio,
than the decline of gold theme is recognized in the depending on cap size,
prices, the gold miners went stock price. As you know, quantitative and qualitative
down dramatically. Gold stock prices discount the factors, as well as valuation.
went down roughly 34% and future, so while the theme
you had gold miners, may be a five to seven year Let's say we want ABC
depending on their market theme, the stock may Company to represent 3%
cap, down 50-85% from discount it three or four of the portfolio. We may
their recent peak. Back in years out. start out buying an initial
December, we saw a lot of position of 1% or 1.5% at
value in the gold miners so At the bottom of the cycle, our buy point with the idea
we bought a basket of a lot of these companies are this will leave us room to
miners that was diversified very lumpy in terms of their dollar cost average into the
both geographically and by business orders and backlog. position if the price declines
market capitalization. In our Many investors want the and gets closer to our
view, the gold miners at the rosy picture and the worst case scenario.
end of the year were comfort of the crowd to (Continued on page 19)
discounting roughly $700 to
Volume

(Continued from page 18) linked and asset-driven problem right now, but over
Sometimes it gets there, businesses tend to be priced the long run it has a
sometimes it doesn't, but on asset values and so tendency to straighten out
this has an influence on our tangible book is our favorite because of the rules put in
total position size. Then as valuation metric for these place by the founding
the stock appreciates, we companies. However, at the fathers and because it's a
review every company at top of the cycle, the same democracy.
fair value for a potential sale companies tend to trade
or trim. The things that will based on earnings, EBITDA, Just to give you an example, Second-place winner Akhil
influence whether we're Subramanian ’14 with Paul
and sales metrics. For less I checked the flow of funds
going to sell or trim is the Orlin and John Friedland ’97
cyclical, steady cash flow from the Federal Reserve at the 2014 Moon Lee Prize
power of the thesis, how generating companies, we and found that foreign Competition.
strong the company is in its focus on free cash flow and investors probably have
industry, and if the company earnings based metrics, as more money invested in
is performing within our book value doesn’t tend to America right now than at
stated theme and be as important. almost any time in history.
expectations. What that shows you is
G&D: There's no shortage irrespective of the
It will vary by company and of people who think the US problems, if you compare
it will vary by market cap — is facing headwinds but you the US to the rest of the
the smaller the market cap, seem to have a pretty world, there really aren’t
the more we have to sell in optimistic view. What drives many other places you
advance. There are many your optimism and does it would go to invest. There
factors that go into it, but affect how you think about may be better pricing, there
ideally we are able to get your investments? may be better
our maximum position and opportunities, but as far as a
then somewhere between AVDB: There are some big place to invest, and a place
our designated fair value and problems, no question to live, and a place to do
sell point, we begin to exit about it. But, what people business, even with all its
so that by our final sell point lose sight of is the fact that apparent shortcomings, I
we're at zero. first of all, the US is a still believe the US is the
democracy. It has private best place. You know what
G&D: Are there certain ownership of assets and it they say in real estate:
valuation metrics that you has no currency location, location, location.
pay the most attention to restrictions. It has the Well, America is probably
when you're evaluating your highest level of technology; the greatest location. In
worst case scenario and fair we're the leader in 3-D addition, and this is very
value scenarios? printing, hydraulic fracturing, important, we have one of
robotics, and the best militaries. When
JB: We look at enterprise nanotechnology. We have you apply some of the
value-to-sales, price-to-cash the largest, most diversified technological advances our
flow, price-to-book, and flexible capital markets military has incorporated, I
EBITDA, and P/E ratios. We in the world. You almost personally believe it is the
look at the entire host of have to be a foreigner to best. Just two years ago
standard metrics. What we appreciate what this country they landed a plane that was
find is that depending on the has over most other piloted by a robot on an
company or the industry, countries. You realize that aircraft carrier. This really
different metrics are more what foreign investors are gives you an appreciation
important than others really looking for is the for our tremendous military
during different times of the stability of the country and a power and capabilities.
cycle. For example, at the sound political system. The
bottom of the cycle, the political system is a bit of a (Continued on page 20)
more cyclical, commodity-
Page 20

(Continued from page 19) seeing the imbalances not predicting this will
While most people in developing in this country. occur, but it is a potential
America don't consider that We talked about the outcome we have to
a big plus, if you lived markets, we talked about consider. It’s a long way
anywhere else in the world, the bubble in real estate, we down from here.
you certainly would, talked about the increase in
especially if you were living the federal debt, and not In addition to potential
in Ukraine or Eastern only in the federal debt but
Europe right now, or if you in the unfunded pension
were in the Second World liability. Just to give you an
War like I was. My parents example, at the time we “Look for patterns
had their own business. wrote that piece, total
They were successful and government debt was $7 because you're
lived in the best part of trillion. Today it’s $17
town, and then, one day, going to be building
trillion. The unfunded
Germany invaded Holland. liabilities were $40 trillion. this mental
Germany took over the Today they're $90 trillion.
country in five days and my When you have an database, a
parents ended up in a environment like this, you
concentration camp. obviously have to start framework of your
thinking about what the end
When you put all of these result will be. experience that
things together, no matter
what you think about the you'll be able to
We've always written that
short term problems in we believe the three most rely upon to help
America, or the short-term important things when it
to maybe intermediate-term comes to investing in stocks impact your
problems in the market, you are interest rates, inflation,
still get back to the fact that and the fundamentals of the decision making.”
America is one of the business. Understanding and
greatest places in the whole applying these elements in
world. I personally don't our valuations are at the inflation, over the next few
think there will ever be heart and soul of what we years, I believe we could be
another place like this. do. These are the things I facing, and again I'm not
pay the most attention to. predicting this, a potential
G&D: A lot of value When I started seeing things currency crisis. That's the
investors are strictly bottom beginning to change in 2004, other reason we were
-up but after 2008-09 macro I began to realize that we happy to pick up the gold
analysis has become a bit might experience another stocks after they declined
more popular in the value period like the '70s, and, 50-80% from their 2011
camp. Can you give us an unless the Fed does the peak, because gold is one of
overview of how you think right thing soon, we could the investments that could
about it? How much weight have a period of higher hedge against a currency
do you give to the macro inflation. When you add to crisis or high inflation. As
environment and are there this the current P/E of about Jim mentioned earlier, we
particular indicators that 18.5 or 19x (depending on also have about 10-15% in
you think are particularly which index you use), oil-related companies. I
telling? coupled with 1970s-like think basic commodities, at
inflation, you could the right price, are also a
AVDB: We wrote a piece eventually end up with P/Es very good way to hedge
in December 2004, and it's on large caps of 8x and on against higher inflation or a
on our website if anybody's small caps of 4x to 6x. I'm (Continued on page 21)
interested, when we started
Volume

(Continued from page 20) Hilton (especially pages 21- stick it out no matter how
currency crisis. 25), and When Genius Failed long it takes, and that you
by Roger Lowenstein. have the belief that you're
G&D: Switching topics Other philosophical books I going to be successful,
now, do you have any books would recommend are As a because everybody can be
you would recommend to Man Thinketh as well as Eight successful in this field if they
aspiring or current investors Pillars of Prosperity, both by make the commitment and
that you found especially James Allen, Think and Grow develop the discipline.
valuable? Or books outside Rich by Napoleon Hill, and
investing as well? The Richest Man in Babylon JB: I would just add that
by George Clason. that learning is a lifetime
AVDB: The book that is endeavor. Upon graduation,
absolutely my favorite G&D: To wrap up, what you need to keep studying
outside of normal advice would you give to and keep reading. Look for
investment books is one I current students interested patterns because you're
personally reprinted in a career in investing? And going to be building this
because the publisher tells do you have any advice on mental database, a
me they only sell about 25- life in general that you framework of your
50 copies a year. It’s called, would be willing to share? experience that you'll be
From Poverty to Power by able to rely upon to help
James Allen. I am happy to AVDB: I would give you guide your decision making.
send it out to anybody who one quote by Dr. Karl Jung, While all the theory and
will read it. If any of your the famous psychologist. Dr. education that you get in
readers would like a copy, Jung claimed that the school is very valuable, the
we’ll send them a copy at subconscious mind contains real world is where you're
no charge. It does not deal not only all the knowledge going to gain that practical
directly with money, that is gathered during the knowledge. While both are
although it does in some life of the individual but, in important, it's been my
aspects, but the philosophy addition, it contains all the observation that those that
is great. I've been reading it wisdom of past ages. That develop the greatest
for 32 years now. Every by drawing upon its wisdom practical knowledge end up
time I go back to it, I find and power, the individual accumulating the most
some new insight. may possess any good thing wealth, not just in terms of
in life from health and monetary rewards, but
For books regarding happiness to riches and wealth in terms of
investments and business I success. I think that's the friendships and non-
would recommend Security best quote that I can give monetary pursuits. I would
Analysis by Graham and you on the subconscious encourage people to look at
Dodd; The Intelligent Investor mind. As far as advice to a their university graduation
by Ben Graham; Common young person starting off in as the beginning of a whole
Stocks and Uncommon Profits, the business, I can only say other life experience that
Paths to Wealth through that it's one of the greatest can pay dividends.
Common Stocks, Conservative businesses in the world. I
Investors Sleep Well, and think there are as many G&D: That is a great note
Developing an Investment opportunities today as when to end on. Thank you both
Philosophy, all four by Philip I got started. I would for your time.
Fisher. I’d also recommend encourage anybody who's
Margin of Safety by Seth interested in the field and
Klarman, Value Investing who loves it to go into it.
Made Easy by Janet Lowe, The only advice I can give is
Contrarian Investment that you make a
Strategies by David Dreman, commitment that you will
Be My Guest by Conrad
Page 22
Allegion, Plc. (NYSE: ALLE) - Long

1st Place, 2014 Pershing Square Challenge
Brian Waterhouse Matt Ford Øystein Kværner
BWaterhouse15@gsb.columbia.edu MFord15@gsb.columbia.edu OKvaerner15@gsb.columbia.edu
Recommendation
We recommend investors buy Allegion (ALLE) equity with a
12/31/16 base case price target of $75. This represents
~50% upside from the current share price. Our investment
Brian Waterhouse thesis rests on four main points:
Brian is a first-year MBA 1) Allegion should see accelerating topline growth as
student at Columbia Business nonresidential construction spending rebounds from
School. He is also Co-President cyclical lows in the US and Europe
of the Columbia Student 2) The European business is significantly under-earning its
Investment Management peer group and own historical averages – this can
Association. Prior to CBS, Brian normalize with self-help opportunities on the cost side
was an Associate at Millennium
3) Irish domiciling and basic tax optimization strategies should reduce the company’s effective tax rate below
Technology Value Partners.
25% (vs. 31% in 2014). This drives low-risk EPS growth independent of any cyclical recovery
4) Given the high FCF this business generates (over $1billion in the next 4 years vs. a $5 billion market cap),
effective capital allocation can drive meaningful upside (either via accretive M&A or buybacks)
Allegion is a leading global provider of mechanical and elec-
tronic security products that include key systems, exit de-
vices, and other access control solutions. The business was
part of Ingersoll Rand before being spun-off in late 2013.
The company generated $2.1 bn of revenue in 2013, with
the majority of its exposure coming from US non-residential
Matt Ford end-markets where it is the #2 player behind Assa Abloy.
Matt is a first-year MBA student We think Allegion is a high-quality business in an attractive
at Columbia Business School. industry with real barriers to entry related to required local
Prior to CBS, Matt was an building code expertise, SKU intensity, and channel com-
Analyst at Reservoir Capital, plexities. With security being a high-value need but only
Farallon Capital, and Bain representing a low percentage of total building costs, cus-
Capital/Sankaty Advisors. tomer lock-in is high and the company has pricing power
over time. This, combined with low capex requirements,
leads to high FCF generation, and high returns on invested
capital (21.4% over the last 3 years). We think Allegion can
be a multi-year compounder with limited downside and the
potential for significant upside.
Investment Thesis
1) Rebound in topline growth
Macroeconomic data suggests US and European non-residential construction spending remains well below long-
term average levels, with Allegion’s relevant end-markets down 40%+ peak-to-trough and only having seen a mod-
est recovery off the lows. In Europe, we think the market has only recently bottomed, with the Southern coun-
Øystein Kværner tries where Allegion has the most exposure also down 40%+ from prior levels. All in, we don’t think non-
Øystein is a first-year MBA residential was ever as overbuilt as residential and current spending remains much closer to the bottom than mid-
student at Columbia Business cycle levels. Allegion has benefitted from high-margin retrofit work during the down-cycle but we think growth
School. Prior to CBS, Øystein will accelerate as the new build market finally rebounds.
was a Senior Associate
Consultant at Bain & Company Taken together, we think the current $25 bn security access solutions market will grow at GDP-plus levels, with
where he focused on Private 1-2% pricing coming on top of any underlying growth in construction spending. We also see secular trends of
Equity consulting. increased budgets for building security and increased complexity/integration needs as driving additional growth.
2) European margin opportunity
In Europe, we believe Allegion is significantly under-earning its peer group and its own historical averages and that
this will mean-revert over time due to identifiable self-help drivers on the cost side. As context, this segment is
breakeven today compared to historical average margins of 8-10%, historical peak margins of low/mid-teens, and
current peer margins of up to 17% in Europe.
The key issue is that while the company’s Southern European end-markets are down 40%+ from the peak, our
diligence suggests the cost structure has basically not changed. This creates a large opportunity for overhead
savings that current management is already executing on after being ignored as part of Ingersoll. In addition, the
same LEAN team that improved US margins from the low-20s to the mid-/high-20s is just now getting started in
Volume
Allegion, Plc. (Continued from previous page)

Europe. We think there should be a real efficiency opportunity here given Europe is 20% of sales yet represents ~55% of
the business inventory.
3) Effective planning around Irish domiciled tax status
Allegion is guiding to a 31% effective tax rate this year but is an Irish domiciled company, a country with a corporate rate
of 12.5% History tells us that other Irish domiciled companies have been able to significantly reduce their effective tax
rates over time. In addition, the fact that ALLE has high US profitability exposure should not mean it can’t pay a much
lower rate with effective planning (as an example, Ingersoll Rand pays an effective rate of 25% despite having a similar mix
of US revenues). Between basic tax optimization strategies and a structural shift to more international profitability, we
think ALLE can lower its effective tax rate to at least 25%, with a good chance of doing even better.
We would also note that Allegion can use its Irish domiciling as a strategic asset going forward. The key way we see that
playing out is via M&A. The company’s tax status gives it a structural advantage as a buyer and any assets they buy in
lower tax jurisdictions should create a positive feedback loop that helps to further reduce its tax rate.
4) Capital allocation upside
Allegion is highly FCF generative – we think the business will generate
over $1 bn of FCF in the next four years vs. a market cap today of $5 bn.
Management has already laid out an initial framework to return at least
35% of annual FCF to shareholders via buybacks and dividends with a
further 50% allocated toward strategic growth initiatives and/or M&A.
Over time, the M&A story here could be compelling. With a still-
fragmented international market, we think Allegion can copy the Assa
Abloy playbook for highly accretive M&A. ASSA has done over 100 deals
in the last 9 years, generally buying tuck-in businesses at reasonable multi-
ples (8-10x EBITDA) and then extracting synergies. If we assume ALLE
can find deals at similar economics as Assa, we think accretive M&A could
add $10-$20 of additional value, taking our $75 base case closer to $100.
Absent M&A, we think FCF can be used to aggressively buy back shares
and drive EPS upside. At current prices, we estimate ALLE would be able
to buy back 22% of its float with cumulative FCF by 2017.
Key Risks
The investment is not without its risks but we think many of the key ones are nicely mitigated. A downturn in non-
residential spending should be largely limited given already cyclically depressed numbers. While there is some risk that
management won’t execute on European margins, we take comfort that most of the low-hanging fruit has been identified
and the company is using the same LEAN team that has already succeeded in the US. As for the risk of increased compe-
tition, we would note a largely stable, localized monopoly type industry structure in the developed world and the inability
of Asian manufacturers to meaningfully gain traction in the US given the high barriers to entry.
Overall, we think the hardest risk to gauge today is management’s ability to optimize capital deployment. Its first few
deals will be critically important in our view.
Valuation
Our $75 price target is based on a 16.5x forward multiple of 2017E EPS of $4.53 (this assumes no M&A but a 13% reduc-
tion in average share count vs. today from buybacks). We think Allegion deserves a premium to a market multiple over
the cycle for its business quality and earnings growth potential. In addition, we would note that if management more
aggressively deployed FCF, we think it could buy back over 20% of its market cap (assuming current prices) and our $75
target would then represent only 14.3x our adjusted 2017 EPS estimate under that scenario.
We also believe the investment has attractive skew, with a base case to downside case reward/risk of 2.6x. We view
absolute downside from current levels as somewhat capped given Allegion is an interesting takeout candidate. Outside of
the core security comps, we think building control solutions providers such as UTX and Honeywell could be interested
in moving more into the security access solutions market. Allegion’s Irish domiciled status adds to its potential attractive-
ness as a target for these companies (which also have lot of international cash on their balance sheets to deploy). If the
share price were to dip much below $40, we expect buyers would likely line up to bang on its door.
Financials: 2010 2011 2012 2013 2014E 2015E 2016E 2017E
Revenue $1,967.7 $2,021.2 $2,046.6 $2,093.5 $2,182.8 $2,313.2 $2,466.8 $2,623.0
% Growth 2.7% 1.3% 2.3% 4.3% 6.0% 6.6% 6.3%
EBITDA $375.3 $405.3 $420.7 $409.4 $425.4 $470.0 $530.8 $588.4
% Margin 19.1% 20.1% 20.6% 19.6% 19.5% 20.3% 21.5% 22.4%
FCF $186.0 $240.0 $249.6 $203.7 $226.2 $265.5 $315.6 $371.4
EPS $2.38 $2.13 $2.36 $2.91 $3.64 $4.53

Avg. Shares Outstanding 96.5 96.5 94.2 89.8 84.1
Page 24
Cablevision Systems Corporation (NYSE: CVC) - Short

2nd Place, 2014 Pershing Square Challenge
Joe Goldschmid Allen Keel Mahmud Riffat
jgoldschmid14@gsb.columbia.edu akeel14@gsb.columbia.edu mriffat14@gsb.columbia.edu
Recommendation As of April 7, 2014 ($ mm, except per share data)

Current Capitalization
Joe Goldschmid We recommend shorting Cablevision (CVC) with a potential return of
+52%. There are three main points to our investment thesis: Stock Price $16.12
Joe is in his final year of the Shares Outstanding 267.6
Joint JD/MBA Program at 1) Real and Accelerating FiOS Threat—Verizon FiOS is a superior fiber- Market Capitalization $4,314
Columbia University. Prior to to-the-home product, which once fully rolled-out, typically leads Debt 9,759
Collateralized Debt (818)
Columbia, he was an analyst in to 40-50% subscriber losses for incumbent cable operators.
Other Adjustments 18
the Investment Banking Division 2) Continued Margin Erosion with an Over-leveraged Balance Sheet— Cash (702)
of Morgan Stanley. He holds a CVC has limited pricing power, and thus, limited ability to pass Enterprise Value $12,572
BS from Massachusetts Institute through soaring programming costs. This reduction in free cash Trading Statistics
of Technology. flow prevents deleveraging and jeopardizes the dividend. 52 Week High / Low $20.16 / $13.88
Avg. 3M Daily Volume (mm) 3.63
3) Takeover Speculation has Artificially Driven Up Valuation—CVC is not Borrow Cost 50 bps
an attractive acquisition candidate, and current shareholders over- Short Interest 16.4%
estimate the likelihood of a takeout.
Valuation
Business Description 2014E 2015E 2016E
Cablevision is the fifth largest cable operator in the US, providing video, EV / EBITDA 8.1x 8.9x 9.3x
EV / EBITDA - Capex 17.4x 21.2x 23.9x
high-speed data, and voice services to 3.2 million subscribers in and P/E 51.8x 580.6x n/a
around the New York Metropolitan area. The cable segment accounts Levered FCF Yield 3.5% 1.5% (0.5%)
for ~90% of the company’s revenue ($6.2 bn) and EBITDA ($1.6 bn). Net Debt / EBITDA 5.3x 5.8x 6.1x
Allen Keel
Allen is a second-year MBA Investment Thesis Target Price / Return
student at Columbia Business Target Price $7.06
1) Real and Accelerating FiOS Threat
School. Prior to CBS, Allen Total Return 52.0%
worked for four years in private For many years, cable operators had de facto monopolies in their re-
equity and investment banking spective regional footprints with minimal overbuild from competitors. However, in 2004, Verizon announced the
at Lindsay Goldberg and Merrill planned build-out of FiOS, a $23 billion fiber-to-the-home network providing video, high-speed data, and voice
Lynch. He holds a BS from services.
Duke University. FiOS disrupts the monopoly model for incumbent cable operators for several reasons, namely the superior prod-
uct offering (highest speed internet available), leading customer satisfaction (lowest industry churn rate), and Veri-
zon’s well-capitalized balance sheet, which allows for promotional offers sufficiently low to compensate new sub-
scribers for their switching costs.
Given Cablevision’s geographically concentrated footprint, the company is the most exposed to fiber out of any
cable operator. Currently approximately 51% of CVC’s footprint is exposed to FiOS, and this is estimated to
increase to ~66% as Verizon complete its obligation to pass 100% of all New York City housing units by June 30,
2014, per the terms of the company’s 2008 Franchise Agreement.
Currently only ~40% of homes in CVC’s NYC footprint in the Bronx and Brooklyn (~23% of CVC’s total custom-
Mahmud Riffat ers) have access to FiOS. We expect this figure to approach 100% as Verizon completes its obligation under the
Mahmud is a second-year MBA NYC Franchise Agreement.
student in the Value Investing To analyze the likely impact of the FiOS rollout on CVC’s customer base, we examined the effect of FiOS entry
Program at Columbia Business into other markets using data from the US Copyright Office. The losses after FiOS entered a market were devas-
School. Prior to CBS, Mahmud tating. For example, in the
worked for five years in private parts of Massachusetts that Estimated Eventual Cable Operator Overlap with Fiber (FiOS and AT&T U-Verse)
equity and investment banking FiOS entered in 2006, Com-
at Global Infrastructure cast (the incumbent cable 100%
Partners and Merrill Lynch. He operator) suffered cumulative
holds a BSFS from Georgetown subscriber declines of 55%. A 26%
University. similar phenomenon occurred
80% 41%
56%
in Staten Island after FiOS was 61% 58% 61% 8%
introduced in 2006. Time 60%

% Overlap
Warner Cable lost ~45% of its 8%
subscribers to FiOS.
40%
Our base case CVC subscrib- 24% 66%
er projections use the Com- 32% 24% 51%

20% 34%
cast Massachusetts decline
curve applied to CVC’s fiber- 14%
19%
9%
overlap footprint. Cablevision 0% 4%
has lost 10% of its subscribers Charter Cox Time Warner Cable Comcast Cablevision -
Current
Cablevision -
Projected
FiOS U-Verse Other No Fiber
Volume
Cablevision Systems Corporation (Continued from previous page)
EBITDA Margin Erosion through 2013, and we project even-

26.0% tual cumulative losses of over 20%.
1.2%
2) Continued Margin Erosion with an
25.0%
2016E EBITDA Margins (%)
Over-leveraged Balance Sheet

24.0%
As Verizon builds out FiOS, Cablevi-
2.0%
23.0% sion faces a limited ability to raise
25.7%
prices, despite soaring programming
22.0% 0.3% costs. Studies have found that cable
22.4%
0.2% prices are 15-30% lower in areas
21.0% 22.2% 21.9% 21.9%
with significant competition versus
20.0%
the norm of near-monopoly markets.
Consensus '16E # of Subscribers ARPU ($/sub/mo) Cost Growth Other (1) Our '16E EBITDA The effect of the FiOS competition
EBITDA Margins Margins
can already be observed in Cablevi-
sion’s significant EBITDA margin
erosion since 2011. Other publicly traded cable operators better insulated from competition have cable-segment
EBITDA margins near 35-40% versus the current 30% for Cablevision. We expect margins to erode further as the
FiOS build-out accelerates.
Cablevision’s profitability is not sustainable in an environment where programming costs have grown at 8 to 12%
annually, but Cablevision’s revenue per user has only grown 2-3% per year. The company’s high leverage (5.3x Net
Debt / ’14E EBITDA) exacerbates this share price decline and puts the dividend at risk.
3) Takeover Speculation Artificially Driving Up Valuation
Cablevision’s stock price has far outpaced fundamentals based on takeover speculation. The M&A rumors began in
June 2013 after Charter made its initial offer for Time Warner Cable, and Cablevision’s stock increased more than
25% over the next month.
Despite high estimated operating synergies in an acquisition, there are no likely strategic acquirers. All of the cable
operators have observed or experienced the devastating results of FiOS competition in their own cable footprints,
and will not want to acquire the operator with the highest FiOS overlap. Moreover, given Cablevision’s bleak compet-
itive outlook, the synergies from a strategic acquisition
Low Base High
would only warrant a 10% takeover premium to current
trading levels. This results in a compelling risk-reward 2016E Subscribers (mm) 2.83 2.93 3.07
ratio for our short recommendation. x: Monthly ARPU $156.77 $156.25 $165.14
Cable Revenue (mm) $5,320.2 $5,486.3 $6,074.4
Plus: Other Revenue 652.8 659.2 664.5
Valuation
Total Revenue $5,973.0 $6,145.6 $6,738.9
Less: COGS & SG&A (4,644.0) (4,796.9) (5,099.1)
We expect a severe reduction in EBITDA by 2016. This
2016E EBITDA (mm) $1,328.9 $1,348.7 $1,639.8
decrease is driven primarily by customer losses and
Multiple 7.0x 7.5x 8.0x
margin erosion in Cablevision’s FiOS overlap areas. Our
TEV $9,302.6 $10,115.2 $13,118.7
target share price of $7 amounts to a 52% total return
when factoring in dividends and stock borrow costs. Less: Net Debt (8,404.3) (8,226.5) (7,585.7)
Target Equity Value $898.3 $1,888.7 $5,533.0
Near-term Catalysts
Divided by: Shares O/S 267.6 267.6 267.6
A) Contractual: Verizon has publicly stated that they will
Target Price per Share $3.36 $7.06 $20.67
comply with their 2008 Franchise Agreement by passing
% Upside / (Downside) on Short Sale 79.2% 56.2% (28.2%)
100% of New York City housing units by June 30, 2014.
B) Political: The Mayor de Blasio Administration seems Plus: Dividends + Borrowing Costs @ 0.5%
Per Share ($0.68) ($0.68) ($0.68)
determined to force Verizon’s compliance with the 2008
% Upside / (Downside) (4.2%) (4.2%) (4.2%)
Franchise Agreement by framing affordable broadband
access as an economic-justice issue. Total Return:
Per Share $12.08 $8.38 ($5.23)
C) Economic: Verizon will aggressively market its FiOS Total % Upside / (Downside) 75.0% 52.0% (32.5%)
product. Once Verizon has “passed” a building, the
Free Cash Flow Metrics:
incremental investment to connect the building is well
2016E Unlevered FCF 488.8 540.2 722.0
worth the expected return on capital. FiOS typically Implied Unlevered FCF Yield 5.3% 5.3% 5.5%
captures more than 40-50% market share. 2016E Levered FCF (73.6) (22.2) 169.2
Implied Levered FCF Yield (8.2%) (1.2%) 3.1%
Key Investment Risks:
(1) An irrational strategic buyer acquires Cablevision, or the Dolan family attempts to take Cablevision private. (2)
Cablevision improves operations and profitability by enhancing product offerings that maintain or increase the sub-
scriber base. (3)The Verizon FiOS rollout does not materialize. Verizon fails to comply with its contractual commit-
ment to build out its fiber network in New York City.
Page 26
Carnival Corporation (NYSE: CCL) - Long

2014 Pershing Square Challenge
Juliana Bogoricin Charles Buaron Ben Isaac
JBogoricin15@gsb.columbia.edu CBuaron14@gsb.columbia.edu BIsaac14@gsb.columbia.edu
(in millions, except per share figures)
Recommendation Current Capitalization
We recommend a long position in Carnival Corp. (NYSE: CCL) with a two-year Share Price (4/17/14) $37.32
Juliana Bogoricin Base Case target price of ~$57 representing ~53% upside from 4/17/14 share price. FDS 776
As a result of one-time setbacks, CCL now trades at a significant discount to its Market Capitalization $28,975
Prior to CBS, Juliana was a intrinsic value. (1) Reversion to positive industry trends on ticket prices in a high
private equity Associate at fixed cost business will lead to substantial margin upside while (II) operational Plus: Debt $9,610
Platinum Equity and an
investment banking Analyst at improvements driven by a new CEO provides additional opportunity. Less: Cash & Equiv. (421)
Enterprise Value $38,164
Credit Suisse. Juliana holds a Business Description Trading Statistics
B.S. from the Wharton School. CCL is the #1 player in the cruise industry with market share of ~48% servicing
At CBS, Juliana is a VP of the 52-wk Range $31.44 - $41.89
over 10 million passengers annually through a fleet of 101 cruise ships and a portfo- Dividend Yield 2.68%
Investment Ideas Club. lio of 10 brands. CCL was incorporated in 1972 and is headquartered in Miami, Avg 3M Dly Vlm (mm) $136
Florida. Valuation Summary
2015E 2016E
Situation Overview
Consensus:
CCL has experienced two major incidents in two years. The Costa Concordia ran
TEV / EBIT 17.6x 14.5x
aground due to captain error causing 32 fatalities in January 2012, and the Carnival
P / EPS 15.9x 12.6x
Triumph lost power stranding the ship for five days without working facilities in
February 2013. These misfortunes have created severe dislocation in CCL’s financial Base Case:
performance highlighted by its unprecedented divergence from industry pricing TEV / EBIT 16.0x 12.3x
trends, best-in-class margins becoming worst-in-class and 40%+ underperformance P / EPS 13.5x 9.8x
to the S&P. This dislocation has created significant opportunity leaving behind an
attractive stock trading below replacement cost. Bull Case:
Charles Buaron
TEV / EBIT 12.6x 10.0x
Prior to CBS, Charles was a Investment Thesis P / EPS 10.2x 7.5x
private equity Sr. Associate at
1. Reversion
Cerberus Capital and an
investment banking Analyst at A) Adjusting for FY13 one-off issues: FY13 was a difficult year for CCL as the incidents drove up expenses and
Goldman Sachs. Charles holds reduced pricing. Repair & maintenance, advertising and pricing were significantly impacted as they diverged
a B.A. from Brown University. from peer and historical trends. By normalizing these
At CBS, Charles is a VP of the line items, we see a clear path to 500+ bps of EBIT Divergence in Avg. Ticket Pricing
$185
Investment Ideas Club. margin improvement.

$180
B) Pricing rebound to industry norm: Over the long-term ~900 bps
Margin
industry-wide pricing has enjoyed an upward trajectory $175 Opportunity
even through cyclical interruptions. Additionally, com- $170
petitor pricing has always trended together with histori-
cal correlations of over 95% until 2012. Subsequently, $165
CCL displayed unprecedented divergence from positive $160

pricing trends. The timing of the incidents were espe-
cially punitive as they interrupted CCL’s rebound from $155
the financial crisis. If CCL’s rebound from the trough in $150

2009 had remained uninterrupted and continued at the 2009 2010 2011 2012 2013
same pace as peers, margins would have nearly doubled CCL CCL Adj. RCL NCL
Ben Isaac from current levels. Meanwhile, competitor margins and

% Delta from Peak
Prior to CBS, Ben was an pricing have largely recovered; some have even reached peak levels. Pricing:
Analyst at Ingalls & Snyder
CCL RCL NCL
–
C) Timing of brand recovery: Before CCL can see price increases, its brand and –
Value Partners. Ben holds a B.A. reputation needs to be repaired. Our research has shown that while the Cos-
(5%)
(6%)
from Williams College. At CBS,
(10%)
ta and Carnival brands were hurt by the incidents, they are not broken. In (15%)
Ben is a VP of the Investment fact, the Costa brand has seen pricing and yield growth at the end of last year, (20%)
(19%)
(25%)
Ideas Club. and the Carnival brand’s recovery is nearly complete. As we pass the second Margins:
CCL RCL NCL
anniversary of the Costa Concordia incident, we approach the point of brand –
(2%)
recovery and a reversion to positive industry pricing trends. (20%)
D) Favorable industry dynamics support reversion: The global cruise sector has
(40%)
(40%)
(60%)
demonstrated yearly demand growth at 5% matching supply growth even (59%)
(80%)
during recessionary periods. The oligopolistic industry structure with con-

sistent market shares highlights that competitors are relatively rational, while high barriers-to-entry preclude
new entrants from taking share. Additionally, demographic tailwinds support volume and pricing growth as
the youngest baby boomer is becoming a core cruise consumer at age 40. Lastly, the cruise product’s value
proposition is strong relative to other travel opportunities. We like these characteristics and believe they lay
a solid foundation on which a reversion thesis can materialize.
Volume
Carnival Corp. (Continued from previous page)

II. Operational Improvements
A) Potential for other significant margin improvement: Given
CCL’s scale advantage in a high fixed cost business, the EBIT Margins
company should enjoy higher operating margins rela- FY 2005 FY 2013
tive to its smaller competitors (~48% market share vs. CCL 24% 10%
EBIT Margins
next largest RCL at ~23%). Since 2005, CCL’s histori- 30% RCL 18% 11%
Financial
cally best-in-class margin profile has dissipated leaving it 25% NCL 4% 15% Crisis Divergence due
to incidents
with the lowest EBIT margin of its peers in 2013. Our 20%
research suggests CCL previously did not manage costs 15%
effectively or take advantage of scale economies by 10%
integrating operations across its 10 brands. Given that
5%
CCL is a roll-up of acquisitions, integration synergies
exist as CCL currently carries 6 headquarters, 10 yield –
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
management systems, 2 sales force offices and 3 reser- CCL RCL NCL
vation systems.
B) New CEO better positioned to execute on margins: Micky Arison, the previous CEO, was instrumental in the consoli-
dation of the cruise industry (ending in 2003 with the Princess acquisition), but less operationally hands-on. He
stepped down during CCL’s run of disasters and announced in June 2013 that the new CEO would be Arnold W.
Donald (a long-standing board member).
We believe the new CEO makes CCL more likely to undergo positive change. Donald is more focused on opera-
tional opportunities and has a good reputation among company insiders. He is also heavily incentivized with equity
and stands to make up to $24mm per year if Total Stock Returns reaches 17%. We think this fact pattern makes
operational improvements within the company much more likely.
Valuation: Our 2-year target price in the Base Case
is ~$57 per share representing a 53% gross return ($ in millions, except per share figures)
from 4/17/14 share price of $37.32. Our assump- Valuation and Upside/Downside Scenarios
tions include: Variance
 Pricing: Improves at a ~3% CAGR. CCL’s pricing Base Bear Bull Street to Base
was growing at 4% in FY11 before the Costa inci- Key 2016E Estimates:
dent interrupted its rebound from the financial Revenue $18,512 $17,170 $19,441 $18,302 1.1%
EBIT $3,093 $2,027 $3,831 $2,629 17.6%
crisis.
EBIT % Margin 16.7% 11.8% 19.7% 14.4% 2.3%
 Volumes: Grow in line with capacity expansion. EPS $3.82 $2.28 $4.97 $2.97 28.5%
Supply pipeline is highly visible as players announce
Valuation:
shipbuilding plans 3-5 years in advance. Target PE Multiple 15.0x 14.0x 15.5x
 Margins: Improve to ~17%. Given the high fixed 2-Yr Target Price $57.26 $31.90 $77.02
cost nature of this business, price increases have a % Upside (excl. dividends) 53% (15%) 106%
substantial impact on the bottom line. % IRR (incl. dividends) 26% (5%) 46%
 Multiple: Apply a 15x P/E multiple on our FY16 Implied Multiples on Current Valuation:
TEV / EBIT 10.0x 12.3x 18.8x
Base Case EPS estimate. CCL has historically trad- P / EPS 7.5x 9.8x 16.4x
ed at 16x P/E across cycles, and we believe CCL is
Key Assumptions:
not structurally different than it was historically. FY13-16 Pricing CAGR 3.3% (0.0%) 5.5%
In conclusion, our assumptions imply investing in FY13-16 Volume CAGR 3.3% 3.3% 3.3%
CCL at less than 10x FY16 earnings in our Base Case
and 7.5x in our Bull Case. We believe substantial capital impairment is unlikely as we are buying ~50% of the global
cruise fleet at below replacement cost. Lastly, we believe CCL offers an attractive risk/reward profile with Base / Bear
yielding 3.7x, and Bull / Bear yielding 7.3x.
Key Risks: (1) Overcapacity could weaken economics; (2) Pricing remain depressed or decline; (3) Mismanagement
potential; (4) Another accident; (5) Consumers’ shift away from cruising as a vacation alternative.
($ in millions; except per ALBD and ticket pricing figures)

FYE November 30, 2007A 2008A 2009A 2010A 2011A 2012A 2013A 2014E 2015E 2016E
Summary Income Statement
Volume (ALBD) 54 59 62 67 70 72 74 76 79 82
% Growth 8.4% 8.9% 5.4% 7.1% 5.1% 2.9% 2.9% 2.8% 3.2% 3.9%
Ticket Pricing $181 $195 $166 $167 $174 $162 $157 $159 $165 $174
% Growth 1.5% 8.0% (15.2%) 0.5% 4.3% (6.8%) (2.9%) 1.0% 4.0% 5.0%
Total Revenues $13,033 $14,947 $13,460 $14,469 $15,793 $15,382 $15,456 $16,017 $17,100 $18,512
% Growth 10.1% 14.7% (9.9%) 7.5% 9.2% (2.6%) 0.5% 3.6% 6.8% 8.3%
EBIT $2,725 $2,729 $2,154 $2,347 $2,283 $1,872 $1,541 $1,819 $2,381 $3,093
% Margin 20.9% 18.3% 16.0% 16.2% 14.5% 12.2% 10.0% 11.4% 13.9% 16.7%
EBIT / ALBD $50 $46 $35 $35 $33 $26 $21 $24 $30 $38
Note: ALBD is a measure of capacity - # of beds available per year (“Available Lower Berth Days”)
Page 28
Clean Harbors, Inc. (NYSE: CLH) - Long

Matt Bracewell, CFA Patrick Enriquez-Fischer Pavel Kaganas
mbracewell15@gsb.columbia.edu penriquezfischer15@gsb.columbia.edu pkaganas15@gsb.columbia.edu
Note: On April 24th (one day after the Pershing Square Challenge finals), Relational Investors filed a 13D disclosing a 9%
stake in CLH.
Recommendation
Matt Bracewell, CFA
We recommend investors buy Clean Harbors, Inc. (CLH) stock with a 12-18-month target share price of $85-95,
Matt is a first-year student at representing ~50-70% upside . There are five main points to our investment thesis:
CBS and is on the board of the
1) A fair valuation of the core hazardous waste management business more than covers the current share price
with only 70% of the EBITDA. “The Core” has dominant market share, economies of scale, regulatory pro-
Management Association. Prior
tection, excellent customer captivity and great ROICs
to CBS, Matt was an Associate
at Navigation Capital. He will 2) The shares are mispriced and out of favor due to transitory issues (weather and FX) and over-focus on the
intern at Owl Creek Asset under-performance of a small segment (Re-refining)
Management in the summer. 3) Several non-core assets should be divested to generate cash for buybacks/acquisitions, and to re-focus man-
agement on the Core business
Key Trading Statistics and Financial Highlights
4) The industry changes that have
Share Price $55.32 ($M) Dec-12 Dec-13 Dec-14 E Dec-15 Dec-16
hurt Re-refining have bottomed,
and some structural industry Mkt. Cap $3,368 Revenue $2,188 $3,522 $3,604 $3,777 $4,034
shifts will convert Re-refining +Net Debt $1,300 EBITDA $374 $528 $583 $679 $764
into a more stable “process EV $4,667 FCF $130 $138 $180 $223 $241
business” 52-Wk H/L $44.9/$64.1 RR FCF $170 $284 $280 $322 $334
5) Management shifts will re-align EV/15E EBITDA 6.9x Adj. EPS $3.09 $2.46 $2.75 $3.56 $4.27
attention on capital allocation 2015E Adj. P/E 15.5x Rev Grth 10.3% 60.9% 2.3% 4.8% 6.8%
and re-focus on the Core
Patrick Enriquez- 2015E RR FCF Yld 10.6% EBITDA Grth 6.8% 41.3% 10.5% 16.4% 12.5%
Fischer Business Description 2016E Adj. P/E 12.9x EBITDA Mrg 17.1% 15.0% 16.2% 18.0% 18.9%
Patrick is a first-year student at The Core (Technical Services-TS, Safety-Kleen Environmental-SKE, and Industrial & Field Services-IFS) is a vertical-
CBS and is on the board of the ly integrated hazardous waste disposal business; from cleaning, to collection, transportation, and disposal/recycling;
Columbia Student Investment carried out through 10K+ specialized vehicles, 8 incinerators (68% of N.A. capacity), and 11 landfills (24% of N.A
Management Association. Prior capacity). The other businesses include used oil re-refineries, housing lodges in Alberta, CA, and O&G Field Ser-
to CBS, Patrick worked at vices (seismic, rentals, waste fluids). CLH has grown organically and though acquisitions and highly successful inte-
Morgan Stanley in Mexico. He gration, compounding revenue and EBITDA at 23% and 26% since 2000.
will intern at Permian NA Incinerator Capacity
Investment Thesis
Investment Partners in the Other, 4%
summer. 1) The Core provides full margin of safety with competitive advantages
Heritage, 7%
 Economies of Scale - CLH is the largest player in every haz-waste end mar- Ross, 9%
ket and dominates national accounts. The incinerators and landfills are large
fixed-cost assets that provide tremendous operating leverage (incinerators Veolia, 12%
have 30-40% EBITDA margins and 90+% utilization; landfills have 20+ year
remaining life), and a multi-year expansion comes online in 2016, increasing CLH, 68%
incineration capacity by 13% at double the revenue per unit. The rest of the
company is focused on driving additional waste volumes into the disposal
network. This allows CLH to be a full-service provider of related waste,
cleaning and technical services and they have over 1,300 employees at cus- NA Landfill Capacity
Other, 5%
Pavel Kaganas tomer sites, supplementing workforces.
Heritage,
Pavel is a first-year student at  Customer Captivity - US regulations mandate that waste generators keep 9%
CLH, 24%
CBS. Prior to CBS, Pavel was a the cradle-to-grave liability on their waste, so there are tremendous pre-
Vice President in the Private qualifications for disposers. There is almost no customer turnover since WM, 18%
Equity group of Morgan Joseph CLH provides full tracking and paper-trail, so customers do not risk switch-
TriArtisan. He will intern at ing providers (customer captivity). ECOL, 19%
Arch Capital Management in
the summer.  Irreplaceable Asset Value - Difficult permitting and regulatory barriers create EQ, 25%
huge moats, and there has not been a greenfield haz incinerator or landfill
for 16 yrs+. High capital costs are generated by a large in-
stalled infrastructure base and complicated logistical network. Technical Services ROIC
CLH assets are essentially irreplaceable and permitting is a
lengthy process, but these assets are insured for $3-4B. 24.8%
23.4% 23.6%
 Regulatory barriers - Regulations protect almost every aspect 22.3%
of disposal operations. Customers are governed by RCRA 20.8%
regulations which mandate which wastes have to be burned

or go to a designated hazardous landfill.
2009 2010 2011 2012 2013
Volume
Clean Harbors, Inc. (continued from previous page)

 TS and SKE (43% of EBITDA) are #1 in their markets for recurring waste from customers’ ongoing operations,
and provide most of the waste volume to the core disposal network. IFS (14% EBITDA) is the leader in event-
driven mission-critical services; heavy-duty cleaning, planned plant turnovers, and natural disaster rapid response.
2) Out of favor on transitory issues and misses in re-refining
 The company was a market darling for years, but has now missed for 6 of the last 7 quarters.
a. Weather issues have hurt CLH for 5 of the past 8 quarters; $30M+ EBITDA effect in 2013 and anoth-
er $15-20M so far in 2014. The street is now extrapolating these margins. CAD FX hit for another
$20M.
b. In late 2012, CLH acquired Safety Kleen (SK) for $1.3B to drive more volume into its disposal assets,
picking up a large collections network with 200,000 customers. The SK Environmental piece of SK has
been a tremendous success, with annual cost saving of $100M+. The Re-refining piece meanwhile
suffered as the industry’s price and cost indices diverged the first time in years and 2013 EBITDA came
in $80mm below original guidance. The knife has already fallen and the industry is correcting.
 The multiple misses on transitory weather and Re-refining have overshadowed the SK Enviro success, turned
sentiment negative, and now the Street is unwilling to reflect their own documented expectations for volume
growth and pricing power in their financial projections. The Street is just dead wrong.
3) Sell non-core Lodging and Seismic assets to re-deploy capital and focus attention on the Core
 Lodging is a $65mm EBITDA business, buried within CLH at the street’s 8x valuation. Meanwhile the industry is
trading assets at 11.0-12.5x, the planned OIS spin-off showing low-teen valuation, and another major acquirer is
seeking to deploy capital. This can generate $700M+ of proceeds with another $100M+ from selling Seismic.
 These proceeds can be directed towards a buy-back (10% accretive in ’16) or to acquire one of the two large
competitors of the Core that are currently for sale.
 These sales will re-direct management and investors’ attention to the Core, proper capital allocation, and ROIC,
which has been dragged down by non-core businesses.
4) Re-refining is not a falling knife and the industry is correcting. Was most of Historical Lube Price Spreads
EBITDA miss, but only small portion of our base case upside.
 Historically, the primary product from the waste oil collections indus-
try has been low-value-add recycled fuel oil. As a result, price paid for Costs flat &…
collected waste oil, the primary input cost, by industry standard was
also indexed to the price of this fuel oil. Prices for base lube, currently
representing 1/3 of output, have also tracked the fuel oil indices for
years, but recently, base lube and used oil costs diverged, pressuring
re-refining margins. But, new recycling technology and cheap nat gas is
…prices down = margin compression
increasingly driving volume into high-value-add base lube production –
and CLH is the #1 lube re-refiner with 51% of N.A. capacity.
 Primary diligence confirms that the industry ($M) 2015 Metrics (base) 2016 Metrics (base)
is starting to re-index the prices paid for EBITDA Multiple EV EBITDA Multiple EV
CORE (a) $606 8.5x $5,149 $681 8.0x $5,445
waste oil to base lube. This will explicitly O&G Field (a) 43 6.5x 277 54 6.0x 324
match revs and costs of lube re-refiners to Re-refining 77 7.0x 537 80 7.0x 561
the same index, eliminate commodity risk Lodging 84 10.0x 840 88 9.5x 838
from the COGS stack, and turn Re-refining Seismic 21 6.5x 137 22 6.0x 132
Corp. OH (151) 7.0x (1,057) (161) 6.5x (1,049)
into a fixed-margin process business, lifting Total EV $679 8.7x $5,882 $764 8.2x $6,251
valuation.
less: Net Debt $1,015 $758
5) Leadership changes can fix some capital allocation Equity Value $4,867 $5,494
mis-steps and redirect attention to Core and ROIC Implied Share Price $82.44 $93.05
Upside to Current 49%
55 68%
55
 Board and management are indicative of (a) Core excludes Lodging and O&G Field excludes Seismic; non-core units to be sold
CLH’s (successful) roll-up history. Board (b) Net debt allocated 80% to Core, 10% to O&G Field, and 10% to Re-refining
enhancements and a permanent CFO would

bring in the experience to guide a $5B, di- EBITDA less Implied
Value Walk Corp. OH Share Value Cummulative Upside
verse environmental firm and bring focus 2015 Core Business (a)(b) $500 $60.93 $60.93 10%
onto capital deployment and returns. 2015 O&G Field Services (a)(b) 27 $1.17 $62.11 12%
2015 Oil Re-refining (a)(b) 62 $5.59 $67.70 22%
Valuation Sell Lodging & Seismic 90 $14.75 $82.44 49%
Base Target $679 $82.44
2015 SOTP and Value Walk show margin of safety New Incinerator 32 $4.59 $87.03 57%
from the Core, with the other segments acting as Core Improvement (1% margin) 27 $3.24 $90.27 63%
“free options.” But 2016 represents CLH’s true Lube $ Reversal (~half of '13 declines) 40 $4.74 $95.01 72%
earnings power, as CLH bring on the new inciner- CAD FX Rate 15 $2.20 $97.21
Near-term Value Potential $793 $97.21 76%
ator, benefits from $200M of growth capex at 20% 2016 Base Case $764 $93.05 68%
ROICs, and Re-refining eliminates some valuation 2016 Bull Case $862 $106.40 92%
discount. This points to the high end of our range.
Page 30
Naspers (JSE:NPN) - Long

Carter Roehl George Taras Luke Tashie
croehl15@gsb.columbia.edu gtaras15@gsb.columbia.edu ltashie15@gsb.columbia.edu
Naspers is the world’s best company you’ve never heard of — and Mr. Market is paying us to own
its core assets
Carter Roehl
Carter is a first year MBA Naspers is a South African internet and media company with a $41 billion market capitalization and a phenomenal
student at Columbia Business collection of compounding assets with sustainable long-term upside. The company’s ownership in publicly traded
School. Prior to CBS, Carter internet assets is worth $45 billion dollars, which is greater than Naspers’ total market capitalization. Additionally,
worked in private equity at Naspers owns over 120+ other
Veritas Capital after spending internet assets, including leading
two years in Bank of America online classifieds, marketplace and
Merrill Lynch’s Global e-tail sites, in winner-takes-all
Leveraged Finance Group. markets at the cusp of monetiza-
tion in the fastest growing regions
of the world. Naspers also owns a
30%+ margin quasi-monopoly
PayTV business currently expand-
ing throughout Sub-Sarahan Africa,
where the subscriber base is ex-
pected to more than double by 2020.
We recommend buying Naspers and shorting the publicly traded assets to exploit this opportunity
George Taras
Naspers operates in three segments: PayTV, Internet, and a legacy print business upon which it was founded.
George is a first year MBA PayTV generates over $1bn in EBITDA annually, has >90% market share in its core markets and we conservatively
student at Columbia Business project y/y topline and EBITDA growth of 12% and 15%, respectively, for the next three years. The internet seg-
School. Prior to CBS, George ment is comprised of Naspers’ 34% interest in Tencent, its 29% interest in Mail.ru and its partial and full owner-
worked in consumer private ship of over 120+ additional internet businesses in emerging markets, mostly focused in online classifieds, ecom-
equity after spending four years merce and marketplace business models. The legacy Print media business is profitable, but not a substantial por-
as a generalist in M&A and tion of the business today.
investment banking advisory at
Citadel and Deutsche Bank. Investment Thesis
The market is currently valuing Naspers’ interest in its listed assets (Tencent and Mail.ru) at greater than
100% of the entire value of Naspers
The Naspers “stub” (in USD billions)
Mr. Market’s
represents the com- Naspers Current Market Cap $41.2
Current Offer
pounding and high
Subtract:
growth business to which Intrinsic Value (in USD billions) Great
the market is currently Pay-TV $10.0 Businesses To
ascribing a negative $3.3 Unlisted Internet Interests 10.0 Which the Market
billion valuation. Conser- Print Media 0.5 Is Ascribing a
Luke Tashie vatively, we think the Tencent (34.2% owned) 42.7 Negative Value
Mail.ru (28.7% owned) 1.8
Naspers “stub” is worth
Luke is a first year MBA student >$20 billion resulting in
Less: Corporate OH (0.3)
Less: Net Debt (0.7)
at Columbia Business School. total mispricing of $23 Naspers’ Intrinsic
Naspers Intrinsic Equity Value $64.0
Prior to CBS, Luke acquired billion. Value
and operated two small The “stub” has historical-
businesses after working as an ly traded at a positive Mispricing ($22.8) Free Money
analyst for four years at value and has only re-
Noonday Asset Management cently traded down as a Implied Unlisted Asset Equity Value (i.e. the "stub") ($3.3)
(Farallon Capital). result of significant in- (PayTV + Unlisted Internet portfolio + Print media)
crease in market value of
$8.0
Naspers’ listed internet
$6.0
assets. This is in spite of
the fact that the value of $4.0 Average = $2.6bn
the assets comprising the $2.0
stub has compounded $0.0
over time and is ex- ($2.0)

pected to compound ($4.0)
>25% well into the fu- ($6.0)
ture. ($8.0)
Jun-04 Jun-05 Jun-06 May-07 May-08 May-09 May-10 May-11 Apr-12 Apr-13 Apr-14
Naspers Stub Value
Issue XVIII Page 31
Naspers (Continued from previous page)

Naspers’ unlisted assets (“the stub”) is comprised of attractive global businesses that are compounding >25%
annually and we estimate should be valued at $20bn+
Naspers’ PayTV is a wonderful asset that is a quasi-
monopoly business with 30%+ EBITDA margins, 90%+
market share in South Africa, exclusive sports and enter-
tainment content and produces $1bn+ in EBITDA annually
that has been growing by mid-double digits. Naspers has
invested heavily to grow PayTV in Sub-Saharan Africa,
where the number of subscribers is expected to more than
double by 2020. We believe PayTV is worth $10bn today
based on comparable multiples of other cable/tv companies
and will continue to be a core growth driver of the busi-
ness going forward.
Naspers’ unlisted internet asset portfolio is comprised of well positioned, market leading online classified, ecommerce,
marketplace and other online businesses. The company has historically provided little to no information on these assets,
but through our primary research, we believe this portfolio is
conservatively worth $10bn today and should compound in
value at a rate of 25-50% over the next five years. In the exhib-
it above, we have highlighted just a few of Naspers’ well-known
internet assets that are leading internet companies in their
respective markets. The value of these four internet assets
accounts for 60% of the $10bn we have included in the intrin-
sic value of the “stub.” Further, we estimate there to be 4-5x
upside potential on these four assets alone. Naspers’ also has a
whole portfolio of 120+ additional internet assets which we
also believe are very attractive. For example, online classifieds
are inherently winner-takes-all businesses, and Naspers has
20+ such businesses which are on the cusp on monetization
and on the path of achieving EBITDA margins of 50-70%+ . The
chart to the right highlights the massive monetization potential
that Naspers is currently on track for in online classifieds.
Naspers’ secrecy in its ownership interests is not new. For example, Naspers purchased 46% of Tencent in 2001 for
$32m and did not disclose its stake until Tencent went public in 2004, when their post-money ownership in the newly
listed company was >$1bn. Although it is unclear if Naspers owns the next Tencent in its portfolio, the 120+ internet
assets combined with a growing PayTV business clearly are substantially mispriced at the negative $3.3bn valuation the
market is currently ascribing to them.
The market is currently attributing a value of negative $3.3bn to the stub, creating a wonderful opportunity to
effectively get paid to own Naspers’ world class PayTV business and interests in 120+ well-positioned internet
businesses in the fastest growing markets in the world
In order to exploit this massive market ineffi- LONG SHORT LONG SHORT
ciency, we have outlined an illustrative transac-
tion based on gross exposure of $500m (net
$440mm $440mm
$38m). Through a simple re-rating of the sta- (85% of listed asset value) (85% of listed asset value)
After stub re-rating…
Payoff:
ble and growing PayTV and unlisted Internet $500mm $777mm +$277mm
Assets to our conservative valuations, investors +738% Net
can generate a net return of 738% (55% gross). $22mm $22mm +55% Gross
Over time, we only expect the stub to be be-
come more valuable as its underlying assets
compound rapidly, thus allowing the patient
Net Position = $38mm Net Position = $315mm
investor to generate returns in excess of these
conservative assumptions. Implied “Stub” Value = ($3.3bn) Implied “Stub” Value = $20.5bn
($10bn Pay TV + $10bn unlisted internet + $500m Print)
Risks/Mitigants
Should the South African Rand (ZAR) further dislocate from the USD/HKD, the stub could widen further
The cost to fully hedge against this risk is inexpensive (~1% annually today) which would only minimally impact returns
The Company takes no actions to help narrow the gap
Ideally for holders of the stub, the company would pursue accretive actions such as selling a portion of its interest in
Tencent and simultaneously buying back shares in Naspers. Additionally, some internet assets are likely to IPO in the
next few years. Lastly, increased disclosure would allow the market to better understand Naspers’ unlisted holdings.
Investors may argue that a holding company discount applies in this case
We believe that a substantial holding company discount is not warranted due to i) lack of tax friction associate with sale
of stake, ii) we are shorting highly liquid assets with low cost of borrow, iii) highly competent management team with
great capital allocation track records, and iv) ability to hedge out any currency risk
Page 32
Eric Rosenfeld
(Continued from page 1) that acquisition but the day We receive ideas from
Graham & Doddsville after the year was up, I left analysts. Analysts may or
(G&D): How did you and started Crescendo to may not be good at finding
become involved in activist focus on the most undervalued stocks, but
investing? interesting and profitable they know when the
parts of what we had done institutional shareholders
Eric Rosenfeld (ER): at Oppenheimer, specifically are unhappy. Having
While I was at Harvard deep value investing and disgruntled shareholders,
Business School, I worked activist investing. shareholders that want and
for a summer at Bear would support change, is a
Eric Rosenfeld Stearns in their risk G&D: Can you describe requirement for us, and so
arbitrage, options, and your investment process? analysts bring us ideas.
interest rate futures groups.
A senior person there told ER: We are really Other value investors are a
me those would be the company-specific and look source of ideas, specifically
three great growth areas into particular industries or value investors that buy a
over the next five years. markets. The first stock and enter the “Wait,
That person sure was right. requirement is to find Hope, and Pray” mode.
undervalued stocks, When things don’t go their
I went back to Bear’s opportunities where there way and they get frustrated,
arbitrage department when I is a value gap and a they may call an activist like
graduated and started difference between where us.
working on takeovers – not the stock is trading and
just plain vanilla types of where we think it can trade. Finally, we get ideas from
situations but bidding wars, employees – either former
unsolicited offers, and the One of the ways that we employees who have lost
more interesting types of come up with ideas is by their jobs and think that
situations. I was recruited to running screens. The most they can get their jobs back
run the arbitrage important metric we look at by bringing us into the
department at is probably enterprise value company or current
Oppenheimer three years (“EV”) to free cash flow. employees who aren't happy
later and managed both firm We also look at EV to with the direction of the
capital and outside capital. EBITDA, EV to operating company or the leadership
income, EPS multiples, and, of the company and feel that
At Oppenheimer, we on the downside, we look at their careers will benefit
focused on the more liquidation value. from having the company on
interesting types of surer footing.
situations – competitive We also get ideas from
situations and aggressive other board members. G&D: How do you get
13Ds. There were We've been on over 20 your name out to those
corporate raiders involved boards and as a result we employees or make them
and we would often become personally know about 200 aware that you're out there?
active in situations. We directors. Many of the
influenced which company directors serve on other ER: Our name typically isn’t
would end up buying boards and may suggest out there to companies we
another and helped to ideas to us. They see the haven’t already identified.
coordinate bidding wars. value we are able to create However, sometimes
We also were activist and they’ll try to get us to people have heard about us
investors. help with other companies in the news or they know
with which they are somebody who was at a
Fourteen years later, CIBC involved. company where we were
bought Oppenheimer. I had (Continued on page 33)
to stay for a year as part of
Volume
Eric Rosenfeld
(Continued from page 32) In that particular case, we EBITDA margins used to be
involved. sent a public letter to the about 14%, and we're
company calling for the actually only assuming that
G&D: Besides disgruntled immediate hiring of they get back to 9% or so in
shareholders, what are investment bankers to start our valuation. We're not
other things you look for in a sales process. And while saying that things are going
an investment? the company has not sold to be as rosy as they were a
itself, they did hire bankers long time ago, just that
ER: We're looking for a and recently announced a they're going to be much
company that's significantly financing deal with better than the trough
undervalued. We're typically Sycamore Partners. earnings that you have right
looking for an upside of at now.
least 50% and maybe
significantly in excess of that G&D: A lot of your
depending on how long we activism has been focused
think it's going to take to “The laws are on Canada. Can you tell our
draw out that value. Our readers why you've done a
average holding period is different in Canada lot of work there?
slightly in excess of three
years, and so, in most cases, than in the United ER: The laws are different
it’s not an immediate value in Canada than in the
creation. States and they're
United States and they're
more favorable to more favorable to
Stocks may immediately shareholder democracy in
increase after we surface. shareholder several respects. The most
That frequently happens but important difference is that
usually we get on the board democracy in if you own 5% of a Canadian
and work over a period of company, you can
years to bring out value. several respects. requisition a shareholder
Occasionally, we'll call for meeting. You can send in a
the sale of a company – we The most important
letter to the board and,
did that a while back with three or four months later,
difference is that if
Aeropostale. the whole board is up for
you own 5% of a election. There are no
Aeropostale is primarily a staggered boards, so the
teen retailer and it also has Canadian company, whole board can be
a division which caters to 4- replaced.
to 12-year-olds. The you can requisition
company has been having That is a tremendously
difficulty recently, as has the a shareholder
powerful tool for the
whole sector, and we think activist shareholder and it
meeting.”
that the turnaround that helps us in negotiating with
they're attempting to companies. When we're
engineer would be better asking for substantial
accomplished in a private representation on the
setting – either under a board, the company knows
financial sponsor or as a G&D: How do you think that unless we reach an
smaller part of a much about normalizing EBITDA, agreement, we may very
larger company – where especially for a retail well replace the whole
they're clear of the public turnaround? board or virtually the whole
microscope and not judged board. I think it helps us get
on a quarterly basis. ER: Well, their average (Continued on page 34)
Page 34
Eric Rosenfeld
(Continued from page 33) feel they can’t get a large alternatives. At the end of
to a negotiated solution, enough stake to make a this period, the regulators
which we greatly prefer change. This would damage or the courts will issue a
over a proxy battle, but shareholder democracy cease trade order which will
when we need to have a amongst some smaller eliminate the poison pill and
proxy battle we will. companies and lower the allow the offer to go
value of some Canadian through. A company that is
Students discuss the pitches Without shareholder
at the 2014 Moon Lee Prize stocks that may just be left put into play in Canada is
support, we can't negotiate to languish in their much more likely to
Competition.
our way onto the boards, undervalued state. transact than a company
nor can we win a proxy that is put into play in the
battle, and that's another Another difference is the United States.
important difference poison pill or the
between Canada and the shareholder's rights plan. Another important
US. In the US, you generally When poison pills were first difference is that you are
can't call a special meeting, introduced in the United more likely to have
and when you do, you may States in 1984, the initial concentrated institutional
need to own 50% or 25% of idea was that they would shareholders. In certain
the company. In very rare give the board some more companies, we'll be able to
cases you can do so with time to look for alternatives go out and speak to five or
10%, and virtually never can when faced with an six institutions and
you call a special meeting unsolicited offer. understand what 35% to
with just 5% of the stock. 45% of the shareholders are
This has morphed over the thinking and whether they
In most cases, you just have last 30 years to a point are willing to support us. In
to wait for the company's where boards in Delaware contrast, in the US, we
annual meeting, and so if can just say no to an offer might have to speak to a lot
your timing is wrong, you that they don't like. You can more shareholders to find
might have to wait 10 or 11 have 95% of the out what an equivalent
months until you have that shareholders supporting an percentage of the
vote and can have a board offer, but if the board shareholder base is thinking.
level change. On top of that, chooses not to accept it,
if the board is staggered, they can hide behind the G&D: Have you looked for
you can only get a maximum poison pill. The bidder opportunities in other
of a third of the board in would need two successful countries that share similar
one year and you have to proxy fights over two years characteristics as Canada?
wait another year to get the to get control of the board
other third needed to gain and remove the pill. ER: No. Our view is that
effective control. since there are so many
It’s better in Canada than it opportunities in the United
Another difference between ever was here. The view States and Canada – and
Canada and the US is that a there is that, since the we're in the same time
shareholder doesn't have to shareholders own the zone, we know the laws, we
publicly surface until they company, they should have know the people – that
own 10% of the company in the ultimate power in there’s no need to go
Canada. This may change; deciding whether a company further afield. For example,
there was a proposal floated is sold. If you have an why go to Japan, where you
in 2013 by the CSA in unsolicited offer in Canada have a different culture and
Canada to move to a 5% and the shareholders want a different language and a
threshold. If they do change to accept the offer, the different time zone? It just
the threshold to 5%, it may board will have several doesn't make sense to make
inhibit activist campaigns months to look for (Continued on page 35)
because the activist might
Volume
Eric Rosenfeld
(Continued from page 34) manufactured their private hired a lot of high-priced
it more difficult. We try to label carbonated soft drinks, branding people, and he put
make it easier on ourselves, CSDs. a sign up on the wall that
not harder. said, "We're not here to
The company was started make money, we're here to
about 60 years ago in make history." He ultimately
Montreal and its succeeded at both – he
Our view is that headquarters were later didn't make any money and
moved to Toronto. It was a now he's history.
since there are so very trusted supplier and
partner with its customers, He proceeded to alienate
many opportunities and CSDs were a very and compete with Cott's
important category to those customers. One of the
in the United States customers. Retailers products they introduced
discounted Coke and Pepsi was called FortiFido. It was
and Canada – and to bring people into their fortified dog water – dog
we're in the same stores but they did not water with vitamins and
make any significant profit minerals added – that sold
time zone, we know selling them. for $1.99 a quart, and came
in four flavors. Rather than
the laws, we know Retailers could sell their going to Walmart, which
private label soda at a lower sells more dog products
the people – that price point but a much than any company in the
higher margin – it was a world, Cott did this on its
there’s no need to very important category to own, and tried to create a
them – and so they would new category and a new
go further afield...It
work with Cott product.
just doesn't make implementing their strategy.
Customers were unhappy,
sense to make it The CEO and founder of sales and profits started
Cott passed away about 16 declining, and the stock
more difficult. We years ago. He was replaced went from $16 to under $3.
by two successive CEOs, The bonds were yielding
try to make it easier each lasting a few years. over 30% at the time, and
Then about eight years ago, that's when we started
on ourselves, not
the board hired a CEO who getting involved. We bought
harder. didn't get the board to drink 8% of the company, I met
the soda, he got the board with the chairman, asked for
to drink the Kool-Aid. He board representation, and
convinced the board that within a few weeks, we
G&D: Can you talk about Cott could double its profit negotiated for four board
any of your other current margins from 18% to 35% if seats out of eleven.
investments or favorite past it moved a lot more into
investments? brands rather than private I went on the board along
label. He thought the with Greg Monahan from
ER: Cott Corporation is an customers would have to Crescendo. We also
interesting story. Cott is the listen to Cott and that Cott brought on a gentleman
largest manufacturer of wouldn't have to listen to its who had been in senior
private label beverages in customers. management at Cott five
the world, and for most of years before and knew how
the major retailers in the He moved the headquarters the strategy worked when it
United States and Canada from Toronto to Tampa, he (Continued on page 36)
and Great Britain, Cott has
Page 36
Eric Rosenfeld
(Continued from page 35) largest private label a potential that this
was the right strategy. Our manufacturer of juices. company could go bankrupt,
fourth board member had and I have no doubt in my
just retired as CEO of Cott is a good example of mind that had there not
Walmart Canada and how we do what we do. been a change, they would
thought it would be a great We don't get involved in the have gone into bankruptcy.
challenge to help turn micro-management of the However, we thought that
around the company. He company – my previous the fix was so simple that it
came from Cott’s largest experience with soda was could be executed quickly
customer, in one of their drinking soda. What we do enough to save the
largest countries, and is make sure that the right company.
brought a retailer's management team is in place
perspective, a customer's (the CFO and the general G&D: You mentioned that
perspective, to the board. counsel were also replaced you don't try to be
at Cott), make sure that the operators but instead try to
While we were in right strategy is in place, and find good management.
negotiations, the existing make sure that the right What do you look for in a
board fired the CEO, and capital structure is in place. good manager and how do
when we came on the you think about matching a
board we were immediately manager to a particular
tasked with finding a new situation?
CEO. We ended up
promoting someone from ER: In general, I’ve found
within the company who
“We don't get
that a good manager is
was great at execution and involved in the someone who is a good
hadn't been responsible for delegator – once a company
setting that wrong strategy, micro-management gets large, it's pretty difficult
and he's been a great CEO. to really micromanage. A
of the good manager has
After that, our job was to confidence in his or her
get the customers to love company….What opinions but is also willing
and trust Cott again. It was to take constructive
simpler since we didn't have
we do is make sure
criticism. A good CEO
to figure out a new strategy that the right works well with the board
– we just had to go back to and has the trust of the
the old strategy, stop management team board and the respect of
competing against our the people at the company.
customers, cut the is in place.”
overhead that had been Knowledge of the industry
built up, get rid of FortiFido, is important, but there are
and take the sign off the good CEOs who have
wall. moved from one industry to
G&D: You mentioned another and done very, very
We did all that and within Cott’s bonds were yielding well.
about one and a half years, 30% which sounds like a
the stock rallied to $9. The distressed situation. Do you G&D: Thank you very
company has instituted a ever get concerned about much for your time.
dividend and a stock buy- something like that or
back program, it has consider buying debt?
refinanced its debt, which is
now trading around 6%, and ER: Their debt was our
it has also made a large biggest concern. There was
acquisition and bought the
Volume
CBS at the Center of Women in Investing
Columbia Business School students talk to panelists at the Heilbrunn Center’s

Women and Value Investing Lunch on March 6, 2014.
Current Columbia Business School students at the Cornell Columbia Business School students
Women in Investing Conference in November 2013. Suhasini Bhargava ’15 and Kathy He ’15.
The CBS team presents their

stock pitch at the Cornell Women
in Value Investing Conference in
November 2013.
For more information, please visit the

Heilbrunn Center’s page on
Women and Value Investing:
valueinvesting/resources/
Women_andValueInvesting
Page 38
H. Kevin Byun
(Continued from page 1) G&D: How has special situ- I’ll add that there is a huge
Graham & Doddsville ations investing, and your secular wave of special situ-
(G&D): How did you be- style, evolved since you ations that is getting bigger.
come interested in invest- launched your fund? New spin-offs are an-
ing? nounced every week it
HKB: Coach John Wooden seems. Pressure is building
H. Kevin Byun (HKB): I used to start every basket- for increased M&A activity.
had always been interested ball season by showing his There are many interesting
in finance and investing but players how to put on their opportunities for special
H. Kevin Byun it became very clear what I socks. The fundamentals situations investors. It’s a
needed to do when I read haven’t really changed at all. very busy time.
Joel Greenblatt’s first book, The framework and philoso-
You Can Be a Stock Market phy has always been that of G&D: Can you talk about
Genius, which is about spe- opportunistic investing. The your perspective on portfo-
cial situations investing. I types of investments de- lio and risk management?
had found a logical way to pends on what opportuni-
find opportunities in the ties have presented them- HKB: I’ve learned that find-
markets. It’s a framework selves, be it liquidations, ing great ideas and portfolio
and philosophy grounded in Dutch tenders, spin-offs, management are very differ-
fundamental analysis and split-offs, bankruptcies, ent skills. Both are critical.
value investing. transformative M&A, et Since the start, my main
cetera. There are many dif- focus was on fundamental
The other equally important ferent special situations that analysis and finding great
influence was Warren Buf- can arise in any sector or ideas. My conviction on the
fett’s original partnership industry. You just have to value of fundamental analysis
letters, which discussed be ready for them. has only gotten stronger.
many of his special situa- But from experience, my
tions investments in the I can speak about my evolv- view on portfolio manage-
1950s. Buffett was an activ- ing approach to special situ- ment has changed. You can
ist investor as well, and peo- ations though. When I start- learn from my experience.
ple forget how aggressive of ed out, I leaned more heavi-
an investor he was. What I ly on quantitative analyses. I Since the start of the fund, I
saw was that there was sub- could hang my hat on the had been running 50% cash
stantial overlap between quantitative analysis and still from 2008-10. We made
Greenblatt and Buffett's do well with that alone, solid returns every year.
processes. While they were without needing the more Even in 2008 we made over
effective across different qualitative feel for context 30% with no shorts, all spe-
decades, I could see the and situational dynamics. cial situations. In 2011 there
overlap in their fundamen- However, now I see you was a concentrated window
tals. I was shocked that develop a sense and become in which many incredibly
most people did not manage more efficient and effective interesting ideas had cata-
their money this way, but in terms figuring out the lysts in the back half of the
it’s a big world and there’s factors that will drive a par- year. I utilized more com-
no one right way. My view ticular investment. Many plex options positions to
was that special situations times it may simply be an express these ideas, some-
investing would be my way understanding of manage- thing I had never done be-
to find great ideas and pro- ment or board incentives, fore or since. That was July
duce outsized returns. The which can be very powerful, 2011. What happened in
great part about it was that while the numbers may hide August the next month? The
they provided me with a what is really there. European financial crisis hit,
clear template on how to and the market tanked.
do it. It’s been working (Continued on page 39)
great so far.
Volume
H. Kevin Byun
(Continued from page 38) attended Columbia Business down. I wanted other risks
It was painful at the time but School and entered the Val- removed, be it business risk,
it was the best experience ue Investing Program specif- career risk, the politics, and
in my career. I learned a ically because I found out so on. I wanted to build a
very good lesson. I really Joel Greenblatt taught a truly independent firm that
questioned everything at class there and I wanted to was structured in the right
that time. I questioned the take it. In business school, I way. I wanted to take con-
research process, I ques- couldn’t shake the feeling centrated positions, which
tioned the portfolio man- that starting my own fund to me means holding five to
agement, and I was deter- was what I had to do. Dur- ten positions at between 5%
mined not to learn the ing that time, if you were to 15% each. This approach
wrong lessons. When I was walking on the streets of made much more sense to
reflecting on the invest- New York City and me than what I was seeing
ments, I actually gained sneezed, somebody would out there.
more conviction in those hand you $100 million. It
ideas, and those stocks end- was that kind of weird envi- It took some time after
ed up accelerating and hit- ronment that I did not think graduation to get through
ting their target prices faster was sustainable. I thought it the mechanics of launching
than the market. My ideas was more sustainable to be the fund and selecting ser-
ultimately played out the independent for many rea- vice providers. I wanted to
way I expected, but it was a sons. ensure I set up the fund the
challenge to navigate right way so that it was op-
through an unexpected cri- erationally efficient. Once
sis. the basic blocking and tack-
“That’s what ling was taken care of, I’d be
That’s what portfolio man- able to focus on generating
agement and hedging are portfolio returns for my investors.
about. You have to be pre-
pared for those unexpected management and What’s more important is
events and be in a position how to structure the part-
where you can manage hedging are about. nership the right way. For
those risks. I’ve grown to this, I basically tore a page
have a much greater appre-
You have to be
out of the original Buffett
ciation for getting that part prepared for those partnership structure in
right. Right now we have terms of the compensation
about a quarter cash and in unexpected events and fee structure because it
this environment it’s a good seemed more aligned to me,
balance. That balance is ac- and be in a position which is a 6% hurdle and
tually what allowed us to above that 25% perfor-
return 67% in 2013 while where you can mance. I like the hurdle.
maintaining 30% cash. 2014
has been a good year so far
manage those
It was really just taking a
as well. risks.” bunch of simple concepts
and setting them up in the
G&D: You started Denali right way. I was basically
Investors in 2007 shortly taking the addition by sub-
after graduating from Co- I wanted my fund to focus traction approach so that
lumbia Business School. Can on compounding returns when I started I had im-
you describe the process and keeping my investors’ proved my chances. Also, a
and challenges in starting interests as the top priority. year after I started came the
your fund? The very structure of some greatest gift that an investor
funds turns this upside (Continued on page 40)
HKB: I’ll start by saying I
Page 40
H. Kevin Byun
(Continued from page 39) ing. You start with basic when the market dropped
could have asked for, the questions, which leads to sharply but rebounded
2008 financial crisis. It was a more questions and it multi- quickly. This past week in
very exceptional time to be plies. But that is the only early April, the same pat-
investing. The fund did very way to get to the other side tern occurred and it is very
well. where you earn the right to volatile beneath the surface.
simplify appropriately. You Funds are struggling. They
One of the early challenges have to go through that are reducing their gross and
for me at Columbia was that difficult, frustrating stage net exposures significantly.
I knew I wanted to launch a first. I remember there was You can feel that pressure
fund, but I also knew I need- this forgotten room behind downwards on a lot of
ed more context and better the IT department with no trendy names. That said, it is
investing situational aware- windows and an industrial creating opportunity for
ness. What I had learned up printer and I would print investors with cash. There
to that point was just the tip out reams of filings, write- are more interesting special
of the iceberg. There were ups, everything, and just sit situation names to look at
skills I needed to develop. I and read through them all. now than there were last
remember thinking – how year despite the markets
do I get the most out of my I kept a detailed record of being higher. My focus re-
time here, learn the most? my questions to ensure I mains on building the port-
One of those crazy projects was diligent about getting up folio one solid idea at a
I took upon myself to do the learning curve and time, but I am diligent about
while at Columbia was to reaching those inflection the position level and mar-
read every Value Investors points. There really wasn’t ket hedges to help get us
Club write-up. I didn’t know anything magical about the through a more volatile
what I was getting myself process when you’re look- environment.
into. ing in from the outside. As I
went through all of these G&D: How would you de-
G&D: I hope there were a materials I absorbed more scribe your current pipeline,
lot fewer write ups then and more investing refer- particularly in the context of
than there are now. ence points, more case your 30% cash position?
studies in terms of the re-
HKB: There’s more than search, the analysis, and the HKB: There are roughly
twice the number of write thought process. It was 400 ideas that are on our
ups now because Value In- something that made a lot watch list. 40 of those 400
vestors Club started in of sense for me personally are in the pipeline, which
2000, but the one thing that and greatly accelerated my are more interesting ideas.
I hadn’t factored in was the understanding. Among those 40, I’m look-
Q&A section. The volume ing for one to be good
of content there is impres- G&D: Contrasting 2008 to enough to replace an exist-
sive, some of it very high now, what are your ing position, of which there
quality. In many ways the thoughts on the market as it are ten. If the market pres-
Q&A is much more valuable currently stands? sure results in another large
than the write-ups them- selloff, it may create another
selves. You have the write- HKB: At the beginning of window to be able to act
up, which is basically adver- 2014, I sized up the position decisively. I’ve always
tising, and then you have the level and market hedges viewed our cash position as
Q&A critique, which helps significantly. I believed 2014 very beneficial and a key
keep things honest. would be a year of height- strategic asset.
My goal then was to read all ened volatility. We saw
these ideas and keep learn- some of it at the end of
ing whereas a lot of people January and early February, (Continued on page 41)
stop because it gets frustrat-
Volume
H. Kevin Byun
(Continued from page 40) situations is that, from point the occurrence of this up-
G&D: How do you source A to point B, you have a coming event. But options
and narrow down your op- clearer line of sight, in the are generally priced off
portunity set? way that a sports event or a models that look backward,
sports game has a start and not what’s about to happen.
HKB: There are many spe- an end. This is similar in that That’s inherently very inter-
cial situation opportunities we expect that a certain esting. It’s very different
these days. Sourcing is event will occur over a cer- from what I think is the Professor Bruce Green-
mostly following the news tain period of time. It may more common narrative wald and Alex Porter at
flow and paying attention. be a spin-off, a merger, a that you’ll buy something the 2014 Moon Lee Prize
Having been at this game a liquidation, or a tender, et and you don’t care where it Competition.
little while, it’s a bit simpler cetera. trades because you’re look-
to identify the particular ing three to five years out. We at Columbia Business
drivers for each idea and to Those investments can School and the whole
decide which ideas to allo- Value Investing Communi-
make sense and we’ve made
cate more time to. A new ty were deeply saddened
them. But I believe definitive to hear of the recent loss
idea may be one that re- “[Idea] sourcing is catalysts create a much of our dear friend and
minds you of a previous idea higher-probability way to thought-leader Alex
or it could be an unex- mostly following the extract value over time. Porter.
pected opportunity. I will
say it is definitely much news flow and Between 1976 and 1993,
Whether you create that
more work to get to fewer through straight equity or Porter’s fund, which he
paying attention.
names. But it’s worth it. whether you incorporate called “Amici,” generated a
net compound annual
Having been at this options as a way to magnify
return on the order of 20
G&D: You’ve talked about the return in a cost-effective percent. Amici Capital
using options to structure game a little while, manner or to skew the risk today manages $2.2 billion.
interesting risk/reward sce- reward by creating certain Alex will not only be re-
narios around special situa- it’s a bit simpler to hedges, there are a lot of membered for his great
tions. Can you talk a bit potential ways to construct success on Wall Street,
more about this? identify the but also for his tremen-
the trade depending on the
pricing and availability. But dously kind and consider-
particular drivers
HKB: The options market when you can put these ate nature.
is actually quite elegant and for each idea and to multiple pieces together it’s
beautiful. For the ideas we The Heilbrunn Center will
much more powerful than be proud to continue
are investing in where we decide which ideas just being purely a straight Alex’s generous legacy of
see that the stock is mis- equity investor or being giving back and supporting
priced, by definition the to allocate more purely an options investor. student ideas through the
option is being priced off of Moon Lee Prize Competi-
the stock so the option is time to.” tion, which we co-produce
G&D: Can you walk us
also inherently mispriced, through a particularly suc- with Amici Capital each
but much more so. Some cessful hedging strategy? January. We feel incredi-
investors may not appreci- bly grateful to have known
ate the options market. Alex and he will be greatly
HKB: In Q4 2011, we iden- missed by all.
They also might not appre- There are some events that tified Genworth as severely
ciate special situations. I’ve you know are approaching mispriced. At the time, it
found that the combination and where you see a discon- was a $5 stock. We accu-
of those different areas can nect between the current mulated a decent position
actually create some very stock price and the appro- that comprised 10% of our
powerful ways to express a priate value. holdings. As the stock dou-
thesis or an investment idea. bled, I became concerned
It takes a while to get a feel The market is forced to this position may start to
for each of those areas. revalue that security upon (Continued on page 42)
What’s great about special
Page 42
H. Kevin Byun
(Continued from page 41) and its spin-off, Knowles that go into all of our
overwhelm the book. I (KN). phones, tablets, laptops, and
wanted to manage the in- hearing aids. Knowles owns
creasing size. One way was Dover is a $15 billion mar- that space. If you think
to use a stock replacement ket cap company and about the number of units
strategy, in which you can Knowles is roughly $2.5 of smartphones, tablets,
take 90% or 95% of the billion. Dover was trading laptops, etc., the runway is
Joe Goldschmid ’14, Allen gains off the table and then
Keel ’14 and Mahmud
close to $100 per share, but simple to understand. The
replace that with 5% or 10% dropped 10% before the ASP for a current system is
Riffat ’14 present their
via calls. That way you’re spin-off when the manage- roughly $2 to $3, which will
thesis on Cablevision
(CVC) at the 2014 Per- still getting similar exposure ment lowered guidance on increase to $4 to $6 as mo-
shing Square Challenge. to a longer term thesis, but its earnings call. Then all of bile devices become more
you’re managing the risk in a sudden you had the mar- sophisticated. On the cost
terms of holding very large ket selloff in February, and it side, Knowles will reduce its
position, and the volatility of was down another 10%. 18 facilities down to 11,
that position over the short which should save it $40 to
term. Now Genworth is at At the time, New Dover (ex $50 million a year. Compa-
$18 so we’ve used that tac- -Knowles) was valued in the rables trade at much higher
tic a number of times. mid to high $60s, and I be- valuations than Knowles. I
lieved the fair value to be believe fundamentals and
Another example is SunEdi- between $80 and $90. I margins will improve signifi-
son from 2012. A series of thought the Knowles spin- cantly.
catalysts occurred with re- off was worth at least $15
spect to SunEdison that to $20 per pre-split share. G&D: What gave you the
resulted in a tripling of its After the sudden selloff, sense that Knowles’ projec-
share price. I took about Dover became incredibly tions were potentially un-
40% of that position and interesting and became a derstated?
placed a collar on it, keeping core position. All of this
it tighter on the downside occurred when the market HKB: I thought it was in-
and more room on the up- lost its mind, and the man- teresting that Knowles grew
side. I didn’t want to have agement created this cover through the implosion of
my investors dealing with by taking down guidance. Nokia and Blackberry sales
short term capital gains Even better, the catalyst was because there were large
when it wasn’t necessary. I right around the corner, customers. This is because
believed there was still sig- less than one month away. Knowles is in every other
nificant upside through OEM such as Samsung and
carve-outs of certain enti- New Dover increased 25%, Apple. Since the NOK and
ties that I expected would reaching our mid-term tar- BBRY headwind is now
drive further value. But giv- get price very quickly by over, fundamentals could
en the volatility in the stock, March. We exited New ramp sharply.
we appropriately incorpo- Dover and rolled the pro-
rated hedges to manage ceeds into the spin-off, More generally, manage-
through the catalysts. Knowles, which had not ment teams are catching on
moved. Knowles appears to to the benefits of spin-offs in
G&D: Let’s discuss ideas. be a classic case of an or- terms of their personal in-
Could you share one you phaned spin-off – it is much centives and compensation;
are involved in currently? smaller than its parent com- the lower the price of the
pany, has a different focus, spin-off entity, the better off
HKB: One company I’ve and started with no analyst economically the manage-
been following for quite coverage. But Knowles’ ment team will be as their
some time and initiated a business is simple: it pro- compensation packages get
position in last quarter is vides the acoustic systems (Continued on page 43)
Dover Industries (DOV)
Volume
H. Kevin Byun
(Continued from page 42) The RYAM spin-off should this was deliberately struc-
struck at lower prices. In- be valued at roughly $25 to tured because Rayonier
centives are powerful and $35 per share post-spin Advanced Materials is a high
may compel management based on my valuation. cash flow business, and will
teams to lean conservatively Based on management com- have the ability to de-lever
on their numbers ahead of a ments during a conference quickly. The initial equity
spin. This could be prudent, call, the dividend yield for valuation for Rayonier Ad-
opportunistic, in their self- RYAM is expected to be vanced Materials will be
interest, or all of the above. 1.5%, which translates very lower due to the initial lev-
roughly to $0.50 per share erage. Interestingly, the
G&D: Could you share on a share price of $25 to Chairman & CEO is going
another special situation $35. Management also stat- with the spin-off. Lastly,
idea? ed that the total expected New Rayonier will have the
“Incentives are
dividend distribution for lowest leverage by far powerful, and may
HKB: Another one that I’ve both entities should be in among comparables, which
been following since last line with the current divi- will be interesting for strate- compel
year is Rayonier’s (RYN) dend of $2 per share. This gics. Events will beget
upcoming spin-off of its spe- leaves $1.50 for the parent events. management teams
cialty chemical business, company to distribute. At a
Rayonier Advanced Materi- 4% yield, that already puts G&D: Is there another idea to lean
als (RYAM) which is two- you in the high $30s. So you can share?
thirds of Rayonier’s busi- what does that mean? If the
conservatively on
ness. Most of the cellulose current stock is at $45 and HKB: Well, no special situ-
specialties business is in their numbers
you have the spin-off that I ations conversation would
cellulose acetate, which believe is worth at the mid- be complete without men- ahead of a spin.
turns wood into the plastic point $30. That creates a tioning John Malone. This is
fiber that is used in cigarette stub of $15 for New Ray- one of the most interesting This could be
filters. It is a very high– onier which should by itself windows in the Malone era
margin and attractive busi- be worth at least $30 to because we have three Lib- prudent,
ness. I believe it warrants a $40. That’s interesting. erty spin-offs that are oc-
much higher multiple. curring this year: Liberty
opportunistic, in
Depending on how the dif- Media (LMCA), Liberty In- their self–interest,
Rayonier is a timber REIT, ferent pieces initially trade teractive (LINTA), and Lib-
and the timber REIT inves- we’re talking about two erty Ventures (LVNTA). or all of the above.”
tor base is generally seeking entities together that are These are seemingly dispar-
dividend yield. There are incredibly mispriced. The ate businesses whose value
already several pure plays in reason is because the exist- will be unlocked in similar
the timber space that trade ing dividend yield seeking ways.
at 3.5% to 4% dividend investor base sees this cur-
yields. Rayonier is currently rent Rayonier as worst-in- With Liberty Media, they’re
wide of that, despite my class because of its chemi- going to create a tracking
belief that its 2.6 million cals business, while the spe- stock for Liberty Broadband
acres of land is of higher cialty chemicals investors (LBRDA). With respect to
quality relative to its peers. are avoiding it because it’s Liberty Interactive, two new
But let’s say I’m not a lum- inside a timber REIT busi- entities will be created: Lib-
berjack and that’s wrong ness. erty Digital (LDCA) and
and it is similar quality. Then QVC (QVCA). QVC is a
it should trade in-line with Another interesting wrinkle very underappreciated busi-
its peers. Well, right now is that roughly three-fourths ness. Liberty Ventures is
the stock is at roughly $45 of the debt will be moved to essentially a publicly traded
and the dividend per share the RYAM spin-off. That hedge fund run by John
is about $2. signals a few things. I believe (Continued on page 44)
Page 44
H. Kevin Byun
(Continued from page 43) as John Malone was able to were no books in English
Malone and Greg Maffei. spin off Starz at a bargain. about him. I complained to
Liberty Ventures will spin- Yet Starz came out and was him that everyone here
off Liberty TripAdvisor incredibly cheap and was wants to know more about
Holdings (LTRPA) which trading at a very steep dis- you. By everyone I meant
will hold the 22% economic count to all of its peers. We me. I said it’s crazy nothing
stake and 57% voting stake bought Starz post-spin. In has been translated yet. I
in TripAdvisor (TRIP) along just over a year and a half said it’s hilarious when your
with the BuySeasons entity Starz more than doubled. first company sold a multi-
and some debt. language pocket translator!
Liberty Broadband is doing a He was deep into the Sprint
Now what looked like three similar structure with a acquisition. But a few
complicated companies in rights offering. What’s great months later the first book
very short order will look about it is that, if you’ve ever in English shows up on
very different and simplify done the background work, Amazon. I recommend Aim-
into six less complicated you can get a sense of the ing High. I think the Sprint T
entities. There is really no context of the events that -Mobile deal happens, by the
analysis across all these enti- are coming around the cor- way. It would be great for
ties particularly because ner. I believe that even to- consumers.
each seemingly operates in a day these entities are trad-
different industry. But the ing at substantial discounts G&D: Those sound great.
way I think about it is, if you to their value with the cata- One last question, do you
do the work and identify the lysts getting closer. So it’s have any advice for current
key drivers for each busi- worth paying attention. students looking to enter
ness, then you can identify the investment management
the opportunities with the G&D: That’s a lot of tick- industry?
most upside. ers, John Malone certainly
likes his tax–free spin-offs. HKB: I’ve always believed
I should mention that Liber- On another track, since you investing is meritocratic.
ty Ventures itself is a sepa- are an avid reader, do you Your work, discipline, and
ration from Liberty Interac- have any book recommen- purpose will determine
tive. When Liberty Ventures dations? whether you make it. There
came out, it was panned is no birthright to insight
pretty heavily because it was HKB: I found it very helpful and that’s a great thing. Get
perceived as an opaque enti- to read books about suc- very focused and earn your
ty and began trading at $40 cessful entrepreneurs, inves- place at the table.
per share. As the discount tors, and financial history.
has narrowed and the NAV You can pick up a lot of G&D: Thank you for taking
has increased, the stock has good ideas. Ray Kroc’s the time to speak with us,
tripled. Liberty Ventures book, Grinding It Out: The Mr. Byun.
also came out with a seem- Making of McDonald’s.
ingly complex rights offering Another one is How to Be
in the way that the separa- Rich by J. Paul Getty. One
tion was structured. more is Alchemy of Finance
by George Soros. Don’t let
The previous spin-off of the bad titles fool you.
Starz (STRZA) from Liberty
Media was another interest- Last year, I began reading
ing idea. John Malone was everything I could about
literally giving his plan away Masayoshi Son. He is one of
ahead of time. You can the greatest entrepreneurs
question how someone as that ever lived. Yet there
well-known and respected
Volume
2014 Moon Lee Prize Competition

On January 31, 2014, Amici Capital hosted the 5th annual Moon
Lee Prize Competition. The prize is given in memoriam of Moon
Lee, a dedicated value investor with Amici Capital from 2003 to
2008, who demonstrated a tireless ability to identify and analyze
deep-value opportunities that few could see. In his honor, his
friends at Amici Capital initiated this competition. Finalists – who
were selected based on pitches submitted by students taking a
course in Applied Value Investing – included Stephen Lieu (XPO
Logistics), Patrick Stadelhofer (World Acceptance Corp.), Akhil
Subramanian (Pandora), and Jackson Thies (Post Hold-
ings). Patrick Stadelhofer won the $15,000 first-place prize while
Akhil Subramanian took home $5,000 for his second-place finish.
Jon Friedland ’97 opens the event.
Patrick Stadelhofer ’14 (first place winner) presents his thesis. Professor Bruce Greenwald asks questions.
The four finalists pose after the competition. Louisa Serene Schneider ’06 talks with alumni.
Get Involved:
valueinvesting@gsb.columbia.edu. Available positions also may be posted directly on the

New York, NY 10027
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Graham & Doddsville
Issue XXII Fall 2014

Inside this issue:
Omaha Dinner P. 3
Wally Weitz —
5x5x5 Student
Power of Good Management
Value Investing
Wally Weitz is the Founder and President of Weitz
Fund P. 4 Investment Management, an Omaha-based fund manager
with over $5 billion in AUM. Influenced by the value investing
Wally Weitz P. 6 philosophy of Benjamin Graham and Warren Buffett, Mr.
Weitz started his career as a securities analyst in New York
Guy Gottfried P. 14 after earning a BA in Economics from Carleton College in
1970. He then joined Chiles, Heider, & Co. in Omaha,
Columbia IIC working there for ten years before starting his own fund in
Meeting Ideas P. 22 Wally Weitz
Development
Capital Partners P. 26
Guy Gottfried —
Editors:
The Value of Capital Allocation
Matt Ford
MBA 2015 Guy Gottfried is the Founder and Managing Partner of
Rational Investment Group, LP, a Toronto-based investment
Peter Pan firm following a concentrated, risk-averse value approach.
MBA 2015 Prior to founding Rational, Mr. Gottfried was an analyst at
Tom Schweitzer, CFA Fairholme Capital Management. He began his career at
MBA 2015 Veritas Investment Research, Canada’s largest independent
equity research firm. Mr. Gottfried graduated with a BBA
Brendan Dawson with Honors from the Schulich School of Business at York
MBA 2016 Guy Gottfried
University, where he was a President’s Scholarship recipient.
Scott DeBenedett (Continued on page 14)
MBA 2016
Michael Herman Development Capital Partners —
MBA 2016
The Changing Landscape in Africa
Visit us at: Development Capital Partners (DCP) is a New York-
www.grahamanddodd.com based investment manager focused exclusively on Afri-
www.csima.org can markets. The fund was co-founded by Paul Tierney,
Matt Tierney ’02, Gordon McLaughlin ’11, and Matt
Magenheim ’11.
DCP Team
Graham & Doddsville (G&D): Could you start by explaining how you became inter-
ested in investing?
Paul Tierney (PT): I got started in the investment business with no background in
investments. I graduated from college having studied philosophy, and then went into
Page 2

It is our pleasure to bring you They think I’m a book with a Development Capital Partners
the 22nd edition of Graham & couple of legs sticking out.” shared with us the excitement
Doddsville. This student-led Indeed, continuous reading and and challenges of investing in
investment publication of learning is critical to succeeding companies across the African
Columbia Business School (CBS) as an investor, and we thank continent.
is co-sponsored by the Heil- you for counting G&D as part
brunn Center for Graham & of your reading regimen. Lastly, we continue to bring
Dodd Investing and the Colum- you pitches from current stu-
bia Student Investment Manage- For this issue we spoke with dents at CBS. CSIMA’s Invest-
ment Association (CSIMA). six investors from three firms, ment Ideas Club meets regular-
each with a distinct investment ly throughout the year, includ-
To recap the happenings since style and focus. We believe ing during the summer, and
our Spring 2014 issue, the Heil- you will enjoy our interview- provides CBS students the
Louisa Serene Schneider brunn Center hosted the fifth ees’ diverse set of perspectives. opportunity to practice crafting
’06, The Heilbrunn Center annual “From Graham to Buffett and delivering investment pitch-
Director. Louisa skillfully and Beyond” Dinner in Omaha, Wally Weitz, Founder and es. In this issue, we feature two
leads the Center, cultivating held on the eve of the Berkshire President of Weitz Investment ideas from our classmates Kev-
strong relationships with Hathaway Shareholders’ meeting Management in Omaha, NE, in Lin ’16 and Sisy Wang ’16:
some of the world’s most and featuring a panel of re- was our first interview. We long Countrywide PLC (LON:
experienced value inves- nowned speakers. Photos of the discuss how Mr. Weitz’s invest- CWD) and short B&M Europe-
tors, and creating numer- event can be found on page 3. ment philosophy has evolved an Value Retail (LON: BME).
ous learning opportunities over time, his views on valua-
for students interested in We also proudly announce the tion, and assessments of his We strongly believe in the
value investing. The classes formation of our inaugural stu- past and current holdings. value of diversity of thought
sponsored by the Heil- dent-run Value Investing Fund, and experience. These insights
brunn Center are among made possible by a generous gift Guy Gottfried, Founder and come from a variety of sources,
the most heavily demanded from Helibrunn Center Advisory Managing Partner of Rational and we look forward to bring-
and highly rated classes at Board Member Mr. Thomas Investment Group, shares ing you these unique perspec-
Columbia Business School. Russo and his wife Georgina. some of his key investing les- tives and fresh ideas during this
Please read more on page 4. sons with us, including the academic year.
importance of partnering with
As our fellow students begin strong management teams and As always, we thank our
their Fall courses at CBS, we are maintaining a high level of in- interviewees for contributing
reminded of a humorous quote vesting discipline. their time and insights not only
from Charlie Munger: “In my to us, but to the investment
whole life, I have known no wise And as we look for investors community as a whole, and we
people who didn’t read all the with a global perspective, Paul thank you for reading.
time...my children laugh at me. Tierney and his partners at
- G&Dsville Editors
the Faculty Director of the
Heilbrunn Center. The
Investing Program, a rigor-
ous academic curriculum
for particularly committed
practitioners.
The Heilbrunn Center Team, Julia Renowned Columbia Business School

Kimyagarov, Louisa Serene Schneider ’06, alumnus Mario Gabelli ’67 shares his
and Marci Zimmerman, at the May 2014 experiences as a panelist at the May 2014
Omaha Dinner Omaha Dinner
Volume
Issue I, Issue 2
XXII Page 3
“From Graham to Buffett and Beyond” Omaha Dinner 2014
Dinner panelists included Bruce Greenwald, Wally Wally Weitz offers his thoughts alongside Bruce
Weitz, Bill Ackman, Tom Russo, and Mario Gabelli ’67 Greenwald and Bill Ackman
Tom Russo of Gardner, Russo & Gardner, LLC Bill Ackman, Louisa Serene Schneider ’06, Paul Hilal ’92,
and Alex Rodriguez converse during the reception
Page 4
5x5x5 Student Value Investing Fund
Tano Santos, Tom Russo, and Bruce Greenwald at the Louisa Serene Schneider ’06, Glenn Hubbard, Tom Russo,
Value Investing Program Welcome Reception. Mr. Russo and Bruce Greenwald at the official inception of the 5x5x5
donated a generous gift to create the first-ever student Student Value Investing Fund
value investing fund: 5x5x5
Columbia Business School is delighted to announce the formation of its inaugural student-run Value Investing Fund.
This innovative fund was made possible by a generous gift from Thomas Russo and his wife Georgina. Mr. Russo is a
frequent guest lecturer at Columbia Business School, and a member of the Heilbrunn Center Advisory Board. Thanks
to Mr. Russo’s creativity and leadership, this unique entrepreneurial fund is both long-term and aligns with the
fundamental principles of value investing, making it unlike any other student-run fund. The Russos’ gift affords
Columbia’s value investing students the opportunity to connect value-oriented investment theories to real world
practice as they apply their classroom learning in the management of this fund.
The 5x5x5 Student Value Investing Fund was introduced by Mr. Russo to the Heilbrunn community at the Value
Investing Program Welcome Reception on September 12, 2014. In addition to Mr. Russo, the 5x5x5 Fund Board will
consist of five students from the Value Investing Program along with Bruce Greenwald, Robert Heilbrunn Professor of
Finance and Asset Management, and Louisa Serene Schneider ’06, Senior Director of the Heilbrunn Center. During the
Spring 2015 semester, students in the Value Investing course taught by Bruce Greenwald and Tano Santos will have the
opportunity to submit their investment ideas to the 5x5x5 Board. The Board will then choose among these investment
ideas and will articulate five reasons behind each investment. Five of the stocks will then be selected and invested in for
a period of five years. At the end of five years, the original amount, accounting for inflation, will be invested back into
the 5x5x5 Fund and the remainder of the gains will be used to support current-use scholarships for students interested
in investment management. As alumni, program students will remain active managers of the 5x5x5 Fund, continuing
their support of, and connection to, the Heilbrunn Center and Columbia Business School.
Tom Russo discussed the details of the newly created Bruce Greenwald provided an overview of the structure of
5x5x5 Fund with value investing program students and the 5x5x5 Fund to students and alumni from the
alumni Columbia Business School Value Investing Program
Page 5
SAVE THE DATE

January 30, 2015
A full-day event featuring keynote addresses and panel discussions

from some of the most well-known investors in the industry.
Presented by:
and
Visit our website for updates: http://www.csima.org

Calvin Chan CChan15@gsb.columbia.edu
Lou Cherrone LCherrone15@gsb.columbia.edu
James Leo JLeo15@gsb.columbia.edu
Page 6
Wally Weitz
(Continued from page 1) firm in 1970 when I graduated. only three outside
1983 with $11 million in I worked at G.A. Saxton, a shareholders. As you can
assets under management small OTC trading firm. It was guess, the meeting has changed
at the time. a terrific training ground. My over the years.
boss, Artie Dunn, followed the
Graham & Doddsville five hundred stocks we actually I have paid attention to
(G&D): We would love to made a market in and you can Warren over the years. A lot
hear about your background. imagine how deeply we of what I try to do has roots in
How did you originally become covered them. I’m not sure if what I've learned from him. I
interested in investing? he knew who Ben Graham don’t claim to do it as well or
was, but he was intuitively a to be as disciplined, but I
Wally Weitz (WW): My value investor. always feel like he’s looking
mother was a single parent and over my shoulder as I invest or
a social worker so my as I write our investor letters.
Wally Weitz grandparents gave her a small
lump sum of money and That brings us to 1983 when I
introduced her to their stock was thirty-four years old. I left
broker to make sure she “I have paid the brokerage firm to start my
would not have trouble making own investment firm. A group
ends meet. She and I went to attention to Warren of clients invested $11 million
lunch with him, and by the end into three partnerships. We
of it, she was bored stiff while I over the years. A lot kept it simple with a flat 1%
was fascinated. management fee and no
of what I try to do
“carry.” Over time, we
On the way back from the converted the partnerships
has its roots in what
meeting, I started reading How into mutual funds, and, thirty-
To Buy Stocks by Louis Engel, I've learned from one years later, we have 11
which you can still find on funds, primarily focused on
Amazon. It explained the him.” equities.
basics of what a stock is, what
a bond is, and so on. I started The firm now has roughly $6
investing two shares here and billion in assets with an
ten shares there. The ideas investment team of 11. We’re
mainly came from the broker It was supposed to be a a little unconventional in that
in New York. summer job, but I just didn’t we’re willing to hold cash, we
leave, and nobody really run concentrated portfolios,
That was when I was 12, and I noticed. I stayed for almost and we don’t manage to any
became hooked. I went three years before getting particular benchmarks.
through a charting phase, and I married and leaving New York Everybody at Weitz has
was keeping 100 charts a day for Omaha. I joined a regional virtually all of their investable
and trading on them using brokerage firm and was asked funds and all of their
technical indicators. Tuition to cover local companies. retirement assets invested in
was cheap in retrospect, but Fortunately, one of those local our funds. Eating the home
losing $50 in the ‘60s seemed companies was Berkshire cooking is true for us. We do
tragic. Hathaway. our own thing, and I feel
fortunate to get paid to do my
Anyway, I stumbled on Ben One of my mentors in New hobby.
Graham when I was at York, Frank Monahan, told me
Carleton College, and I read about Warren Buffett, and my G&D: What was the
Security Analysis. Then, I took a boss in Omaha was a good inspiration to strike out on
correspondence investment friend of Warren’s. He took your own?
course with the New York me to the Berkshire annual
Institute of Finance, giving me meeting when it was held in WW: When I was at Saxton,
the credibility (as to initiative, the National Indemnity the head of the firm called me
not knowledge) to get a lunchroom, and there were (Continued on page 7)
summer job with a Wall Street
Page 7
Wally Weitz
(Continued from page 6) business model and its “paying up” for stocks, because
in one day and said, “You’re competitive “moat.” We try to history has shown that when
doing fine, we’re not paying have a general sense of the the weighted average price-to-
you much, so there's no economic environment, but we value of our portfolios rises,
problem, but what do you do not want to depend on the returns over the next six
want to do with your life?” making correct macro- to twelve months tend to be
economic predictions. In short, lower than when we start
I said, “I’d like to manage if the price of the stock is well from lower P/V levels. If this
money like Harold and Frank.” below what an intelligent were not the case, we would
owner would pay today for the have to find a new investment
He said, “Great, go get some.” whole business, the odds are method.
strong that something good
That was the cold slap in the will happen with the stock. G&D: Could you talk about
face that helped me realize I That's the basic idea. how your investing philosophy
needed to figure out where has changed over time? For
the capital would come from if example, you became more
I wanted to make investment comfortable paying higher
decisions and manage money. multiples for higher quality
“We try to have a businesses. Companies like
My wife and I preferred the Google and TransDigm may
Midwest to New York so we general sense of the not have been in the portfolio
moved to Omaha where a 25 years ago.
regional brokerage firm agreed economic
to let me do research and try WW: I've been paying very
to find accounts to manage. environment, but we
close attention to Warren for
For the next ten years, I 40 years. I heard him say early
do not want to
managed accounts as a broker, on that Munger taught him that
but I thought I could do a depend on making a great business is worth
better job for clients if I could paying up for. In one of his
pool the accounts and charge a correct annual reports, he talked about
fee rather than transaction- economic goodwill as
based commissions. So, I macroeconomic distinguished from accounting
started Weitz & Co. in 1983. goodwill. Economic goodwill
predictions.”
measures the franchise value,
G&D: Could you talk about or the ability to charge
the specific style of investing at premium prices, because of
your fund and your your moat.
philosophical approach?
G&D: How much of a At an intellectual level, I’ve
WW: We try to think like discount to intrinsic value or been aware of that concept for
business owners. We believe private market value is 40 years. I’ve also been familiar
that the value of a business is required to get you interested? with the idea of picking stocks
the present value of the cash as if you only had 20 “punches”
the business will generate in WW: We always used to say on your investing ticket. Being
the future. Investors use we wanted a 50% discount, able to act that way has only
varying definitions of “cash and for years we found that come gradually over time.
flow” or “free cash flow,” but kind of bargain. In recent years, Value investors can be drawn
we focus on “discretionary we have found ourselves to the “statistically cheap,” like
cash flow” – money that could paying 60% or 70%. Valuations a moth to the flame, but
be taken out of the business have risen, and it’s possible our eventually the pain of living
but which the owner might valuation methods have been with mediocre companies
voluntarily reinvest in the too conservative (We use a catches up with you. Learning
business. In making estimates 12% discount rate when we do where to draw the line
of future cash flows, we have discounted cash flow models.) between paying up for quality
to make judgments about the At any rate, we are wary of (Continued on page 8)
sustainability of the company’s
Page 8
Wally Weitz
(Continued from page 7) will try to understand the companies, maybe you would
and accepting a flaw because of company’s business model and not build in much buyback.
a cheap price is part of the fun the degree to which it has Judgment is required. We
of investing. control over its own destiny. eventually get to a model that
Then they'll start developing a we discuss among ourselves.
I would also say that model. We try to estimate the We argue and develop some
management is a major future cash flows that we can level of confidence that we
Mr. Weitz discussing his consideration. Warren has said count on. have an approximately correct
investment experiences that it is good to buy a appraisal number for the
with attendees at the 2014 company that any idiot can business.
Omaha Dinner. run, because sooner or later,
an idiot will be in charge. Fair That might take a month on a
enough. But if we’re buying new company that no one
companies that generate “Learning where to knows much about, or it might
excess cash, it’s terrific if we take an afternoon if it's an area
can trust management to do draw the line we're pretty familiar with and
something smart – accretive to we know the people involved.
per share business value – with between paying up
If a stock has fallen out of bed
that cash. Warren Buffett and for some reason that we
for quality and
John Malone have done believe is temporary, we can
wonders with discretionary accepting a flaw act pretty fast on it.
cash over the years. Most
others have not. because of a cheap G&D: Is there any part of that
process you would say
G&D: Can you take us price is part of the distinguishes Weitz from other
through your investment investors?
process? Perhaps starting from fun of investing.”
idea generation through WW: Our process is probably
establishing a position. similar to that of other value
managers. What might
WW: The ideas come from all I think the most useful part of distinguish us is temperament.
over. We don't do much building the model is making We are not just knee-jerk
mechanical screening. We're sure we understand the contrarians, but we are willing
aware of a number of relationships among the to be early and out of step
companies as a result of variables. We need to know with the market at times. It’s
assessing the businesses we what is important to the future often a good sign when
own, their competitors, and success of the company and investors and analysts agree
the ecosystem. Also, how realistic our assumptions that “the stock is extremely
everybody is reading are. Precise predictions are cheap, but we shouldn’t buy it
interviews and thinking about not required (or possible). We yet because there might be
companies all the time. We believe in the adage: “It’s another bad quarter coming.”
pay attention to a handful of better to be approximately
other investors that we right than precisely wrong.” G&D: You spoke previously
respect. I think the initial idea about how you try to poke
may come from any number of Capital structure is also holes in an investment thesis.
places. important. Is the balance sheet Is there a way to systematically
appropriately levered? How approach that?
When it's a company that's much option dilution will we
really new to our analysts and face? Can we expect WW: I know that others have
new to me, the analysts will opportunistic buybacks? If a process where they assign a
read all the filings for the last we're dealing with a Malone devil’s advocate to look for
few years as well as transcripts company, I think it's okay to trouble. We don’t formalize
of conference calls and assume some stock buybacks that. With a group of eight to
investor days. They will read over time. If you're dealing ten of us, each one coming
about the industry and talk to with many of today’s tech (Continued on page 9)
others in the business. They
Page 9
Wally Weitz
(Continued from page 8) make no pretense about being or they go sideways for a while
from a different place and able to predict the next six or so that business values can
background, we are pretty twelve months. For what it’s grow into their stock prices.
good at poking at the story. worth, the view that seems
We have that debate and, at generally correct to us is that Being reasonably optimistic
some point, if we decide we’re the economy is okay, and so about the environment, if the
comfortable with our appraisal, companies have some control stock market dropped 10% to
we buy the stock. But there over their destinies. 20% tomorrow, we might be
often may be multiple rounds Companies with competitive willing to be 90% to 95%
of research work that come advantages will continue invested. It wouldn’t take a
out of the initial meeting. performing well and becoming move like the one we saw in
more valuable, so I’m not 2008 and 2009 for us to get
G&D: Could you elaborate on bearish – I’m actually pretty excited about some of the
how you view the cash portion optimistic. companies we follow.
of your portfolio? Is it
optionality on future However, it seems as if stock G&D: How do you define and
opportunities or just prices have moved faster than think about risk? Is it in terms
representative of a lack of underlying intrinsic values. The of volatility, permanent loss of
current opportunities? Fall of 2011 was the last time capital, or some other way?
any of us around here were
WW: Well, we would be really excited about price WW: It's absolutely not
quick to say it’s not a market levels in general. Since then, volatility. Howard Marks has
timing call. It’s just a residual almost all our companies have written about this extensively.
that comes from selling things done just fine, but their share He explains it so well that I
when they get expensive and prices have gone up faster than like to point people towards
not finding cheap enough his stuff. He has a new essay
replacements. We try as hard that focuses on various types
as we can to be fully invested, of risk. It's all about the risk of
and the cash represents failure permanent loss as opposed to
to find opportunities that we “It’s often a good volatility.
really like.
sign when investors We love volatility. We try to
G&D: What is the range of appraise a company’s business
cash that you are willing to and analysts agree value and its likely growth
hold? path. The stock price should
that ‘the stock is
be loosely tethered to the
WW: We may hold as much extremely cheap, but business value over time, but
as 30% cash. We have one volatility around that value
fund that’s allowed to borrow we shouldn’t buy it gives us the chance to buy at a
and sell short, and that fund is discount and sell at a premium.
currently 63% net long. Most yet because there
of the funds have around 20% In late '08 and early '09, what
to 25% held in cash at the might be another was then called Liberty Capital
moment. got down to around $3.50.
bad quarter
That was fabulous. The
G&D: Do you have a view on coming.’” successor to that is now about
where you think we are in the $150. Volatility is terrific.
economic cycle? Does that What we don't want is the
view impact your portfolio? permanent loss. In that recent
Marks essay, he goes into all
WW: I’m very skeptical of my their business values. We have the different ways you can
own or anybody else’s ability gone from 60 cent dollars to suffer permanent loss. He talks
to predict the direction of the 90 cent dollars. It seems very about having leverage risk,
stock market. We try to have plausible to me that either liquidity risk, credit risk,
a sense of whether we face stock prices drop back down (Continued on page 10)
headwinds or tailwinds, but we
Page 10
Wally Weitz
(Continued from page 9) rates, one popular notion that cable companies borrowed
interest rate risk, basis risk, may have been carried too far huge sums to build out their
and all those things. Those are is buying “high quality dividend- systems before they had many
all variations that can cause paying stocks.” High quality subscribers. Interest costs and
permanent damage. depreciation created large
losses in the early years.
You have people risk too. You However, cable is a
have situations where “I like Liberty Global
subscription business with low
managers push too hard on the “churn” rates, and cable
because they build
underlings to perform. I think companies developed new
that's where you get the out cable systems products (telephone, pay per
Enrons and the Worldcoms: view and broadband) that they
the frauds. using a lot of could deliver over their
Professionals engage with existing plant. Cash flow
There are all sorts of ways you leverage, generate eventually turned positive and
each other during the
Omaha meetings.
can incur permanent loss, but the stocks went up several-
that's what we're talking about, huge amounts of
fold. We had a similar
not volatility. experience with cellular
free cash flow, and
telephone and benefitted when
G&D: You’ve mentioned in then buy back lots of the industry consolidated.
the past that you view
disproportionate overreactions stock.” G&D: Speaking of cable
to stock market selloffs as companies, we noticed that
ideal opportunities. Given the one of your larger positions is
reduction in quantitative companies that are growing in Liberty Global. Could you
easing, are you positioned to value may be good investments discuss your general thesis on
try to take advantage of a if bought at reasonable prices, that company?
potential market reaction? but the success of the strategy
will not be based on their WW: I like Liberty Global
WW: We joke about that. At dividend yield. Cynical because they build out cable
some point, rates have to go managements have raised a lot systems using a lot of leverage,
up. It’s inevitable. of cheap capital by using the generate huge amounts of free
MLP format to sell over-priced cash flow and then buy back
When that happens, some securities that look attractive lots of stock. Their balance
people will probably be to unsophisticated investors sheet is highly levered, but
surprised and unhappy. We are because of their high current they have a very tax efficient
not positioning the portfolios yields. The most extreme case way to generate equity value
for a particular market may be those royalty trusts per share.
reaction to rising rates. We which will become worthless
consider the likely effect on in a few years yet sell at high That's great when you have
each company of future rate prices, because of their current Mike Fries who is really a good
increases, but we are simply dividend payments. operator and John Malone who
trying to hold companies that is making sure that they're
are cheap in relation to the G&D: Are there common managing that balance sheet. I
future values of the businesses. characteristics in some of your might not be interested in the
most successful investments same company if it were run
G&D: Do you have a view on over time? by some other people.
current popular investment Management makes a huge
themes where people think the WW: We have done really difference in all kinds of
ideas are good, but they are well trading financials when the businesses and it is critical
actually just bad ideas in Fed was raising interest rates. when you're dealing with
disguise and may be exposed at We have done very well over leverage.
some point? the years with cable TV
companies. Investors were They've been very efficient on
WW: Over the last several skeptical in the early years as (Continued on page 11)
years of unusually low interest
Page 11
Wally Weitz
(Continued from page 10) They get terrific margins and when that makes sense. We
the cost structure. They are their business is almost like a generally won’t have a lot of
cost conscious operators and, subscription business. If you advice about how to manage
with Malone, you are also are the sole supplier of the business, but we will let
dealing with hypersensitivity to seatbelts or some type of them know how we feel about
taxes. Their recent merger fastener that has to be bought, strategic direction and capital
with Virgin Media provide it can be a great business. allocation.
major tax advantages. They
have high debt on a per share We like managements that are Management is not going to
basis, but the debt is focused and demanding, but it call us for advice in times of
compartmentalized in that can be dangerous if there is crisis or of great opportunity,
each part is attached to a too much pressure to “make so we want to know them well
different system. They hedged the numbers.” Mae West said, enough that we will trust them
currency and the interest rate “Too much of a good thing can to make the right decisions in
risk. They have paid up in the be wonderful.” Maybe so, but those critical times.
last few years in order to lock we try to be alert to the
in long term interest rates. possibility that a corporate G&D: You’ve talked about
overachiever may be pushing Valeant in the past. Could you
We value it in the mid-$50s too hard. share your view of the
and the stock is around $40. investment case with and
without the Allergan deal?
G&D: Many of our readers Would the failure to complete
know about Buffett and the deal change your opinion
Malone, but are there any “We like to invest in any way?
other underfollowed CEOs or
management teams that you with managers we WW: Well, it would be great
think highly of? if Valeant is able to acquire
trust to treat us Allergan. Given the kinds of
WW: In the banking world businesses they're in, Allergan
the Wells Fargo culture is fairly – to treat us as
has been a natural target for
impressive. They've had three partners rather than Valeant. I don't know what the
or four CEOs since we got odds of success are at this
involved a couple of decades necessary evils.” point. They are probably not a
ago and each has been a strong lot better than 50/50.
leader. They have a culture
that's very different from many But if they don’t buy Allergan,
other major U.S. banks and they will buy something else. I
that's served them very well. G&D: What is your approach get a little queasy when a
When certain large banks got in dealing with management company announces an
crushed in the 2008 and 2009 teams? acquisition and both the buyer
period, we were comfortable and the target go up. The
with Wells. WW: We like to invest with implication is that there's some
managers we trust to treat us magic there. The “magic” with
Nick Howley at TransDigm is a fairly – to treat us as partners Valeant is that the earnings of
very disciplined buyer and rather than necessary evils. the target company increase,
strong operator with a private We want to know if they have because of Valeant’s cutting of
equity mindset, but he's a good, long-term business bloated cost structures. The
collecting companies to keep plan and have a sense as to bear case is that they cut too
instead of selling them a few whether they will execute it far and there’s no real organic
years later like most private well. We want to trust them growth.
equity players. He's buying with capital allocation –
companies that are typically investing in the business when I do feel as if we're riding a
sole suppliers of aftermarket there are good opportunities tiger with Valeant. It's not the
airplane parts. Then once he to compound value and to give same as Berkshire Hathaway
buys them, they just squeeze capital back to shareholders (Continued on page 12)
the costs out year after year.
Page 12
Wally Weitz
(Continued from page 11) other kinds of payment because we took more risk
or a Liberty company. systems, but we were just not than we realized in buying
willing to pay the price. Maybe those stocks. Those banks
G&D: Has your team looked someday we will. It's always a were often over-levered and
at Allergan on a standalone tug of war between the poor loan underwriters, but
basis? Would that be a comfort of owning a great they (and we) got away with it
Tano Santos and value potentially interesting business and the temptation to because home prices always
investing program students investment even if the Valeant buy the statistically cheap rose. Foreclosed properties
at the 2014 Value Investing deal doesn't close? business. In the '70s, I bought a could be sold at minor losses
Program Welcome Recep- few things that were literally (or sometimes gains) and the
tion where the 5x5x5 Stu- WW: Our analyst that net-net Ben Graham stocks. risks didn’t catch up with the
dent Value Investing Fund specializes in healthcare has They were cigar butts. banks. Until they did… in 2007
was announced. liked the business, but not the Hopefully I’ve gotten over that. -2009. We foresaw trouble in
price. It seems as if the the mortgage business, but we
promises they're making now G&D: Can you give an owned some financials that we
about how they're going to be overview of an investment that thought were strong enough
more efficient, have better didn’t go as anticipated, what to survive and take advantage
margins and grow faster are a lessons you learned from that, of the problems of their
little too late. It makes you and how it improved your weaker competitors. When
wonder why they weren’t investment process? losses came in 10-20x as bad
doing that before. as ever before, our “strong”
companies were swamped by
G&D: What would you say is their losses and we suffered
the most important factor for some permanent loss of
a great business? capital.
WW: Well, monopolies are From that experience, we

great. We also like “It's always a tug of learned to be much more
subscription businesses. The imaginative about what can go
cable model is a very good war between the wrong with a business.
one. They had local
monopolies on pay TV in the comfort of owning a
G&D: Munger has this
past and, although they face concept of lifelong learning
great businesses and
more competition today, they that he has talked about. What
still have great business the temptation to do you do or read to make
characteristics. You want the sure you keep getting better all
company that has the great buy the statistically the time? Is there some area
asset that everybody has to where you think you’ve really
have and where you have cheap business.” improved over the years?
pricing power. But then those
things tend to trade at pretty WW: We read all the time.
high prices. Although we like We travel around and see
the comfort of having the great companies, and we read. I’ve
business at a fair price, which tilted a little more toward
Munger talks about, we are WW: Over the years, we business history or biographies
really looking for mispriced have had a series of successful lately. A book like The
assets. The best of the best trades – buying banks and Outsiders is a good example of
rarely look cheap. thrifts after the Fed raised what I like to read. It uses
interest rates and those stocks eight case studies to illustrate
We've come close on some fell. Six to nine months later, how unconventional managers
great businesses like Visa and the Fed always lowered rates can make a huge difference in
MasterCard a couple of times again and the financial stocks creating per share value for
when there were fears that rallied. I now consider those shareholders.
they would be forced to cut trades “bad ideas we got away
prices or that they would be with.” They were bad ideas (Continued on page 13)
hurt by competition from
Page 13
Wally Weitz
(Continued from page 12) been able to buy it at a
Hopefully by reading about the discount to the present value
successes and failures of of its assets, we have. We
others, and examining our own don’t know what the Ventures
mistakes, our investment team portfolio will own in future
has learned to be more years, but we trust
discerning and realistic about management, in this case, to
the companies we research. make good investments on our
behalf.
G&D: Is there a more recent
addition to the portfolio that G&D: This has been great.
you’d be willing to discuss? Thank you for taking the time
with us, Mr. Weitz.
WW: A spin-off of the Liberty
complex, Liberty Ventures, is
complicated but potentially
interesting. Through a series of
acquisitions, Liberty had
accumulated stock positions in
companies they didn’t really
want to keep. In order to
extract the value of these
assets in cash without incurring
capital gains taxes, they sold
exchangeable securities that
are convertible into those
shares. The bonds had 25 to
30 year maturities and very
low coupons. But, because of
the optionality involved,
Liberty imputed a 9% interest
cost that they deducted from
their earnings. So they have
more tax savings than they
have coupon costs. They got
all the value out in cash by
selling these bonds, but they
have a negative cost-of-carry.
In a sense, they receive
additional zero interest loans
each year from the
government. In 20 plus years,
Ventures will have to pay off
the principal of the bonds and
the deferred taxes, but in the
meantime they can invest the
cash any way they wish.
Very few people will want to

bother to figure this one out,
but I think it’s an interesting
investment that is really a
blank canvas for Malone and
Maffei. There has been some
speculative interest in
Ventures, but when we have
Page 14
Guy Gottfried
(Continued from page 1) anything I could get my hands wouldn't have guessed back
Graham & Doddsville on: Greenblatt, Klarman, then that I'd one day be a
(G&D): Can you tell us about Fisher, OID, articles and regular speaker at that very
your background and how you interviews. At Veritas, we had conference.
became interested in a career access to an article database
in investing? called Factiva. Any time I'd In any case, within a few
come across a value investor months of joining Veritas full-
Guy Gottfried (GG): It was or manager that seemed time in 2004, I was promoted
during the junior year of my interesting, I'd search for every to sector analyst covering
undergraduate studies in article that had ever been Canadian income trusts. It was
Toronto when I realized I had written about them and every a solid position for a twenty-
to get a good summer interview they'd ever done and four year old, but the more I
internship in order to land a just devour them. delved into investing, the more
Guy Gottfried desirable job after graduating. motivated I became to excel at
Everyone at my school was it, and by 2006 I resolved to
flocking to accounting, work for a prominent value
marketing, or investment investment firm to further
banking, none of which hone my skills. Fortunately, I
appealed to me. One of my “I read Security managed to join Fairholme as
professors that year, Anthony Analysis, followed that an analyst. Despite having a
Scilipoti, was (and still is) a multi-billion dollar asset base,
partner at Canada's largest up with every there were only five of us on
independent investment the investment team. Everyone
research firm, Veritas Berkshire Hathaway else was roughly twice my age
Investment Research. I worked and I learned some valuable
hard to excel in his class and, letter to shareholders, lessons there.
through that connection, was
able to summer at Veritas. I and by that point I G&D: How did you get
ended up parlaying that into a was hooked on value introduced to Bruce Berkowitz
full-time position. and the Fairholme Team?
investing. I simply
I enjoyed the work right away GG: I knew that I was
and toward the start of my couldn't fathom how competing with Harvard,
summer position, I decided Columbia, and Wharton MBAs
that, if I was going to any other approach with serious work experience,
potentially pursue investing, I and here I was with an
should learn as much as I could could even be undergraduate degree from a
about the discipline. I asked considered investing.” Canadian school that many
the president of the firm if Americans had likely never
there were any books he could heard of. I recognized that I
recommend, and he suggested needed to distinguish myself
Graham's Security Analysis. I somehow. With that in mind,
read that and followed it up I also went to the very first in 2006 I wrote a
with every Berkshire Hathaway Value Investing Congress in comprehensive research
letter to shareholders, and by 2005. I paid for the tickets report on a stock in order to
that point I was hooked on myself and flew from Toronto illustrate what I could
value investing. I simply so I could learn first-hand from contribute and sent it to 12 or
couldn't fathom how any other the likes of Klarman, Einhorn, so firms that I thought would
approach could even be and Ackman. The cost to be great to work for, one of
considered investing; as attend the conference was a which was Fairholme.
Charlie Munger once said, "All lot of money for me back then.
intelligent investing is value Like a true value investor, I G&D: Can you share some
investing – acquiring more than stayed in Midtown Manhattan key lessons you learned while
you are paying for." at a two-star hotel, which was at Fairholme?
really a quasi-hostel with
From there, I gobbled up shared bathrooms. I certainly (Continued on page 15)
Page 15
Guy Gottfried
(Continued from page 14) more than the average fund, that it was like nothing I'd ever
GG: As I mentioned earlier, I the need to understand the experienced. There was one
had long been a voracious insiders' backgrounds, week in particular – the week
reader of books, articles, and operating style and capital of October 6 – when every
interviews by and about allocation throughout their stock I was following fell 10% a
countless great investors, going careers and in different day. I decided that the
back decades. I picked up their business environments. valuations I was seeing were
unique insights and too good to pass up.
perspectives on investing and G&D: You launched Rational I launched Rational in early
applied them to my own Investment Group in 2009. 2009 with $500,000 in outside
portfolio. My time at Fairholme What factors led you to launch capital from one investor. I
reinforced many of those ideas your own firm? knew this would be a difficult
and gave me the opportunity climate in which to raise
to be immersed in value GG: I'd always had the desire capital, but I figured that either
investing every day. to start my own fund and the whole world was coming
hopefully one day become a to an end, which was highly
For instance, Fairholme respected value investor in my unlikely and in which case
reinforced my appreciation for own right. I distinctly you'd be screwed no matter
the value of cash. The first remember one day in the what you were doing in life, or
reason is obvious: it's better to summer of 2005 when I was this represented an
earn nothing in cash than to thinking about the last few extraordinary chance to
potentially lose money by market crashes and the exploit some unbelievable
making a risky investment that bargains and to start building a
isn't up to your standards. strong record.
Second, and perhaps less
intuitively, cash is a weapon. Since inception, we've
When a general market generated net returns of 21% a
dislocation erupts or a “When a general year. That compares to 13%
compelling individual for the TSX Composite Index
opportunity arises, it is only market dislocation in Canada, where the vast
those who have cash – majority of our portfolio has
precisely when everyone else erupts… it is only been invested over the years.
lacks it or is afraid to use it – We've beaten the index by
who are able to capitalize. This those who have about 8% annually while
was an important concept at averaging 24% cash.
Fairholme, and it's a lesson that
cash… who are able
has served me well. to capitalize.” G&D: How would you
characterize your investment
Also, one of the attributes that approach and philosophy?
originally attracted me to
Fairholme's approach when I GG: One of my favorite
researched the firm was its investing quotes comes from
disproportionate emphasis on tremendous investment Benjamin Graham, who wrote
management. At Fairholme, we opportunities that they in The Intelligent Investor,
wanted to understand exactly created. I recall reflecting on "Investing is most intelligent
with whom we were how rarely these events when it is most businesslike."
partnering and to whom we occurred and thinking that the Suppose you were a
were entrusting our capital, next time something like that businessperson considering
just like any sensible happened, I'd do my best to taking a stake in a private
businessperson or private pounce on it. company. What are the
investor would want to do. Of questions that you'd ask
course, none of this came at After Lehman collapsed in late yourself? Chances are you'd
the expense of studying the 2008, the markets’ reaction ask, do I understand this
business, industry, accounting, was so severe, and the fear business? Is the balance sheet
valuation, and so on. But I'd say and irrationality so rampant, (Continued on page 16)
that Fairholme prioritized,
Page 16
Guy Gottfried
(Continued from page 15) start by screening for stocks trusts. Income trusts
sound? Am I partnering with with low multiples to their resembled REITs and MLPs in
the right people – is earnings or free cash flow. But that their structure allowed
management capable and does the most attractive companies to avoid taxation.
it allocate capital shrewdly? opportunities often involve However, in a Canadian twist
And, of course, am I getting a businesses that are under- that was subsequently barred
bargain? earning or even losing money by the federal government, any
Bruce Greenwald discusses
competitive strategy with a and that therefore won't be business in any industry could
And chances are that as a found in a screen. For become a trust.
second-year MBA student
at the 2014 Value Investing private businessperson, you'd example, when Warren Buffett
Program Welcome Recep- probably insist on all of these first invested in GEICO for Since income trusts tended to
tion. criteria being met to your Berkshire Hathaway in the trade at premium valuations,
satisfaction; it would be too many companies adopted the
risky to do otherwise when trust structure, including some
tying up your hard-earned that had no business paying out
capital for multiple years. If you “Knowing that you
all of their earnings. However,
think about it, as a long-term can always change if a trust ever reduced or, God
value investor in the public forbid, eliminated its dividend,
markets, that's exactly what your mind and sell its shares would be cut in half
you're doing. Yet in the public like clockwork. When I was
markets, people often out of a position still at Veritas, I noticed that
compromise on one or more there were almost no
of these criteria. For example, creates a subtle, professional investors who
they'll say, "This isn't as systematically sought out
undervalued as I'd normally subconscious
trusts that stopped paying
like, but I really like the temptation to loosen dividends or cut them
business," or they'll invest in a substantially. This unique
highly leveraged or your standards, special situation became a
mismanaged company because source of a plethora of
it's statistically cheap. That especially when the bargains over the years,
happens all the time and it's including several in Rational’s
arguably due to the illusion of market is strong, and early days.
liquidity. Knowing that you can
always change your mind and that's often where
Another example involves
sell out of a position creates a dilutive debt recapitalizations.
people go wrong.”
subtle, subconscious Suppose that a company has an
temptation to loosen your upcoming debt maturity that it
standards, especially when the 1970s, it was mired in red ink cannot pay off or refinance and
market is strong, and that's and was facing financial is therefore forced to settle
often where people go wrong. difficulties. It is very doubtful that debt with shares. As an
I've found that it's rarely worth that GEICO would have shown equity holder, few things are
making exceptions and that if up on a computerized screen, likelier to make you cringe
you're going to commit your but it was arguably the greatest than your investment being
capital to an investment, you investment that Berkshire ever massively diluted. However, a
should insist on the complete made. debt recap is like a built-in
package. catalyst because the event
Because the best investments itself can eliminate the very
G&D: What is your process don't necessarily stand out by problems that precipitated it. It
for identifying opportunities? conventional means, I try to will often leave companies with
look for special situations that a clean balance sheet and be
GG: First, you can't do the are relatively unrecognized and accompanied by the arrival of
same thing as everybody else underexploited. For instance, intelligent lead shareholders
and expect different results; it as I mentioned earlier, I and the replacement of
is going to be difficult to find formerly was a sector analyst incumbent management that
truly compelling investments covering Canadian income (Continued on page 17)
that way. Many investors might
Page 17
Guy Gottfried
(Continued from page 16) for $1 billion, for a gain of discussed publicly, The Brick
got the company in trouble in $800 million. Consequently, I and Holloway Lodging
the first place. Further, since looked further into Riddell and suspended their dividends,
firms that need to be found out that in the prior half underwent dilutive
recapitalized tend to already a year, he had bought 15% of recapitalizations and had
trade at depressed valuations the outstanding shares of excellent lead shareholders
and the announcement of the another Canadian public come aboard in conjunction
recap will cause their shares to company called Newalta on with their respective recaps.
plunge further, they can still be the open market. Riddell, who
quite cheap despite the had been a Newalta director G&D: These are great
dilution. So here's another case for 20 years, had spent some examples, specifically with how
of a situation that causes $65 million on these purchases you identified Newalta. It
indiscriminate selling and can at double or triple the price at reminds us of a recent
therefore be an attractive which it was trading at the comment from Seth Klarman
source of undervalued time. about how "pulling threads" on
investments. an existing investment leads to
additional investment
Another example arises when opportunities.
you identify great owner-
operators or controlling GG: That's right, and by the
shareholders. Brilliant “Brilliant managers way, there's no shame in using
managers and capital allocators the same method multiple
are rare, and when you find and capital times. It's so difficult to find
one, it can pay to ask, "What truly compelling ideas that you
else is this person involved allocators are rare… have to take them any way you
with?" On occasion, you'll find can get them. When I find
that this individual may be it can pay to ask,
some way of simplifying the
present at other undervalued ‘What else is this process of locating bargains,
companies. For example, in I'm unapologetic about reusing
2009, we invested in a person involved it for as long as it works.
Canadian energy company
called Paramount Resources. with?’” G&D: Can you share with us a
Paramount was founded and current idea in your portfolio?
remains controlled by a
phenomenal owner-operator GG: Holloway Lodging is one
in the Canadian energy space of the ideas that I presented at
named Clay Riddell. What I delved into Newalta and the recent Value Investing
initially drew my attention to found that it, too, was dirt- Congress. Holloway is a
the stock is that it appeared to cheap, trading at just 3x to 4x Canadian hotel company that
have a single asset that was free cash flow despite having a had historically been
worth more than the market near duopoly in its core mismanaged. The company ran
value of the company, giving business of outsourced oilfield into severe problems last
you the rest of the business for waste management. Rational decade after the financial crisis
free. ultimately invested in both and had to eliminate its
companies and made dividend (Holloway used to be
As I dug into the company, I approximately 170% on a REIT). That obviously hurt.
was increasingly impressed Paramount in nine months, and The situation became even
with Riddell's capital allocation. 175% on Newalta in a year-and worse in late 2011 when
Most notably, Paramount had -a-half. Holloway announced that it
leased a significant amount of would have to pay off a
acreage in the Canadian oil In exceptional cases, you'll find maturing debenture entirely
sands in 2001, before people one security that exhibits with shares, diluting existing
were even talking about the oil multiple special situation shareholders by some 90%.
sands. Then, in 2007, when the characteristics. For example, The stock traded at $5 at the
oil sands were all the rage, it among investments that I've (Continued on page 18)
sold a portion of its acreage
Page 18
Guy Gottfried
(Continued from page 17) What makes Royal Host such a and banquet hall, while
time of my presentation tremendous opportunity for Holloway's has no food and
compared to the $150 range, Holloway? The company was beverage offerings. Yet Royal
split-adjusted, before the crisis. very poorly managed for close Host's hotel only generates
Our average cost is around $4. to a decade. From 2006 to around 30% more net
Along with the recap, an 2013, it had three presidents operating income despite being
activist investor took control or CEOs whose average double the size and having the
Students in the 2014-2015 of Holloway in 2012, replaced
Value Investing Program tenure was just 13 months, and food and beverage business.
management, and significantly the rest of the time it was run Second, Royal Host had a hotel
discuss potential investment
ideas. improved the operations. The by committee with no effective it recently sold in Chatham,
company's legacy portfolio is leader prior to the current Ontario, where it was paying
performing very well today. chairman. Without adequate nearly double the property
Where it gets really management, Royal Host didn't taxes of another hotel in
interesting, though, is that pay attention to costs, Chatham owned by a rival
Holloway just completed a underinvested in its assets and company. Same city, same type
transformative takeover whose generally failed to do the basic of hotel, similar size, and Royal
potential I don't think the blocking and tackling of Host was paying approximately
market has caught on to. operating a hotel business. $100,000 more a year in
Specifically, it just closed the property taxes. Amazingly, the
acquisition of another hotel company just never bothered
company called Royal Host. to check competitors'
Although Royal Host doubled “It's so difficult to property tax records and
Holloway's size, it generated appeal its own taxes. Royal
less than 20% of its free cash find truly compelling Host has since made these
flow due to extreme appeals and was able to receive
mismanagement. The deal ideas that you have
prior-year refunds for a
creates tremendous value, majority of its hotels and
to take them any
which I'll demonstrate shortly. generate ongoing savings of
way you can get several hundred thousand
At the time of the dollars annually.
presentation, the stock traded them. When I find
at 7.7x free cash flow based The magnitude of the cost-
only on Holloway's and Royal some way of cutting opportunity at Royal
Host's combined trailing Host is enormous. Some of
results, without any further simplifying the
these initiatives have already
adjustments. That compared to been achieved but have yet to
process of locating
11.7x for Holloway's publicly- flow through Royal Host's
traded peers. If you normalized bargains, I'm trailing financials, let alone
the results for actions that are Holloway's, as the acquisition
already being taken to improve unapologetic about only closed on July 1. Others
Royal Host, the stock would are being worked on as we
trade at just 5x estimated free reusing it for as long speak. Holloway is addressing
cash flow. virtually every major cost item
as it works.”
at Royal Host such as property
Further, if you ignored Royal management, food, insurance,
Host altogether and pretended wages, etc. Overall, Holloway
the acquisition never I'll give you a couple of can generate millions of dollars
happened, Holloway was still examples that illustrate the in annual cost savings, a
valued at 8.4x, equivalent to a mismanagement. Both Royal significant amount for a
12% free cash flow yield and a Host and Holloway have hotels business with $12 million in
28% discount to its peers. In in Yellowknife, Northwest trailing free cash flow. And
other words, the market was Territories. Royal Host's hotel none of these measures are
giving you Holloway at an has 129 rooms; Holloway's has herculean – this is just the
attractive price and throwing 66. Royal Host's is a full- result of running the business
in Royal Host for free. service hotel with a restaurant (Continued on page 19)
Page 19
Guy Gottfried
(Continued from page 18) assets. Factor this in and you bought 9.5% of the company
the way it should be run. I wind up with an estimated on the open market since May.
should also add that these are valuation of 5x free cash flow.
after-tax improvements, as Then, beyond Royal Host, G&D: How have you evolved
Holloway will not be cash Holloway's management is very as a professional investor, and
taxable for the foreseeable capable and allocates capital what are some lessons you
future. intelligently, as the Royal Host have learned at Rational?
acquisition attests. You have a
As another case study, for multi-year horizon over which GG: I launched Rational during
years Royal Host under- management can continue a very anomalous time when I
invested in its most valuable executing accretive deals. If was only twenty-seven years
asset, the Hilton in London, Holloway can grow its old, so I was bound to learn a
Ontario, which is now portfolio from 33 (including thing or two. I'd say that one
Holloway's most valuable asset assumed near-term of my greatest regrets has
as well. Management estimates dispositions) to 50 over four been not reaping the
that by spending $5.5 to $6 appropriate rewards on some
million renovating the hotel, it of my highest-conviction ideas,
can boost net operating and that relates to the issue of
income by $1.5 million per portfolio concentration.
annum. At a 9% cap rate, you'd “...just one
get a $17 million increase in It's fashionable to say you're a
property value on a $6 million unnoticed or concentrated investor, but in
investment. practice it's very challenging.
misinterpreted detail Rejecting an investment that
Royal Host also has numerous clearly has a poor margin of
hidden assets: it has a hotel can result in making safety is easy. The hard part is
near Toronto's Pearson finding an idea that actually is
Airport which only earns cash
the wrong
attractive and still turning it
flow (net operating income investment or down because it isn't up to
less capex) of $300,000 to your high standards and you
$400,000 a year, but could passing up the right can do better, be it by adding
probably be sold for $15 to your current best holdings
million due to its real estate one.” or by waiting for future
value. If Holloway can divest opportunities whose timing
this property and redeploy the you can't know, but which
proceeds into hotel invariably come around from
acquisitions at a 10% cap rate or five years, think about what time to time. That takes great
with a 55% LTV mortgage at free cash flow will be then. discipline.
6%, it would add $2 million to Ultimately, this stock will trade
its free cash flow. And again, at a low single digit multiple, G&D: What is the size of
we're talking about a company which is hard to find in any Rational's team now?
with $12 million in trailing free business nowadays, let alone a
cash flow, so each of the real estate heavy company GG: It's just me and our CFO.
actions I've discussed will that's very well run and has It's unconventional, but I'm a
provide a sizeable boost. years of growth ahead of it. control freak when it comes to
There are likely $20 to $25 What'll the stock be worth at the research process and being
million in disposition that point? Should it trade at entrusted with other people's
opportunities in Royal Host's 8x, 10x, or 12x? It's hard to capital. I'm very cognizant of
portfolio. say, but it doesn't really the fact that just one unnoticed
matter; the point is that your or misinterpreted detail can
So you have this huge growth margin of safety is huge and result in making the wrong
opportunity due to the Royal that it's hard to find a scenario investment or passing up the
Host acquisition that won't where the shares don't right one. Don't get me
take anything heroic to realize; skyrocket. And insiders seem wrong, our due diligence is
it's just cutting costs and to agree: six of them have (Continued on page 20)
capitalizing on under-earning
Page 20
Guy Gottfried
(Continued from page 19) unheralded is the tremendous Imagine that a market
heavily dependent on the focus and productivity he dislocation arrives and instead
knowledge and insights of an achieves on a daily basis by of being able to take advantage,
extensive network of people, structuring his life so that he you're forced to use your cash
including management teams, can virtually always do what he to meet redemption requests
industry specialists, fellow enjoys and actually wants to from panicky investors while
investors, and others who may do. I think I still have a long the opportunity passes you by.
Bill Ackman converses with be familiar with a given way to go before I perfect this, Not only is it counter-
guests at the 2014 Omaha business. You can't attain and but that's how I try tried to productive, but also
Dinner. sustain the necessary arrange things here as well. psychologically, the anguish and
conviction level in an helplessness of being
investment entirely on your handcuffed can leave you
own. People are a critical part “It's fashionable to vulnerable to becoming
of the process; it's just that for irrational and making bad
us, it's been more external say you're a decisions. It is much easier to
than internal in the form of cope with temporary losses
having a team of analysts. That concentrated when you feel that at least
said, I certainly wouldn't rule you're capitalizing on the
out adding an analyst or two investor, but in
environment.
over time under the right
circumstances.
practice it's very
G&D: We noticed you are
challenging… The one of the key speakers at
G&D: Other than your Canada's Capitalize for Kids
presentations at the Value hard part is finding Investor Conference this
Investing Congress, you tend October. How do you view
to keep a low profile. What is an idea that actually this philanthropic endeavor?
your view on publicity as an
investor? is attractive and still
GG: There are countless
turning it down prominent investing
GG: Actually, even the conferences in the US, so this
Congress opportunity came because it isn't up to may be hard to believe, but
about by happenstance, after I Capitalize for Kids is probably
was introduced in 2011 to the your standards… the first large-scale investment
organizer, John Schwartz, by a conference in Canada, let
mutual friend. But you're quite That takes great alone one that is devoted
right, I do tend to keep a low entirely to a philanthropic
profile. Rational doesn't have a discipline.”
cause. What attracted me to
website and it isn't unusual for Capitalize for Kids when I was
me to be contacted by One of the advantages of not first contacted about it by Kyle
prospective investors doing much marketing is that MacDonald, one of the co-
apologizing for calling or the people who do tend to founders, was that it targeted
emailing me directly because locate you are more likely to specific areas within The
they couldn't find any other be like-minded investors. I'm Hospital for Sick Children in
contact information and asking really thrilled with Rational's Toronto that it identified as
me to forward them to our IR capital base – we have being underfunded or in need
person (which, of course, we unbelievable partners. It's very of special attention. The folks
don't have). easy to take such things for at Capitalize for Kids put a
granted, but it's important to great deal of thought not only
I've worked hard to structure stress that regardless of your into organizing the conference
my life and work in a way ability as an investor, you itself, but also into how to best
where I can focus on being won't be able to execute your allocate the proceeds. I was
efficient, eliminating waste and strategy successfully over the impressed by that.
clutter and being in total long haul without a stable
control of how I spend my capital base.
time. Of all of Buffett's great (Continued on page 21)
attributes, one of the most
Page 21
Guy Gottfried
(Continued from page 20) sure turns some people off. I
G&D: Can you share any could go on, but you get the
advice with our readers? idea. You'll go farther in the
long run – and have a great
GG: In one of his old deal more fun – if you do what
partnership letters, Buffett resonates with you instead of
makes the important point that worrying about convention and
in investing, there's a difference how you look in the eyes of
between being conventional others.
and being conservative. Since
convention is dictated by the G&D: That is a valuable piece
crowd, following it will of advice and a great way to
frequently lead you in the conclude our interview. Thank
wrong direction. This is in you for your time, Mr.
keeping with his philosophy of Gottfried.
having an internal scorecard –
of doing what makes sense to
you and judging yourself by
your own standards rather
than the standards of others.
This has been a guiding
principle for me in building
Rational. I've often done things
that didn't exactly help our
marketability because they
were right for me and enabled
me to create an environment
that was suited to my investing
philosophy and personality. For
instance, Rational has never
engaged in short selling. Some
allocators consider this
blasphemous, and there's no
lack of managers who short
mainly to justify their fees.
Personally, I consider it
virtually impossible to find
any short that can come close
to matching a well-researched
long; not only is the upside
capped and downside
unlimited, but even those who
do find great shorts tend to
size them so small that they'd
arguably be better off avoiding
them. Sure, shorting can
reduce volatility, but over time
it's nearly destined to
underperform. There are many
ways to get to heaven in the
industry, but that's what makes
sense to me.
Similarly, I don't have a team of

analysts for the reasons I
articulated earlier, which I'm
Page 22
B&M European Value Retail SA (LON: BME) - Short
Sisy Wang
SWang16@gsb.columbia.edu
Thesis Key Statistics

B&M is an over-hyped IPO story stock (“Dollar General of the UK,
with Tesco management as chairman”). At 25x FY14 and 20x FY15 Share Price (10/7/14) £ 265
Sisy Wang ’16 EV/EBITDA, the stock price is discounting very bullish assumptions Revenue (FY14 - March) £ 1272M
around TAM and market share relative to a small and saturated UK
Sisy Wang is a first-year MBA Adj. EBITDA margin 10.2%
market. Meanwhile, saturation of the concept will intensify competi-
student at Columbia Business tion and drive down margins (at peak today). There is also a stock Market Cap: £2650M
School. Prior to CBS, Sisy was lock-up that expires Dec 2014. Enterprise Value: £3030M
an Analyst at Delaware
Investment’s Emerging Markets Background 3-month avg. daily volume: 4M
Fund and a pre-MBA Summer  B&M is the #2 UK general merchandise discounter (pound store) FY15 EBITDA (my estimate): 20x
Analyst at Plymouth Lane by sales, with a similar operating model as dollar stores in the US.
Capital.  Pound stores’ value proposition is price + convenience. They have a small number of SKUs (3000-5000 vs.
30K for a discount store), which allows them to sell only the most profitable SKUs (highest turn consuma-
bles, highest margin general goods).
 B&M was acquired by two brothers in 2005, and the store base has grown 18x since (21 to 373).
 IPO’ed in June 2014. CD&R bought half of the company in 2013 from management and installed Tesco’s ex-
CEO Sir Terry Leahy as Chairman.
Competitive Landscape – why B&M is not the next Dollar General

 DG benefited from white space in the US – small, rural populations that were not profitable enough for big
box. Given the country’s large size, DG and FDO could grow profitably within their own geographies with-
out much direct competition. Dollar stores mainly gained share from grocery stores, a fragmented and less-
efficiently run group. Operating Metric Comparisons
 The UK retail landscape is much smaller and more B&M PLND DG FDO
concentrated. 50% of the UK population shops Store count 373 458 11,215 7,916
for non-food items in just 90 locations. Unlike in
Sq ft / store 14,145 5,143 7,400 7,200
the US, the grocer space is concentrated (Big 4
Sales / store £3,410 £1,922 $1,561 $1,313
has ~75% share)
Gross margin 34.0% 36.7% 31.1% 34.2%
 Pound stores also face 2 sets of unique competi- EBITDA margin 10.2% 4.9% 11.8% 8.8%
tors that US dollar stores didn’t have: grocery
Turns (on Tang IC) 7.4x 19.5x 5.6x 4.5x
discounters (Aldi, Lidl – a category that largely
PP&E as % sales 5.1% 4.3% 11.9% 16.7%
doesn’t exist in the US) and the “express” ver-
sions of Tescos (Wal-Mart and Target are later to NWC as % sales 8.3% 0.8% 6.0% 5.5%
small format convenience stores vs. UK big box CROTIC (EBITDA / Tang IC) 76.0% 95.7% 66.2% 39.6%
retailers). Net Debt / EBITDA 2.9x (0.3x) 1.4x 0.4x
 Within pound stores, competition is also fiercer.

The sector as a whole doubled store count since 2008 (+1,100 stores total), and the main players are plan-
ning to double store count again (implying UK pound store penetration at 3x that of the US on a % of retail
sales basis).
 Converging geographical expansion: B&M stores are mostly in Northern UK / Midlands, but they are now
expanding into Southern UK. As they expand, they will face more competition from Poundland (national
player) and 99P (Southern UK focus), who are in turn starting to enter B&M’s geographies.
 Recession retail bankruptcies created a one-time land boon for pound stores (around 1/3 of B&M’s leases
today). However, bankruptcies peaked in 2012 both in number and size. Going forward, B&M will face a lot
more pressure on finding cheap leases (rent at 4% of sales is much lower than older competitors).
Management & PE Cashing Out

 IPO was 93% secondary with both management and PE halving their stakes.
 Although CD&R has a track record of creating value, they held this investment for only 1 year (doubling
their money). The extent of their value-add seems to include a small German acquisition (to sell a longer-
term international story) and installing ex-Tesco CEO, Leahy, as Chairman.
Leahy (ex-Tesco) holds no shares in B&M. He is a CD&R advisor and owns shares in the 2009 fund. He sits on
the board of 4 other companies (2 of which he actually is a significant direct investor).
US margins from the low-20s to the mid-/high-20s is just now getting started in
Volume
Issue I, Issue 2
XXII Page 23
B&M European Value Retail SA. (Continued from previous page)

Valuation
 Even putting aside issues on competition, the current valuation barely justifies the most bullish long-term growth
assumptions
 Valuation methodology: I focus on the time it takes for the stock to re-rate to a reasonable multiple (I use DG’s 10x
EV/EBITDA from before the M&A talk) and where CROTIC (cash ROIC) will go. I assume 50 stores per year
(management’s goal is ~40).
 High Case: To stretch the bull case, 8 years for the multiple to erode to a normalized level and CROTIC to expand
to 100% (beyond PNLD’s 96%). This is a scenario where B&M outcompetes its competitors to become one of the
dominant players in the UK, thus retaining profitability as it grows.
 Low case: 3 years for the multiple to erode and CROTIC to mean revert to 60% due to market saturation, increas-
ing competition, and less profitable geographies (still a good return vs. DG’s 66%, FDO’s 40%).
Catalysts
 CD&R’s 180 day lock-up expires Dec 2014
 Growth slows due to less available space (fewer bankruptcies)
 High margins mean-revert due to competition and industry saturation
Risks
 Continued strong growth in short-term from new store opening.
 Strong return profile / cash flow generation – management has set dividend payout at 30-40% ratio
 Technical risk: B&M may get added to FTSE 100 index if market cap reaches £3 billion
Page 24
Countrywide, Plc. (LON: CWD) - Long
Kevin Lin
YLin16@gsb.columbia.edu
Recommendation
Market Overview
Buy Countrywide (LSE:CWD) equity with a 12/31/18 base case price Stock Price (10/8/14) £4.73
target of £8.35. This represents ~90% upside from the current share
Shares Out (Diluted) 226
price, including dividends. The investment thesis has five main points: Equity Value £1,067
1) Countrywide should benefit from a recovery in housing transac- Less: Cash (44)
Kevin Lin ’16 tion volumes in the U.K., which currently sits ~15%-20% below Plus: Debt 118
historical levels Enterprise Value £1,141
Kevin Lin is a first-year MBA 2) The cost structure has changed post recession, with ~40%+
student at Columbia Business incremental margins and long term margin targets well in excess Current Valuation (Consensus)
School. Prior to CBS, Kevin was
of prior 2006 peak EV / 2014E EBITDA 9.0x
an associate at Sansome
Partners, a long only family 3) The business will generate high FCF (~£400m over next 5 Price / 2014E EPS 11.8x
years), and the Company has directed 35%-45% (but up to 70%, Dividend Yield 2.4%
fund.
barring any acquisitions) of net income to be returned to share-
holders
4) Countrywide continues to find opportunities to “roll up” rental businesses at 20-25% return on acquisitions
(within 2 years) and believes there is room to double its market share over time
5) Management incentives are aligned with shareholders, with options based off EPS and TSR targets
Countrywide is the largest real estate agency in the Revenue / EBITDA Breakdown (LTM 6/30/14)
United Kingdom, operating ~1,370 branches and 47 100%
brands. The Company has 6% market share of UK LSH LSH
90% Conveying Conveying
housing transactions, followed by LSL Property Ser-
Surveying Surveying
vices (3%) and Connells (estimated ~3%). The Com- 80%
pany was acquired by Apollo in 2007 (Oaktree and Financial Financial
70%
Alchemy took stakes in 2009), and IPO’d on the
60% £660.5Lettings
London Stock Exchange in March 2013. LTM Lettings
6/30/2014, Countrywide generated £661 million of 50% £105.2
London &
£105.2
revenue and £105 million of EBITDA. 40%
Premier
Countrywide is the dominant player in a cyclical 30% London &
industry that is operating below historical norms. Premier
20%
Following the recession, the Company restructured, Real Estate
10%
reduced fixed costs, and improved employee Real Estate
productivity. In addition, the Company has diversified 0%
by growing its lettings (rental) business, which is Revenues EBITDA
countercyclical to transaction volumes and now
accounts for ~1/4 of EBITDA.
I believe Countrywide has significant operating leverage and will be able to generate strong earnings growth as the
market recovers. The Company enjoys economies of scope (provides surveying, conveyance, and financing ser-
vices in conjunction with real estate brokerage) as well as economies of scale (national back office infrastructure).
Combined with low capex requirements, good reinvestment opportunities, and strong shareholder alignment, I
believe Countrywide can compound at double digits over the next 4-5 years.
Investment Thesis
1) Rebound in Housing Transactions
Transaction volumes in the UK were ~1 million in 2013, and are estimated to be ~1.2 million this year. This com-
pares to long term averages of ~1.4 million (after factoring out the number of transactions associated with increas-
ing home penetration levels). Residential investments sit at 4.0% of GDP, compared to 4.5%-5.0% pre-recession
(7% at peak), and UK household turnover has fallen to 4.1%, versus an estimated 6.9% average since 1971. The
current rate implies households will now move every ~25 years versus every ~14 years pre–recession. As UK’s
economy recovers over the long run, I believe credit will loosen and the volume of transactions will move closer
to the norm. In addition, the government has signaled its support for first time home buyers through its Help To
Buy programs, and UK’s own Office for Budget Responsibility forecasts >1.5 million property transactions by
2018. The Royal Town Planning Institute also suggests that there may be a ~375,000 shortfall in UK households.
2) High Incremental Margins
Coming out of the recession, Countrywide has reduced its fixed cost base by closing unprofitable branches, con-
solidating its IT infrastructure, and outsourcing back office functions . Incremental margins over the past 3 years
Volume
Issue I, Issue 2
XXII Page 25
Countrywide, Plc. (Continued from previous page)
are in the neighborhood of ~40% (the Company guides to 40%-60%, exclusive of investments in personnel that are cur-
rently ramping up). Incremental margins are high since the current infrastructure can support higher transaction volumes ,
and only ~half of staff costs (56% of revenues) are variable (though it will begin to fall if volumes come back in such a way
that additional headcount is needed).
3) Free Cash Flow and Shareholder Returns
Countrywide has historically been a very capex light business, but will be ramping capital expenses for the next 2 years to
implement its IT transition (~£20m a year). Post this, capex is expected to tail off. I believe the Company will be able to
convert ~90% of its net income to FCF as provisions wear down over time (2014E FCF yield of ~6%).
On the first half 2014 call, Countrywide stated it would return 35-45% of net income back to shareholders, and up to
~70% barring any major acquisitions. In July, the Company declared a special dividend from the liquidation of a portion of
its Zoopla stake (recently IPO’d real estate portal CWD owns ~4% of). The Company also commenced a £20m share
repurchase program on October 1st.
4) Investment Opportunities
Post IPO last year, Countrywide’s debt has fallen to less than 1x net leverage. The Company is using FCF and a new term
loan to buy up lettings agencies (in conjunction with its own organic growth in existing real estate branches). The Compa-
ny made 28 lettings acquisitions in 2013 and 16 in the first half of 2014. Management believes the opportunity to roll up
small lettings businesses will persist for years.
Countrywide targets a 20% to 25% return on acquisitions in the second full year of ownership (and which management
confirms they are in line to achieve). The Company is able to acquire at such low multiples since 1) it changes the cost
profile of the acquired business by stripping out and outsourcing the costs (sometimes the entire business is lifted into an
existing branch), and 2) it has tons of visibility into the lettings market, and acquires businesses that are currently under-
priced and have room to increase rental fees over time.
5) Management Incentives
2/3 of long term share incentive awards (up to 300% of salary) are subject to absolute EPS targets. “25% of this part of an
award will vest for EPS of 57.6 pence increasing pro rata to 100% vesting for EPS of 70.4 pence for the year ending De-
cember 31, 2016.” The remaining 1/3 is based on relative TSR versus the FTSE 250, with 25% vesting if performance is the
median of the group.
Key Risks
The UK could very well be in a new normal where housing transactions are permanently below historical averages. How-
ever, the shares don’t appear to be too expensive even at 2014’s estimated 1.2 million homes, and both commissions and
lettings should serve somewhat as a natural hedge in a lower-level environment. Discount brokers could potentially take
share, but I believe people will inherently want an agent to be involved in the sale of a home (~90% of sellers are fairly/
very satisfied with their agents). The UK has already has one of the lowest commission rates (1.5%, vs. the U.S. at 5%-6%)
in the world , so online brokers like Redfin seem to be less economically viable.
In the UK, property portals Zoopla and Rightmove control the market and charge real estate brokers monthly fees to list
homes on their sites. The companies have been increasing ARPA rates at double digit percentages due to their dominant
positions. I believe a 10%-15% increase in rates would increase Countrywide’s advertising costs by ~£1 million. To combat
this, six real estate agents (including Savills) have gotten together to launch an alternative (non-profit) 100% agent owned
portal. The portal plans to launch in January with ~5,000 participating branches, and should alleviate the existing duopoly
pricing pressure.
Valuation
My £8.35 price target is based on roughly 14x 2018E diluted EPS £0.58. I assume transaction volumes return to 1.4 million
by 2018, commission fees fall from ~1.75% to 1.5%, while average prices post 2014 increase at 2% (this compares to OBR
and Savills projections at 3.5%-4% pricing growth). For London and Premier, I am predicting 2% pricing and transaction
growth and flat commission rates. I model incremental margins at 35%, falling to 30% over time, and assume the Company
keeps leverage at 1x net, using FCF to buy back shares and make tuck in acquisitions.
Barring another global meltdown, I believe a downside case could involve a new “normal” of ~1.1-1.2 million transactions,
no growth in price or transaction volumes, and a higher stabilized commission fees. At a 12x 2018 exit multiple, I believe
investors could still achieve a high single digit IRR.
Restated Projected
2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E
Revenues £477.9 £509.1 £524.7 £584.8 £705.3 £730.8 £755.8 £780.1 £803.9
% Growth 6.5% 3.1% 11.4% 20.6% 3.6% 3.4% 3.2% 3.0%
Total EBITDA £63.6 £56.4 £63.0 £86.6 £120.2 £133.3 £146.8 £159.6 £172.9
% margin 13.3% 11.1% 12.0% 14.8% 17.0% 18.2% 19.4% 20.5% 21.5%
Diluted EPS -£0.05 -£0.02 -£0.02 £0.17 £0.34 £0.40 £0.45 £0.51 £0.58
% growth 104.8% 16.4% 14.6% 12.6% 12.4%
Free Cash Flow -£91.6 £0.3 -£16.0 -£38.3 £39.6 £45.0 £54.2 £59.6 £67.5
Page 26
Development Capital Partners

(Continued from page 1) neur. I wanted to financially That firm was the originator of
the Peace Corps for two years. back and invest in lots of differ- a whole variety of investment
In the Peace Corps, I had in- ent businesses, participating in partnerships, which all tended
tended to pursue a career in a whole portfolio of creative to have something to do with
economic development. While activities, rather than just tak- corporate reorganizations,
there I observed that there ing a concentrated shot at one activist investing, mergers and
were an awful lot of smart, acquisitions, risk arbitrage or
thing.
well-intentioned people in the event-driven marketable secu-
Development Capital
field of economic development, That interest continued to rity purchases. There was a
Partners Team
(from left to right): but collectively there were grow in the next few stages of little bit of private investing,
Jason Yang ’14, very few practical skills in the my career. I went from doing but for the most part it was a
Gordon McLaughlin ’11, community. It was full of PhDs that with the New York entity, private investing approach to
Paul Tierney, in Economics and Political Sci- to helping start a merchant marketable securities.
Matt Magenheim ’11, ence but had very few people bank in London, which in turn
Matthew Tierney ’02 with training or experience, financed lots of entrepreneuri- It was pretty successful. In the
the sorts of things that make al activities worldwide. Then, late 90s, we decided to shut
privatizations work, or that after spending one year in the down the partnerships that we
enabled cooperatives of small, federal government on a quix- had with outside limited part-
poor farmers to make a living. ners and I began a private of-
fice to invest my own capital
After leaving the Peace Corps, together with friends and part-
I won a Ford Foundation fel- ners that I had known. I formu-
lowship to go to graduate lated an emerging market spe-
school. There were about ten “I made an
cialty investing my own and
other winners and all of the some friends’ capital outside of
others went into programs in
important decision,
the United States — usually in
Political Science and Econom- that instead of being conjunction with local partners
ics. I chose to go to Harvard or money managers in those
Business School, which was a an entrepreneur and countries. We spread from
very suspect decision to the China to Russia, then Latin
fellowship. Consequently, I had building or starting a America. Then about five years
to take extra courses and find ago, I started focusing on Afri-
a mentor at the Kennedy business, I would be
ca.
School. a financial
Part of my reason for being
Through the program, I be- entrepreneur. I interested in Africa was the
came very interested in entre- fact that I had been Chairman
preneurship and investing. I wanted to financially of TechnoServe for a long
started a PhD Program at Har- time. TechnoServe is a not-for-
vard, but never finished it be- back and invest in profit organization that does
cause I started working at an economic development work
investment firm in New York. lots of different
in Africa, Latin America, and
That’s about the time when I India. It started in Ghana and is
got more interested in invest-
businesses.”
now in 33 different countries,
ing. most of which are in Africa.
I’ve had a long-standing in-
Since I can remember, I have volvement in Africa and an on-
been interested in creative otic venture, I joined White the-ground experience with it.
things: the creation of value, Weld, an investment banking
the creation of new entities, firm in New York. I was a jun- Due to my long involvement in
the creation of new businesses. ior partner of that firm until the region and what I observed
At that time I made an im- we were acquired by Merrill there, I thought Africa was the
portant decision - instead of Lynch, at which point I left to place that had the greatest
being an entrepreneur and start my own firm with two opportunity and where I had
building or starting a business, I other partners. (Continued on page 27)
would be a financial entrepre-
Page 27

(Continued from page 26) were happening in emerging Matt Tierney ’02 (MT):
the greatest personal interest. and frontier markets. Ultimate- DCP was created to employ a
And so three years ago, the ly, I decided to go back to similar investment strategy to
four of us began Development school to try to find an area in what Paul, Gordon and I had
Capital Partners. emerging and frontier markets been doing, but was organized
to apply the security analysis as a new entity to bring in out-
Gordon McLaughlin ’11 skills that I had been develop- side capital and be a standalone
(GM): When I was in high ing. That's how I ended up at business. I knew I liked Gor-
school I worked part time in- Columbia Business School and don when I first met him and I
stalling software systems in the in Paul’s class on investing and found out he had run a person-
homes of Radiologists so that entrepreneurship in Africa. al stock portfolio since high-
they could view images from In Paul’s class, I was exposed school.
home at night as opposed to
having to work “on call” at the You'd asked how we got inter-
hospital. I became so interest- ested in investing. I grew up in
ed in the software and hard- a household where investing
ware I was installing that I “We quickly became was talked about a lot. My
opened a brokerage account brother, sister, and I would sit
and invested a few hundred more and more
around the table on Sunday
dollars in two of the compa- night at dinner, and Paul would
interested in Africa
nies that owned the technolo- be talking about a deal that
gy. Eventually my consulting after we saw a lot of was being done.
gigs dried up, but I ended up
making more money on the the macroeconomic There are two things that got
companies I’d invested in. That me to where I am with DCP.
experience really planted the changes taking One, I have been interested in
seed of my interest in invest- entrepreneurship and investing
ing. place, which
since a young age. Two, I have
eventually led to the a passion for international af-
My first real professional role fairs and emerging markets. I
after college was working for formation of DCP.” went to Georgetown, where I
an economic consulting firm studied international relations
providing valuation analysis on with a concentration and focus
patents, trademarks and early on Latin America. After under-
stage technologies. But I always to CEOs running highly profit- grad, I wanted to gain experi-
knew that ultimately I wanted able companies across Africa. I ence in emerging markets, so I
to get into the investment in- was also able to study the in- worked for TechnoServe in
dustry and make decisions as a vestment management industry Peru for a year. I ended up
principal as opposed to as a in Africa and observed that the working with small businesses,
service provider. relative intensity of competi- primarily in the agricultural
tion of investment manage- space, that TechnoServe was
After a couple of years of con- ment in Africa seemed less consulting with, both in Peru
sulting, I joined an investment than in other geographies. and across Central America.
manager in Chicago called Se-
curity Capital, which is part of All of these observations about During my second year at
JP Morgan. At Security Capital Africa were very appealing to TechnoServe, I focused on
I was able to get formal train- me. By the time I hit my last Africa and conducted cost-
ing in the areas of investment semester at Columbia, I was benefit analysis of Tech-
research and security analysis. I quite keen on the opportunity. noServe’s programs across the
also spent a couple of years in I started spending three days a continent. I had been to Africa
London leading an effort for week working with Paul and before, but that was the first
Security Capital researching Matt Tierney identifying invest- time I spent a lot of time there
real estate companies across ments in Africa, and that led to professionally. I realized rather
Europe and Asia. The interna- my involvement in helping to quickly that there's only so
tional work allowed me to form DCP. (Continued on page 28)
witness a lot of the things that
Page 28

(Continued from page 27) perfect information, but it was on and so forth. Here it would
much you can learn from an stimulating, rewarding work. have been an easier task.
analysis standpoint at a non- And during my time there, I
profit, so I joined an analyst quickly recognized that these While sophisticated financial
program at Credit Suisse in markets would offer some of analysis is an important part of
New York. I worked in the the most attractive financial what we do, the ability to get
global corporate finance group returns. data and information to inform
Bruce Greenwald, Wally for a few years, before going your assumptions and view of
Weitz, and Tom Russo at to Columbia Business School. My career path was somewhat the business and management
the 2014 Omaha Dinner. I graduated in 2002 and joined backwards in that my financial is a more important differenti-
Paul and a couple of other analysis skills were mostly de- ator. Of course, you never
folks to help start a health care veloped after Mongolia, during want to take a framework or
venture capital initiative called my time at Morgan Stanley and lens from one country or mar-
Aperture Venture Partners. I ket and apply it blindly to an-
enjoyed doing venture capital other, but I believe there are
deals, but after several years, I “While sophisticated skills beneficial for investing or
realized that health care was doing business in imperfect,
not something that I wanted to financial analysis is inefficient markets that can be
spend the rest of my life on, transferred across geographies.
and I missed the emerging an important part of
markets aspect of what I'd what we do, the After Columbia Business
previously done. School, I knew I wanted to
ability to get data focus on emerging markets
Thus in 2008, Paul and I start- investing. Given the nearly four
ed talking more about what we and information to years I had spent living and
could do in emerging markets, working in Central and South-
and began investing our own inform your east Asia, I was leaning to-
capital through various means, wards Asia. However, as part
by taking direct or indirect assumptions and
of Paul’s class, I traveled to
positions across EM, in both view of the business Ghana to work on a project
public or private opportunities. with a mortgage company
Then we quickly became more and management is based in Accra. I added two
and more interested in Africa weeks in East Africa to my trip
after we saw a lot of the mac- a more important and spent the time both on
roeconomic changes taking safari and meeting numerous
place, which eventually led to differentiator.” medium and large companies in
the formation of DCP. Tanzania and Kenya. I was im-
Columbia Business School. pressed by the managers I met
Matt Magenheim ’11(MM): However, I believe my earlier - from a banana beer entrepre-
My passion for emerging mar- jobs overseas provided much neur to the CEO of a major
ket investing was developed more valuable learning experi- East African bank - and the
early in my career. Six months ences. These jobs trained me opportunities for growth they
into my first job, I was sent to to build contacts and find data saw. I came home and imme-
Madagascar to work with the and information in developing diately began to focus my job
Malagasy government on an countries, a task which is much search on Africa-focused in-
undersea cable project. After- less straightforward there than vestment firms.
wards, I spent 15 months in it is in the US. For example,
Mongolia setting up two busi- when I needed to find staff for Following graduation, I joined
nesses for a MENA (Middle our halal abattoir in Mongolia, I Allan Gray, a Cape Town
East-North Africa)-based in- had to visit a funeral in a town based asset manager that was
vestment group. I was hooked with a large Kazakh population attractive for the quality of the
by the massive opportunities in order to speak with the investment team and the firm’s
and challenges that these mar- local imam. He referred me to value-oriented strategy. I
kets provide. It was difficult to someone, who then referred worked there until I got a call
land in a foreign environment me to someone else … and so (Continued on page 29)
with limited contacts and im-
Page 29

(Continued from page 28) not set up to allow the easiest New York. The access to in-
from Paul about what the team raising of capital, but we didn't formation is getting better.
was planning in DCP. The want to compromise the struc- There are publicly available
chance to work with these ture of the fund in order to documents that you can pull
guys was too good an oppor- make it easier to market. from Bloomberg. You can get
tunity to pass up, and I was We wanted to be able to make them off websites, but that
soon on a plane back to New good, long-term investments information is often limited.
York. with high rates of return and There are several companies
not have structural impedi- which only give half year or
G&D: Your investment philos- ments get in the way. annual results. Those are the
ophy is probably a little differ- types of companies where you
ent than some of the tradition- GM: At the heart of it, we have to actually go and gather
al value managers that we have really formed the partnership more information. Aside from
featured over the years. Could to invest in the best companies the analytics and the numbers,
you give us an overview? and the best management it's really important to go and
teams at the best price that we decide if management is good
PT: Well, we are similar to or not. That's where our net-
other value investors, but per- work comes into play, which is
haps different than other inves- really helpful. It's not just
tors in Africa, in that our pri- meeting the CEO; we look to
mary focus is on a concentrat- “At the heart of it,
understand mid-level manage-
ed portfolio of publicly traded ment, the board’s corporate
we really formed the
long positions. We normally governance policies and other
have 20 to 25 positions. partnership to invest factors in finding strong, for-
tress-like companies.
Because we deal in markets in the best
with a lot of volatility, we have GM: I would add that another
an initial two year lockup on companies and the element of the diligence pro-
the capital. It was my feeling cess that's somewhat unique is
that the fund structure would best management
accessing publicly available in-
make it more difficult to raise formation. Information is theo-
teams at the best
capital, because people want to retically available to all, but it
believe that there is daily li- price that we could sometimes takes extra work
quidity even if it doesn’t always to access in Africa. Even for
exist. We are allowed to have find.” simple things like finding long
up to 20% of our partnership histories of annual reports,
capital invested in non-quoted sometimes you have to go
securities. We didn't want to could find. The philosophy is knock on the broker’s door in
pass up special investment op- not terribly different from order to find an actual hard
portunities that we wouldn’t what you would find in the copy from six years ago. Some-
be able to cover, nor did we value investment community. times you can call someone
want to do them on the side When we decided to form the sitting in Lagos and have it
with some carve-out where partnership, we said we just scanned to you in a 100 mega-
the general partner could do wanted the 10 to 20 best long- byte documents. These things
some things in the partnership term investment ideas we can be frustrating at times, but
and some things out. All four could find in Africa. we think they enhance the
of us have extensive relation- potential of a strategy like
ships all over Africa. If one of G&D: Tell us a little about ours.
them happened to be a great your investment process and
chief executive officer running the diligence you perform. PT: You can’t have it both
a company where all we could ways. You can’t have the bene-
do is invest privately, I didn’t MT: There is certainly a lot of fits of being in an inefficient
want to let that go by the travel involved. There are simi- market with maybe a little low-
board. larities to the analytical pro- er level of competition and
cess, which we do here in (Continued on page 30)
Our partnership was certainly
Page 30

(Continued from page 29) market efficiency or decreases public offerings have taken
also have access to easily ac- in potential opportunities? Do place and markets have risen,
cessible information. This is you think that there's still a there's more competition
probably a generational thing, long runway to finding mis- there. It's similar to elsewhere
but I'm amazed at how much priced securities? in the world when good com-
information is available even if panies start to show what they
it's somewhat difficult to ob- PT: I think there's still a long can do and capital markets are
tain. Ten or fifteen years ago, runway, but there's also been broadened, more and more
you couldn't do what we’re more capital and more atten- money flows into them. The
doing now. tion being paid to the region. dynamism of the region cre-
The whole region from the ates a continuous stream of
MT: Even five years ago. Middle East down to South opportunities.
Paul Hilal ’92 at the 2014 There's been a really big Africa is dynamic and the op-
Omaha Dinner. change in the level of interest portunity set changes on an MT: Obviously there are 54
in Africa, especially in the US. I ongoing basis. Periods of fear countries and they're all quite
think Europe definitely had and optimism tend to get exag- different. There's not too
more interest in Africa from an much correlation when you
investment standpoint. About look across regions in Africa.
five years ago, I remember Dislocation in one country
going to a conference and from a macroeconomic stand-
“You can’t have the
there were maybe twenty peo- point oftentimes creates a lot
ple in the room. It was a gen- benefits of being in of opportunity from a pricing
eral conference about Sub- standpoint. There's typically
Saharan Africa. Two years ago, an inefficient market something wrong somewhere
there was a conference across in our universe. Asset prices
the street with two hundred with maybe a little may be rising in one area
people just on Kenya alone. where you’ll also see IPOs,
There's definitely a lot more lower level of
which we've seen taking place
interest, a lot more infor- over the last year. At the same
competition and also
mation available, but nowhere time, you can see pricing of
near what you get in devel- have access to easily great companies drop in an-
oped countries. other area that is experiencing
accessible a more volatile period. Falling
GM: One other important prices often draw our atten-
component of our work is information.” tion.
accessing people. Getting the
first interaction with a manage- GM: Some of the scariest mar-
ment team can be a significant gerated. Egypt is one of the kets to us exist when every-
challenge. We often work three largest capital markets, thing is perceived to be calm
through existing relationships and Egypt has been very vola- politically and the prices of
to facilitate introductions to tile over the last several years. assets get too high.
certain management in order This year, Egypt is the first or
to get a first meeting. Once we second best performing public- G&D: Outside of South Afri-
have the first meeting, it's very ly-traded index on the conti- ca, what are the market cap
easy for us to establish a rap- nent. We shifted our attention sizes of these countries? What
port and the trust level re- to Egypt pretty early and have are the investable opportuni-
quired to develop an ongoing some great holdings there. ties in places like Ghana, Ken-
relationship. As the years go ya, Tanzania, Tunisia, et cetera?
on and accessibility increases, When the Arab Spring went
it's advantageous to have de- through North Africa, one of MT: Our investable universe,
veloped relationships earlier the most misunderstood areas including some opportunities
on than later. was Tunisia, which has proven that we see that aren’t listed in
to be a place where there's Africa, has a total market cap
G&D: Given the interest in been a lot of opportunity and of about $1.4 trillion.
Africa over the last few years, not too much competition. As (Continued on page 31)
have you seen any changes in
Page 31

(Continued from page 30) face interactions are critical, countries where there's a local
especially when building new exchange. Then there's often-
GM: If you break it up, though, relationships. All investors times surrounding countries
it's really about $130 billion of typically meet with the same where a company is working in
market cap in North Africa four or five individuals on their and so we'll take a trip there.
and then approximately anoth- first visit to a new country. Ethiopia, in particular, is very
er $150 billion in Sub-Sahara The key is getting beyond this interesting and we’ve spent a
excluding South Africa. There first wave. It is great to have a lot of time there. I wouldn’t
is near $1 trillion in South Afri- network of key contacts that say we're experts in every
ca. The liquidity is also a more we can call from New York for country, but the ones where
challenging element than over- quick feedback, but we are the companies are located we
all market cap. For example, if definitely have an institutional
you exclude South Africa from knowledge base, which is help-
the other exchanges in Africa, ful.
the approximate liquidity for
all the markets is approximate- “Some of the PT: There are changes occur-
ly equal to that of a single US ring and some government
stock like Home Depot. scariest markets to regulations and restrictions,
which make countries more
PT: Another part of our strat- us exist when attractive at one point in time
egy is to know a lot about Afri- than another. The changes in
ca and then find ways of taking everything is Egypt are pretty obvious. Ethi-
advantage of that knowledge – opia, which Matt mentioned, is
knowing about an opportunity perceived to be calm
another big country and big
despite the fact that the com- politically and the opportunity, but it’s currently
pany might not be traded on closed. It's a tough place to do
an African exchange. It might prices of assets get business and a tough place to
be traded in London or Mum- acquire assets. The country
bai, but have growth potential too high.” still has a government-
and strategic focus in Africa; controlled telecommunication
that's part of our universe and system. That can't continue
that enlarges the pool a lot.
into the future.
G&D: We imagine you must always looking for new per- Tanzania had limits on foreign
travel a lot. How much of your spectives. Meeting with suppli- ownership, but they recently
time is actually spent on the ers, customers, former em- dropped the 60% maximum
ground there and how do you ployees and mid-level manage- foreign ownership position. So
approach it? ment is invaluable to under- you had situations where non-
standing a company, and these Tanzanian investors were ne-
GM: In general terms, one or conversations can frequently gotiating with each other to
more of us is in Africa every only be done in person. buy stock that was available
month and each of us probably because both of them didn’t
spend 25% or 33% of our time G&D: Are you at the point qualify as Tanzanians, and there
on the ground in Africa. Each where you have some level of are similar kinds of changes in
trip is, on average, two to four institutional knowledge of eve- Saudi Arabia now, so this
countries, a lot of times in a ry country in the continent? makes certain countries and
region, because it's easier to Are there some areas where certain exchanges more inter-
cover ground that way. you're still developing exper- esting. Angola has no ex-
tise in the companies that are change, but has plans to set
PT: We've never had a day in available in those markets? one up.
which we've sat down and said,
you know, we have spent MT: North of South Africa, G&D: Some investors look
three weeks and nobody has there are about 16 exchanges into countries that have re-
gone to Africa. that we would consider, so cently had poor economic per-
MM: Though the flights can be we're primarily focused on the (Continued on page 32)
painful sometimes, the face-to-
Page 32

(Continued from page 31) for everybody. As new, unin- companies, it’s pretty interest-
formance. Do you have a simi- formed money entered the ing to see any potential change
lar framework for identifying region, certain companies with that’s taking place that will
new opportunities – is it more a good franchise and all the affect the larger economy.
systematic? Or more organic other qualifications – we al- There have been a lot of ex-
as opportunities arises? ways mention Nestle Nigeria ploration and gas discoveries in
as an example – became the East Africa over the last five
PT: We meet regularly. We fashion of the day. It might be a years. We’ve looked at those
have scheduled meetings and good company, but is it a good companies and then tried to
then we have a million un- enough company to purchase figure out what related indirect
scheduled meetings. I would at 40 times earnings? investments might do well as a
say we all have a nose or an result of that. As the economy
interest in countries where the While we’re still interested in grows, how is it going to affect
Ken Shubin Stein and Bruce
Greenwald at the 2014 market has been smashed and consumer products companies, the consumer? What industries
Omaha Dinner. things are very cheap, and it doesn’t constitute as big of a are going to grow as a result?
skepticism about things that percentage of our portfolios as Many of them are the ones
have gone up too quickly. Our it used to. We’re also not gen- that Gordon mentioned.
choice of investments is all
bottom up, but our instinct, or GM: There are many indus-
smell, increases when we see tries where we believe latent
situations that are either too demand exists, but where
good or too bad and we look “We like transparent products and services aren’t
into them. reaching the population. For
companies that have example, with retail, which is
We also follow themes of in- an industry that we like a lot,
vestments that we like, so if good corporate
an estimated 90% of trade out-
we've observed a certain type governance, audited side of South Africa in Africa
of consumer products compa- occurs in informal settings.
ny or telecom or financial insti- statements and good Purchases of basic food, for
tution be successful in one example, don’t generally occur
country, we will look for more and deep in an organized grocery store.
opportunities with similar pro- Oftentimes these situations
files in neighboring countries. management have evolved in other parts of
teams.” the world and by studying his-
G&D: Given that you invest in torical trends, we inform our
Africa, you have a limited in- view of what might occur in
vestment universe. Natural Africa in the future.
resource and other commodity erally commodities players.
type companies have a large We try to buy into companies G&D: How do you think
presence. Can you elaborate that provide a product or ser- about investing from a top
on the types of opportunities vice that generates good cash down perspective? Are there
where you have been success- flow. countries that hold a greater
ful? What do you like and what appeal for you now that you
do you look for in the compa- GM: None of us have a deep may want to consider investing
nies that you typically invest in? background with commodity- in? And, conversely, are there
based businesses. We see large other countries that you want
PT: We like transparent com- opportunities in healthcare, to avoid given macro factors
panies that have good corpo- retail, financial services, even and geopolitical stability?
rate governance, audited state- industries that support infra-
ments and good and deep structural development like PT: We unanimously agree on
management teams, but in cement. what companies we sell and
terms of industries, when we what companies we buy, but I
started, one of our priorities MT: As has been mentioned, don’t know if we’d all unani-
was looking at fast-growing we’re bottom-up, but from mously agree on a macroeco-
consumer products companies. looking at natural resource (Continued on page 33)
Guess what? It was a priority
Page 33

(Continued from page 32) what we think the long-term but as far as the ones that
nomic profile of each country. drag from that currency will we’re close enough to that
One of the biggest risks in our be. Ultimately, our considera- we’d have regular dialogue
portfolio is currency risk, and tion of currency risk manifests with and would have come
we often debate and make itself in the rate of return that make presentations in the US,
decisions on the currencies in we are requiring on invest- say at Columbia Business
Africa. For example, Ghana has ments that derive their income School, that would probably be
been the worst performing in a given currency or curren- around half of them.
market in Africa this year cies. For example, we might
from a US dollar perspective, make an investment in Botswa- GM: It’s a requirement that
mainly due to currency depre- na where we are expecting an we understand their motiva-
ciation. 18% Botswana pula return tions, incentives and general
ethos, but it’s not necessarily a
We followed Ghana closely requirement that we have an
and have a lot of friends there. extremely special relationship
We have a lot of first-hand with them.
information, not inside infor- “Finding ways to use
mation, but information on PT: A couple of things that are
how the Ghanaian government management’s time different about publically trad-
makes decisions. We had a ed marketable securities in-
large concern regarding the efficiently, asking the vesting in Africa is access to
currency and were lucky and people, because they must feel
smart enough to exit our in- right questions and somewhat like purchasing
vestments in Ghana before the agents that are besieged with
cedi started to unravel. On the winning their
neophytes who are coming in
other hand, we started to build confidence is part of who want to talk to the com-
positions in Tunisia and Egypt pany. Somebody sends in a
quite soon. Personally, I’m very what we have to junior guy to see whether they
worried about South Africa's ought to have a fund in Africa
political and macro environ- do.” and he calls the CEO and
ment. However, there’s a big thinks he’s going to be treated
enough investment universe like royalty. Well, these are
that I don’t think that a top very sophisticated people run-
down approach in South Africa ning key organizations in their
is worth very much for us. over seven years, but we might countries, so they don’t have
require a 27% return for in- time to meet with everybody
G&D: Can you speak to the vestments in companies that else. Finding ways to use their
process of managing currency earn Ghanaian credits. As Paul time efficiently, asking the right
risk? Do you take a view based mentioned, we also limit our questions and winning their
on a macro assessment, or do overall exposure to various confidence is part of what we
you take a different approach? fiscal and political regimes de- have to do.
pending on our views.
PT: It’s very hard to hedge The other thing is that sourc-
our currency risk. We try to G&D: You alluded to the fact ing stock is not so easy, be-
have diversification in the port- that you have close relation- cause there’s not much liquidi-
folio with different currencies ships with the management ty in many of the markets. It’s
represented and manage our teams of many of the compa- nothing like calling a broker
level of cash, but we don’t do nies you invest in. When ana- and placing an order with a
any currency hedges. lyzing a business, how close do limit. It’s often necessary to get
you typically need to get with some help. Some of these
GM: Generally speaking, when the management team and companies have chief executive
we are looking to make an understanding their strategy officers who have had a mean-
investment, we consider the before you actually invest? ingful personal family stake in
expected return on an invest- PT: Well, we try to meet and their businesses for a long
ment in its local currency. know every management team, (Continued on page 34)
Then we’ll also have a view of
Page 34

(Continued from page 33) ing the UN General Assembly. months or more to get com-
time. They might know that fortable with a particular team,
one of the family members GM: We don’t think it would no matter how good the busi-
who’s ill or wants to sell his be an advantage to have an ness fundamentals are?
stock, or some institution that office in Kenya and be investing
backed him five years ago, who in Nigeria. It would be very PT: It can be. I would say that
now has made 10 times his different types of companies
money, might want to sell. require attention to different
Mario Gabelli ’67 at the
They can help you source areas of management. Some
2014 Omaha Dinner.
stock, or brokers can because companies require attention to
they want to work with you, mid-level and front line man-
or know that you’re for real if “It was a tactical agement. For example we
you indicate an interest. were interested in a company
choice for us to have in Kenya, Equity Bank, which is
G&D: How have you thought run by a guy named James
about potentially having an all key decision Mwangi. We have known
office in Africa? There are ob- James for a long time. The
viously pros and cons. Could makers sitting next
question is not whether James
you explain how you decided is a smart guy. Helios Invest-
to each other. What
to be in New York? ment Partners owns 25% of
we face is a constant the company. In this instance,
PT: We’ve thought about it a the relevant question is also
million times. Currently we stream of complex not whether the Helios team is
rely heavily on a network of a great team or that the direc-
relationships in each of the decisions that need tors that they have on the
important countries, in places bank are great. Equity Bank has
where if we want to use a to be made with
grown into an extremely large
friend’s office we can, and re- and fast growing company. The
limited emotion.”
ciprocally when they come relevant question for us with
here, we’ll help them. With the regard to management is how
relationships these guys have deep the team is, and how
with all of the business and deep the bench is where some
investment community there, I of the riskier day to day parts
think we might even be at an of the business are being run.
difficult to fund and manage a
advantage. It’s the sort of thing local presence in all of the dif- That can take a while to ana-
that Warren Buffett talks ferent countries we’re invest- lyze and then the question is
about by being in Omaha and ing in right now. It was a tacti- valuation, right?
having a better perspective cal choice for us to have all key
than being in New York. decision makers sitting next to Then there are some other
We’re not as much in the ru- each other. What we face is a companies for which it takes
mor mill perhaps. constant stream of complex us a while to get to know key
decisions that need to be made individuals. For example, there
MM: After spending nearly five with limited emotion. There is a retail company in Botswa-
years as an expatriate in Asia are always complicated situa- na that is more of an up-and-
and Africa, I appreciate the tions that we need to get our coming, more entrepreneurial
extremities of the highs and heads around, so it’s really company. We have all visited
lows when living in the devel- important that we sit next to the company several times.
oping world. When battling the each other and debate solu- The head of the company has
daily logistical and infrastruc- visited us here in New York.
ture challenges, it is sometimes tions and decisions.
He is coming back again soon.
difficult to keep perspective G&D: Management is clearly We also want to know our
and detect the incremental important to you for investing. other partners that are invest-
improvement. New York also How often do you meet with ed in the business including in
attracts more private and pub- management over time? Is this this case the private equity
lic sector leaders than most a process that will take you six (Continued on page 35)
African capitals, especially dur-
Page 35

(Continued from page 34) markets that we're in. IRRs drop below 10% in local
firm that is invested in the currencies. Of course whenev-
company. That can take quite a GM: We try to use as many er we find something that we
long time. tools as possible when consid- really love, we start kicking out
ering valuation. We look at the the lower return ideas – it’s a
Then there are some business- fair value of a company based constant competition of ideas.
es, not many, that aren't as on forecasted models. We also
management-sensitive. They look at historical ratios, peer Aside from simply valuation,
are relatively easy to under- analysis and the multiples that one of the things that we really
stand and might be a listed the company is trading on. look for are businesses that
affiliate of a foreign company, Generally, when we invest, a are efficient with their capital.
such as Nestle Nigeria. You five-to-seven year expected We are interested in deter-
are pretty sure that the finan- IRR is a critical point of discus- mining, at the unit economic
cials are clean, the manage- sion. level, what kind of return on
ment is at least competent and its capital a company can earn.
they might have licenses from We are probably more inter-
the parent company. ested in this than things like
multiples, in many cases.
MT: In fact, for subsidiaries of
multinationals it is quite com- “Exceptional A big difference between com-
mon for there to be a rota- panies in Africa and those in
tional program. You will get to management teams most other parts of the world
know a CEO, but he or she is that debt costs are still ex-
may leave in a year or two. in Africa can do
tremely high for most of these
You can check the back- companies. They really can't
grounds on them, but they are
extraordinary things
finance growth projects with
usually at a certain level, which and create a lot of debt. For example, health care
you could feel more comforta- companies in Nigeria are pay-
ble with maybe faster. value. Investing the ing around 20% interest on
their debt. That’s an enormous
GM: Management talent is time to get to know burden on any company and
scarce in Africa and exception- it’s a death sentence for capital
al management teams can do them yields large
intensive or inefficient compa-
extraordinary things and cre-
dividends.” nies.
ate a lot of value. Investing the
time to get to know them G&D: Can you speak about a
yields large dividends. recent success and take us
through your process?
G&D: What is the valuation
criteria that you focus on? If you look back and say, GM: Sure. There's a listed
What would be an interesting "What's been the average ex- company in Nigeria called Stan-
investment from a valuation pected rate of return in your bic IBTC. It's a listed affiliate of
standpoint? Is there a minimum base case for all the invest- Standard Bank, which is a
hurdle that you view as appro- ments that you've made?" The South African company. It's
priate for the fund structure answer would be between 20% really a financial services com-
that you have? to 30% in local currencies. pany with three lines of busi-
Selling tends to be much more ness. It make loans to individu-
MT: Gordon touched upon difficult. We don't simply sell if als and small enterprises and
the expected returns from a the expected IRR goes below provides financial related ser-
local currency perspective, vices to those groups of cus-
mid-20s for example.
which of course vary depend- tomers, it has an investment
ing on where we are. But the Generally, the heated discus- bank which serves large com-
fund is in USD. From a US sions around selling a position panies, and it has the dominant
dollar perspective, we're look- from a valuation standpoint asset management franchise in
ing for high rates of return have occurred when expected (Continued on page 36)
given the riskiness of different
Page 36

(Continued from page 35) think that people are underes- preneur. The current CEO
Nigeria, which is the real rea- timating the overall potential moved from India to Botswana
son we love the company. of the asset management in- about 20 years ago, and one of
dustry in Nigeria. Even after 10 his first assignments upon ar-
In 2004, there was a major years of 30% AUM growth, riving was to audit this particu-
pension industry reform. Since pension assets only represent lar business.
that time, pension assets in around 5% of GDP. By con-
Nigeria have grown at about trast, Kenya's are 18% of GDP, At that time, Choppies only
Louisa Serene Schneider 30% a year, every year, and we South Africa’s are 67%, and in had one or two stores and was
’06 and Tracy Britt Cool at don't see asset growth ending the United States pension as- nearly insolvent. Despite this,
the 2014 Omaha Dinner. for a long period of time. the CEO saw a big opportunity
in retail and decided to join the
When compared to other business. He has since grown
banks in Nigeria, Stanbic looks “We still think that the company into the leading
relatively expensive on a price supermarket chain in Botswa-
to book multiple, but the asset people are na. The CEO is essentially a
management business gener- founder and he owns a large
ates more than a 50% ROE. It's underestimating the piece of the company.
not appropriate to apply bank
book multiples to an asset overall potential of We started tracking Choppies
management business. the asset about three years ago when it
IPO’d on the local Botswana
Additionally Stanbic’s been management exchange. It was raising capital
investing heavily in people to to expand into the northern
grow its two banking divisions. industry in Nigeria. section of South Africa, which
We view these investments as it has done successfully. It’s
a form of capex in people and Even after 10 years interesting because there's
infrastructure as the bank obviously a very mature mar-
grows. But the expenditures of 30% AUM growth, ket in South Africa compared
flow through the company’s to other parts of Sub-Saharan
income statement and have
pension assets only
Africa. The CEO thought he
dragged the profitability of represent around 5% could compete in the rural
those divisions as they are markets of South Africa against
growing. of GDP.” the larger format stores of,
say, ShopRite or Massmart,
The historical result has been which he's successfully doing.
that analysts see a sub-20% Choppies typically has a small-
ROE bank and a relatively high sets are over 100%. There's a er footprint store.
book multiple. We looked at it lot of room to grow in the
and saw a dominant, fast- Nigerian asset management GM: The payback on a new
growing, pension management industry. It could easily be a Choppies store is typically one
business, with huge opportuni- $150 to $250 billion industry to three years with an ROIC
ties in other wealth manage- in terms of assets and today of around 25% to 40% at the
ment business lines. We also it’s $30 billion. store level.
saw quite clearly that the com-
pany’s ROE was subdued by G&D: What are some other MT: So it’s pretty attractive.
investments it was making in investment ideas that you He should be breaking even in
future growth. could share with us? South Africa soon. Botswana's
quite profitable and he's also
It's been a very good success MT: One investment, which expanded into Zimbabwe.
for us as the fruits of the com- we've alluded to in the conver- Those countries are all in the
pany’s investments started to sation, is Choppies. It's a food same region and an important
materialize and investors and retailer which is based in Bot- part of any food retailer is the
analysts perceptions of the swana. It was started more distribution network, which he
business have changed. It's one than 20 years ago by an entre- (Continued on page 37)
that we still like a lot. We still
Page 37

(Continued from page 36) taken more than seven years South Africa, it's significantly
spent 15 to 20 years building to build. higher because there’s been
up. A lot of goods come in more development of formal
from southern South Africa MT: We like the smaller foot- retail. South Africa is closer to
and feed right into his depots print model that can go up 60% formal.
in northern South Africa that almost anywhere, and he has
service the entire region, so he various price points that serve MM: This story is also not
can still expand further into different customers. We think unique to retail. With in-
Zimbabwe as well as other that it's the right model to creased urbanization and
surrounding areas of southern growth in the middle income
Africa. segment, we are seeing similar
trajectories in ICT adoption,
GM: It also has a relatively banking penetration, and con-
small base of stores, so it sumption of many consumer
should be easier to grow from “At that time, goods. Since 2000, African
a 100 stores to 1,000 stores mobile phone penetration has
than it would if you had 1,000 Choppies only had gone from less than 2% to
stores growing to 10,000. One more than 80%. The growth
of the reasons that the ROIC
one or two stores
rates in other areas have not
at the store level is so high is and was nearly been as profound as that found
that he does not really have a in the telecommunications
credit card infrastructure, so insolvent. Despite sector, but we know where
his customers pay cash and he the trends are heading. We
gets supplier terms. The stores this, the CEO saw a just need to find the brands,
are actually working capital distribution networks and
positive to him. The growth big opportunity in most importantly management
essentially finances itself after a teams that are best positioned
retail and decided to
time. We really like that. to leverage these opportuni-
join the business. He ties.
G&D: Are there other com-
petitors that have come close has since grown the G&D: For our readers that
to Choppies in Botswana? might be interested in becom-
company into the ing investors in frontier mar-
GM: There is definitely com- kets, what sort of advice would
petition in Botswana. There's leading supermarket
you give them?
another local company called
Sefalana, and South African
chain in Botswana.”
MT: Well, investing in Africa is
retailers are also active in Bot- difficult. It's amazing we got to
swana and other parts of where we are in creating this
southern Africa. South African fund. We looked at every pos-
retailers are much larger than expand across Africa, certainly sible entry point and there's a
Choppies and have tended to southern Africa and potentially limited sphere of public equity
focus on putting up big box beyond. funds, which are hard to access
stores. as an individual, and then
G&D: What's helped pene- there's really only a handful of
MT: One challenge for these trate this food supermarket or ETFs.
bigger retailers in South Africa retailing, generally speaking?
to expand to the rest of Africa You mentioned that lots of GM: If you are looking to start
is basically finding enough retail markets are very informal. a career investing in Africa,
space, because there's not that What is the penetration of there are probably more funds
much commercially developed organized food retailers in the from South Africa that are
real estate. total market? looking for investment talent.
Generally Africa and frontier
GM: Development of new GM: Across the continent, it's funds are unlikely to come to
space is not trivial either. close to 10%. In Botswana and (Continued on page 38)
Some malls in Nigeria have
Page 38

campus, but that's where I'd be
writing letters and making calls.
MM: Do your homework and

be proactive. I was a bit naïve
when I started my search for
Wally Weitz at the 2014 Africa funds. I remember being
Omaha Dinner. initially amazed that there
were South African firms like
Allan Gray with $40 billion of
AUM. As capital markets and
pension systems mature across
Africa, you will find more large,
indigenous funds in Nigeria,
Egypt, Kenya and other mar-
kets. Have a local stock pick,
preferably a write-up. It can set
you apart from other appli-
cants.
MT: There is definitely a lack

of high quality talent across the
continent from corporates to
investment firms, so certainly
people who are willing to go
live there or travel extensively
there could be successful.
GM: It's a strange dynamic

because it's a small universe so
there are a relatively limited
number of spots that come up,
but I guess there's also fewer
people looking. On the other
hand, there's also an extremely
limited set of very experienced
people, so I think it's a path
worth pursuing, though I’m
obviously biased. I guess we
have to hustle a little bit, but
it’s worth it.
G&D: Thank you very much

to all of you for taking the
time.
Get Involved:
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mford15@gsb.columbia.edu
ppan15@gsb.columbia.edu Graham & Doddsville Editors 2014-2015
tschweitzer15@gsb.columbia.edu
Matt Ford ’15
Matt is a second-year MBA student and member of the Heilbrunn Center’s
Value Investing Program. During the summer, Matt worked for Signpost Capital, a New
York-based long/short equity hedge fund. Prior to Columbia, he worked as an analyst at
Reservoir Capital, Farallon Capital, and Bain Capital/Sankaty Advisors. Matt graduated
from The Wharton School of the University of Pennsylvania with a BS in Economics and
BA in East Asian Studies. He can be reached at mford15@gsb.columbia.edu.
Peter Pan ’15

Peter is a second-year MBA student and member of the Heilbrunn Center’s
Value Investing Program. During the summer, he worked for Fidelity Management &
Research, where he evaluated securities across the capital structure. Prior to Columbia
Business School, he worked at Wells Fargo, where he structured and executed LBO
financings. Peter graduated from the University of California, Berkeley with a BA in Inter-
disciplinary Studies. He can be reached at ppan15@gsb.columbia.edu.
Tom Schweitzer ’15, CFA

Tom is a second-year MBA student and member of the Heilbrunn Center’s Value
Investing Program. During the summer, Tom worked for Centerline Investment Partners,
a New York-based equity hedge fund. Prior to Columbia Business School, he worked at
Citigroup and Munich Reinsurance. Tom graduated from Columbia University with a BS
in Applied Math and a minor in Economics. He can be reached at
tschweitzer15@gsb.columbia.edu.
Graham & Doddsville
Issue XXIII Winter 2015

Inside this issue:
24th Annual Bill Ackman —

Graham & Dodd The Creative Side of Investing
Breakfast P. 3
Bill Ackman is the CEO and Portfolio Manager of Pershing
Bill Ackman P. 4 Square Capital Management L.P., a concentrated research-
intensive fundamental value investor with approximately $19
Jay Petschek & billion in assets under management. Prior to forming
Pershing Square, Mr. Ackman co-founded Gotham Partners
Steve Major ’94 P. 13
Management, an investment fund that managed public and
private equity hedge fund portfolios. Mr. Ackman began his
Andrew career in real estate investment banking at Ackman
Wellington P. 21 Bill Ackman Brothers & Singer. Mr. Ackman received an MBA from
Student Ideas P. 29 (Continued on page 4)
Corsair Capital —
Editors:
Investing on Change
Matt Ford
MBA 2015 Jay Petschek and Steve Major ’94
are the co-portfolio managers of
Peter Pan
Corsair Capital Management, a
MBA 2015 value-oriented, event-driven, long/
Tom Schweitzer, CFA short equity investment firm with
MBA 2015 $1.4 billion in assets under
management. The firm’s strategy
Brendan Dawson Jay Petschek Steve Major ’94 focuses on small to mid-cap
MBA 2016 companies predominantly in the US
and Canada going through strategic and/or structural change with impending
Scott DeBenedett catalysts. Corsair Capital Partners, L.P., the firm’s flagship fund, was founded in
MBA 2016 (Continued on page 13)
Michael Herman
MBA 2016 Andrew Wellington —
Working Hard to Find Easy Investments
Visit us at:
Andrew Wellington co-founded Lyrical Asset Management
(LAM), a New York-based boutique investment manage-
www.csima.org
ment firm, where he serves as the firm’s Chief Investment
Officer and Managing Partner. Lyrical began investing client
capital at the start of 2009. Over the six years ended De-
cember 31, 2014, LAM’s U.S. Value Equity-EQ strategy re-
Andrew turned 323.7%, net of fees, more than doubling the S&P 500
total return of 159.4%.
Wellington
Mr. Wellington has been involved with active portfolio
management for almost twenty years. He was a founding member of Pzena Invest-
ment Management, where he was the original equity research analyst, and later
Page 2

It is our pleasure to bring you Andrew Wellington, found- Lastly, we are proud to once
the 23rd edition of Graham & er of Lyrical Asset Management again highlight pitches from
Doddsville. This student-led discusses his approach to port- four CBS Applied Value Invest-
investment publication of folio construction, and shares ing students selected as the
Columbia Business School (CBS) insight into several investments finalists for the 2015 Amici
is co-sponsored by the Heil- which convey his thought pro- Capital Prize Competition to
brunn Center for Graham & cess as an investor. be held in February. Formerly
Dodd Investing and the Colum- known as the Moon Lee Prize,
bia Student Investment Manage- This issue also highlights pho- the Amici Capital Prize is given
ment Association (CSIMA). tos from the 24th Annual Gra- in memoriam of Alex Porter,
ham & Dodd Breakfast, held on Founder and Managing Member
In this issue, we are fortunate to October 24th, 2014 at the of Amici Capital, and Moon
present four investors from Pierre Hotel in New York. This Lee, a dedicated value investor
Louisa Serene Schneider three firms representing differ- Breakfast brings together alum- with Porter Orlin, LLC and
’06, the Heilbrunn Center ent investing approaches, but ni, students, scholars, and prac- friend of the Amici Capital
Director. Louisa skillfully each reflecting the common titioners for a forum on cur- team.
leads the Center, cultivating underlying tenets of value invest- rent insights and approaches to
strong relationships with ing. investing. This year’s featured This year’s finalists include
some of the world’s most panelists included Bruce Berko- fellow classmates: Kirill Ale-
experienced value inves- Bill Ackman recounts his early witz of Fairholme Capital, Mar- ksandrov ’15 - First Solar
tors, and creating numer- influencers as an investor, de- io Gabelli ’67 of Gamco Inves- (FSLR), Short; Harry Garcia ’15
ous learning opportunities scribes the traits he values in a tors, Jonathan Salinas ’08 of - JetBlue Airways (JBLU), Long;
for students interested in CEO, and discusses recent in- Plymouth Lane Capital, and Luke Tashie ’15- Schibsted
value investing. The classes vestments, including Herbalife, Professor Bruce Greenwald of Media Group (SCH: NO),
sponsored by the Heil- Allergan, and Zoetis. Mr. Ack- Columbia Business School. Long; and Brian Waterhouse
brunn Center are among man also sheds light on the cul- ’15 - CDK Global (CDK), Long.
the most heavily demanded ture of Pershing Square Capital. We are proud to announce Summaries of these pitches can
and highly rated classes at multiple strong showings from be found on pages 29-36.
Columbia Business School. Jay Petschek and Steve Ma- CBS teams during the Fall’s
jor ’94, co-PMs of Corsair Cap- cross-MBA stock pitch compe- As always, we thank our
ital, share examples where Cor- titions, with 1st place finishes at interviewees for contributing
sair’s approach led to variant the Darden @ Virginia Invest- their time and insights not only
perceptions in key investments. ing Challenge and the UNC to us, but to the investment
Mr. Petschek and Mr. Major ’94 Alpha Challenge, and a 2nd community as a whole, and we
also discuss the importance of place finish at the Michigan thank you for reading.
investing in companies whose Stock Pitch Competition. The
- G&Dsville Editors
management team’s interests teams’ respective pitches can
are aligned with shareholders. be found on pages 37-42.
Professor Bruce Greenwald,
Heilbrunn Center. The Cen-
ter sponsors the Value In-
vesting Program, a rigorous
particularly committed stu-
dents that is taught by some
of the industry’s best practi-
tioners.
Professor Bruce Greenwald and Louisa Jon Salinas ’08, Founder and Managing
Serene Schneider ’06 at the October, Member of Plymouth Lane Capital, served
2014 Graham & Dodd Breakfast. as a panelist during this year’s Graham &
Dodd Breakfast.
24th Annual Graham & Dodd Breakfast—

October 24, 2014 at The Pierre Hotel
Panelists included Professor Bruce Greenwald, Mario Tom Russo of Gardner Russo & Gardner speaking with
Gabelli ’67, Bruce Berkowitz, and Jon Salinas ’08. Dean Glenn Hubbard.
Henry Arnhold with Jean-Marie Eveillard of First Eagle. The panelists speaking with Dean Hubbard.
Page 4
Bill Ackman
Harvard Business School BA: I had very few actual think about mentorship within
and a Bachelor of Arts mentors in this business Pershing and about developing
magna cum laude from because I didn't really know your team on the investment
Harvard College. anyone. I bought Seth side over time?
Klarman's book, Margin of
Graham & Doddsville Safety, which was published my BA: I don't think we have any
(G&D): If we were to go back first year of business school. I particular programmatic way
to the period before launching called him up and said, "Hey, to develop people. The
Gotham, how did you get your I’m a business school student Goldman Sachs' of the world
start in investing? and bought a copy of your have real training programs. At
book.” He said, "You bought a Pershing, people on the
Bill Ackman (BA): I started copy of my book?!" I don't investment team side are
Bill Ackman investing in business school. A think many people had done pretty good investment
friend recommended that I that. analysts by the time they get
read Ben Graham's The here. They've already spent
Intelligent Investor and it three or four years training at
resonated with me. I decided investment banks and private
to go to Harvard Business “...if you can find a equity firms. Some may even
School and learn how to have finance experience from
become an investor. great business, and if their undergraduate programs.
I got to HBS and unfortunately

you can switch out a The rest is just working as part
there were no classes really mediocre management of a ten-person team. Our
focused on investing. The first analysts work very closely with
year is a set program – it didn't team for a great one, me and other members of the
have much in the way of team. We learn from each
choice. I thought the best way you can create a lot of other; not just the older
to learn is by doing, so I people teaching the younger
started investing on my own. I value. That was an people, but the younger people
found that it fit with what I like teaching the older people. It
evolution over 22
to do. The first stock I bought just sort of happens. We learn
went up. I think if it had gone years.” new things every day.
down I would have become a
real estate developer or G&D: How would you
something. Then, six months In a sense, he was a mentor describe the evolution of your
later, I roped in a classmate, because he had graduated from investing philosophy from
David Berkowitz, who was in Harvard Business School ten Gotham to Pershing Square?
my section – it was a little years earlier and started a
lonely going back to the dorm hedge fund right out of school. BA: Gotham was not set up to
room on my own to do this That's what made it seem be an activist hedge fund – it
kind of thing. The two of us possible. I don't know if he was just sort of happened. I don't
started looking at investments a mentor per se – a mentor is remember the moment we
together toward the end of my someone you have more decided to intervene in a
first year and the beginning of interaction with, but he was company. There were a couple
my second year. At a certain certainly someone that I of different cases where it
point in time, I said, "What if looked up to. Of course, seemed obvious what should
we did this as a real business?" Buffett was a mentor in a happen. The basic evolution
I figured the worst case, if we sense. He didn't know me. You was this: Version 1.0 was
failed, is we'd have a lot of very can still learn a lot from people classic value investing, which
good experiences. And if we're without ever meeting them. entailed investing in statistically
successful, great. cheap securities. Version 2.0
G&D: There have been a was recognizing the difference
G&D: Did you have any number of analysts at Pershing between businesses of
mentors back then? Square that have gone on to different quality. I think over
great success. How do you time we developed more of an
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Bill Ackman
appreciation for the value of a We size things based on how position.
quality business. Version 3.0 much we think we can make
was understanding the impact versus how much we think we The biggest investment we
of activism. More recently, can lose. We'll probably be ever made was Allergan
Version 4.0 is understanding willing to lose 5-6% of our (AGN), which, at cost, was
that if you can find a great capital in any one investment. approximately 27% of our
business, and if you can switch With Fannie (FNMA) and capital. There we were
out a mediocre management Freddie (FMCC), you have partnering with a strategic
team for a great one, you can highly leveraged companies acquirer and it had an
create a lot of value. That was where the government is immediate catalyst to unlock
an evolution over 22 years. effectively taking 100% of the value. It was a very high quality
profits forever. There's legal business. We felt it was hard
G&D: You manage a risk and political risk, and an for us to lose a lot of money,
concentrated portfolio and enormous of amount of so the position could be quite
there are some inherent risks uncertainty. We could large. Could we lose 20% of
to that. Broadly speaking, how realistically lose our entire our capital? Sure, it was
do you think about investment. That's a 2-2.5% possible, but very unlikely. So
constructing the portfolio position at today's market in some sense, we think about
today and how has that price. losing 20% on 27% as risking 5-
changed over time? 6% of our capital.
BA: I'm a big believer in “We look at G&D: You mentioned

concentration. But it's not just companies failing to achieve
analysis that protects you, it's management the their true earnings potential as
the nature of the things you possible opportunities. How
invest in. If you invest in super
same way we judge do you evaluate management
high quality, durable, simple, people we want to teams and what metrics do
predictable, free cash flow you consider?
generating businesses, that hire for Pershing
should protect you as well. BA: We look at management
Square. We're looking the same way we judge people
If you pay a fair to cheap price we want to hire for Pershing
for businesses of that quality, I for character, Square. We're looking for
think it's hard to lose a lot of character, intelligence, and
money. The key is you have to
intelligence, and energy, but we're also looking
be a good analyst in order to energy, but we're also for relevant experience. If you
determine whether it truly is a look at Seifi Ghasemi at Air
great business. You have to looking for relevant Products (APD), he knows the
really understand what the industrial gas business very
moats are. You have to experience.” well. He spent nearly 20 years
understand the risk of with The BOC Group and
technological entrants – the In our other investments, it is spent the last 13 years at
two guys in a California garage very hard to lose money. We specialty chemical company
working on the next new like to own businesses with Rockwood Holdings (ROC).
thing. Buffett would always dominant competitive So he had both disciplines –
write about the newspaper positions, such as railroads, the qualitative characteristics
business being one of the great industrial gases, and specialty and the experience. He had
businesses, but print has been pharmaceuticals. Some of our been a public company CEO
disintermediated as a result of investments also benefit from for a meaningful period of
changes in technology. So undermanaged operations or time. It was very easy to
we're concentrated, but we try reported earnings that support him as CEO of the
to invest in businesses where understate true economic company.
it's very hard to lose money, earnings. When we pay a fair
particularly at the price we price for those situations, we We helped recruit Hunter
pay. can make it a significant Harrison to Canadian Pacific
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Bill Ackman
Railway (CP). He had turned the launch of a public entity BA: Probably not. If Carl Icahn
around two other railroads and a fair amount of internal had not come in and bought 17
including a Canadian capital, we're devoting million shares of stock, this
competitor. If you meet him, effectively all of our resources would have played out very
you'll understand his leadership to active investments. If you're differently. What made this go
qualities. It's easy if you're going to be active in a a slightly different direction
Professor Tano Santos
backing someone who's situation, it's very helpful to than we had expected was
listening to the panelists at already done it before. It’s have it be geographically Carl went first in a big way,
the 2014 Graham & Dodd more difficult when you are proximate, operating in the and that attracted a lot of
Breakfast. taking someone who has not same language, under the same other participants who viewed
been successful before and law, where you're well known this as a trading opportunity to
betting on their success. and you know the players. make money on a short
squeeze.
G&D: Do you have examples
of bringing in successful CEOs I don't think it affected the
who did not previously have ultimate outcome, and I think
relevant experience? “We’ve yet to hear we'll make more money as a
result, so maybe we were
BA: We focus on candidates one fact from investors compensated for the extra
with previous experience. You time by being able to buy a
can meaningfully reduce the that own the stock or bigger notional short position.
risk if you can find someone We bought a lot of put options
who's done it before. We have any bull case that in the stock in the $70s and
an affection for older CEOs in caused us to think $80s that we could not have
some sense. With both Seifi economically purchased when
and Hunter, they have 50 years Herbalife was a stock we first established the
of experience. Someone at position.
that stage of their career that you should buy as
has been successful is not G&D: I'm sure you've heard
really driven by financial opposed to one you an opposing thesis from any
considerations. It's more about number of smart investors. Is
legacy and the fun they have. should sell.” there any compelling piece of
That's why we think old CEOs evidence that has made you
are best. question your conclusions on
HLF?
G&D: Why hasn’t Pershing With a strategy where we're
invested in more businesses doing two things a year, maybe BA: No. We've yet to hear
outside the US? Certainly three, we don't need to go one fact from investors that
there are legal considerations outside the U.S. or Canada. own the stock or any bull case
from an activist perspective, We would be open to that caused us to think
but even among the passive something international at Herbalife (HLF) was a stock
holdings, there does not some point, but it would have you should buy as opposed to
appear to have been many to be extremely compelling. one you should sell. The
purely international focused We feel like we've got plenty quality of work done by the
businesses in the portfolio. of things to do here. people that own this stock is
really poor. If they continue to
BA: Passive investments have G&D: Let’s talk about a own it, they will lose 100% of
been placeholders until we find couple of ideas. One that their investment. 13-Fs are
the next activist investment. people love to ask you about is coming out on Monday for this
They've also been a way for us Herbalife (HLF). Do you think name (Editors’ Note: this
to have more liquid the return has been worth it interview was conducted in
investments in case we get relative to the amount of time November 2014). I will be
redemptions from investors. and effort you've had to amazed. I'm always looking
As our capital base has expend on this investment? forward to find out who
become more permanent with bought it. There seems to be a
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Bill Ackman
new victim each quarter. your Herbalife thesis? Americans find it a fancy thing
Statistically, it screens really that you don't do at home.
cheap. It's trading at 7-8x BA: Why was Bernie Madoff in They think there must be
earnings. That sounds cheap, business for 37 years? I don't something shady about it.
but it’s based on projected know, it seems so obvious.
earnings. We think earnings Herbalife's been around for 34 G&D: You mentioned you
projections are going to come years. It's on the New York only invested in two new
down meaningfully and they've Stock Exchange. It has a positions this year. Can you
already begun to. Ultimately, market cap of $8 billion. Yet if tell us about an idea that you
we think earnings will go you go to L.A. and ask people spent a lot of time on, but
negative. about Herbalife, they go, "Oh, ultimately decided to pass?
that pyramid scheme?" They've
G&D: Do you have a set had that thought for 20 years. I BA: We did a lot of work on
process to keep yourself think the company has done a McGraw-Hill (MHFI) a few
intellectually honest in terms very good job at creating the years ago. It is a conglomerate
of assessing the counterview perception of legitimacy by with several businesses and
to what your thesis is? products. One of them is the
S&P franchise, which we think
BA: We're always open to a is one of the best businesses in
contrary point of view, “We're always open to the world. Capital IQ is
particularly if it's someone another McGraw-Hill product
who's smart with a good a contrary point of that we use and like. It’s a
record that's on the other side great and valuable asset. The
view, particularly if it's
of something we own or company on the whole looked
something we're short. We someone who's smart undervalued and interesting.
want to hear it and we're going
to listen to it. With Valeant with a good record Ultimately, we couldn't get
(VRX), there are some well- comfortable with the potential
known short sellers, Jim that's on the other side liability associated with being in
Chanos in particular. I don't the bond rating business. We
know if he's still involved, but of something we own had a pretty negative view on
he was publicly short the how the ratings agencies had
or something we're
stock. I wanted to hear all of managed the crisis. We had big
his arguments. I called him, and short. We want to hear short positions in bond
he was very charitable in insurers that had AAA ratings.
sharing them. I appreciated him it and we're going to I met with the ratings agencies
doing that. many times to try to convince
listen to it.” them that their ratings were
One of the best ways to get just ridiculous to no avail.
confidence in an idea is to find
a smart person who has the surrounding themselves with We felt that MHFI had real
opposing view and listen to all legitimate people. Madeleine liability and the potential losses
of their arguments. If they have Albright is a consultant to the they may face from litigation
a case that you haven't company. They have a Nobel were unknowable considering
considered, then you should Laureate on their scientific the amount of bonds that were
get out. But they can also help advisory board. They brought purchased and the amount of
give you more conviction. If on the former surgeon general money that was lost relying on
what I've heard are the best in the last year. They sponsor those ratings. With our
arguments that can be made soccer stars, such as David strategy, we must be willing to
against being short Herbalife, Beckham, and the L.A. Galaxy. put 15-20% of capital into a
then I want to be short more. It's a brilliant scheme. particular idea. We can’t invest
in a security where it is
G&D: Why do you think it's Also, the general public is just possible that you wake up
been so difficult for the market not interested or comfortable tomorrow and it's worth 50%
to wrap their head around with short selling. Most or 80% less than what you
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Bill Ackman
paid. So that was something way to think about that story with respect to each of
we passed on even though we business. our failed retail investments.
thought it was unlikely that And there are retail
there would be a claim that G&D: One area that's been investments where we made a
wipes out the value of the difficult for Pershing in the past lot of money – Sears (SHLD)
company. has been retail. What has in 2004, Sears Canada (SCC),
made that sector so difficult and food retail businesses
We saw this as different from relative to some of your other would be examples. But I think
Fannie (FNMA) and Freddie areas of focus? retail is a very difficult
(FMCC) because we thought business, particularly fashion
MHFI was a potential double, retail. That's a tough category.
while we think we can make
25x our money in Fannie and G&D: Are there other
Freddie. A small investment in “Fundamentally what industries that you'd say are
Fannie and Freddie can still be you're looking for is too challenging?
very material in terms of
profits for the firm, yet if how much cash the BA: We have generally
something happens and we avoided technology as well as
lose our entire investment, we business can generate commodity-sensitive
won't really notice. For MHFI businesses. With commodity
to be a meaningful contributor, on a recurring basis businesses, it's very difficult to
it would have to be a big predict the future price of the
investment. over a very long period commodity – this year being a
of time. That's what good example. If you asked
G&D: Buffett uses the people at the beginning of the
concept of owner earnings. we do.” year, I don't know how many
Are there any particular would say that WTI would be
metrics you find helpful? below $76. So we avoid a few
sectors, but we try to stay
BA: I think the job of the BA: I think retail has become open-minded. For example,
security analyst is to take the much more difficult. A big part healthcare was something I
reported GAAP earnings of a of that is Jeff Bezos and would have put on that list a
business and translate them Amazon (AMZN), a large year ago. Right now, we have
into what Buffett calls owner company that does nearly $75 two healthcare investments
earnings. I call them economic billion in revenue growing comprising 40% of the
earnings. The next step is to faster than 25% annually. They portfolio. In every sector there
assess and understand the are reinvesting 100%, maybe are businesses that can meet
durability of those earnings. more, of their profits to our standard, but most won't,
Fundamentally, what you're improve the customer and that's why we haven't
looking for is how much cash experience, expand their spent a lot of time looking in
the business can generate on a reach, and so on. I think it’s an some of these areas.
recurring basis over a very incredibly formidable
long period of time. That's competitor that gets stronger G&D: Would you be willing to
what we do. GAAP accounting every year. When you grow at share your thesis on Zoetis
is an imprecise, imperfect those rates, that revenue is (ZTS) and what the playbook is
language that works for very coming from somewhere. He's going to be there?
simple businesses. For a widget got a better mousetrap. He's
company that grows 10% a got the support from his BA: I think it's a great
year, GAAP earnings are really investors to invest a huge business. It has a dominant
good at approximating amount of capital in the position as the largest
economic earnings. For Valeant business. That's a very difficult company in animal health.
Pharmaceuticals (VRX), for competitor for the retail There are very good trends
example, a company that's industry. supporting the growth of the
been very acquisitive, GAAP company. Rising income levels
accounting is not a very good Aside from that, there is a and increasing demand for
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Bill Ackman
protein in people's diets a super high quality business which these vehicles were out
benefit the company. The you can buy for a discount of favor in the investment
companion animal health where there's an opportunity community. Our Allergan
segment of their business for optimization? activist campaign was
should also benefit from rising somewhat unprecedented as
incomes. With more affluent G&D: Many respected well.
William von Mueffling ’95 cultures, people have more investors have publicly praised
of Cantillon Capital pets, but also care for them your investment creativity. It I don't think it's as much
Management speaks with more. It meets our standard seems to be one of the creativity as it is a willingness
Columbia Business School for a high quality business. It's defining qualities of Pershing to consider opportunities that
Senior Associate Dean Lisa also a spinoff, which can create Square. How do you cultivate are unconventional and outside
Yeh at the 2014 Graham & interesting opportunities. I that creativity? Is there a way the box. What's required is
Dodd Breakfast. don’t think we are ready for for someone to develop that that you have to have a basic
comment beyond that. ability? understanding of what's right,
what's legal, and what's
G&D: How do you typically possible, and not limit the
source ideas? Is there one universe to things that no one
method in particular that's had “What's required is else has done before.
a lot of success?
that you have a basic We are absolutely going to
BA: Interestingly, Allergan consider things that haven't
(AGN) and Air Products
understanding of been done before. We don't
(APD) were brought to us. what's right, what's need a precedent. We're just
That's a good way to get ideas. interested in things that create
We have a reputation for being legal, and what's value and we're going to look
a good, proactive investor. at them objectively. To
Canadian Pacific (CP) came possible, and not limit execute the strategy, you have
from an unhappy CP to be willing to do things
shareholder. Air Products the universe to things without caring what other
came from a happy CP people think. You need thick
shareholder who made a lot of
that no one else has skin. In this strategy, not
money with us and said, "Hey, done before.” everyone's beloved,
this is the other dog in my particularly on the activist
portfolio, maybe you can help." short side. You're not going to
Allergan came to us through make many friends in that
Valeant because they were BA: Someone once pointed business except for the first
looking for someone who out that almost everything person who took your advice
could help increase the we've done has been and got out.
probability of their success. unprecedented. We shorted a
company and announced to G&D: Given that we're in this
We're looking for big things. the entire world that it is a "golden age of activism," there
Today we have $19 billion in pyramid scheme. With General are lots of investors and capital
capital. We want to put 10% Growth Properties (GGP), we focused on activism. Have you
or more in an investment so bought 25% of the equity of a found it more difficult to find
we prefer companies with company on the brink of ideas to add to your portfolio
market caps above $25 or bankruptcy, convinced them to as a result?
even $50 billion. We are file for bankruptcy, and helped
looking for high business them restructure. We started BA: No. First of all, it depends
quality and opportunities to a company from scratch with on what you count. In terms of
make the business much more Howard Hughes (HHC). That dedicated activist funds, there
valuable. Some of our sourcing was a collection of assets we is something like $150 billion.
comes from reading the spun out of GGP and replaced That's a still a small number in
newspaper and just looking for the management team. We’ve the context of the size of the
companies that meet that very had two successful investments market. We are one of the
simple model. Where is there in SPACs during a period in largest at $19 billion. We are
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Bill Ackman
also one of the most lot of CDS outstanding, I recognize that the stability of
concentrated activists. A would be much more inclined your capital base has a huge
combination of concentration to do that than having to impact on your returns over
and scale means we're doing borrow stock to go short and time. The Buffett Partnership
very big investments and these risk the stock price rising. had no corporate level tax. At
are very big companies. Every Berkshire Hathaway he had to
company we've invested in, we G&D: What are you trying to work for $100,000 a year with
were the first activist who accomplish with the creation no stock options, and pay
bought a stake. of Pershing Square Holdings corporate level tax. This tells
(PSH)? me that he viewed the
Generally this is fertile ground. permanency of the capital base
I would say there's more as much more material than
activism happening in small and these other features.
mid-cap companies, so I don't “I do think companies
think it has affected us. I do That's basically what inspired
think companies are trying to are trying to fix us to create a public entity.
fix themselves before an We didn't want to pay
activist shows up, and that's a themselves before an corporate level tax so we
threat. As businesses become didn't want to merge with a
better managed and boards of
activist shows up...as corporation. While PSH is
directors replace weak CEOs, businesses become structured as an offshore
there's less for us to do. closed-end fund, we think of it
better managed and like an investment holding
G&D: You mentioned some of company. We have these
the benefits of having boards of directors subsidiary companies which we
permanent capital on your have a lot of influence over.
ability to do more activism on replace weak CEOs, We’re often on the board of
the long side. Are you going to directors and we own them
spend less time on shorts as
there’s less for us to for years. We add one or two
that shift continues? do” new businesses each year. Our
goal is to compound at a high
BA: After the MBIA (MBI) rate of return over a long
short where we made our period of time. This is different
thesis public, I was asked by from Berkshire Hathaway.
our investors if we were going BA: In 1957, Buffett formed Buffett is not an activist
to do this again. I told them it the Buffett Partnership. Eleven anymore. His past investments
was going to be a long time years later, after buying with Dempster Mill
before I did another one of control of Berkshire Hathaway Manufacturing and Sanborn
these big public shorts. It was (BRK), he gave investors a Maps had an activist bent
five years between MBIA and choice of cash if they wanted though.
Herbalife (HLF). Although, if to exit the partnership, or
this in fact goes to zero, stock if they wanted to merge The key for us was how do we
perhaps all we need to do the their shares into Berkshire get to permanent capital in a
next time is just say, "We're Hathaway. Buffett gave up the way that's investor-friendly so
short company XYZ" and it advantage of $100 million and we can do it in scale? We have
will go straight to zero and we the right to collect 25% of the what I think is a closed-end
won't even have to make a profits. He left that to be CEO fund with the biggest market
presentation. We hope it for $100,000 a year with a value – it's $6.6 billion. Why
works that way. public textile company which I did we do that instead of
think had a market cap of $30- reinsurance? Because I don't
Short selling is inherently less $40 million. know anything about
rewarding. We like shorting reinsurance, and I didn't want
credit as opposed to shorting Why would he do that? I think to mix investment risk with
equities. If we could find a big the answer is that if you are a property casualty risk. It's too
leveraged company that had a control-oriented investor, you complicated.
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Bill Ackman
G&D: From an investor values for the firm? What do as being places where you look
perspective, when they invest you look for in the people you for talent. Do you have a
in a public entity, they're have as part of your team? preference for people who
paying lower fees, they have have looked at businesses on
more liquidity. Do you think BA: We are very, very careful the private side?
PSH will impact the hedge fund about who we bring on to the
part of Pershing Square? team. I call our culture a BA: This year we've made two
functional family culture. This investments – Allergan at
BA: Most of our investors in is a very high quality, very beginning of the year and
the hedge fund part of Pershing smart, capable, motivated Zoetis at the end of year.
Square don't invest in publicly team. For the most part, we all That's a very different pace of
traded things. I think it's good like each other, which is investment when compared
for everyone that we welcome unusual in a business context. with your typical long-only
investors in whatever form hedge fund or mutual fund
they want to invest. firm. We have to find people
who are comfortable spending
G&D: You must have an a lot of time researching and
“At many hedge funds,
incredibly busy schedule. How analyzing, looking for the one
do you allocate your time? people are idea thing out of many that's going
to be interesting.
BA: Not as well as I should. junkies. It’s the idea of
It's the single biggest thing I At many hedge funds, people
need to work on. I have a the week. That’s why are idea junkies. It's the idea of
tough time saying no. I need to the week. That's why private
say no more. It's hard for me. private equity tends to equity tends to be a better
background for us. A private
be a better background
G&D: What about allocation equity investor might spend a
of time within investments – for us.” whole year working on a deal
what portion of your time is and if they are not the high
spent generating ideas versus bidder, they don't get it.
analyzing companies versus Whereas here, you might
engaging in activism? I interview everyone – every spend a lot of time working on
person who works at the something, but if we want to
BA: It depends. This year I reception desk, who cleans the make the investment, we can.
spent a lot of my time on offices, who works on the We have to pay the market
Allergan (AGN), the IPO of investment team. I think I'm a price, but we don't have to be
Pershing Square Holdings pretty good judge of character. the high bidder per se.
(PSH), and a little bit of time What we're looking for are
on Zoetis (ZTS). But we've got fundamentally good human For a person with a private
a very capable team focused on beings, people that you want equity background, it's a very
a few major things. to spend your day with, easy transition. We've never
because you're going to. That really hired anyone from a
It's much more of a team is a key success factor. It hedge fund. Effectively, our
approach and strategy than a depends on the role in terms approach is private equity
typical investment firm. Usually of what we're looking for, but without buying control.
you have a back office and an we like hard working, honest,
investment team. At Pershing, smart people who are fun to G&D: You've been
we are totally integrated in spend time with. extraordinarily generous to
everything we do – public Columbia Business School over
presentations, legal analysis, We have very little turnover at a long period of time. Why is
compliance, and so on. Pershing Square, even at the philanthropy important to you?
reception desk.
G&D: In terms of putting BA: One of my colleagues,
together Pershing Square, what G&D: You mentioned some of Paul Hilal, got us involved at
would you say are the key the larger private equity firms Columbia and came up with
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Bill Ackman
this idea of an investment class biology. We have a pretty Amazon Cloud and other
that’s become Applied Security broad, eclectic range of development resources. I think
Analysis and the Pershing philanthropic endeavors. I would be starting a company
Square Challenge. But I would There's not an overarching today as opposed to managing
say Columbia is on the smaller strategic plan. We're money. You can always manage
side in terms of what we've experimenting. money. In fact, if you do well in
Bruce Berkowitz of done philanthropically. whatever you do, you're going
Fairholme Capital with G&D: Before we close, do to have to manage your money
Michael Schmerin. We've given away more than you have any advice for anyway. It's good to learn the
$250 million over the last six students who are interested in skills. I think we have enough
years. What's interesting is I've potentially starting their own people in the investment
come to believe that I can fund or going into investment business. We want some more
make a much greater management after they start-ups.
contribution in my for-profit graduate?
life than my not-for-profit life. G&D: Thank you for taking
I'm working to figure out how BA: You should only work the time to sit down with us.
to get a higher return on with someone that you like,
investments in the not-for- trust, and admire. You should
profit activity. be smart about who you
choose to work for.
G&D: How have you decided
which areas to get involved in In terms of starting something
philanthropically? right out of business school,
it's something that I did a long
BA: We're trying to address time ago. I was fortunate to be
problems. I think there are lots able to have a 2.0 – Gotham in
of different ways to do that. some ways was a training
My first choice is to find a for- ground for Pershing Square. I
profit solution. There are think I was much more
some problems that do not successful at Pershing Square
appear to have for-profit because of the experience I
solutions, or at least someone had at Gotham. You can have
hasn't thought of one yet, and that kind of experience
then we help fund not-for- working for someone else. It
profit solutions to these wasn't really my nature to go
problems. work for someone else which
is why I didn't do it, but you
In terms of things we get can learn a lot that way. I
involved with, usually it's wouldn't worry very much
driven more by the person about how much money you
running it. There are lots of make. I'd worry much less
important problems – it's very about compensation than I
hard to rank them. Criminal would about what you can
justice reform is something learn.
we're interested in. We're also
interested in economic I also think that in order to be
development and education. a great investor, it's very
We've done some things for helpful to understand business
New York City on the cultural and how to run a business. I
side. We helped start think it's a really interesting
something at Harvard called time because it's so easy to
Foundations for Human start a business today,
Behavior, which is basically relatively speaking. Start up
behavioral economics costs are much lower due to
integrated with psychology and the ease of access to the
Page 13
Jay Petschek & Steve Major ’94

1991 and has yielded an came together. pay for dinner that night, so to
annualized net return of hear that we're worth half a
14% since inception. G&D: Who were some of million dollars was sort of a
your earliest influences? Were novel concept. That day we
Graham & Doddsville there any early career learned that you're not worth
(G&D): How did you first experiences that were what your bank account says
become interested in investing? important to your you’re worth, you’re worth
development as an investor? your future earnings potential.
Jay Petschek (JP): My dad
was an investment banker and JP: My dad was my earliest Another professor I had was
we talked stocks constantly influence. He always Fischer Black. He taught us
when I was growing up. I’ve approached the world from a about his options model, but
Jay Petschek also always been good with quantitative perspective. He the real takeaway for me was
numbers and liked games and taught us the binary system at the importance of change.
puzzles where you have to a young age and joked that Future volatility can be very
guess an outcome based on there are 10 types of people in different than past volatility,
partial information. Investing is the world – those who especially when an unexpected
similar, only this “puzzle” is understand the binary system event occurs. If you just used
based on financial data. You’re and those who don’t. I historical volatility, you would
trying to estimate, with only a developed a similar get the wrong value of an
company’s past financial quantitative sharpness as my option. He helped us
information, how well it can father, and that has helped me understand the potential
perform in the future. You throughout my career. valuation discrepancies and
have to invest on what isn’t investment opportunities that
fully appreciated and isn't fully can arise when change has
understood. That’s how you “I’ve also always been occurred.
get an edge.
good with numbers and SM: While I was at Columbia,
Steve Major ’94 Steve Major ’94 (SM): I I worked as a summer intern
liked games and
worked as an investment at Millennium and fell in love
banking analyst at Goldman puzzles where you with spin-offs, value investing,
Sachs after college. But I ended and situations with companies
up realizing that investment have to guess an going through change and
banking wasn’t where my transition. I ended up at
passion was. In those days, outcome based on Oppenheimer where I wrote
there was no internet, so research on post-reorg
Goldman would distribute on a partial information. equities. But my good fortune
daily basis printed copies of the really started when I met Jay in
Investing is similar,
firm’s equity research. I found 1996 at Ladenburg Thalmann.
myself really excited every only this “puzzle” is Who would have known that
morning to come into work Jay and I would quickly become
and read equity research based on financial investing soul mates and close
reports that were left in my friends. We shared a common
inbox bin – a plastic, data.” philosophy and approach to
rectangular, black, physical valuing spin-offs, companies
tray; not a Microsoft Outlook coming out of bankruptcy,
inbox. Company analysis and I later attended the Sloan multi-divisional companies, and
stock valuation ignited a spark School at MIT to get an MBA companies with a change in
inside me. After banking, I in finance and investing. Robert corporate activity. At the age
went to Columbia Business Merton, the famed Nobel Prize of 28, I was given the
School and took classes on winner, one day told our class incredible opportunity to
leveraged buyouts, investing, that he would buy 10% of our manage money on my own,
and stock-picking with Bill future income for $50,000. Of and that was unusual. Jay and I
Comfort, Paul Johnson, and Jim course, we were all students became partners over time and
Rodgers. That's where it all trying to figure out how we'd the rest is history.
Page 14

G&D: How have those typically looking for? G&D: Has that been the
experiences shaped Corsair’s philosophy since day one, or
approach to investing? JP: We also want a signal from are there parts of it that have
the management team that evolved over the last 20+
JP: Corsair has a philosophy of they care about their stock years?
long-term investing in good price and believe their business
businesses at discounted is undervalued. We look for That's always been the
valuations. Good businesses insider buying, companies underlying philosophy. The
will increase in value over initiating or increasing a guiding principles we laid out in
time. Time is working for you. dividend, stock buybacks, and our January 1991 initial letter
This is what has allowed us to new employment agreements have remained consistent.
act as real investors – our with a heavy emphasis on One, increase our capital at a
average holding period for a stock compensation. Those are rate comfortably ahead of
core position is two years and a few of the things that signal inflation and the effect of taxes.
almost all of our gains since that management believes in Two, take prudent risks while
1991 have been long-term in maintaining a diversified
nature and tax efficient for our portfolio. And three, good
investors. Likewise, we want investment ideas are hard to
to short bad businesses when “What's a really good find and deserve the time to
they’re fully priced because work out. I will say that, while
their values degrade over time. business to us? A not in our original guiding
It’s a very simple concept: own principles, a management team
good businesses at really good business with recurring we are comfortable being
prices and sell bad businesses partners with has proven to be
at full prices. What's a really
revenue, a good moat, critical.
good business to us? A high returns on
business with recurring We also like to try to keep in
revenue, a good moat, high invested capital, and a mind that it’s not where the
returns on invested capital, and stock has been, it’s where the
a management team that is management team stock is going. One of the early
focused on working for the examples of this for me was
shareholder. that is focused on Cott Corporation (COTT) in
the early 1990’s. Considering
We believe you can find working for the purchasing the stock at $18
opportunities when these shareholder.” per share was psychologically
companies are going through difficult as it had risen from a
change and transition. When a price of $3 in less than a year.
company goes through a major But over the next two years,
acquisition, spin-off, the business and will, at least the stock went to around $350
privatization, new product going forward, care about their when adjusted for stock splits.
introduction, new regulation, stock price. When we see We emphasize that even
post-bankruptcy, new those factors intersect – a though the initial human
management, or a company with a really good reaction is to feel like you’ve
recapitalization of the balance business going through change, already missed out on a big
sheet, future results could be with an undervalued stock move, the key is where we
much better than past results. price, and signals by think the stock is going from
The opportunity presents itself management that they care here.
when the market does not about their stock price – we
recognize this inflection point look for an opportunity to G&D: In working together,
of change and/or does not invest. On the short side, we how is your decision process
reflect that future financials will look for the opposite signals – structured? For example, what
be materially better or worse bad businesses where would you do if there's any
as a result of this transition. management seems interested disagreement on an
in getting out. investment?
G&D: What else are you
Page 15

SM: We have a very strong market’s lens (i.e., what is the In 1988, I joined a group with
discipline in place at the firm. market missing?). some friends to buy a 24.9%
It's not about Jay. It's not about position in a company called
me. It's about the Corsair If the company passes our Tri-State Motor Transit of
philosophy and methodology, quality test and we think it is Delaware, a specialty trucking
rooted in three principles: materially undervalued, we company which we thought
finding a good business with take our research to the next was highly undervalued. Tri-
strong cash flows, a solid level and try to meet with or State owned a lot of real
balance sheet, and a winning speak to management to gain estate that we thought was
management team with a more conviction. In the end, valuable, and management was
proven track record of it’s a question of whether a doing nothing to optimize the
creating shareholder value. We stock has low risk and really business. We actually formed a
may disagree around the edges good reward. hostile bid and ended up losing
on relative quality or on how a very close proxy contest.
big a position should be, but Ultimately, because we were
it's rare that we disagree on still pressuring the
whether a particular stock management team, they sold
“We also want a signal
should be in the portfolio. themselves in a leveraged
from the management buyout. We made a great
To help our process we use a return but I realized that I
rating model to evaluate and team that they care didn’t like hostile investing. I
standardize the potential decided to form Corsair
quality of an idea. Our Corsair about their stock price Capital Partners in January
Rating Model uses a 1991 while still at Ladenburg
combination of 1) our and believe their with money from friends and
probability-adjusted expected family. The idea was that we
business is
return and 2) a quantitative wouldn’t put all our eggs in
score to reflect qualitative undervalued. ” one basket like the Tri-State
factors. As far as modeling is Motor deal – we'd spread
concerned, we want to them around. It would be the
determine what we think the same core philosophy of
company is worth today, what looking for a company that was
it could be worth on the G&D: What was the original undervalued and was going
upside if management executes impetus for starting Corsair? through a transition, but I also
its business plan, and what the wanted management teams
downside could be if the JP: After working in the that would work for me
company stumbles. On the corporate finance department instead of against me. So it
qualitative side, we focus on of Bankers Trust following started with this one-off
four questions: How good is business school, I realized that situation, but we've been
the business overall? How is I wanted to do something fortunate to grow it over the
the balance sheet? Is it a good more directly stock related last 24 years.
management team? What is and I had an opportunity to
our conviction level? The join Ladenburg Thalmann & G&D: Would you be willing to
overall goal in using the Co, which was a small walk us through an example of
Corsair Rating Model is to investment banking firm akin your investment process?
score how good the risk/ to a smaller-sized Bear Stearns
reward is for an individual back then. You could do a little JP: The Shaw Group (SHAW)
stock. When a company hits bit of everything there, so I is a good example. While
our screen – because it’s learned everything from being covering one sub-contractor
executing an acquisition, a retail stock broker to working on the clean-up of the
spinoff, restructuring, or any corporate finance, and I ended BP oil spill, we came across
other corporate action – we up running their investment Shaw, a company that had a $2
typically outline why this management and research billion market cap and more
company looks different departments. than $1 billion unencumbered
through our lens versus the cash on the balance sheet that
Page 16

was the lead contractor on had started Shaw as a small avoid getting shaken out. We
that project. It had a nuclear fabrication business in 1986 do not have an automatic stop-
power plant maintenance and grew it into a diversified loss rule. A lot of firms do. If
business and was building two Engineering & Construction your thesis is intact, we think
new nuclear reactors in the company with $6 billion in that’s actually an opportunity
U.S., so the Fukushima plant revenue. He seemed like a guy to average down. I think if
Erin Bellissimo of Aravt disaster in Japan had been who did an amazing job in you’re a trading oriented firm,
Global with Jon Salinas ’08 weighing on the stock in 2011. building a business. it probably does make sense to
of Plymouth Lane Capital. cover and move on. Everyone
There was a reason why we has to be true to their own
saw it and others didn't. It discipline. It is not fun to
screened terribly on average down, unless it
Bloomberg due to complicated “A proven record of ultimately works out.
financials and investors were Fortunately for us, we woke
afraid of owning anything
success is critical. If up in late July 2012 and
nuclear related but there were someone's been Chicago Bridge & Iron (CBI)
several misconceptions we made a bid for the company at
could identify. Bears argued successful before, a very nice premium.
that the Fukushima disaster
would slow the development that’s a very good G&D: What have you learned
of nuclear power globally. over time about identifying
Instead, we saw a plant indicator of a good management teams?
maintenance business, with
50% market share in the U.S.,
management team JP: A proven record of
which would stand to benefit you want to partner success is critical. If someone's
from potentially tighter been successful before, that’s a
industry regulation. Investors with the next time.” very good indicator of a
also seemed to be worried management team you want to
that Shaw was taking write- partner with the next time.
downs on two construction And there are two reasons for
projects which were nearing Furthermore, Shaw’s that. One, he's successful, and,
completion. Our approach management put their money two, the shareholders did well.
focused on pro forma earnings where their mouth was, buying We love to find managers like
once those two bad projects back $500 million of stock in Jim Reid-Anderson of Six Flags
rolled off. the aftermath of the tsunami (SIX), who was very successful
and announcing another $500 in turning around Dade
Another misunderstanding million program later in 2011 Behring. When he came out of
about the company related to as the stock slumped. They retirement to take over Six
its balance sheet. Due to a JV clearly believed in the value of Flags, we immediately wanted
with Toshiba in a nuclear the business. The stock traded to hear why. He laid out plans
technology company, Shaw had for $25 per share, and, for the as to what he thought was
to consolidate $1.6 billion of next year or so, despite achievable. Given his past
debt on its balance sheet. This several positive developments, accomplishments and
debt, however, was non- the stock faded down to as reasonable plan, we invested as
recourse and the entire low as $20. We only saw the Six Flags was coming out of
investment could be put back company announce good news bankruptcy and did very well.
to Toshiba at Shaw’s request. over this time and still the A proven track record at the
So when you adjusted for that stock traded lower. CEO level means a lot to us.
noise, the company actually
had over $1 billion in G&D: Did you add to your G&D: Do you always meet
unencumbered cash and no position? with CEOs or are there cases
debt. Then there still was the where the track-record alone
question of management. As JP: Our conviction allowed us is enough?
we did our digging, we saw to average down. You better
that the CEO, Jim Bernhard, know your stocks well to JP: In almost all cases, we’ve
Page 17

met with, or at least spoken and the stock was cheap, but the great value creators of our
to, management before making management was investing in day. Now we’re thinking this
an investment a core position. what appeared to be very low could potentially lead to
We can read transcripts and ROI projects and M&A. So we another catalyst. Two weeks
take a small initial position, passed. However, we came later CLW announced an
what we call a “farm team" back to it because our screens accelerated share repurchase
position. However, in order to showed a new CEO and CFO program. Since then, in about
establish a name as a core had joined. We took another two years, CLW has bought
holding, we want to speak to look at the company and back more than 20% of the
management. identified change. We saw a company on a market cap
new slide in their investor basis. CLW is a perfect
In the case of a John Malone presentation about how example of a business we
and Greg Maffei type of undervalued the stock was. It always liked but couldn’t get
management team, we know seemed like some sort of new involved with under previous
the track record they’ve put religion might be taking hold. management. Once we spoke
together and can read the to the new CEO and CFO, we
transcripts. Their success is gained conviction that value
already well-known and they would be created.
“But we also ask
typically outline their thinking,
so we might not need to have ourselves: what has Another example of this is
the one-on-one to hear it. But Orora (ORA AU), a classic
for the overwhelming majority this CEO done in the spin-off from a much larger
of our portfolio, we meet with company in Australia called
and try to get to know past? Is he personally Amcor (AMC AU). Orora was
management well. one tenth the size of Amcor
buying stock in the and shareholders wanted to
G&D: One of the key tenets own the big packaging
open market? What is
of the Corsair philosophy is conglomerate, not the much
clearly management and he doing with the smaller Orora. When we
shareholder alignment. Are approached the stock, it had
there other situations you cash? Has he created just spun off with a market cap
could discuss that highlight of approximately $1.4 billion,
your focus on good stewards value and sold a yet there was no U.S. analyst
of capital? coverage and large
business or is he just shareholders in Australia were
SM: You always have to look punting it. We saw a company
an empire builder who
at the empirical data and that was number one or two in
fundamentals of a business to doesn't care about its markets, with stable cash
increase the probability of flow, a manageable balance
being right. But we also ask shareholders very sheet, and a management team
ourselves: what has this CEO with a track record of creating
done in the past? Is he much?” shareholder value. Orora CEO
personally buying stock in the Nigel Garrard arrived to
open market? What is he doing Amcor in 2009 after being
with the cash? Has he created At that point, you had new CEO of another publicly
value and sold a business or is capacity ramping up, excess traded company in Australia
he just an empire builder who legacy costs being stripped out, which he sold to a strategic
doesn't care about and EBITDA rising – it looked buyer. Garrard tripled the
shareholders very much? like an inflection point in value of the company in his
That's all important. earnings power. Then we saw four years as CEO – he is a
the company add two new winner.
With Clearwater Paper board members, including
(CLW), which was spun off a Kevin Hunt, who was the CEO We saw other signals, too.
few years ago, we liked the of Ralcorp (RAH) and a There was a big cost cutting
private label tissue business protégé of Bill Stiritz, one of program that we thought
Page 18

would change the earnings dislocation. Nobody has the strength to Indigo Partners.
complexion as a standalone same lens. Everybody has his What remains is the core
company. And we saw insider or her own biases and ways of business – a fixed fee operator
buying of the stock in the open looking at data. Maybe of short flights for United
market immediately following everybody has the same Airlines, American Airlines,
the spinoff. The CEO bought screens, but it's really the lens, and Delta, that has been in
over $1 million worth of stock the philosophy and the ability business for 40 years and has
and another director was also to see something that the never had a quarterly loss.
buying stock. Besides trading at market doesn't see. After purchasing Frontier in
single-digit multiple of pro 2009, RJET posted losses from
forma free cash flow and with the rising price of oil and the
a management team that wants market underappreciated the
to create shareholder value, steady, profitable fixed-fee
they're paying out 70% of their operation. All you had to do
earnings in dividends. We think “We need catalysts was get rid of Frontier and
they understand capital refocus on the fixed fee
allocation and will do the right and we need to make business, with its long term
thing. When you think of the contracts and stable cash flow.
premise of spin-offs, it’s the money for investors
creation of value – that's why Today, the market sees a
we look at spin-offs. And ORA every year. But you leveraged balance sheet from
is another prime example of debt associated with the jets.
management having a history
also need to have We actually see unrestricted
of creating value with a patience across a cash of approximately $4 per
credible plan to unlock more share on a $13-$14 stock with
in the future. portfolio of ideas with a business that will generate
more than $2.50 per share of
Investing can be a humbling catalysts.” cash earnings in 2015. With
business, and it’s important to the new business that they'll be
have the insight that you're taking on over the next couple
going to make mistakes. of years for United Airlines
Fortunately, over our 24 years, and the business they've been
we’ve had many more ORA’s The “Corsair Lens” allows us ramping for American Airlines
and CLW’s than we’ve had to focus on what we think is more recently, you can get to
material negative performers. important when the market is over $3.50 per share of cash
Choosing great management focused on other factors. The earnings in 2017. Put a 10x
teams is a key ingredient to “Corsair Lens” picks up on multiple on that and you can
hitting at a high batting signals that others might not have a $35 stock. The market
average. appreciate. We understand just doesn't see it yet because
what the market sees, but it is focused on RJET’s labor
G&D: Building on your we're able to look past it. situation with its pilots. We
investment framework, are I’m thinking of Republic have watched management
there ways that you think Airways (RJET) as an example. execute very well for three
you've really differentiated The stock’s been in the $13- years and are confident they
your process or sourcing $14 range, and the market sees will reach a deal with the
methodology versus other a management team that newly elected union leadership
special situations investors? previously made a bad over the next 6-12 months.
acquisition in Frontier Airlines, CEO Bryan Bedford is also an
SM: There are a lot of people a potential pilot shortage, and innovator, thinking several
looking at the companies that the recent struggles of steps ahead of the
we're evaluating, but it's a competitors in the industry. competition. We expect him
question of how you look at We see a management team to creatively separate RJET’s
something. More competition that restructured Frontier profitable large jet business
actually might even help us by Airlines to profitability and from its breakeven small jets
potentially creating more sold it from a position of business (50 seats or less).
Page 19

These two overhangs should consolidated through mergers lose a lot even if you only
be lifted over the next year and bankruptcies. We had assume small changes to the
and the market will then be conviction and enough margin value of the company. Good
able to focus on $3.50 per of safety to be patient and ride management, good balance
share in pro forma cash out a bumpy road – it paid off. sheet, and good business
earnings power. RJET stock As management executed, model – these allow you to
has done notably well since earnings power tripled and the take bigger positions.
being a $5 stock in 2011, but stock reacted positively. We
we believe it is a better buy believe it’s a better buy today Typically, we hold roughly 25
today as earnings are quickly than it was three years ago. core positions in our portfolio.
ramping and management has Through this diversification
proven its ability to execute. with very manageable position
We’re looking for these types sizes and no leverage, we
of low risk opportunities, believe our investors are
where our lens can detect “There is a protected. Basically, the margin
asymmetric risk/reward. of safety we look for in every
tremendous amount of stock we invest in is the same
G&D: A key challenge of margin of safety all of our
investing is getting the timing luck in this business, investors have with their
right. With Republic, you investment in Corsair. In fact,
outlined a few catalysts. What being in the right we're actually able to buy
is your level of patience if stocks when other funds are
these catalysts don’t turn out?
place and at the right being forced to unwind or de-
time. Having said that, lever positions. With many
SM: We need catalysts hedge funds, even though they
because we need to make it is definitely a case might be hedged or have low
money for our investors every net exposures, the problem is
year. But we also need to have of the harder you that their gross exposures are
patience across a portfolio of quite high. They're certainly
ideas with catalysts. Some will work, the luckier you over 100%, and that's what
happen earlier than we think, forces them in difficult
others later. Sometimes the
get.” situations to retreat and bring
market is very stubborn and it down.
that is why discipline is so
important. It’s also why our G&D: Do you also take into
Corsair Rating Model is so account concentration by
valuable. As much as we love a G&D: How does Corsair strategy type when looking at
business or a management compare potential new investments? For instance,
team, it’s important to be opportunities and think about would you care if all the
disciplined and ask: do we sizing? positions in the portfolio were
want to own it here? Perhaps spin-offs or bankruptcies?
we really love it 10%-20% JP: From a portfolio
lower, so we should be construction point of view, we JP: We don't worry about
patient. Entry price is crucial. balance four factors into where the idea came from, so
RJET is a good example of position size. One is risk to speak. We do care about
entry points, patience, and the versus reward. Two is risk by what business they're in. If it
need for margin of safety. We itself. Three is correlation with happens that we have three,
entered the stock in 2011, other names in the portfolio. five, or ten ideas that were
when the sell-side was focused Four is liquidity in the name. post-bankruptcy, or were spin-
on losses at Frontier and could The riskier the name, the less offs, or privatizations, that’s
neither recognize the value of we will invest overall. Again, okay – we really care more
the fixed-fee segment nor what these are qualitative about whether or not the
we thought was a great judgments, but if the company underlying businesses are
fundamental environment for is highly leveraged and it is not correlated.
the company, as peers very liquid, obviously you can
Page 20

G&D: Some of these a flavor of what you really own your views, have the
investments you’ve discussed and hear more about the confidence to take risk and
have a macro component to thesis. That’s both good and take ownership of your
them. How much does the bad. It definitely helps them decisions – own it. Taking risk
macro picture influence your understand the type of ideas is the only way to getting lots
thought process and ideas over we invest in. It also shows that of reward. As a mentor of
time? Corsair doesn’t own the mine loves to point out, not
market, but that we have some taking risk is actually taking lots
JP: We're definitely bottom-up idiosyncratic names. The of risk. But, always understand
stock pickers. Ideas, as we said, downside is that it focuses your downside before you
come through change and investors on those names day- focus on your upside.
management signaling. to-day or week-to-week, and Remember, upside is seductive.
Having said that, we're that shorter-term thinking is There is no such thing as a free
cognizant of what's going on in not real investing. We are in it lunch.
the world, and we react to for the long-term.
macro events as opposed to By sticking to your knitting,
projecting them. If there is a G&D: Before we end, do you staying disciplined, taking
change in the world, for have any final words of advice prudent risk and not using
example natural gas plummets for our readers? leverage, you can position
from $10/Mcf to $2, we're yourself to make investment
going to look at whom that JP: There is a tremendous decisions based on good
helps and whom that hurts. amount of luck in this business, judgment. At the end of the
We won't make the being in the right place and at day, good judgment plus
investment bet that natural gas the right time. Having said that, working hard is a winning
is going to go from $10 to $2, it is definitely a case of the formula.
but once it's happened, one harder you work, the luckier
could argue the world has you get. It's not an original G&D: Thanks to you both for
changed and, if the forward thought, but I truly believe taking the time to talk with us.
curve says gas stays at $2 for that. You make your own luck.
many years, a company like
LyondellBasell (LYB) may really SM: Tommy Lasorda said,
benefit. “The difference between the
impossible and possible lies in a
G&D: Part of the reason we man’s determination.” You
ask is that we had noticed your have to work hard and have
investor letters often start lots of grit. You also have to
with a discussion of the macro. make good judgment calls and
use your common sense. This
JP: Our letters include some was instilled in me by my
macro thoughts just because parents, who, as Holocaust
that’s how we started doing it survivors, immigrated to this
historically in order to give our country in 1956 without any
investors – mostly friends and money or any knowledge of
family – a sense of the macro the English language. To me,
environment. In the beginning, it's not about how smart you
we gave very little information are – it's really what choices
on the names we owned and and judgment calls you're
didn't give out performance making. As J.K. Rowling wrote,
numbers monthly. Over time, “It is our choices, Harry, that
we grew, and different show what we truly are… far
investors have different more than our abilities.” But
requirements. Now we have you also have to be aggressive
monthly reporting. when you are presented with
an opportunity. Think out of
But investors also want to get the box, have conviction in
Page 21
Andrew Wellington
became a principal and In late 1995, I met Rich Pzena, fund. I was co-PM in 2002, and
portfolio manager. He who had just left Sanford Bern- then I became the sole PM in
then went on to Neu- stein where he ran their do- 2003 when Bob left to start his
berger Berman where he mestic equity portfolio. He was own hedge fund.
became the sole portfolio starting his own firm, Pzena
manager for their institu- Investment Management, and I G&D: What is your invest-
tional mid‐cap value prod- joined Rich as his research ment philosophy and has it
uct, growing it from $1 analyst. Rich’s business partner changed over time?
billion to $3.3 billion in in that venture was Joel
AUM, and earning a five- Greenblatt. I worked with AW: Throughout the almost
star Morningstar rating. them for over five years. I 20 years I’ve been investing,
Andrew Wellington He was also a managing couldn’t ask for two better the style and philosophy has
director at New Mountain people to learn value investing always been similar. First and
Capital, where he played a from. foremost, there is a focus on
key role in establishing and value. I am a deep value inves-
managing the $1.2 billion tor. By deep value, I mean I
New Mountain Vantage look for the companies that
Fund, a value‐oriented, “There are no style are trading at the biggest dis-
long‐only, activist hedge counts to intrinsic value that I
fund. Early in his career, points in investing. We can find. The bigger the dis-
Mr. Wellington worked as count to intrinsic value, the
a management consultant
don’t get extra bigger the return you generate
at Booz Allen & Hamilton percentage points for when you’re right. No matter
and First Manhattan Con- how great a business is, no
sulting Group. Mr. Wel- making money on a matter how well you know it,
lington graduated summa if it’s not undervalued, you
cum laude from the Uni- stock that’s really can’t make a superior return
versity of Pennsylvania’s investing in it.
Management & Technolo- difficult to understand.
gy Program, earning both Then there are two things I’ve
a Bachelor of Science from
If you make a huge settled on that improve the
the Wharton School and a return on a really odds of success – quality and
Bachelor of Science from analyzability.
the School of Engineering. simple stock, that still
The emphasis on quality is the
Graham & Doddsville counts.” Joel Greenblatt influence rub-
(G&D): Tell us about your bing off. Amongst the cheapest
background prior to Lyrical. stocks, I only want to invest in
those that are also fundamen-
Andrew Wellington (AW): The firm had a great deal of tally good businesses. Good
I graduated from the Universi- success both in terms of in- businesses have flexible costs,
ty of Pennsylvania’s Manage- vestment performance and stable sources of demand, rich
ment and Technology Program fundraising. It grew from basi- margins that provide more of a
in 1990 and first started my cally nothing to over $1 billion gap between cost and reve-
career in management consult- around the five-year mark. nues. When things go wrong, a
ing. Investment management Toward the end of my time at lot of times you don’t even
wasn’t even on my radar at Pzena, I was promoted to be a notice because good business-
that point. It was a different portfolio manager and a princi- es are able to offset it. On the
world back then – hedge funds pal, but I still wanted more other hand, when little things
were rare and nobody was autonomy to make my own go wrong with a bad business,
watching CNBC yet. I spent decisions. I left in early 2001 to it tends to result in dispropor-
five years in management con- join Neuberger Berman. It was tionately big problems.
sulting before I started to look a co-portfolio manager role
more seriously at investment with Bob Gendelman in their Analyzability is important be-
management. institutional mid-cap value cause the simpler the business
Page 22
Andrew Wellington
is, the more transparent it is, When we see businesses that you get the margins right,
the smaller the problems it’s are difficult to get right, we you’re almost all the way
facing, the easier it is to accu- skip them and keep looking. As there. You don’t need to build
rately determine future earn- I like to explain it, we work a complicated model. A com-
ings. If you get the future earn- really hard to find the easiest plicated model with the wrong
ings right, you get the invest- investments. margin assumption is not going
ment right. to do you any good.
G&D: How would you de-
There are no style points in scribe your research process? G&D: What is your process
investing. We don’t get extra What do you focus on? for replacing a stock in the
percentage points for making portfolio?
money on a stock that’s really
difficult to understand. If you AW: At a high-level, this is
make a huge return on a really “When we see how our process works. First,
simple stock, that still counts. we start with a valuation
businesses that are screen on the top 1,000 US
Our process is to first sift difficult to get right, listed stocks. That screen is
through the statistically cheap- where we generate all our
est stocks, just on the num- we skip them and investment ideas.
bers. We find that most of
those stocks are either not keep looking. As I like We pick one company at a
very good businesses or time from our screen to re-
they’re complex. But there are to explain it, we work search, analyze, and investigate,
exceptions, usually a handful of and typically spend about a
stocks, that don’t have any
really hard to find the month on it. At the end of the
major problems and aren’t easiest investments.” research process, we will
very complicated that we can come to a conclusion on quali-
go research and analyze in ty, analyzability, and valuation
more detail. If you have a of the stock. If it meets all our
small, concentrated portfolio, AW: Our research and analy- criteria, then it goes onto our
you can fill it with just these sis is really about immersing bench. Through this process,
exceptions. Because they don’t ourselves into the history of a we end up with a handful of
have major problems and be- company – seeing how it per- stocks on our bench.
cause they are good business- formed quarter after quarter
es, you can get a high percent- after quarter, looking at what We’re always looking at what
age of them right. past long-term objectives were are the best names on our
and how they were realized or bench versus what’s already in
One metric we track is our not realized, and examining the portfolio. When we think
batting average – how often what caused the under or out- the portfolio would be materi-
we get something right. For us performance. Then, you can ally better by replacing a name,
to be “right,” the stock has to build a deep qualitative under- we make the switch. It has to
outperform the market. We’re standing of the business. You be overwhelmingly better, hit-
able to track this because we see how that matches up with yourself-over-the-head kind of
don’t do any trading around the financials so you can make better. Replacing a 30% upside
positions. 65% of the invest- a quantitative forecast of fu- stock to buy one with 40%
ments we’ve made at Lyrical ture earnings. upside just doesn’t make that
have outperformed the market much of a difference on a 3%
over their life. This is a fairly Modeling is an element of what position.
high batting average, but it is we do. To value a business, we
not because we are much bet- need to estimate its future We employ a “one-in, one-
ter analysts than everyone else. earnings and so we need a out” philosophy and keep the
Rather, we have a high batting model. But a model is simply a number of names in the port-
average because we invest in tool. The critical part is using folio constant, which enforces
stocks that are relatively easier the correct assumptions. If you a certain discipline in our pro-
to get right. get the sales growth right and cess. So what typically happens
Page 23
Andrew Wellington
is we patiently wait until one of is huge now, and you start to With 3% positions, I can be
our stocks appreciates and focus more on the 50% chance completely analytical and dis-
approaches fair value. Normal- you lose $1 million and you passionate about everything.
ly, we look to replace a stock probably don’t take the bet. We make better decisions
when it has 5-10% upside to because we’re able to stay
fair value. But we will replace it There are fantastic risk/reward unemotional about them and
before then if the new oppor- opportunities that you are that leads to better risk/
tunity is significantly better. willing to do at 3% of your reward in the portfolio.
portfolio that you might be
We also sell if we ever lose unwilling to do at 10%. When a G&D: On a related topic, why
conviction in the fundamental position gets that big, you look is every position a 3% weight?
thesis. There’s no room in a for perfection and there’s no Why not adjust position sizing
concentrated portfolio for such thing. You become overly based on conviction?
stocks you don’t really believe sensitive to the downside, re-
in. mote as it may be. And for AW: I don’t have equal con-
every unit of downside you viction, but I’ve learned that
G&D: How did you determine eliminate, you tend to sacrifice my conviction does not add
that 33 is the optimal number multiple units of upside and, value.
of holdings? Buffett’s famous over the long the run, end up
quote is that no one gets rich with lower returns. I did not start out with the
off their sixth-best idea. Have idea of running an equal-
you considered more concen- weighted portfolio. I looked
tration? back at the three and a half
year period I managed a fund
“There are fantastic
AW: Well, the sixth-best idea at Neuberger Berman. Over
we’ve owned is Jarden Corp risk/reward that period of time, I outper-
(JAH). We’ve made 827% on formed the U.S. equity markets
that, which goes to show you opportunities that you by about 1000 basis points per
can do ok on your sixth-best year. I went back and analyzed
idea. But to address the ques- are willing to do at 3% what my performance would
tion, the 33 comes from a few have been if I had equally
things. An academic statistical of your portfolio that weighted my portfolio, thinking
study shows that when you get that the analysis would show
to the 30s, you’ve captured
you might be unwilling how much extra alpha I creat-
almost all the benefits of diver- to do at 10%. When a ed with my judgments about
sification. So there is definitely conviction weights. Instead, I
a risk mitigation benefit of 33 position gets that big, discovered that my weighting
versus six or eight. decisions had cost me 70 basis
you look for points per year.
I also believe our returns are
higher with 33 stocks than perfection and there’s Since that original analysis, we
they would be with six or have expanded it to look at all
eight. This gets into the psy-
no such thing.” mutual fund managers. What
chological and behavioral as- we found was that we’re not
pect of investing. Let’s play a the only ones that don’t add
game. We’ll flip a coin and if any value with conviction
it’s heads, you win $500, but if A key driver of success in val- weighting. Contrary to conven-
it’s tails you owe $100. That a ue investing, besides making tional wisdom, most funds
5:1 payoff on a 50/50 bet. I judgments about businesses, is would generate higher returns
would hope everyone knows to realize that nothing’s per- by simply equal weighting their
that’s a good bet. Now let’s fect. There are risks with eve- portfolio.
make one change. Heads you rything. You need to be able to
win $5 million, tails you lose tolerate uncertainties and po- G&D: How actively do you
$1 million. It’s the same risk/ tential downside. trade in your portfolio?
reward but the size of the bet
Page 24
Andrew Wellington
AW: Our turnover is around We don’t trade around posi- multiple we use comes from
17% per year, which implies a tions. When our stocks aren’t the history of the market.
six-year average holding peri- doing well, we don’t add more. While we know the market
od. Some stocks we’ve held for When they are doing well, we has historically been valued at
as a little as a year. There have don’t trim them back. The only about 15.5x one-year forward
been a lot of stocks we’ve held trades we do in our process earnings, our analysis of histor-
for six years and counting. The are when we sell a position in ical valuations suggests the
bigger the discount to intrinsic its entirety and replace it with market is valued at about 9x
value, the more patient you a new position at full weight. five-year normalized forward
can be. If the upside in your It’s contrary to the way every earnings. Sometimes the mar-
investment is only 5%-10%, other manager I know in the ket is at 10x like it is today. In
you better realize that gain business operates but we have other periods, such as in 2008
Bruce Berkowitz of
Fairholme Capital address-
quickly. But if you’re upside is tested both methods and or 2009, the market could be
ing a question from the 60%+ and it takes you five found our way actually per- below 6x. But the market has
audience during the 2014 years instead of two or three, forms better. always reverted back towards
Graham & Dodd Breakfast that’s okay because that’s still a 9x over time.
panel. substantial amount of outper-
formance per year. “The only trades we We don’t use different multi-
ples for different businesses or
We’ve realized it’s impossible do in our process are industries because we hope to
to determine how long it will capture everything that might
take for a stock to work. We when we sell a make one company or industry
might be able to estimate what better than another in the fu-
the earnings will be but you position in its entirety ture earnings number. There’s
have no idea how long it might elegance to the framework
take the market to recognize
and replace it with a that allows us to compare dif-
those earnings. new position at full ferent companies from differ-
ent industries with different
Goodyear Tire (GT) is an in- weight. It’s contrary to stories and still have one abso-
teresting example. Over the lute valuation paradigm.
six years we’ve owned it, GT is the way every other
up 370%. That’s 210 percent- G&D: How do you assess the
age points better than the mar- manager I know in the quality of management?
ket. Yet it’s still at 9x earnings.
They’ve done a great job
business operates...” AW: In terms of management
growing earnings and reported skill and running a business,
record margins but it’s still G&D: What valuation meth- what I’ve learned over the
cheap because the market is odology do you rely on? years is it’s really hard to tell
slow to accept that this level of how good management is.
profitability is sustainable. It’s AW: One fundamental law in Some businesses you can tell
been a great investment in part economics is that the value of they’re great because you can
because of how cheap it was in a business is the present value see how much better their
the past and also their funda- of its future earnings. But in business is performing relative
mental success in improving the real world, there are all to peers. We look for a high
profitability. kinds of problems with the level of competence. If we
traditional DCF formula, in- were to grade management,
The tougher ones are where cluding figuring out terminal we would want to grade them
you expect the company to growth rates, discount rates, with an ‘A’ or a ‘B’. We would-
improve but there are bumps etc. We take that same con- n’t want to own a company
along the way. Part of what cept but apply it in a more where we would give them a
separates great investors from practical framework. ‘C’. In some businesses, there
less good ones is the ability to are more capital allocation
sift through the noise and fig- Our approach is to value com- decisions to be made. You
ure out if the company will panies on their five-year for- want to be able to rate those
ever get things right. ward normalized earnings. The management teams an ‘A’. We
Page 25
Andrew Wellington
own AerCap (AER), an aircraft dervalued because there is an will not be investing in any
leasing company, for example. I inflection point and the future airlines.
would not want to own an is expected to be much better
aircraft leasing company with than the past, but those are It’s really interesting to com-
‘B’ management. Fortunately, I rare exceptions. Most of our pare the differences between
think AerCap’s management is stocks are undervalued be- the car rental and the airline
an ‘A+’. cause they are benignly ne- business because they have
glected by the market. There is very similar sources of de-
One major factor we analyze is nothing going on today that is mand. The biggest driver of
capital allocation. If the compa- different than what was occur- demand for car rental is de-
ny generates a lot of free cash ring last year or the year be- planements. People go on air-
flow and the management team fore, but because of random planes and when they land,
proceeds to waste it, that free ups and downs in the market they rent cars. But these two
cash flow has no value to in- or through earnings growth business are structurally very
vestors. Capital allocation outpacing price appreciation, different. One business we
doesn’t have to be perfect or the stock has become under- love, the other business we
optimal. I just don’t want to valued. won’t touch. Even with the
see it wasted. benefits of consolidation, air-
lines are still not a good busi-
Acquisitions are the biggest “We are short ness to us because the cost
way a company can blow itself structure is fixed. If your busi-
up. When companies do acqui-
companies that are ness earns only a 10% margin,
sitions, you want to make sure significantly and there’s a 10% fall in de-
that they’re buying at an at- mand with most of your costs
tractive price and realizing overvalued and yet being fixed, you can get a 100%
synergies. Otherwise you’d like fall in earnings.
to see the excess cash eventu- they’re very simple
ally returned to shareholders. Contrast that with car rental.
and easy to analyze In the car rental business, 70%
Our preference is for compa- of costs are variable. They’re
nies to employ cash for stock
but are often able to right-size their busi-
buybacks because we believe overlooked by ness. They don’t need the
every stock we own is under- economy or demand to return.
valued. A dividend distribution traditional short- They could shrink to current
may not be optimal, but it’s levels of demand over a few
hardly a bad thing, so we don’t sellers because there’s quarters and get back to prof-
get too worked up over that. If itability. That’s a much better
they want to leave some cash no catalyst.” business structurally. It’s a
on the balance sheet for stra- much more robust business to
tegic options or for safety, that the ups and downs of what can
might be sub-optimal but I We do own a few stocks happen in the future. You can
don’t have a problem with that which are beneficiaries of con- afford to take more risk be-
either. solidation, such as Avis (CAR), cause the resiliency and flexi-
Hertz (HTZ), and Western bility of the business is risk-
G&D: Do you also look at Digital (WDC). Consolidation mitigating.
businesses or industries that is one element of the thesis,
reach potential inflection but consolidation by itself isn’t G&D: You recently launched a
points? For example, a situa- enough to make the invest- long/short fund. What was the
tion where significant capacity ment attractive. We own them rationale for doing so?
came out of an industry? because they are quality, ana-
lyzable businesses at significant AW: My business partner, Jeff
AW: We look for quality, ana- discounts to intrinsic value. Keswin, co-founded Greenlight
lyzable businesses at significant The airline industry is benefit- Capital. He has substantial ex-
discounts to intrinsic value. ting from consolidation but we perience in the long/short
Sometimes a company is un- world so even though we de-
Page 26
Andrew Wellington
cided to initially focus on long- We aren’t short stocks such as many other funds. Why is that
only at Lyrical, we thought Tesla (TSLA) and Netflix beneficial versus employing a
there might eventually be an (NFLX) because I don't know larger team with coverage on
opportunity to manage a long/ what they’re going to earn in specific sectors or industries?
short fund as well. Betting on five years. Those are new
ourselves, we started our long/ business models. No matter AW: When you only buy, on
short fund in early 2013, initial- how expensive they are today, average, five stocks a year,
ly with just internal capital. no matter how likely they are how many people do you
to be overvalued, if I don't need? That’s less than one eve-
We’re doing shorts because know with a high degree of ry two months. I have a lot of
we believe we can be as good certainty what their future titles at the firm, but my main
on the short side as we’ve earnings will be, then that’s not job at Lyrical is Junior Analyst.
been on the long side. If I did- a very good investment for us. If I pick the right stocks, every-
n’t think we could be, I would- thing else at Lyrical is easy.
n’t be interested in diluting our
reputation or degree of suc- I think part of our edge comes
cess. We really believe that we from the fact that I, along with
have a differentiated approach “We aren’t short my co-portfolio manager Car-
to shorting. stocks such as Tesla oline Ritter, bring a lot of ex-
perience to analyzing business-
What’s driven our success on and Netflix because I es.
the long side is looking for
significant misvaluations in don’t know what On the margin, we make bet-
businesses where we have a ter decisions because we’re
high probability of getting the they’re going to earn the ones listening to every
future earnings right. That’s earnings call. We’re the ones
exactly what we look for on in five years...if I don't going through the financials
the short side as well. We’re know with a high and seeing it all first-hand as
not short accounting frauds. opposed to having junior staff
We’re not short businesses we degree of certainty do that, and then processing
think are going to disappear. what they have.
We are short companies that what their future
are significantly overvalued and G&D: Would you be willing to
yet are very simple and easy to earnings will be, then walk us through a current
analyze but are often over- idea?
looked by traditional short that’s not a very good
sellers because there’s no cata- investment for us.” AW: It’s interesting that the
lyst. second-best stock we’ve ever
owned is AerCap (AER) and it
We believe we can be relative- still shows up as one of the
ly accurate at estimating future cheapest stocks in our portfo-
earnings power and reliably For the first six months, we lio today. Even though it has
identifying stocks that are sig- shorted ETFs as a placeholder appreciated 1,200% since we
nificantly overvalued. until we could build a portfolio first bought it, AER trades at
of single-stock shorts. We 7.9x this year’s earnings. When
Many people think you have to have been running single-stock we first got involved in January
short bad businesses. In some shorts now for 18 months. It’s 2009, AER was priced around
cases, we’re short great busi- working exceptionally well. In $3 a share and had $2 a share
nesses. These stocks often fact, over that 18-month peri- of earnings. You don’t need a
have high multiples for long od, our batting average on the very sophisticated screen to
periods of time. If a great busi- short side is 75%, compared to identify stocks at 1.5x earnings.
ness is worth $100 a share but 68% on the long side.
the stock is at $150, that’s a AER is in the business of rent-
good short. It doesn’t have to G&D: Lyrical has a smaller ing commercial airplanes to
go to zero to be a good short. investment staff relative to airlines around the world. If
Page 27
Andrew Wellington
you looked at airlines in the While the stock is up, it was down the low-end business
U.S. in 2008, you’d have a pret- cheap before the deal and the and the related plants. That
ty negative view of businesses earnings power increased so takes a lot of time and ac-
that rent airplanes to airlines. much that, on a prospective P/ counting charges – you can’t
There are a lot of things wrong E basis, the stock still is incred- just do that overnight.
with that view though. First, ibly cheap. It hasn’t been a
A Graham & Dodd Break- airlines in America aren’t the good performer in 2014 even Along the way there were dis-
fast attendee looks over same thing as airlines around though they’ve executed on appointments. In 2007, syn-
the morning’s agenda. the world. There are different the integration of ILFC excep- thetic rubber prices spiked
trends in different regions. tionally well. with oil. They were able to
They are very healthy and pass through the costs but it
growing in the Middle East and took several quarters. They
in Asia. Also, airlines around were finally ready to start mak-
the world are often supported “If AER’s customers go ing good profits in 2008 but
by their governments, so they then the global recession hit.
don’t have the same financial bankrupt, it can With 80% of their tire sales
stress. being replacement, and only
repossess the airplane 20% to OEMs, the recession
While it sounds risky to rent shouldn’t have had as big of an
and easily find
an airplane to an airline, when impact on the business. But
you look at the business and someone else who OEM car production fell by
the history of it, you see that 50%, enough to lower capacity
losses are really minimal. With wants to rent it. AER’s utilization at their factories and
AER, what matters most is not hurt their overhead cost ab-
if an airline goes bankrupt, but business was nowhere sorption. GT did some more
do they have the right planes, restructuring, and earnings
those in demand by most air- near as credit-sensitive started coming back.
lines? If you own a 757 that
as one might think, but
people aren’t really flying any- I think people got frustrated
more, and it is repossessed, it’s back in 2008, it was with GT and moved on to oth-
going to be hard to find some- er things. I passed over it on
one else to buy it. If it’s a mod- priced that way.” the screens a number of times.
ern, fuel-efficient 737 or A320 The truth was obscured by
that everybody around the lots of noise. Investors just had
world uses and where there is to peel it back and sift through
a production backlog today, G&D: You mentioned Good- it. When you did, you saw a
there is much less risk to the year Tire (GT) earlier in our company that was positioned
collateral. If AER’s customers conversation. What makes it a to do very well. They previ-
go bankrupt, it can repossess good business? ously had peak earnings in
the airplane and easily find 2007 of $1.66. They were sup-
someone else who wants to AW: GT has not always been posed to make $3 a share this
rent it. AER’s business was a great business. It used to be year, record earnings, record
nowhere near as credit- a lousy business that we would margins, and while the stock is
sensitive as one might think, have never touched before. up to $28, it’s trading at a
but back in 2008, it was priced modest valuation of just over
that way. The company used to make 9x earnings.
low-end commodity tires and
AER earned $2.63 last year, high value performance tires. There’s a lot of institutional
and this year they’re projected Asian imports killed the low- memory in stock valuation.
to earn $4.95. That big jump end part of the business. With Most of the time it’s right, but
was because year they ac- factories and unionized labor, you can find exceptions. In our
quired ILFC in December of it took GT the better part of view, there’s nothing wrong
last year from AIG and the the first decade of the 2000’s with Goodyear. It’s cheap be-
deal was incredibly accretive. to exit that business. The cause of an outdated view of
whole US tire industry shut what the business is. Today,
Page 28
Andrew Wellington
it’s a good business and still Another successful short for multiples adjust to the right
significantly undervalued. us has been Whole Foods level.
(WFM), a similar story to
G&D: Is there a short you Coke. We expected them to G&D: Thank you for taking
would be willing to discuss? continue to perform at the the time to speak with us.
high level they had been per-
AW: We are short Coca-Cola forming but even if they did
(KO). Coke’s a great company. that, they were significantly
They make a great product. overvalued. And now we may
But Coke trades at about 20x be seeing a negative inflection
earnings. They’ve grown their in the business with increased
earnings at only 5% a year for competition nipping away at
the last five years and they’re their position. They still might
not expected to grow that be the best organic foods mar-
much faster over the next five ket, but their competitors are
years. Why does Coke have a selling more organic foods and
20x multiple? Because Coke at lower prices.
used to be worth 20x and in-
vestors have become anchored The stock is already down a
to that multiple despite funda- lot but now the company is
mentals. earnings less than we initially
estimated. We believe it has
If you go back to the late ‘90s, further downside and still
Coke was a global growth looks like a really attractive
powerhouse. They produced short here despite the fact that
double digit EPS growth year we think it’s a great company.
after year and penetrated
emerging markets. But now, The vast majority of the names
they have reached a certain we are short, I’d be happy to
maturity level. We are also be long if they were at a signifi-
starting to see some cracks in cantly lower valuation. Any-
the business. Consumers don’t thing we’re long, if it were at a
like carbonated soft drinks as significantly higher valuation, I’d
much anymore and you’re see- probably be happy to be short.
ing that category shrink. The difference in valuation is
everything.
We feel we can reasonably
estimate the future earnings of Interestingly, while we are long
a company like Coke. Margins value, we are not short
are stable. Sales growth is growth. The businesses in our
pretty stable. Not a lot of cata- short book don’t grow any
lysts that can dramatically faster than those our long
move the earnings of a compa- book. They have high multiples
ny of that size and scale and because they grew really fast a
scope. long time ago. There’s a cer-
tain stickiness to multiples. We
Coke is getting credit for con- see that with Goodyear too. It
tinued high performance, but if still has to shake off that repu-
things don’t go that well, tation of its past and continue
there’s much more downside. to perform. On the flip side,
It’s been a very profitable you also see it with Coke. Mul-
short over the past 18 months tiples are slow to adjust. Over
for us. It has underperformed subsequent years, as the earn-
the market by 16% at this ings come through, eventually
point. the market catches on, and the
Page 29
First Solar (NASDAQ: FSLR) - Short

Finalist—2015 Amici Capital Prize
Kirill Aleksandrov
KAleksandrov15@gsb.columbia.edu
Recommendation
Sell First Solar (FSLR). The company is overearning due to legacy projects in its Capital Structure
pipeline and elevated near-term demand resulting from the pending expiration of Share Price (1/15/15) $40.2
the solar investment tax credit (ITC). Declining pricing, increasing competition, and
Kirill Aleksandrov ’15 weak project volumes will result in significantly lower revenue and earnings vs.
Shares Out. (mm) 101
consensus forecasts. Market Cap. ($ bn) 4,073

Kirill is a second-year
+ Debt 218
MBA student at Columbia
Business Description - Cash & Equiv. (1,115)
Business School. Prior to
FSLR manufactures solar modules (10% sales) and acts as a project developer for
CBS, Kirill was an Enterprise Value 3,176
utility-scale solar projects (90% sales). FSLR provides engineering, procurement, and
associate at PennantPark Current Valuation
construction services (EPC) for solar asset owners and also develops and holds
Investment Advisers, a Consensus 2015 EBIT 5.7x
solar projects on balance sheet to be ultimately sold to customers.
credit fund focused on
Consensus 2015 EPS 9.2x
mezzanine debt
Investment Thesis
investments.
1) The full extent of price declines in the utility-scale solar industry is obscured by revenue recogni-
tion on legacy projects that were signed at significantly higher prices than FSLR will be able to realize
in the future.
 FSLR recognizes revenue on a percentage of completion
$160
PPA and ASP Trends
$4.5
basis on EPC projects and upon sale for projects held on $140
$140
$133 $4.0
$123 $125
balance sheet. The Company is currently recognizing reve- $120 $4.25 $3.5
nue on multiple large projects (Topaz, Desert Sunlight) that $100 $3.23 $86
$3.0
$2.5
were negotiated in 2011-2012 in a significantly higher pricing $80
$2.43
$2.0
$60
environment. $40
$2.02
$1.68
$1.5
$1.0
 Power purchasing agreement (PPA) prices have fallen from $20 $0.5
$140/MWh in 2010 to $86/MWh in 2014 (-39%), with $0

2010 2011 2012 2013 3Q'14
$0.0
some PPAs signed below $50/MWh in 2014. Lower PPA Source: GTM PPA ASP/W
prices decrease the present value of a solar asset’s earnings

and reduce the price that FSLR can realize on projects.
 Declining PPA prices and increasing competition have caused ASP/w to fall from $4.25 in 2010 to $1.68 in 2014
(-60%), with pricing as low as $1.50 on some projects in 2014. FSLR’s projects signed in 2014 were priced at
~$1.94/w. FSLR’s average recognized 2014 ASP/w is ~$3.42 vs. $2.48 implied pricing for remaining MWs in its
backlog as per company’s own filings. A build-out of FSLR backlog by project implies blended pricing of $2.44/w
and $2.20/w for 2015 and 2016, or a 29% and 10% decrease in pricing, respectively, vs. 2014. 2017 pricing is
likely to experience a steep decline as legacy projects run out and new projects are signed at prices closer to
(and likely below) current levels.
 The significant fall in ASP/w means that FSLR will need to book higher MW volumes simply to maintain its
current levels of revenue.
2) The U.S. utility-scale market is saturated and will not be able to sustain the volumes that FSLR
needs to maintain the current level of earnings.
 The step-down of ITC from 30% to 10% in 2017 has pulled forward a significant amount of demand, as a pro-
ject needs to be completed and connected to the grid by 2017 to receive the ITC. Installed utility-scale solar
capacity will double vs. 2013 in the next 2 years as 13.5GW of current project backlog will come online.
 Demand is driven by state renewable portfolio standards (RPS), and states with significant RPS have already
contracted the majority of MW needed to meet them. California accounts for 62% of planned and existing
solar capacity. The three main CA utilities have contracted the majority of solar capacity needed to meet RPS
by 2020, with only 1.3GW of additional capacity required through 2020 (or only 220 MW/year).
 None of the three major U.S. developers – FSLR, Sunpower, or SunEdison – have project backlog beyond
2016. New PPAs signed in CA and NV are for 2019 power delivery, showing that utilities only need to fill out a
small amount of remaining back-end compliance demand.
 ITC expiration acts as a major demand headwind, as project costs will increase by 20%.
 Increasing competition for fewer projects is driving some developers to sign PPAs at uneconomic levels ($30-
40/MWh signed in latest Duke Energy RFP) or build projects without PPAs (FSLR’s Barilla, TX project).
3) Increasing competition will make it difficult for FSLR to compensate for a slowing U.S. business by
expanding overseas and management is overstating FSLR’s ability to compete internationally.
 International projects account for only 10% of FSLR’s current pipeline. Project development is a local business,
requiring knowledge of local politics, permitting, and regulations (the reason why foreign developers have not
been able to penetrate the U.S.).
Page 30
First Solar (FSLR) - Short (Continued from previous page)

 17 of top 20 module suppliers already have in-house project developers, including Chinese (Trina, Yingli, Jinko, ET Solar)
and Japanese (Panasonic, Sharp) competitors, which effectively shuts FSLR out of the 2 largest international solar markets.
Chinese, Japanese, and U.S. module manufactures are also competing with FSLR in India, Australia, and South America.
Pricing and margins in these regions are quickly converging to U.S. levels.
4) 3rd-party modules business is unprofitable and unlikely to mitigate project shortfall.

 FSLR’s module gross margins averaged 6% from 2012-2014, and operating margins were -14% over the same period.
Modules are commoditized and manufacturers lack pricing power. Due to competition, FSLR module sales outside its
own projects were only 12% and 10% of total revenue in 2013 and 2014, respectively.
 FSLR’s thin-film technology lacks a cost advantage vs. competitors, barring a significant increase in silicone prices, and
lower module efficiency makes FSLR panels more expensive on a BoS basis.
 Lack of industry capex discipline means that increases in demand are met with significantly higher capacity expansions.
FSLR is expanding capacity by 46% in 2015 with 77% capacity utilization as of Q3’14. Most large players (both U.S. and
foreign) are expanding 2015 capacity in spite of low utilization.
5) Potential margin compression as prices fall and project lead-times shorten can act as an additional catalyst.
 Project margins have fallen from 36% in 2013 to 27% in 3Q’14. Margins are likely to fall further due to increasing compe-
tition and expiration of ITC, as the loss of 20% ITC by customers should put further pressure on pricing.
 Costs have historically fallen slower than prices (-58% module pricing vs. -18% cost in 2010-2013). Module pricing is
already low and balance of systems (BoS) costs are difficult to decrease due to labor and shipping as significant compo-
nents.
 Transition to smaller projects due to limited demand and difficulty of finding suitable locations creates less project lead
time and less opportunity to take advantage of cost declines during the life of a project.
Valuation
Given that project volumes will peak in 2015 and will then begin to normalize, I believe that a price target based on an average
of earnings over the next 3 years (2015-2017) is the most appropriate way to value FSLR. My $30 price target, which repre-
sents a downside of ~25%, is based on a blend of EBIT (8x) and EPS (12x) multiples (historical average multiples over the last 3
years). The value of the operating business is ~$13 per share, with the remaining value consisting of average cash/share of
~$17. Given FSLR’s volatile WC needs and potential for WC to remain trapped in projects held on balance sheet for longer
than anticipated, cash/share may be significantly lower, which represents potential additional downside. Note that 2017 gener-
ously assumes recognition of 800MW of project revenue while FSLR currently has no 2017 backlog.
Base case assumptions:
2014 2015 2016 2017 EBIT EPS

Project MW Recognized 933 1,646 1,177 800 3Y Average 149.4 1.2
Avg. Price/W $3.42 $2.44 $2.20 $1.40 Multiple 8.0x 12.0x
3rd-party MW Recognized 276 281 287 293 EV 1,195
Avg. Price/W $0.68 $0.65 $0.60 $0.55
Net Avg. Cash 1,764 1,764
Equity Value 2,960 3,288
Systems Gross Margin 28% 25% 25% 25% Shares 104 104
Modules Gross Margin 6% 6% 6% 6% Price/share (Ops.) $11.55 $14.72
Annual SG&A Reduction -2% -4% -3% -3% Cash/share $17.04 $17.04
Tax Rate 11% 15% 15% 15% Total price/share $28.59 $31.77
2012 2013 2014 2015 2016 2017

Systems Revenue 3,043 2,928 3,200 4,011 2,588 1,120
3rd-party Modules Revenue 325 381 188 183 172 161
Total Revenue 3,369 3,309 3,388 4,194 2,760 1,281
% Growth 21.8% (1.8%) 2.4% 23.8% (34.2%) (53.6%)
COGS 2,516 2,446 2,676 3,391 2,239 1,050
Gross Profit 853 863 712 803 521 231
% Margin 25.3% 26.1% 21.0% 19.1% 18.9% 18.0%
SG&A 421 407 398 382 369 356
% Sales 12.5% 12.3% 11.7% 9.1% 13.4% 27.8%
EBIT 431 455 314 421 153 (125)
% Margin 12.8% 13.8% 9.3% 10.0% 5.5% (9.8%)
EPS ($1.11) $3.75 $2.81 $3.71 $1.51 ($0.88)
Diluted Shares Out. 87 94 102 102 104 105
FCF 383 690 47 229 282 (85)
Page 31
JetBlue Airways Corporation (NASDAQ: JBLU) - Long

Harry Garcia
HGarcia15@gsb.columbia.edu
Summary:
Over the past three years, JetBlue’s ROIC has fallen short of management targets and has
lagged the ROIC of competitor airlines by several hundred basis points. In the last two
months, JetBlue has signaled it is becoming more shareholder-focused by selecting a new
Harry Garcia ’15 CEO (Robin Hayes) and announcing initiatives to drive $450 million in pre-tax earnings
($0.79 EPS) which will improve ROIC by 300+ bps. These actions have driven the stock price
Harry is a second-year
up 60% from a low of $9.41 in early October to its current price of $15. However, I believe
that the stock still has significant upside. My key insights to JetBlue reflect my bullish thesis:
CBS, Harry worked as an
1) The initiatives announced at analyst day are low-hanging fruit and results will exceed
internal strategy consultant
management guidance
at NBCUniversal. Prior to
2) JetBlue can implement overbooking to increase its load factor by 100-300 bps
that, Harry founded a real
3) Robin Hayes is the right CEO to improve ROIC at JetBlue
estate investment
company and spent four
I believe that the first two factors could drive an additional $190 - $350 million of operating income. Overall, JetBlue will expand
years as a buy-side equity
ROIC by 700+bps. At 8x 2017 adjusted EBIT, JetBlue would be worth $26 per share – 64% upside to its current price of
analyst at Palisades
$15.15 (12/10/14).
Investment Partners.
Setting the Stage:
Over the past summer,
Harry interned as an  JetBlue is the 5th largest airline in the United States and, even though Jet-
equity analyst at the Blue is only 20-30% of the size of the big-four airlines, it is a major player
Growth Equity group at where it operates. JetBlue is a low cost carrier but has positioned itself on
Morgan Stanley Investment the high-end of the service the spectrum by providing premium amenities
Management. After and customer service.
graduation, he plans to  Several trends have driven airline profitability over the last 5 years. 1) Mer-
work in investment gers have consolidated the industry. The combined market share of the top four carriers increased from 51% in 2009
management. to 76% in 2013. 2) System capacity has fallen since its peak in 2007. 3) Fewer players and lower capacity has led to
stronger pricing. These trends are reflected in the total operating income for the airline industry – a $583 million loss
in 2009 to $10 billion profit in 2013.
Key Insights:
1) The initiatives announced are low hanging fruit and results will exceed management guidance
In mid-November, JetBlue outlined three initiatives (Fare Families, Cabin Refresh and Other) to achieve an additional $450
million of pre-tax operating income by 2018 ($0.79 EPS) and add at least 300 bps to ROIC by 2017. I believe management
was abundantly conservative. JetBlue will exceed its objectives by at least $100 million.
Fare Families: JetBlue will price tickets based on the bundling of services and features. At the cheapest level of service,
JetBlue will charge first checked bag fees which are currently free. Execution will be easy (systems already installed) and
the impact is predictable (many historical examples). I model additional operating income of $208 million and $222 million
in my base and bull scenarios, respectively.
Cabin Refresh: JetBlue will increase seat density on its A320s (65% of its fleet) by decreasing seat thickness and pitch.
The total number seats on the A320 will increase from 150 to 165 and will increase JetBlue’s available seat miles (ASM) by
7.2%. Management expects at least a $100 million run rate of incremental operating earnings. This is the biggest opportunity
to exceed guidance. Even with the conservative assumption that the new seats yield 62% of the revenue of other seats, the
initiative would add $232 million of additional revenue per year. After accounting for additional costs, JetBlue would earn
$185 million of operating income from seat densification.
Other Initiatives: This includes six initiatives that management expects to earn $150 million in operating income by 2018
($0.27 EPS). Management’s guidance appears abundantly conservative considering that three of the six (Even More,
TrueBlue, Mint) will conservatively generate $155 million. Even More will generate $68 million of incremental operating
income with 2% annual price increases. TrueBlue will generate $60 million according to contracts that management is
currently finalizing. Mint will earn $26 million with no expansion. This leaves us with a free option on the other three
initiatives (Wi-Fi and ancillary product sales) which could yield $30-40+ million.
Page 32
JetBlue Airways (JBLU) - Long (Continued from previous page)

2) JetBlue can implement overbooking to increase its load factor by 100-300 bps
 Load factor is an airline’s version of operating leverage – there is low incremental cost but high margin incremental
revenue for every additional seat filled. JetBlue is an outlier in the airline industry because it does not overbook flights. This
is great customer service but JetBlue loses every time a customer cancels an itinerary and JetBlue is unable to fill the
seat. I believe JetBlue can improve its load factor significantly by implementing an overbooking policy. In my base
model, I assume load factor increases 170 bps ($136 million operating income; $0.24 EPS); in my bull model, I assume
load factor increases 260 bps ($208 million operating income; $0.37 EPS). Importantly, the market expects load factor to
remain flat or increase only slightly.
 Interviews with several industry contacts (including high-level industry executives and former JetBlue executives)
indicated that JetBlue can improve load factors by 100—300 bps by overbooking. If JetBlue improved its load factor
to the industry average, it would increase load factor by 120 bps ($96 million operating income; $0.18 EPS). This is
reflected in my base case scenario. In my bull scenario, load factors increase 200 bps ($160 million; $0.30 EPS). This
is the type of initiative that JetBlue would implement behind the scenes (i.e. not highlight it at an analyst day). Im-
portantly, the market is not discussing the potential of overbooking. Airlines have overbooking down to a science so
the downside to would be minimal. Industry-wide, only 9 out of every million customers are “bumped” from flights.
3) Robin Hayes is the right CEO to improve ROIC at JetBlue

 Hayes has an excellent track record. Before joining JetBlue in 2008, Hayes spent 19 years at British Airways where
he ran the Americas segment. Interviews with industry contacts and executives that worked with Hayes were ex-
tremely positive across the board. A former JetBlue executive who worked closely with Hayes says, “[Robin] has
delivered very strong financial results… Robin has been instrumental in driving profitability at JetBlue.” An executive
who worked with both Hayes and his predecessor extensively says, “Hayes is the right CEO. He has demonstrated
this with all the things he’s led. I am very bullish and confident in his ability to lead JetBlue.”
 JetBlue is at an inflection point. JetBlue is transitioning from an airline focused on capacity growth to an airline focused on
returns. Other airlines reached this inflection point several years ago and were able to improve ROIC substantially
(300 – 900+ bps). JetBlue is at that point now. Hayes recently announced that JetBlue will be deferring the delivery
of 18 aircraft over the next four years. This reduces the number of new aircraft over the next four years by 32% and
reduces capital expenditures by $0.9 – 1.0 billion – freeing up cash equal to 20% of JetBlue’s market capitalization.
Furthermore, In 2013, JetBlue adopted a new long-term performance-based incentive program based on two items:
cost per available seat mile (weighted 50%) and ROIC (weighted 50%).
Valuation
 JetBlue currently trades at 9.2x enterprise value to forward adjusted EBIT (2015). If we apply an 8.0x multiple on
forward adjusted EBIT (the industry average is 8.3x), it implies JetBlue will worth $26.42 per share (74% upside) in
2016 (8x FY17 adj. EBIT). At my target price of $26.42 in 2016, JetBlue would be trading at 11.8x forward earnings.
 ROIC will grow from 8.5% in 2015 to 15.0% in 2018. ROIC will exceed management’s guidance of 10%+ in 2017 by
about 290 bps.
 In my bull scenario, load factors reach all-time highs without pricing concessions. At 8x EV/Forward 2017 adj. EBIT,
JetBlue would be worth $29 per share in 2016 (94% upside). In my bear scenario, load factors drop and ancillary fees
are
Page 33
Schibsted Media Group (SCH: NO) - Long

Luke Tashie
LTashie15@gsb.columbia.edu
Thesis Curre nt Share Price 482 NOK 52.80 EUR
Schibsted (SCH: NO) is a 175 year old media company FD Shares (m) 107
based in Oslo, Norway that is in the midst of a transfor- Market Cap (bn) 51,746 NOK 5,668 EUR
mation into the premier online classifieds operator in 20+ Less: Cash (831) NOK (91) EUR
countries. Despite its undisputed classifieds dominance in Add: Debt 2,508 NOK 275 EUR
Luke Tashie ’15 both Norway and Sweden, Schibsted is getting little credit Enterprise Value 53,423 NOK 5,852 EUR
for its long run potential for high margin (60%+), double LTM 2017E
Luke is a second-year MBA EUR (m) 9/30/14 Dow ns ide Bas e Ups ide Ups ide +
digit revenue growth in its online classifieds businesses in Revenue
student in Columbia 1,635 1,741 2,313 2,892 3,525
the six countries in which it has already begun monetizing
Business School’s Value EBITDA 213 258 682 999 1,252
and 20+ countries in which it is likely to attain similar
Investing Program and the EBITDA Margin 13% 15% 29% 35% 36%
outcomes. Its property in France (Leboncoin, or “LBC”) is
recipient of the Heilbrunn
expected to be worth 80% of the company’s current Total Re turn to 12/31/16 (24%) 99% 213% 339%
Fellowship. While at IRR thr ough 12/31/16 (13%) 40% 75% 107%
market cap by 2017. With increased disclosure of the
economic potential of its classified assets, visibility of EV /EBITDA 27x 23x 9x 6x 5x
he has worked at Luxor
Schibsted’s shift from “investment mode” to “monetization mode” and as the story simplifies to a pure play online classi-
Capital, Arbiter Partners,
fied business, I expect 40%+ annual EBITDA growth and shares to re-rate to trade in-line with its classified peers, resulting
Sunriver Capital and MSD
in a double over the next 2-3 years.
Capital (London) on long/
short and special situations
Thesis Points
investments across a broad
1) Schibsted’s #1 position in print and online
range of sectors. Investment spend
media in Norway and Sweden is stabilizing,

Rev/User <€1€5.7 and reduction due to Naspers
40% EBITDA margin at JV and less sites in
Subito.it begins to monetize investment mode
yet at ~4% of 2017 EV, is now immaterial, thus #1 position
He and his team were
mitigating risk of further decline: The company Reflects core growth
finalists at the 2014 Pershing consistent w/ prior years
has the leading digital newspapers & tabloids in both Growth in Rev/User: Reflects continued
Square Challenge where Finn: €39.2€44.5 decline in both revenues
Norway and Sweden, generating 10-15% EBITDA Blocket €12.8€16.4 (3% pa) and EBITDA
they pitched a stub trade Leboncoin (ex-RE) €2.7€3.9 margins (3%)
margins. Schibsted is quickly transitioning from an

investment for a long
offline media business to an online business with 55%
position in Naspers (NPN:
of rev and 64% of EBITDA now online, up from a
SJ).
30%/45% split in 2011. Including Real Estate,
Rev/User €2.4€4.6
and 60% EBITDA margin
Leboncoin Rev/User €3€6.5; due to Milanuncious
Prior to school, Luke was an 100% of EBITDA growth “in acquisition
2) Schibsted’s dominant online classified proper- the bag” due to Jan 2015
investment banking analyst at expiration of Spir agreement
ties in Norway and Sweden are phenomenal

Wells Fargo Securities, a
businesses and are prototypes for its leading
long/short and merger
sites in 30+ additional countries: Online classi-
arbitrage analyst at Farallon
fieds are a winner-take all business with the top site
Capital, and raised a private
in a country or vertical generating 60%+ pre-tax
equity fund where he
purchased, acquired and margins, >100% of market profits and the ability to grow revenues 10%+ indefinitely via price increases and user
growth (due to inelastic demand). The key categories for online classifieds include Generalist (i.e. Craigslist), Auto,
operated two small
Real Estate and Jobs. Once a site becomes the clear leader (2-3x its peers or 40-50% share), network effects take over
businesses. Luke holds a BS
and the value of the network grows exponentially. Today, Finn and Blocket (Schibsted’s dominant Scandinavian online
in Accounting from the
classified properties) generate €38 and €13 in rev/internet user, respectively, a combined €273m TTM revenues, ~50%
University of Alabama and an
EBITDA margins and are growing high single digits. I estimate Finn and Blocket to be worth ~40% of Schibsted’s cur-
MS in Finance from Boston
College. rent EV by 12/31/16.
3) There is an extreme monetization gap between Schibsted’s Scandinavian properties and its other 20+
dominant sites: Schibsted’s properties Norway + Sweden = 12m internet
in Norway and Sweden are monetizing at users; 145m additional internet
levels significantly higher than its other users in red box + >600m additional
in 20+ countries with #1/2 positions
30+ #1/2 sites due to dominance across
all four major verticals in Norway and
Finn and Blocket having established their
#1 position 7-10 years prior, allowing for
many years of price increases in inelastic
markets. Schibsted has generated €131m
in TTM EBITDA in Scandinavia, yet the
population of the countries of the other
six sites in the table is 14x that of Nor-
way + Sweden.
4) As Schibsted’s property in France (Leboncoin) approaches monetization levels achieved by Blocket, it

will be worth 80% of Schibsted’s current value: LBC has 70% EBITDA margins, a 50% revenue CAGR since
2010, the #1 position in all four key verticals, and ranks behind only Google and Facebook in terms of display advertis-
ing in France (note that Blocket only dominates two verticals). Schibsted has indicated now that LBC is the clear win-
ner in France, it will focus on significantly driving monetization. I estimate LBC’s real estate TAM alone to be ~€400-
500m [26,000 agents x €1,300/month], with 60% spent online today.
Page 34
Schibsted Media Group (SCH: NO) - Long (Continued from previous page)
(and migrating upwards a few % annually). Further, LBC’s real estate vertical has been under-earning in France and will
accelerate rapidly in 2015/2016 due to the expiration of the legacy “Spir” agreement at the end of 2014. It is estimated
that this venture generates ~€50m in revenue (versus #2 site Seloger’s €125m), of which LBC only receives €10-15m
despite driving 80%+ of the traffic due to the poor economics to LBC of the original deal when it was a small player.
Beginning in 2015, LBC should start to see a revenue lift of €40-50m as it can earn 80-90% of the economics versus the
15-20% today. Given LBC’s traffic is larger and growing faster than #2 Seloger, a similar €125m run rate in 2015 for
real estate alone should prove to be an easy target. Further, I estimate LBC’s Auto TAM to be ~€450m: 5.5mm used
cars sold annually in France at $10k; $100/car (1% take-rate) = ~€450m TAM.
5) Schibsted’s “Core five” classified properties in 2017, (Norway, Sweden, France, Spain & Italy) are esti-
mated to be worth €10-13bn, or 70%- 2017e EV /EBITDA Ente r pris e V alue
120% greater than Schibsted’s valuation Eur (m) EBITDA Low M id High Low M id High
today: while Schibsted does not break out Norw ay
Sw eden
96
72
12x
12x
14x
14x
16x
16x
1,152
870
1,344
1,014
1,536
1,159
financial details on sites in France, Spain or Franc e 287 14x 16x 18x 4,024 4,599 5,174
Italy, I have conservatively modeled France by Spain 137 14x 16x 18x 1,917 2,191 2,464
Italy 133 14x 16x 18x 1,858 2,124 2,389
vertical and arrive at a 2017 rev/internet user Total 726 14x 16x 18x 9,821 11,272 12,723
of €6.5, or ~40% of that achieved by Blocket.
Although Blocket is more mature, it is only Current Sc hib sted Enterpris e Value 5,852 5,852 5,852
"Cor e 5" as % of Cur re nt Schibs te d EV 168% 193% 217%
dominant in two verticals versus LBC’s four,
emphasizing the conservatism in these estimates. I have thus used €6.5 rev/user as the proxy for revenue potential for
Spain and Italy, and then adjusted this figure by GDP/capita to arrive at similarly conservative estimates.
6) Schibsted’s “Other Non-Core Established” sites in Brazil, Ireland, Finland, Austria, Thailand, Indonesia,
Bangladesh and Malaysia are likely to contribute at least 15% of Base Case EBITDA Growth; and this
ignores the optionality of the 20+ other dominant sites covering ~770m internet users by 2017.
7) The JV with Naspers announced on 11/13/14 was a game changer: Schibsted and Naspers are the leading
players in online classifieds, with either ranking #1 in most countries with little geographic overlap, but both had been
investing heavily to win the Brazilian market in past years. To the market’s delight (+34% stock move on the announce-
ment), Schibsted created a global online classifieds JV with Naspers, immediately ending capital-intensive marketing
wars across these markets, in particular Brazil, where Schibsted was investing more than €100mm per year. Additional-
ly, Schibsted has now ensured dominant competitive positions in huge and attractive markets. Brazil is a market of
200mm people (20x Sweden) where Schibsted’s “Blocket” generates €100mm+ in annual revenue.
8) Avito (Russia’s now dominant classified site) merged with the #2 and #3 sites and is a good case study
for future Schibsted monetization: Avito was crowned the winner in Russian classifieds in May 2013 when it
merged with the #2 and 3 sites. Prior to the transaction, Avito was generating rev/internet user of ~€1 and a negative
EBITDA margin; now 1.5 years after the deal, Avito is generating 4x the revenue and has dramatically reduced its in-
vestment spend, resulting in Q314 EBITDA margins of 65%. This is clear evidence that the moment a winning site is
crowned, revenues grow rapidly, marketing spend is cut, and EBITDA margins expand dramatically.
LTM 2017E
EURm 2011 2012 2013 9/30/2014 Dow ns ide Bas e Ups ide Ups ide +
Re ve nue
Total Classif ieds 412 494 506 546 835 1,236 1,816 2,449
Total Media Houses 1,306 1,358 1,199 1,188 906 1,076 1,076 1,076
Other 134 148 103 31 0 0 0 0
Total Re ve nue s 1,852 2,001 1,808 1,765 1,741 2,313 2,892 3,525
G rowth y/y CAG R 9/30/14 through 12/31/17

Classif ieds 20% 2% 14% 29% 45% 59%
Media Houses 4% (12% ) (8% ) (3% ) (3%) (3%)
Total 5.1% 8% (10% ) (1% ) 14% 27% 40%
EBITDA
Total Classif ieds 135 149 102 156 321 636 953 1,206
Total Classifieds ex-Investments 221 221 229 371 661 978 1,231
Total Media House 186 163 147 133 0 94 94 94

Total Other/HQ/Eliim (39) (35) (51) (59) (63) (48) (48) (48)
Total EBITDA 281 277 198 230 258 682 999 1,252
CapEx (24) (25) (37) (74) (52) (69) (72) (88)
EBITDA Margins
Total Classif ieds 33% 30% 20% 29% 38% 51% 52% 49%
Total Classifieds ex-Investments 45% 44% 42% 44% 53% 54% 50%
Total Media House 14% 12% 12% 11% 0% 9% 9% 9%
Total EBITDA 15% 14% 11% 13% 15% 29% 35% 36%
Adj. EPS (Euros ) 1.82 1.78 1.14 1.10 1.46 4.34 6.56 8.24
Curre nt V aluation M ultiple s

EV /Re ve nue 3.3x 3.4x 2.5x 2.0x 1.7x
EV /EBITDA 25.5x 22.7x 8.6x 5.9x 4.7x
EV /(EBITDA plus non-capitalize d inve s tm e nt s pe nd) 19.4x 19.0x 8.3x 5.7x 4.6x
EV /(EBITDA-CapEx) 37.6x 28.5x 9.6x 6.3x 5.0x
P/E 48.0x 36.3x 12.2x 8.1x 6.4x
Cons e ns us (EURm ) 2017E Bas e Cas e vs . Cons

Re ve nue 2,052 1.1x
EBITDA 414 1.6x
Adj. EPS (Euros ) 1.26 3.5x
Page 35
CDK Global (NASDAQ: CDK) - Long

Brian Waterhouse
BWaterhouse15@gsb.columbia.edu
Thesis
CDK Global was spun-out from ADP in September 2014 and exhibits
classic spin dynamics. The company is significantly under-earning its
nearest competitor, Reynolds & Reynolds (REY), with EBITDA mar-
Brian Waterhouse ’15 gins of 21% vs. REY at 52%, but its true profitability is being masked
by a bloated cost structure. Going forward, CDK’s stock will be
Brian is a second-year MBA
driven by three main factors: 1) topline growth driven by secular
student in Columbia Busi- tailwinds from underinvestment / increased shift of spend toward
ness School’s Value Invest-
digital marketing, 2) significant margin expansion, and 3) substantial
ing Program, Co-President
FCF generation that can be used to repurchase stock. Using a 17x
of the Columbia Student forward FCF multiple on 2018E FY (6/30) FCF and adding expected
dividends, I derive a $65 price target, or 61% upside from current
Association, and a member
price (21% IRR).
of the winning team for the
2014 Pershing Square
Business
Challenge.
 CDK provides information technology and digital marketing/advertising solutions to the automotive retail industry. It is
Brian worked at Blue Ridge the operating system that runs auto dealerships (pre-sales advertising, sales, financing, parts supply, insurance, and
Capital during the summer repair/maintenance of vehicles). The company serves over 26,000 retail locations and auto OEMs in approximately 100
and plans to return there countries.
after graduation. Prior to  CDK earns money by selling software (currently via licenses) to dealerships on a 3-5 year term (with annual pricing
CBS, Brian was an Associ- escalators). They also sell dealers equipment (servers, etc), web services (marketing, web site management), and vol-
ate at Millennium Technol- ume-based products (like financing requests or VIN registration). CDK will make money as long as the dealer is open
ogy Value Partners. and has upside optionality from increasing car sales.
 CDK operates in an oligopoly market with CDK having 40%market share and private competitor REY at 30% market
share, and the balance made up of a
handful of smaller competitors.
Thesis Points
 CDK will see solid topline growth, as
the recession resulted in underinvest-
ment in dealer information services
systems. N. American new vehicle
sales have normalized and increased
dealer profitability enables them to
reinvest in their businesses. This is
badly needed (some systems are still
DOS based) and CDK will benefit as
the industry transitions from analog to
digital. In addition, N. America dealer
consolidation should drive more deal-
ers to switch over to enterprise-grade
solutions like CDK (CDK already has
7 of the 10 largest US dealers). Digital
marketing will also gain in importance
as dealer allocation of advertising spend to digital media lags consumer shopping behavior and preferences. By 2017,
eMarketer forecasts that US digital automotive ad spend will reach $9.3 billion, representing a 15.7% CAGR from 2013
spend. Lastly, there will be an EM growth opportunity as auto sales in China grow faster than most Western markets.
 This is a remarkably resilient business - during the economic downturn, CDK’s N. America organic revenue declined
by 4% between FY09 and FY10, while US car sales volumes declined 21% from CY08 to CY09 and 760 dealerships
closed (3.6% decline nationally).
 CDK’s margin opportunity is significant. It has 2x the employees of REY and is clearly overstaffed. REY was taken
private in 2006, at which time it had a similar margin structure to CDK today. REY was able to boost its EBITDA
margins to over 50% (nearly 60% at peak) by turning over a relatively expensive workforce ($110,000/year average
salary) and cutting other costs. Diligence checks with industry experts suggest there is no reason why REY and CDK
should have different margins and that CDK has a lot of fat to cut. CDK’s management indicated as much in its first
conference call, saying they can increase margins without too much effort and targeting at least 100bps of margins
expansion annually. A 10% reduction in headcount at $100,000/year would boost EBIT margins by 5% and save CDK
$90 million or $0.57/share annually. Headcount will likely be cut more and salaries are likely higher, implying even
greater potential savings.
 CDK is currently underpricing its competitors. Industry sources have hinted to pricing as being as much as 20% below
REY which is clearly impacting margins and unneeded given REY’s poor reputation in the dealer community for service
and technology.
Page 36
CDK Global (CDK) - Long (Continued from previous page)

 The company is also under-earning in its Digital Marketing business - CDK’s 7% EBIT margin is far below digital mar-
keting businesses like Conversant (formerly ValueClick) in the 30% range.
 CDK generates higher FCF than net income due to relatively low capex requirements (~2-3% of sales) and high D&A
(they are amortizing intangibles associated with past acquisitions and their investment in software upgrades). The
business should generate over $200 million of FCF in FY 2015, growing to the $500 million range by 2018, and may
have additional cash available for shareholder return from potential leverage increases. My model assumes debt/
EBITDA is capped at 2x (per management’s initial target, but well below REY’s 8x) which creates room for an addi-
tional $1 billion of debt that could be
used to repurchase shares. I assume 60%
of annual FCF is used to fund repurchas-
es (at prices that increase 10% annually).
The company already has a $0.48/share
annual dividend.
 CDK is run by a group of ADP veterans,
with CEO Steven Anenen (61 years old)
a 39 year veteran of ADP, serving as
president of ADP dealer services since
2004. CDK’s executives are incentivized
against a wide range of criteria -revenue
growth, EBIT growth, divisional financial
performance (that includes client reten-
tion and sales targets), and strategic objectives (that include market share increases, new product introductions, and
leadership pipeline). The executives team’s options have exercise prices of $40.28 to $79.31, all above the current
stock price, and 52% of the CEO’s target compensation mix is weighted toward long-term incentive comp. The
management team, and the CEO in particular, have a lot of skin in the game here.
Valuation
 At the current price of $40.29 (12/19/14), the market is not giving CDK any credit for realistic margin expansion or
topline growth. REY clearly laid out the playbook when they increased margins from 20% to 52% shortly after the
LBO. All of my primary diligence leads me to believe that CDK will be able to increase margins to at least 30%, and
40% more realistically.
 The market seems to be only currently pricing in that CDK will improve margins to the low 20%s, a level which can
be achieved with minimal headcount reduction. If CDK grows at the midrange of management’s guidance and makes
minimal EBIT margin improvements (still at a substantial margin differential to REY), that alone justifies the current
price. This also assumes no buybacks and no increase in dividends. My model assumes CDK will rapidly expand mar-
gins as they cut costs and increase prices. Additionally, they will be able to modestly grow topline revenue.
 At present, CDK trades at 11x 2018 FYE FCF, which is absurdly low for this high-quality of a business. As manage-
ment executes and jumps over the one-foot hurdles ahead of it, CDK will rapidly grow earnings and FCF, allowing it
to repurchase substantial amounts of stock (36% of the current market cap by 2018 FYE by my estimates).
 CDK will earn $3.73 in 2018 FCF and should be able to trade at 17x FCF. Adding cumulative dividends over that
time results in a $65 price target, or 61% upside the most recent price. A DCF model results in a similar conclusion.
 CDK has further upside optionality from a potential SaaS conversion over time (discussions with industry profession-
als and dealers lead me to believe this will happen in the future, albeit not likely anytime soon). The math below
illustrates how an eventual SaaS conversion will boost CDK’s topline and should also result in higher margins.
Page 37
SolarCity (NASDAQ: SCTY) - Short

1st Place—Darden @ Virginia Investing Challenge
Brendan Dawson Aaron Purcell Sisy Wang
BDawson16@gsb.columbia.edu APurcell16@gsb.columbia.edu SWang16@gsb.columbia.edu
Thesis SCTY - Capitalization Table

SCTY is a market leader in the large and growing solar energy installation industry, Price *11/13/14 $ 50.84
but current valuation ignores major business risks to long-term sustainability. We FDS 96.0
Brendan Dawson ’16 believe SCTY has limited differentiation on a brand or customer experience basis as Market Cap $ 4,881
Brendan is a first-year well as no demonstrated cost advantage vs industry peers. In addition, the ITC Cash (733)
MBA student at stepdown and potential net energy metering regulation present legitimate threats to
Debt & Minority Interest 1,851
Columbia Business industry profitability and the value proposition to customers. Wall Street’s focus on
School. Prior to CBS, market size and revenue growth rates instead of competitive position, a mistake TEV $ 5,998
Brendan was part of the made in 2007 with solar panel manufacturers, has driven valuations to levels that
investment team at the leave limited room for upside surprise. We have a price target of $39 over the next Consensus '15 EPS $ (5.09)
UVA Investment 18 months, suggesting 25% downside from current levels. Consensus '15 EBIT $ (469)
Management Company.
Business Model & Background
 SCTY designs, installs, and sells/leases solar ener-
gy systems to residential, commercial, and gov-
ernment customers.
 SCTY has grown to become the largest residen-
tial solar energy provider by offering solutions to
customers with $0 upfront cost, with consumers
expecting to save 10-20% off their existing elec-
Aaron Purcell ’16 tricity costs. SCTY provides solar equipment and
Aaron is a first-year installation free of charge, with customers signing
MBA student at 20 year contracts that typically include 2% annual
Columbia Business price escalators. SCTY owns the system and
School. Prior to CBS, maintenance/monitoring are included in the con-
Aaron worked in private tract for free.
equity at Riverside
Partners after spending Thesis Points:
two years in Citigroup’s  While the bulls point to a scale and vertical inte-
technology investment gration advantage, our review of an NREL indus-
banking group. try whitepaper suggests SCTY has no cost ad-
vantage, with a total install cost for SCTY of
$2.82 (installation cost-per-watt of $2.49 + G&A
cost-per-watt of $0.33) vs. the industry average of
$2.83 (installation cost-per-watt of $2.56 and
G&A cost-per-watt of $0.27). Additionally, the opportunity for further cost structure reductions appears questionable
- the company was able to reduce its annual cost-per-watt by 16% from 2012-2014, but guidance suggests this will
slow to just under 5% from 2015-2017.
 We believe the playing field in residential installation is being leveled via the emergence of new point of sale loan
products. SCTY’s pioneering use of the PPA/lease model solved a key pain point as traditional lenders weren’t com-
fortable with solar as collateral and homeowners didn’t want to pay $30k+ for a system. Additionally, the PPA/lease
Sisy Wang ’16 model required tax equity financing to monetize the ITC credit and MACRS depreciation. Given the complexity and
limited availability of tax equity capital, only the most sophisticated installers could offer no money down options.
Sisy is a first-year MBA However, because of partnerships with financial institutions like Admirals Bank, EnerBank USA, and Sungage Financial,
student at Columbia the long-tail of 3000+ installers are now able to offer no-money down solutions, becoming more powerful at the
Business School. Prior customer’s kitchen table and eroding SolarCity’s advantage.
to CBS, Sisy was an
Analyst at Delaware  Our research and analysis in several of SCTY’s major markets suggests that SCTY’s customer experience and brand
Investment’s Emerging are not superior to those of local and national competitors.
Markets Fund and a pre-  We also see sophisticated players increasingly moving into this space, with several residential solar installation acquisi-
MBA Summer Analyst at tions in 2013 and 2014. SunRun, the largest financing platform in solar, recently pursued vertical integration via an
Plymouth Lane Capital. acquisition of installation partner REC Solar, the 8th largest installer. NRG, a power company that has been vocal
about the threat of solar to the utility business model, acquired Roof Diagnostics Company, the 7th largest residential
installer. And Centrica’s US subsidiary, Direct Energy, acquired Astrum Solar, giving Astrum access to 6 million of
Direct Energy’s existing paying customer relationships.
The ITC step-down from 30% to 10% in 2017 will further worsen uncompelling unit economics. A top-10 installer we
spoke with suggested that the after-tax unlevered returns for residential deals are generally in the single digit to 10%
range today and that if the ITC reduction were to happen tomorrow, it would be crippling for the industry. While
SCTY is more optimistic, SCTY’s “healthy profit” level of $1 NPV per watt would still be 42% lower than current
levels.
Page 38
SolarCity (SCTY) - Short (Continued from previous page)

 Net Energy Metering (“NEM”) is the practice of crediting residential solar customers with their excess power gener-
ation and has effectively been a subsidy for residential solar customers in two ways: 1) the utility is effectively being
forced to buy at retail electricity prices, and 2) all power generation sources except solar pay transmission charges.
As a result, the net-metered customer does not share equally in the overhead costs associated with the grid or
other services provided by the utility, a result that produces a very substantial “cross-subsidy” funded by all other
utility customers who must pay proportionately more in rates. The regulatory response toward NEM has been lim-
ited so far, but interviews suggests potential regulation is a significant downside risk as solar adoption increases.
 We see SCTY’s recent acquisition of Silevo, a start-up solar panel producer, as a potential risk. At the time of the
acquisition, Silevo had only 35MW of production capacity in a pilot facility in Hangzhou. Some industry experts sug-
gested its cell-level efficiencies are “not impressive” and the key drivers of their cost advantage “can easily be repli-
cated”. SolarCity intends to scale Silevo production to 1GW within 2 years, but there are only a handful of compa-
nies in the world with 1GW production capacity. Bulls claim the acquisition is low risk due to the limited purchase
price, we would note that SCTY has committed to a $5 billion investment in this business over the next 10 years.
 Finally, we would note that the current framing of SCTY makes us question whether history is about to repeat itself.
A focus on growth at the expense of competitive dynamics with panel manufactures in late 2007 resulted in massive
overvaluation with companies like First Solar, Yingli, Trina Solar, and SunPower.
Valuation
 We believe management guidance for Retained Value / Watt is too aggressive. Their guidance assumes 90% renewal
rates at 90% of the 20 year forward PPA price, continued. We think 90% renewal is only possible at 60% of the price
given system cost declines and solar escalators can be above utility cost growth.
 We assume lower revenue escalators and continued elevated sales & marketing spend given industry competition.
Blue Sky
 Even using aggressive assumptions, we can only justify a stock price that is 77% of the current price
 Key assumptions include: 1) 40% revenue CAGR over the next 11 years, 2) OPM expanding to 16% over time, 3)
14x exit EBIT multiple
Page 39
Cardtronics Inc. (CATM) — Short

1st Place — Alpha Challenge @ UNC Kenan-Flagler
Damian Creber Edward Reynolds Kevin Lin
DCreber16@gsb.columbia.edu EReynolds16@gsb.columbia.edu YLin16@gsb.columbia.edu
Damian Creber ’16 Thesis

CATM is the world’s largest non-bank operator of ATM machines. CATM partici- Shares Outstanding (mm) 44.5
Damian is a first-year pates in the secularly declining paper currency market, continues to generate dimin- Share Price (Nov. 14, 2014) $37.39
MBA student at ishing returns on capital, and has a deteriorating core business. However, acquisi-
Columbia Business Market Capitalization $1,665
tions and changes in accounting estimates have created the perception of an ever-
School. Prior to CBS, growing business that Wall Street has supported with a string of buy recommenda-
Damian worked on the tions. In addition, CATM faces an existential threat as their largest contract— plus: debt outstanding 598
private equity team at representing ~45% of EBITDA—is under attack. We have a price target of $20
Onex Partners after less: cash (141)
over the next 18 months, suggesting ~50% downside from current levels.
spending two years in Enterprise Value $2,122
the leveraged finance Business Model & Background
group at RBC Capital
Markets.  CATM installs, operates, and services ATM machines in retail locations across the US, UK, Canada, Mexico, and
Germany.
 CATM traditionally generates revenue through a combination of surcharge fees (paid by customers) and interchange
fees (paid by financial institutions).
Thesis Points:
 ATM Usage Is In Secular Decline. As we move towards a paperless
economy, ATM usage has begun to decline. Since 2009, ATM usage has
declined 1.1% per year and is accelerating to the downside. However, man- 6
agement has indicated that they expect same-store-growth to increase at 3-
ATM Withdrawls
Edward Reynolds ’16 5.9
5% annually, despite almost-zero same store transaction growth over the
(billions)
Edward is a first-year past few years. 5.8
student at Columbia
Business School. Prior  Declining Organic Business. Over the past four years, CATM has seen 5.7
to CBS, Ed was at returns on capital shrink meaningfully. Today, CATM is barely earning above 5.6
a return above a standard cost-of-capital, yet is framing their business as
Citadel in the Electronic 5.5
Execution and Market- “growing double-digits”. Incremental returns on invested capital have been
below 5% for two of the past three years and negative in 2013, illustrating 2002 2007 2012
Making groups.
that CATM is unable to find attractive places to deploy capital. In
addition, CATM’s organic revenue has declined meaningfully over 2010 2011 2012 2013
the past few years as revenue per transaction has fallen more than
20% since 2010 .
Reported EBIT $70 $83 $97 $110
 Acquisitions / Accounting Games Are Masking Decline. less: incremental D&A (5) (9) (10) (26)
Despite a rotting core business, CATM has shown ~15% annual Fundamental EBIT $64 $74 $87 $84
revenue growth and ~25% annual earnings growth through a combi-
nation of acquisitions and changes to accounting estimates. These Invested Capital $379 $612 $691 $846
acquisitions have not been creating shareholder value; however, as
Kevin Lin ’16 ROICs have consistently degraded under this strategy. In addition,
ROIC (with acquisitions) 17.0% 12.1% 12.5% 10.0%
CATM has adjusted the useful life estimates on its equipment in
Incremental ROIC 4.2% 15.8% (1.6%)
Kevin is a first-year order to reduce depreciation expense.
MBA student at
Columbia Business 2008 2009 2010 2011 2012 2013
School. Prior to CBS,
Kevin was an analyst at Depreciation Expense $38 $37 $40 $46 $59 $66
Sansome Partners. Gross PP&E 231 253 291 362 460 632
Implied Average Life 6.0 6.5 6.8 7.2 7.0 8.3
 Declining Interest Rates Have Inflated Operating Income. For the machines that CATM owns, CATM is
responsible for providing ‘vault cash’ (stocking the ATMs with cash). This cash is borrowed at a spread above LIBOR
from large banks. CATM has benefitted meaningfully from the compression in interest rates; however, this benefit is a
double-edged sword and CATM is likely to see a significant compression in profitability as interest rates increase.
2010 2011 2012 2013
Vault Cash $1,132 $1,703 $2,210 $2,744

Vault Rental Expense 37 41 49 50
Effective Rate 3.2% 2.4% 2.2% 1.8%
Page 40
Cardtronics (CATM) — Short (Continued from previous page)

 CATM’s Largest Contract Is Under Attack. CATM’s largest customer, 7-Eleven, represents 24% of revenues
and 45% CATM’s EBITDA, respectively. However, after considering CATM’s depreciation and interest expense, the
7-Eleven contract represents 100% of Cardtronics’ earnings. 7-Eleven is owned by Seven & I Holdings, which also
owns 45% of Seven Bank. Seven Bank operates all ATMs in 7-Eleven’s Japanese locations and has publicly stated that
it plans to expand in the US. Seven Bank acquired FCT, a California-based ATM operator in October 2012, and the
US ATM business of Global Axcess in August 2013. The combination of Seven Bank’s acquisitions, coupled with the
relationship between 7-Eleven and Seven Bank, positions Cardtronics to either lose or receive less favorable eco-
nomics on the 7-Eleven contract. The 7-Eleven contract expires in June of 2017.
Valuation
Fair Value
 CATM currently trades at a 4% cash flow yield,
9x LTM EBITDA, and 35x our view of normal- Precedent Valuation $21.80 $29.91
ized earnings.
 Our analysis suggests that Cardtronics’ shares
have downside potential of 40% to 80% over
Free Cash Flow Yield $15.52 $19.40
the next twelve to eighteen months.
 The main catalyst for decline will be the loss or
reduced economics associated with the 7-
Eleven contract, which we believe will be con- Comparables $22.66
cluded well in advance of the June 2017 roll-off.
 In addition, we believe the core business will
continue to accelerate to the downside and
investors will see the declines start to bleed Discounted Cash Flow $8.02 $11.97
through the M&A-masked figures.
 We believe the potential upside in the shares
(or downside to the short) is in the range of
15% to 20% over the same period, implying a Current Share Price $39.37
3:1 short-term upside-to-downside associated
with our recommendation.
$- $10 $20 $30 $40 $50
Key Risks
Per Share Value
 Continued M&A. Management has done an
excellent job of showing the Street growth in
both the top-line and bottom-line by making acquisitions with balance-sheet cash or incremental debt. To the extent
that management is able to continue to make acquisitions, it may continue to mask declines in the core business,
although we believe that universe of attractive M&A opportunities is much smaller than a few years ago.
 7-Eleven Contract. While we view the odds of Cardtronics winning the 7-Eleven contract as extremely unlikely
(and, even if that unlikely event occurs, we believe the economics will be substantially reduced), we do acknowledge
that small-probability events can cripple a short thesis. Having spoken to members of the investment community, we
believe the potential overhang in the stock today is ~10-15%, which we believe is the short-term upside associated
with this risk.
Timing
Consistent with all short investments, we view timing as very important, especially given the biggest catalyst (the loss or
economic adjustment of the 7-Eleven contract) will not occur until 2017. However, given (i) the continued deterioration
of the core business, (ii) the increased overhang that will likely develop in the stock as 2017 approaches, (iii) the current
extreme valuation of the business, and (iv) the potential reduction in the actionable M&A universe, we believe investors
should consider engaging at these levels.
Historicals Forecast
2010 2011 2012 2013 2014 2015 2016 2017 2018
Number of ATMs 36,970 52,886 62,760 80,594 80,594 80,594 80,594 80,594 80,594
Transactions Per ATM 11.2 9.8 11.2 10.7 10.6 10.5 10.4 10.3 10.1
Number of Transactions 413,780 516,564 704,809 860,062 851,461 842,947 834,517 826,172 817,910
Revenue Per Transaction $1.29 $1.21 $1.11 $1.02 $1.02 $1.02 $1.02 $1.02 $1.02
Revenue $532 $625 $780 $876 $868 $859 $850 $842 $834
% growth 17.4% 25.0% 12.3% (1.0%) (1.0%) (1.0%) (1.0%) (1.0%)
COGS $360 $420 $536 $587 $587 $587 $588 $589 $590
Gross Profit $172 $205 $244 $290 $281 $272 $263 $253 $244
SG&A 44 56 65 84 84 84 84 84 85
EBITDA $128 $149 $180 $206 $197 $188 $178 $169 $159
% margin 24.0% 23.8% 23.0% 23.5% 22.7% 21.8% 21.0% 20.1% 19.1%
Page 41
Progressive Waste Solutions Ltd. (NYSE, TSE: BIN) - Long

2nd Place — Ross Investment Competition (University of Michigan)
Matt Brownschidle Winston Hu Jay Ju Steve Lin
MBrownschidle16@gsb.columbia.edu WHu16@gsb.columbia.edu JJu15@gsb.columbia.edu SLin16@gsb.columbia.edu
.
Recommendation Trading Overview
Matt Brownschidle ’16
Buy Progressive Waste Solutions (NYSE, TSX:BIN) equity with a three-year base Stock Price (1/9/2015) $29.67
Matt is a first-year MBA case share price of $46. This represents ~55% upside from the current share price. Dil. Sh. Out. (mm) 114.7
student at Columbia The investment thesis has three main points: Equity Value $3,404
Business School. Prior to 1) New management team brings a focus on enhancing ROIC from 4.7% in 2012 Less: Cash 30
CBS, Matt was a private to a targeted 8-10% through profitability improvements and disciplined use of Plus: Debt 1,465
equity associate at capital. Enterprise Value $4,899
Sycamore Partners. 2) Favorable changes in industry dynamics including a rational pricing environ- Current Valuation (Consensus)
ment, recovery in waste volumes and continued industry consolidation 2014E 2015P
3) Improvements in free cash flow generation enable attractive options for capital EV / EBITDA 9.4x 8.8x
allocation including increased dividends, share buy-backs and accretive add-on EV / FCF 21.9x 22.3x
acquisitions Price / EPS 22.9x 22.0x
2017 Price Target
2017 Price Target $46
Progressive is North America’s 3rd largest provider of non-hazardous solid waste % Price Upside 55%
collection, recycling and landfill disposal services for commercial, industrial and Fwd EV / EBITDA-CapEx 13.8x
Winston Hu ’16 residential customers in Canada, the U.S. South and U.S. North East. The company Fwd EV / EBITDA 8.9x
operates 120 collection operations supported by 31 landfills, 72 transfer stations Fwd Price / EPS 24.1x
Winston is a first-year and 47 material recovery facilities. Key competitors include Waste Management
MBA student at Columbia (WM), Republic Services (RSG) and Waste Connections (WCN).
CBS, Winston was an The company has grown rapidly over the past decade through acquisitions (revenue of $190 million in 2004 vs. $2 billion in
Associate at Crescent 2013) under its ex-CEO/founder. In 2012 and 2013, the company made changes to its CEO, COO, CFO and EVP of Strate-
Capital’s Mezzanine Fund. gy and Business Development positions.
Progressive’s margins vary amongst its three operating regions. The company operates with EBITDA margin of 36% in Can-
ada, which is a highly consolidated market where Progressive and Waste Management command market share of ~75%.
Progressive operates with EBITDA margin of 25% in the US South and 21% in the US North East, which is a fragmented and
competitive region.
Investment Thesis
1) New management team brings focus on ROIC improvement in a historically poorly-managed business.
As a result of rapid growth through acquisitions in the past, Progressive has historically operated with ROIC that has lagged
Jay Ju ’15
its competitors (4.7% in 2012 compared to 9-10% at WM and RSG). The new management team seeks to enhance ROIC to
Jay is a second-year MBA a targeted 8-10% through profitability improvements and disciplined use of capital.
student at Columbia
Business School. Prior to Vertical integration of collection, transfer and landfill services enables Progressive to benefit from improvements in its inter-
CBS, Jay was a portfolio nalization ratio, or the percentage of waste volume tipped at its landfills from its collection operations. Internalization al-
manager at Mirae Asset lows the avoidance of third-party disposal fees, a steady supply of waste and greater pricing power with third-party collec-
Global Investments. tions companies. By increasing route density in markets where Progressive also offers landfill services, the company can
strengthen the internalization and margin profile of its existing operations. Progressive’s internalization stands at 45% today
compared to 68% at WM and RSG.
Management has been executing on its strategy of optimizing pricing and volume arrangements in its US operations. In the
North East, recent lower volumes reflect management’s focus on reducing non-profitable collection volume to drive higher
margins. EBITDA margins in the North East improved to 21% in 3Q13 from 16% in 1Q14.
Other capital improvement initiatives include extending the life of its trucks through better/preemptive maintenance to
decrease replacement capex, use of CNG-fueled trucks to decrease fuel costs, use of automated trucks to decrease em-
Steve Lin ’16 ployee injuries, and improvement of route productivity to decrease the number of trucks needed.
Steve is a first-year MBA 2) Change in industry dynamics brings various tailwinds for both pricing and volume.
student at Columbia Prior to 2012, WM was known for price aggression (notably underbidding RSG for a large contract with Home Depot),
Business School. Prior to depressing prices in the industry. Following a restructuring in 2012, WM has begun to pursue a strategy of raising prices and
CBS, Steve was a Vice cutting costs, a marked change from previous share-maximizing behavior. In 4Q13, WM’s pricing on existing volumes in-
President at Investcorp’s creased 4% while volumes declined 2.2%, despite increasing volumes for other public competitors. WM is currently guiding
FoF and Technology PE for price increases of 2-2.5% in 2015 which should benefit Progressive as well.
groups.
Residential, commercial and industrial waste volumes are expected to increase at CAGRs of ~1% in the US and Canada as
household formation, commercial and industrial activity recover and recycling/diversion levels have moderated.
Page 42
Progressive Waste Solutions (BIN) - Long (Continued from previous page)

The number of landfills in the US has declined significantly over the past 30 years (~8,000 landfills in 1988 to ~2,000 in
2014), driven by increasing costs and regulations (enhanced engineering requirements to reduce environmental footprint,
stringent procedures to manage odor, etc.). This trend has encouraged larger, regional landfills while preventing new en-
trants and challenging smaller landfills. Tipping fees have steadily increased, benefitting large, vertically integrated players
such as Progressive, and driving consolidation of stand-alone collection companies who find rising tipping fees increasingly
challenging for their economics.
3) Improving free cash flow generation enables attractive options for capital allocation
Capex has been elevated (13.5% of revenue in 2013) due to a number of discretionary infrastructure projects that
amounted to ~$80 million of investment from 2012-2Q14. Post-completion, total capex is expected to be 10% of reve-
nue going forward. Expected replacement capex was revised from 10% of revenue to 8%, attributed to capital spending
discipline and pre-emptive servicing of trucks to extend useful life.
Progressive announced in its 3Q14 earnings call that it expects its go-forward effective tax rate to be 25% compared to 35
-40% in prior years due to changes in its internal financing structure and its Canadian domiciling.
Progressive has shown a willingness to return capital through dividends (25% of FCF generated from 2011-2013, 1.9%
dividend yield) and share buy-backs ($135 million in 2011 and 2012). Progressive will generate $1 billion in free cash flow
over the next three years compared to its current market cap of $3.4 billion, and will likely be able to increase the
amount of capital returned to shareholders.
Tuck-in acquisitions can be particularly accretive for Progressive. M&A has been discussed by both WM and RSG, who are
able to acquire collection companies for 6-7x pre-synergy EBITDA or 4-5x post-synergy EBITDA. Progressive has circled
$600 million in revenue at 25% pre-synergy margins for acquisition over the next 5 years. Assuming Progressive can find
targets at similar economics, ROIC on such acquisitions should be higher (~10%) than current overall ROIC. Its tax rate
advantage (WM and RSG have higher tax rates of 35%) should give it an advantage against other acquirers as well.
Valuation
Our base case target price of $46
is based on a 13.8x forward mul- ($ in millions) Base Case Bear Case Bull Case
tiple of 2018P EBITDA-CapEx of Forward EV/(EBITDA-CapEx) 13.8x 12.4x 13.8x
$490 million. An EV/(EBITDA- 2018P EBITDA $757 $524 $875
CapEx) multiple best reflects the 2018P CapEx 267 221 291
earnings power of the company 2018 EBITDA - CapEx 490 304 583
as margins expand and capex 2017 Enterprise Value $6,773 $3,764 $8,061
declines. We believe using an Less: 2017 Debt 2,005 1,511 2,266
average peer (WM, RSG, WCN) Plus: 2017 Cash 606 423 540
multiple of 13.8x is justified as we Implied Market Capitalization $5,374 $2,676 $6,335
forecast the company’s EBITDA
Dil. Shares Outstanding 115 115 115
margins to move closer to that of
Implied Price per Share $46.84 $23.32 $55.21
its peers (31-32%). Progressive
Current price $29.67 $29.67 $29.67
currently trades at a 15x forward
Upside (%) 57.9% (21.4)% 86.1%
EBITDA-CapEx multiple as it has
over the past couple of years.
Financials ($US M) 2012A 2013A 2014E 2015P 2016P 2017P 2018P 2019P '14-'19 CAGR
Revenue $1,896.7 $2,026.0 $2,000.0 $2,160.4 $2,325.6 $2,495.9 $2,671.3 $2,851.9 7.4%
% growth 6.8% (1.3%) 8.0% 7.6% 7.3% 7.0% 6.8%
EBITDA $511.3 $521.6 $503.6 $560.3 $623.6 $689.1 $757.1 $813.0 10.1%
% margin 27.0% 25.7% 25.2% 25.9% 26.8% 27.6% 28.3% 28.5%
FCF1 $181.8 $282.7 $262.0 $290.9 $328.5 $367.5 $408.0 $439.1 10.9%
% growth 55.5% (7.3%) 11.1% 12.9% 11.9% 11.0% 7.6%
EPS $0.81 $1.02 $1.17 $1.25 $1.46 $1.68 $1.91 $2.07 12.1%
% growth 25.8% 14.1% 6.9% 17.0% 15.1% 13.7% 8.2%
ROIC2 4.7% 5.5% 6.8% 6.9% 7.7% 8.6% 9.5% 10.1%
(1) Cash flow from operations - maintenance capex
(2) NOPAT / (Net Debt + Equity)
Key Risks
 EBITDA margins don’t improve as expected due to lower price increases and increased competition
 Internalization stays significantly below competitors’ levels
 Capex requirements are higher than expected
 Tuck-in acquisitions may not be available or accretive
Get Involved:
valueinvesting@gsb.columbia.edu.. Available positions also may be posted directly on the Co-
lumbia website at www.gsb.columbia.edu/jobpost.

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Contact Us:
mford15@gsb.columbia.edu Graham & Doddsville Editors 2014-2015
ppan15@gsb.columbia.edu
tschweitzer15@gsb.columbia.edu Matt Ford ’15
York-based long/short equity fund. Prior to Columbia, he worked as an analyst for Res-
ervoir Capital, Farallon Capital, and Bain Capital/Sankaty Advisors. Matt graduated from
The Wharton School of the University of Pennsylvania with a BS in Economics and BA in
East Asian Studies. He can be reached at mford15@gsb.columbia.edu.
Peter Pan ’15


Graham & Doddsville
Issue XXIV Spring 2015

Inside this issue:
2015 CSIMA First Eagle Investment
Conference P. 3
Management
Amici Capital Prize P. 4
Matthew McLennan and Kimball
First Eagle P. 5 Brooker are the heads of the Global
Value Team at First Eagle Investment
Josh Resnick P. 16 Management. Matt joined First Eagle
Investment Management in 2008. He
Harvey Sawikin P. 25
started his career with Queensland
Alder Hill P. 33 Investment Corporation (Australia) in
1991. In 1994, he joined Goldman Sachs
Rolf Heitmeyer ’06 P. 42 Matthew Kimball in Sydney before moving to New York
McLennan Brooker
Pershing Square (Continued on page 5)
Competition Ideas P. 51
Josh Harvey
Editors:
Resnick Sawikin
Matt Ford
MBA 2015 Josh Resnick is the Harvey Sawikin
founder and co-founded
Peter Pan managing partner Firebird
MBA 2015 of Jericho Capital, a Management in
Tom Schweitzer, CFA hedge fund focused 1994 and is lead
on investing manager of
MBA 2015
Josh Resnick primarily in the Harvey Sawikin Firebird’s
Brendan Dawson global technology, Eastern Europe
MBA 2016 media and telecommunications sectors. and Russia funds. He also serves on
Josh founded Jericho Capital in 2009 with the Management Boards of the
Scott DeBenedett $36 million in assets under management Amber private equity funds. Before
MBA 2016 (Continued on page 16) (Continued on page 25)
Michael Herman
MBA 2016 Alder Hill Rolf
Management Heitmeyer ’06
Visit us at: Eric Yip is a Man- Rolf Heitmeyer ’06
www.grahamanddodd.com aging Partner, Co Rolf Heitmeyer is the Co-Portfolio
www.csima.org -Portfolio Manag- Manager of
er, and Chief In- Breithorn Capital
vestment Officer Management, a
Eric Yip & at Alder Hill Man- value-oriented
Mark Unferth agement. Prior to Rolf investment firm
founding Alder Heitmeyer with $190 million in
Hill, Eric spent four years at Appaloosa ’06 assets under
Management as Senior Analyst from 2010- management. The
2014, where he was responsible for the firm manages a long-only fund and a
firm’s equity and credit investments in real long/short fund. Prior to Breithorn,
Page 2

We are pleased to bring you the ern Europe. Mr. Sawikin also When we inherited Graham &
24th edition of Graham & discusses several interesting Doddsville as editors last year,
Doddsville. This student-led in- ideas, including Gazpromneft we wanted to continue the
vestment publication of Colum- and Bank of Georgia. tradition of providing our read-
bia Business School is co- ership with high quality inter-
sponsored by the Heilbrunn Eric Yip and Mark Unferth views and investment ideas.
Center for Graham & Dodd of Alder Hill Management dis- We also strived to provide
Investing and the Columbia Stu- cuss their approach to investing diversity of thought and experi-
dent Investment Management across the capital structure and ences via our interviews. We
Association (CSIMA). the benefits of bringing a credit hope we have lived up to those
perspective to the world of objectives.
In this issue, we were fortunate equity investing. Eric also
to speak with seven investors shares lessons from his time We are honored and privileged
Louisa Serene Schneider from five firms who provide a with two legendary investors, to have continued the Graham
’06, the Heilbrunn Center range of different perspectives Carl Icahn and David Tepper. & Doddsville legacy, and we
Director. Louisa skillfully and investment approaches. look forward to reading the
leads the Center, cultivating Matthew McLennan and We are always proud to high- next generation of issues,
strong relationships with Kimball Brooker of First Eagle light CBS alumni, and this issue helmed by three outstanding
some of the world’s most Investment Management discuss includes Rolf Heitmeyer ’06 individuals in Brendan Dawson
experienced value inves- their value approach to invest- of Breithorn Capital Manage- ’16, Scott DeBenedett ’16, and
tors, and creating numer- ing, shaped by their own respec- ment. Rolf discusses his deep Anthony Philipp ’16. We want
ous learning opportunities tive professional histories, as value investing approach, and to thank Brendan, Scott, and
for students interested in well as their fund’s resident several ideas, including AXL, newly-elected 2015-2016
value investing. The classes value investing legend, Jean- BBBY, and Hermes (RMS.FP). CSIMA Co-President Michael
sponsored by the Heil- Marie Eveillard. Herman ’16 for their commit-
brunn Center are among This issue also contains pic- ment and dedication to Graham
the most heavily demanded Josh Resnick of Jericho Capital tures from the 18th annual & Doddsville over the last year.
and highly rated classes at shares his perspectives on TMT CSIMA Conference, featuring
Columbia Business School. investing, and discusses several Dan Loeb and Michael Mau- We are incredibly grateful to
ideas, including Amazon boussin as keynote speakers. the investors we have met and
(AMZN), MercadoLibre (MELI), Additionally, we feature pic- who graciously shared their
and Telecom Italia (TI). tures from the Amici Capital wisdom and insights with us. As
Prize Competition. always, we invite you to con-
Harvey Sawikin of Firebird tact us with any feedback, and
Management discusses his transi- Lastly, this issue includes the we thank you for reading.
tion from M&A lawyer to finalist pitches from the annual
emerging/frontier markets inves- Pershing Square Challenge - G&Dsville Editors
tor focused on Russia and East- which took place on April 22nd.
Heilbrunn Center. The Cen-
ter sponsors the Value In-
vesting Program, a rigorous
tioners.
Keynote Speaker, Third Point’s Dan Louisa Serene Schneider ’06 with CBS
Loeb, at the 2015 CSIMA Conference student Jamie Lee ’16 at the 2015 CSIMA
Conference
2015 CSIMA Conference at Columbia Business School
Keynote Speaker Dan Loeb interviewed by Munib Islam, CSIMA Conference Coordinators (L-R): James Leo ’15,
both of Third Point Calvin Chan ’15, Lou Cherrone ’15, and Mike Appleby ’15
Keynote Speaker Michael Mauboussin Shorting in Today’s Markets Panelists (L-R): Jeremy
Mindich, Whitney Tilson, Anthony Bozza, and moderator
Bruce Greenwald
Full audience listening to Finding Value in Uncertain Best Ideas Panelists (L-R): Lauren C. Templeton, David
Times Panelists Tano Santos, Anna Nikolayevsky ’98, Rick Samra ’93, Alex Duran, and moderator Rishi Renjen
Gerson, and moderator Jason Zweig
Page 4
2015 Amici Capital Prize for Excellence in Investing (February 13, 2015)
Paul Orlin of Amici Capital with the four finalists Amici Capital Prize attendees
Winner Luke Tashie ’15 presents his analysis of Schibsted Judges discuss the four ideas
ASA (SCH:NO), profiled in the Winter issue of G&D
Judges and attendees listen intently to the finalists’ idea

presentations
Page 5
First Eagle Investment Management

to Goldman Sachs Asset thinking: one of total caught my interest

Management GSAM. In trepidation from my intellectually. He defined an
2003 he founded Global grandparents who lived investment as something in
Equity Partners. Matt through the depression and which, once you had done
received his Bachelor of one of optimism about the your research, you could have
Commerce with first-class markets and the US, more a level of comfort based on the
honors from the University broadly, from family who grew level of risk you are taking.
of Queensland. up post-war. What was even more
interesting to me was that his
Kimball joined First Eagle It wasn't until college that I work, with concepts like
Investment Management became more interested in margin of safety, incorporated
as a senior research investing. A friend of mine gave a sense that mistakes could be
Matthew analyst in 2009 covering me a copy of The Intelligent made, and that you could face
McLennan banks, commercial Investor, which was really my obstacles. For me, that was a
services, financial services first systematic exposure to very realistic way of thinking.
and holding companies. He investing.
joined the Global Value After college, I worked in an
portfolio management investment bank and learned
team in 2010. Kimball quickly that investment banking
began his career in 1992 as wasn't for me. After a few
a financial analyst at “When you look back years, I landed at J.P. Morgan
Lazard Frères & Co. From and worked for a fund set up
there, he joined J.P.
on your journey, there to invest in distressed
Morgan as an associate in is often a combination situations, particularly in
the Corsair private equity financial services. I was there
funds. He was named Chief of internal motivations for about 15 years, only leaving
Investment Officer of the for two years to attend
Corsair Funds and and external mentors business school, and then I
Kimball Brooker managing director in 2005. joined First Eagle Investment
Kimball received his BA who help inform your Management in 2009.
from Yale University and
his MBA from Harvard
mental models over Matthew McLennan (MM):
University. time.” I was born in Rabaul, Papua
New Guinea. After moving to
Graham & Doddsville Australia at age six, I spent
(G&D): Tell us about your most of my childhood in the
respective backgrounds and state of Queensland in
how you became interested in Some key ideas really Australia. I’d say my interest in
investing. Were there any resonated with me. For one, investing stemmed from a
major influences or mentors Graham, in some ways, bridged desire to provide a sustainable
along the way? the gap between these two platform for wealth creation. I
competing ways of thinking grew up in a house that was
Kimball Brooker (KB): I about investing. He lived full of love, but without
grew up in Chicago and had a through the roaring '20s with a electricity. We had a
number of family members lot of enthusiasm, speculation, wonderful home surrounded
who worked in the securities and leverage. He also lived by the woods, but it wasn't
industry, spanning a few through what came afterward, connected to the grid. I guess
generations. So I was around so he had the benefit of those were formative years:
financial markets and knew personal experience, with both you start to think about what
about them, but gained more the boom and the bust you can do to evolve your
in-depth knowledge later in my experiences in his rear-view circumstances over time.
career. I'd say that the mirror.
generational differences were I had the benefit, early on as a
important in shaping my views. Graham’s distinction between high school student, of being
I grew up with two strains of investing and speculation really interested in markets, of seeing
Page 6

all the “right” mistakes made. I styles of equity investing, value of patience and gold’s
had one teacher who wanted because we also used external role in a portfolio and Bruce
to create an investment club managers. The experience was distilling a mental model for
that would predict the Dow formative. competitive analysis and
futures using Elliott Wave explaining how to synthesize
Theory. You can imagine how I joined Goldman Sachs in valuation-thinking across
well that ended. It was also a 1994, and in my 14 years businesses that do or don’t
time, in the 1980s, when there, was fortunate enough to create value.
corporate raiders were doing have many mentors. A few
M&A, and consolidations were truly shaped my thinking during While at Goldman Sachs, I
all the rage in Australia. Most that period. Paul Farrell, who hired a few talented analysts
of those stories ended very managed the small cap funds, who had graduated from
badly; stretched businesses had worked previously with Columbia University’s Value
overpaying and overleveraging. Lou Simpson at GEICO. He Investing program where
introduced me, broadly, to the Bruce's book, Value Investing:
In college, a group of friends readings of Warren Buffett and From Graham to Buffett and
and I created an investment Charlie Munger. Also, Mitch Beyond, was required reading.
club. I received a small amount Cantor, who ran the large cap His valuation thinking really
of stock in a small regional funds, had previously been at resonated.
bank from my grandfather, Alliance Bernstein, and
who always had an interest in introduced me to Ben I have also been mentored by
investing. While I watched Graham’s theories of paying John Arnhold who astutely
people trying to get rich low prices and looking for repositioned the First Eagle
quickly losing money quickly, businesses with low multiples business over time with his
this small regional bank of normalized earnings power. father, Henry Arnhold, who co
compounded in value at a nice -managed our first fund in
clip. It taught me the Later on in my career at 1967 with George Soros. Both
importance of a well- Goldman, I was fortunate John and Henry have taught
positioned business, prudently enough to be a co-founder of me the benefit of being a
managed and purchased at the the high net worth investment fiduciary outside the world of
right price. strategy group. I worked with investing.
Sharmin Mossavar-Rahmani,
I was fortunate to have who was the head of fixed When you look back on your
mentors in college such as income business at the time. journey, there is often a
Don Hamson, a professor at She taught me a lot about fixed combination of internal
the University of Queensland, income investing and episodic motivations and external
who taught me early on about investing in high yield during mentors who help inform your
anomalies, such as the value liquidity crises. By that point in mental models over time.
effect, and a lot of theory time, I was managing a global
around capital structure, which equity portfolio and in that I joined First Eagle in
I found very interesting. I took role we also had to make value September 2008, a week
my first job with Don at the judgments about equities and before the financial crisis.
Queensland Investment other economically sensitive Sometimes great things emerge
Corporation, where I assets, such as commodities, out of crisis. We're in a
ultimately ended up being high yield bonds and business where temperament
responsible for the company’s currencies. is a key asset - being patient,
global equity portfolio. The maintaining a long-term
Queensland Investment Here at First Eagle Investment perspective, staying mentally
Corporation was a state Management, we are able to flexible. Working together at
pension fund, a CalPERS-like make all of those decisions on First Eagle through the financial
entity that had quasi-privatized. a single platform. Since I joined crisis reinforced the
Working there provided me a the team, Jean-Marie Eveillard importance of maintaining
great opportunity to look at and Bruce Greenwald have prudent underwriting
asset allocation as a whole and been very valuable mentors - standards for Kimball and I. As
taught me about the different Jean-Marie teaching me the difficult as the environment
Page 7

was to navigate, it created points in the track record not to force capital to work
investment opportunities and were acts of omission: we that makes the difference. I
also generated solidarity for were not in Japan during the think the crisis really
the team around its late '80s, even though Japan underscored those lessons.
underwriting standards. It was was the largest component of
a blessing in disguise. the MSCI World Index; we KB: I would also add that,
Christopher Crawford ’16,
were out of tech in the late coming out of the crisis,
Tyler Boone ’16, and Bran- G&D: Could you discuss '90s, even though it was the generally a number of the
don Cohen ’16 field ques- other ways your philosophy largest component of the businesses we owned not only
tions from the judges at might have changed over time? markets; avoided financials in survived, but really improved.
the Pershing Square Chal- Did the financial crisis in '08 the last cycle; had a limited They were relatively well-
lenge in their presentation and '09 cause you to think presence in the BRICs over financed, with no contingencies
of Fiat (FCIA). about things differently today the past few years. in capital structure, well-
than you would have positioned within respective
otherwise? industries, and well-managed.
“If you look at the Many of these companies were
MM: The past decade able to take advantage of the
underscored principles that we history of First Eagle dislocations during that period
individually believed in already. at the expense of their weaker
As a value investor, you want as a whole, some of competitors. When selecting
to buy assets cheaply. You the key turning points securities, it’s important that
have to view equity as a investors underwrite
residual claim on a business, so in the track record defensively to help protect
capital structure is very capital. But during difficult
important. Identifying and were acts of omission periods, those same defensive
normalizing earnings power as characteristics often allow
a reflection of the underlying […] It's the ability not businesses to take advantage of
assets and market position are those circumstances.
very important. to force capital to
work that makes the MM: One of the great lessons
Through the financial crisis, of the crisis was learning the
investors’ learned about the difference. I think the difference between volatility,
nature of equity as a residual which most people perceive as
claim as there were opaque crisis really risk, and a permanent
portions in the balance sheet impairment of capital, which is
assets of many financial firms underscored those what we believe is risk. Many
that were large relative to the of the great businesses Kimball
thin equity sliver. Many of lessons.” referenced were actually down
these businesses had tangible 30% – 50% during the crisis.
equity that was only 2-3% of The thematic growth trends - These businesses experienced
assets, so if you bought a all of those were great at the negative volatility, but no
business at book value, no time - often attract a lot of permanent impairment of
matter what you paid for the capital, flowing indiscriminately capital. As a result, generally
equity, you still paid 97 cents to indices and index funds and the businesses were able to
for the assets. If the opaque worse still among competing gain a stronger market
portion of the assets was more firms. For us, the rubber meets position, to buy back stock at
than the tangible equity, you the road one security at a very low prices, and to emerge
didn't have a margin of safety. time. If you look at the with more earnings power per
underwriting decisions that share. Even though the
It brings one back to basic Jean-Marie made, or those that businesses’ stock prices went
principles of investing: the true Kimball and I and the team down during that period of
value added is often in acts of have made, the acts of time, intrinsic values accreted.
omission. I think if you look at omission occurred when we On the other hand, there were
the history of First Eagle as a couldn't find good businesses many stocks that looked
whole, some of the key turning at good prices. It's the ability cheap, such as the financials,
Page 8

but because the businesses had in terms of how we think down calls on which country
so much leverage, the equity about business model duration. or which sector, as Kimball
was wiped out by the crisis. said, but we seek scarcity in a
Not only was there volatility, The big change, to a certain business model, a market
but there was also permanent extent, has been exogenous. If position, or in tangible assets
impairment of capital. we look at debt in the world - that are hard to replicate.
household, corporate,
G&D: When Graham & sovereign debt relative to We look at the market as if it
Doddsville interviewed Jean- nominal GDP around the is a block of marble and we
Marie Eveillard in 2007, he world - it's higher today than it chip away at the pieces we
commented on his evolution as was in 2007. The financial don't want. If the business
a value investor, from a architecture of the world is doesn't embody the right
Graham and Dodd approach less healthy than it was a characteristics, if the capital
to a Buffett investment style. decade or two ago. That structure has excessive
Has there been another implies that we've had to contingency, if management
evolution in the philosophy at become more aware of the behavior is imprudent, or if the
First Eagle with you managing role of currencies and price is wrong, these are all
the portfolio? sovereign risk. Jean-Marie casts reasons not to own it.
a wary eye to what can go
MM: I think both Kimball and I wrong from a top-down At First Eagle we chip away at
stand behind by the adage, “if it standpoint. We cast that same the 90% of the universe we
ain't broke, don't fix it.” wary eye given how the don't want. The residual we
However, there have been world's financial architecture feel, incorporates a margin of
minor areas of evolution. For has evolved. safety that gets represented in
example, we've been very the portfolio. No individual
focused on making sure we G&D: Talk about your idea investment is perfect. In the
have the best trading generation process: how much context of Graham and Dodd,
execution. Markets have of it is informed by a top-down Kimball alluded to how
changed, too, in terms of how view versus specific bottoms- important it is to create a
trading occurs. I think that's up analysis? process that's error-tolerant.
given us a bit more flexibility. By seeking what we believe to
We're not high trading KB: We keep an eye open to be a multi-dimensional margin
frequency: the average holding macroeconomic events and of safety, we hope to
period for the Global Value conditions around the world, implement that process over
Team is about six or seven but it doesn't really drive our time.
years. Still, we build big decision to buy anything.
positions gradually, and work We're not thematic investors; KB: When you hear people
our way out gradually. Having we’re much more focused on talk about risk management or
a talented and experienced security-specific decisions. I portfolio management, it's
trader like Doug DiPasquale will say, however, there have often at a 50,000-foot view.
heading First Eagle’s trading been circumstances where we What often seems lost in the
desk has been invaluable. have been uncomfortable with defense of capital are really the
an entire industry as a result of individual companies in the
The evolution from Graham to macro concerns, in which case portfolio and the managements
Buffett continues. Many we move on. As a result, the running those companies. You
companies we own embody macro view might inform a know that some challenges will
business model scarcity, have a decision to not do something. emerge and management will
degree of pricing power, and have to confront them. By
by virtue of their market MM: To add to Kimball’s investing in businesses that are
position are resilient. In crisis, point, I believe a core problem well-positioned, with an
these businesses can be in the world is monetary element of scarcity and what
opportunistic. In good times, superabundance. It has we believe to be a margin of
they can distribute cash flow reinforced the need to seek safety, we improve our
to shareholders. We have scarcity in businesses in which chances of handling the
sharpened the saw, if you will, we invest. We don't make top- inevitable challenges.
Page 9

G&D: Are there any particular G&D: Would you give an National Oilwell Varco has the
practices that have helped you example of a security that you potential to improve its
key in on distressed areas? currently own where you feel position both in its core
How do you think about that? it’s undervalued and you've wellbore and rig systems
reallocated capital to that? segments as well as the after-
KB: At various periods of market segments of its
time, there will be an industry, MM: National Oilwell Varco business. For example, it may
country, or region that has hit (NYSE: NOV), a business held be able to buy good companies
an air pocket. You can often in the First Eagle Global Fund to supplement these segments
find businesses that have been and Strategy, has a very strong at low multiples of cash flow in
sold somewhat indiscriminately market position. It provides a distressed situation. It could
without regard to valuation. high technology components, also continue to buy back its
Sometimes those periods can rig subsystems, and after- stock at depressed levels.
last for years. Take Japan for market equipment to the
example, which until recently, drilling rig market around the We can’t predict the bottom
had been neglected or ignored world. It is highly-regarded for of the energy market or the
by investors because of more complex fracking or ultra bottom of National Oilwell
concerns about the economy, -deep water extraction Varco’s order book. However,
demographics, and corporate solutions. because of its strong position
governance. in segments of the energy
capital expenditures that are
MM: At First Eagle, we tend to “Benjamin Graham growing and unconventional,
take an incrementalist we are comfortable with the
approach to capital allocation. made it clear that company’s long-term
We have roughly 150 prospects and its potential to
intelligent investing is
securities in our portfolios. be an even stronger force over
The world of concentrated all about arithmetic. the next decade. NOV trades
investing often has negative at a single-digit earnings
behavioral side effects. People We spend a lot of time multiple based on trailing peak
tend to have commitment bias earnings and around 5x trailing
to their ideas. When an idea is thinking about how to peak EBITDA. If you think this
either in or out of a portfolio is a business that in five to
the logic structure is binary, it reconcile the multiple seven years could have higher
can force people to be peak earnings and higher peak
we're paying with the
desensitized to disconfirming EBITDA, and you look at
evidence when they've made underlying arithmetic where the private market
an investment. multiples have been for energy
of the investment M&A, this is an example of
Charlie Munger often claims time arbitrage where we may
that the best opportunities are return.” experience further downside
those already under your nose. volatility in the short term, but
We often source opportunities where we feel comfortable
from what we already own. With the price of oil moving possibly owning a security for
From a bottom-up perspective, from over $100 to under $50, the next five to ten years and
we can pinpoint which we believe NOV’s prospects where we've added a little bit
securities are out of favor and for the next 12 to 18 months on weakness here.
allocate capital at the margin to will suffer pretty dramatically.
those securities. We also trim Despite challenging short-term G&D: How do you think
capital off the securities that fundamentals, the company has about intrinsic value? What
are closer to, or in excess of, a leading market position and methodologies do you look at
what we believe to be intrinsic about $12 billion of backlog and at what discount to
value. So we employ a natural and net cash on the balance intrinsic value do opportunities
“opportunity-recycling” sheet. We believe it is well- begin to interest you?
process. positioned to emerge stronger
from this crisis. KB: First we try to determine
Page 10

the sustainable level of the market bottom, but value of the business, we'll
earnings for a given business. because we saw businesses discuss it in the context of
There are many businesses available at the right prices. trimming. In many cases,
that, for various reasons, are intrinsic value is not a static
either under- or over-earning G&D: To what extent do you number. It can grow. When we
their sustainable levels. To attribute your cash position to feel a stock is at or above
Bill Ackman with incoming ascertain intrinsic value, we a lack of current opportunities, intrinsic value, we’ll trim the
CSIMA Co-Presidents Mi- assess what we believe versus optionality on future position. If the stock price
chael Herman ’16 and normalized earnings will be and opportunities? rises far north of intrinsic
Damian Creber ’16 at the the sustainability of those value, we may have to exit the
Pershing Square Challenge earnings. MM: We can’t predict what entire position.
following their 3rd place the future will bear. At First
finish. From there, it's really a Eagle, we view cash as a G&D: Are there any common
triangulation. We review past residual of a disciplined themes in past investments
transactions, like the National underwriting approach and as that have been very successful?
Oilwell Varco example, that deferred purchasing power. What about those that have
involved well-informed buyers Typically, it arises because not worked according to plan?
acquiring businesses. We also we're selling stocks that are
look at what multiples produce close to what we believe to be MM: We're very process-
sensible returns relative to the intrinsic value or that have oriented at First Eagle. We
nature of the business. gone through intrinsic value. In believe in systematically
more expensive markets, it's analyzing our mistakes, as well
MM: Benjamin Graham made more difficult to identify new as our successes. In fact, we
it clear that intelligent investing ideas that meet return hurdles, have an annual offsite where
is all about arithmetic. We thus the cash builds. we do a post-mortem to
spend a lot of time thinking review what's worked best
about how to reconcile the We don't feel the need to over the last five years and
multiple we're paying with the force cash to work just where we have seen
underlying arithmetic of the because it is a zero-cent yield permanent impairment of
investment return. There's a today, because the return to capital. Then we perform the
willingness to pay higher cash has two components: it “should have, could have,
multiples for franchise has the current yield, and it has would have” analysis. So given
businesses. By going in at 10x – the option of redeployment in what we knew at the time, we
12x EBIT, you could get a 6% distress. We feel, given the discuss the filters we could
normalized free cash flow yield state of the financial have applied differently to
that can potentially grow 4-5% architecture, there will be reach better outcomes.
sustainably over time, and thus more windows of opportunity
you may achieve the prospect over the coming years to buy Certain threads of continuity
of a double digit return. If it's a businesses that offer potential emerge from that analysis. On
businesses that is more return hurdles in windows the positive side, we've found
Graham in nature, with no where the markets are less top-performing companies that
intrinsic value growth, we may complacent. were not necessarily in hot
be inclined to go in at 6x – 7x growth categories, but rather
EBIT, where we get our G&D: Can you talk about they have business models that
potential return through a low your sell discipline? persisted over time, and the
double digit normalized companies have held strong,
earnings yield. KB: There are two main stable market positions.
reasons to sell. First, if your
Having those simple mental investment thesis is inaccurate One pattern we’ve seen is the
models and looking for the or you own something that involvement of a founder or a
arithmetic to work also gives wasn't what you thought it family that is also generational
us the fortitude to deploy cash was. Second, the sell decision in their capital allocation
in crisis. We had our lowest can be linked to intrinsic value. perspective. That combination
cash levels in early 2009, not Once a stock price converges of a persistent cash flow-
because we correctly timed with what we believe to be the generating business, and
Page 11

stewards that share a long- While the starting valuation If it's a great business, there's
term horizon, has tended to may have been good, the an argument to be made, not
produce some of our best long terminal valuation was less necessarily for paying 100
-term investment ideas. attractive. In the former is a cents on the dollar, but for
business with earnings power paying 80 to 85 cents on that
On the other hand, if we look grinding higher, while dollar. As Charlie Munger
at the less-attractive tail of the enterprise value is shrinking, would say, it’s a fair price for a
portfolio, there haven't been producing an increase in the great business. Your time
many mistakes where we went real value. horizon's long enough that
in at elevated prices. Instead, you're capturing less spread
it's typically been a more asset- day one, but if the business has
intensive business, where a drift to intrinsic value of 4-
there's a legacy issue to some 5% a year, held for a decade,
of those assets which imputes you may potentially reclaim
declining profitability, and the “...we believe the that and then some. The more
company needs to reinvest to patient you are, the more
sustain its earning power. margin of safety is you're potentially rewarded for
Unfortunately, asset-intensive holding good businesses.
businesses often lack pricing embedded in the
power. What sometimes I think there have been a
occurs is a need to reinvest
quality of the business. number of great businesses we
during a time of weak pricing You have to weigh invested in that, with the
power, and this results in passage of time and benefit of
balance sheet deterioration that against discipline hindsight, should have had a
and reduced earnings power. more substantial position size
on valuation.” and where we could have seen
Also, asset-intensive businesses adequately rewarded even with
tend to have longer tail assets. slightly higher entry multiples.
With those come management
teams that promote their KB: There is a school of
desire to reinvest and grow thought, which I believe
the business. As a result, Charlie Munger has expressed,
there’s less return of capital. that the margin of safety is
G&D: What about errors of embedded in the quality of the
If you think about those two omission? Have you noticed business. You have to weigh
classes of business, with the any patterns in businesses that against discipline on
cash-flow business, the passage you've consistently avoided valuation.
of time shrinks the enterprise that, in retrospect, would have
value, because it’s generating been great investments? MM: I think there's a subtle
cash and can pay down debt or addendum to that discussion.
buy back stock. The asset- MM: At First Eagle, we've Traditional Graham investing
intensive business has poorer likely been too frugal when it has, arguably, a lower return
positioning and legacy assets. comes to great businesses. For on time invested. If the
As a result, the passage of time example, we've typically business is not growing in
actually increases the business’ looked to buy 70 cent dollars. I intrinsic value, once it gets to
enterprise value, because it think the mental model of what we feel is intrinsic value,
may need to replace the legacy paying 70 cents for a business the investment needs to be
assets, and may not have the makes great sense; if the replaced in the portfolio.
pricing power to generate the normal equity is priced for 7% There's an element of
earnings, so it needs to returns, and you’re going for maintenance capital
borrow. 70 cents on the dollar, you're expenditures in terms of
starting with a 10% ROI. research, which tends to be
A bad case has a combination Closing that valuation gap over higher for those kinds of
of diminished earnings power five to ten years may generate businesses than ones that you
and greater enterprise value. a low-teens return. can own for a decade or
Page 12

longer while intrinsic value Buffett is an investment hero with the annual extraction.
improves. of ours. And he has criticized We've seen the impact on oil
gold because he believes it is markets this year.
Obviously, if you own a great useless. But it's precisely gold’s
business, and it gets too chemical inertness that makes Gold is unique in terms of its
expensive in valuation, you it useful as a potential hedge. demand-side resilience and its
should replace it. If it's starting supply-side predictability. We
to price that future growth, Consider useful commodities can know with virtual certainty
you've mortgaged that value- such as oil or copper, which what the supply of gold will be
creation drift. Unfortunately, tend to have a sensitivity to in 5, 10, or 15 years. What
there is no maintenance capex- the market and broader other commodity can we say
free investment strategy at all. economic activity that's close that about?
The return on time invested is to one-for-one. Those are not
also an important actually hedge assets, but We look for scarcity in
consideration. market- and economically- securities, and gold is one of
sensitive assets. In order for the scarcest elements on the
G&D: First Eagle is known for something to have limited periodic table, with less than
using gold as a potential sensitivity to crisis, it has to be one ounce of it per capita in
hedging mechanism. Is there an close to chemically inert and the world. The stock of gold
investment case for gold or not that useful in an industrial has been roughly constant the
gold mining stocks? context. In fact, if you look at last 40 years at about 0.8 of an
the historical price of gold, it's ounce per capita globally. Gold
MM: I think that gold is still had close to no correlation is also very dense. In fact,
broadly misunderstood in the with equities, and in extreme people often joke that you
investment community. People states of the world, has been could fit trillions of dollars of
often say to us, "If you want a negatively correlated with the wealth in a swimming pool, or
hedge, why don't you buy valuation of equities. a hundred million dollars of
credit default swaps or do a wealth on a library shelf full of
put option on the S&P 500 Because of gold’s inertness, it gold bars. Low storage costs
Index?" First, all of those is resilient. The stock of above- increase gold’s attractiveness.
instruments have some degree ground gold is over 50 years of If you think of the opportunity
of counterparty risk. one year's mining supply, which cost of holding a real asset, the
means that, not only is gold higher the economic
Second, most forms of option- the most resilient real asset sensitivity, and the less the
based hedging are expensive. If from a demand sensitivity density, the higher the
you look at the cost of implied standpoint in our opinion, but opportunity cost of storage,
volatility, it's typically greater it's also the most resilient in because you've got to pay to
to buy at-the-money options terms of its supply character. If store it, and you should get a
than the risk premium for the mining supply is only 2% of the risk premium. But if
underlying assets. stock of gold and that supply something's naturally
was to increase by 30% due to economically insensitive,
Third, those instruments are some unexpected naturally resilient and naturally
time-definite. I remember technological development, it dense, the opportunity cost of
buying puts on the S&P 500 would only increase the rate of storage is very low. That's
Index in 1999 that expired growth of the stock of gold why, if you go through a
worthless about a month from 2% to 2.6%. process of elimination, there's
before the market collapsed. no other element on the
For pretty much every other periodic table better suited to
We believe that the best commodity, silver being an be a monetary potential hedge
potential hedge has to be a exception, the stock of those than gold.
real asset outside the world of commodities is a fraction of a
man-made securities and year. Those commodities are Since the breakdown of the
counterparties. This is where I produced for use because Bretton Woods agreement in
believe gold is most often they’re useful. The supply of the early '70s gold traded at
misunderstood. Warren those commodities will vary trough valuations during the
Page 13

peaks of systemic confidence G&D: Would you take us because it owns half a dozen
like the late '60s or the late through other investment publicly traded large European
'90s. During periods of ideas? blue chip companies. Our view
systematic concern, such as is that it continues to trade at
the early '80s, pre-Volcker, KB: We own Bank of New a double discount, in the sense
after the second oil shock and York (NYSE: BK) in the First that if you do a sum of the
large inflation; or even a Eagle Global Fund and parts comparison with the
Graduating CSIMA Co-
President, Brian Water- couple of years ago when Strategy. It's a combination of public price, that's a discount.
house ’15, presents his long Standard & Poor’s downgraded asset management and what Additionally, a number of the
recommendation for CDK United States debt, and the we refer to as “Wall Street businesses it owns have been
Global at the 2015 Amici Euro was on the verge of plumbing” - custody, clearing, trading below intrinsic values.
Capital Prize for Excellence collapse, gold traded at its and administration of assets.
in Investing. peak valuations. It’s interesting Those two fee streams MM: With multiples and
to note that, over a 40-year account for just over 80% of margins at historic highs today,
period, both gold and equities Bank of New York’s business, the scarcity and resilience that
have roughly maintained values as opposed to most banks, we seek out are not obviously
relative to world nominal GDP which rely on credit available. Many great consumer
per capita, but in inverse cycle intermediation and interest staple companies are trading at
time. income. 25x earnings, so you have to
look for the unobvious. Take
People often criticize gold We bought Bank of New York for example, Oracle (NYSE:
because they believe it has no a few years ago because we ORCL), in First Eagle Global,
expected return. If the supply believed it was under-earning an idea originated by Manish
of gold per capita is constant in a few dimensions as a result Gupta and a position we’ve
but the money supply and of interest rates and built over the last few years.
world GDP per capita is operational expenses which It’s the leading provider of
growing, then the equilibrium had room for improvement. relational databases, with a
price of gold has a positive Bank of New York waived fees very dominant, stable market
drift because the assets you're on its money market funds share position. It's also a leader
hedging, and the income you've because interest rates were in the applications that attach
built to purchase that hedge, too low. And, due to the to that database: enterprise
are growing in value. Gold has timing of the Mellon merger, resource management
had a return which is which happened just before applications, middleware that
expressed in capital gains over the financial crisis, the helps those applications
the long term, as opposed to company never really had a communicate with the
yields. The irony is that it is chance to attack its expense database, and some of the
sovereign debt today that has base until now. In addition, the underlying hardware.
no return. company was re-segmenting its
customers in an effort to With Oracle, people were
Gold is an important part of enhance profitability. When we worried about the threat from
First Eagle portfolios and an bought the company - and we the cloud. Yet the company
important part of our still think there's a discount to has such scale economies in
philosophy of humility. If we intrinsic value - it was earning R&D that it was able to play
knew with certainty that the returns on tangible capital that “fast-follower”. It doesn’t need
system was resilient, we were attractive. We believed to invent every new
wouldn't need a potential the balance sheet was clean technology because its
hedge. But to the extent that and liquid. platform is already entrenched
70% of our portfolios are in the corporate world and can
invested in enterprise that's One long-time position in First be built out over time.
sensitive to the state of the Eagle Global is Groupe
world, and to the extent that Bruxelles Lambert (GBLB.BB), In a world where consumer
we see generationally high a holding company owned by staples are expensive, we've
levels of debt and complicated two families that have a strong sought out corporate staples.
geo-politics, we value that investment history. It's a A relational database is an
potential hedge. simple company to understand (Continued on page 14)
Page 14

extremely difficult thing to “Why should there be a continues to buy back stock,
change and thus falls into the discount?” We don't see a which is what it's been doing,
latter category. Mark Hurd, reason. Normally, you could at a discount to what we think
the Oracle CEO, gave the apply a discount to a company it’s worth, which is what
analogy that changing a like that if the assets it owns Groupe Bruxelles Lambert has
database is like performing a weren't that good, if there been doing, that's value-added.
heart transplant on a marathon were tax-leakage, or if the
runner while he's running a management were bad. We MM: Going back to the 70
marathon. This is a mission- think none of that applies to cent dollars discussion, if you
critical application that the Groupe Bruxelles Lambert. It’s can buy in through the holding
whole business IT architecture in an advantageous position, company at a 30% – 40%
is built around. similar to Berkshire Hathaway, higher earnings yield because
where it can take advantage of of the discount, the internal
If you look at the historical investment opportunities that economics just compound at a
profit stream of Oracle, it's others won’t. more attractive rate.
more like a Colgate Palmolive
than a volatile semi-conductor G&D: Do you have any advice
or software company. It's very “Ultimately, as an for aspiring investors or other
stable because the vast students at Columbia Business
majority of EBIT comes from investor, you will make School who would like to sit in
installed maintenance, not your seat one day?
from new license revenues. mistakes despite best
With multi-year maintenance MM: Read voraciously. Learn
contracts, 90% plus retention efforts. It’s a very more broadly about behavior,
rates, and built-in inflation philosophy of thinking,
escalators, Oracle is a cash
humbling business. biographies, and history. Get a
flow machine. The people I’ve seen sense of the possible. Look at
the repeating cycles in human
It's also chaired by founder succeed in this history. There's an abundance
Larry Ellison, so its of material out there, so you
management has a long-term business have stuck to can build your own invisible
focus. Since management gets board of directors, if you will.
paid in equity-related it and have been That’s incredibly important.
incentives, their incentives are
aligned to ours, as
obsessive about The second piece of advice I'd
shareholders. This is a learnings from their give is to persist. Ultimately, as
company that's buying back an investor, you will make
stock, has traded at a mid- to mistakes.” mistakes despite best efforts.
high-single-digit free cash flow It's a very humbling business.
yield over the last few years, The people I've seen succeed
and has underlying EBIT from in this business have stuck to it
the maintenance stream that MM: On that point, I would and have been obsessive about
can compound out at a 6% or add that Groupe Bruxelles learning from their mistakes.
7% clip. The arithmetic works Lambert has a model of soft This improves the value of
for us. control. It has board their human capital over time.
representation, and has
G&D: You mentioned a exhibited discipline by making G&D: Anything else you might
double discount with respect sure that its companies are recommend reading?
to GBLB. Is the thesis that distributing cash flows and
there's a perception gap that healthy dividends. MM: I’d recommend
should close over time? How biographies on John Law and
much do you care about KB: We don’t need a catalyst, Richard Cantillon by the
catalysts if so? because it's almost always built Professor Antoin Murphy. I
in the price. From our suggest those books because
KB: There's a related question: perspective, if the company (Continued on page 15)
Page 15

this was the point in time, We recognize that the future's
historically, where we had the uncertain, that's why we stick
evolution of paper money in to a margin of safety approach,
Europe. One sees some of the why we're willing to own some
benefits of paper money, in gold as a potential hedge, and
that it frees up capital for why we're willing to own cash
investment and productive and not force the cash to work
enterprise, but one also sees if the arithmetic doesn't make
the risk of paper money, in the sense. All of that stems from
intrinsic agency risk embedded the temperament variables
in the political process, where rather than a crystal ball.
there's an excessive issuance at
the bank level, or the central G&D: This has been great.
bank level of such currency. Thank you very much for
John Law and Richard taking the time to meet with
Cantillon were fascinating us.
characters, because they both
had different mental models of
how the economy worked and
were both leading
theoreticians.
Their mental models are well

captured in these books. In
some ways, John Law was pre-
Keynesian, and Richard
Cantillon was pre-Austrian
school of economics. Richard
Cantillon wound up wealthy,
John Law destitute.
G&D: Do you have any

parting words to share?
MM: Jean-Marie Eveillard has

often spoken about the
fallibility or the limits of
knowledge. I think it's
important to focus on
controlling what you can
control, such as your own
behavior and temperament. At
First Eagle, we spend a lot of
time thinking about how to
improve our approach to
investing. If you've studied
history, you can see the
recurring mistakes in human
behavior through hubris,
dogma or haste.
At First Eagle, we also strive to

embody the inverse of those
behavioral defects into the way
in which we allocate capital.
Page 16
Josh Resnick
and has grown the fund to would be attractive for involved in the investment
$2 billion. Before founding investment banking. decisions, but Eric was the sole
Jericho Capital, Josh was a portfolio manager. We did well
key principal at TCS The following summer, I in 2001, held up in a tough
Capital during which time worked at Bear Stearns and market in 2002, and had a
he helped grow the fund joined their Investment great year in 2003. We
from $5 million to over $3 Banking Analyst Program after developed a reputation for
billion. Previously, Josh was graduation. The first project I generating independent and
a Managing Director at was staffed on was Time interesting ideas and were able
KPE Ventures, a media, Warner’s acquisition of Turner to grow the fund nicely
entertainment and Broadcasting Systems. This was thereafter.
technology venture capital happening at the same time
Josh Resnick fund, and prior to that an that Netscape was going As 2009 rolled around, I
analyst at Fox public, and we were also decided to launch my own
Entertainment Group in involved in selling a company fund. My thinking was that the
Los Angeles. Josh began his to AOL. You could just see best time to start a hedge fund
career as an analyst in the that the media and telecom is when nobody wants to start
media and entertainment and technology industries were a hedge fund. That was the
investment banking group going to be very dynamic situation in 2001 and I saw a
at Bear Stearns. Josh places over the course of my very similar landscape in 2009.
graduated summa cum lifetime.
laude with a B.A. in We started out in July of that
Economics from Emory At the end of my analyst year. We really could not raise
University. Josh serves on program, I had an opportunity any institutional money, but it
the Board of Directors of to join Fox in Los Angeles, was a fantastic time to be
the Child Mind Institute in which was one of our clients. involved in the market. There
New York City. During my time at Fox, I was were a number of very
spending every minute of my compelling investment
Graham & Doddsville free time looking at stocks. I opportunities and we had an
(G&D): Can you tell us about had a lot of fun thinking excellent year. We have been
your background and path to through industry dynamics and able to perform in years
investing? taking positions based on my following 2009 as well.
research.
Josh Resnick (JR): I grew up G&D: You focus on industries
in Jericho, New York, which is I eventually left Fox for a brief where things can change
where I came up with our fund stint to help my friend’s quickly, and that challenge is
name. My father was a dentist, brother launch a venture compounded as you often look
but he followed the stock capital fund. The subsequent at international businesses
market, and we always used to internet meltdown convinced where you are not necessarily
talk about stocks. Through me that I didn't want to invest on the ground next to the
those conversations, I became in the private markets. I management team. How did
interested in Wall Street and wanted the flexibility of exiting that approach evolve?
investing. positions if I changed my mind
on an investment. JR: Upon joining Fox in 1997, I
After my freshman year at had the privilege of working
Emory University, I spent the In 2001, I decided to join Eric for Rupert Murdoch. He
summer interning at Republic Semler shortly after he viewed everything as a global
National Bank. I was so launched TCS Management, a opportunity. Fox probably
inspired by the pace and the long/short hedge fund focused generated around 60% of
intelligence of people who on the TMT sectors. Eric and I revenue and earnings from
worked on Wall Street, I knew had a number of mutual friends international markets. This was
that was what I wanted to do. and former colleagues, and we at a time when most media
During my junior year, I really hit it off. When I joined, companies were very US-
focused all my energy on it was the two of us and our centric. Many of them continue
building a background that CFO sitting in one office. I was to be very US-centric.
Page 17
Josh Resnick
Every time he would see been VimpelCom (VIP). People years, and the multiple was too
something work in one call us crazy for owning a high. At the time, all the IP was
market, he would try to Russian telecom, but when owned by Disney, and the
capitalize on that opportunity people take a broad brush bears thought that Disney
in other parts of the world. approach to a market that has would pull the plug on Pixar if
Satellite television is one nothing to do with the they made a bad movie, wiping
obvious example. He launched company's fundamentals, that out the stock. That was the
Sky in the UK and in Latin creates opportunity. More general consensus. But Pixar
America. He also worked on than half of VIP’s operations just kept putting out amazing
satellite in the US before are outside of Russia and the movies one after another.
ultimately deciding that the US Ukraine, but the stock traded
market was a different market with near perfect correlation We spent a lot of time with
structure because of the to the Russian index last year, the management team at
presence of cable. which created an opportunity Pixar’s headquarters, and we
for us. realized these people were
Another example is the very smart and disciplined, and
National Geographic Channel. G&D: You mentioned the that they had an excellent
We recognized that the lesson of a global and process for making movies.
competitive landscape in the opportunistic approach from We made a big bet on the
US was very difficult due to the your time at Fox. Were there company. The bears just didn't
presence of Discovery any other lessons from your appreciate how important the
Communications, but in time at an operating business? DNA of that company was,
international markets, National and how that DNA was going
Geographic had an open-ended to create so much value. In the
opportunity. We had satellite media world, there are not
distribution in markets around “...when people take a that many examples of
the world and could companies creating new and
immediately put National broad brush approach valuable intellectual property
Geographic in all of these over the last 20 years, but the
homes and create a to a market that has Pixar team was among the few
tremendous amount of value. that could consistently
nothing to do with the accomplish this feat.
I adopted that way of thinking.
For example, when we started
company's I firmly believe the
our fund, we had 15% of our fundamentals, that management and culture of
capital in Australia. I know companies are
from my time at Fox that creates opportunity.” underappreciated. I’m willing
Australia is normally an to pay premium multiples to
expensive media market. own great businesses managed
When we were launching in by great management teams.
2009, a number of investors These are the investments that
were talking about Australia as JR: Definitely. I would say outperform and generate
the next housing bubble to probably the single most higher returns on capital. I’m
burst. All these funds were important variable for us when rarely drawn to the cheaper
short everything in Australia. I we're looking at companies is companies on a relative basis.
flew to Australia and met the assessing management, and an
media companies. Business was operational background When I worked at Fox, I
going great and executives certainly helps for that. One of noticed that it was very
didn’t see any weakness at all. the best investments I had in difficult to motivate tens of
We made a big bet that we my career was Pixar. We first thousands of employees. It is a
thought was asymmetric and it started buying Pixar in 2002 very challenging task, and
worked out well for us when the whole world was companies that can implement
short the stock. Everyone the processes and the
Also, one of our best talked about how they only procedures to motivate
performing stocks this year has released one movie every two people, to align their goals with
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Josh Resnick
creating value for the business, you gain conviction on struggling, we spoke to a
these are the companies that valuation, considering their handful of employees at
will reward their shareholders lack of profitability is always Amazon who said, "I love
over time. such a vigorous debate? working at Amazon, but I’m
not paying to work at a
G&D: Do you have to meet JR: We have watched AMZN company." So we realized that
with management before for a long time. Jeff Bezos has AMZN would need to change
making an investment, been very focused on the long to retain these incredible
particularly if a business is term, and has continued employees. When they
based outside the US? investing in the business at the reported 4Q results in
expense of margin February, not only did they
JR: Typically, meeting improvement. He also hasn’t exceed earnings estimates by
management is required before offered Wall Street much in 100%, but they also disclosed
we make a meaningful decision. the way of transparency. Last that they were going to be
There are some exceptions. year, with the negative releasing separate financials for
We have a position in Amazon sentiment toward internet their Amazon Web Services
(AMZN) right now. I'm very companies, AMZN declined (“AWS”) business in the next
unlikely to get access to Jeff around 25%. We think that earnings report.
Bezos; he does one investor precipitated a change in
meeting a year. In situations AMZN’s behavior. The alarm went off for us. It
where you aren’t able to meet became clear that AMZN does
management, you have to just care about the share price.
to figure out what the variables And if they actually do care
“I firmly believe the
are and what makes you think about the share price, it will
it's a great stock. management and increase significantly.
You never get to travel as culture of companies Improved transparency will

much as you want. If it was up also showcase that AMZN's
to me, I'd be out of the office are underappreciated. retail business is actually quite
300 days a year. I’d just go and profitable. A lot of investors I
visit companies all around the I’m willing to pay speak to think Amazon’s retail
world. It's not practical to do business is break-even to loss-
premium multiples to
that from a personal or making. But AMZN now sells
professional standpoint, but I own great businesses nearly 45% of units via its 3rd
try to get out and talk to party marketplace, which we
people. managed by great think is extremely high margin.
Also, our research suggests
In the previous example, management teams.” that AWS runs at negative 10-
visiting Australia was important 20% EBIT margins, which
to finalizing the thesis. If you implies much higher EBIT
don’t travel, you don't get that margins than people realize.
crystallization of the idea in One thing that people may not
your head. Company visits also appreciate with AMZN is that Basically, we see the market
give insight into the the highest paid employee moving to value in AMZN in
personalities of the employees there draws $165k in cash three components: First, core
and other underappreciated salary; most compensation is retail business in the US;
elements that can help you. stock-based. Employees at second, AWS; and third, the
When you're looking at it from Amazon are told to expect international ecommerce
your computer in New York, that the stock will return 15% business.
you see it in a different way per year on average and to use
than when you are meeting the that estimate to determine With AWS, we think it could
company in their offices. total compensation. be spun off as a separate public
entity. As the leader in the
G&D: Staying on the topic of As we approached the end of cloud, it could fetch a revenue
your AMZN position, how do last year with the stock multiple given the growth rate
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Josh Resnick
and the potential future margin in our valuation. There is be great for CBS. We're not
structure. With US essentially no video revenue. involved. If the stock really got
ecommerce, we have an idea Some of the value of the video hammered, we would be very
of long term margin potential business does get captured in interested in it, but right now
and apply a multiple to that. the retail business because the valuation seems well-
On International ecommerce, video helps drive Prime balanced relative to the risks.
Professor Greenwald pro- we estimate that it may lose subscriptions to some degree.
vides introductions at the roughly $1 billion in China. We G&D: In the past, you have
Amici Capital Prize for Ex- have heard through our G&D: Speaking of content, do talked about how we will
cellence in Value Investing. relationships that AMZN is you have a view on CBS? eventually see differentiation
changing how it views the between the real strategic
China opportunity. We are JR: The multiple gap has assets and the more marginal
amazed that there is still not a narrowed considerably content in the US media
single example of a US internet compared to peer media landscape. What do you think
company building a successful companies over the last few are the great strategic assets
business on its own in China. years. It's been a phenomenal for US media?
We don’t think Amazon is performing stock and I think
going to be the first. Based on that really speaks to the JR: That's a good question. I
our conversations, we think strength of the management don't really know that we have
AMZN is likely to fold its team led by Leslie Moonves. a great play in US media right
China operations into JD.com With CBS, we think the whole now. I think the greatest
in exchange for an equity business revolves around the strategic asset in US media is
stake, which should television ecosystem staying Instagram, which we own
meaningfully improve the intact, and I have some through Facebook (FB). The
margin profile of the concerns. If you simply look at valuation of Instagram could be
international business. last year’s expectations and really incredible if FB had not
today’s reality for the US TV purchased them. When they
G&D: Would you like AMZN ad market, you would start to advertise on Instagram,
to do that in India as well with definitely see some it's going to be a massively
Flipkart? underperformance. Digital valuable company.
media seems to be capturing
JR: No, I think it's possible to some of the TV ad spend. G&D: Speaking of these
build a business in India. It’s There was a 200 basis point technology companies, some
challenging, but it's not like movement from television into valuations are off the charts.
China. India is more of a free digital media. I don't see any How do you think about
market for international counteracting forces that valuing these technology
competition and there is would stop that trend. When companies?
Western-based rule of law. I you look at the consumption
don’t know if they will be patterns of the demographics JR: It depends. To me, FB is
successful in India, but it’s a that really matter for not an expensive stock. Next
much higher probability of advertisers, they're all watching year, we have FB earning
success than in China where YouTube and Netflix. They're above $3 and the stock today
we think their probabilities are consuming video in very is at $79. They have assets like
less than 5%. different ways compared to Instagram and WhatsApp, both
the average 54-year-old CBS of which have not been
G&D: And the video business? viewer. monetized in a significant way,
so they're not captured in the
JR: Our approach essentially CBS still provides a multiple. They have yet to
gives negative value for the tremendous amount of value press the accelerator on video
video business, which we think to the ecosystem. If you ads, which could be a huge,
is quite conservative. We compare share of affiliate fee multiple-billion dollar
estimate they are losing revenue to share of ratings, opportunity for them.
between $1.5-$2 billion from you see CBS is valuable to
content spending this year, and distributors. That gap will FB is in a similar situation to
we don’t add these costs back continue to narrow, which will what I referenced earlier: we
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Josh Resnick
are looking for situations around RMB 4 billion. the idea for the company.
where people are painting with
a broad brush. There clearly G&D: How do you generate He saw how successful eBay
are some stocks, especially in your ideas? was in the US and he basically
the private market, which are said, "I can create that business
trading at aggressive valuations. JR: We are always looking for in Latin America," and so they
We think FB is a massive share interesting companies, and raised venture capital money.
taker in the media world, and when we find them, we track It was probably a $20 million
we think that is going to them over time. Sometimes valuation when we passed on it
continue for a while. our knowledge and perspective in my prior job. I watched that
allows us to spot great company over time dominate
G&D: There has been some opportunities. ecommerce in Latin America
discussion that WhatsApp is despite a very complex
making a strategic error by not ecommerce landscape.
trying to build a more robust
mobile ecosystem and mobile The fixed broadband network
platform, and they are ceding penetration is low and the
the opportunity to Snapchat “If you don’t travel, quality is terrible, wireless
and others. Do you have a smart phone penetration is
view? you don't get that very low, there are entrenched
retailers that have the ability to
JR: Maybe. I think they're both crystallization of the spend tons of money, and
in very different situations. consumers are oriented
WhatsApp, as a subsidiary of idea in your head. toward making purchases via
FB, has the luxury of not Company visits also installment plans.
feeling monetization pressure.
The user growth of WhatsApp give insight into the These guys have just
is astonishing, so I don't know persevered, and they have built
how you can criticize that. FB personalities of the a phenomenal business. From
seems to be focused on what I can tell, they're the only
building engagement first and employees and other company in Latin America that
focusing on monetization after. actually makes money in
underappreciated ecommerce.
Some of these companies have elements that can
built such loyal user bases that The question has always been,
ads can easily be incorporated. help you.” when do you initiate a position
Another example is Tencent given valuation is usually
(700.HK), one of our largest challenging? Last summer, we
positions in the fund. We ended up getting a great
believe Tencent is a very opportunity to enter. Around
exciting and interesting stock, 23% of its revenue came from
and on our numbers for next Venezuela and the exchange
year, we believe Tencent will One example is our biggest rate in the black market was
be trading in the teens. That’s winner last year, MercadoLibre diverging significantly from the
with accelerating revenue (MELI). It has historically been official rate. According to the
growth, and much of that known as the eBay of Latin accounting principles, it had to
revenue will be coming from America. I actually met their record the revenues and the
advertising, which is a higher- team while I was in the VC profits based on the stated
margin revenue stream industry. The founder of MELI, market rate, not the black
compared to mobile gaming. Marcos Galperin, went to Penn market rate.
We estimate the monetization undergrad, worked as an
potential on Tencent's investment banker in the TMT As a result, the Street
platform for next year could group at JPMorgan, and later developed a short case of how
be RMB 7 billion, while Wall attended Stanford Business MELI's earnings are going to
Street currently expects School where he came up with take a massive hit when they
Page 21
Josh Resnick
have to move to the new move down to Sao Paulo or G&D: Do they face any first-
translation rate for the Rio. To that we say: good luck. party competition, from more
Venezuelan bolivar. Secondly, They're not relocating their of an Amazon-type model?
another one of its large families down there and if
markets is Argentina, where they're doing it, you have to JR: Yes, the largest first party
there is also a gap between the pay them some godly amount competitor is B2W, which is a
stated market rate and black of money per year. division of a very large retailer
market rate for pesos. in Brazil. They have had some
We built the position while impact, but MELI has done a
The stock’s short interest every Wall Street analyst good job innovating to stay
built, and the stock price discussed how expensive it ahead. MELI has built its own
performance was fairly weak. was. The stock went from as shipping network,
The share price got to the mid low as $82 to $130 today, MercadoEnvios, so you aren’t
$80’s. Then the company trampling the bears in the receiving product from sellers
ripped off the Band-Aid. It process. We have reduced our just shipping everything on
went from translating the position somewhat as the their own.
bolivar at 8 to 1, to 50 to 1. share price continued to
These currency translation increase. Also, in some cases, we are
adjustments had a massive very comfortable owning a
optical impact on earnings. The G&D: From what we position without a
stock went down, and that was understand, your EPS differentiated view on near
when we started buying. expectations for MELI were 7% term EPS expectations. Our
above consensus on a forward differentiated view might
G&D: How did you think basis. We wouldn’t simply come from a willingness
about valuation for MELI? characterize that as a massively to apply a different multiple.
variant view. Do you attribute This was certainly the case in
JR: We weren’t valuing the your edge to the ability to our positions in Moody’s and
company on trailing earnings. think about the long-term McGraw-Hill a few years ago.
To me, the enterprise value is opportunity and your
$4 billion. How does that willingness to look out farther It was very well known by the
compare to the opportunity? than some other analysts? market that the Department of
There is a huge addressable Justice and Congress had been
market for this company over JR: Yes, that’s part of it. It's evaluating the credit rating
many years. They have a also our understanding of the agencies and assessing a
population of 520 million strategic value of the company. potential fine for them as a
people to address in regions We think MELI is slightly result of their ratings on
where ecommerce penetration misperceived as a structural CDOs issued during that 2004
today is under 2%. And I think loser because of its association to 2007 time period. Eric
that they are the winners. I as the eBay of Latin America. Holder openly discussed what
have visited them multiple We actually think it is more bad actors they had been
times in Buenos Aires. The similar to Alibaba’s business during this time period.
management team is best in model considering it’s a fixed McGraw Hill was fined $5
class, and they have done a price marketplace without any billion, and both stocks were
fantastic job of building a great auction format. And MELI was down about 45% in the next
durable culture. Employee launching a business similar to week.
turnover is very low and T-Mall. They were onboarding
everyone seems smart and big brands to sell on their Some very prominent hedge
social. Most of the team is US- platform. That aspect of their fund managers were on CNBC
educated. business had grown discussing how the credit
dramatically over the first six rating agencies were going to
There are real barriers to months of last year and we have their equity values wiped
entry from international were excited about that. I out and the companies would
players. If eBay wants to build thought the association would be put into receivership. A
a business in LATAM, it will change upon Alibaba’s IPO. number of investors were
have to get its employees to using words we like to hear:
Page 22
Josh Resnick
“open-ended legal risk”, appropriate amount of time period of time, as we
“wiped out”, “unknowable”. and attention on the private mentioned earlier. In other
We looked at the business and market investments. Also, rare cases, we get conviction
thought they would earn $4 a having the appropriate fund from doing more research and
share, which implied very low structure right is very analysis than other investors.
valuations at the time. That can important. There are funds That can definitely be a source
work for us. that have private investment of conviction and comfort on
arms entirely separate from the short side. That might have
G&D: You just talked about the public team. I think that is been the case in our largest
selling. What caused you to the right approach. overall winner in 2012 with
trim MELI? Groupon (GRPN). We made
One challenge for public funds 450 basis points of fund
JR: The stock has had a pretty is the illiquidity of the attribution on the GRPN short
big move which reduces the investments. In 2008, we saw and our success was helped by
asymmetry of risk/reward. the challenges illiquid side- the amount of work we had
Venezuela also likely needs pockets can pose for investors done on the company before it
another round of currency in the public markets. That’s listed publicly.
revaluation, so we have to another consideration.
assess what exactly is priced in. Our research helped us clearly
And then this past quarter, see that the story management
they had a blow-out on the top was spinning to Wall Street
line, but they lost ten points of “A number of investors was wildly different from
margin on the bottom line due were using words we reality. Upon going public,
to investments in marketing GRPN gave 12-month forward
and logistics. That took our like to hear: “open- guidance of $1 billion in
earnings expectations down EBITDA. 70% of that was
for the year, reducing our ended legal risk”, coming from international
differentiation versus markets, and based on our
consensus. “wiped out”, research, we thought the
international operations were
In general, we like investment “unknowable”. We in real trouble. Our estimate
opportunities where earnings looked at the business for the whole company using
are going to increase or generous assumptions was for
outperform consensus [of Moody’s] and $350 million in EBITDA. It
expectations by 25% or 30%, ended up being $300 million.
and we can assume a constant thought they would We're always trying to find
or lower multiple. We don’t situations where we know
like relying on multiple earn $4 a share, which things that the market does
expansion as much, but it can not. That is the greatest
work for us. implied very low challenge in this business.
valuations at the time.
G&D: Given your TMT focus, G&D: To what would you
have you been active at all in That can work for us.” attribute your success in being
the late stage, pre-IPO market? able to do that?
JR: We haven’t invested in JR: I think that the biggest

those types of companies. G&D: It appears a number of driver for me is humility. By
From my experience in your best ideas were that, I mean that I constantly
venture investing, you spend contrarian to some degree. question my thinking on a
an incredible amount of time How do you go about building stock. I am not wed to any
on one single investment conviction in your ideas? particular view. I am not going
opportunity. As a manager of a to be arrogant and say that I'm
public market portfolio of JR: In many cases, it’s the right and the market is wrong
equities, it would be very cumulative experience with without constantly reassessing
challenging to spend the those companies over a long what the market is concerned
Page 23
Josh Resnick
about. BBRY presented, but we just consolidation. In Austria,
felt like it was going to be this Ireland, and Germany, the
Of course, sometimes we are period of time where investors market has already shrunk
very wrong. We were short are going to focus on the story from four players to three.
BlackBerry (BBRY) in 2013. and Chen’s background. A recent development was the
John Chen had joined as CEO, CEO of Orange mentioning in
and if you look at his G&D: Are there any the Wall Street Journal that he
background, you can tell this is additional favorite ideas that was open to acquiring Telecom
not a guy you want to short. you would be willing to Italia. That raises the possibility
He was on the board of Wells discuss? of cross border consolidation.
Fargo, Disney, and Cal Tech. That's really exciting for
He had executed multiple JR: One of our favorite stocks Telecom Italia, especially since
successful turnarounds. is Telecom Italia (TI). It is tied everything we have learned
However, it was pretty clear to two different themes we about the company suggests
that there was a ton of have been working on, which is the Italian government is not
imagination in between the the consolidation of the wed to having Telecom Italia as
current state of affairs and European and Brazilian an independent operator.
what they talked about as their telecom industries.
goals. We had conviction that Interestingly, because of Telecom Italia company could
they would miss the quarter Telecom Italia’s 67% generate M&A interest from
and the long term expectations ownership of the Brazilian Deutsche Telekom, Orange, or
for the stock would be reset. subsidiary TIM Participações, Telefónica. This is a hugely
we actually think Telecom strategic asset yet it trades at a
Part of that thesis came to Italia is one of the better ways big discount to where other
fruition, after they reported to play Brazilian consolidation. operators in Europe trade.
earnings in December. The One of the reasons it trades at
stock opened down 10%, but Historically, Europe telecoms a discount has been the
then amazingly finished the day have been viewed as a public leverage, and concerns around
up 22%. good. These companies have its ability to access the capital
continually been required to markets. Last month, the
I thought about it all weekend. buy spectrum from the company borrowed at 3.3% so
We were right, but we lost a government and pay higher I don't think that is a legitimate
lot of money. When I looked taxes on certain revenue concern.
at the calendar, I realized items. The response from the
BBRY was going to be able to operators has been to avoid There is also the potential for
present at CES and meet a ton investment in their networks. mobile consolidation in Italy.
of investors. John Chen would But now we are at a point The #3 and #4 operators
definitely impress everyone where you need to go to a (Hutchinson and WIND) are in
and convince them the café to access a Wi-Fi discussions. Mobile ARPUs
turnaround strategy was network, and the speeds will have fallen by so much that in
winnable. We know from past be really slow. The network order to return to the average
turnarounds that managers quality dramatically lags the ARPU of the other European
typically get a 6 or 12-month networks in other regions. markets, ARPU would have to
honeymoon period. Investors increase 40% from here. All of
will just ignore the numbers German Chancellor Angela which would be high margin
and give the CEO credit for Merkel gave a speech last revenue.
whatever turnaround plan he summer where she noted that
plans to implement. I got in on there are 1.3 billion people in In the fixed line business, Italy
Monday, covered the whole China with three telecom is one of the only markets in
short and we actually went operators, 300 million people Europe that doesn't have cable.
long. It was one of our largest in the United States with four Additionally, a government
winners last year. We always telecom operators, and 350 initiative to spur economic
thought it would be very million in Europe with 28 growth is providing financial
challenging to deliver the telecom operators. Slowly but assistance for fiber deployment
results over the long term that surely, we will see market (Continued on page 24)
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Josh Resnick
around the country which team, you'll constantly be
Telecom Italia will own. So you positively surprised by the
can imagine them owning the smart things that they do.
whole enterprise market and When you back the bad
most of the residential market management teams, you're
in Italy. constantly negatively surprised
by the stupid things that they
Finally, we think its 67% stake do.
in TIM Participações in Brazil
will be very valuable upon G&D: Many of our readers
consolidation. We think are students interested in
consolidation is inevitable, but becoming professional
it has been delayed by Oi’s investors. Can you share any
financial situation. When Brazil advice on how to enter the
goes from four players to field, and to remain successful
three, it will be a bonanza over the long term?
because it's a 200 million
person country with low smart JR: The best way to enter the
phone penetration, low data field is to meet with as many
related revenue, and a people as possible and hone in
population of people who love on specific ideas that you have,
to talk and access the internet. along with supporting
materials. You really want to
Telecom Italia’s stock today is demonstrate that you are
€1.08. We think it's worth at extremely committed to a
least €1.50, and with certain career in investment
consolidation scenarios, it management and have been
could be worth €1.80 or risking your personal capital
more. for years. In my opinion, the
most successful investors are
G&D: One of the most the individuals who really love
aggressive consolidators in what they do. You need to be
Europe has been Patrick Drahi. thinking constantly about
He seems to fit a number of where you might be wrong
the characteristics of what with your thesis and how you
you'd like to see in managers. can verify that you aren’t
Have you spent time on missing anything. The market is
Numericable or Altice? very smart and you have to
respect it and continually
JR: I think that's the biggest reconfirm what you know
regret I have with our about a situation that the
European investments over the market doesn’t appreciate.
last year. We should have
owned Altice or Numericable. G&D: Thank you for your
In our meetings with their time, Josh.
team, we were very impressed.
Sometimes you’ve just got to
go with your gut about these
people. Their recent deal to
buyback Vivendi’s Numericable
stake for 19% below the
current market price is
incredible. It’s a great
illustration that if you back a
great CEO and management
Page 25
Harvey Sawikin
founding Firebird, he was a tell if the US stock market was money into the voucher
clerk on the U.S. Court of a good buy or not if the auction program in Russia.
Appeals and earnings yield was double the
an M&A specialist at the bond yield. At that time, it Our first voucher investment
law firm of Wachtell, wasn’t even close. But still, if was into an oil and gas
Lipton. Harvey is a you were American, you company called Surgutneftegas
graduate of Columbia should have 25% of your net (“Surgut”) in January 1994. We
University (magna cum worth in US stocks even if the knew very little about it. The
laude) and Harvard Law market valuation was not only available information was
School (laude), where he particularly attractive. So, I put on one sheet of paper. Surgut
was an editor of the 25% of my money in stocks, had the same amount of oil
Harvard Law Review. He is and said, “I’ll wait until the reserves as Mobil. At the time,
Harvey Sawikin a member of the New earnings yield is double the we calculated that its implied
York State Bar. Harvey bond yield,” which actually market capitalization in the
serves on the board of PR took 16 years because it didn’t voucher auction would be
Foods (Estonia) and is a actually reach that relationship about $40 million, versus $40
Trustee of Churchill until 2008-2009. billion for Mobil. We said,
School and a member of “Look. It doesn’t have to be as
the Visiting Committee of I was at the library at good as Mobil. It only has to
the Department of Columbia and I ran into a guy be a little less bad than Mobil,
Photographs of the named Dan Cloud, who’s now and we could make 2x or 3x
Metropolitan Museum of Geoffrey Batt’s partner at our money.” In fact, at the
Art. Euphrates Advisors, a hedge peak, Surgut actually had a
fund focused on investing in market cap above $40 billion.
Graham & Doddsville Iraq. Dan had just come back
(G&D): Can you tell us a bit from Asia where he had been People often ask me, “Weren’t
about your background and working for a brokerage. He you scared when you invested
how you became interested in said, “If you want to talk about in Russia? You took a big risk.”
investing? value, you need to look at At that moment, I was pretty
emerging markets. That’s sure we were going to make a
Harvey Sawikin (HS): I was where real deep value is fortune. How could it be any
an M&A lawyer at the firm found.” He convinced me to more obvious than when
Wachtell Lipton for five years. start a little friends-and-family you’re buying something for
I always had an interest in partnership called Morningside one cent on the dollar? When
investing. When I left Capital in October 1993, in we visited Russia in January
Wachtell, one of the partners which we invested in emerging 1994 I saw with my own eyes
gave me a copy of The markets. that it was a real country. It
Intelligent Investor and said, wasn’t nice, it didn’t smell
"This is what you should read In December 1993, Yeltsin good and there was no food,
if you want to be a serious disbanded the parliament and but it was a real country. In
investor." I read it and I began a mass voucher the course of my investing
thought, "This seems pretty privatization program in Russia. career, I’ve had three or four
easy. I could do this." Dan, Ian Hague (our third of these big revelations where
partner), and I thought this I just was absolutely
I started doing research on would be a major investible overwhelmed by something.
stocks. In those days (1992), I opportunity. We looked at the Russia was the first one I ever
had to go up to Columbia program, and realized that they had. So that’s how I got
Business School; there was no were going to be privatizing started.
Internet back then, so I sifted this vast economy of
through these big Value Line resources. Based on the low There were four of us who got
books for stock ideas. I started valuation the Russian people together and launched
buying value stocks according were attributing to the Firebird. We were all from
to Benjamin Graham’s vouchers, companies could be different backgrounds. I was a
principles. One of his main selling for one cent on the lawyer. Ian was a political
principles was that you could dollar. So we put all of our scientist. Dan Cloud had
Page 26
Harvey Sawikin
emerging markets experience. out yet – it’s still struggling, but been through political change
The fourth partner who joined, that’s typical with the frontier that has made things more
Brom Keifetz, had just finished markets. stable. For example, Russia had
an MBA. come out of a period of chaos,
I have never invested in a and Yeltsin finally established
The fact that none of us had frontier market that didn’t more personal control and
much mainstream professional have those growing pains in installed a prime minister who
investing experience was a the first few years. It’s always could make things happen.
benefit at that time, because the same: they start out We’ve seen this many times, in
we didn’t have any amazing and everybody gets Georgia in 2004, and Mongolia.
preconceptions; if you very excited. Then, something Second is macroeconomic
required good financials to goes wrong and you go into stabilization. If you have a
invest in a name, you would the wilderness. The first time government that is determined
never have touched the stocks we went to the wilderness in to stabilize the economy, it’s
we looked at. In fact, you Russia was in late 1994 until often after a period of high
probably wouldn’t have about the third quarter of inflation or when they’ve lost a
touched it for ten years, 1996, before it started to work war and everything is in chaos.
because it really didn’t start again. Someone comes in and
looking like that until about manages to get control of the
2004-2005, but by then, a lot “People often ask me, economy, and bring the
of the money had been made. inflation rate down. Third, we
Because we were very green, ‘Weren’t you scared look for a functioning capital
but we had some big ideas, it market that should have a few
was a benefit to us. when you invested in investible stocks. It doesn’t
have to have a lot. You can
G&D: What were your other Russia? You took a big make a lot of money on just
major revelations? one stock, which is what we
risk.’ At that moment, did in Georgia where we made
HS: We started investing in I was pretty sure we 10x our money on Bank of
Kazakhstan in 1997 because it Georgia.
was a repeat of Russia, in a were going to make a
way. G&D: If you talk to a number
fortune. How could it of emerging market managers,
We started a private equity they call Russia un-investible.
fund for the Baltic States in be any more obvious They worry that the rule of
2002. I was very excited about law is murky, that there is
that. With U.S. stocks in 2009,
than when you’re corruption. That said, you’ve
I was not as excited as I had buying something for clearly managed quite well
been about Russia in 1994, but there. What would you say to
I felt that, finally, Benjamin one cent on the those investors who consider
Graham’s requirements were it an un-investible country?
met – I had been waiting for it dollar?”
for 16 years. It was then that I HS: People have been saying
finally added a decent that for the last 20 years. I
weighting in U.S. equities. G&D: You’ve obviously think it’s always required
expanded since investing in careful management, but the
There have been other times Russia. What statistics or data opportunities in Russia were,
when I thought I had it, and it points do you look for to help and are, huge. I think it’s
hasn’t worked out. We have a you determine what country actually gone through periods
fund dedicated to Mongolia run to invest in next? where it was more investible
by my partner James Passin. than it is now. Now, it’s more
When he first showed that to HS: In the early stages, we’re was akin to the early days
me in 2010, I thought that was looking for a few things. First, where you really had to be a
another amazing opportunity. is the political environment: stock picker. I don't think the
So far, it hasn’t really broken you want a country that has ETFs are a good way to play
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Harvey Sawikin
Russia and they haven’t been means to me: I consider any very pro-Western government
since 2008. country “investible” where with a radical reform program.
there are liquid listed They called us, looking for
In general, ETFs have proven companies run by somebody to buy shares from
to be a poor way to invest in managements that are aligned the old management. The
emerging markets. Institutional with shareholders. EBRD (European Bank for
investors who want low fees Reconstruction and
and that have played emerging G&D: Could you talk about Development), which was
markets through ETFs are your investment process when involved with recapitalizing the
starting to realize that it may it comes to looking at these bank, suggested Firebird,
not be suitable, and there’s a early stage macro and political because they knew we had
reason why: ETFs are market catalysts? Can you also discuss been interested in Georgia.
cap-weighted. Market caps the transition from these early We wound up buying 20% of
tend to be the largest in state stage opportunities to the later the bank in two transactions.
owned or state-influenced stages where you can start to At that point, it didn’t have
companies, which generally look at the fundamentals and much earnings. We knew that
tend not to be managed for the reporting becomes better? the book value was overstated,
the benefit of minority and that much of the loan
shareholders. The top five book was worthless. But we
stocks in the MSCI Russia had acquired 20% of the bank
constitute 60% of the index. for less than $10 million.
You’re missing out on all these
amazing companies that have Over the next ten years, the
smaller market caps. “Generally speaking, bank cleaned itself up, cleaned
up its balance sheet, and did
So Russia is investible, but our
once companies capital raises at higher prices
required return is higher now become well-accepted with good institutions, which
than it has been at times in the diluted us down. Bank of
past because the macro risks and start to see the Georgia eventually listed on
are so high, and because there the London Stock Exchange,
is more government influence big mutual funds in which is where they are now.
on private property. It now has an $800 million
the shareholder base, market cap with a blue chip
Ukraine was different. Ukraine investor base.
was a country where you
that’s usually a time
couldn’t even find to start taking In 2003, we bought a stock in
managements that were Russia called Uralkali, which
aligned with shareholders at all. profits.” was a potash producer. It was
In Russia, there are a lot of not a profitable company. Any
companies where the the profits were being hidden,
companies are controlled by but we noticed one quarter
majority shareholders who, a when things started to change.
long time ago, determined that So, we started buying stock at
they were going to get value HS: In emerging markets five cents a share; we also did
from the company through investing, the dream is to buy a little bit of research and
share ownership, not through an early stage frontier stock concluded that there was a
theft. and hold it all the way until it potential structural supply
becomes a NYSE-listed stock deficit in potash, so we were
At a lot of these Russian that’s highly regarded. That has bullish on the resource.
companies, the corporate occurred in a number of our
governance is equivalent to an investments. For example, the The management was trying to
average company in Europe. In Bank of Georgia, which we convince us not to buy it,
Ukraine, there have been first bought in 2004. Georgia because they were buying it
almost no such companies. had just changed its themselves! This was
That’s what un-investible government. They had a new, something we called the
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Harvey Sawikin
"Scooby Doo" where they try nationalization or something. maybe you’re talking about 2%
to scare you to go away. You These things happen all of a to 3%.
know that’s what they're sudden. Also, the liquidity
doing, because usually they end disappears very quickly. I remember in 2003, Yukos
that by saying, "By the way, if Investors get in trouble when was almost 30% of the Russian
you have any shares, we’ll buy they are over-concentrated. I index. We were taking heat
them from you because we’re believe that an emerging from investors because we
nice guys… but you shouldn’t markets fund should not be were 2/3rds underweight in
buy them." over-concentrated; it’s a big Yukos and underperforming as
mistake. a result. I kept saying, "Well,
We were also right about we don’t think it’s as safe as
potash, and the stock went everybody else seems to
from five cents, which was our think." Then the arrest of
first purchase, eventually “The first thing you Khodorkovsky (then-CEO of
peaking above $12, so it was a Yukos) occurred and we
huge win.
learn as a value heavily outperformed the
investor is if your stock index in 2004.
G&D: In the example that you
just went through, with the goes down you should G&D: How do you think
Bank of Georgia shedding its about geographical
non-performing loans, be buying more. In an diversification?
improving corporate
governance, etc., what if emerging market, very HS: We have Russia funds and
something politically or Eastern European regional
often, that first leg
economically adverse happens? funds. Even our Russia funds
How do you determine the down is just the are fairly diversified. For
risk-reward profile? example, our Firebird New
beginning of a total Russia Fund is about 57%
HS: Generally speaking, once Russia. That’s on the lower
companies become well- meltdown because of end of what it’s been and that’s
accepted and start to see the because of the geopolitical
big mutual funds in the some major change situation. Even at the peak, it
shareholder base, that’s usually was no more than 90% Russia.
a time to start taking profits.
that’s happened at the The rest consisted of our best
For example, with Uralkali, we macro level.” ideas from Eastern Europe.
were reducing exposure as it
went up. Of course, the risk- Studies have shown that even a
reward starts to shift a little When you’re over 10% in a small amount of diversification
bit. Now, you start to have single stock, alarm bells should enhances expected return
things priced for growth. start ringing. If you want to be significantly. Our regional funds
over 10%, you should be aware are about 25% Russia and very
But there’s another element in that you’re taking a very diversified.
what you said, which is what aggressive view. Generally
happens if something goes speaking, our position size for On the other hand, personally,
wrong. In my 20 years of doing something that is a great value, I’m not a big fan of global
this, I’ve seen a lot of things is liquid, and has good emerging markets equity funds.
blow up that people thought management and a good macro I think fixed income and
were unassailable, such as situation, is somewhere currencies funds are different.
Yukos. There is only one between 4% and 6%. That’s But I know how hard it is to
solution to that problem, pretty much it. If any of those feel that we keep an edge in
which is diversification; elements is less, then it would just the 12 markets that we’re
because everybody thinks that be less. If it’s got all these great currently active in, much less
they are going to know to get things, great value, great having to follow what’s going
out before somebody says management, etc., but the on in Indonesia and Egypt and
something about re- liquidity isn’t so good, then everywhere else.
Page 29
Harvey Sawikin
At the same time, I think a bottom-up. The macro was That was why in 2009, most
single country fund is relatively stable in our region people failed to get back
problematic because it’s very and geopolitics was relatively invested at the bottom,
hard if the country is not doing calm, so it was easier to just because they kept thinking
well to just go to 100% cash. focus on stocks. about what they should have
What if you’re wrong? Your done in 2008. In emerging
investors would be very angry This is one of the pitfalls of markets, certainly, it’s always a
if you were wrong and the being a value investor in blend.
market continued rallying and emerging markets. The first
you missed the whole thing if thing you learn as a value G&D: In our interview with
you’re calling yourself say a investor is if your stock goes Geoffrey Batt last year, he
"Russia fund". down you should be buying talked about the delta between
more. In an emerging market, perception and reality in
Our regional funds are free to very often, that first leg down emerging markets. In that
exit a country if it’s not is just the beginning of a total context, when you think about
working. Last year, after the meltdown because of some Russia and Ukraine and some
events in the Crimea, we major change that’s happened of these other countries, what
reduced Russia in our regional at the macro level. do you see as the perception
funds by a third very quickly. versus reality there?
We felt no compunction about
doing that; we reallocated the HS: In the Ukraine, there is a
proceeds partly into Romania perception that this new
and Estonia, which we thought “...the day that I feel government is the same old
would have a better year, and thing. I think some of this is
they did. that oil bottomed was actually disinformation. In fact,
the new government in
the day in early
G&D: A lot of funds Ukraine really is trying to do
categorize themselves as being January when something new and different.
bottoms-up, fundamental
investors. Given your firm’s Goldman Sachs put In Russia right now, I don’t see
EM focus, does it necessitate a a huge gap between perception
top-down approach? Does it out this piece of and reality. People perceive
require an assessment of that Russia’s motives toward
what’s going on politically and research that said that Ukraine are not particularly
any geopolitical risk? benign. We tend to see it the
oil was going to be low same way, which is why we
HS: All of our investing is forever.” reduced Russian exposure.
hybrid top-down and bottom- There are specific trends that
up because every company people may not understand.
that we invest in has to For example, everybody thinks
operate within the context of a that because oil prices are
dynamic macro situation. I've found that with all fund down, they’ve taken down the
Obviously, there is no way you managers, both in EM and in prices of Russian oil stocks by
could invest in Russia just the developed markets, people 30%. But Russian oil companies
running models on Sberbank are always fighting the last war. are not that much less
and Lukoil without For example, right now, profitable with oil at $60 than
understanding what was going everybody is a macro person they were at $80.
on in Ukraine, and what was thinking about the oil price and
going on in the oil industry. the Euro. All the things that The reason is that the ruble is
blew up on people last year, highly correlated to the oil
We spent a lot of time on the everyone’s focusing on that price. When the ruble goes
macro over the last year. It when maybe now is the time down, the companies’ costs do
comes and goes in waves. they should just be picking as well, since their costs are
Between 2010 and 2013, we their favorite stocks and buying largely denominated in rubles.
were really focused on the value. At the same time, the tax
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Harvey Sawikin
regime in Russia is set up in a day I feel that oil bottomed into the fourth quarter and
way that as oil goes down, the was the day in early January drove oil down in advance.
tax burden gets lower, and as when Goldman Sachs put out
oil goes up, they tax away a lot this piece of research that said G&D: How does Firebird get
of the profit. That’s something that oil was going to be low comfortable investing in
the market may not fully forever. The piece of research frontier markets given the
perceive. got a lot of attention. They limited information available
talked about it on CNBC. I and and/or the opacity of the data?
The delta between perception a few other people who think
and reality is greater in frontier a lot about oil found it to be HS: In frontier markets,
markets than it is in more full of holes. My thought about you’re never going to get the
developed emerging markets. it was that this was the kind of kind of full information that
There are a lot of investors research that Goldman puts you like. You don’t necessarily
doing a lot of research on out is when they’re ready to buy stocks on that basis.
Russia. Maybe we have some cover their shorts. You’re buying franchises, large
insights they don’t have, but assets trading at 10% of
generally speaking, investors replacement cost. You’re
understand Russia more or betting not on current
less. profitability, but on what it
could earn if it became a
Some of our smaller markets “In frontier normal country and a normal
may be different. Kazakhstan is company, and the management
a country where people who markets...you’re does the right thing. You’re
don’t specialize really have looking for a management
betting not on current
very little understanding about that’s competent and
how things work there. The profitability, but on incentivized properly. You’re
more “frontier” a country is, looking for a world-class
the greater the inefficiencies in what it could earn if it franchise or a company that is
terms of understanding the a dominant player in its
macro, and in stock-picking. became a normal market. Also, you want to find
the right sectors within a
G&D: You said that Russian country and a normal country. When we first came
oil companies are not to Russia, we chose to buy oil
company, and the
significantly less profitable at stocks. Not everybody did
$60 a barrel partly because of management does the that. In hindsight, it seems so
the tax. How low can oil prices obvious, but at that time, a lot
go such that these companies right thing.” of people were focusing on
are only just breaking even? retailers, which were terrible
retailers at the time, or
HS: I think $40 is a level that consumer goods companies
I’ve seen Russian oil companies that could never survive.
mention as a level where they
would have to re-think a lot of I think we’ve seen the lows. Each country has a different
their projects. By the way, Pricing is pretty solid at these sector that’s attractive. It’s a
here is something I noticed levels in spite of production comparative advantage
about oil. Everybody focuses still rising. Maybe that has to question. In Mongolia, it’s coal;
on the fact that oil got down do with the financial buyers of they are the Saudi Arabia of
to $35 in 2008, and on why we oil now pulling forward the coal. When we came to the
might get back to those levels. better supply/demand picture Baltic States, it was about
We did get there, when you that we'll have in the second banking and retail, because
adjust for inflation. When oil half of the year. Just as in the they were a trading entrepôt
hit $45 in January, it was like fourth quarter of last year, between Russia and the West.
we were back to those levels – investors pulled forward the If you’re requiring perfect
so we got there. I may be bad supply/demand picture financials, you’re not going to
proven totally wrong, but the get the deep discounts.
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Harvey Sawikin
G&D: Do you find yourself G&D: We’ve talked about a Among oil companies, we like
investing in certain sectors number of names so far. Can Lukoil, which trades at about a
more than others? you share any other ideas with 5% dividend yield. They have
us? transitioned into a company
HS: We invest in banks and that runs efficiently and pays
resource companies much HS: I mentioned Bank of big dividends.
more than others. If you Georgia. When I look out five
Rick Gerson of Falcon Edge believe in the economy of a years and I look at the In Russia, we also own
Capital responds to a ques- country, buying the bank is a portfolio and I try to figure out Gazpromneft. It’s a subsidiary
tion from the audience at
the 2015 CSIMA Confer-
leveraged play on the growth which stocks I have a pretty of Gazprom. I actually
ence. of that economy. That could high degree of confidence in, presented it in 2013 at two
work both ways; when things that’s one that I focus on just value investment conferences.
go wrong, it’s the banks that because Georgia is growing It’s a company that has a
take the biggest hit. You have anywhere from 3% to 5% portfolio of more mature and
to be careful and take profits. sustainably. newer assets, generates a lot
of cash flow and pays a large
Also with banks, particularly if dividend. Because they are a
they’re systemic banks, they subsidiary of Gazprom, they
are generally going to be more “Long-term, I’m bullish were allowed to acquire a lot
regulated and less prone to of young oil fields from
theft. Take Sberbank for on fertilizer, because I Gazprom. They were a
example – it’s too dominant. don’t see any major preferred buyer. And they
They hold half of Russia’s have a very good management
deposits. Of all the listed banks substitutes on the team, which is unusual for a
in Russia, here’s one that you state-owned company. The
feel is going to have to be horizon. It’s not like oil quality of management is the
under a microscope and it’s main reason that they’re
going to be pretty clean. with electric cars and allowed to be independent and
not fully absorbed into
In Kazakhstan there are some alternatives. The Gazprom, because they add so
resource companies that are population of the much value. If they had poor
huge and have unique assets. If management and were
you could find them in a world keeps growing, inefficient, they would have no
developed market, you’d be justification for staying
paying 2x the multiple, at least. so crop yields have got independent.
We’re always trying to achieve
sector diversification, which is to be high.” Uralkali is an interesting case
a challenge. study. When potash prices
came down over the least two
There aren’t a lot of listed years, this was actually an
consumer products companies. Bank of Georgia has a 40% exercise in cartel behavior.
Over the years, there have market share and the best They have to protect the
been a few, but they keep management in the country. cartel long-term by deterring a
getting taken over. Over the They not only have their bank few major projects. They did
years, we had Wimm-Bill- business, they also now have so successfully. Now, gradually,
Dann, which was a dairy that the largest healthcare business they’re raising their prices
was acquired by PepsiCo. We and one of the best real estate again. This company took a
had Baltika Beer, which was developers. It’s sort of a play double hit because of not only
acquired by Carlsberg. It’s very on the whole country now, the potash prices and Russia
difficult to find listed consumer not just the banking side. It’s problems, but they had an
companies because they are not dirt cheap. It trades at accident with one of their
often logical takeover targets about 1.4x book, but I feel like mines that knocked out 20% of
for the big international that’s something that I have their capacity. The stock is
players. confidence is going to go up down 65% from where it was
over time. two years ago. The
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Harvey Sawikin
management is probably think is a perfectly good way
among the highest quality in to get in the business.
Russia in terms of transparency
and corporate governance. The other way to get into the
This is one of the stocks that business, which is totally
was considered investible by different, is to do it the way I
the big institutions. I think it did, which is just basically
still is, although some of them figure out something that
got scared off because of the other people haven’t noticed
macro situation in Russia. I still and just go and do it. If
like Uralkali, and we’ve been somebody noticed that some
buying it back. country in Africa was
developing a great capital
Long-term, I’m bullish on market, went there, made
fertilizer, because I don’t see contacts, tested it out with
any major substitutes on the their own money, and figured
horizon. It’s not like oil with out what was good, and then
electric cars and alternatives. came to New York, they
The population of the world would find lots of doors open
keeps growing, so crop yields to them. Everybody wants to
have got to be high. hear about a new idea.
G&D: Are both of Even though the Firebird team

Gazpromneft's assets relatively all really came out of nowhere,
well positioned on the cost because we had a great idea,
curve such that they can still doors were opened to us
produce profit if the price of quickly. That’s the other way
oil declines further? to get into the business, which
is riskier, but ultimately can be
HS: Yes. In Russia, even more rewarding if you’re right.
though costs have gone up,
particularly at the older fields, G&D: This has been really
the lifting costs are still much fascinating. Thank you very
lower than a lot of other much for your time.
mature assets. Because of the
tax regime I mentioned, they
still generate a lot of free cash
flow even with oil at $60. Even
with oil at $50 they are still
profitable.
G&D: Do you have any advice

for people wanting to
specifically invest in emerging,
developing, and frontier
markets?
HS: There are two paths. One

path is to go to work at a
company like ours. We’ve
hired a lot of people out of
Columbia's Value Investing
Program. Going to be an
analyst at a buy side fund or
emerging markets brokerage I
Page 33
Alder Hill
estate, gaming/lodging/ Mark received a B.A. in terms, etc. Those documents

leisure, and was lead ana- Economics from the Uni- force you to understand your
lyst in a multi-billion dollar versity of North Carolina protections and rights as a
portfolio of commercial at Chapel Hill in 1990 and lender. I might not have recog-
mortgage backed securi- an M.B.A. in Finance from nized the skills that I was ac-
ties (CMBS). From 2006- the University of Roches- quiring at that point, but they
2009, Eric was a principal ter in 1995. turned out to be very im-
at Columbus Hill Capital portant to what we do today. I
Eric Yip & Management where he Graham & Doddsville also participated in field exams,
invested in credit and equi- (G&D): Let’s start by talking which entailed meeting clients,
Mark Unferth ty across a variety of indus- about your backgrounds and evaluating financials, and kick-
tries. From 2004-2006, Eric how you got your starts as ing the tires on collateral. As
was an Investment Analyst cross-capital structure inves- an asset-based lender, you
at Icahn Associates, where tors. have limited upside in getting
he focused on activist equi- your money back with interest
ties and distressed credit Eric Yip (EY): As far as I while your downside is a real
investments. Prior to join- know, I am the only investor diminution of capital, so under-
ing Icahn Associates, Eric to have worked for both David standing asset value is critically
worked at Franklin Mutual Tepper and Carl Icahn, two important. This experience
Series, Stanfield Capital, legends who are in the invest- also helped shape my value
and Mellon Bank. He grad- ing Hall of Fame. But by to- investing philosophy and in-
uated in 1997 with a B.S. in day’s standards, I got my start tense focus on risk and down-
Accountancy from Villano- in a very non-traditional way. side minimization.
va University.
In terms of background, I’m After a few years in Philadelph-
Mark Unferth is a Manag- always reading profiles of great ia, I wanted to move to New
ing Partner, and Co- investors where people talk York. I joined Stanfield Capital
Portfolio Manager at Alder about being born to invest, and in their CDO group. The early
Hill Management. Prior to it seems their whole life was years were spent working with
founding Alder Hill, Mark planned with that goal in mind. the senior analysts, attending
spent five years as Head of It was quite the opposite for bank meetings and high-yield
Distressed Strategies at me. I grew up in a lower mid- road shows, and learning the
CQS, where he managed dle class immigrant family, and business and applying some of
$400 million in a number that path was never obvious. I the lessons from my time at
of investment vehicles. studied business at Villanova Mellon.
From 2007-2008, Mark was and when I graduated in 1997 I
a principal (with Eric Yip) was unsure what to do next. I After about a year and a half,
at Columbus Hill Capital knew I wasn’t going to get into the fund hired a PM from the
Management, responsible the pedigreed Wall Street pro- outside to start their dis-
for making credit and equi- grams. I wasn’t interested in tressed hedge fund. He saw
ty investment recommen- working for one of the big the work ethic that I had, ap-
dations. From 1998-2002, accounting firms. So the best preciated my first in-last out
Mark served as Managing opportunity at the time was a mentality and preached the
Director/Co-head of Dis- job with Mellon Bank in Phila- importance of taking advantage
tressed Research on the delphia. of your opportunities. Once I
Distressed Bond Trading joined his team, I got a taste of
Desk at Credit Suisse/ I worked in the asset-based what I found to be the real fun
Donaldson, Lufkin & Jen- lending group as an analyst, not stuff - distressed debt and deep
rette. Prior to DLJ, Mark doing anything glamorous, but value equities. That's when I
worked at Metropolitan learning the nuts and bolts of started connecting the dots as
West Asset Management, commercial lending. Early on in an investor.
in Loan Sales & Trading for the training program, there
Citibank, and at the Feder- was a lot of reading, particular- After that PM left, I went to
al Reserve in the Interna- ly lending agreement documen- work for Franklin Mutual Se-
tional Finance Division. tation regarding covenants, ries, which was among the first
Page 34
Alder Hill
funds to invest across the capi- where I eventually became Co- both debt and equity. We
tal structure. I wanted to join a head of Distressed Research worked closely together in
traditional value shop that was for the bond trading desk. 2007 and 2008, which was the
agnostic about where in the opportunity of a lifetime to
capital structure to invest, as In those seven years of work- invest in distressed situations,
well as to work for one of the ing on the sell-side, I had an and our teamwork in that vola-
most respected distressed opportunity to interface with a tile time is the bedrock for
groups on the Street (led by lot of very large distressed Alder Hill now. I left Columbus
Mike Embler and Shawn Tu- investors. In observing the Hill in 2009 to become the
multy, both of whom are still different styles and approaches head of the Distressed and
good friends and mentors). those investors took, I started Special Situations group at
to assimilate what I thought CQS, a London-based $15
We had several billion dollars were the best ways to ap- billion hedge fund, where I
of capital to allocate to dis- proach distressed and value built a five-year track record
tressed at the time and were investing. At the same time, I investing across US and Euro-
very active in some of the larg- was putting it into practice by pean markets. I left CQS to
est opportunities, particularly investing capital for the desk, reunite with Eric and form
companies like Adelphia, NTL, which at the time was run by Alder Hill.
and WorldCom. I focused pri- Bennett Goodman, Tripp
marily on utilities and IPPs, Smith and Doug Ostrover who G&D: Eric, tell us about the
where what mattered were later went on to start GSO transition to working for Carl
replacement values and the Capital Partners. Icahn and David Tepper.
power markets themselves.
Names like Calpine, NRG, and I moved over to the buy side EY: While I was still at Mutual
Dynegy ended up working out in 2002 when I joined Metro- Series, I built a working rela-
well for us. politan West Asset Manage- tionship with some of the team
ment (now TCW) and it was at Icahn. After a while, the
Mark Unferth (MU): After there that I had my first chance appeal of working for Carl
finishing school in 1990, I went to manage capital during a dis- Icahn was hard to resist. He is
to work at the Federal Reserve tressed cycle as a PM. I ended an iconic figure and I couldn't
Board in Washington, D.C. for up working on quite a number say no to the opportunity.
three years as an economist of bankruptcies during that I always found activist investing
building large econometric timeframe. The most salient to be very interesting and I still
models. I thought I’d end up experiences for me were Fi- believe in the value it can cre-
getting my PhD in Economics nova, Worldcom and Conseco ate in the right situation. Eve-
but ultimately decided that where I sat on official or ad ryone knows Carl as an activ-
wasn’t for me and moved to hoc creditors’ committees. I ist, but what people don’t of-
Wall Street. loved that. It was an oppor- ten appreciate is how success-
tunity to provide insight into ful he has been at making mon-
When I joined Citibank in investments that are off- ey in the area of distressed
1995, I started in a group that market. Distressed invest- debt. He can take very large
was structuring loans. My first ments don't have the same stakes in companies in the
introduction to the bankruptcy characteristics that you find in hopes of restructuring them
code and process was from a large-cap equity that is well- and controlling them when
structuring DIP facilities. I did followed by the Street. A lot of they exit bankruptcy. It's all
that for about a year and then these things are very situation- about understanding the pro-
moved over to the trading al. There is quite a bit of game cess. For Carl, activism in dis-
desk. Loans were an infre- theory that's involved and it’s tressed debt and equity activ-
quently traded asset back in very analytical. ism are not that different.
the mid-1990s, but this was the When you look at investors
early stages of when distressed Eric and I met at Columbus today, there are very few peo-
loan trading was about to be- Hill Capital in 2006, where we ple who can succeed in both of
come a big thing. I worked as a were principals responsible for those areas.
desk analyst for three years generating investment ideas
before moving over to DLJ across the capital structure, I primarily worked on activist
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Alder Hill
equity investments in both the on what he has done since, understand what they were
US and internationally due to people might even consider buying. As an investor, you
fewer distressed companies at him a macro guy. But he want- have to ask some important
that point in the cycle. That’s ed to start investing in struc- questions. What are the cash
the benefit of shops with a tured products, mainly CMBS, flows? What's the replacement
broad mandate and capabilities; even though he wasn’t really value? Does it generate enough
it allows you to search a wider known for having expertise in cash to pay fixed charges?
area for the very best opportu- that area. That’s why it is hard While most people were run-
nities. to define him. ning away, we were digging
into a new situation that was
Luke Tashie ’15 receives After a few years there, I had ultimately not too different
the 1st place prize from an opportunity to join Colum- from corporate securities.
Paul Orlin at the 2015 Ami- bus Hill, which is where I met “As an investor, you
ci Capital Competition. Mark. The fund was founded At Appaloosa, I also worked
have to ask some
by Kevin Eng and Howard Ka- on the fund’s gaming/lodging/
minsky, who, prior to starting important questions. leisure sector coverage as well
it, had been managing domestic as everything real estate-
and international credit invest- What are the cash related on the corporate side.
ments at Duquesne for Stan That includes both debt and
Druckenmiller and had also flows? What's the equity investments. At Appa-
worked with David Tepper at loosa, you are taught to be
Appaloosa. What I did at Co- replacement value? both a value investor and an
lumbus Hill is very similar to opportunist, which requires
Does it generate
what we do here at Alder Hill, moving around to where the
which is investing across the enough cash to pay opportunities are.
capital structure, looking for
event catalysts, and searching fixed charges? While G&D: Talk about some of the
out ideas anywhere in the key lessons from working with
world. I was with the fund most people were those two investors and how
from 2006-2009, which encap- they’ve shaped your philoso-
sulated some of the best times running away, we were phy or process over time.
in the market and also some of
digging into a new
the worst. In the aftermath of EY: From Carl, the first lesson
the housing market collapse, I situation that was was thinking about investments
worked on some high profile with an ownership mentality.
real estate bankruptcies and ultimately not too And this wasn’t simply a theo-
near-bankruptcies. retical exercise, because in the
different from right situation he really could
G&D: And Appaloosa came buy the entire business, so I
after Columbus Hill? corporate securities.” had to apply that same rigor
consistently in my analysis.
EY: That’s right, and after join- CMBS is really just a portfolio Secondly, Carl is also great at
ing, David I had two main du- of first lien debt. If I had you understanding his rights as a
ties. The first one was helping look at CDOs, it would typi- shareholder and creditor, and
build out a multi-billion dollar cally be a portfolio of first lien knowing both the business side
CMBS portfolio. David was syndicated bank loans for cor- and the legal side of his invest-
well-known as a distressed porates. This was not different ments. A third lesson was the
debt guy, but what he did, except it's backed by real es- importance of understanding
which makes him brilliant, was tate properties. You still have management's motivations and
recognize opportunity in other to analyze it. The massive incentives. Carl has an amazing
areas and pursue it. He made growth in CMBS issuance prior capacity to understand human
big investments in equities dur- to the downturn, like many nature. Lastly, Carl built a
ing the financial crisis when he things at the time, was very great organization and I had
wasn’t thought of as part of artificial. They were purchased the pleasure to work with in-
the equity community. Based by investors who did not really credibly talented colleagues.
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Alder Hill
Vince Intrieri, who is still with first doing the hard work, so and underappreciated situa-
Icahn, and Keith Meister, who that we’re ready to defend our tions.
has gone on to start his own position and stick with that
very successful firm Corvex, conviction if the market goes We were very thoughtful
were instrumental in my devel- against us. about the team. Our current
opment. group is made up of senior
G&D: How influential were people. That dynamic is im-
As for David, I've never seen they in how you thought about portant because our strategy
anyone who is so great at so setting up Alder Hill? requires the dexterity and vari-
many disciplines, yet is also ety of talent to switch, for ex-
very generous and humble. As EY: Very few hedge fund man- ample, from evaluating foreign
a CIO, as a PM, as a trader, as agers would do this, but early sovereign debt, to levered eq-
an analyst, and as an econo- in our process of setting up uities, to REIT arbitrage, to
mist, he can hold his own with the fund, David sat down with high yield credit, to M&A situa-
anyone. I have seen him do all Mark and me on numerous tions and other special situa-
those things at Appaloosa, and occasions. He knew that we tions like equity spinoffs. We
across a broad range of invest- could invest so he wasn’t con- require people who are able to
ing styles. He's also not afraid cerned with that part. What he do all those types of things,
to take risks or invest in a situ- really emphasized was the im- and in order to do that, we
ation where everyone else is needed to hire people who
running away. In my opinion, were experienced and were
that’s where he's the absolute trained in cross-capital struc-
best. He can connect the dots ture fundamental investing.
on a theme or idea better than
anyone, and that has influenced “What [David Tepper] Mark and I have a rule that we
my way of thinking today. Eve- always want our entire invest-
rybody is focused on E&P and really emphasized was ment team to be able to fit
energy services right now, and around a conference room
the importance of
that’s fine, but now my mind table. If they can’t, then we
goes to, what about the car building the business know we’ve grown too large.
dealership chain in Canada that We want to go back to the
might have got really beat up the right way - ways of the old-school hedge
because they had significant funds, in that we're going to
exposure to the Alberta re- creating the run a little more concentrated
gion? How about that bank or portfolio, and with a large de-
hotel company with exposure infrastructure, hiring gree of collaboration and re-
in Texas? Are there opportuni- spect for our team’s opinions.
the right team, finding
ties there that might be more We sit around the table and
interesting as second or third the right investor critically review every invest-
derivative ideas from the fall- ment idea as a team. What
out in oil prices? It's that type base.” that means is you're going to
of non-traditional thinking that really know your investments,
we're still very influenced by properly create a margin of
today. safety, and develop the convic-
tion needed to succeed.
G&D: What did you learn
from him in terms of getting portance of building the busi- G&D: Have there been other
comfortable with making big ness the right way - creating influences in how you’ve
contrarian bets? the infrastructure, hiring the thought about the culture at
right team, finding the right Alder Hill?
EY: He has been able to do investor base. And these issues
that because there is exhaus- are especially important for a MU: Make no mistake, you
tive research backing up the fund that may invest in esoteric have to work really, really hard
ideas. At Alder Hill, we won’t products or require the flexi- in this business. That will be
make an investment without bility to run toward the ugly true wherever you go, but one
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Alder Hill
thing we learned at Columbus become special situations in off. So, I guess from an early
Hill was its culture of collabo- that manner, they lose coverage that is what really appealed
ration. We’ve tried to bring age. They become less fol- to me.
that to Alder Hill. lowed and it gives you a real
opportunity to invest, and MU: The other thing that real-
We wanted a close-knit group that's what really appeals to ly stands out is that we are
where everyone can collabo- me as an investor. both value investors that can
rate and where we value peo- move around the capital struc-
ple's thoughts and participa- EY: I’m opportunistic in my ture. Eric and I have been
tion. Our view is that the through several cycles, and
more eyeballs you have looking given that we were initially
at something, the more likely both credit-trained but have
you get to the right answer. “It’s not just also extensively invested in
When we have meetings, one equities, we really understand
of the things that we picked up identifying the upside/downside and where
over the years at different things can move around.
spots that we worked was to
idiosyncratic value
allow people to take a contrar- situations, because G&D: Some people view cred-
ian position. It’s okay to exit investing and equity investing
press it if you have a different anyone can run a as being quite distinct. You
view, because at the end of the don't run into that many peo-
day the most important thing is spreadsheet, but you ple that have very successful at
we get to the right answer for both. Is that false logic or why
our investors. need to understand the do you think that is the case?
G&D: How would you de-

process and catalysts EY: What we're trying to do is
scribe yourselves as investors? to realizing full value.” to find assets that we think are
trading at a deep discount to
MU: I am really a distressed intrinsic value. They could be
investor. I lean toward the credit or equity. If our man-
situations that have an element ideas, and I consider myself an date was to be a cross-capital
of active involvement, where old-school Munger geek, par- structure fund and I started
I’m rolling up my sleeves and ticularly his passions for read- telling you about our equity
getting involved in the restruc- ing, retrospective/contrarian investments in growth compa-
turing, working on ad hoc thinking and psychological self- nies that trade at 10x revenue
committees, or maybe a litiga- awareness. I also enjoy the or 50x P/E, or that we invested
tion situation in bankruptcy Buffett-ism of buying dollars in investment grade, low yield-
like Six Flags or Visteon in the for fifty cents, which increases ing paper trading at par, then
last cycle. upside while also minimizing I’d agree that would be a
downside. Since value oscillates strange mix.
I would say that's the side of across cycles, you need to
investing that I particularly have the tools to invest in both What we're investing in for
enjoy because it's a bit like equity and credit to find those credit and equities is actually
putting together a really com- fifty-cent dollars. And lastly, it’s quite similar. I will give you
plicated puzzle. There are of- not just identifying the idiosyn- one historical example: MGM
ten times these things take a cratic value situations, because Mirage is the type of company
little gestation to work them- anyone can run a spreadsheet, we would typically look at. It
selves out and for the pieces but you need to understand has high yield debt and levered
to fall in place and you deci- the process and catalysts to equity. During the 2008-2009
pher all of that, but that's the realizing full value. When I was downturn, MGM had senior
kind of work that, generally growing up, Macy’s would have bonds that were trading in the
speaking, and this is not to their big annual sale and the 30s and 40s. As the company
knock the sell side, but that's dream was to buy that elusive started to fix its balance sheet
not the kind of stuff that they thing that never went on sale, and the market was improving
do. Very often when things like a white Polo shirt, for 50% in the 2010-2011 period, the
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Alder Hill
equity became a play on the 20%, so there was some dis- ered, and get scared off. It is
continued repair of the balance connect in how the two mar- not for the faint of heart but
sheet, continued repair of the kets were looking at it. Yes, it this is our bread and butter,
fundamentals, and with upside is levered and that's part of where we get to apply our
optionality from a normaliza- why the FCF yield was so high, credit expertise into under-
tion of industry growth. On but this is the type of stuff standing the equity. The added
top of that, you had an opco/ where we start off by asking benefit in this particular invest-
propco element that you were "what is the credit market ment is that it came from an
seeing elsewhere. It's that type view?" and, in this scenario, it industry that I had been cover-
of situation that we focus on at seemed different than the equi- ing for over ten years so I
Alder Hill - one day it's the ty market. The credit metrics knew the fundamentals very
equity we'll invest in, but then well and understood there
Brian Waterhouse ’15 in the next downturn, we may were multiple other ways to
receives the 2nd place invest in the credit of the same win.
prize from Paul Orlin at
“[Equity investors will]
company and vice versa, de-
the 2015 Amici Capital
Competition. pending on the cycle. When come across something MU: The Holy Grail of invest-
you stick to value-based situa- ing is finding a situation with an
tions like that, the credit vs. like this, see that it’s asymmetric upside/downside
equity dynamic is not really an ratio. Part and parcel with that
issue. The question for us is 5x levered, and get is how you can get there, what
consistently, what is the ful- scared off. It is not for are the paths to realization. If
crum security which creates we had to add one other thing
the most value based on our the faint of heart but that we’ve taken from our
analysis? That could be debt, prior jobs that applies here, it
or equity, or debt that might this is our bread and would be the idea that when
one day be converted into you're investing, if you can find
equity. Covering that whole butter, where we get a number of different paths
range of outcomes gives us an that you can go down for value
advantage over funds with re- to apply our credit realization, all of which can get
stricted mandates. expertise into you where you need to be, the
more the better.
G&D: Can you give us anoth- understanding the
er example where your debt EY: When we started looking
expertise helped you identify equity.” at this situation, we had a
an interesting equity oppor- starting point that even if noth-
tunity or vice versus? ing else happens, you’re getting
were solid. They were gener- a 20% levered FCF yield and
EY: I'll give you an example ating free cash flow and using you’re already trading at a sig-
without giving you the compa- all of it to de-lever. We nificant valuation discount to
ny’s name. There was a gaming thought the equity was espe- the 10x EBITDA deals that
company we invested in that cially interesting because we were getting done in the mar-
was trading at 7x EV/EBITDA didn't feel like there were any ket. So if valuation remains the
and the leverage was 5x knockouts for the credit - no same and they use the FCF to
EBITDA. As we all know, that liquidity issues, no near-term keep paying down debt, the
is clearly a levered equity. It’s a maturities to worry about; stock should go up 20% one
high-yield issuer, and when we interest coverage was fine. year from now. And then you
put on our credit hats, we no- still had other sources of po-
ticed the most junior debt was This is the type of investment tential upside that we didn’t
trading at a 6.5% yield. The where we feel like we have an think we were paying for. If the
high-yield markets appeared to edge over the typical equity valuation gap closed, if the
be comfortable with the lever- investor, because those inves- company explored an opco/
age. tors may not know or even propco structure, or if a buyer
look where the debt trades. acquired them, all of which
Meanwhile, the free cash flow They’ll come across something seemed like reasonable possi-
yield on the equity was around like this, see that it’s 5x lev- bilities, then we had meaningful
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Alder Hill
upside potential. but there seems to have been years, there was around $1
a shift in the paradigm in their trillion of debt issued in the
G&D: What are the dynamics willingness to listen. The other E&P space. There are probably
you see in the market today? thing is that the large mutual $150 billion of bonds still out-
Where are you seeing the funds are feeling pressure from standing, which is around 20%
most interesting opportunities? low-cost ETFs, so they are of the high-yield space. A fair
looking to find alpha in these number of these companies
MU: There are various points types of situations. In the past, are not going to make it with-
in time where credit is cheap it was a lot harder to get a out a significant amount of
to the borrower. Out of that blue chip mutual fund to sup- capital that will come in and
comes a lot of very interesting port you. Nowadays they are either subordinate everybody
transactions, and thus event- much more willing to. In fact, I in the debt stack or dilute the
driven investment opportuni- have heard that a lot of times existing equity.
ties. That is the type of market they are actually suggesting
we see today. Managements certain names to the activists. EY: But it’s not clear to us yet
and boards feel compelled to how compelling the opportuni-
do something for shareholders We think all of this is leading ty is at today’s valuations. Yes,
and there are a number of some of these energy names
tools by way of cheap credit that now trade in the 50s or
that they accomplish that. How 60s with double-digit yields
do we capitalize on it? Part of “Just because [a traded at par and had 5% yield
it comes from Eric’s experi- to maturity a few months ago
ence working for Carl Icahn
security] has traded when oil was much higher, but
and knowing the activist play- down doesn't mean it's it doesn't necessarily mean
book so we can spot where they’re cheap. Just because it's
these transactions are likely to cheap, as there has traded down doesn't mean it's
occur and start investing in cheap, as there has been a dis-
advance. been a distinct tinct bifurcation between high
quality and low quality compa-
EY: You have two things. bifurcation between nies, and you can’t fix bad hard
With this cheap credit, it is assets. Our concern is that
very hard for a credit investor
high quality and low some of these names are going
because the risk/reward is not quality companies, and to have liquidity issues and
attractive. But of course that because the docs have cove-
means it’s a great time to be a you can’t fix bad hard nants with holes you could
borrower. The other thing we drive a truck through. So like
know is that topline growth assets.” Mark said, you're going to see
has been very elusive, and a lot of issuance of first and
companies have cleaned up second lien debt that will layer
their balance sheets and have to a golden age of event-driven the rest of the stack.
the firepower and credit mar- opportunities. For us, it is real-
ket support to put on leverage ly about focusing on these We're focused on that area,
to manufacture growth. The types of situations - companies but today our limited energy
M&A space will be very active that we think are going to ac- exposure is in companies that
given how cheap it is to finance quire, get acquired, break up, are secondarily connected to
these deals. do recaps, convert to a REIT oil prices and where the valua-
or MLP, etc. Those types of tion overhang is inconsistent
Activist investors have raised ideas are a large portion of our with oil’s impact on the funda-
tons of capital. But they also current portfolio. mental business. For example,
have two other positives going we have a position in a $10
for them. One is that corpo- G&D: How much time are billion market cap MLP which
rate management teams have you spending on the energy is the subsidiary of a high pro-
been more receptive to listen- sector? file energy company. Its reve-
ing to them. It doesn’t mean MU: Energy is another hot nues are completely contract-
they’ll agree with their ideas topic. In the last seven or eight ed, yet it trades at a 25% dis-
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Alder Hill
count to NAV, with a strong agement teams and you have stock.
current dividend yield. All of to be able to get comfortable
the headline issues which are with that. Ideally, we would Again, this is the type of situa-
worries for the parent are only love to invest behind some- tion where we would invest
sources of further upside for body like a John Malone or a because it had the classic spin-
the MLP. Many of our energy Bill Stiritz, but you won’t find off dynamics. It was barely cov-
positions today are similar in these kinds of super value gen- ered on the Street. At less
that they are in companies that erators in most of our names. than $5 billion market cap, you
have sold off for no good fun- Interestingly though, we did just have less eyeballs looking
damental reason, have great invest in a spinoff of a larger at the names. You won’t find
upside if oil recovers (and company in which a well- this type of opportunity on
good upside even if not), but respected CEO was involved. screens. We found it just from
for whatever reason aren’t We originally invested in it following all of the spinoffs that
trafficked so thoroughly by the because it was trading at what are happening and then doing
sell side and conventional we thought was a 50% dis- the work to get comfortable
hedge funds. count to intrinsic value. It was they would unlock value.
a portfolio of private equity
G&D: Can you talk about investments. When you see G&D: Are there any other
your idea generation process these big discounts, however, ideas or themes you would be
in more detail? Do you take a you have to look at the man- willing to share?
macro view, or a bottoms-up
approach? EY: One area that we're
spending a lot of time on now
MU: We're a bottoms-up is what I would call “broken
shop. We do think you need
“We're a bottoms-up IPOs.”
to be aware of the top-down shop. We do think you
risks that are going to poten- These are situations where a
tially affect fundamentals. It need to be aware of private equity sponsor still
helps inform us in how we owns a large stake, and where
manage the portfolio and think the top-down risks that the current price is something
about risk management. Most like 25% below where the IPO
of our ideas are internally gen- are going to priced within the last year.
erated. We prefer dislocations, With the sponsor overhang
disruptive change, anything that
potentially affect reducing liquidity, these com-
complicates the analysis and fundamentals. It helps panies tend to be a little small-
lessens sell-side coverage. er so again they don't get the
Think of Eric’s earlier example inform us in how we same attention.
in CMBS. Then we use our 35
years of experience to act manage the portfolio We’ve invested in a ski compa-
quickly in identifying key driv- ny that trades at a substantial
ers to valuation, the catalysts and think about risk discount to its peers and has a
to unlock that value and the hidden real estate angle to it. If
process to get there.
management.” you back out the real estate,
we think we’re buying it
G&D: There has been a lot of around 7x EBITDA when its
talk about “Outsider” CEOs agement team to say, "Are main peers trades for 10-11x.
recently since the book was they going to unlock this val- It was a busted IPO that we
published in 2012. How do you ue?" What made this one in- like for a few reasons. The
think about the importance of teresting was management was valuation discount is one. It’s
management teams in the com- announcing value-enhancing also generating a double-digit
panies you invest in? catalysts – they were spinning free cash flow yield and its
off various assets, giving cash balance sheet is fine. It’s 4x
EY: With distressed, a lot of back to shareholders – while levered with just a term loan
times you are unfortunately the stock price was declining. and 4-5% cost of debt. It gen-
dealing with very weak man- It really was an orphaned erates around $115 million of
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Alder Hill
EBITDA. by our fund or another firm.
We’re currently looking at a
I think all of the companies $1 billion market cap company
that have hidden real estate with an extremely inefficient
will eventually be forced to do capital structure. The company
something with it because of has no debt, but a comparable
the massive arbitrage. In this business was recently taken
particular company, that's op- private with leverage equiva-
tionality. Now they probably lent to the entire EV / EBITDA
won't do it because they multiple of this company. So
would have $1 billion plus of there is opportunity for 20%
NOLs so there is no tax arbi- accretive share buybacks, an
trage from doing that, but LBO at a 50% premium, or a
somewhere down the line it merger with the #1 player in
will make sense. But given their market, which could also
they’re not going to pay taxes work at a 50% premium. As
anytime soon, what are they always, we’re remaining flexi-
going to do? They're going to ble and trying to find those 50
buy stuff. cent dollars in underappreciat-
ed places.
The sponsor is smart and cer-
tainly understands financial G&D: Thanks to you both for
engineering so you would think taking the time to talk with us.
there would be optionality in
monetizing that NOL, but
we’re not assigning value to it
in our own valuation. We’re
also not giving full credit to the
land value – we have it at 50%
of its 2006-2007 book value. It
used to be $300 million of
value that we are assuming is
$150 million in our model. The
land could be used to develop
condos and time shares - there
is value there.
I don’t think it should trade at

11x, but 9x wouldn’t be unrea-
sonable. If you mark it to our
numbers, you’re looking at a
stock that could easily end up
being a double, but it's because
it's still majority-owned by a
private equity sponsor, so you
have this overhang and with a
sub-$1 billion market cap, in-
vestors just aren't going to be
focused on it. That allows a
fund like us who isn’t afraid of
companies that are a little
hairy to get involved.
We are also spending time on

potential activist targets, either
Page 42
Rolf Heitmeyer ’06

he was a Research Analyst market over a 30 year period. Short Fund.

at Donald Smith & Co., a There, I learned how to pick
deep value asset manager. deep value stocks but also G&D: Could you tell us more
He received an MBA from gained experience short selling. about the long/short fund and
Columbia Business School why it was the time to do that?
and a BA from the I’ve always wanted to build my
University of Michigan. own business, so I left Donald RH: We conceived the idea by
Smith and Co. last year to asking ourselves a simple
Graham & Doddsville become a co-portfolio question: what kind of fund
(G&D): To start off, can you manager, along with Benner would we personally want to
take us through your Ulrich, at Breithorn Capital invest in to maximize our long-
background and what led you Management. Benner is a like- term absolute returns? That
Rolf Heitmeyer ’06 to Breithorn? minded value investor who determined both the
was formerly a med-tech investment strategy and the
Rolf Heitmeyer ’06 (RH): I analyst at UBS and a Director vehicle we chose. Regarding
arrived at value investing in an our strategy, first and foremost
unusual way. Coming out of we believe that making
college, I wanted to be an “We always try to relatively concentrated
investor, but I didn’t have a investments with a statistically
great understanding of value.
determine if disciplined value approach is
My first buy-side job was at a management has a the best way to generate
publicly traded venture capital outperformance over the long-
firm. It was 2000, and this clearly articulated term. Second, we believe in
company was the poster child being significantly net long,
for the internet bubble. It capital allocation plan between 50% and 100%, to
made investments in startups take advantage of the long-
at ridiculous valuations based based on appropriate term appreciation of the stock
on clicks and eyeballs, and all market. Third, we believe in
sorts of other non-GAAP metrics like ROIC. We short selling to expand our
metrics. Predictably, that greatly prefer universe of alpha generation
imploded a year after I joined, opportunities, and to provide
which was a very formative companies that have a downside protection in market
investing experience. It really declines. Our typical exposure
forced me to think about the specific quantitative might be 110% gross long, 30%
meaning of intrinsic value and gross short, and therefore 80%
margin of safety. Watching a return hurdle as net long. However, that will
company collapse like that fluctuate based on the number
probably also sparked my opposed to qualitative and quality of ideas we find on
interest in short selling. goals that are open to both the long and short side.
We believe this structure
That’s when I started reading interpretation.” enables us to enhance absolute
value investing classics like returns if our shorts
Graham’s The Intelligent of Research at an activist significantly underperform our
Investor. Subsequently, I got to hedge fund, Oliver Press longs. That’s important to us.
explore value investing in- Partners. He and his brother,
depth through the Value Adrian Ulrich, a CBS classmate G&D: Do you have any limits
Investing Program at Columbia of mine, were exploring ways on portfolio construction since
Business School, and that was to expand the long-only you have a mutual fund
definitely the best academic business they had been running structure?
experience of my life. After at Breithorn since 2009. We
that I worked for eight years at decided a partnership made RH: Given our strategy, it is
Donald Smith and Co., a sense. Currently, we manage not a constraint. For example,
traditional Graham and Dodd- $190 million and recently with a mutual fund you can’t
style asset manager that has launched an alternative mutual go over 150% long on a gross
outperformed the stock fund called Breithorn Long/ basis, but that is not an issue
Page 43

for us because we don’t plan the difference between daily is typically between 3% and 5%.
to go over 130% under normal liquidity and quarterly liquidity Our goal is to limit positions
market conditions. isn’t that drastic. Traditional to a maximum of 10%, because
hedge funds can and do get big unexpected things always
The reason we chose a mutual redemptions at inopportune happen, and we don’t want to
fund vehicle is because we times. It just happens at the be overly concentrated. On
think it is appealing from an end of the quarter instead of the short side average position
investor’s perspective. First of during the week. To sizes are generally smaller,
all, we charge a management discourage short-term usually 1% to 3%, because of
fee of 1.5% instead of the 2% investors, we do have a the inherently asymmetric risk
and 20% charged by traditional redemption fee of 2% for profile.
hedge funds. We think investments held less than 90
traditional hedge funds have days. From an investor’s Currently, I think the deep
underperformed the stock perspective, I don’t want to be value bucket is a point of
market partially because of locked up for a long time, and I differentiation for us. In
their fee structure. Second, we think that’s why those general, I think the traditional
believe the convenience of structures are becoming Graham and Dodd approach is
mutual funds is attractive. They increasingly rare. overlooked right now. Like
have daily liquidity and daily everyone else, we like to buy
price transparency, and there G&D: Can you give us an idea exceptional businesses at a
is typically less paperwork. of how you construct the discount. The problem is that
portfolio? by definition there aren’t a lot
As we looked at the existing of exceptional businesses.
long/short mutual funds out RH: One of the biggest Also, I think there are more
there we noticed something takeaways from my experience people chasing those
interesting. We think the vast in the CBS Value Investing opportunities than ever before
majority of these funds are Program was an appreciation because you have multiple
geared towards minimizing for the different flavors of generations of Buffett disciples
volatility rather than generating value investing. Several on Wall Street - enough to fill
superior absolute returns. different styles work, but not a stadium in Omaha every
They tend to have consistently always at the same time. year. Most value investors say
low net exposures which we Realizing that, we they’re looking for high ROE
believe is a drag on absolute opportunistically allocate our businesses with wide moats.
returns in the long-term. They portfolio into three buckets. However, let’s assume there’s
also tend to be highly Our deep value bucket an average quality business that
diversified and have low gross consists of average quality we expect to earn an ROE that
exposure, which makes it hard businesses trading at very is merely equivalent to its cost
to generate alpha in our cheap valuations. Our of equity, say 10%. If we can
opinion. We saw a void in the compounder bucket consists buy that business at half of
market for relatively of high quality businesses stated book value, then we’ll
concentrated long/short funds trading at slightly higher earn 20% on our investment at
focused on generating superior multiples. Finally, our special market value of equity, which
absolute returns, and that’s situations bucket consists of is very attractive. The
why we launched our fund. catalyst-oriented investments difference is we won’t hold it
that may or may not screen forever like a compounder.
G&D: Is daily liquidity an cheaply, but are none-the-less We’ll sell it when it
impediment to long-term value cheap on a pro-forma or sum- appreciates to fair value. That
investing? of-parts basis. We’ll usually is what my experience at
have something in every Donald Smith & Co. taught me.
The most important thing is bucket, but the amount
cultivating an investor base depends on the quantity and Keep in mind that while Buffett
that understands your long- quality of opportunities that is best known for his
term perspective and is willing we’re seeing in each area. investments in compounders,
to stick with you for that time he started off as a “cigar butt”
horizon. At the end of the day, Our average long position size investor. In his most recent
Page 44

letter, Buffett says that in the learning curve. I think we have exceptional managers running
1950’s when he was investing identified an underserved part the show. Our primary goal is
in “cigar butts”, he generated of the market that we think to find managers that will do
by far the best returns of his rational investors will gravitate no harm.
life, both on a relative and towards. In general, I think the
absolute basis. He can’t invest alternative mutual fund There are many ways that
that way anymore because he structure is attractive and will managers can do harm. Our
manages too much money, but eventually transform the hedge biggest concern is usually
luckily we can, and that is fund industry. Given our capital misallocation. We
where we spend a fair amount current size we are nowhere always remind ourselves that a
of our time. near the point of limiting our DCF valuation is only valid if
We also believe strongly in opportunity set. I’m not sure the free cash flow is returned
maintaining a statistical value when that would happen, but to us or reinvested at a decent
discipline. In aggregate, we my guess is north of $1 billion. rate, which is often not the
expect our longs to trade at a case. We always try to
discount to the market and determine if management has a
our shorts to trade at a clearly articulated capital
premium on numerous allocation plan based on
valuation metrics. In our appropriate metrics like ROIC.
opinion, this provides a strong We greatly prefer companies
long-term tailwind. Take “Catalysts are a higher that have a specific quantitative
something as simple as price to return hurdle as opposed to
earnings ratios. We have priority for shorts qualitative goals that are open
observed that over the past 50 to interpretation. Then we
because time is
years through 2014, stocks in evaluate if their past actions
the lowest decile of P/E ratios generally not on our are consistent with their stated
returned roughly 16% annually principles. For example, have
versus 12% for the market as a side given that the they made bad acquisitions in
whole. Conversely, the highest the past? In general, the fewer
decile returned roughly 7%. stock market goes up acquisitions the better. By
Despite this, people are analyzing their past behavior
reluctant to invest in longer-term.” and incentive structures, we
statistically cheap stocks also try to determine whether
because they aren’t “high managers are looking to enrich
quality” enough. This is why themselves or shareholders.
the opportunity persists. Our
goal is to profit off of this G&D: Can you explain how G&D: How do you
spread through long/short your assessment of incorporate macro analysis
investing. We make decisions management teams factors into into your investment process?
based on a lot more than your investment process?
valuation alone, but we think RH: As bottom-up investors,
maintaining a valuation RH: We prefer not to rely too we would love to ignore
discipline is important. much on our ability to assess macro. However, we live in an
management teams because environment where
G&D: How do you think they are usually good government intervention in
about scaling the fund longer salespeople and have the ability financial markets is so extreme
term? How do you offset to mislead. We’re far more that our investments will be
potential size with still finding comfortable basing our heavily influenced by macro
actionable deep value investment ideas on historical factors, so it’s not something
opportunities? financial data, which usually we can ignore. The way we
doesn’t lie. We also try not to approach macro is to focus on
RH: We’re figuring it out. I’ve rely on management’s ability to big things that could go wrong.
spent most of my career add value. This is particularly
picking stocks as opposed to true in deep value situations At the top of my list is the
capital raising, so there’s a where there usually aren’t likelihood of unintended
Page 45

consequences related to from 30% five years ago. China on our side given that the
rampant money printing by is a big reason why Hermès stock market goes up longer-
central banks around the has grown sales at a 16% term. Occasionally we will
world. Economics is a dismal CAGR over the last five years. short on valuation without a
science because it’s more of an Obviously $8,000 handbags are specific catalyst, but that can
art than a science. However, highly discretionary, so if the be risky because an excessive
central bankers conduct Chinese economy weakens, valuation can easily become
business with a false aura of that could have a big negative more excessive. In those cases,
scientific precision, and I think impact on this business. there are two things that we
people have too much trust in like to do to mitigate our risk.
their abilities. Also, there’s From a valuation standpoint First, we generally make the
rarely a free lunch in Hermès has significant position sizes smaller. Second,
economics, and I think the downside risk. The company we try to use the law of large
market may not be considering trades at 35x 2015 consensus numbers to our advantage.
the ultimate cost of all the earnings estimates, which are For example, if we’re
stimulus it has enjoyed. projected to be an all-time anticipating that a glamour
high. It’s clear to us that stock’s revenue growth will
Another thing I worry about is investors are extrapolating mean revert down, it’s easier
a hard landing in China. The past revenue and margin to do that with a company that
debt fueled investment binge growth trends into the future, has billions of dollars in sales
that has powered growth in and we believe that they could facing natural deceleration.
that country could end very be disappointed. Also, from a market cap
badly. I see returns on fixed standpoint, it’s a lot harder for
asset investments drastically There is also a technical a company with a $45 billion
diminishing. In my opinion, catalyst here. Last year LVMH market cap, like
there is overcapacity in a lot of tried to take over Hermès, and Salesforce.com, to double than
industries, so they don’t need in the process, shrank an it is for a company with a $45
to build more factories. They already small free share float. million market cap.
don’t need to build more This caused a big run-up in the
residential or office buildings stock price. Hermès family G&D: Could you give us an
because of the high vacancy members fought back by example of a management
rates we are seeing. The day of pooling their shares into a team who are poor capital
reckoning has been delayed vehicle that controls 51% of allocators?
because of government the company, greatly reducing
stimulus programs, and the likelihood of a takeover. RH: We think a glaring recent
because China has a closed and LVMH threw in the towel and example is Weight Watchers
manipulated financial system. agreed to divest the Hermès (WTW). In 2012, the company
However, there may be signs stake it acquired to its issued $1.5 billion of debt to
that things are starting to shareholders, so technical repurchase 25% of its
unravel. For example, housing support for the shares has outstanding shares at $82 per
starts and housing prices have been reduced. Now if the share, near all-time highs. This
started to decline significantly company disappoints, its stock happened right as secular
in recent months. The price could hit an air pocket. challenges to their business
property sector accounts for model were starting to appear
15% of GDP, so that’s a G&D: How important are in the form of competition
problem. I think that there is a catalysts to you? from free smartphone dieting
big risk that China misses its apps and fitness bracelets. The
7% growth targets. RH: All else being equal, we shares were repurchased from
always prefer to have a reason a controlling shareholder, Artal
As an example, our short why a cheap stock will Group, which serves as a
thesis on Hermès International appreciate and an expensive cautionary tale of how conflicts
(RMS.FP) incorporates our stock will decline in value. of interest can lead to bad
macro view. An estimated 50% However, catalysts are a capital allocation. Now the
of all luxury industry sales are higher priority for shorts stock trades at around $8 and
to Chinese nationals. That’s up because time is generally not the company has leverage
Page 46

issues. (BBBY) are two of your larger Comparable insurance
positions. Take us through companies trade at a big
Without naming specific your thought process there premium to book value. At a
companies, on the short side, from an upside/downside minimum, we believe AIG
we are doing work on a few perspective? should trade at book value
serial acquirers who we which provides a margin of
believe are playing safety.
“There are several
unsustainable financial
engineering games. These general types of value G&D: Some shorts believe
companies appear to be AIG trades at a discount
creating value by rolling up a traps we look out for because it’s not earning its cost
lot of small companies at of capital. What levers could
relatively low multiples. in our investment they pull to improve
However, this eventually profitability?
comes to an end when they process. The first are
have to keep making bigger RH: In 2014, AIG had an
companies in secular
and bigger acquisitions to operating ROE of around 6%
move the needle. These are decline masquerading while comps earn greater than
more expensive and have 10%. We think there is no
much higher integration risk. as companies in reason why AIG won’t close
the gap based on several levers
One thing we try to do is back cyclical decline […] A at their disposal. First, there is
out organic growth from a lot of low hanging fruit for
acquisition growth. If a second type are improvement in profit margins.
company is touting big revenue Hank Greenberg cobbled this
management teams
growth, but it is all being company together through a
purchased, then that is a red that destroy value, slew of acquisitions over a long
flag for us. We also try to period of time. We don’t
determine if previous most commonly by believe these were ever
acquisitions delivered on properly integrated, and there
promised expenses synergies, misallocating capital. are significant cost saving
which are generally oversold opportunities from
by investment bankers. If there A third type are streamlining and consolidating
is no aggregate improvement operations. Historically, AIG
companies that
in costs, that’s also a red flag also had poor underwriting
for us. chronically earn less discipline, and so we see a big
opportunity to bring loss ratios
G&D: Could you explain your than their cost of down. Overall, we think AIG’s
approach to sizing positions? property and casualty
capital.” insurance combined ratio
RH: Generally, we rank every could move from around 100%
idea on a scale of one to three, towards the 90% range longer-
with one being the highest RH: AIG is an example of a term. Importantly, we’re not
target position size and three company in our deep value expecting a miracle here, just
being the lowest. The rank is bucket. For us the main mean reversion to comps.
based on our assessment of attraction is that it is very
expected value versus cheap, not that it is an I should note that we think
downside risk. If something has exceptional business. Although, underwriting discipline in the
big upside potential but is given its global scale, we entire insurance industry has
binary, we won’t make it a believe it has the potential to improved. It used to be that
large position. be an above average business. insurance companies deployed
The stock price is around $54, all of their capital to write new
G&D: We noticed that while book value per share business, which contributed to
American International Group excluding accumulated other poor pricing. Now, rather than
(AIG) and Bed Bath & Beyond comprehensive income is $70. write unprofitable business,
Page 47

companies are returning capital isn’t necessary for this to be a will reduce margin declines
to shareholders. One reason good compounder over time. going forward.
for this is that it’s harder for We think share count
them to make money on their reduction at attractive prices G&D: Could you take us
float given low interest rates, will drive EPS growth. I should through another deep value
so they have to make money mention that there is an investment and how you came
on underwriting instead. embedded growth option in across it?
the form of BuyBuyBaby, one
AIG’s other big lever for of the company’s retail RH: American Axle &
improving ROE is increasing its concepts which is growing Manufacturing (AXL) is one of
asset to equity ratio, which is rapidly but off of a small base. our top holdings and a good
currently lower than comps. example of a deep value
AIG can do this by growing its Given the strength of the investment. The company
business or returning capital to franchise, we believe the makes driveline systems for
shareholders. It has been doing downside is pretty limited. We the auto industry. A majority
the latter through large also take comfort in the macro of its products are used in light
buybacks. As AIG’s ROE mean- backdrop. Lower oil prices are trucks, and 68% of sales were
reverts to industry averages a big tailwind for U.S. to General Motors in 2014.
and the stock trades at a consumer spending. We also The company initially came to
premium to book value, we think housing starts are below our attention through a high
think the stock will be worth longer-term norms, and free cash flow yield screen.
over $100 per share. BBBY’s houseware sales are We think the stock trades at a
Bed Bath & Beyond (BBBY) is correlated to the housing discount for three main
an example of an investment in market. reasons. First, AXL is
our compounder bucket. We perceived to be a boring
believe this is an exceptional G&D: How big a threat is provider of commoditized
business, with a leading Amazon here? products. Second, its high
position in the housewares customer concentration is
retail category and a return on RH: We think that is the perceived as a weakness.
invested capital that is biggest overhang on the stock, Third, the company is seen as
consistently above 20%. The and the main reason why it’s riskier than comps due to its
company spins off a lot of cash cheap. Over the last few years, higher leverage. We disagree
and has returned it to BBBY has maintained its with all of these perceptions.
shareholders in large amounts. market share, but margins have
Over the last ten years, BBBY been pressured by competition To the first point, if you go to
has repurchased over $7 from online retailers, primarily an auto supplier conference it
billion of stock. The current Amazon. BBBY has responded seems like all anyone wants to
market cap is under $13 by investing a lot of money talk about are hot themes like
billion. The company recently into ecommerce. They’ve autonomous driving or
upped the ante by issuing $1.5 totally revamped their web infotainment systems. If you’re
billion of inexpensive debt to presence, invested in online a supplier in those segments,
accelerate the buyback. We analytics and marketing, and you’ll probably have a standing
believe BBBY has medium- improved their ecommerce room only audience. On the
term earnings power of logistics. As a result, we think other hand, if you go to an
approximately $7 per share. they are nearing an inflection AXL presentation, you may
Applying a 15x multiple to that, point where they’ll start to see hear crickets chirping. We
we arrive at a target price of the benefits of their investment think AXL is not getting credit
$105 per share compared to and the expense tapers off. for the fact that it actually has
around $75 today. In the past, BBBY’s products innovative products. For
were priced at a premium to example, they have a new
With over 1,500 stores, BBBY Amazon which was one of the lightweight, disconnecting axle
already has significant market drivers of margin declines. that cuts off power to tires
penetration, so this probably That price gap has now closed, when it’s not needed to
won’t be a high revenue and BBBY is actually cheaper in increase fuel efficiency. This
growth story. However, that some categories. We think this has enabled AXL to grow
Page 48

revenue faster and achieve on an absolute basis and it’s a G&D: How do you assess
higher operating margins than big discount to comps. investment opportunities to
most comps. protect against potential value
G&D: What’s the nature of traps?
To the second point, we think the commercial arrangement
AXL’s exposure to GM light with GM? Can they come back RH: That’s an essential
trucks is actually a huge next year and renegotiate it question, particularly with
positive. In general, we think given how important they are deep value investments where
the US light truck segment is to AXL? cheap stocks are often cheap
extremely attractive. U.S. for a reason. There are several
pickup trucks are 13 years old general types of value traps we
on average, a record high, look out for in our investment
which we think provides a “...my first preference process. The first are
replacement cycle tailwind. companies in secular decline
Lower oil prices are a big is to buy stocks that masquerading as companies in
positive for large vehicle sales, cyclical decline. Telling the two
which is evident in recent are cheap based on apart can be tricky. A second
increases in light truck market type are management teams
share. GM specifically is
asset value. The next that destroy value, most
benefitting from a strong new best thing are stocks commonly by misallocating
product cycle. This is capital. A third type are
consistently GM’s highest that are cheap on companies that chronically
margin segment and suppliers earn less than their cost of
share in the wealth. To the historical earnings capital. If a company doesn’t
extent that high customer earn its cost of equity, it
concentration is a concern, power. Growth is mathematically deserves to
this should be resolved over trade below book value.
time as AXL diversifies its
something I don’t pay
customer base. The company for, although free Another type would be
has a large backlog of new companies with unsustainable
business that should bring GM options are nice.” balance sheets. For example,
concentration to below 50% of valuing a company on mid-
sales over the next few years. cycle earnings power doesn’t
RH: One nice thing about auto hold water if the company
To the third point, we believe suppliers is that there is a lot goes bankrupt at the trough of
AXL’s debt load is very of visibility into their sales and the cycle.
manageable. Net debt margins because agreements to
currently stands at 2.5x supply any given car program G&D: Can you talk about
EBITDA and is steadily are locked in for several years Energy, which obviously has
declining. The company spins into the future. GM just rolled been a tough sector? How do
off about $200 million in free out its new light tuck platform you analyze downside risk in
cash flow a year which in 2014, so the current this context? Some of the
compares to $1.3 billion of economics should be intact valuations are compelling, but
debt. AXL has an industry- through the end of the decade many of these companies
leading free cash flow yield to at least. Also, these contracts might not make it to the other
equity of over 10%. tend to be very sticky. Upon side of the cycle given their
We estimate AXL’s earnings renewal, AXL has negotiating balance sheets.
power to be approximately $3 leverage because it would be
per share over the medium very disruptive for GM to take RH: Energy is difficult, because
term. If you apply a low double its business elsewhere. GM with commodities it’s hard for
digit multiple to that, say 12x, would also have to incentivize us to determine intrinsic value.
you get a target price of $36 a competitor to build out the Theoretically, over the long-
per share versus a current specialized, high-volume term, the price of oil should
price of around $25. We think capacity necessary to fulfill gravitate towards its full-cycle
that multiple is undemanding such a contract. cost of production. However,
Page 49

in the near-term the floor on incentivized with performance- power is $3 per share. We
prices is determined by the half based stock compensation. think a multiple of 13x earnings
-cycle, or cash cost, of is very reasonable for a
production, which is really low. We think Vectrus is a decent company like this, and a big
Current valuations are business given its low capital discount to comps. That gets
definitely not pricing in a intensity and potential to us to a target valuation close
downside scenario of sustained generate a lot of cash. Its to $40 per share compared to
oil below let’s say $50 a barrel. government contracts are the current price of $25.
These cycles can last a long sticky and provide good
time, and given our lack of earnings visibility. The stock Another special situation that
conviction, we haven’t bought recently sold off when illustrates our approach is
much during the decline. But management issued Investors Bancorp (ISBC). This
that could change. There’s a disappointing guidance for is a small regional bank with a
price at which almost anything 2015 due to lower than footprint in New York, New
becomes interesting. expected margins. We think Jersey and Pennsylvania. The
that’s a temporary problem bank recently demutualized in
Given the high debt levels of a partially due to the cost of May of 2014, and is currently
lot of energy related ramping up some new overcapitalized as a result of
companies, there’s a possibility contracts. Also, Vectrus will be that transaction. This is
that equity value could be renewing a lot of its existing depressing ROE, and the stock
wiped out, so position sizing is contracts under a fixed price trades at 1.1x tangible book
important. We own two structure that we believe will value. On average, comps
levered offshore drillers, and give them the ability to profit trade at over 1.5x. We think
we have sized them according from efficiency gains in the Investors Bancorp will increase
to our view that the outcome future. That should be margin its ROE by growing its loan
there is binary. They are expansive. book and returning excess
effectively call options. We are capital to shareholders. The
comfortable making A potential positive catalyst company recently received
investments like that as long as relates to a big contract approval from regulators to
the expected value is high and Vectrus has for managing the buy back stock earlier than
the position size is small. U.S. military base for anticipated.
operations in Afghanistan. This
G&D: Do you have any special is projected to account for Investors Bancorp has a track
situations you could take us about 15% of the company’s record of highly accretive
through? revenue in 2015, and has acquisitions, and we think the
higher margins than the rest of company has generated a lot of
RH: I have a couple that the business. Due to a planned value organically too. For
demonstrate our approach. withdrawal of U.S. troops, this example, they have increased
One is a company called contract was assumed to be their mix of low cost core
Vectrus (VEC), a defense wound down by 2016. deposits dramatically in recent
contractor that was spun out However, the government years. The company is growing
of Exelis in September 2014. recently reversed course and its loan book in the
Vectrus specializes in extended the timeline for commercial and multi-family
infrastructure asset withdrawal. This is not baked real estate segments, primarily
management for U.S. military into management’s guidance or in the New York region. Based
bases. This has some typical sell-models yet. on our analysis, we think their
spin-off dynamics. There is loan growth looks prudent.
selling pressure from Exelis Vectrus also has a big pipeline
shareholders who received of new business that it is The track record for bank
one Vectrus share for every 18 competing for, which could demutualizations is generally
Exelis shares. With a market provide upside. They recently very positive. There is
cap below $300 million, the had success winning a contract frequently book value multiple
company is underfollowed and away from a competitor, expansion after they become
has minimal analyst coverage. Lockheed Martin. All in all, we public, and over half of them
Its management is newly think medium-term earnings get acquired within three
Page 50

years. We’re not assuming the good value investor, and that
latter is going to happen, but requires a broad perspective. If
that provides upside potential. you’re considering a career in
Also, the company’s largest investing, be certain that
shareholder is an activist fund, you’re doing it because you
Blue Harbor Group. We think have a deep intellectual
management allocates capital interest in it. If your idea of a
wisely, but it is nice to have an good time is reading a 10-K
involved investor guarding the and learning about a new
cash register, so to speak. business, that’s a good sign. If
you’re doing it only because
G&D: Given that you’re an you want to make a lot of
alumnus, can you go through money, you probably won’t be
how your experience at CBS very good at it.
helped develop you as an
investor? G&D: That is great advice –
thank you for your time.
RH: The best thing that I got
from CBS was a wide
perspective on value investing.
Learning about different
approaches and why they work
was fantastic. I also picked up
some investing frameworks
that I find very valuable. One in
particular is Bruce Greenwald’s
“three sources of value”. With
that in mind, my first
preference is to buy stocks
that are cheap based on asset
value. The next best thing are
stocks that are cheap on
historical earnings power.
Growth is something I don’t
pay for, although free options
are nice. I think about that all
the time.
G&D: Lastly, do you have any

advice for our readers who are
looking to break into the
investment industry?
RH: First of all, I would

recommend experimenting
with the different flavors of
value because the
temperament required for
each is different, and you won’t
know what you’re best at until
you try it. Also, force yourself
to find ideas in as many
different industries as possible.
I think appreciating absolute
value is the key to being a
Page 51
Altice S.A (Euronext: ATC) - Long

1st Place - 2015 Pershing Square Challenge
Brendan Dawson Patrick McDonald Moiz Valji
BDawson16@gsb.columbia.edu PMcDonald16@gsb.columbia.edu MValji16@gsb.columbia.edu
Investment Opportunity Summary
Our 2018 base case target price of €180 (15.5x 2018 FCF of
€11.59) represents nearly 80% upside. Bull scenarios involving in-
market consolidation, mobile market repair, and further accretive
Brendan Dawson ’16 M&A offer upside as high as 160+%, representing an IRR of 30%
Brendan is a first-year MBA over nearly 4 years.
student at Columbia
Business School. Prior to Business Overview
CBS, Brendan was an Altice S.A. (ATC), is a holding company for leading cable/telco
investment analyst intern at
businesses in 6 countries, with France and Portugal as the two key
Slate Path Capital after
spending 4+ years as part of
geographies.
the investment team at the In each geography, ATC owns a high speed, high capacity fixed line
UVA Investment network as well as a mobile network, enabling them to offer high
Management Company. quality quad-play services (premium cable TV, highspeed broadband,
fixed line telephony, and mobile telephony and services)
Thesis Points
1) Patrick Drahi—A true Cable Cowboy: ATC Chairman and
controlling shareholder Patrick Drahi is an incredible entrepreneur,
capital allocator, and operator. He is 50% wealthier than John
Malone despite being 20+ years his junior. In addition to being an
excellent and opportunistic capital allocator (demonstrated through
his successful rollup of the French cable industry starting in 2002),
our references indicate Drahi and his team are lean operators, capable of achieving massive cost reductions at
acquired companies. With Drahi holding a 60% stake in ATC, we love being aligned with such an impressive
Patrick McDonald ’16
value creator.
Patrick is a first-year
2) A portfolio of differentiated, advantaged assets: In each geography, ATC has a network based competi-
student at Columbia
Business School. Prior to tive advantage. In France, they face minimal FTTH overlap and in Portugal, they own a fiber network passing
CBS, he spent 4 years 56% of homes. An excellent feature of ATC’s current asset base is their relatively low broadband penetration
working at JPMorgan’s across geographies. As data consumption grows secularly at 40+% per year, ATC will become a monopoly
Private Bank. He holds a broadband provider in most markets. For instance, NUM-SFR has 80% market share among very-high-speed
BA from Rice University. subscribers in France. This dynamic provides a long duration runway for market share gains. Additionally, the
ownership of mobile networks will allow ATC to drive per-subscriber profitability higher through triple play
and quad play bundles within their fixed line footprint.
3) Investors are underestimating the magnitude of opex, capex, and NWC synergies at two recent
significant acquisitions: In ATC’s recent acquisitions of French #2 mobile provider SFR and Portugal’s incum-
bent telco Portugal Telecom, we expect ATC to deliver improvements well beyond consensus expectations.
Deconstruction of SFR FCF Improvement
Moiz Valji ’16

Moiz is a first-year student
at Columbia Business
School. Prior to CBS, he
worked for four years in
investment banking at
Macquarie Capital and in
equity research at Jacob
Securities, a Toronto-
based investment bank,
where he focused on
power & infrastructure. He
holds a BMath from the
University of Waterloo.
Page 52
Altice S.A. (ATC) - Long (Continued from previous page)

With SFR, we believe cost savings from migrating DSL subs to NUM’s cable network as well as the capex savings from ending SFR’s FTTH
program and a redundant B2B DSL network will deliver synergy outperformance. Additionally, we expect €450 million in opex cuts be-
yond synergies, a number in line with savings achieved at past ATC acquisitions. With PT, the incumbent telco had 33% of industry reve-
nue yet 75% of headcount, a discrepancy highlighting the inefficient nature of the previous management which we expect ATC to rectify.
4) The need for consolidation in European telecoms provides a long M&A runway to an excellent management team: We think
there is a big game to be played in the consolidation of the European telco industry. There is total industry revenue of >€340 billion and
35 cable/telco operators with greater than $250m in revenue. The large universe of potential targets provides a great setting and oppor-
tunity for ATC. Of the companies we have evaluated, they are one of the best positioned to serve as a consolidator in the industry. The
compounding in ATC’s core business from broadband combined with the opportunity to deploy significant capital in consolidating acquisi-
tions bears many similarities to great wealth creating companies such as Capital Cities, John Malone’s TCI, Constellation Software in Cana-
da, and Ambev under 3G.
Key Risks and Mitigants

 Advantaged fiber and cable providers could face an aggressive regulatory regime in Europe
 The current regulatory regime across Europe is positive and in favor of consolidation. With average broadband speeds badly
lagging other developed economies, we do not foresee a significant change in the regulatory outlook in the near term.
 The Eurozone faces serious macroeconomic issues which could impair operations in France and Portugal
 The secular growth of data demand will occur independently of macro outcomes, benefiting high speed broadband providers.
 The recurring nature of revenue streams creates some predictability and stability
 The increase exposure to the mobile business is not a good thing, especially in a competitive market like France
 French mobile pricing is some of the lowest in Europe and has shown recent signs of stabilization
 50% of the post-2011 ARPU decline is due to regulatory cuts of MTRs. With MTRs below 1c, the headwind is largely exhausted
 #3 mobile provider Bouygues Telecom is EBITDA-Capex breakeven, limiting their ability to withstand further ARPU declines
 Price disruptor Iliad’s MVNO agreement with Orange expires in 2017. We think a renewal at existing terms is unlikely.
 Given ATC’s high financial leverage, rising interest rates may adversely impact profitability, FCF conversion, and financial flexibility
 The maturity profile of ATC’s debt, with the first significant maturities occurring in 2019, reduces financial risk
Valuation
 We value ATC on 2018 FCF. A composite of well managed European cable peers, incumbent telcos, and other cable businesses trade
at roughly 20x FCF. We believe our 15.5x exit multiple embeds our expected IRR with conservatism. In fact, our exit multiple is at a
discount to all comparable companies within the composite except for one incumbent telco.
Page 53
Fiat Chrysler Automobiles NV (NYSE: FCAU) - Long

2nd Place - 2015 Pershing Square Challenge
Brandon Cohen Christopher Crawford Tyler Boone
BCohen16@gsb.columbia.edu CCrawford16@gsb.columbia.edu HBoone16@gsb.columbia.edu
Thesis
The market misunderstands Fiat Chrysler Automotive’s business
and industry. Despite it’s name, Fiat Chrysler generates no profit-
Brandon Cohen ’16
ability from either Fiat or Chrysler. It would be better suited with
a name change to Ferrari Jeep Ram Maserati Automotive. Those
Brandon is a first-year student at
brands alone are worth well in excess of the current market cap.
Columbia Business School and is
Managing Partner of Abrika
Ferrari could be worth €15-25/share in 2018, compared to a total
Capital Management, LP, a long price for the whole business of €14.94/share today. The ex-
biased, value oriented Ferrari stub has normalized earnings power of ~€1.5/share but will be generating €4+/share in 2018, with no net debt and
investment management a fully funded pension, if management successfully executes its five-year plan. At 10x earnings, plus €15-20/share for Ferra-
company established in 2008. He ri, Fiat should be worth €30-60/share in 2018, 2-4x the current price. With Ferrari as the margin of safety, there is very limited
graduated from Washington downside.
University summa cum laude with U.S. Is Not At A Cyclical Peak
degrees in finance, economics,
and accounting. Fundamentally Better Industry 22,000
Population Adjusted US SAAR 30 Year Avg.
During the financial crisis, fixed costs were reduced, labor was
brought down to ~5% of the price of a car, capacity was reduced, 20,000
US Population Adjusted SAAR (000’s)

and dealerships were closed. These factors create a much more
rational competitive environment. GM used to require industry 18,000
volumes of 16 million vehicles in the U.S. to break even; but that 16,000
number is now only 10 million, which is lower than the lowest
volume posted during the financial crisis. Because of this, GM 14,000
recently announced a 20% ROIC target, as compared to the old

days when managers wore lapel pins that said “29”, symbolizing 12,000
Pent Up Demand
the need to maintain 29% market share. Ability to break-even at 10,000
lower volumes will make for a much more rational pricing envi- 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012
ronment.
Christopher Crawford ’16 Excellent Management

Christopher is a first-year Fiat’s CEO, Sergio Marchionne, has compounded shareholder
student at Columbia Business wealth by ~22%/year for 17 years over three separate company
School. Prior to Columbia, turnarounds. Had one invested $1 with Marchionne in 1996 when
Christopher was a Corporate he became CEO of Alusuisse, it would be worth ~$32 today. He
Finance Associate at Gerson has ~€200 million personally invested in Fiat and all of his stock
Lehrman Group, where he was
compensation is tied to hitting his five-year plan targets. He re-
responsible for its capital
structure. Prior to GLG, tires in 2018 and is intensely focused on creating value for share-
Christopher founded Locket, a holders.
consumer mobile advertising
company. He graduated from Marchionne reports to Fiat’s Chairman, John Elkann, Chairman &
UC Irvine, where he studied CEO of Exor, a holding company controlled by the Agnelli family
psychology and finance. that owns 31% of Fiat. Elkann attends the annual Berkshire Hatha-
way meeting in Omaha every year, and has proven to be a very
successful capital allocator who buys low and sells high. The combination of an incredible operator in Marchionne and an
incredible capital allocator in Elkann is hard to beat.
Ferrari - The Margin of Safety

The market misunderstands Ferrari’s brand potential and the capital intensity of its business. It’s F1 racing budget is not
disclosed, but estimates are in the range of €300 million and this spending does not need to scale with additional produc-
tion. More importantly, it has the ability to produce 10,000 units per year without additional capex, but has voluntarily
capped production at 7,000 units per year. Marchionne fired long time Ferrari CEO Luca di Montezemolo last year over a
disagreement about the production cap and immediately raised the cap by 5%. He has also publicly stated that by scaling to
10,000 units per year, Ferrari would generate EBITDA “well in excess of €1 billion” and that growth in the number of high
Tyler Boone ’16 net worth individuals will warrant raising the cap. In its Form F-1, Fiat discloses Ferrari Cost of Goods Sold, which shows
that incremental margins for an additional Ferrari are in excess of 55%, but EBIT margins for Ferrari are currently only
15%, so additional production will significantly increase Ferrari margins. The Form F-1 also discloses cash flow from invest-
Tyler is a first-year student at ing activities for Ferrari, which was €314 million in 2013, almost exactly equal to depreciation and amortization. Therefore,
Columbia Business School. Prior
to Columbia, Tyler was a private
EBIT margins are a very good proxy for free cash flow for Ferrari. And since ~50% of revenue is in USD or USD linked
equity associate at American currencies, but costs are entirely in EUR, Ferrari margins will increase significantly in 2016 when it’s currency hedges roll
Capital, where he focused on off.
middle-market leveraged
buyouts. He graduated Southern At a 1.08 EUR and 10,000 units per year, Ferrari EBIT margins would double to 30% and EBIT would increase to €1,159
Methodist University with a BA million. To put that in perspective, Hermes EBIT margins are 32%. If Ferrari could increase prices by 5%/year, consistent
& MS in Accounting, and is a with increases over the past decade, EBIT margins would grow to 42%, and EBIT would increase to €1,919 million. Ferrari
CFA Charterholder.
only appears to be a capital-intensive business because it is underutilizing its capacity; but, as it scales to 10,000 units per
year, its capital intensity will fall dramatically.
Page 54
Fiat Chrysler Automobiles NV (FCAU) - Long (Continued from previous page)

Hermes trades at 22x EBIT. At that multiple, assuming it takes four years to scale to 10,000 units, Ferrari would be worth between €25,498 million and
€42,218 million in 2018, depending on the level of annual price increases.
Five Year Plan

Management’s publicly stated five-year plan would have the ex-Ferrari stub earning in excess of €4/share in 2018 driven primarily by globalizing the Jeep brand,
producing luxury products for export using excess Italian capacity, and rationalizing competition between Chrysler and Dodge.
Jeep - Annual volumes will grow from 1 million units to 1.9 million units, driven primarily by local production in China and Brazil, as well as two new models to
compete at the high and low end. Jeep has de minimis market share in China and Brazil due to 25-30% import tariffs. Local production will finally make Jeep
pricing competitive. Its Brazil facility will have 20%+ EBIT margins due to government handouts and the introduction of the Renegade, Jeep’s smallest model
ever, will result in significant growth in Europe, where Jeep also has de minimis market share.
Premium Brands – Development of the Alfa Romeo and Maserati brands will enable Fiat to utilize excess European capacity, resulting in very high incremental
margins. Maserati volumes will double, driven primarily by the launch of its first SUV, which will increase its coverage of the luxury market from 50% to 100%.
Alfa Romeo will be relaunched in the U.S. with eight new models designed by two former heads of Ferrari design with a €5 billion budget.
Chrysler/Dodge – Chrysler has suffered from underinvestment and internal competition with Dodge, but Dodge is being repositioned as a performance brand,
and Chrysler’s lineup will see a significant refresh and expansion to address 65% of the market by segment, compared to only 25% today.
Architecture Convergence – Fiat and Chrysler integration will have 1 million vehicles on its three principal platforms. This substantially reduces R&D and capex
per vehicle, lifting margins to competitive levels.
Normalized Earnings Power

When Fiat purchased Chrysler, Chrysler had outstanding debt that ring-fenced Chrysler’s cash. This debt has been uneconomical to repay to date, but the first
of the two bonds was just recently prepaid and the second will be prepaid next year. Because Chrysler cash was ring-fenced, management had to borrow on
the Fiat side to invest in its plan. It has therefore been intentionally carrying excess liquidity, the release of which will reduce interest expense by €1 billion, or
€0.46/share after tax. Its earnings are also currently depressed by elevated recalls and elevated incentives to clear old inventory in anticipation of significant
refreshes. After accounting for these factors, 2015 normalized earnings power would be ~€1.5/share.
Auto Industry Consolidation Kickstarter

Marchionne has publicly stated many times over the last few years his belief that the industry needs consolidation. In the last month, he has elevated the rheto-
ric and announced his intent to release an analysis on the potential savings that could be generated through consolidation. He has also publicly stated that he
wants to close another big deal before he retires in 2018, and has said he has an “ideal partner in mind” and a merger with Ford or GM would be “technically
feasible.” There could be massive synergies on R&D, as the major OEMs are spending billions of dollars on duplicative research. We believe a merger with GM
could create in excess of €4 billion per year in synergies.
The major roadblock to consolidation has historically been manager self-interest. There can only be one CEO in a merger, and as Marchionne has said, “One
of the most difficult things to do is to get the turkey to invite himself to Thanksgiving dinner.” But because Marchionne plans to retire in 2018, he could poten-
tially overcome this hurdle, as he could be the “interim” CEO of a larger MergeCo to facilitate the integration, since he has experience integrating two large
automakers, with plans to hand over the reigns to a much larger more profitable company in 2018 to the acquired CEO.
Fiat is the seventh largest automaker and will produce ~5 million vehicles this year. The top seven automakers control about 75% of the market, but there are
more than fifteen automakers that sell more than 1 million vehicles per year. A large merger between Fiat and one of its larger competitors could initiate an
industry wide domino effect. Fiat/GM MergeCo, for example, would produce ~15 million vehicles, compared to Toyota which would be the new #2 at ~10
million vehicles. Toyota, Volkswagen, Renault-Nissan, Hyundai-Kia, and Ford would then find themselves in need of a partner to compete with the scale of
Fiat/GM MergeCo. Through a round of mergers, the top seven could become the top four. Then the remaining small automakers would be so disadvantaged
that they would likely be purchased in smaller add-on mergers. The industry could end up with only four or five players in five to ten years, which could lead
to much more rational competition and higher multiples, as it did for the airlines.
Key Risks
Macro – Fiat is an operationally and financially leveraged business, a major macro shock could cause material downside; however, Ferrari provides a margin of
safety. Ferrari revenue only dropped ~8% in 2009 and completely recovered in 2010.
Unions – Unions could claw back concessions made during the crisis. However, right to work laws in Michigan and Indiana, as well as two-tier wage system,
reduce the power of unions. Reasonable wage increases can be passed on through price. A 20% increase in wages would only require a 1% increase in prices
to maintain margins.
Uber – Uber could reduce demand for second cars, which would reduce U.S. SAAR; however, Jeep, Ram, Ferrari, and Maserati are worth well in excess of the
entire current market cap. Ram, Ferrari, and Maserati are completely unaffected by Uber, and Jeep benefits from a secular mix shift towards SUVs, which will
offset any reduction in long term U.S. SAAR from car sharing.
Page 55
HCA Holdings Inc. (NYSE: HCA) - Long

3rd Place, 2015 Pershing Square Challenge
Damian Creber Michael Herman
DCreber16@gsb.columbia.edu MHerman16@gsb.columbia.edu
Opportunity
The market is presenting the opportunity to buy HCA at
less than 10x 2017E earnings. Demographic trends and
healthcare reform will provide a meaningful tailwind to
Damian Creber ’16 profitability, while the regulatory overhang will dissipate in
June. In addition, HCA owns all of its real estate which, if
Damian is a first-year stu-
monetized, would unlock significant equity value, and the
dent at Columbia Business Company has enough firepower to buy back 35% of its
School. He is also Co-
shares.
President of the Columbia
Student Investment Man- We believe the shares have ~75% upside over the next
agement Association. Prior
three years as earnings will accelerate meaningfully. Our
to CBS, Damian spent two
view is that the shares have ~25% downside over the same period, implying a 3:1 upside/downside ratio.
years as an Associate in the
private equity group at
Company Overview
Onex Partners.
HCA is the largest hospital operator in the US with 166 hospitals and 113 freestanding surgery centers.
Damian is a CFA Charter- Average EBITDA Margins Revenu
Investment Thesis
holder and graduated from Name 1- Year 3- Year 5- Year
1) Structural Competitive Advantage
the University of Toronto
HCA’s market position (#1 or #2 in each of its local markets)
with a Bachelor of Com- Community Health Systems 15% 15% 15%
gives it significant leverage when negotiating with commercial
merce. LifePoint Hospitals 13% 14% 15%
insurers. HCA owns between 20% and 60% of the beds in each Tenet Healthcare 12% 12% 12%
of its markets, which drives a 30% price premium. Additionally,
HCA’s scale allows it to negotiate meaningfully lower costs on Mean 13% 14% 14%
purchases. HCA’s margins allow the Company to earn returns Median 13% 14% 15%
on invested capital that would not be possible by a new entrant
HCA 20% 20% 20%
– creating a meaningful barrier to entry.
HCA Advantage (vs. Median) 713 bps 577 bps 474 bps
2) Attractive Capital Deployment Opportunities Current ASC Revenue (mm) $1,000

HCA’s management team is very shareholder friendly and has contin- Number of ASCs 113
ued to deploy capital into highly attractive projects (>50% incremental Revenue Per ASC (mm) $8.85
ROICs since 2007). HCA is currently pursuing an ambulatory surgery
center (ASC) development strategy whereby they look to place ASCs EBITDA Margin Per ASC (@ 30%) $2.65
in a hub-and-spoke format around their urban hospitals (ASCs have
Michael Herman ’16 Cost To Build $15.00
~18% ROICs). While acquisitions have not been a large part of the
Michael is a first-year stu- story, management has continued to evaluate opportunities and com-
pleted acquisitions have had attractive returns. Existing ASC ROIC 17.7%
dent at Columbia Business
School. He is also Co-
President of the Columbia Component 1 (Current Cash)
Student Investment Man- 3) Significant Free Cash Flow and Debt Capacity Cash on Balance Sheet $566
agement Association. Prior HCA’s management – having been through two private equity
buyouts – understands the attractiveness of repurchasing shares Component 2 (Debt Capacity)
to CBS, Michael spent
Additional Debt (@ 4.0x) $5,999
three years as an Invest- opportunistically. The strong and stable free cash flow profile of
ment Analyst at East West HCA allows the Company to constantly re-lever to return Component 3 (Free Cash Flow)
Investment Management. capital to shareholders. HCA management has returned a total Cumulative Free Cash Flow $5,782
of $7 billion back to shareholders – this compares to the IPO
Michael is a CFA Charter- market cap of less than $13 billion. Total Cash Available to Shareholders $12,347
holder and graduated from Current Market Cap 34,306
the University of Western % of Mkt. Cap. Returned (2 Years) 36%
Ontario with a degree in 4) Meaningful Industry Tailwinds
Software Engineering, as The Medicare eligible population (65+) will grow at a CAGR of 500 30%
well as an HBA from the ~3.0% a year over the next 20 years. Simply shifting today’s aging 400 25%
Richard Ivey School of population forward 10 years illustrates that HCA is going to bene- 300
20%
Business. fit from a significant tailwind regarding the aging population. Incre- 15%
mental EBITDA margins per admission are in the range of 40-50% 200
10%
and we estimate that EBITDA will increase by ~75% from the aging 100 5%
demographic alone. In addition, health care reform will drive a - 0%
meaningful reduction in highly unprofitable uninsured patients 1-4 5-14 15-24 25-34 35-44 45-64 65-74 75+
which we believe will drive an incremental $1 billion of EBITDA
Admissions Per 1000 People % of population
through the system over the next two years.
Source: Morgan Stanley, company financials, US census
Page 56
HCA Holdings Inc. (HCA) - Long (Continued from previous page)

5) Hidden Real Estate Value Value of OpCo Value of PropCo
HCA owns all of the real estate under its hospitals and
freestanding surgery centers. By spinning its owned Adjusted EBITDA $4,979 Triple-Net Rental Income $2,406
land and buildings into a PropCo, HCA shareholders EBITDA Multiple 8.8x less: REIT management (60)
could capture the hidden value associated with the real OpCo Enterprise Value $43,816 Funds From Operations (FFO) $2,346
estate. Healthcare REITs trade between 16x and 25x
less: debt (21,163) FFO Multiple 14.0x
EBITDA (and the recent Ardent transaction was com- less: minority interest (1,396) OpCo Enterprise Value $32,841
pleted at 14x), whereas HCA trades at ~8.5x EBITDA. plus: cash 566
OpCo Equity Value $21,823 less: PropCo debt ($19,293)
PropCo Equity Value $13,548
Equity Value (OpCo + PropCo) $35,371
plus: special dividend 10,811 PropCo Coverage Ratio 2.0x
Total Equity Value $46,182 Implied Interest Expense $1,173
Effective Interest Rate 6.1%
Shares O/S 439.6 PropCo Debt $19,293
Per Share $105.05
% upside 34.6%
Risks and Mitigants
Risk / Street View Our View

There is currently a  The King v. Burwell ruling, which will occur in June, will decide whether plans purchased on federally-run healthcare
large overhang on the exchanges are eligible for ACA subsidies
stock as the market is
worried about Kin g v.  The impact of a negative ruling would only be temporal vs. structural as states would create their own exchanges
Burwell  “There is not a single Republican governor in the United States that is cheering for a King victory – we all understand this will fall
squarely on our shoulders” - High-Ranking State Healthcare Official
The industry is looking  Consensus remains concerned about the ambiguity of the shift from a fee-for-service model to a fee-for-value model
to move towards a fee-
for-value model and this  We believe this threat is overblown as (i) the government has indicated the profit pool will remain flat through the con-
may harm hospitals version, and (ii) HCA’s quality metrics are industry-leadin g
 “We currently have 30% of our patients on a capitation model and we are not making any less than we were under a fee-for-
service model” - Partners HealthCare
There is concern that  ~30% of hospitals in the US have negative operatin g margins and average operating margin s are ~5% – this leaves very
there will be significant little room for below-inflationary in creases (let alone cuts) in reimbursement rates
reimbursement pressure
going forward  Historical market basket increases have never been below 2% on an annual basis, and have averaged closer to 3%, as the
government understands the importance of offsettin g rising costs of healthcare
 Hospitals employ more than 5.4 million people in the US today – the second largest private sector employer (very pow-
erful voice)
Valuation Fair Value

Based on a variety of metrics, HCA appears meaningfully undervalued. We believe there is ~75% up- Current Share Price $78
side over the next three years under a probability-weighted scenario, which translates to a 21% IRR.
Base Case $132 $142 +75%
Our downside includes an adverse ruling on King v. Burwell, as well as associated multiple compres-
sion.
The shares represent an attractive risk-reward proposition with ~25% downside over the same period, P/E 18x (Bull) $161 $171 +115%
representing a 3x upside / downside ratio. Value-creating catalysts / positive signposts include:
P/E 18x (Base) $150 $160 +100%
1) A reversion in trading multiples (to levels before the Supreme Court agreed to hear King v. Burwell)
would result a 17% increase in the share price P/E 16x (Bear) $55 $65 -25%
2) Continued decline in uninsured patients
3) Monetization of the Company’s real estate assets
4) Announcement of Medicaid expansion in Texas or Florida
EV/EBITDA 8x (Bull) $134 $144 +80%
EV/EBITDA 8x (Base) $115 $125 +55%
EV/EBITDA 7x (Bear) $48 $58 -30%
10
Page 57
Genuine Parts Company (NYSE:GPC) - Long

Lauren Harmon, CFA Derek Johnson, CPA Adam Kommel, CFA
LHarmon16@gsb.columbia.edu DJohnson16@gsb.columbia.edu AKommel16@gsb.columbia.edu
Recommendation
We recommend investors buy Genuine Parts Company (GPC) with a two year price target
of $127, representing a total return of 45%. There are three main points to our investment
Lauren Harmon ’16 thesis:
Lauren is a first-year
student at Columbia Busi- 1) Strength of the automotive parts segment as a pure play
ness School. Prior to CBS, 2) Office segment Reverse Morris Trust merger transaction with United Stationers
Lauren was a risk analyst at 3) Tax-free spin of the industrials and electrical parts segments
GE Asset Management and
a senior analyst at Rocaton Business
Investment Advisors. She  GPC is a conglomerate operating within three primary industries. The company’s larg-
will intern at MFS Invest- est segment is its automotive parts group, which represents approximately 53% of sales and 55% of EBIT. GPC operat-
ment Management this ed as an auto pure play until the mid-1970s when it acquired Motion Industries and S.P. Richards.
summer.
 Motion Industries is GPC’s industrial products subsidiary, and it represents approximately 31% of sales and 29% of
EBIT. Motion is a value-added distributor of replacement parts to factories across a number of different end markets.
In a highly fragmented market, its main competitors are Applied Industrial Technologies (AIT), Kaman and DXP Enter-
prises.
 S.P. Richards is GPC’s office supplies subsidiary, accounting for 11% of sales and EBIT. S.P. Richards is a national whole-
saler of office products competing with $1.6 billion United Stationers.
 The remaining 5% of sales and EBIT comes from GPC’s electrical parts subsidiary, EIS.
Investment Thesis
Over the last 15 years, GPC has outperformed the

broader market, as proxied by the S&P 500. However,
Derek Johnson ’16 over the same period of time, GPC has substantially
Derek is a first-year underperformed its automotive peers. Since Advance
student at Columbia Busi- Auto Parts went public in November 2001, GPC has
ness School and is on the underperformed O’Reilly, Advance Auto Parts and
board of the Columbia AutoZone by 2-3 times.
Student Investment Man-
agement Association. Prior Our primary research indicates that GPC is a great
to CBS, Derek was a business that is suffering from an unwieldy conglomer-
senior associate at PwC. ate structure and an overly conservative management
He will intern at Poplar team. As such, we believe GPC is ripe for an activist.
Forest Capital this sum-
mer. 1) Strength as an automotive pure play
 GPC’s automotive parts group operates under the NAPA brand name and sells nearly 500,000 parts including car
batteries, break pads and wiper blades. Within the space, GPC primarily competes with O’Reilly, Advance Auto Parts
and AutoZone. In comparison to peers, NAPA sales are more skewed to the faster-growing commercial Do-It-For-Me
market. Further, NAPA employs a capital-light model through its 4,900 independently owned stores.
 Within its commercial niche, NAPA has created a tremendous network effect and captive customer base through its
15,000 NAPA AutoCare locations. Local economies of scale within the space have created significant barriers to entry.
Across the industry, the NAPA brand is known for its superior quality. We think NAPA is well-positioned to take
market share from local and national competitors, particularly from Advance Auto Parts as the company has had diffi-
culty integrating its newly acquired CARQUEST locations.
 The auto parts aftermarket has several significant tailwinds, including increased car complexity and an aging vehicle
fleet. NAPA has also been making significant strides within the retail market, delivering year-over-year growth of 8% in
Adam Kommel ’16 2014. Our primary research indicates much of this can be attributed to the group’s president, Paul Donahue. During
Adam is a first-year student our channel checks, we learned Donahue has changed the culture within the automotive segment and has consistently
at Columbia Business improved execution. Donahue is widely considered to be the heir-apparent to the current 67 year-old CEO. As such,
School. Prior to CBS, we think an activist campaign could help to expedite this transition.
Adam founded Activist
Shorts Research and was a
former shareholder
activism analyst at FactSet
SharkRepellent. He will
intern at Manikay Partners
this summer.
Page 58
Genuine Parts Company (GPC) - Long (Continued from previous page)

2) Office segment Reverse Morris Trust merger with United Stationers
 We propose that GPC spin off S.P. Richards and merge it with United Stationers via a tax-efficient Reverse Morris
Trust transaction. We think a merger would allow the combined company to cut costs and halt margin-damaging price
wars. We estimate synergies equal to 2% of the combined company’s annual sales, a figure consistent with last year’s
merger of paper distributors xpedx and Unisource Worldwide. Subtracting restructuring costs and capitalizing the
synergies at 10x would create new value of $1.5 billion. Half of that would accrue to GPC shareholders, providing in-
cremental value of approximately $5 per share.
 Significant synergies were confirmed through our primary research. The founder of an ERP system used by office prod-
ucts distributors told us that United Stationers and S.P. Richards have duplicative warehouses that would be a clear
source of cost savings in a merger. Our contact, who has decades of experience in the industry, told us that S.P. Rich-
ards had only won first call at Office Depot last year after the OfficeMax merger because S.P. Richards had bid extreme-
ly low on price.
3) Tax-free spin of the industrials and electrical parts segments

 Motion Industries is essentially a break/fix business—when a machine on an assembly line breaks, they sell the parts to
fix that machine. The company is viewed as the best in the business, and several people across the industry think that
Motion would be better as a standalone company. We are recommending a tax-free spin of the industrial and electrical
parts segments for several reasons. First, Motion and EIS have no material synergies with auto or with office. When
asked about synergies between the different segments, the company has told us that it’s tough to see anything glaring
since the businesses serve very different end markets. Further, the industry is highly fragmented. With a leading market
position, management at the new, independently run company can better focus on growing share and realizing synergies
through strategic acquisitions. We think an independent Motion could follow a roll-up strategy after the spin. While
smaller targets are more feasible over the next 2-3 years, the company could eventually consider acquiring one of its
larger competitors—DXP, Kaman or even AIT.
Valuation
 To properly value GPC, we used a sum-of-the-parts methodology. Adding up the value of each of GPC’s segments, we calculated a two-year price tar-
get of $127 for a total return of 45%. In estimating earnings, we started with industry revenue forecasts from the Auto Care Association. After speaking
with the director of market intelligence at the industry group, as well as many other industry participants, we gained confidence that NAPA would
continue to gain market share going forward, particularly from Advance Auto Parts and independent shops, bringing us to a revenue figure above con-
sensus in our base case.
 For margins, we focused on the company’s substantial operating leverage. A former NAPA supply chain executive told us that NAPA had far too much
overhead at the distribution center level for the current volume, suggesting that incremental revenue would come with minimal SG&A increases.
 Because we wanted to evaluate how the company would fare without activist intervention, we’ve included four cases—a base active, a base passive, a
bear passive and a bull active. Earnings estimates are the same for our base active and base passive, so you can see we believe an activist adds $19 per
share, the difference between base active and base passive.
 We will also note that while our base case provides a 45% return, we believe this is a long-term compounder as NAPA and Motion should each contin-
ue to consolidate and gain market share in fragmented markets where they are the market leader.
Key risks include 1) dividend-oriented shareholders may be reluctant to support an activist campaign, and 2) S.P. Richards and United Stationers may face anti-trust
scrutiny.
Page 59
Precision Castparts (NYSE: PCP) - Long

Aaron Purcell Ben Hansen Yinan Zhao
APurcell16@gsb.columbia.edu BHansen16@gsb.columbia.edu YZhao16@gsb.columbia.edu
Recommendation
Capitalization Other Metrics
We recommend a long position in Precision Castparts Current Share Price (4/17/15) $201.15 Short Interest 2.4%
(PCP) with a two-year target price of $300, representing Shares Outstanding 141.8 52-Week Low/High $186 / $275
Aaron Purcell ’16 ~50% upside. PCP is a long for four major reasons: Market Cap $28,517
EV / FY'15 EBITDA 10.5x
Less: Cash ($430) EV / FY'16 EBITDA 10.0x
Aaron is a first-year MBA 1) PCP is the market leader in an industry with meaning- Plus: Debt $4,172 Price / FY'15 Earnings 15.8x
student in Columbia Busi- ful barriers to entry. Enterprise Value $32,259 Price / FY'16 Earnings 14.8x
ness School. Prior to CBS, 2) PCP has a history of best-in-class FCF generation and capital allocation with further opportunities for accretive M&A
Aaron worked in private and share buybacks.
equity at Riverside Partners 3) PCP’s end-markets benefit from strong secular tailwinds, providing confidence in near-to-midterm FCF generation.
after spending two years in 4) The opportunity exists due to recent negative sentiment regarding potential market share loss, which we believe to be
Citigroup’s technology unfounded but has provided an attractive entry point.
investment banking group.
He holds a BS from Business Description
Brigham Young University. Precision Castparts is the market leading provider of mission-critical metal components to the high-end aerospace market,
which accounts for ~70% of sales, primarily to commercial aerospace. The company generates $10 billion in annual reve-
nue and over $2.8 billion in operating income. It is a nearly $30 billion market cap company with only ~$3 billion in net
debt. PCP produces highly engineered, high-value metal components that are found all over airplanes, especially in the
engine, including nickel and titanium investment castings that go in the hot section of the engine, forgings that help encase
the engine, and airframe products that go on the outside the plane, such as fasteners that hold the plane together.
Investment Thesis
1) A formidable competitive moat
PCP has had significant success for over a decade due to the following three factors, which represent a formidable com-
petitive moat. First, PCP is fully entrenched in its customers’ ecosystems. The company supplies products to every major
airplane platform, including the 787 and A380. It is extremely expensive and difficult to try to build an airplane engine
Ben Hansen ’16 without PCP. A new entrant would need to wait several years for regulatory and quality approvals and would incur a sig-
nificant capital outlay to build scaled capacity. Second, PCP has dominant and stable market share, including 50% share in
Ben is a first-year MBA investment castings and the top market share in forgings. The company has maintained this position over the last decade-
student at Columbia Busi- plus with a combination of sole-sourced products, for which it has unique manufacturing capabilities, and defined market
ness School. Prior to CBS, share products, where it faces competition from other top players. Third, PCP is the low-cost leader in the space. The
Ben worked in private company has operated since WWII, and a combination of experience, a fanatical focus on cost reduction, and vertical
equity at Avista Capital integration helps it maintain this pole position. The numbers back up the durability of these advantages as PCP has been
Partners after spending the leader in operating margin, ROIC, RONA and FCF margin over a sustained period of time.
three years in UBS’s indus-
trial investment banking
5-Year Average EBIT Margin 5-Year Average ROIC 5-Year Average RONA 5-Year Average FCF Margin
group. He holds a BA from
Columbia University. 28% 14% 36% 14%
10%
Competitor
16% 9% Competitor
Avg: 13% Competitor 21%
14% Avg: 0.1%
12% Avg: 7%
Competitor 3%
9% Avg: 9% 3%
4% 4%
7%
4% 4%
-3% -3%
PCP Alcoa ATI/ Triumph Carpenter PCP Alcoa ATI Triumph Carpenter PCP Alcoa ATI Triumph Carpenter
Ladish
PCP Alcoa ATI Triumph Carpenter
2) Best-in-class capital allocator

Yinan Zhao ’16 PCP has been a phenomenal capital allocator and we believe this will continue through both M&A and share buybacks. PCP
has clearly demonstrated its ability to do accretive M&A in the past by leveraging its operating expertise to buy down
Yinan is a first-year MBA purchase multiples to levels that were effectively one-half to one-third of the stated purchase price. PCP achieved this by
student at Columbia Busi- driving significant synergies over a period of time that was often ahead of their original guidance.
ness School. Prior to CBS,
Yinan worked in equity Operating Margins – Before & After PCP Purchase
research at Susquehanna
International Group and Wyman Gordon (Forging) SPS (Fasteners) Special Metals (Vertical integration)
Merrill Lynch. He holds a Before After Before After Before After
BS from Stanford Universi- EV/EBIT 14.7x 12.7x 9.6x 8.0x 16.9x 14.6x 8.9x 5.5x 10.2x 3.6x 1.8x
ty. Purchase
Multiple 15.6%
16.7% 17.4% 22.0%
12.7% 12.8%
14.0%
9.2%
7.4% 7.6% 7.4%
5.0% 5.2% 5.6%
5.6%
1997 1998 1999 2000 2001 2002 2001 2002 2003 2004 2005 2006 2006 2007E 2008E
Page 60
Precision Castparts (PCP) - Long (Continued from previous page)

We feel that there is significant runway to continue to drive growth through M&A. Based on PCP’s guidance, conversations with industry experts and bankers
covering the space, the airframe structures market represents significant opportunity given its fragmentation. Another interesting area of potential is highly-
engineered components in the hot section of the engine that would allow PCP to expand its capabilities in a critical part of the engine. Based on these oppor-
tunities, we believe PCP is well positioned to continue to grow through M&A. However, the sell-side severely misunderstands this capital allocation story. PCP
generates significant cash flow and is very good at allocating that cash intelligently, but analysts are not modeling that in. For a company that has rarely had
more than $400mm of cash on the balance sheet, it is unlikely they’re going to build $2-6bn on the balance sheet going forward. We believe PCP will utilize
their cash and use both M&A and buybacks to continue to drive meaningful EPS growth. Our conviction is further strengthened by investing behind CEO Mark
Donegan, who is the driving force behind PCP’s status as a best-in-class operator and capital allocator. Even competitors speak highly of him. Indicative of
many conversations we had, one competitor told us that he was an “Outsider type CEO, hands down the best CEO in the space.”
$5bn
$4bn
$3bn
$2bn
$1.5
$1.3
$1.1
$1bn $0.9 $0.9 $0.8
$0.7 $0.7 $0.7
$0.1
$0bn
FY6 FY7 FY8 FY9 FY10 FY11 FY12 FY13 FY14 LTM FY15E FY16E FY17E FY18E
Dec 14
Cash Balance - Historical Cash Balance - Base Case Cash Balance - Consensus FCF Generation - Historical
Production Backlogs are at All-Time Highs

3) Strong secular tailwinds in key end-markets 10.0 60.0%
The last leg of our thesis rests on the robust secular tailwinds in the commercial aerospace market, 9.0
which give us confidence that PCP’s FCF will continue to be strong. As discussed earlier, 70% of PCP’s
50.0%
8.0
sales are tied to aircraft deliveries. Over the last 10 years, production backlogs at major commercial 7.0
6.0
40.0%
aircraft manufacturers have grown to all-time highs as orders have consistently outpaced deliveries to 5.0 30.0%
match rising global air travel demand. We see limited risk of a sharp pull back in deliveries, given the 4.0
delivery cycle is much less volatile than the order cycle and deliveries as a percentage of the worldwide
20.0%
3.0
fleet are only at average levels historically. 2.0
1.0
10.0%
0.0 0.0%
4) Destocking misperception
1990A
1992A
1994A
1996A
1998A
2000A
2002A
2004A
2006A
2008A
2010A
2012A
2014A
2016E
2018E
2020E
2022E
2024E
2026E
2028E
2030E
2032E
2034E
Despite these strong secular tailwinds, PCP shares have underperformed due to investor concern over Years of Production Backlog Backlog as % of World Fleet
slowing organic sales growth. Destocking further down the supply chain at Rolls-Royce, one of PCP’s Rolls-Royce $ Value of Engine Deliveries
largest customers, is the primary reason behind the weak organic sales. The issue emerged two years $16,000
ago and has not gone away. This, combined with the lack of a formal guidance program, has led to $14,000
21.6% CAGR from
2014A to 2018E
speculation among analysts about structural market share loss. Our diligence calls point firmly to de-
$12,000
stocking at Rolls, a poorly managed company, as the main culprit. Because of the complexity of the
aerospace supply chain, it is possible that different parts of the supply chain will experience the end of $10,000
Rolls' destocking at different times. Although there is some uncertainty as to when it might end, the $8,000
fact that a smaller competitor (Alleghany Technologies) indicated on its most recent earnings call that $6,000
Driven by a ramp up of the
Trent XWB and the Trent 7000
destocking was no longer an issue might be a positive sign that it could be over soon for PCP as well. $4,000
To be clear, calling the end of destocking is not critical to our core thesis. The strong trend of rising
$2,000
Rolls-Royce engine deliveries will more than offset any ongoing destocking impact.
$0
1995A
2005A
2015E
1991A
1992A
1993A
1994A
1996A
1997A
1998A
1999A
2000A
2001A
2002A
2003A
2004A
2006A
2007A
2008A
2009A
2010A
2011A
2012A
2013A
2014A
2016E
2017E
2018E
Valuation
PCP currently trades at a forward P/E of 14.8x versus a historical average of 17.4x. At today’s price, PCP is valued at 10.4x our F18 EPS estimate of $19.30 in
our base case. We value the existing business at $287 based on 15.7x F18 EPS. Additionally, we ascribe $13 of value to acquisitions done over the next five
years, assuming PCP is able to close $750 million worth of deals annually at 10.5x EV/EBITDA. Our SOTP price target of $300 in our base case implies a P/E of
15.6x, a very reasonable below market multiple to pay given the quality of the business. In addition to a bull case with 79% upside and a bear case with 10%
downside, we believe there is a leveraged recap opportunity that offers 87% upside. PCP has always maintained leverage at modest levels, but given the com-
pany’s steady mix shift towards aerospace, an industry with great sales visibility, we believe it can take a more aggressive approach to its balance sheet. We
view this opportunity as an embedded lottery ticket and estimate that a leveraged recap could result in over 20% accretion to F18 EPS.
Key Risks
We’ve identified several risks to our thesis but believe the overall risk profile is manageable. The emergence of another viable competitor could negatively
impact PCP’s market share. Engine OEMs have tried to develop smaller competitors into suppliers of scale. These efforts have largely failed however due to
poor yields and difficulty moving down the cost curve. A second major risk involves a push-out of aircraft delivery schedules due to a cyclical downturn, which
would negatively impact sales; however, as mentioned previously, our analysis indicates that deliveries are much less volatile than orders. As an example,
deliveries kept up through 9/11 even when orders cratered.
Get Involved:

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http://www.csima.org/
Contact Us:
mford15@gsb.columbia.edu Graham & Doddsville Editors 2014-2015
ppan15@gsb.columbia.edu
tschweitzer15@gsb.columbia.edu Matt Ford ’15
York-based long/short equity fund. Prior to Columbia, he worked as an analyst for Res-
ervoir Capital, Farallon Capital, and Bain Capital/Sankaty Advisors. Matt graduated from
The Wharton School of the University of Pennsylvania with a BS in Economics and BA in
East Asian Studies. He can be reached at mford15@gsb.columbia.edu.
Peter Pan ’15


Graham & Doddsville
Issue XXV Fall 2015

Inside this issue:
Omaha Dinner P. 3 Alex Sacerdote of Whale Rock Capital

Alex Sacerdote P. 6 Alex Sacerdote is the founder and portfolio manager of Whale
Rock Capital Management, a $1 billion global long/short equity
Columbia IIC manager focused on the technology, media and telecom (TMT)
Meeting Ideas P. 16 sectors. Prior to founding Whale Rock, Mr. Sacerdote was an
analyst and sector portfolio manager at Fidelity Investments.
Ed Bosek P. 22 He began his career in Smith Barney’s TMT investment
Jane Siebels P. 34 banking group, and also served as VP of Finance at Interactive
Imaginations, an internet advertising start up. Alex received his
Global Endow- MBA from Harvard and earned his BA from Hamilton College.
ment Management P. 38 Alex Sacerdote Alex currently serves on the Board of Trustees of Hamilton
Editors:
Ed Bosek of Jane Siebels
Brendan Dawson
MBA 2016 BeaconLight of Siebels
Scott DeBenedett
Ed Bosek is the
Asset
MBA 2016 founder and managing Management
Anthony Philipp partner of
MBA 2016 BeaconLight Capital, Research
a $250 million global
Brandon Cheong long/short equity Jane Siebels,
MBA 2017 fund. Before founding CEO of Siebels
Eric Laidlow, CFA Ed Bosek BeaconLight, Ed was Jane Siebels Asset
a partner at Atticus Management
MBA 2017 (Continued on page 22)
Benjamin Ostrow
MBA 2017
Global
Endowment
Visit us at:
www.grahamanddodd.com Rolf Heitmeyer Management
www.csima.info
Global Endowment
Management (GEM)
was founded in 2007
and manages $7 billion
Hugh Wrigley James Ferguson Andrew Burns for clients including
endowments,
foundations, and other institutional investors. Hugh Wrigley is a co-founder of GEM.
Previously, he served as Head of the Private Investments Group at DUMAC and as
Page 2

We are pleased to bring you the (AAPL), Amazon (AMZN), Ellie Hugh Wrigley, James Fer-
25th edition of Graham & Mae (ELLI), and NetEase guson, and Andrew Burns
Doddsville. This student-led in- (NTES). If readers are interest- from Global Endowment Man-
vestment publication of Colum- ed in hearing more of Alex’s agement discuss compensation
bia Business School (CBS) is co- views and perspectives, he will in the investment industry, the
sponsored by the Heilbrunn be presenting at the Boston importance of being able to
Center for Graham & Dodd Investment Conference on invest in smaller spaces, and
Investing and the Columbia Stu- Thursday, November 12. the risks inherent in transition-
dent Investment Management ing from analysis to manage-
Association (CSIMA). Ed Bosek of BeaconLight Cap- ment.
ital shares his perspectives on
Meredith Trivedi, the Since our Spring 2015 issue, the variant perception through Lastly, we continue to bring
Heilbrunn Center Director. Heilbrunn Center hosted the identifying Fundamental, Mean- you pitches from current stu-
Meredith skillfully leads the sixth annual “From Graham to ingful, and Different (FMD) dents at CBS. CSIMA’s Invest-
Center, cultivating strong Buffett and Beyond” Omaha ideas. Ed discusses his global, ment Ideas Club provides CBS
relationships with some of Dinner. This event is held on the generalist strategy, which al- students the opportunity to
the world’s most experi- eve of the Berkshire Hathaway lows his team to identify differ- practice crafting and delivering
enced value investors, and Shareholders’ meeting and fea- entiated opportunities to gen- investment pitches. In this is-
creating numerous learning tures a panel of renowned erate alpha on long and short sue, we feature three ideas
opportunities for students speakers. positions, and walks through from our classmates Nielsen
interested in value invest- current ideas including Daqin Fields ‘17, Justin Hong ‘17, and
ing. The classes sponsored In this issue, we were fortunate Railway (601006) in China and Alexander Levy ‘17: a special
by the Heilbrunn Center to speak with six investors from Builders FirstSource (BLDR) situation based paired trade
are among the most heavily four firms who provide a range in the U.S. incorporating a long position in
demanded and highly rated of different perspectives and Rentech Nitrogen Partners LP
classes at Columbia Busi- investment approaches. Jane Siebels of Siebels Asset and a short position in CVR
ness School. Management Research discuss- Partners (RNF, UAN), long
Alex Sacerdote of Whale es her unique exposure to Tenneco (TEN), and short Las
Rock Capital discusses his commodities from an early age Vegas Sands (LVS).
unique approach to technology and focus on opportunity funds.
focused investing. His S-curve Jane shares some thoughts on As always, we thank our
and competitive advantage the outlook for commodities interviewees for contributing
frameworks allow for the identi- and emerging markets, and also their time and insights not only
fication of companies with the explains her open outsourced to us, but to the investment
potential to exponentially in- research platform, another community as a whole, and we
crease their earnings power. He hallmark in her attempt to do thank you for reading.
also shares a number of compel- things differently.
ling ideas, including Apple - G&Dsville Editors
the Faculty Co-Director of
the Heilbrunn Center. The
ous academic curriculum for
tioners.
Mario Gabelli ’67 shares his Meredith Trivedi with Professor Bruce
experiences as a panelist at the May 2015 Greenwald at the Value Investing
Omaha Dinner Program Welcome Reception
“From Graham to Buffett and Beyond” Omaha Dinner 2015
Mario Gabelli ’67, Bill Ackman, Tom Russo, and Tano Panelist Bill Ackman shares his views at the Omaha
Santos speak on the Omaha Dinner Panel Dinner
Budge & Carol Collins. Budge serves on the Heilbrunn Board of Overseer Member and Pershing Square Capital
Center Advisory Board Partner Paul Hilal ’92
Former Heilbrunn Center Director and current Special

Industry Advisor Louisa Schneider ’06 & Mario Gabelli ’67
Page 4
Columbia Business School Events:

Pershing Square Challenge and Value Investing Program Welcome Reception
Pershing Square Challenge finalists pitch their stock to Michael Herman ’16, Bill Ackman, and Damian Creber
the panel of judges ’16 after the Pershing Square Challenge presentations
Pershing Square Challenge judges listen intently to CBS Students mingle at the Value Investing Program
student pitches Welcome Reception
Bruce Greenwald speaks with students and alumni at the

Value Investing Program Welcome Reception
SAVE THE DATE

January 29, 2016

investors in the industry, presented by:
and
Visit our website for updates: http://www.csima.info

Alex Carrington RCarrington16@gsb.columbia.edu
Jason Klein JKlein16@gsb.columbia.edu
Stephen Lin SLin16@gsb.columbia.edu
Page 6
Alex Sacerdote
College and Shady Hill some cases they knew as much matter of time before they
School, and is active on or more than even the expanded beyond books.
their investment management teams. If you are
committees. really intellectually curious and At the time Amazon was very
you want to spend 90% of out of favor, and I made a 25
Graham & Doddsville your time critically thinking, page presentation to the entire
(G&D): Can you discuss your the buyside is where you want equity department advocating
background and your path to to be. that Fidelity buy shares in
investing? Amazon. I think half the
At the same time, the internet investment team thought I was
Alex Sacerdote (AS): I’ve revolution was just beginning. I crazy because of the high
been interested in the stock decided to work for an valuation and losses, but some
Alex Sacerdote market from an early age. In internet advertising start up in people must have liked the
the early ‘80s, my father New York City in 1997 before analysis because I got the job
bought each of me and my two going to business school. The at Fidelity, and that's how I got
siblings a share of Apple and I company, Interactive into the business.
watched it incessantly and was Imaginations, actually
delighted when it split three pioneered the concept of the I spent the next six years there
for one. Although I was too ad network. It gave me a as an analyst and sector
young to understand that I had deeper understanding of portfolio manager primarily
not tripled my money. In the internet based businesses, and focused on technology. It could
second grade I distinctly there were a handful of other not have been a better training
remember doing a report on publicly traded internet ground. First, there were so
the stock market with crude companies like AOL and many great investors to engage
stock charts. Yahoo that I carefully followed with and observe: Danoff,
and invested in on my own. Wymer, Tillinghast with his
Out of college, I started out as unique brand of value, and
an investment banker in the So at business school I Myers, who actually started in
Tech, Media, and Telecom targeted buyside opportunities my intern class back in 1999. It
Group at Smith Barney. It was and secured a summer was a very individualistic place
a boot camp-like experience in internship at Fidelity. I was with so many different styles
which I really learned the very fortunate because Fidelity and processes. I also got some
mechanics of finance. We were provides their interns with a nice time with Peter Lynch
active with M&A deals, IPOs, tremendous amount of who loved to mentor younger
and high yield offerings across responsibility. They said to me, analysts. His temperament,
a range of subsectors from “There is this new thing called curiosity, and love of the craft
media, software, and wireless the Internet. You know were amazing. I've read his
to semis, so it was great something about this. Why book several times. You also
exposure. don't you cover e-commerce get great exposure to
for the summer?” I was in management teams and a
But my initial interactions with heaven. I travelled the country chance to really master your
buyside investors led me to visiting the roughly ten industry and the confidence
believe that was the place for internet companies that were that comes with that. Finally,
me. During our roadshows for public at the time and met the you get the chance to run
IPOs and high yield offerings, CEOs and founders. I was able money pretty early on to hone
we brought our management to attend Amazon’s first your skills and investment
teams to a number of buyside investor day and had lunch style.
institutions. The buyside with Jeff Bezos. He had the
analysts across the table at the same laugh back then too! By Ultimately, I decided to go out
big firms like Fidelity were meeting with the companies on my own. Fidelity was really
roughly my age, but they were and studying them carefully, I about running large pools of
much more knowledgeable came to the conclusion that capital diversified across
about the industry, even Amazon was going to run the industries, and I viewed myself
though I had been working on tables and win in e-commerce as a tech specialist. In the
the deal for three months. In in a big way, and it was only a technology sector, it’s
Page 7
Alex Sacerdote
important to be a specialist. wealth creation in the internet are removed, and the
The long/short format is great sector over the past 20 years. technology moves on the S-
for TMT because there are By some measures, it is $2 curve from the early adopter
always winners and losers, and trillion in wealth. As phase into the majority phase.
the ability to short can dampen technology goes deeper and At that point a massive wave
inherent volatility. deeper into society and of demand kicks in, and you
spreads around the globe, can see three to four years of
But throughout all these there is a chance this wealth incredible unit growth.
experiences and from an early creation accelerates. I had the
age, my father was clearly the opportunity to watch some of Everybody says tech is so
biggest influence on me. He this play out over the past few unpredictable, but if you
was a great role model both as decades. I started to realize understand the way S-curves
an investor and a human being. that there are three common work, it actually can be quite
He had a wonderful career in characteristics of great winning predictable during certain time
finance at Goldman Sachs as periods. You are able to
head of Corporate Finance and understand how fast units
then Chairman of the Private “It can be tricky to might grow over a three to
Equity group. He represented five year period. In analyzing
the old guard. He was a true invest in the tech the S-curve, it’s important to
gentlemen and was known for assess both the slope of the
sector. There is
his keen intellect, leadership, curve as well as the height of
and mentoring. Not many constant change, the curve.
bankers are known as great
investors, but he certainly was. brutal competition, One example of an S-curve
He chaired the credit and was flat panel TVs. Flat panel
investment committees there price deflation and TVs came out in 2000, but the
for more than two decades products were very expensive
and kept them out of a lot of often high and and there was no HD content.
trouble. He was an electrical However, by 2005, the price of
“bubble" like
engineer from Cornell and was a 40 inch flat panel TV fell to
smart as a whip and could valuations. At the $1,500. Monday Night Football
instantly get to the heart of and other high quality HD
any issue, but he always same time, it’s clear programming was available on
exhibited humility and TVs and the demand just
graciousness. The best thing that there has been exploded.
about my father was that he
was such a great mentor to so massive, large scale We went from 2 million units
many and when he passed to 50 million units in a four
wealth creation in the
away in 2011, I received year period. It was clear that
countless letters and stories internet sector over once flat panel TVs hit the
about this. mainstream, you were going to
the past 20 years. ” get this incredible unit growth
G&D: Identifying S-curves is that you just don't get in any
an important part of your other part of the economy.
process. Can you talk about technology stocks that
that? produced this wealth. The most famous recent S-
curve is the smartphone
AS: It can be tricky to invest The first characteristic relates adoption cycle. Smartphones
in the tech sector. There is to the S-curve of technology were actually out in the 1990s,
constant change, brutal adoption. All technology but they were clunky, internet
competition, price deflation adoption starts very slowly. It access was unreliable and
and often high and “bubble" can be held back for a variety there were no real apps or any
like valuations. At the same of reasons: high price, complex features we commonly
time, it’s clear that there has products, lack of an ecosystem. associate with smartphones
been massive, large scale At some point, these barriers today. Apple changed that and
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Alex Sacerdote
you went from one percent might exhibit really strong but HTC, RIM, Nokia,
penetration to 50% in a five competitive advantages. Motorola, and LG destroyed
year period. This became a value. Several went bankrupt
billion unit market and this is G&D: Is it hard to assess and didn't make a dime out of
well known now but at that competitive advantage during the smartphone S-curve.
time you’d be shocked at how rapid growth? The rapid
Former CSIMA Co-
few people truly grasped this. growth may obscure what will Investors have occasionally
President Brian Water- eventually be fierce grown skeptical of Google’s
house and current CSIMA Understanding where a competition. competitive advantage. During
Co-President Damian technology sits along the S- our research of Google
Creber ‘16 discuss invest- curve and if you are nearing AS: Growth investors will roughly five years ago, we met
ments with H. Kevin Byun that inflection point is occasionally find an attractive S with Microsoft's head of
’07 of Denali Investors powerful. The inflection point -curve, but the important piece search. Despite Microsoft
not only creates incredible unit really is competitive advantage making a huge push, it was
growth, but it also reduces risk and operational abilities. clear that even Microsoft’s
because one of the biggest Finding that competitive search team realized the
drivers of tech company advantage, understanding it, tremendous uphill battle they
failures is faltering demand or appreciating it before other were fighting. We developed a
demand well below people, and developing a more new appreciation for Google
expectations. It’s very hard for in-depth understanding of its given that Microsoft, one of
that to happen in the middle of strength are really important the most valuable companies in
an inflection point on the S- the world, could not
curve. successfully enter the market.
“When you have an S-
Sometimes understanding the S We're constantly looking for
-curve can help you time your curve in combination similar stories to illustrate
exit as well. When adoption competitive strengths.
gets close to 50%, growth can with a really strong Microsoft invested several
rapidly decelerate. billion dollars for multiple
competitive years to take share in search,
G&D: You have important advantage, the and they have 15-20% of the
parts of your process beyond US desktop search market.
the S-curve. Do you want to earnings can grow Google has 60-70% in the US
expand on those? and 80-90% share in most
exponentially...Apple's other geographies around the
AS: When we find an world.
attractive S-curve, the next earnings per share
thing we do is search for We think they can sustain this
companies benefiting from the went from $0.50 to $9, advantage because of their
S-curve that have strong Priceline’s earnings massive scale, significant R&D
competitive advantages. Tech budget, and so many other
can be brutally competitive, went from $2 to $40, pieces throughout the sales
but, occasionally, a company channel. Their ability to add
can emerge with a near and Tencent’s went adjacent markets on top of
monopoly. There are many search with Android gives
subtle factors within from $0.12 to $2.58.” them a further advantage.
technology ecosystems that
create powerful competitive G&D: The last characteristic
advantages. On the internet to us. Just about every e- you evaluate is valuation?
it’s about network effects, in commerce company I
software it’s about coalescing evaluated in the Fidelity report AS: Right, we don't just invest
around standards like PC in the late 1990s is gone, blindly when we think we have
operating systems. So we except for Amazon. In found a winner. We need to
spend time assessing smartphones, Apple created see long term under-
companies within S-curves that half a trillion dollars in wealth appreciated earnings power.
Page 9
Alex Sacerdote
When you have an S-curve in 100% penetration among world catches onto the story
combination with a really recruiters at early adopters and it is no longer under-
strong competitive advantage, like Microsoft and Google. And appreciated based on long
the earnings can grow yet most Fortune 500 term earnings power. This
exponentially. This happens companies were just beginning happened with LNKD and
more frequently than you to adopt it. Our research also within a year and a half it hit
might think. Apple's earnings suggested that they would have our target. Also, the company
per share went from $0.50 to pricing power. launched a few new products
$9, Priceline’s went from $2 to that didn’t receive significant
$40, and Tencent’s went from We also spent time assessing adoption. That, combined with
$0.12 to $2.58. If a company is LinkedIn’s market penetration, the rapid share price
experiencing strong unit which can be a challenging appreciation caused us to be
growth and a competitive statistic to calculate. We asked more cautious on our outlook.
advantage prevents price questions like what is annual Another good example is
compression, the company will employee turnover, how many Apple (AAPL). We have been
grow revenue rapidly and will businesses are there of various big Apple bulls for a long
be able to leverage their headcount sizes, what period of time. In 2012, US
expense structure. That’s what industries have a lot of smartphone penetration hit
produces exponential earnings turnover that are more white 50%. The 50% level starts to
growth. If we have a lot of collar oriented. We came to make us nervous. Adoption
confidence in both the S-curve realize that LinkedIn was will begin slowing down. Apple
and the competitive position, maybe 3% to 4% penetrated, also had started to lose share
we are able to model out the but it was definitely hitting the in 2012. We were hoping
business with a high degree of mainstream. Android would fragment which
confidence and ensure we are would hurt the Android
buying at reasonable long term We determined that there was ecosystem, but by 2012, it was
multiples. probably $8 per share in clear that Android was here to
earnings power. At the time stay. The idea that Apple could
A great example was LinkedIn many people said, “I like potentially fully run the table in
(LNKD). They came public in LinkedIn, but it's so smartphone software was no
2011. We really liked their S- expensive.” For us, it was a longer a possibility. And lastly,
curve. They have 3 businesses, bargain. Our price target was we were previously well ahead
and the most important one is almost 2.5x what the stock of Wall Street on our EPS
their talent management was trading for based on a 30x expectations, even 100% in
business. LinkedIn has a fully multiple of our $8 estimate of some cases, but the world had
updated database of almost earnings power. There are a caught up to us.
every single white collar lot of reasons we thought it
worker in the United States would still trade at 30x even So the S-curve was not a green
and beyond. We realized this three or four years out light anymore. The competitive
was a huge game changer. because if you look at other advantage was very good, but
Before recruiters were relying subscription or information not getting better and maybe
on two solutions: Monster, a database businesses like getting slightly worse. And
resume database of Factset or CoStar, they still third, the under-appreciated
unemployed people, and head have very high multiples, even earnings power had become
hunters, a really expensive with low single digit revenue appreciated. We exited the
option. It was so superior to growth rates. position at that point.
the existing solutions that we
knew it would see widespread G&D: Can you discuss your G&D: What is your current
adoption. decision making process to positioning with regard to
exit? Apple?
We attended a number of
human resources trade shows AS: Sometimes share prices AS: There have been a lot of
and spoke to 50 or 60 reflect the potential future developments since our exit.
recruiting companies and scenarios we are envisioning But last year we came back in.
found out that LinkedIn had for a company. The rest of the The idea that Apple’s value is
Page 10
Alex Sacerdote
in their platform not their record and some simple not own cars and only use
hardware was strengthened assumptions, it can actually be them in an on demand fashion.
with the launch of the Apple additive to the share price That likely reduces the role of
Watch, the App Store growth, today. If you assume Apple design and likely favors Google
their innovations in payments, achieves 3% market share of over Apple. How do you think
and the TV product. None of the car industry, sells units at about that?
those on their own are big an average price of $75k, and
enough to double the earnings achieves gross margins in line AS: There are still a lot of
of the company, but if iPhone with Porsche, this could unknowns in cars. I think our
can still grow 5% to 10%, the actually move the EPS needle vision for Apple’s car is a four
addition of those four things in a big way even for a to five year vision while
might get to 20% growth. And company of this size. Benedict’s may be even longer-
even if iPhones are flat, these term. I think we still have a
other segments might have a We think Apple has the track long time before autonomous
potential to drive 10% growth. record and scale to be driving is mainstream, so
successful. Tesla has already people will be buying cars like
We remain pretty excited demonstrated that the barriers they normally have for some
about the App Store. Gaming to entry are not time and even when they are
revenue and app revenue are insurmountable. Apple can autonomous people likely will
starting to become meaningful afford to invest billions in R&D want their own.
for Apple. It might be just without endangering the
under 10% of profits, but it’s company, which only a few I don't want to give the
growing significantly faster. companies can say. impression that I'm super
That stream of earnings should bullish on Apple being a home
command a premium multiple It's not an important part of run success in the car market.
as well. When Tim Cook made our thesis and we’re not But over the coming years, I
the announcement that their counting on this but if it kicks think other investors will begin
sales in China were in, that could double the P/E of to appreciate that there may
progressing well even in the the stock from an absurdly low be more potential for an Apple
face of the stock market crash, level, roughly 10x. It wouldn’t car than they previously
he cited the App Store as be crazy to see it at a P/E of expected.
having record revenues there. 15x or even 18x. The other
aspect is capital allocation, G&D: You have mentioned a
Lastly, many people laugh at which generally is not a large handful of frameworks you are
the idea of an Apple car. They driver in our typical looking for with regard to
think it is way out of Apple's investments because we competitive advantage. Are
realm, but the fact is, there is a typically focus on companies in there any other common
lot of change in the car. It is their growth phase, but with situations you gravitate
becoming a supercomputer on Apple as a somewhat mature toward?
four wheels with millions and company, it can be a really
millions of lines of code, great way to improve stock AS: We like it when
hundreds of semiconductor performance. They're doing companies become industry
chips, visual graphical user the right things there. standards. We already
interfaces, high quality audio mentioned Microsoft, but
and video output, wireless G&D: Benedict Evans of Oracle is another obvious one.
entry with your phone, and venture capital firm Oracle’s position within the
there is even the driverless Andreessen Horowitz agrees relational database has
possibility in the near future. that barriers to entry are translated to an excellent
There's no doubt that an coming down and that the car competitive position.
Apple car is a long way away market is really the only Everybody has been trained on
and analyzing the potential market that can rival phones in it, a number of other software
value of such a business is terms of total value. However, programs were integrated with
difficult. However, Apple is he points out that autonomous it, and the companies that had
investing heavily in the car driving is a negative trend for adopted it were reluctant to
business and given their track Apple. It means we likely do change given the mission
Page 11
Alex Sacerdote
critical nature of certain Their customers today are AS: Short ideas can fall at any
databases. generally smaller mortgage point along the S-curve. The
companies, but the Big 6 classic is the maturing
Another good example is Ellie mortgage players like Wells industry, but you don't want to
Mae (ELLI), which we feel is in Fargo have not yet adopted it. just short companies at the top
the process of becoming an These companies represent of the S-curve. We would also
Faculty Co-Director of the industry standard. They 200k of the 600k in industry like the company to be losing
Heilbrunn Center Tano provide a Software as a Service headcount. To date, they have their competitive advantage
Santos welcomes a student offering for the mortgage used their own systems, but and have over-estimated
to the Value Investing Pro- industry. The process of filing a they are client-server based, so earnings power, which is
gram mortgage in the US is we think there is a good essentially the opposite of
incredibly paper and time chance that Ellie Mae could get what we look for on the long
intensive. There are all kinds of one of them to sign up as a side. Newspapers were an
different players in this customer. This would be a interesting example where the
ecosystem and layers upon huge accelerator to the growth industry had been mature for a
layers of regulation. Mortgage rate. Their current margins are long period of time, but then
lenders basically do not have the internet came along and
the technical competencies to “[Ellie Mae’s] value significantly eroded their
design a technology solution competitive advantage. That’s a
that keeps up with the
proposition is obvious. classic short we would look
regulations and the paper and There are fewer for.
time intensive steps in the
industry. The value proposition mistakes, lower costs, We like looking for companies
is obvious. There are fewer without competitive
mistakes, lower costs, and and streamlined advantages as well. We
streamlined processes saving mentioned all the losers in the
time and money. You protect processes, saving time smartphone game as well as in
yourself against regulatory and e-commerce. Another area is
compliance risks. We think
and money […]We technology in the early phase
Ellie Mae will become the think Ellie Mae will of the S-curve. These
common cloud for the technologies can get really
mortgage ecosystem almost become the common overhyped. Electric cars a few
like Bloomberg is for financial years ago were a good
professionals. There are cloud for the mortgage example. There was a
600,000 mortgage company called A123 that was
professionals in the US. ecosystem almost like perceived to have an excellent
The industry’s S-curve has position. They claimed they
recently started accelerating
Bloomberg is for had proprietary battery
for secular and cyclical financial technology and some high
reasons. Underinvestment in percentage of cars would
technology by mortgage professionals.” eventually be electric, so their
lenders during the housing earnings power would be
downturn means lenders are around 20%. We think they significant. The company
being forced to adopt Ellie can double or triple sales and ultimately went bankrupt
Mae. have 40% operating margins. because the barriers to
This is a company we are still adoption were still significant
They are growing subscribers excited about even though it and they had no competitive
at 30% per year, and revenue has been a successful stock for advantage in a commoditized
per subscriber is also growing us so far. battery market. There were no
as subscribers adopt more good OEMs using their
features and modules. This is a G&D: Can we discuss technology, and there were
recurring revenue business and shorting? Do you also use your still concerns about electric
we think Ellie Mae will be hard S-curve framework in car range. It was just too early
to displace. evaluating shorts? in the S-curve ramp.

Page 12
Alex Sacerdote
G&D: Have there been have incredible management strategic M&A, executing and
situations where you were teams, so it makes sense for us building the culture of the
bullish on a company in the to spend time with them. company, and he also has that
beginning of a growth phase, broader vision of connecting
but transitioned to a short G&D: Have you come across the world.
when the thesis played out and any management teams that
other investors continued to you think are especially If you compare Facebook to
extrapolate the great results? underrated? Twitter, so much of the
difference is execution. I think
AS: Sure. Certain companies AS: He is not exactly Facebook is a better asset
have incredibly powerful and underrated, but I think Mark because frequency of use is
durable competitive Zuckerberg is higher and it’s more broadly
advantages, while other underappreciated as a adopted, but if you talk to
companies might have a businessman. He saw earlier advertisers, even Facebook’s
competitive advantage that ad systems are more robust
only lasts two or three years. than Twitter’s. Facebook has
This is often the case in an impressive ad platform and
semiconductors. One of the “We think [Amazon’s distribution and sales process. I
few ways we found to play the think he's done a tremendous
flat panel TV S-curve was a AWS division is] a job there.
chip company that made an
image processor for the TV. leader in a market Another CEO is Jeff Bezos of
They had 15% share going to that represents $500 Amazon (AMZN). He is not
30% share in a period when underrated either but he
units were growing from 2 billion in annual deserves even more praise
million to 50 million. The than he gets. Most CEOs might
problem is the Chinese or spending. They are accomplish one great thing,
Taiwanese end up reverse which would’ve been the retail
engineering the chip. In those focused on the public operation for him. He now has
cases, you have to be really on helped create a second
top of it to know how long the cloud, which we think massive opportunity with
advantage can persist. is the biggest AWS.
G&D: It’s clear that Whale opportunity in all of I think Amazon's e-commerce
Rock travels pretty extensively business is pretty well
and that management meetings IT.” understood. I think the main
are a key part of your process. misunderstanding with regard
Can you talk about this? to Amazon is AWS. I think
than anyone else how valuable Amazon shareholders know it
AS: Yes, we do 1,000 face to Instagram and WhatsApp is an interesting opportunity,
face meetings a year despite would be. Both assets have but I don’t think they fully
being only a team of five. I tremendous value. He also understand what they are
think we travelled something moved quickly on virtual sitting on.
like 250k miles last year. We reality. There are indications
go to Asia three or four times today that VR could be a G&D: Can you explain the
a year. We recently travelled mainstream medium. He found AWS opportunity to us?
to India to meet with 30 a management structure
private and public Indian enabling him to focus on the AS: We think they are a
internet companies. long term future of technology leader in a market that
while Sheryl Sandberg and represents $500 billion in
Within our framework, we do other incredibly talented annual spending. They are
not specifically include professional management can focused on the public cloud,
management quality, but it focus on the business. He which we think is the biggest
does tend to play out that seems quite skilled at opportunity in all of IT. It will
these great companies often delegating and hiring, acting on encompass spending on
Page 13
Alex Sacerdote
servers, storage, networking, similar to Coke and Pepsi more in an attempt to improve
systems management, related except there is no Pepsi. A the competitiveness of Google
services, and several other recent study we reviewed Compute. Amazon
areas that aren’t even fully suggested that 50% of immediately responded with a
developed yet. customers use Amazon, 10% similar cut. And they have cut
use Azure, and Google is not price essentially every year.
The FAA recently completed a particularly relevant. Another But we haven’t seen a big
large transformational deal interesting insight was that the dramatic move recently, so
with Amazon. They will be customers using Amazon have AWS is growing revenue in
spending $100 million per year much higher volumes than the line with usage and achieving
with Amazon, and that will not average customer. The usage high teens margins, but pricing
even be their entire IT budget. differential can be 10 to 1, or could see another significant
That's about 50 basis points of more. cut in the future.
their budget. That gives some
indication of the scale of the The software lock-in is not on Given how impressive the
opportunity. It’s not hard to the same level as a Microsoft moat is, that switching costs
envision a majority of global operating system, but it's will only increase in the future,
companies spending 50 bps of enough to where you don't and the fact that they are
sales on AWS. Even with all want to switch providers. Your already making 20% margin, I
the discussion of cloud activity team is trained on it and they think ROIC will likely be very
and the movement to the become familiar and efficient good. Moore’s Law should also
cloud over the last six or with the tools of AWS. help them lower the capital
seven years, the amount of intensity per unit of server
compute that's done on AWS Even if it were a commodity, capacity.
is 2% to 3% of the world's AWS would be 10 times the
compute. It’s really just getting size of the next biggest We think half of all compute
to the mainstream now. competitor anyway. The scale will be in the public cloud
of AWS gives it a big advantage versus 3% today. Bezos draws
We think the S-curve has the in unit costs, but it also allows the analogy to the old days
potential to last 20 years. AWS to invest significantly when corporations had their
These big shifts in enterprise more in R&D. We are hearing own power plants before we
IT happen once every two that AWS has some of the best eventually developed
decades with mainframes in computer scientists in the centralized utilities. We think
the ‘60s and ‘70s, client server world working as part of their AWS could wind up as the
in the ‘90s up until now, and team. They added 350 features equivalent of a centralized
the public cloud will be the this year. Last year it was 100 utility with 50% to 70% market
next one. and what we're hearing is share around the entire world.
they're pulling away from the We are convinced this is going
On competitive advantage, competition in terms of to be an extremely valuable
most investors think that the features and additions. business. The stock is getting
public cloud is a commodity credit for it now but we still
business. The reality is that G&D: What about overall think people are missing how
AWS is pretty sticky due to returns on capital? Bezos has big the opportunity is and how
the whole software layer on cited the capital intensity of thoroughly Amazon will
top, 10 different flavors of AWS as one of his worries. dominate it. It’s a large
storage, systems management position for us now and it
containers, all kinds of AS: That is a big question that continues to amaze me how
software that increases we have spent time thinking one company has been able to
switching costs. about. We have analyzed position itself so well for two
server costs, required data of the largest business
They're the biggest player and center capex, and AWS unit opportunities of our
they are out-investing the pricing by service. One part generation in e-commerce and
competition. We have spoken that is challenging to predict is the public cloud.
to a couple hundred users of pricing. Within the last 2 years,
AWS and they say that this is Google cut price by 50% or G&D: You have an interesting
Page 14
Alex Sacerdote
thesis on gaming. Would you company, for years. It has a NetEase was early to
like to discuss that? very high quality management appreciate the potential of
team. The CEO, William Ding, mobile gaming. Two years ago,
AS: We own companies owns 50% of the company. He they started developing mobile
related to traditional console does not spend time talking games and thinking of ways to
video games as well as with sell-side analysts, he is take their great IP from PCs to
companies benefiting from the very focused, and he has mobile. They recently launched
Students enrolled in Ap-
plied Security Analysis at- mobile S-curve. On one of our essentially built the Activision a mobile game, Fantasy
tend the Pershing Square trips to China two years ago, I of China. The company has Westward Journey Mobile. We
Challenge Finals noticed a teenager on the grown their net income from have been tracking it actively.
subway who had a really big $50 million to $700 million in Our interns on the ground in
phone and was playing a really PC gaming. Their PC gaming China have been visiting
intense game. It started to Internet cafes and we have
become clear to me that different ways to track app
mobile gaming would “Some stock picking store activity. Our research
eventually be huge. It has been suggests it is the number one
very hard for companies to can be trained or game in China. We think it
effectively monetize mobile will generate about $1 billion
games. The screen sizes were learned but there may in revenue. To put that
much smaller and the graphics revenue figure in context, the
power in mobile CPUs were be an innate aspect to company generated around
much weaker so the only $2.6 billion in revenue last
games that succeeded in any it — an inherent year, so it is a very meaningful
way were very casual games. savviness, contributor. They have several
The casual games tended to other mobile games in the
have relatively short lives, contrarianism, and pipeline that could deliver
posing additional difficulties to additional upside.
effective monetization. creativity in thinking. I NetEase has appreciated in the
last six months, but we still
What we are now seeing is view it as a willingness, think this is the best
very positive for mobile gaming opportunity for playing the
monetization. With bigger if not a passion, to mobile gaming S-curve.
screen sizes and better challenge the status
graphics, you can have games G&D: And the console gaming
with richer stories that require quo or vehemently opportunities?
a much larger development
team. These developments argue other AS: Everybody thought mobile
favor scale players. On top of would kill the console. That is
that, these PC games have viewpoints, coupled not happening at all. The
millions of players to the point console has remained strong
that it is similar to a social with a flexibility and due to the connection to the
network. Virtual goods can be openness to adjust to internet and the ability to
purchased for low price points generate recurring revenue
but the user base is so large it new facts.” through downloadable content.
can be meaningful revenue. A The popularity of certain
Japanese gaming company, console games has continued
GungHo, launched a game that revenue is an attractive base of to increase massively. The
generates over $1 billion in recurring revenue supported margins have generally
revenue. It’s been going for by long duration franchise increased as downloadable
two or three years now, and games. The value proposition content has high incremental
there are no signs of it going to the customer is very margins without any margin
away. compelling. It works out to shared with retailers.
roughly 2 cents per hour of
We have followed NetEase game play. We see it as a big renaissance
(NTES), a Chinese video game (Continued on page 15)
Page 15
Alex Sacerdote
for the gaming industry. The thinking. I view it as a we do at Whale Rock can be
console market is now more willingness, if not a passion, to found in this book. And finally,
lucrative and mobile is opening challenge the status quo or I can't leave out The Tao Jones
up a potential new market for vehemently argue other Averages: a Guide To Whole-
them. We are looking for viewpoints, coupled with a Brained Investing by Bennet
companies with great IP that flexibility and openness to Goodspeed. The thesis of the
can now use that IP in other adjust to new facts and book is that Wall Street and
ways that might not be information. You have to love academia favor and attract left
appreciated. We think learning and really get excited brain thinkers who are good at
Electronic Arts (EA) has done when you gain conviction in a linear thinking and can crank
a fantastic job with FIFA and theory. You have to be a through problem sets
NFL Ultimate Team. sponge for information and quickly. But to really spot big
ready to learn from anyone or inflections and change (where
G&D: Do you have any advice anything. the real money is made),
for Columbia students looking especially in technology, it’s
to enter the investment Munger talks about how often the domain of the right
management industry? Warren Buffett is a learning brain which is more spatial and
machine with his constant intuitive. Right brainers can
AS: I think you have to be in reading. At Whale Rock we connect dots from seemingly
the business for the right talk about this concept of the disparate sources to put the
reasons. It's really important to learning machine and how we whole picture together.
be very curious and have a can become better learners
passion for investing because individually and as a team. It’s I also encourage students to
there are so many people out not how many brain cells you invest on their own. It doesn't
there competing with you. It’s have, it’s how the synapses fire have to be a lot of money, but
really important to love what together and this is why we if you do it on your own
you are doing. focus a lot on effective account, you will learn a great
communication within the deal.
In this business, it's not about team. We spend a lot of time
sheer brain power, SAT collecting data, but much more Lastly, if you are trying to
scores, or an MBA from a important is developing enter the business, make sure
leading business school. Those insights from it and building it you have two or three reports
factors help and of course are into our collective thinking. on companies you really like
nice to have, but they do not with supporting models and a
guarantee success by any Also, for those interested in well-articulated thesis. It’s
stretch. I've worked closely investing, there are a lot of important to demonstrate that
with scores of investors across really helpful books that you you can really do the research.
roles and across strategies in can read. My favorite for
my career, and really a small growth investing is Common G&D: Thanks so much for
percentage are truly gifted and Stocks and Uncommon Profits by your time, Alex.
able to generate alpha over Philip Fisher. It is essentially
long periods of time. I've the Bible of growth Investing.
thought a lot about what Philip Fisher was doing this in
characteristics these people the 1950s and almost
have in common which I think everything he says in that book
may be important for your is true today. In the book, he
younger readers to consider if outlines 15 elements of a great
buyside public markets are the growth stock. When I read the
right path for them. book, I was amazed at how
similar it was to our process
Some stock picking can be for conducting research.
trained or learned but there
may be an innate aspect to it The Gorilla Game by Geoffrey
— an inherent savviness, Moore is the best book on
contrarianism, and creativity in tech investing. A lot of what
Page 16
Merger Arbitrage with Special Situation Spin-Off

Long RNF/Short UAN
Nielsen Fields, CFA
nfields17@gsb.columbia.edu
Executive Summary
 Rentech Nitrogen (RNF), a publicly traded variable rate fertilizer MLP, is selling its East Dubuque, IL facility to
competitor CVR Partners (UAN). RNF holders will receive 1.04 shares of UAN, $2.57 in cash, an estimated
$0.23 of incremental distributions, and continued ownership of the Pasadena, TX facility which will be either
Nielsen Fields ‘17
sold or spun-off prior to close of the transaction.
Nielsen is a first year MBA
 The market, pricing RNF shares at $12.00, fails to recognize positive incremental value through the distribu-
tion disparity between RNF and UAN while also ignoring additional value accretive to RNF shareholders
School. Prior to CBS, Nielsen
through the sale or spin-off of the Pasadena facility – an ammonium sulfate producing facility likely worth be-
was a Co-Portfolio Manager
and Senior Analyst at Summit tween $0.77 and $2.25 per RNF share.
Global Management, a long  By going long RNF shares and shorting the necessary number of UAN shares (1.04 per RNF Share) the inves-
biased hedge fund. tor can create a net position for roughly $2.00. At close, the investor will receive UAN shares in the amount
to cover the short, $2.57 in cash, net incremental distributions per share of $0.15, and any value created
through the sale or spin-off of the Pasadena facility worth a probability weighted value of $1.43. In total, the
investor accrues $4.14 in cash on a $2.00 net investment.
Relevant Statistics
RNF UAN The Offer
Price $12.00 $9.63 UAN Price $9.63
Shares Outstanding 39m 73m UAN Shares/RNF Share 1.04
% Free Float 40% 46%
Value in Shares $10.02
Majority Owner Rentech (RTK) Icahn Ent (IEP)
Cash Per Share $2.57
Liquidity Statistics
Total Offer Value $12.59
Avg Daily Volume 145k Shares 230k shares
Avg Daily Value ~$2,000,000 ~2,500,000
50% of Volume $1,000,000 $1,250,000 Unrecognized Value
Pricing Prior to Deal Announcement Net Expected Distributions $.15
Day Prior Price $10.30 $10.69 Pasadena Expected Value $1.43
30 Day VWAP $13.56 $12.40 Total Additional Value $1.58
Deal Rationale
Parent Rentech (RTK) a Forced Seller
 Rentech is transitioning from an alternative energy business to a wood fiber business
 Leverage grew substantially with debt, financed by GSO Credit Partners, to fund wood fiber expansion
 RTK needed to monetize RNF ownership to pay down debt and fund rising wood fiber expansion costs
 New CEO focusing entire organization on wood fiber business versus operating two disparate businesses
CVR Partners a Motivated Buyer
 CVR Partners input is petroleum coke vs Rentech Nitrogen’s input of natural gas
 CVR Partners’ facility is located in Coffeyville, KS while Rentech Nitrogen’s facility located East Dubuque, IL
 Combining these assets diversifies both input costs and facility locations and offsets turnaround years
 RNF facility ideally situated in the heart of corn belt, with barge access and adjacent land for future expansion
Pasadena Facility Excluded But a Lynchpin
 Pasadena has been a troubled asset since RNF purchased the business in 2012, CVR Partners has no interest
 2015 is the first year under RNF ownership that Pasadena is expected to generate positive EBITDA
 S-4 lists Pasadena equity value at just 30% of RNF’s original purchase plus associated capex
Why is there still an arbitrage opportunity?
Liquidity Impediments
 The trade has a gross exposure 11x greater than net exposure
 RNF average daily value traded is $2m while UAN average daily value traded is $2.5m
 Both are limiting factors in arbitrage funds’ ability to build a meaningfully sized net position
Master Limited Partnership Structure
 Investors have to be willing to file a k-1 due to the MLP structure of RNF
 Excludes some institutional investors and reduces total capital able to arbitrage opportunity
Investors Fail to Realize Pasadena Piece
 65% and 84% of RNF and UAN free float respectively is held by retail investors
 Bloomberg deal premium at ~5% (Pasadena sale cited in notes) → Quants not seeing deal economics properly
Issue XXV Page 17
Merger Arbitrage with Special Situation Spin-Off (Continued)

Pasadena Asset Value
Due to parent company Rentech’s decision to explore strategic alternatives for RNF and the subsequent belief that the
Pasadena facility would be either sold or disposed of, the company performed an impairment test in Q2 2015. Manage-
ment concluded the Pasadena facility’s carrying value was no longer recoverable and wrote down associated assets by
$101.8m to their estimated value. A value based on indications of interest received from potential buyers. The remain-
ing $73.7m of equity value listed in the recently filed S-4 represents the best estimate of Pasadena’s fair value, equating
to $1.9 per share.
Alternatively one could value Pasadena based on facility EBITDA, which management projects to be $10m in 2015. In
fact I believe this to be conservative guidance. Year to date EBTIDA totaled $5.4m and when questioned whether the
lower second half balance of $4.6m was seasonally related or other, the CEO answered, “I think it's prudence from
trying to get a number right for once on that plant.” At a range between 4x and 7x EBITDA, Pasadena would be worth
between ~$1.00 and ~$1.80 per share. Likewise a free cash flow based DCF model yields values between ~$0.80 and
~$1.50 per share (seen in the tables below).
Pasadena Value Based on EV/EBITDA Pasadena Value Based on DCF

EV/EBITDA Growth Rate
$1.41 4.00x 4.75x 5.50x 6.25x 7.00x $1.05 (1.5%) (0.75%) 0.0% 0.75% 1.5%
$7.50 $0.77 $0.92 $1.06 $1.21 $1.35 11.50% $0.79 $0.85 $0.91 $0.98 $1.06
Discount Rate
$8.75 $0.90 $1.07 $1.24 $1.41 $1.57 10.75% $0.84 $0.90 $0.97 $1.06 $1.15
EBITDA
$10.00 $1.03 $1.22 $1.41 $1.61 $1.80 10.00% $0.90 $0.97 $1.05 $1.14 $1.25
$11.25 $1.16 $1.37 $1.59 $1.81 $2.02 9.25% $0.96 $1.04 $1.13 $1.24 $1.37
$12.50 $1.29 $1.53 $1.77 $2.01 $2.25 8.50% $1.03 $1.12 $1.23 $1.36 $1.52
Alternative View & Key Risks

The key risk with the investment is the transaction not closing. If prices of both RNF and UAN revert back to the pre-
deal closing prices, the expected downside is $2.80. One could also take the viewpoint that the market does in fact
recognize the value of Pasadena but believes the probability of the transaction closing is just under 60%. Even at an
implied 60% chance of close, the probability weighted upside/downside ratio is still ~2.2x.
The probability of close is far higher than the market’s expecta-
tions solely based on the majority ownership of both companies, Upside/Downside Ratio Calculation
each having agreed to the deal. Additionally, UAN is acquiring Downside Shares Price Prior Price G/(L)
the facility for $2,300 per gross ammonia ton, a similar price to RNF Shares 1.00 $12.00 $10.30 -$1.70
recent new builds in the region near the end of their consecution UAN Shares (1.04) $9.63 $10.69 -$1.10
timeline. In buying the facility UAN avoids a risky four year
Total Downside -$2.80
construction runway and benefits from immediate cash flows.
Probability of Break-Up 40%
For an additional valuation point, CHS recently purchased 8.9%
of CF Industries’ North American production at a price >$4,000 Probability Weighted Downside -$1.12
per gross ammonia ton. UAN is by no means overpaying for the
assets (see figure below: Cost per Gross Ammonia Ton). Mean- Upside DPU Pasadena Cash
while RNF is a forced seller at the $2,300 per gross ammonia ton RNF Shares 1.00 $0.15 $1.43 $2.57
due to its need to pay down debt and fund growing wood fiber UAN Shares (1.04)
expansion costs. Total Upside $4.14
Finally, the likelihood that regulation will be an impediment to Probability of Deal Close 60%
this deal closing is de minimis given that on a combined basis
Probability Weighted Upside $2.49
production is just 3% of North American nitrogen fertilizer de-
manded.
Upside/Downside Ratio 2.22x
Page 18
Justin Hong ‘17

Tenneco Inc. (NYSE: TEN) - Long
Justin is a first year MBA
student at Columbia Business Justin Hong
School. Prior to CBS, Justin was JHong17@gsb.columbia.edu
an Associate in the High Yield
Thesis Trading Statistics
Bonds group at Oaktree Capital
Price as of 09/30/15 close: $44.77
Management. He is currently a Tenneco's share price has declined recently due to concerns over a slowdown DSO as of 09/30/15: 61.4
school-year intern at a family in China, cyclical depression in the mining/agricultural end markets, and most Market Capitalization ($mm): $2,747
investment office. recently, a large disruption at a major customer (Volkswagen). However, these Cash and Equivalents: $250
issues do not impact the secular tailwind from increasing global automotive Total Debt: $1,230
emissions standards. Tenneco has #1/#2 global market share in components and Enterprise Value: $3,798
systems that help reduce emissions and will benefit both from increased per-
P/E (FY15E EPS): 10.5x
vehicle content adds and robust volumes as OEMs increasingly seek suppliers
EV/EBITDA (FY15E EBITDA): 4.85x
with scale. Lastly, the Street is also discounting the accretive potential of
Tenneco's recently announced accelerated share repurchase program. My target 52-Week High: $61.73
52-Week Low: $39.13
price of $61.00 represents ~36% upside from the current share price.
Avg. 3-Mo Daily Volume (mm): 0.717
Tenneco is a global Tier 1 auto parts supplier that serves both automobile OEMs and the repair and replacement
aftermarket. The company operates in two divisions: Clean Air (emissions control) and Ride Performance
(stability, comfort, and safety). Revenue and EBIT split between Clean Air and Ride Performance, excluding low-
margin substrate sales, are roughly 60%/40% and 63%/37%. Aftermarket sales are about 15% of total sales. The
company has 90 manufacturing centers and 15 R&D centers located on every continent. As of FY14, Tenneco had
~70 different OEM customers and is well diversified for a Tier 1 auto supplier, with only two customers repre-
senting over 10% of revenues (Ford at 15% and GM at 13%).
Investment Merits
 Increasingly Stringent Emissions Standards and Enforcement: Government regulations in both
developed and developing markets require automotive OEMs to substantially reduce vehicle tailpipe emis-
sions. Tenneco will benefit directly from this secular trend as it has global #1/#2 market share positions in
the growing market for emissions reduction products. In addition to rising standards, an underappreciated
aspect of the secular story is the increase in enforcement of these standards. For example, in Europe, vehicle
manufacturers will be required to meet emissions levels in real world conditions, as opposed to simulated
conditions, beginning in September 2017. In China, compliance with emissions standards is currently low
(~45%) but is expected to increase dramatically in the coming years. Stricter enforcement will put even more
pressure on auto OEMs to seek components and systems that help them to achieve mandated targets.
 Significant Per-Vehicle Content Add Opportunity: I project Tenneco's organic revenues to grow at a
faster rate than underlying growth in vehicle unit volumes due to increasing per-vehicle content additions.
The power of Tenneco's content add story is seen in its most recent quarterly results - when global demand
for commercial and off-highway vehicles were down 25% Y/Y, Tenneco's sales to this sector were only down
by 4% Y/Y. Tenneco was able to offset the vehicle volume decline with significant per-vehicle added content.
 Continued Trend of Vehicle Platform Standardization: Light vehicle platforms such as Volkswagen's
MQB and GM's Delta platforms that support well over 1mm+ units are expected to grow from 51% to 56%
of global OE production from 2014 to 2019. Thus, OEMs are increasingly seeking suppliers with the scale to
supply components for extremely large volumes on a global basis. Tenneco stands to benefit from this trend
as one of the two largest and globally diversified suppliers of critical emissions reduction components.
 Ride Performance and Countercyclical Aftermarket Exposure: Tenneco's Ride Performance busi-
ness, (40% of total revenues), is a solid business in itself. Similar to the Clean Air business, Ride Performance
offers OEMs the scale and ability to supply to massive standardized vehicle platforms and also enjoys modest
secular tailwinds due to the increasing need for technologies that advance fuel efficiency (efficient braking and
handling) and vehicle safety (roll-over protection systems). In addition, ~37% of Ride Performance's revenues
are from the aftermarket and its brands command #1 market share in most global markets. Aftermarket
parts generally command higher margins than OE parts, and exhibit more consistent demand which offsets
some of the cyclicality of Tenneco's OE businesses.
 Accelerated Share Repurchase Program: Management recently expressed frustration over Tenneco's
valuation and accelerated its 3-year $350mm share repurchase program to conclude a year early - by the end
of 2016 ($175mm per year). The repurchases will boost EPS in the near term and provided that shares con-
tinue to be undervalued, I believe management has the willingness to continue the repurchase program be-
yond 2016. Tenneco currently has the balance sheet and FCF generation to support this.
 Opportunity in Adjacent Markets: Tenneco is working to translate its emissions reduction technology
to adjacent markets including locomotive, marine, and stationary motor applications. In fact, Tenneco re-
cently became the first company to receive Chinese approval to sell marine SCR systems for diesel-powered
Chinese-flagged vessels. Tenneco is also developing turnkey aftermarket emissions treatment systems for
large locomotive engines. As emissions regulations for these adjacent markets are also becoming increasingly
Issue XXV Page 19
Tenneco Inc. (Continued from previous page)

 stringent, I expect this to be a small but rapidly growing market opportunity for Tenneco.
Investment Risks and Mitigants

 The Auto OE Parts Sector is Highly Competitive and Cyclical: The automotive parts sector has histori-
cally experienced cyclical downturns. Although we are currently in a healthy part of the auto OEM cycle, it is
difficult to predict when the cycle will turn. However, Tenneco’s secular emissions tailwind will remain intact
despite the cyclicality. Tenneco also has the balance sheet and cost structure to withstand the next cyclical down-
turn. Management has done an excellent job of reducing leverage (currently ~1.3x net debt / EBITDA) since the
recession, and cost rationalization programs have been successful at reducing overhead and administrative costs.
 The Mining and Agricultural Markets are in a Cyclical Downturn: The mining and agricultural end mar-
kets are both seeing cyclical depressions in equipment demand. However, the secular emissions story is still intact
in these markets, and Tenneco stands to benefit once the cycle turns. Also, Tenneco has mitigated the cyclical
downturn in the off-highway market by offsetting unit volume declines with per-vehicle content adds.
 China Slowdown (and Other Macro Risks): Concern over a slowdown in China's economic growth is cur-
rently spooking the markets. However a slowdown in the Chinese economy is not expected to slow the increas-
ingly stringent emissions regulations that are being introduced there. In fact, Chinese President Xi Jinping recently
announced that China's slowing growth will not deter much needed reforms, including reducing pollution from
vehicle emissions. Tenneco’s reported topline has also been pressured recently due to the strengthening USD, but
on a constant-currency basis, revenue growth is still expected to be in the mid single-digits going forward.
 Volkswagen Emissions Cheating Scandal: As Volkswagen is Tenneco's third largest customer, Volkswagen’s
recent emissions cheating scandal has weighed on valuation. However, I believe this is a large overreaction from
the market. Tenneco's revenue exposure to Volkswagen's North American diesel engine business is just $7mm,
only ~0.08% of total revenues. Revenue from the entire affected global MQB platform totals $310mm, or roughly
4% of total revenues. The Volkswagen scandal will be a very short-term issue for Tenneco, and in fact I see this
event as a long-term positive as it highlights how difficult it is for OEMs to meet emissions standards, and how
serious regulators are in enforcing them.
Variant Perception Recap

 The Street is currently preoccupied with potential macro/cyclical/temporary issues and is temporarily forgetting
about Tenneco’s underlying and long-term secular emissions story.
 Historical valuation multiples and comparables analyses suggest Tenneco should trade in the high range of compa-
rable auto parts suppliers. The Street is currently lumping Tenneco within the broader universe of cyclical and
lower value-add auto parts suppliers. I expect Tenneco’s valuation multiples to mean-revert to more appropriate
multiples as temporary headwinds subside and Tenneco continues to deliver solid organic growth.
 The Street is ignoring the impact of Tenneco's accelerated share repurchase program. Given the current underval-
uation of shares, I expect the repurchases to be immediately accretive. In addition, if the undervaluation persists, I
expect continued repurchases beyond FY16, given the company's strong FCF generation and low leverage.
Valuation
Method Price Commentary
DCF $63.50 My best estimate of a conservative intrinsic value.
EV/EBITDA $59.47 EV/EBITDA is an effective way to compare multiples between different industries. I believe
auto parts suppliers should generally trade at around 5x - 6x, and that Tenneco deserves to be
valued at the higher end of this range.
P/E $59.88 Given competitor multiples and relative quality of Tenneco's business, I believe a 14x P/E
multiple is conservatively appropriate. In addition, this implies a ~7% current earnings yield,
which I believe is also appropriate for this business.
Sum of the Parts $61.13 More a confirmatory exercise as I don't believe the businesses would be separted, but if they
were, the Clean Air division would command a higher multiple than Ride Performance.
Target Price $61.00
EV/EBITDA Valuation
Base Case Continued Repurchases
Current Current Upside FY18 Upside CAGR FY18 Upside CAGR
Share Price $44.77 $59.47 32.8% $91.07 103.4% 24.2% $94.62 111.3% 25.6%
Shares Out 61.36 61.36 54.74 48.99
Mkt Cap 2,747 3,649 4,985 4,635
Debt 1,230 1,230 1,230 1,230
Minority Interest 71 71 71 71
Cash (250) (250) (771) (421)
EV 3,798 4,700 5,516 5,516
EBITDA 783 783 919 17.3% 5.0% 919 17.3% 5.0%
EV/EBITDA 4.85x 6.00x 6.00x 6.00x
P/E Valuation
Base Case Continued Repurchases
Current Current Upside FY18 Upside CAGR FY18 Upside CAGR
Share Price $44.77 $59.88 33.8% $79.22 76.9% 19.0% $91.00 103.3% 24.1%
Shares Out 61.36 61.36 54.74 48.99
EPS $4.28 $4.28 $5.66 32.3% 8.9% $6.50 52.0% 13.6%
P/E 10.5x 14.0x 14.0x 14.0x
Page 20
Las Vegas Sands Corp. (NYSE: LVS) - Short

Price Target: $30
Alexander S. J. Levy, CFA

alevy17@gsb.columbia.edu
Alexander Levy ‘17

Alexander is a first year MBA
Executive Summary
School. Prior to CBS, he was an
LVS previously thrived on rapid Macau gambling growth. That story is no longer intact as the Chinese economy
equity research associate at
slows, a corruption crackdown hits spending, and the industry faces margin pressure from oversupply. The compa-
Morgan Stanley covering coal,
ny’s traditionally reliable non-Macau cash generators face headwinds, and less likely but still real tail risks loom.
steel, and iron ore equities.
Despite these challenges, consensus is betting on stabilization/recovery instead of on more realistic mean rever-
Alexander graduated from
sion away from boom times, creating an attractive short opportunity with ~35% downside to my $30 price target.
Duke University with a degree
in political science and is a Optimistic Consensus/Valuation: Despite major headwinds, consensus remains bullish, with estimates calling
CFA® charterholder. for 2016 EBITDA stabilization (+6% growth at SCL) and +7% growth in 2017. Only one sell-side analyst has a sell
vs. 11 buys. The avg. target price is ~$54. Short interest is only 6.9% of float, suggesting buy-side positioning is not
too bearish. On optimistic consensus numbers, LVS trades at ~11x 2015/2016 EBITDA, but trades at an expensive
~12x/13x 2015/2016 EBITDA on my more achievable estimates (12%/20% below consensus in 2015/2016). Adjust-
ing for non-attributable earnings from Sands China, LVS is even more expensive at ~14x/15x 2015/2016 EBITDA.
Dividend/Buybacks at Risk: LVS currently pays a 5.5% dividend yield on top of a remaining ~$1.7b in buyback
authorizations. However, the dividend, let alone the buybacks, are not covered by cash flow through at least 2017
on my estimates, creating risk of a cut longer term.
Why This Opportunity Exists: The China growth narrative, in general and related to Macau, is alluring – it
worked for 10+ years. Today, both the sell-side and LVS’ shareholders are betting that the current slowdown is a
blip and that growth resumes in short order. Forecasting is anchored by years of profitability and growth, making
contemplating a lasting downside shift difficult. Dividends/buybacks, although not covered, pay investors to wait,
while the company is optimistic even as competitors admit caution.
Why Short LVS and Not SCL: 1) US market procedures and protections; 2) Most of LVS’ leverage sits in the
USco entity (6.4x net debt to TTM EBITDA vs. 0.5x at SCL and 1.5x consolidated), raising LVS’ vulnerability to
lower intercompany cash flows from Macau/Singapore.
Company Description
LVS is a US-based gaming and lodging company that operates integrated resorts with hotel, gaming, entertainment,
and retail components in Las Vegas, Pennsylvania, Singapore, and Macau. In 2014, 13% of revenue and 8% of prop-
erty EBITDA were earned in the US, with 22% and 32% respectively earned in Singapore and 65% and 60% respec-
tively earned in Macau. LVS operates in Macau via a 70.1% stake in Sands China Ltd. (SCL, publicly listed in Hong
Kong as 1928.HK). Sheldon Adelson is the controlling shareholder (54% stake), chairman, and CEO.
Investment Case: Short
LVS’ Macau earnings are driven by 3 factors: visitor
count, gross gaming revenue (GGR), and non-gaming
spend (shopping & hotel). I expect all to be pressured
as demand slows and competition intensifies.
1) Visitor count already falling & unlikely to
resume steady growth near-term
 Slowing Chinese economic growth, a corruption
Editors’ Note: LVS share price
crackdown, and visa restrictions have weighed on
as of September 18, 2015 as
Macau visitor count, with entries falling 3.5% YoY
originally presented. YTD. 67% of Macau visitors are from mainland China.
 Macau has proposed capping the number of Chinese
visitors at current levels (~21m/year) to preserve resident quality of life.
 Improved travel infrastructure is unlikely to materialize over the next few years. The Macau-HK bridge slated for
2016 could take until 2017+ to finish as costs rise. A light rail project in Macau may not be ready until 2017/2018.
 Proposed expanded smoking ban could scare away customers, given ~25% of China smokes.
 Bulls argue that Macau has a long penetration runway given 34% of people in the US gamble, but only 1.5% in
China have visited Macau. However, a much larger 8.7% of people in Guangdong (province closest to Macau) have
visited. Furthermore, China’s GDP/capita is ~$7k vs. $53k in the US, meaning income levels must meaningfully
increase (not easy with slowing growth) before people can afford to visit.
Issue XXV Page 21
Las Vegas Sands Corp. (Continued from previous page)

 Chinese consumption patterns mean that avg. hotel stay length is unlikely to grow. Visits to Macau are high frequency
but short duration (1.2 nights on avg. vs. 3.6 nights in Vegas). High minimum table stakes mean gamblers often exhaust
funds quickly. In China, annual vacation entitlement is only 5 days for people with <10 years of work and 10 days for
people with 10-20 years, limiting time off. During public holidays, people often go home instead of abroad.
2) Gross gaming rev. (GGR) under pressure from corruption crackdown and shift to mass market
 An ongoing Chinese corruption crackdown has had a chilling effect on Macau VIP gambling. Mix is shifting towards the
lower spending mass market. Enforcement is also targeting junkets, which recruit high rollers.
 LVS will have trouble making up for lost VIP business as mass market has a lower GGR/capita: $232 avg. in Vegas vs.
$1,399 in Macau. In addition, bulls point to 40% mass market gaming margins vs. 10% VIP, but LVS already gets ~74% of
Macau gaming profits from mass market.
3) Explosive gaming/lodging supply growth (despite slowing demand) will likely pressure margins
 Casinos are rapidly expanding gaming and hotel capacity over the next 2-3 years. There are six integrated resort &
two hotel projects under way. If these materialize, the number of rooms will grow by 47% vs. 2014 while the number of
tables and slot will rise by 53% and 75%, respectively. Even the most optimistic demand scenarios are insufficient to
absorb this new capacity, and I see total hotel occupancy in Macau falling from 86.5% in 2014 to ~60% by 2016, and only
recovering to ~70% by 2018. Hotels are ~15% of LVS’ Macau profits.
 Gaming licenses require casino projects to advance and remain operational regardless of conditions. As oversupply
grows, margins will come under pressure as competition intensifies to fill resorts. Gaming/lodging is a competitive, high
fixed cost, capital intensive industry. Once the capital is in the ground, owners are incented to fill capacity by competing
on price to take advantage of high fixed cost leverage.
 Amidst oversupply, LVS may need to increase discounting/advertising/promotions to fill rooms. Wages are growing by
5-10% annually as unemployment is sub-2%. For reference, Vegas EBITDA margins are ~20% vs. ~30-35% in Macau.
 Regional competitors in Korea & Philippines are adding new casinos to attract Chinese tourists, while Japan could do
so before the 2020 Tokyo Olympics. The number of Chinese visitors to Korea has grown by 5x vs. 2009, and Korea is
closer to Beijing/Shanghai than Macau. Non-Macau avg. minimum table stakes are lower ($270 in Macau vs. $50 in Singa-
pore, $20 in Korea/Vegas), increasing mass appeal.
4) Non-gaming spend not immune from slowdown and vulnerable to non-Macau competition
 Mass market customers have a lower ability to pay for high priced lodging/food/luxury goods than VIP visitors.
 LVS’ strategy to increase non-gaming revenue relies on large retail complexes (~12% of LVS’ Macau profits). A slowing
Chinese economy and corruption crackdown could lower sales, which drive ~30-40% of rent income. While sales at
LVS malls have been resilient, jewelry sales in Hong Kong are -15% YoY YTD while clothing sales are -5% YoY YTD.
 LVS’ strategy to increase reliance on non-gaming revenues (hotel, food, shopping) strays from gaming, which has a
competitive moat (Macau is the only part of China with legal gambling). In comparison, the market for China’s non-
gaming tourism dollars is quite competitive, with new destinations such as Disneyland Shanghai opening up.
5) Singapore & Penn. casinos, usually reliable cash flow generators, are facing headwinds many overlook
 YTD, the Singapore Dollar has appreciated by ~14% vs. the Malaysian Ringgit and ~9% vs. Indonesian Rupiah, disad-
vantaging gamblers from these countries, while at the same time weakening vs. the USD by ~5% (negative for earnings
translation). Slowing Chinese growth could affect the Singapore economy (~17% of local GDP from exports to China).
 New casinos in the Northeast (PA, NJ) could take market share from Sands Bethlehem.
6) Downside optionality: Political/tax tail risks threaten terminal value
 LVS’ Macau gambling subconcession expires on June 26, 2022. Unless it is ex-
tended, all casinos transfer to the government without compensation. In addition,
the cap on the number of gaming licenses in Singapore expires in 2017.
 LVS has two significant tax arrangements with Macau that expire at the end of
2018, which could subject SCL to a 12% tax on dividend distributions.
Valuation
My $30 price target is derived from a DCF valuation cross checked
against a sum-of-the-parts valuation model. My EBITDA estimates are
12%/20% below consensus in 2015/2016, respectively, as I anticipate
further deterioration in the market on both demand declines and mar-
gin compression from increased competition. Note that my terminal
year assumes a generous 15% ROIC, meaning that a more severe struc-
tural impairment of the Macau story could lead to further downside. For
valuation purposes, it is important to properly adjust out non-
attributable earnings/cash/debt related to the non-controlling interest in
SCL. Some may not make this adjustment, flattering LVS’ valuation.
Downside Catalysts
1) Opening of competing Studio City casino on October 27, 2015; 2) Negative sell-side estimate revisions and/or down-
grades; 3) Continued declines in Macau quarterly revenues/earnings; 4) Further weakness in Macau’s monthly GGR/
visitor statistics; 5) Stronger USD and/or weaker RMB; 6) Expanded smoking ban; 7) Loss of preferential tax treatment;
8) Changes to gambling subconcession; 9) Dividend cut.
Upside Risks
1) China relents on anti-corruption drive; 2) Chinese stimulus; 3) Macau relents on smoking ban and/or visitor caps; 4)
New hotel/gaming supply delayed; 5) Macau infrastructure projects accelerated; 6) Aggressive share repurchases.
Page 22
Ed Bosek
Capital. decided that I wanted to get where you want to work, you
my MBA. I didn’t want to go should spend a lot of time
Graham & Doddsville back to school later for a thinking and focusing on who
(G&D): Could you start off by graduate degree, so the idea of you are going to work with.
telling us about your getting an MBA in conjunction The hedge fund industry, in
background? with my undergraduate degree essence, is a group of small
was very attractive. I had businesses run by
Ed Bosek (EB): I was raised started school early and was entrepreneurs where each
in Staten Island and went to young for my class so, if I managing partner does things
Regis High School in completed the Wharton MBA differently. Generally speaking,
Manhattan. I think my submatriculation program, I the whole organization is really
background ties into what I’m could still graduate on a reflection of how the person
Ed Bosek doing today as I learned early running it wants it to operate.
on to have a differentiated When I met Tim Barakett, the
view and pursue my own path “I learned early on to founder of Atticus, within 10
for success. In my formative minutes I was thinking, "Okay,
years, I chose to do something have a differentiated I want to work for him."
very different from everyone
view and pursue my
else in the neighborhood. G&D: What about Tim
While my friends went to the own path for success.” Barakett made you want to
local high school, I, by choice, work there?
commuted two hours each
way to the Upper East Side to schedule. I was lucky enough EB: I joined the Atticus
attend Regis, an all-scholarship, to be accepted and graduated European fund when their
Jesuit prep school. The Regis with an MBA at 22. AUM was about $250 million
experience gave me a different dollars, around the same size
perspective on life and taught For most of my early life I as BeaconLight is today, and
me how to think for myself. never really left the United overall, Atticus managed
States or the East coast and, in approximately $1 billion
I was accepted to the fact, really only knew this 90 dollars. Tim had incredible
University of Pennsylvania and, mile corridor around Staten charisma and a focused energy
at that point, I wanted to be a Island. To broaden my that just blew me away. I was
doctor. Growing up in Staten horizons, I decided to do an also interviewing at bigger
Island, I wasn’t really exposed MBA internship in Europe and places that were probably
to investing as a career option. worked at Deutsche Bank in more like investment banks in
After arriving at Penn, I was London. After the internship, I terms of culture. Atticus was
surrounded by Wharton received a full-time offer from more appealing as I would be
students, who brought an Deutsche Bank and I accepted. the fourth person on the
intellectual rigor to finance and However, I quickly realized European team. I took a week
economics that I hadn’t seen that investment banking was off in between investment
before. I became intrigued by not my calling so I started to banking and joining Atticus. It
investing and started taking look around for other was just four of us sitting in a
some economics classes in opportunities in London. room in London picking
addition to my pre-med stocks. Looking back now, I
coursework. I began learning more about realize that success in life is
the hedge fund business, which not only just about how good
At the end of my freshman was nowhere near what it is you are, but also how good the
year, I transferred to a dual today—there were only a opportunity set is. We were
degree program with the handful of household names. I emerging from the fallout of
College and Wharton, in order wanted to join a place called the tech bust and there was
to receive both a pre-med and Atticus Capital, which was not heightened tension in the
Wharton degree. Towards the a widely known firm at that Middle East, so the market was
end of my sophomore year, point. I think it's really very depressed. It was August
which coincided with the important to realize that, when of 2003 and it was a really
height of the Internet bubble, I you are making decisions about attractive entry point for
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Ed Bosek
stocks. value investor and Tim is more today at BeaconLight. I would
of a quality—and in some ways search for ideas that would
Fast forwarding a few years, by momentum—investor and he look cheap to David, so they'd
the end of 2007, Atticus’ assets likes really great stories. I be great value investments, and
had soared to $22 billion would pitch things that David that, simultaneously, had a
dollars, of which $13 billion loved, and Tim would hate great story, which I knew
was due to performance. them. Then I would pitch would be really appealing to
There was still a small things that Tim loved and Tim. That really was how I
investment staff, all of whom David would hate them. When started doing things at Atticus,
were generalists, outside of you're confronted with two and it's carried on over the last
the occasional specialist. I was starkly different ways of decade to how I see the world
fortunate to be able to thinking about investing, it at BeaconLight. For us, it’s
contribute to the firm’s forces you to examine and about finding interesting
success. develop your own investment opportunities where we see
philosophy. businesses very differently than
The performance run at Most investors’ philosophies the market, often on multiple
Atticus came after a transition can be boiled down to a set of levels.
in investment strategy. Atticus
had a risk arbitrage and event- G&D: When did you decide
driven bias, but there was a “Most investors’ to leave Atticus?
dearth of opportunity in risk
arbitrage in 2003 because rates philosophies can be EB: I decided to leave in early
were really low and every deal 2009. When you’re managing
was getting done in cash. The boiled down to a set of $10, $15, or $20 billion in
fund evolved to be more essentially one fund, it's quite
directional and concentrated. rules. How well you hard to be differentiated and
create alpha. In addition, when
By 2004 I became involved in follow and hone those you’re that big, it's also difficult
some activist situations before rules over time is really to be nimble and generate
activism took center stage in alpha on the short side which I
markets. It was an amazing what determines your believe is a critical component
experience to see so much at a of managing capital through
very young age. I worked for investment acumen.” every market cycle. To give
two portfolio managers at you some perspective, if you’re
Atticus: David Slager, who ran $20 billion, your minimum
the European fund, and Tim rules. How well you follow and position size is probably half a
Barakett, who ran the U.S. hone those rules over time is billion dollars.
fund. What made the really what determines your
opportunity at Atticus so investment acumen. It’s My investment philosophy
extraordinary was that both important to keep in mind that translates extremely well to
PMs were willing to back you you have to maintain some the short side because we
as an analyst if you were willing flexibility around those rules. employ the exact same
to do the work and convey People can have very different process both long and short. A
conviction in an investment. rules and be very successful lot of investors’ approaches to
Whether you were 22 or 42, it investors. You have to match evaluating companies don’t
didn't really matter. That was your rules to your personality function well on the short side,
really empowering as a young in order to avoid behavioral so they need different long and
investor. biases or other problems that short strategies. I have based
detract from your process. our philosophy on conducting
At the end of 2004, the deep, fundamental research
European team moved back to In order to be consistent with where we see things differently
New York and we became one both Tim and David, I began and can be proven right.
team. We were still two funds, refining my own investment Whether you're long or short,
but we were all working philosophy, which is the it's really the same type of
together. David is more of a foundation of what we employ analysis, I believe. If you were
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Ed Bosek
to have the same for my own idea generation we are doing a lot of work in
concentration on the long side and all the analysis. Delegating China and we can talk about
that we used at Atticus, part of the investment process this in greater detail. We think
balanced by a rigorous short to my team, while also there is an enormous
book that’s all alpha-driven, remaining highly involved, was opportunity on the long side
over time you could really one of the bigger learning right now given the level of
reduce volatility. Quite simply, curves. government stimulus and
you wouldn't have drawdowns market dislocation.
that long-biased funds have G&D: Do you have any Internationally our exposure
and, by being concentrated, exposure to emerging has largely been Western
you could still compound markets? Europe and other developed
capital if you’re right. That was markets. We've had emerging
and continues to be the EB: We have had very little market positions here and
mission at BeaconLight. exposure to emerging markets there, but they tend to be sort
Ultimately, I left Atticus in as we only consider stocks of one-off.
early 2009, and I launched in that we can take a medium-
January of 2010. sized, 3% or 4% position in. G&D: What was the fund-
Today that’s $10 million a day raising process like, especially
G&D: Did your investment in average daily volume. There coming out of the crisis?
philosophy at BeaconLight are 6,000 stocks in the world
change over time? that trade about that much— EB: I think we have a very
2,500 are in the U.S. and about unique history as a firm. People
EB: Not really, but our look at us today and say,
execution has been fine tuned. “I was given a "Now, you have a five or six
We launched BeaconLight year track record. You're still
when I was 29 with just $50 remarkable relatively small. You have good
million of total capital, a pedigree. Why do you exist?"
portion of which was internal, opportunity and, as a Hedge fund managers who
so we were a very small fund. have been around this long
To date, we have grown in a result, learned a lot of would have either quit or
controlled fashion because, would be managing more
regardless of size, we have the lessons that capital, and we don't make
wanted to maintain a sense to some people in that
disciplined investment process others maybe never context.
that is focused on deep
research. learn in their I was, in some ways, really
lucky that my entire career
Given that I had a long bias
careers.” was incredibly accelerated. I
during my tenure at Atticus, I 1,500 are in China. The rest of graduated with an MBA at 22
was extremely focused on the world pales in comparison and was a partner at one of
having a balanced portfolio at which limits our exposure to the world's biggest hedge funds
BeaconLight. I certainly those regions. I think the at 26. I was given a remarkable
experienced growing pains and European country with the opportunity and, as a result,
a learning curve as any investor most names with that level of learned a lot of the lessons
would. Investing is a journey to liquidity is Germany and they that others maybe never learn
understanding yourself. To have less than 100 companies in their careers, such as being
understand who you are as an we could consider. too big in a position or
investor, you have to expose investing in illiquid assets. I
yourself to grow and improve When you start thinking about experienced disruption post
and, ultimately, to figure out the emerging markets, Brazil the financial crisis at a time in
how your strategy works best. has less than 30 companies my life where it might have
For me, the biggest area for that trade enough for us to seemed more ideal to stay the
growth was working with and invest. So, we're a bit course. If Atticus had been
leveraging a team of analysts. constrained around the structured differently and were
At Atticus, I was responsible emerging markets; however, still around today, I would have
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Ed Bosek
been perfectly happy being a spread can be. We think we it makes perfect sense for
partner there. have a lot of running room people that have been partners
between here and that point. at massively successful funds to
Given the initial trajectory of We’ve been fortunate enough want to do something else
my career, I made the to take the long view on asset with their time.
conscious decision to take growth while putting together
things very slowly with what we think is a world class G&D: You mentioned earlier
BeaconLight. When we were team. I think if you do that and that it’s key to see something
launching in the end of 2009 perform, the capital will follow. differently than how market
the environment was awful. It is easy to grow your assets sees it. What does that mean
There were some former ahead of your business and not for you?
Atticus investors, who might have longevity. For the long-
have partnered with us, but term, I think it’s important to EB: We look for opportunities
given our fund was going to do things your way. that are “FMD.” That’s our
run 30% net exposure, and not own jargon for “fundamental,
100% net, it didn't really make G&D: Are any other former meaningful, and different.”
sense to talk to these Atticus folks who started funds “Fundamental” really has to do
investors, even though they still around? with the underlying drivers of
were familiar with me. For us, the business. It’s about the
it was about raising enough EB: None of the spinouts from earnings being different from
capital so we could run our that vintage are around today. consensus expectations—not
process the way we wanted to But you have to remember, I the multiples being different.
run it. I was lucky enough that was young and some of those “Meaningful,” for us, is about
I could take the long view in the magnitude of the
building the firm’s culture and “A lot of people think difference. We’re not looking
process. Specifically, one of the for a company that could beat
reasons we turned down some being a hedge fund earnings by 5% this quarter; we
seed offers was the seeds’ are looking for companies
emphasis on raising substantial manager is really where next year its earnings
capital by the end of one or could be 100% to 200% higher
two years which we weren’t
glamorous, but it’s not. on the long side. On the short
ready to do. The fundraising It is hard work.” side we want to find a business
market was tough, which was that is going to be worthless
certainly a headwind, but we managers were a bit further but where everyone else
didn't really have ambitions to along in their careers. I don't thinks they're going to make a
be very big upfront. As we think that the fact that they lot of money over the long-
walk through some of those shut down is a reflection of term. That is really what we’re
market liquidity statistics, it them not being good, but thinking about when we're
means that equity funds and probably more a function of thinking “different.”
hedge funds with our strategy where they were in their
probably should never be that careers. There are some Then the question is how does
large. We firmly believe that incredibly talented people in that happen? We are global
$2 billion of capital is the that pool. generalists and think the best
maximum size where we can way to invest is to generate
still generate the type of alpha A lot of people think being a ideas as a generalist. We look
we'd like to create. hedge fund manager is really for things that don't seem to
glamorous, but it’s not. It is make sense, and then as we do
Our average long has out- hard work, particularly in a the work, it’s important that
performed our average short long/short equity structure we become experts. To take
since we launched—that’s with one portfolio manager: it really concentrated, conviction
what we call alpha spread. all comes down to you getting -weighted positions, you need
With our approach to things right. If you love doing to be an expert to truly
investing, there is probably a it, the hard work is well worth understand the investment. I
direct correlation between size it, but it can be very stressful, think edge is difference
and how strong that alpha so it's not for everyone. I think multiplied by conviction. It's
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Ed Bosek
really easy to think you see from a performance There tends to be a
something differently but not perspective generally took a reductionism in looking at
have conviction. It's also easy lot of the structural risks to performance down to net
in some cases to have the highest level they could— results. The average investor
conviction but not be different. in a rising market this look tends to invest in the strongest
The combination of the two really impressive. Through past returns and get the worst
creates really exciting cycles, however, I'm not sure forward returns. That's been a
investments where you can this is sustainable. You need function of markets for as long
have substantial returns. Given some of the structural as they’ve been around. As a
the way our portfolio is elements to allow really good manager you try to pick the
structured, we don't use stock picking to show through. best things you can that are
leverage or take a lot of gross No matter how good your
exposure; so for us, it's all stock picking is, if you don't “The average investor
concentration risks. Our top have enough of it, it gets sort
five positions are 50%+ of our of washed away. You need the tends to invest in the
long book and we have similar combination of the two. A lot
types of concentration on the of gross exposure funds run strongest past returns
short side. Our gross what we would call “lazy
exposure in some cases is half gross,” where they're just and get the worst
of the industry norm and that hedging and, by definition, not
forward returns. That's
makes our life really hard in looking to create alpha. I think
terms of generating high the alpha portion of picking been a function of
returns, as stock picking is individual assets differently is
critical. But I think it also puts the piece that doesn't scale. markets for as long as
us in a position to see things in Structural advantages can scale.
some cases very clearly It's one of the reasons we are they’ve been around.”
because we don't get swung so cautious about getting too
around by markets as much. big and have limits around how going to go up if they’re longs
much capital we can run. or down if they’re shorts, in
G&D: Can you talk about the almost any environment,
challenge in picking The last few years have tested thereby setting up a structure
idiosyncratic ideas in a bull investors, particularly if you’ve where your alpha can shine
market like the one we've erred on the side of caution as through whether the markets
experienced, particularly in the multiples have just gone in one are up or down.
context of out-performing the direction in certain parts of the
benchmark where correlations world like the United States. Upward markets have clouded
are high? Now, in other parts of the whether hedge funds are
world, largely emerging putting up great returns. But
EB: Investing is hard. There markets, multiples have only this year the hedge fund
are a few ways to beat the gone in the other direction. It industry in general has done
benchmark. For example, you can be hard to discern if your really well because markets are
can take structural risks, you stocks are really working down while the hedge fund
can use leverage, you can use because you're really smart or industry is up. If you've been
beta, you can reduce liquidity, if it is just money flows that blaming lack of relative
or you can use stock-picking are chasing certain things. I performance on rising markets,
skills to create alpha. That is, think the more clearly well, this should be the year
per unit of risk that you take, delineated your roles and where you get to tell people,
you're better than the processes, the more you know "Look, the markets aren't up
benchmark. if you're doing things how you and we're creating absolute
want to. Returns are very returns." This should be the
In the last five years, almost important but how people time to remind allocators
every asset class has gone up, define the concept of risk- about performance.
so it's been next to impossible adjusted returns is really
to catch benchmarks. Those important to understand in this G&D: How do you go about
investors who have done best industry. finding these FMD situations?
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Ed Bosek
Are there any common We’re on the lookout for water slippery, and enables
characteristics among them? those turning points and more oil to be extracted from
answering questions around the ground. They were saying
EB: We've generally found complexity and/or change. that if a company invested 1%
that the really great or 2% on the cost of the well,
investments come down to G&D: Can you give an they'd get 30% more oil out of
one or two drivers that tell a example of a key question? the well. We concluded,
story differently than people "Wow! That sounds pretty
think. Part of it is experience EB: If you want to come up good. I bet people would want
and seeing different things over with differentiated ideas, you to buy that product."
the last 13 or 14 years play out have to accept that the work
across different geographies. If you're doing has to be As we conducted the diligence
you can identify what has separated from the urgency of to verify that, we started to
potential to be those drivers, needing an idea today. For realize there were customers
formulate a really good example, we've been spending who were seeing lots of other
question around those drivers, 40% to 50% of our time on products and techniques to
and then just focus on understanding China this year. drive even more efficiency in
answering that one question, There might be a lot of firms drilling. Our idea is that U.S.
you can really reduce the where a portfolio manager onshore drilling is, in some
noise. ways, a closed system, where
every dollar generated goes
We typically find that
“Markets are pretty back into the ground, and each
specialists or people who good at extrapolating dollar that goes back into the
closely follow businesses or ground generates more barrels
industries get things wrong trends that are in of oil due to investments in
when there is substantial efficiency. To take this idea a
change. Maybe they have stale place and pretty bad step further, each barrel of oil
frameworks, i.e., some things coming out of the ground, was
have worked for a long time at identifying inflec- also generating a higher profit
but something really new is margin as producers gained
happening. Sometimes having a
tion points. We’re on efficiency, which would then
fresh perspective helps you see the lookout for those drive exponential growth in
changes more clearly. Another capital available to re-invest
example is when there’s an turning points.” into this closed cycle.
element of complexity not
necessarily specific to the wouldn't want his analysts At a high level, it was clear that
industry. It might be that spending that kind of mismatch the marginal cost of oil in the
there’s a tech specialist who of time versus investing; but world was falling pretty
has a macro issue affecting a we are prepared to do the dramatically. For us, it was
business or a legal issue work and be patient. about asking this original
affecting a business. That might question about one company's
be an opportunity for a An example of how our products and being able to tie
generalist to come in and say, questioning process works it to a broader trend. We
“We’ve seen this in other might be energy. Currently, we started to see this real
sectors, so we actually have no longer have a very big short explosion in U.S. production in
some expertise here.” Change position in energy, but last 2014. We had done the work
and complexity often lead August we were quite active. two years earlier to clarify
markets to get things wrong The genesis of the idea actually how this could happen. As it
and hence create an came from the work we had happened, it conformed to
opportunity. done on a long idea from 2012 what we thought we would
on Flotek Industries (FTK). see and we started to short
Markets are pretty good at They make chemicals called pretty broadly across the
extrapolating trends that are in surfactants, which you put into industry.
place and pretty bad at oil wells when you're fracking
identifying inflection points. them. It essentially makes G&D: Are you still short
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Ed Bosek
today? What are the questions G&D: Did you look at the business has only improved.
you're asking? other potential angles maybe You realize it’s going to
where low oil prices are an continue until the whole
EB: When crude oil was at input cost and somebody sector has found the bottom.
$100, we were pretty might benefit from that? The people who own that
convinced we were really stock probably own other
different. Next we ask “what is EB: We have to some degree. energy names and are probably
Pershing Square finalists the risk/reward?” Usually, if But when commodities are an getting redeemed so they can't
present their investment you think you really see input, often it's the same have one name left in their
thesis to the judges
something differently, and commodity for everyone else, books.
you're wrong, you don't get so if economics get much
hurt that badly because better in an industry, it just If you were to get back to that,
nobody else is betting on it. If gets better for everyone. you'd say, "Okay, we think the
you're right, you can do very You'd need to find a company business is getting much better.
well. In this case, we saw What's the recognition point?
asymmetry in companies that “Really great theses When will people care or start
provided services or, in some to see what we see?" We think
cases, owned some resources have drivers that push that's a really good way to stay
in the oil industry. honest about your investment
on misperceived levers theses. Being firm about
Today, the debate is what the recognition points on the
such as industry
near-term low is going to be— short side has led to a fair
not so much what the long- consolidation; a amount of success in the last
term price will be. If I were few years. You could say, "This
forced to do something, I change in incentives; a is a bad business, and it's one
would probably still be leaning or two multiple points more
a little short. We have one real change in behavior; a expensive than it should be, so
position left in the energy I'm going to be short it." That
space. We don't want to be in new product; or large type of investment lacks a
the position of fighting trends. recognition point and is not for
acquisitions which
If money's flowing in, how are BeaconLight.
you going to know you're changes competitive
right? After we establish our G&D: What questions are you
thesis, we think about dynamics.” asking in China and how are
something called a recognition you approaching that
point. If we see a thesis very that has a real franchise that opportunity?
differently, it’s important to can hold pricing while their
know when people will be input costs are going down. EB: We think really great
forced to see what we see. We haven't found many of theses have drivers that push
We are going through the those. Certainly last year when on misperceived levers such as
recognition point right now in oil first started going down, industry consolidation; a
energy and we'll probably be there was a rush to buy change in incentives; a change
covering this last short soon. anything that uses oil. Three or in behavior; a new product; or
four months later, people large acquisitions which
The benefit of being a global realized that all of their changes competitive dynamics.
generalist is that we're not competitors used oil and all We consider these levers
forced to do anything. We just the stocks did poorly after when evaluating the financial
need to find the best ideas that. statements. Next in our
from a wide universe. You're process, we ask ourselves why
never going to catch the top to We're currently long a there is a misperception. I
the bottom in names. You have company that benefits from think many of these factors are
to accept that and just hope lower oil prices, but is relevant now in China. The
the next thing you find is considered an energy MLP and economy is slowing down in a
better than what remains in as a result, is just getting sold way that's concerning and
what you've left behind. down every day while the there is confusion from a
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Ed Bosek
macro level within China. services costs and are not a
There are hundreds of viable alternative. Daqin has
I think people who doubted companies exposed to these established a pricing team
China for the past ten years dynamics. I think you want to within the organization to
will continue to doubt it, and be and you can be very choosy analyze pricing since they think
people who have loved China because there's a lot going on their customers are incredibly
for the past ten years probably and people are not super inelastic which would justify
still love it. It's somewhat focused on it. We think it's further price hikes. There's
problematic to know exactly important you do the work some "we need to do what's
what's going on, but at the today so you can be prepared good for the country in the
company level, it's actually a bit when things start to really play short-term," but in the long-
easier. Two of the most out. term, there's an incredible
powerful drivers with the most ability to raise prices. If there
levers for an investment thesis One example is the largest were free market prices here,
that we've ever witnessed are cargo railroad in the world we think this year's earnings
deregulation and called Daqin Railway (SHSE: are going to be around RMB
demutualization. 601006). Prices have been set 1.10, so just about eight times
for almost 20 years by the earnings. Daqin is net cash, and
At Atticus, my biggest NDRC, the national regulator. pays a big dividend. We think
contribution was buying The NDRC allowed Daqin to those earnings could go to
financial exchange operators increase prices last year for the RMB 3.00 if they were to have
around the world. The theses first time and then allowed broadly liberalized free market
were relatively prices which would imply
straightforward. Exchanges significant upside.
were transitioning from being “Two of the most
owned by their customers to G&D: China has built
their shareholders that, in powerful drivers with tremendous over capacity over
turn, really drove a change in the past 20 years. Are any
behavior, particularly around the most levers for an volumes at risk due to over-
cost allocation and investment building in China?
in the cost base. This led to investment thesis that
potential for mergers, which EB: They carry some cargo,
would also dramatically change
we've ever witnessed but the bulk of where they
cost structures. In some of the are deregulation and make their money is carrying
exchanges that we owned, coal, which we view as an
margins were 10% and demutualization.” ongoing expense for the
ultimately skyrocketed to 60%. economy. Long-term, China
would obviously like to use
China is still a command them this February to lift less coal rather than more, but
economy where there are a lot prices again. In August, the they use three billion tons
of regulated areas and a NDRC allowed Daqin to currently. Daqin carries 400
market where 70% of the determine the prices so, for million tons on their main line
market cap is owned or the first time ever, they could and we reckon their
controlled by the state. We have some flexibility in setting addressable market is 1.5
think that we're starting to see prices, and they’re already a billion tons, leaving a lot of
a demutualization of a lot of 30% EBITDA margin business. room for demand for coal to
those companies against a contract before they’re really
backdrop of uncertain China is structurally short rail impacted.
economic outlook, which is capacity and needs more of it,
certainly leading to confusion so a lot of cargo is sent by G&D: Any other situations
and a lack of fundamental truck, which is rail’s main you've been excited about?
analysis. In China we’re zeroing competition. Daqin is
in on companies where there essentially sold out and trucks EB: There's a Hong Kong-
is both deregulation and cost roughly three times the listed state-owned enterprise
demutualization. amount that Daqin’s rail called China Resource
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Harvey Sawikin
Ed Bosek
Enterprises (SEHK: 291) which line? Probably not. But this is One other benefit for us is
is 50% owned by China an example where we see that we do work on individual
Resource Holdings. CRE own something playing out Chinese companies.
50% of the biggest beer differently from what you Sometimes the data you get
company in the world, called might initially expect. For around what's going on in the
CR Snow, or China Resource example, a Chinese SOE is economy and specific
Snow, while the other 50% is going to buy some assets from companies is worse than
owned by SAB Miller (LSE: minority holders. You might macro data as far as quality of
SAB), one of the world’s best assume they're going to data. But sometimes it's much
beer operators who has a underpay but to see that better and can give you a clear
vested interest in how the they're actually rewarding sense for the situation a
company is run. The beer minority shareholders and company’s facing.
industry in China is really going to start doing things that
interesting as it's the lowest are improving the asset in a In Daqin, you get really good
priced beer in the world. CR dramatic way is really eye- volumes of the coal being
Snow has about 25% market opening. transported in different areas.
share. They make 11% EBITDA It's more timely and, in some
margins, while SAB's global Those are some of the best ways, directionally much more
business makes high 30s. They ideas I think we ever find. accurate and interesting than
think that over the next five or Because we are generalists and macro data. By following the
six years they can reach parity we're turning over a lot of action in Daqin we have a
with SAB’s global margins, stones, we have enough to be good window into other
which will be partly due to well versed in a wide array of investments in China. We've
industry consolidation. names. Some of the greatest certainly exported some of the
theses for us are things that, information that we've found
Recently China Resource when you start digging in, are around how bad some trends
Holdings made a bid for all completely different than the in China are into the rest of
CRE’s non-beer assets. It was general, widely held our short book globally. As a
equivalent to roughly 80% or perception. generalist, the goal is to is
85% of the entire market cap cross-pollinate—and ideally
of CRE before this bid. The Daqin is a monopoly rail see things with a varying
SOE basically gave a gift to infrastructure and CRE is a perception and build on it.
minority shareholders and valuable company with beer
bought the assets that nobody assets and are just two As we research ideas, we will
wanted, nearly giving full credit examples of opportunities use smaller positions in
for the entire stock price. That where the upside could be opportunities that are really
has been approved now and meaningful as demutualization exciting as a way to put a stake
will be paid out in October. and deregulations takes place. in the ground, forcing us to
They've also said that after focus and do even more work.
they pay that, they're going to G&D: How do you think The wind in China could blow
buy 20% of the market cap, about sizing these positions? a different direction and they
which is 40% of the free float could stop the SOE reform.
at a price that's also above EB: Given we are a They've tended to be pretty
today's stub value. So, they're concentrated fund, the top good about long-term thinking
doing things that are actually 50% of our book is in five in China, but we have to keep
quite friendly toward names and if we can find an an eye on that.
international investors. And additional one or two great
then they've essentially said ideas in China over the next I'd much rather be spending
that they're now going to few years, that would be a win our time there where nobody
consolidate the industry and in for us. These aren't else is looking. People think I'm
the next five years try to get opportunities that will be up a crazy when I talk about it and
to SAB Miller margins. In mere 30% or 40%—we think the deregulation and
which case, we think EBITDA they have tremendous upside. demutualization are actually
can increase by 5x in the next But let’s face it, China is scary, happening. There's just a lot
five years. Will it be a straight and it is a bit path-dependent. less competition around the
Page 31
Harvey Sawikin
Ed Bosek
margin in some regions balance. You never want to be they can still have a great
internationally and we can too cautious where you miss a performance.
create edge. great opportunity and it runs
away from you. G&D: Given the high valuation
G&D: When you're building levels in the U.S., how are you
conviction and looking for We focus on key drivers finding these situations that
recognition points, can you moving in directions that we have such meaningful
talk about when the wind does think we see clearly. If the data differentiation and upside?
shift or how you think about is tracking 1% or 2% different
revisiting your thesis in that than we'd expect, it's generally EB: We wrote earlier in one
context? not enough to scare us. But, of our quarterly letters this
for example, if Daqin’s prices year that we couldn't find any
EB: We ask ourselves the are going down when I think long ideas. We looked around
following questions. Do we see they’re supposed to go up, the world and couldn't find
things differently? Are we then that's a big delta, or if CR anything terribly compelling.
fundamental, meaningful, and Snow is engaging in a price We were starting to see some
different? Is there a recognition war, while we're expecting of the trends in China, but it
point? Can we really rational price discipline and was really difficult: investors
understand the things that margin expansion, those are were very bullish. The U.S.
matter? What are the trends in market at the low has
the business? If we want to be “I'd much rather be corrected over 10%—that’s
long in something, they should one index. Then the question
be getting better. If we are spending our time is “how do the components of
short something, fundamentals that index do?” There's been a
need to be getting worse. there where nobody lot of damage under the
What are the expectations? surface this year, so while
Then, what's the risk/reward? else is looking...There's overall the market's down a
Embedded in our decision- just a lot less little bit and earnings for the
making is staying on top of year are probably flat to down
what's happening in a business. competition around slightly, the multiple hasn't
Given that in some ways we're moved very much. There is
looking for the story to drive the margin in some certainly a segment of stocks
value, rather than waiting for that have been massively de-
value that will ultimately be regions internationally rated. We are not in the game
unlocked, it's really important of looking to catch falling
that the story is on track. We and we can create knives, but there has been a
stay on top of our businesses edge.” fair amount of correction
and make sure we have high around valuation in large parts
conviction in what we think is the types of fact patterns that of the market that I think can
going to happen is actually would immediately set off be easily missed if you observe
playing out. alarm bells for us. just the indices broadly.
I've generally found that Sometimes the difference G&D: Could you tell us about
sometimes when you’re between a really great year or an idea in the U.S.?
waiting to be proven right, you a really great track record and
actually can build conviction not such a good year or track EB: This year a position that
and have a higher batting record is how quickly you we are intrigued by is a
average, and often the market recognize your mistakes. company called Builders
doesn't see it until much later. Certainly not adding to FirstSource (BLDR). We think
There's a sweet spot of being detractors can make a the U.S. housing market has
early, but not too early. If the dramatic difference. I know routinely disappointed
fundamental thesis is happening some investors that think they investors over the last three
and there's proof of concept, can have a 40% batting average, or four years as
but the market is not yet but if they press their winners hopes for a recovery have
tuned in, there’s a delicate and avoid taking big losers, been dashed. In cyclical
Page 32
Harvey Sawikin
Ed Bosek
markets like housing, in some could be worth $50 or $60. dislocations when there is a
ways, the longer the A number of things are coming great story you stumble upon.
disappointment lasts, the more together to drive the value in
attractive the opportunity the shares, including higher G&D: Could you talk about
becomes, as investors become volumes and cost-cutting. how your approach translates
more cynical. Previously, it was also a to shorting?
relatively small company with a
You're starting to see a lot of private equity owner, so the EB: One of the shorts in
the evidence of a housing free float was limited and it energy was Helmerich & Payne
recovery materializing. The was under the radar. Following (HP) which is an oil services
labor market has improved, the merger, they did a placing company involved in horizontal
financing has become more which has increased the drilling. In the last down cycle
accessible, and mortgages are liquidity and now it's nearly a for oil services, horizontal
still affordable. Household $2 billion market cap company drilling was still in the early
formation is starting to grow attracting coverage. The days of penetration, so they
as demographics have become runway is still long for the were essentially immune from
a tailwind. There's also a need combined entity and the full the pull-back. This time, they
to add housing inventory and, story will play out in the next have not been insulated and
while some parts are over- 18 months or so. there's been a serious pull-
supplied, we're pretty bullish back in utilization. We thought
about activity. That alone We’re upbeat on the that others might realize there
wouldn't be enough for us to prospects as we think it’s would be a downdraft in
take a position, but we're trading at an 11% or 12% free utilization but would assume
aware of the change in trends cash flow yield before any that pricing would be
and monitoring the situation recovery. Looking at the sell maintained at its former level
for investment opportunities. side consensus recently because it did in the previous
indicates there is upside to cycle. However, from our
Builders FirstSource is a numbers and as soon as we standpoint, we thought
lumber distributor in an turn the calendar, it looks like utilization would decline and
industry where there has been the shares are trading on 6.5x while a recovery in utilization
serious consolidation. This earnings. We are, in some may ensue, there would
year, there have been two ways, early to a story that not actually be a price-down. We
mergers between essentially many people understand and remained negative as people
four of the top five players that there will be discovery value as have been very excited about a
have created two dominant people see what's going on recovery that will never
players that have taken here. materialize and as they figure
appropriate measures to offset that out EBITDA differs vastly
some of the competition. The G&D: How do you think on multiples to replacement
company that Builders was about the recognition point for costs. We think the best way
able to buy was a Fidelity this idea? to think about H&P now is to
private equity investment consider them in an
which never really cut costs EB: I think the recognition oversupplied machinery
during the downturn, so point is when the deal closes market and, therefore, their
there's a big margin gap and they start delivering on the price-to-book should look
between the two companies. cost synergies and the story similar to vertical rigs going
We think today by factoring in becomes more widely forward.
cost-cutting efforts, the stock broadcasted. Their equity
is worth about $20. We were placing coincided with the That's a prime example of
paying $12 or $13 to buy the market selloff in late August so seeing something differently. In
stock, and the stock is still I'm not sure many investors this case, there was a clear
around $12 today. We think in were looking at brand-new, recognition point around when
a mid-cycle, the stock, using fresh ideas when their books pricing would change. We did
seven or eight times were getting hit. Sometimes a lot of work around
EBITDA—peers trade at ten you get lucky and get to take horizontal rigs, and the trends
times EBITDA—the stock advantage of these market were obviously terrible, as
Page 33
Harvey Sawikin
Ed Bosek
they were 45% utilized and for students looking to get into
getting worse. Expectations in the industry?
the near-term in cyclicals are
hard because they were EB: The further you go in your
depressed and people were career, the more the path
hoping for rebound. We could makes sense retrospectively:
then gauge the risk/reward you can connect the dots. The
clearly. Using all of these more you can understand
elements in our analysis is yourself and take this time—I
exactly the same whether we think business school is an
are making decisions from the amazing time to learn—to
long side or the short side. meet people and really soul
search and learn about
I think the real place that we’re yourself, the better. The more
a bit different on the short side you can know who you are,
vs. the long side is that we are the more you can figure out
tighter on the recognition what you want to do. To me,
points for shorts, which tend that's probably the most
important thing. People come
to me all the time and ask me
“The more you can for advice, for example, what
job they should take. I ask
know who you are, the them the question, "What do
you want to do?" Very few
more you can figure people know the answer to
out what you want to that. I think an MBA program
is a great time to learn more
do.” about yourself. Once you do
that you can more easily
to be within three to six navigate the industry and find a
months. Sometimes on the strategy that fits.
long side we can wait a bit
longer. In shorting it’s much G&D: This has been really
harder to underwrite your great. Thank you.
downside which is something
crucial to keep in mind.
G&D: If you were to sum up

your strategy, what would it
be?
EB: If I were to sum up what

we're trying to do in two
words, it's to be “different”
and “right.” If we can do both,
we will perform. We can
ensure that we're different but
it's harder to ensure that we're
right. That's why we spend a
great deal of time on our
research and use the same
approach on both our longs
and shorts.

Page 34
Jane Siebels
Research, has always Stanford tuition when he had on art movements, such as
invested differently. Her paid state taxes all those years. Impressionism or Modernism. I
open outsourced I graduated with a degree in essentially was assessing the
investment research firm Finance. After focusing on correlation between the two.
is the latest iteration of finance at University of Iowa, I My analysis suggested that art
investing differently, went to the Thunderbird movements were impacted by
although elements of this School of Management for a broader macroeconomic
research platform have year before receiving a Rotary trends. The qualitative
driven her outperformance Fellowship to study at St. explanation is that when you
Jane Siebels for the last 15 years. She Gallen in Switzerland. have difficult economic times,
has recently made the everyone is fearful and worried
research platform available In the gap year before starting about the economy. It helps
for any investor to use. in the program at St. Gallen, I people understand what
went to Chicago to work with they're really made of, and it
Graham & Doddsville UBS. I spent time working on brings out creativity. You see
(G&D): Can you discuss your their Forex Money Market this trend with major
background and your path to desk, conducting credit analysis inventions as well as in art
investing? for some of their lending movements. On the other
operations, and even helping to hand, when everyone is eating
Jane Siebels (JS): I grew up set up their futures seat in high on the hog, as everyone
in Iowa. My father was a grain Chicago. It was great says in the Midwest, creativity
dealer. I literally started taking experience. declines.
grain prices at the age of 5.
You can imagine the At St. Gallen, I tried to focus G&D: When did you first get
frustration of the traders on on an area where no one else involved in the money
the phone with me! My father management industry?
always said you have to know
something that no one else “My father always said JS: After St Gallen, I went to
knows, and I have relied on Norway with my fiancé. I
that advice throughout my you have to know started working at Storebrand,
career. For trading grains, that something that no one a Norwegian reinsurance
meant literally flying up and company. I was 24 at the time,
counting corn fields, soybean else knows, and I have and they gave me a $100
fields, and how the crops were million global equity portfolio
looking across the whole relied on that advice and a $25 million venture
region. I had received my capital portfolio. It was really
pilot’s license at age 16 so I throughout my sink or swim – I had to figure
could do that with my father. It this out on my own. My
was a wonderful introduction career.” general approach was to
to the markets. Another early identify industries that would
influence was my family’s was focused. I conducted long have attractive and improving
encouragement to always have wave economic analysis on the fundamentals for the next 10
a job. For me, this meant I was art market. Long wave years. Then I studied
always mowing lawns, cleaning economic analysis intrigued me everything I could about the
houses, lifeguarding, and those because it was an interesting industries and the companies
sorts of activities. This was combination of both the within the industries.
also influential because you interests of my mother and Interestingly, that's what I still
learn a lot about business father. My father was of course do to this day.
common sense. involved in markets, and my
mother was a psychologist. The venture capital experience
After high school, I was Long wave economic analysis was fantastic because I was
accepted at Stanford, but I incorporates an element of involved as an early stage
ended up attending the generational psychology. I investor in Magellan Navigation
University of Iowa. My father studied the impact of long as well as IMAX. After
wasn’t excited about paying term macroeconomic trends Storebrand, I worked at UBS
Page 35
Jane Siebels
as the Head of Equity appreciated the opportunity I also generally focused on
Management in Europe before and decided to invest in my attracting families and high net
heading back to the US to be long/short tech focused hedge worth individuals to build my
closer to family. fund. I actually didn't have one investor base. Wealthy families
at the time, so we took the have the advantage of thinking
G&D: When did you connect Latin American fund off the long term. From what I can
with Sir John Templeton? shelf and changed the name. see, they are basically the only
investors that can be long-
JS: Around the time I returned Our fund was long emerging term. Due to demographics,
to the US, I interviewed with market tech companies and regulation, or benchmarking, it
Sir John. I was able to get the short developed market tech is difficult for other investors
position, so I started managing companies. In 1999, it was like and institutions to think long
$3.5 billion in separate standing in front of a train, but term.
accounts as well as a Latin we did reasonably well. On the
American fund and a personal short side, we pursued a Benchmarking is an interesting
hedge fund for Sir John. In strategy focused on companies issue. When Sir John first
1996, I approached Sir John with expiring lockups which started investing, the MSCI
about starting a hedge fund. helped. Despite painful World did not even exist. If
Since my performance on the performance, Sir John stuck you went back and
personal hedge fund was so with the strategy and actually retroactively calculated the
good, he was willing to back added several times to the performance, Sir John
me. I added 6 other families to fund. He even added to his underperformed the MSCI
the investor base. shorts and ended up with a World for his first 10 years in
pretty significant short position business. In today’s world, he
I started an emerging market essentially at the peak in might not even be around! It’s
long/short hedge fund. I was March. So we ended up doing rare for a manager to
again motivated to focus on quite well, and eventually underperform for 10 years and
areas where no one else was closed the fund in 2002 as the remain in business, but he
focused, and because everyone anomaly went away. obviously turned out to be an
assumed there was no borrow excellent investor. I think that
available, there was no one G&D: Did you manage any highlights that benchmarking
else shorting emerging market evergreen funds that had could very well be negatively
equities. We actually found a indefinite lives? Or have you impacting the ability for
few different sources of always been focused on managers to think long term.
borrow and were positioned opportunity specific funds?
quite nicely for some of the G&D: What other
emerging markets turmoil in JS: No, I have focused on opportunities did you pursue?
1997 and 1998. Unfortunately, opportunity specific funds
we were still hit on some of throughout my career. Going JS: In 2000, we launched
our long exposure, but we back to the theme of doing Siebels US Relative Value to
were able to outperform other things differently, I’ve tried to take advantage of the
funds during the time period. set up funds targeted at dispersion in valuations
specific anomalies. I feel between small cap value and
In May 1999, I mentioned to strongly that investors should large cap growth. We closed
Sir John that emerging market be able to understand how that fund in 2003 when the
tech stocks were trading at their money is invested, and it opportunity went away.
single digit P/E multiples even is more easily accomplished
though they were growing with opportunity specific funds. In 2002, I saw that there was
rapidly. Meanwhile, developed When the anomalies went an opportunity with
market tech stocks were away, I closed the funds and I commodities. We were 20
trading at triple digit P/Es. I returned the money. In every years into a bear market. At
thought capturing the eventual instance, I returned investors that point, most commodities
normalization of this spread capital above the high water were trading below the cost of
represented an opportunity. mark. production. Yet we saw
Sir John immediately tremendous demand growth in
Page 36
Jane Siebels
China and other emerging research arm of Green Cay of course avoid any insider
markets. The fund was long Private Client. We started this information. We typically focus
commodities and short real in 2000 because I was sitting in on qualitative information, but
estate. I believed that the Bahamas and thinking we do require a replacement
increasing commodity prices about how to do this value calculation because we
would trigger higher interest differently. think it is the ultimate value
rates, which would negatively metric.
impact real estate values. It I realized that I could have an
was a very nice setup for the army of 500 analysts and yet I We now have 2,500 people
fund and we did well. We still may not have the analyst registered with us around the
eventually sold the Siebels with the right language skills, world. We previously used the
Hard Asset Fund in 2013 as we with the right industry research internally at our
started to see the peak in background, or with the right hedge funds and we still use it
commodities. local knowledge. At the same internally for our private
time, I read about a company clients. However, our internal
G&D: Which commodities that designed logos for portfolio for the private clients
were you most worried about corporations based on internet is only 10 stocks with less than
in 2013? competitions. They published a 20% turnover, so we felt it
mandate, reviewed would be an interesting
JS: We worried about pretty opportunity to offer the
much every commodity across research to other investment
the board. Commodity prices “We have found the firms.
were well above production
costs, and that dynamic was advantage of local We have found the advantage
bringing so much supply into of local expertise to be quite
the market. The commodity expertise to be quite powerful. There are multiple
pricing and supply/demand examples of local knowledge
dynamics had reversed
powerful. There are helping identify and clarify
significantly since we started multiple examples of really significant stock specific
the fund. With some issues. For example, in India,
commodities, China accounted local knowledge one real estate company
for more than 70% of demand, actually had empty sites with
and with China’s helping identify and customers demanding their
demographics, we were very deposits back. It was clear that
worried about the long term clarify really significant wasn’t an attractive investment
sustainability of that demand. opportunity!
So with a negative view on
stock specific issues.”
commodities and our real We try to structure
estate thesis having played out submissions, chose the finalists, compensation to incentivize
earlier, we decided in 2013 and awarded the winners with high quality work. Analysts
that it would be appropriate to cash prizes. I thought we could accumulate points based on
sell the fund along with the do that for qualitative analysis. the quality of their work, and
hedge fund business. That's when Siebels Asset the point totals place them in
Management Research was one of 3 levels of seniority.
G&D: What are you focused started. For example, if we Compensation doubles with
on today? wanted to do a report on Tata each increase in level of
Motors, we would advertise seniority.
JS: I manage Green Cay the qualitative research
Private Client. We work with opportunity in India, on G&D: Has the research led to
high net worth families to help relevant industry sites, and any actionable ideas recently?
them think long term about message boards. Prospective
how to grow and protect their analysts register with us and JS: One industry study we
wealth. One area I’m really can submit their research recently finished was an
excited about is Siebels Asset related to the opportunity. We evaluation of the cruise
Management Research, the look for original research and industry. It has been a tough
Page 37
Jane Siebels
industry. Everyone has been JS: India has problems that SDR is certainly not being
perpetually disappointed. We China does not have. One is priced as a high probability
gathered information that the tremendous bureaucracy. today. I might then short some
suggests the dynamics of the No matter what government of the countries that have
industry could finally be gets elected, there are certain funded a lot of their growth
improving. The long awaited limitations to the pace of with US dollar denominated
restructuring may finally be reform. I think that debt.
occurring, and there is an bureaucracy is leading to
opportunity for further another growth roadblock in G&D: Do you have any advice
consolidation in the industry. India. Yes, if you look at the for Columbia students
Additionally, with oil prices numbers, if you look at the pursuing a career in investment
down and new routes like potential, it should definitely management?
Cuba and parts of Asia opening become the next great
up, we think the cruise commodity importer, but I JS: A big one is “Do it
industry is a pretty interesting think it will take time. I also differently.” I have mentioned
place to invest. I will hold off don’t think the cultural this several times throughout
from mentioning any specific tendencies in India tend the interview because it has
companies, but I think the toward consumerism to the been an important theme
larger companies with stable degree they do in China. That throughout my life. Also, not
balance sheets will be able to has likely been a driver of only do you have to do things
take advantage of this consumption in China that you differently, but you have to do
opportunity. might not see in India. things passionately. The money
is not worth it. You need to be
G&D: Given your past G&D: Do you have a passionate. You need to love
experience, we would love to perspective on the stability of what you do. Usually, if you
hear your thoughts on particular countries in really get in touch with
commodities today. There has emerging markets? Will there yourself and follow your
been plenty of debate, both be another Asian crisis, and passion, you will be different
bullish and bearish. How do where might it occur? than anybody else because
you think it's going to play out? there's only one of you.
JS: That's a great question.
JS: I think we are getting close One benefit of this cycle is that G&D: Thanks so much for the
to a bottom, but not yet there. less emerging market debt is interview, Jane.
In a typical commodity cycle, dollar denominated as
price has to bounce around compared to 1997 and 1998.
the bottom for a long time in You still have some, but it is
order for excess supply to be not on the same magnitude. I
taken out. We are only just would definitely avoid
now seeing some supply taken countries with current account
out of certain markets. Iron deficits or high US dollar debt
ore, oil, even some of the as a percentage of GDP.
precious metals are in the
early phase of supply exiting. Another interesting emerging
When we see companies market out there at the
exiting industries, closing moment is China. I think
assets, or really just having a Chinese government debt in
tough time, that can be an renminbi could be a very
interesting signal. But I think attractive investment. I think
we're just starting to scratch the skepticism around the
that surface at the moment. renminbi devaluation is
overdone. I think there is a
G&D: Is India going to be the high probability that the
next China in terms of demand renminbi comes into the SDR,
for commodities? which I expect will stabilize the
currency. Inclusion into the
Page 38
Global Endowment Management

a Vice President in the backgrounds and then launch GEM in 2007. Before joining
Mergers and Strategic into a discussion on the history Duke, I was a student at UNC
Advisory Group at of Global Endowment Chapel Hill, which is where I
Goldman, Sachs & Co. He Management? first fell in love with investing. I
graduated with an L.L.B. ended up writing an
(honors) and a B. Comm. Hugh Wrigley (HW): As independent study about
from the University of Director of Investments, I Buffett, Graham, Soros, and
Hugh Wrigley Melbourne. coordinate the activities of others. During school I
GEM’s public and private worked an unpaid internship at
Campbell Wilson, CFA is investment teams. Previously, I a local investment advisor, just
the founder of Old Well led the private investment to get my foot in the door, and
Partners, the first “GEM team at Duke University under I realized that there were
Cub,” which will be Thruston Morton, our founder these endowments, including
primarily focused on the and then CIO of Duke Duke's, right down the road
direct investment strategy University’s endowment. We that had several billion dollars
deployed at GEM. launched GEM in 2007 as an invested with the best
Campbell joined GEM in investment firm that would managers in the world. They
June 2007 and headed the invest in the long-term, value- have an analyst program where
public investments team. oriented style of the leading they hire people to join a small
Campbell is a member of university endowments, but on team right out of college,
Value Investors Club and behalf of smaller endowments where you could interact and
James Ferguson he is on the Board of and foundations who lacked a learn from some of the best
Directors at KIPP dedicated investment office. By investors in the world. It was
Charlotte, a free, open- pooling their assets, our an absolute dream job for me
enrollment, college investors could invest like the and something I am still doing
preparatory public school largest endowments without today.
serving underserved the inefficiencies and conflicts
communities. He received that frequently arise in James Ferguson (JF): I am a
his B.A. of Economics and separately managed account bit of a late bloomer in terms
Political Science from structures. of doing this full-time. I have
University of North always been interested in
Carolina at Chapel Hill. We sought to create a public investing and grew up
structure that allowed us to sitting around the table with
James Ferguson, CFA invest as similarly as possible my dad and brother, talking
joined GEM in 2012 as an to the large endowments—the about stocks. I graduated from
Andrew Burns Associate. Previously, Yales, the Dukes, the MITs, Duke in 2006 and then worked
James was a Marketing and Notre Dames of the for a private real estate
Principal for Childress world. Philosophically, development firm that spun
Klein Properties. James investing a large endowment out of Trammell Crow in the
received an MBA with means searching for external late ‘80s. I was there for six
distinction from Wake managers across asset classes, years, but during that time,
Forest University School of globally, while maintaining an nights and weekends, I was
Business and a B.A. in opportunistic mindset. At the reading annual reports, looking
Economics from Duke end of the day, we are at manager filings, and then
University. bottoms-up value investors going to the Berkshire
looking to invest with the best Hathaway meetings with my
Andrew Burns, CFA joined managers, evaluating the least dad.
GEM in 2008 as an Analyst efficient asset classes we can
after graduating from find, and taking a long-term I came to the conclusion that I
Duke University with a view. The main tenets have shouldn’t spend 20 hours a
B.S. in Economics. been consistent over time. week doing that in my free
time—that I should really do it
Graham & Doddsville Campbell Wilson* (CW): I full-time—so I began a dialogue
(G&D): Could we start off was also on the investment with the GEM team in
talking about your individual team at Duke before joining Charlotte, and then we
Page 39

reconnected at one of the closely together. We have the early 2000s. About 20% of
Berkshire meetings. I joined whole-team meetings and look our portfolio is invested
GEM’s public team in 2012 and at investments together, so directly today, with the
spend time on both our that we can really understand remaining 80% invested with
external and internal public and debate the merits of managers. We have tried to
investments. investing publicly or privately have even more collaboration
in different asset classes. In between the public and private
Andrew Burns (AB): James fact, unlike many of our teams. As I mentioned, we
and I work closely together on endowment brethren, we do don’t have a specific budget for
the public investment team, not set allocation targets for private investments anymore.
focusing on both public equity private investments. We seek a A lot of endowments will say,
and hedge fund investments. I “We are going to invest X in
graduated from Duke in 2008 public equity and Y in private
and, attracted by GEM’s team,
“In almost every equity.” We say, “We want X
investment philosophy, and strategy, smaller is in equity,” and the teams work
open-minded culture, joined together to find the best
the firm right out of school. better… we are trying opportunities. Otherwise,
GEM has been an incredible though, there are a lot of
learning experience for me. to invest in mispriced similarities. We have always
The strong culture allows us to been focused on small early-
fully embrace Charlie Munger’s securities, and, stage managers and are really
mantra about making sure that looking for investment
you go to bed smarter than
generally, those are partnerships day-to-day, not
you were when you woke up; found in smaller big asset managers.
we are constantly trying to
improve ourselves and our spaces.” G&D: How would you define
processes. We are excited small managers?
about both the foundation that constant competition for
we’ve built thus far and the capital between public and JF: The median assets under
chance to continue improving private opportunities. management in our public
each and every year. portfolio is about $720 million.
G&D: Can you talk about
G&D: Could you tell us about influences from the experience G&D: Including public equity
the structure of the at DUMAC on GEM, certain and hedge funds?
organization? How are you parts of the DNA that have
divided up? How many people transferred over, for example, JF: Yes, public equity and
work on the various teams and the way you structured the hedge funds. Some are as small
how do you cover the globe? team or lessons taken from as $50 million where we are
your time at DUMAC that you most of the assets and we are
HW: We have 16 people on have built on? fine with that. In almost every
the total investment team, led strategy, smaller is better.
by our CIO Mike Smith. We HW: DUMAC was an early There are a few exceptions,
currently have five investor in hedge funds, but we like small because, at
professionals on the public side venture capital and private the end of the day, we are
and six on the private side. equity, so great manager trying to invest in mispriced
The public team is responsible relationships have carried over securities, and, generally, those
for our public equity and hedge to GEM and have been really are found in smaller spaces.
funds, including public credit. important. At GEM, we’ve
The private team is responsible continued to nurture that G&D: Could you talk more
for things like private equity, creativity gene we developed about how you approach
venture capital, real estate, at DUMAC. Early on at GEM, allocation?
private oil and gas we started investing directly
partnerships. Everyone has a with a portion of our AB: We divide public
home base, on one team or portfolio—something we investments into two
the other, but we work really weren’t doing at DUMAC in components. There’s public
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equity, which we think of as opportunity, we want them to say the underlying businesses
predominantly long-biased, and have the ability to invest there. haven’t changed and the
hedge funds, which are Ultimately, our goal is to invest multiples have, but it is
primarily funds with either low with managers who can another thing to react
net exposures or a low generate the best risk-adjusted accordingly. Ideally, we would
expected correlation to global returns, and we believe that get to know them over
equity markets over the long having the ability to invest multiple years and really see
term. across the capital structure how they behave when they
provides them with the most are put in successful and
Credit has historically had an opportunities. difficult situations and
opportunistic (i.e., not everywhere in between. In
constant) place in our practice, we end up spending a
portfolio. We never have to do
“Credit has historically lot of time on references,
anything in credit: just because had an opportunistic looking for people who can
something is relatively speak to how the manager
attractive in the credit world (i.e. not constant) handled a variety of different
doesn’t matter to us unless it situations.
is attractive on an absolute place in our portfolio.
basis. Our credit investments G&D: How important is their
compete with our equity We never have to do idea generation process to you
investments from a return when you are thinking about
perspective, which typically
anything in credit…” what they are looking at?
means we usually stay away
from performing credits and G&D: Can you talk about AB: The importance of idea
look to add distressed credit your process of vetting generation varies case by case,
investments when managers, particularly if they depending on a manager’s
opportunities arise. are on the smaller side and strategy. For example, an
maybe have recently launched investor focused on large cap
For example, we made a and don’t have much of a track stocks probably doesn’t
number of distressed credit record? require idea generation as an
investments during and after important edge. For us, in that
the global financial crisis in JF: We are really trying to case, it’s more important to
2008 when we thought we underwrite two things: process understand the investor’s
could make equity-like returns and temperament. Arguably, temperament and underwrite
in investments with superior temperament is more difficult their understanding of a
downside protection by nature to underwrite than process. business—its competitive
of investing higher in the You can go through the position, return on invested
capital structure. We invested process and drill down into capital, reinvestment
a fair amount of our portfolio examples; you can read the opportunities, etc. On the
into distressed mortgage- annual reports and then come other hand, if a manager is
backed securities and back with very pointed looking at micro-cap stocks in
corporate credits. Today, questions, but the Asia, idea generation—flipping
however, we have almost no temperament piece is much over as many rocks as possible
exposure to credit in the more difficult. So many to source investment ideas—
portfolio. We would hope to managers say they are long- might be the single most
size that back up again when term and think about things on important factor in
another distressed cycle hits. a multi-year basis, but we find determining that investor’s
that how they define long-term success.
JF: Long-term, equity oriented varies significantly.
funds are the core of our G&D: Continuing on this
public portfolio, but we like For example, you don’t know notion of process, how do you
the managers to have how they will react during a filter down what managers are
flexibility. If our managers are difficult period where, on a worth spending more time on?
looking at a business and a mark-to-market basis, they are
tranche of debt is the best down 50%. It is one thing to JF: We have a broad filter and
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leverage our team’s experience ultimately more important business profile meaningfully—
to evaluate multiple than where someone went to these are reasons we’ve
opportunities, but our goal is school. redeemed historically.
to be able to say “no” quickly
based on a number of criteria. G&D: Can you talk about how G&D: Do you get approached
It could be they are too big. It you balance having a long-term by small endowments or
Scott Trenary ’16, Anthony could be they have 10 different partnership with managers families that want to be a part
Philipp ’16, Yinan Zhao ’16, funds, and it’s really more of an with moving in and out of of your organization?
and Aaron Purcell ’16 enjoy asset management business. It certain strategies in your
themselves at the Value could be they’re not a good fit portfolio? HW: Yes, we do. Today, we
Investing Program Welcome for our portfolio at the time. are managing about $7 billion
Reception It’s a balance between the two: CW: The credit example we in assets for 35 investors. We
thinking about our overall talked about is one of the few set out with the goal to get to
portfolio and how great an where we think that we have $7 billion or $8 billion, and
investor is on a standalone to be opportunistic, moving then to reassess. We had been
basis. One of the toughest money in and out, depending managing just under $8 billion
parts is when we identify on the market environment. In when we left DUMAC, so we
world-class managers but don’t terms of our more equity- are very comfortable with our
add them to the portfolio focused managers, we think current size. In addition to
because of our strong longer term. We have the managing our AUM growth
conviction in our existing ability to hedge-out certain carefully, we think carefully
managers. It’s clearly a high- risks at the portfolio level. So if about the number of investors
class problem but nonetheless we have two great managers we will work with—and for
difficult to pass on a world- we love and want to invest similar reasons: we want to
class manager. with for the next 20 years in maintain quality, both in
Europe, but our CIO is performance and investor
G&D: How important is concerned that we have too service. In fact, we closed to
resume pedigree as you work much risk in Europe, we have new investors in 2015, but
through the filtering process? the ability to hedge that at the expect to open selectively
portfolio level, leaving our again next year.
CW: It is important to bottoms-up investments intact.
understand where an investor G&D: With respect to scale
learned how to invest. We In terms of manager turnover, as an advantage, could you talk
actually think, increasingly now, generally, a change in people more about why that’s so
that it is becoming possible to or process would be a reason important? What else
learn from the greats without why we would redeem from a differentiates you from your
having worked with them. manager. Ideally, we would peer group?
There is so much info on never have to redeem and
Buffett, Klarman, Greenblatt, have an extremely long-term HW: If you look at
and others, that we’re holding period, but things do endowment history, the largest
constantly finding self-taught change at these organizations ones have performed the best
investors who just devoured and partnerships. It is usually because they have been able to
everything ever written by or not about performance. We attract and then keep a
about those people and have have redeemed from some talented team, and that has
become great investors managers who have performed been really important. Their
themselves. Given the extraordinarily well for us. A size also helps them get the
apprenticeship nature of our common reason is that they first call when really talented
business, it’s still tough to get too big for our preferences managers want to raise capital.
replace working for a world and are forced to invest If you are the world’s best
class investor but there are differently or to be a different stock picker and want to raise
clearly self-taught managers kind of organization because of a fund, you could call five or 10
who are extremely successful. their size. Otherwise, staff big endowments and raise the
Like most careers, a passion turnover, strategy drift, or a money, or you could call 50 to
for one’s work as well as an manager launching multiple 100 small ones. Obviously, that
intense work ethic are products, changing the is an easy choice.
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At the same time, we generally build a closer relationship with those that haven’t, and why. A
think size is more often than them. These strong few lessons stand out and the
not the enemy of performance. relationships can provide us co-portfolio manager model is
It would be really hard to with the necessary conviction a good place to start.
manage $30 billion and achieve to support an investor during
the results we do. With $7 inevitable periods of difficult One of the biggest challenges
billion or so, you can write big performance. We also has been the co-PM
enough checks to get the encourage our managers get to partnership where there is no
attention of good managers, know and build trust with us clear driver and no clear
but you’re not so big as to be too. If an investor has passenger. When things are
forced to change investment conviction that GEM is a long- going really well and the
strategy. term and like-minded partner, investments have performed
it can provide them with a key well, it is easy to have a great
CW: In terms of our competitive advantage. It’s easy partnership. However, when
competitive advantages, to pay lip service to the value business is under a lot of stress
certainly our network helps, of a strong partnership, so we and the stocks are not
going back to the DUMAC typically encourage prospective performing well, it can be
days with all the manager partners to speak with some of difficult to resolve conflicts in a
relationships we developed. our existing managers to get a 50/50 partnership.
Our team also brings depth of better sense of our own
experience and industry mindset and, hopefully, gain We’re also focused on our
relationships—we have three conviction in us. own return on time. It’s easy
former CIOs and a number of to treat the most precious
other people who have come “When somebody commodity that we all have as
from direct investing roles as disposable but, ultimately, the
well. I think that all helps our shifts from being a way that we use our time will
own process, and hopefully it dictate our long term results.
helps our manager great stock picker to As a result, we’re spending
relationships, too. We try to more time looking for
be helpful, value-added managing an managers that can compound
investors for the managers we our capital over multiple years
organization and
invest with—not just calling and preferably into the
once a quarter to check a box. delegates the idea decades. This not only
Hopefully, we bring something mitigates our risk through the
to the table, whether it is being generation and strength of the relationship but
helpful through connections also mitigates the reinvestment
and insights from our network research to someone risk that we face when we
or through our own history redeem from a manager and
and experience. else, that is usually a look for a new opportunity to
redeploy that capital.
mistake”
G&D: Is the relationship
different when you’re the main G&D: Have you seen other
investor versus when you are G&D: You have had the commonalities of what makes
one of many? If so, is that opportunity to evaluate a lot of organizations successful or
intentional? managers. Has that helped you prone to failure?
to evolve your own mental
AB: It definitely can be. As models and investment CW: There are different ways
Campbell mentioned, we frameworks within GEM by to do it. Some of the best
always seek to have deep evaluating all these managers? investors in the world have set
relationships with our up their firms to decentralize
investment managers and in JF: We’re always looking at the organization. I think of
cases where GEM is a key investments that we have Buffett as an example. He
source of capital, it’s typically made or haven’t made, spends all his time reading and
easier for us to improve managers that have made great thinking—not managing
transparency and access and to partnerships over time and people. That’s great but hard
Page 43

to pull off, of course. The best the investment thesis when we crossing part of the ocean, not
investors generally try to first met?” We can check in for getting all the way, so we
maintain a small team with them, and ask, “How have have been promoting
structure, so they can spend things changed with the structures like that. We want
most of their time investing. underlying business? Aside to reward managers if they
Having a really strong from stock price performance, generate great long-term
operations team, for example, what was your view on the performance, but not just for
to manage all the non- business? Did you think it was having one good year— or
investment activities is going to grow by 20%, and the worse, for just showing up or
important. When somebody business is actually shrinking? riding a beta wave.
shifts from being a great stock Why is that? Was it a mistake
picker to managing an in process or something else?” CW: We have also been
organization and delegates the We think about the outcome structuring management fees
idea generation and research that we’re seeing play out in to scale down as the manager
to someone else, that is usually the context of their original grows. We think that, at the
a mistake. They are managing thesis and, as a result, think end of the day, the
people and process, and that is about the portfolio on a look- management fee should keep
entirely different. Some people through basis in terms of the the lights on, pay people’s
make that transition individual businesses that we salaries, and keep everyone
successfully—for example, a own. comfortable. But we think that
number of the big hedge fund a manager should get wealthy
managers now have done that G&D: How do you think of from our capital if they
well—but we have seen a lot alignment of incentives with generate great performance
of bad outcomes there. the managers and yourselves? over multiple years. Our ideal
structures would have some
We advise managers who are HW: First, we want to see elements of what Hugh and I
starting up not to compromise our managers have all or most just described. Over a third of
their investment process. It is of their own net worth our managers now have at
so easy to set out saying, “I am invested alongside us. We least one of those
going to do this. This is how I think that is the best alignment components.
want my own money invested. possible, but we have also
This is what I believe in,” and made a push over the years to G&D: We noticed that you
then somebody comes along improve alignment of the started posting thought pieces
and says, “Could you change it terms of the partnerships we on your website over the past
a little bit, and I will write you invest with. For example, we year. Can you talk about the
a big check?” That’s hard to have a number of funds that genesis of that?
turn down when you’re we invest with now where we
starting off and you’re worried structured the incentive fee to HW: Well, we’ve only posted
about growing your business. be paid out over a multi-year two pieces but intend to do
period. We think it makes a lot more in the future. That has
G&D: After you have made of sense. Managers say they been something that we
the initial investment, how do have a multi-year investment thought would be helpful to
you monitor the fund to approach, and I think everyone our investors. In particular, the
ensure that theirs is a would agree that it takes capital market assumptions are
repeatable investment process multiple years for results to something we talk about with
that works the way that you even mean anything. In the our university and foundation
initially understood? hedge fund world, the 20% investors a lot. Our research
carry came from Venetian lays out what they could
JF: In evaluating a manager on merchants who got to keep reasonably expect for long-
a forward-looking basis, it is 20% of their profits if they had term returns given where
easier to investigate what’s a successful voyage across the markets are today because
worked and what hasn’t versus ocean. But we think that paying they need to think about their
reviewing past case studies. a hedge fund manager an spending requirements and
We can say, “Okay, what did incentive at the end of the year budget partially based on what
the manager tell us? What was is like paying a merchant for could happen to their
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endowments over time. So, biggest positions in Oaktree It was unfortunate as a whole
that literature has been in Capital. We thought that he for GEM to lose Todd as a
response to that need. knew the financial sector manager. One silver lining was
better than anybody—he was that we actually bought Castle
Then we do have a couple of our only financials-oriented Point’s stake in Oaktree and
investors who fall outside of fund. Oaktree is a business transferred the shares to GEM.
the endowment and model we understand and We have held a position in that
foundation space where they could underwrite. It’s not ever since, and it has been a
view us as a strategic dissimilar to our own business nice investment for us. I think
partner—a few family offices, a model, we had been a that is an example of a one-off
few sovereign funds. We customer of their products at opportunity where we think
produced the literature to DUMAC for a time. we can understand the
share our thoughts with them business and also leverage our
on what’s happening for our “...the 20% carry came managers.
equity space.
from Venetian We really liked Todd, and he
A good example is the GEM loved this position. That is
Implied Private Premium (or merchants who got to usually the starting point for
IPP), a concept we developed our direct investments because
to improve our evaluation of
keep 20% of their we want to do it in a way that
illiquid investment profits if they had a is complementary to the fact
opportunities. One of the that we spend most of our
challenges with these successful voyage … time investing with managers.
opportunities—of which
private equity funds are a great paying a hedge fund G&D: Has your view on
example—is that a simple IRR private equity evolved over the
doesn’t account for the manager an incentive years as the space becomes
opportunity cost of forgoing more crowded?
public alternatives (for
at the end of the year
example, an S&P 500 ETF). To is like paying a HW: Our philosophy there is
solve this problem we calculate similar to the public team,
the GEM IPP to answer the merchant for crossing where we are always trying to
question, what additional invest our capital in less
return, if any, did an investor part of the ocean…” competitive markets and in
receive for agreeing to forgo areas where we think
the liquidity of the public Then Bruce Karsh joined the mispricings are more likely to
markets? The answer helps DUMAC board, eventually be found. For example, on the
guide our evaluation of the chairing it. When Todd was private equity side recently,
private investment opportunity pounding the table about our team has been spending a
relative to other, more liquid, Oaktree, we started talking to lot of time looking at small
alternatives. him about whether we could turnaround opportunities in
buy some directly. He was Europe. Since starting the fund
G&D: How long have you open to the idea, and he from scratch in ’07, the
been doing the direct actually started sharing his percent in overall privates has
investing? research and walking us grown to where about 25% of
through the accounting, which the total pool is invested in
HW: Since we started GEM in was a bit messy, and sharing private assets—private equity,
2007. We do a few different his model—we had a good private real estate, private oil
things there. For example, back back-and-forth on Oaktree. and gas assets. We think that is
in 2010 we were invested with getting closer to the steady-
Todd Combs at Castle Point. We were ready to buy the state level where it will level
Several of us had known him shares ourselves when we got off: closer to 30% over time is
since being an early investor the call from Todd saying that where we would like it to
during the Duke days. At the he was shutting down the fund settle, but that will fluctuate
time, Todd had one of his and going to work for Buffett. with the opportunity set.
Page 45

G&D: Are emerging markets interesting on a long-term of mispricing we perceive.
an area of opportunity either basis? Would you look at
on the public side or private markets that are short-term G&D: Do you feel like you are
side for you or managers you destructive like Russia? able to instill best practices
are working with? through your partnerships with
CW: There is a great book by emerging market or frontier
AB: We are actively investing Bill Browder about Russia. If market investors?
in emerging markets in both you haven’t read Red Notice, I
public and private investments. would recommend it. We have JF: We are always thinking
We also consider investing in a couple of managers who have about ways that we can be
emerging markets, one of the dabbled in Russia, but that is helpful to our managers, both
highest risk investment areas in one of the few markets where on the investment side and the
our portfolio. However, in the it would be hard for us to have operations front. For example,
right circumstance, the large exposure. There our CFO used to be in the
potential rewards outweigh probably are some good back office of Blue Ridge
the risks. Developing equity opportunities, but I doubt that Capital before moving down
markets can provide skilled we could get comfortable—at south. We have several people
investors with great hunting least not today—with having a on our operations team who
grounds for mispriced large position, given all the worked in hedge funds or
securities. Not all “emerging obvious issues. audited hedge funds, so they
markets” fall under the same have seen the best practices
umbrella, of course. Today we G&D: What about India? operationally of a number of
believe that many markets in different funds across
Asia represent an especially CW: We think that a market strategies and regions.
compelling opportunity due to like India over the long term is
the combination of the sheer great. There are more stocks When a manager is launching a
quantity of listed securities and listed in India than in any new fund, we try to be helpful
the relative dearth of country other than the U.S. by providing best practices
exceptional investors looking Over the next 20 years, we from an operations standpoint
at those markets. This dynamic think a lot of those companies as well as using our experience
is, of course, particularly will grow a tremendous and network to provide
pronounced for less-liquid amount. There will be a lot of different perspectives around
investments. To help GEM differentiation and a lot of incentives, fund structure,
exploit this opportunity set, I inefficiencies, given the service providers, etc.
spent two months last year relatively low level of
based in Hong Kong and competition in the market, so On the investment side, we try
traveled around the region in that is one we are excited to connect managers where
attempt to uncover some about. Even in Japan, we think they would both benefit from
smaller, off-the-radar managers there are far fewer long-term different perspectives. For
like the ones we can more value-oriented investors than example, one of our managers
easily find and partner with in in a market like the U.S., focuses on China, while we
the U.S. I think it’s important despite it being a major market have another manager who
to mention that our positive with lots of companies listed. invests a lot in technology and
view of the opportunity set in Obviously Japan is not growing Internet business models
Asia is not related to our view like China or India, but it globally and probably knows
on the consumer or China’s represents a market with a lot the Internet better than
GDP growth—it’s a function of of mispricing. anyone. We think our China
finding more mispriced manager knows China better
investments due to a lower In Europe, too, there are not than anyone. It turns out they
level of competition among as many long-term fundamental both were looking at Chinese
professional investors in the investors as there are in the Internet opportunities, so we
markets. U.S. There are a lot of places thought it made sense to
we like more than the U.S. connect them. Having our
G&D: Are there other from an opportunity global network of people in
markets that you find similarly standpoint because of the level (Continued on page 46)
Page 46

different places, doing different We only want to invest in have to have the right investor
things, and then, when it makes long/short managers if we base and a truly long-term
sense, connecting them, is just think that they’re great on the mindset, but we have seen
one way that we can be short side and truly add value examples that have worked
helpful. there over time. Arguably, a successfully. Then you can
lot of hedge funds short to call have great time-weighted and
G&D: Broadly speaking, long/ themselves hedge funds and capital-weighted returns.
short, as a strategy, has justify the fee structure, and
struggled over the last couple we think very few managers G&D: Do you have any view
of years. Could you share your are great at shorting. on activism and what seems to
thoughts on what you think of be the growing trend of activist
the strategy, how it has G&D: What do you think are managers?
evolved over time, and some the biggest risks to your
of the challenges it has faced portfolio, and how do you JF: Interestingly, at the Daily
recently? think about that on a manager Journal meeting, Munger
level and then also on a macro basically acknowledged that in
JF: We think that short selling level? some cases they are needed,
is exceptionally hard, and but in other cases, they are
obviously it has been a tough CW: I think that we share the not, and I think that’s probably
market for shorts since the views of a lot of smart how we think about it—it’s
market has gone straight up managers today that all the very dependent on the
for six years. It’s also much money printing and artificially situation and the activists
more challenging than it used low interest rates are a big themselves.
to be given the change in wild card that could be a risk
interest rates. That being said, over the next decade. What It is about the time horizon of
we do think it is an important would we do then? Well, the activists: are they really in
tool for a select group of we’ve tried to build a it for the long haul? I am sure
managers and one where the battleship that can survive there are some people tagging
best short managers can add different environments. Like along, calling themselves
value through the process. Buffett says, “Predicting rain activists, trying to get
doesn’t count. Building arks companies to lever up and buy
Ultimately, we think that does.” back shares to get a stock pop.
managers have to run their That probably is an increasing
funds in a way that lets them For managers one risk that has risk, but some activists do add
sleep at night. Some of the increased in recent years is real value— it’s probably a
best investors in the world managing inflows into their good thing to have them
simply aren’t comfortable funds. It’s a risk to managers if watching over a company at
taking 100% market risk and they grow at the wrong times. the end of the day.
being long-only; they sleep There is a big difference
better at night knowing that between dollar-weighted and G&D: Could you talk about
they have a short book to time-weighted returns. There the mission of Global
protect them against are some great managers with Endowment? In addition to
uncertainty in a world of very strong performance track managing capital, is there an
volatility. We know other records, who have actually lost academic mission?
great investors who can’t sleep dollars for their investors over
at night knowing that they have time. Money comes in at the HW: We do not pursue an
a small short position in a wrong time and leaves at the academic mission ourselves,
stock that could lead to wrong time. As a result, we although we obviously serve
unlimited losses. Investing is have seen managers who have academic institutions and work
personal at the end of the day, deliberately tried to limit to further their missions. But
and you have to do what inflows when things are hot we do believe that serving
you’re emotionally equipped to and opportunity sets decrease; one’s community is important,
do, to think about it as if it then they raise their hands in an absolute sense, of course,
were all your own money. when it’s a great time to but also as a way to develop
invest. It’s hard to pull off. You (Continued on page 47)
Page 47

our internal culture. For Sinegal worked before leaving industry and help in thinking
example, a few years ago we to co-found Costco. Several of through each part of the
created a virtual foundation— us also read Brad Stone’s The process: Who are the right
the GEM Foundation—that is Everything Store about Jeff LPs? Do you want to partner
managed by GEM employees Bezos. Another book that I with someone else? How big
and gives away a certain really enjoyed is Capital Account do you want to be?
amount of the company’s by Edward Chancellor. It’s a
earnings to impactful local compilation of excerpts from We have seen a lot of funds
charities in Charlotte every Marathon in London. that have basically built the
year. Our employees actually Cadillac model right away.
diligence potential charities Their unique focus on the Then they put themselves in
much like our investment team supply side and the idea that it the position where there is so
diligences managers! Each of is the main driver of returns much pressure from a business
our five partners has a on capital instead of aggregate standpoint that they really have
background in the non-profit demand provides a different to go raise a huge fund. A
world—in addition to four of view of the world. better bet might be to start
us having been principal small and bootstrap the
investors—and that it is G&D: Do you have any advice organization to create the
something that we are proud for our readers who hope to track record and then build the
of. It keeps us excited about invest as a career and even run team accordingly.
our work and reminds us that a fund some day?
the underlying institutions for The last thing to add is that
which we invest want to JF: If I were in an analyst’s before starting on your own, it
achieve great things. If we shoes, I would really think helps to have worked for an
generate better returns, they about why I want to start a exceptional investor. At the
can hire more professors, do fund. There are a lot of people end of the day, it’s easy to get
more research and give more for whom, if you asked that distracted by money, titles, or
scholarships, and do things that question, the ultimate answer some other outward trapping
we think are positive in the might be that they shouldn’t of success. However, given
world. We actually hold start a fund. If your goal is to the ability to compound
regular overview presentations do really well financially, there knowledge in our business, a
on what our investors do at are a lot of funds where you great foundation will at least
our weekly company-wide can work and do very well tilt the odds in one’s favor and
meeting—every employee financially, so I don’t think that probably lead to all of the
eventually ‘presents’ a deep is a good enough reason. Do above in the long-term. And if
dive on a particular investor to you want to be in charge of it works for your personal life,
the group, to remind us all things? Maybe you can run a focusing on a less efficient
about the good they are doing portfolio in size. I don’t think market right now could
and what our efforts support. that alone is a good enough present significant
To keep that front and center reason. As we were saying opportunities.
in our minds is really earlier, about investing being
important. so personal, it really is a G&D: This has been great.
question of figuring out why Thanks so much.
G&D: Are there any you want to start a fund. That
resources or books that you being said, we love new funds
have read that you could and spend a lot of time looking
share? at them. If someone does want
to start a fund, we think that *Since the original interview
JF: I have spent a lot of time talking to people like us pretty was conducted, Campbell left
reading business biographies early in the process can be the firm to launch the first
lately. I really enjoyed Robert helpful, not to figure out if we “GEM Cub,” Old Well
E. Price’s Sol Price Retail are going to invest, but just for Partners, which will be focused
Revolutionary and Social perspective. We can provide on the direct investment
Innovator about the man who perspective for different things strategy deployed at GEM over
founded FedMart, where Jim that we have seen in the the past eight years.
Get Involved:

3022 Broadway
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http://www.csima.info/
Contact Us:
bdawson16@gsb.columbia.edu Graham & Doddsville Editors 2015-2016
sdebenedett16@gsb.columbia.edu
aphilipp16@gsb.columbia.edu Brendan Dawson ’16
Brendan is a second-year MBA student and member of the Heilbrunn Center’s
Value Investing Program. During the summer, Brendan worked for Thunderbird Partners,
a London-based global long/short equity fund. Prior to Columbia, he was a member of the
investment team at the UVA Investment Management Company. He also was an invest-
ment analyst intern at Slate Path Capital. Brendan graduated from The University of Vir-
ginia with a BS in Commerce. He can be reached at bdawson16@gsb.columbia.edu.
Scott DeBenedett ’16

Scott is a second-year MBA student and member of the Heilbrunn Center’s
Value Investing Program. During the summer, Scott worked for Maverick Capital, a New
York-based long/short equity fund. Prior to Columbia Business School, he worked at
Lightyear Capital, Citigroup, and Morgan Stanley. Scott graduated from Princeton Universi-
ty with a BA in Comparative Literature. He can be reached at
sdebenedett16@gsb.columbia.edu.
Anthony Philipp ’16

Anthony Philipp is a second-year MBA student and member of the Heilbrunn Center’s
Value Investing Program. He spent the summer as an investment analyst at Blue Ridge
Capital in New York. Prior to business school, Anthony worked as a private equity asso-
ciate at Flexpoint Ford in Chicago, and before that as an investment banking analyst at
Centerview Partners in New York. He graduated from the University of Illinois at Urbana
-Champaign with a BS in electrical engineering. He can be reached at
aphilipp16@gsb.columbia.edu.
Graham & Doddsville
Issue XXVI Winter 2016

Inside this issue:
25th Annual Craig Effron of Scoggin Capital
Graham & Dodd Management
Breakfast P. 3
Craig Effron P. 5 Craig Effron is the co-portfolio manager of Scoggin Capital
Management, which he founded with partner Curtis Schenker in
Jeff Gramm P. 19 1988. With approximately $1.75 billion in assets under
management, Scoggin is a global, opportunistic, multi-strategy
Shane Parrish P. 30 Craig Effron event-driven fund. Scoggin focuses on identifying fundamental
Jon Salinas P. 39 long/short investments through three primary strategies including
event driven equities with a catalyst, special situations, and distressed credit. Mr.
Student Ideas P. 47 Effron began his career as a floor trader on the New York Mercantile Exchange and
New York Commodity Exchange. Mr. Effron received a BS in Economics from the
Editors:
Brendan Dawson Jeff Gramm ’03 Shane Parrish

MBA 2016 of Bandera of Farnam
Scott DeBenedett Partners Street
MBA 2016
Anthony Philipp Jeff Gramm manages Shane Parrish is
MBA 2016 Bandera Partners, a the curator behind
Brandon Cheong Jeff Gramm
value hedge fund based Shane Parrish the popular
in New York City. He Farnam Street
MBA 2017 teaches Applied Value Blog and founder
Eric Laidlow, CFA Investing at Columbia Business School of the Re:Think Workshops on
MBA 2017 and wrote the upcoming book “Dear Innovation and Decision Making.
Benjamin Ostrow
MBA 2017
Jon Salinas ’08 of Plymouth Lane Capital

Management
Visit us at:
www.grahamanddodd.com Jonathan Salinas founded Rolf
Plymouth Lane in April 2013 and acts
Heitmeyer
www.csima.info as sole portfolio manager to the Fund. Prior to founding
Plymouth Lane, Jonathan worked as an analyst at Marble Arch
Investments, a long/short hedge fund manager. Before joining
Marble Arch, Jonathan served as a consultant at ZBI Equities, a
Jon Salinas
long/short hedge fund manager operated by Ziff Brothers
Investments. Prior to ZBI, he was an analyst at Festina Lente
Investment Management, a concentrated, value-oriented investment manager, and
worked as an analyst in capital markets and research divisions at UBS AG.

Page 2

We are pleased to bring you the walks through current ideas investing. This year’s breakfast
26th edition of Graham & including Famous Dave’s featured a conversation with
Doddsville. This student-led in- (DAVE) and Star Gas Part- Philippe Laffont of Coatue Man-
vestment publication of Colum- ners (SGU). agement moderated by Profes-
bia Business School (CBS) is co- sor Bruce Greenwald of Co-
sponsored by the Heilbrunn Shane Parrish discusses the lumbia Business School.
Center for Graham & Dodd origination of Farnam Street
Investing and the Columbia Stu- and his focus on becoming a Lastly, we are proud to bring
dent Investment Management better learner, as epitomized you pitches from current stu-
Association (CSIMA). by Warren Buffett and Charlie dents at CBS. We feature final-
Munger. Shane explains how ists from the Darden at Virginia
Meredith Trivedi, the In this issue, we were fortunate these learnings apply to becom- Investing Competition, Colum-
Heilbrunn Center Director. to speak with three investors ing a better investor and shares bia Business School’s inaugural
Meredith skillfully leads the and the founder of the popular his hopes for Farnam Street CSIMA Stock Pitch Challenge,
Center, cultivating strong blog Farnam Street. and its readership. and Alpha Challenge at UNC
relationships with some of Kenan-Flagler.
the world’s most experi- Craig Effron of Scoggin Capital Jonathan Salinas ’08 of Plym-
enced value investors, and Management discusses the evo- outh Lane Capital discusses his The three finalist ideas from
creating numerous learning lution of his firm and his invest- experiences with varied invest- our classmates include: Marc
opportunities for students ment approach from commodi- ment approaches and mentors Grow ’17, Benjamin Ostrow
interested in value invest- ties to the stock market. Craig and how his background lead- ’17, and Evan Zehnal ’17 —
ing. The classes sponsored offers insights into his risk man- ing up to founding Plymouth Dexcom Inc. (DXCM) Short;
by the Heilbrunn Center agement mentality, challenges Lane has contributed to the Nielsen Fields ’17, Joanna Vu
are among the most heavily facing the investment manage- firm’s world view and how he ’17, and Adam Xiao ’17 —
demanded and highly rated ment community, and creative seeks to invest. Jonathan also Quest Diagnostics (DGX)
classes at Columbia Busi- ways to express investment shares current ideas DHX Short; and Justin Hong ’17,
ness School. theses while managing against Media (DHXM) and Sequential Zachary Rieger ’17, and Cristó-
downside risk. He shares recent Brands Group (SQBG). bal Silva ’17 — XPO Logistics
case studies in the event-driven (XPO) Long.
space and opportunities he cur- This issue also highlights pho-
rently see in distressed credits tos from the 25th Annual Gra- As always, we thank our
in Puerto Rico and energy. ham & Dodd Breakfast, held on interviewees for contributing
October 9th, 2015 at the their time and insights not only
Jeff Gramm ’03 of Bandera Pierre Hotel in New York. This to us, but to the investment
Partners discusses his book on event brings together alumni, community as a whole, and we
activism “Dear Chairman: students, scholars, and practi- thank you for reading.
Boardroom Battles and the Rise tioners for a forum on current
of Shareholder Activism” and insights and approaches to - G&Dsville Editors
tioners.
Keynote speaker Philippe Laffont Attendees gather at the 25th Annual

addresses attendees at the 25th Annual Graham & Dodd Breakfast
25th Annual Graham & Dodd Breakfast—

October 9, 2015 at The Pierre Hotel
Mario Gabelli ’67 at the Graham & Dodd Breakfast with Professor Bruce Greenwald with Philippe Laffont at the
keynote speaker Philippe Laffont Graham & Dodd Breakfast
Sid and Helaine Lerner speak with Heilbrunn advisory Heilbrunn advisory board members David Greenspan ’00,
board member Tom Russo William von Mueffling ’95, and Jenny Wallace ’94
Page 4
SAVE THE DATE FOR THE 7th ANNUAL
“From Graham to Buffett

and Beyond” Dinner
Friday, April 29, 2016

6 p.m. to 9 p.m.
The Omaha Hilton

1001 Cass Street • Omaha, Nebraska
Tickets will go on sale in March at

Page 5
Craig Effron
Wharton School of try my hand at trading right.

Business of the University commodities. I said that if I
of Pennsylvania. didn't do well, I would go to After about a year of managing
law school a year later. I did Paul’s money and these other
Graham & Doddsville well. I learned a lot about life accounts, I realized that I liked
(G&D): Could you tell us and about commodities and doing this more than trading
about your background and trading. And I was fairly good commodities. I left and told
how you came to investing? at it. everybody I was going to put
together a fund called Scoggin
Craig Effron (CE): It’s The problem with with my partner Curtis
important, because I am not commodities trading is that it Schenker, who is still my
the traditional hedge fund ends at 2:30 in the afternoon. partner.
Craig Effron story. I didn’t work two years When you’re 24 years old you
in investment banking and then can get into a lot of trouble if Here’s a key element of our
go to Harvard Business School. you’re done at 2:30pm unless partnership and how Curtis
I went to Wharton for you have something to do. I and I complement each
undergrad. I did not get into decided to start learning the other—it’s an important fact
NYU Law, but I got into Duke. stock market. I had gone to about Scoggin. Curtis was my
I went down to Duke for a Wharton for undergrad and best friend before we started
weekend with my parents and somewhat thought I knew Scoggin. He’s my best friend
everybody there was 6'4” and what I was doing, but I didn’t still. Curtis and I keep each
blonde. I said, "I'm not going to really know how to invest. other grounded. We realize
do very well here. Socially, I About five years into trading we caught a 30 year bull
cannot go here." My parents on the COMEX, I started market. We weren't that
said, "I tell you what, take a doing risk arbitrage. smart. We happened to have
year off, defer, and then money under management, and
reapply to NYU a year later That was the heyday of Mike it worked out. Curtis and I
and hopefully get in.” Milken. I thought I was a genius don't take ourselves too
because every time there was seriously. He has always been
During that year, I met up with a deal announced, Mr. Naysayer, and I'm Mr. It’s-
two buddies for a card game at automatically—within a Always-Bullish.
Penn. They were playing for week—there would be a
stakes that I had never even topping bid. Then there would He’s the guy who kept us in
known existed. I said, "What be a third bid; it was crazy. business a lot because I
do you guys do for a living?" Everyone on the floor knew would've been a lot more
One said, "We trade about my success trading aggressive during the
commodities. On the floor, we stocks. They all gave me their technology bubble. He said,
buy and sell gold and silver. It's money, as my friends, to run “Craig, leave it alone. This is
really fun and you should come for free. I did that for a year not what we do. We don’t
check it out." and it was fun. I had about 30 know what that means. We’re
accounts and I was doing it for not doing that.” And of course
I had been working at EF free. later technology blows up.
Hutton, which was big in That’s why it works, and that’s
everything, but they went Paul Tudor Jones, who stood why we’re still best friends and
bankrupt in the ’80s. I had next to me in the ring, was a still partners.
gotten a job there right after good buddy of mine and said,
school and worked there for a "You know what? Run my Part of this Scoggin charm, if
few months. But, then I played money, as well. But one caveat: you want to call it that, is that
in this card game and, I want you to charge me a fee." we still are friends first and
afterward, went down to the I asked, "Why do you want me partners second. I think it sort
floor with my friends. I to charge you a fee?" And, of flows through the whole
thought, "Wow, this looks like being as smart as Paul is, he office. The average tenure of
a lot of fun." Somehow, I said, “Because if you charge me my analysts here is 10 to 12
convinced my parents to lend a fee, you will pay attention to years. There are a few new
me forty thousand dollars to my account first.” He was dead guys who are two or three
Page 6
Craig Effron
years but basically I have 12 could get involved in distressed lose.” I had to go through this
analysts, and six or eight of credit, spin-offs, and whole process for my
them have been here since restructuring—anything that investors explaining why they
before 2000. It’s a very nice has an event. We went from shouldn't pull their money out.
feeling to know that I can go running $3 million to running A lot of them did a year later.
on vacation and know that I’m $3 billion by the late 2000s. We blew up after redemption
not going to have someone We sort of stopped raising dates so the investors had to
blow me up. money because I liked my life wait to redeem. We made
and I didn't want to be a most of the money back in
Incidentally, the name manager of people; I wanted to 2009, but they were all so
“Scoggin” comes from a camp be a manager of money. And, stunned about what had
that Curtis and I went to in mostly, I wanted it to be my happened that we lost about
Maine. I met him there and we own money. 25% of our capital through
reunited at Penn. We started redemptions in 2009. That was
Scoggin together with these 30 Then ’08 happened. We had a learning experience for me.
accounts, Curtis’s money, and no losing years until 2008. We You don't ever want to have
my money. It was about $3 had twenty years where every people think you are what you
million in total and that was year we made money. At that are not. Then the Madoff thing
how we started in 1988. To point we were up 17.5% net to happened the same year, so
put it in perspective, as a investors. 2008 occurs and, they started saying, "Wait a
hedge fund with $3 million in minute. Madoff didn’t lose
1988, we were not even the money for 20 years either." I
smallest, while the biggest fund actually had to explain why I'm
“I realized how
was about $80 million. not Madoff to my big investors.
fleeting success can be They knew I wasn’t, yet they
G&D: At that point, were you had to check the boxes to
just focused on risk arbitrage? in a market, whether make sure I wasn't actually
Madoff.
CE: Yes, that's all we were it’s a stock market or a
doing at that point. We were G&D: Were they institutions?
up a lot of money in ’89 and in commodities market.
September of ’89 the biggest CE: Yes, they’re my big guys,
My whole perspective
deal in history was United and they were worried that
Airlines. The deal blew up and on investing has been, they were going to be fired
everybody in my world went from their jobs. Imagine having
out of business. We went from and hopefully will another fraud that you
up 65% to up 20%, which is a invested in. A lot of institutions
big draw down, but still up continue to be, not to were invested with Madoff.
20%. Before this, I had been
competing to attract the best lose.” The reality is that a lot of the
talent, but I couldn’t afford to fund is my money and Curtis’s
hire many of them. Now, they depending on which fund you money. If you do the math, we
were working for free because look at, we lost between 20% can do much better making
they were all out of work. I and 30%. To my investors, I good returns on our own
hired a restructuring analyst, a was known as a “Jewish T-bill.” money than with management
long/short analyst, and others This is a very bad thing to be fees. Except, this year we are
whom I could never have known as—not the “Jewish” losing money. It’s the second
afforded before that. part but the “T-bill” part. time we’re losing money since
Because when you then have a 2008. We are down about
That is when Scoggin was losing year, they say, "Oh my 10%. It's really nauseating
really born because we could God, it's not a T-bill." Then because we have done a good
now do things besides just get they start to realize, "Wait a job to be down 10%—that’s
lucky with Mike Milken doing minute, he's got risk after all. what’s scary. We’ve done very
topping bids. We could still do We thought you were really few things wrong, but those
risk arbitrage, but now we safe. We thought you couldn't things we have done wrong
Page 7
Craig Effron
have been fatal in 2015. market. My whole perspective come back from it, but not
on investing has been, and typically. You’re given one
G&D: Could you talk about hopefully will continue to be, chance to go out of business
how you think about managing not to lose. and that’s it in our industry.
the downside in your You can't redo it. 2008 was
portfolio? Relatively speaking, making different. People gave you a
Matthew Baredes ’17,
money is easy. It’s avoiding free pass in 2008. Otherwise, if
Matheus Romariz ’16, and CE: Let’s go back to the floor losing that’s important and you lose money of any real
Nicholas Turchetta ’17 experience. Managers you’ve much more difficult. This 10% size, you’re out of business
volunteer at the Graham & spoken to in the past and with down year is going to cost me pretty quickly. There’s another
Dodd Breakfast whom you will speak in the two years of money. I can tell smart guy down the street
future are probably “traditional you next year will be a very who has done really well and
analysts.” They come from he will take your money.
good schools, they learn at
Morgan Stanley or Centerview G&D: How much more
Partners how to be an analyst. “I’ve learned that competitive is the hedge fund
They start becoming investors people tend to give industry now compared with
and that’s their thing. I am when you started?
totally different. I am a trader. I you a one-year grace
am a risk manager. I was very CE: Here is a crazy stat: when
successful on the floor because period. They realize I started business there were
I didn't go out of business. 300 hedge funds in the world.
that the S&P is flat for There are now over 10,000.
I remember when I was 23 or We were the 165th biggest in
24, there were the “Michael the year but the real 1990 with maybe $30 million,
Jordans” and the “Tom market is not. There 155th in 2000 at around $1
Bradys” of the floor. They billion, and we were 177th in
were famous. They were the are 327 stocks down 2008 at $3 billion. No matter
big traders who traded how big we got, we never got
hundreds of lots. I’m there for this year out of 500 in any bigger relatively. It’s
about six to nine months and symptomatic of the issues
I’m a little baby trader at this the S&P with a we’re having now in our
point. I get tapped on the business. There’s too much
shoulder by a veteran trader. handful money in it.
He was one of the biggest outperforming.”
traders in gold. He taps me on The business was an amazing
the shoulder one day and says, business when no one knew
"Hey, can I talk to you? I'm difficult year as well. In fact, if what it was. In my world, at
wondering if I could borrow we fight back to even in two your age, mediocrity in my
some money from you. I had a years I will be happy. The key business made you very
little problem: I was short to our business, I’ve learned, is wealthy. People wanted to be
gold." Gold went crazy and he this: don't go down. It’s fatal to invested in hedge funds. They
went out of business. a lot of firms. The average age didn't care if you were the
of a hedge fund that goes out best. They wanted to be in a
I said, "I don't have any money of business is seven years. hedge fund; that was the cool
to lend you—I'm 23 years We're on our 27th year. That’s thing to be in the ’90s. If you
old—but I appreciate that not by accident. We had 20 were just mediocre, making 8%
thought." I said to myself, years of never losing. We had a year, people were delighted
"Wow this guy was a 2008, we also lost 3% in 2011, because they were doing it in a
millionaire." He was looking and now this year: three losing hedge fund as opposed to
for money because he went years out of 27. That's how doing it in a mutual fund. Now
out of business. I realized how you stay in business. you're in a position where it’s
fleeting success can be in a not good to be a hedge fund
market, whether it’s a stock A lot of very good investors unless you're really good at it.
market or a commodities have blown up. Some have
Page 8
Craig Effron
People that were terrible were theoretically have catalysts, deal. Five days later they
making tons of money on and that has been a horrible announce a deal with Marriott
management fees. That all business this year. (MAR) at $70: a take-under. I
changed in 2008; they went had not seen that in 25 years.
out of business. Now, in our G&D: Did the catalysts not
business, if you’re not in the come through or did the Now obviously there’s more
top 20%, you don't make any catalysts not matter much? to the story. Maybe it’s
money, and that’s the way it because something is going on
should be. Like any business, CE: Some didn’t come in the company that I don't
you should be required to be through and some came know about. We thought,
in the top percentile of through and ended up with bad “There are three buyers. We
performers to remain in results. I’ll give you a case in are going to make a lot of
business. That's the new point which I find amazing. money." We lost 10%
dynamic, the new normal in my Starwood Hotels (HOT) went overnight on that trade. That's
world. If you aren't good at it, up for sale in June. The stock just one example of what is
you actually are out of at the time was at $80/share. going on this year.
business. Every year, I’ve got Everybody had a break-up
to be good again because there value of somewhere between Also, Mylan (MYL) was trying
are many options out there. $90 and $105. On June 15th, to buy Perrigo (PRGO) this
Whether it’s another hedge when Starwood announced year. It was a big deal. Mylan
fund or a quant fund, there are that the company was up for came in hostilely and Perrigo
so many options that people sale, the stock was up a little had no defenses. They went
say, "Look, we love you as a bit that day. Then the market down to the last week, where
person, but you’re making no they needed 50.1% of the
money for me." votes to vote “yes” for the
deal from Mylan. If you vote
Now for 2015, we are down “There are a lot of “yes,” you make $20; it’s that
between 10% and 11% at this simple. If you vote “no,” the
things out there that
point, and we have had very stock will go down and you
few redemptions. I’ve learned are scaring me. But, lose $15. There's a $35
that people tend to give you a differential. In the history of
one-year grace period. They I’m paid to play, and the world, I've never seen
realize that the S&P is flat for people vote without their
the year but the real market is that’s what I do. But I pocketbooks under
not. There are 327 stocks consideration. Not only did it
down this year out of 500 in don’t play with not go through, but also the
the S&P with a handful deal lost by a lot.
leverage.”
outperforming.
What I learned was that
G&D: Those are companies people like making money, but
like Google and Amazon? blew up and the stock was there are things they like
down into the $60s. By the more. In this case, they liked
CE: Out of those stocks that time the market came back the CEO of Perrigo so much
are up, it’s about six that make about a month later, the stock that they felt badly for him.
a difference. That's not what I was at $75. They said, "Let this guy try to
do. I don't trade Google make it." They hated Mylan's
(GOOG) and Amazon In the first week of November guy. I’m not saying I loved him,
(AMZN). If I did, I wouldn't management announced there but he was offering me $20
need to be in this business. I’m were three buyers. One is a more than where the stock
doing things that are "tricky” Chinese buyer who owns The was trading. They chose not to
or “clever,” and not so much Waldorf; one is Hyatt Hotels take the $20 and lose $15
this year, obviously. It’s not (H); and one was an instead. I thought it was a no-
just me. Because, as you know, undisclosed name. The stock brainer. It was the biggest
my world is getting destroyed. goes from $75 to $78 because position on the street and
We are trading on events that it’s going to be an awfully good people got destroyed. Who
Page 9
Craig Effron
would think that people would thought they would take the friends, and they’re brilliant
throw off $20 and take a $15 money, because everyone guys, who have four or five-
loss? But, that’s what we’re takes the money. times leverage now, and I
reading now. always wonder, "How do they
That’s what I’m dealing with sleep at night?" If, God forbid,
G&D: Did they think there this year. The events space has something happens out of the
would be additional bidders? been a disaster, an unequivocal blue, the next day they’re
disaster. Unless you’re long losing something like 15% or
CE: No, we were already past Amazon and Netflix (NFLX) 20%. But look, that’s how they
that. We thought initially there and the Jim Cramer FANG were brought up. I was
would be. Now it is the last stocks, you’re having a really brought up a different way
day; it’s over. Either you take lousy year. If you’re an energy- because I was a commodities
the $20 or you table it. In all related guy, you’re out of trader where leverage was a
my years doing this business, business. Things are bad in bad thing. You could get blown
I’ve never seen people not take retail, too. Macy’s (M) is the away by being too big.
the money. It was a big gold standard and it is down
difference. Not like it was a $2 50% this year. Hospitals and For the last five years, it has
premium. It was $20 on a $140 HMOs were obliterated the been fine because the Fed had
stock. When things like that last two months, I don't know your back. It's been a very easy
happen in my world, it’s hard why. If you’re in the wrong market until this year. Once
to make money. I’d make that sectors, you think it is a bear the Fed stopped QE the
bet every day of my life. It’s market like 2008 versus the market became difficult. So
just how it goes. market being very quietly up what it really shows is that
1%. most of us have just been
G&D: Do you know anything gliding along because of the QE
about the make-up of the wind at our backs. And now
votes? “‘Don’t be so big that QE’s done, that’s why the
market has been flat. QE is
CE: It was every arbitrageur, where your eyes are over and now we have the
representing about 25% of the prospect of higher rates. There
float. They voted “yes,” bleeding and you’ve are a lot of things out there
obviously. The indexers ended that are scaring me. But, I'm
up voting “yes,” which had got to get out. Size paid to play, and that’s what I
been a big issue. When I heard your positions so that do. But I don’t play with
the indexers were going to be leverage. Now, we do use a
voting “yes,” I said, "This is you can withstand modicum of leverage, maybe
going to be a no-brainer." 120% gross, but not 300%
Every plain vanilla or Fidelity of what happens if you gross.
the world had a one-on-one
with the CEO on that are wrong.” G&D: Could you go into a bit
Thursday of the vote. And that more detail?
guy pleaded. He said, "Guys,
you are going to end up G&D: You don’t use a lot of CE: Our average exposure is
owning Mylan stock. He’s a leverage. Was that a product about 120%. Our net is about
criminal; he does terrible of 2008 or have you always 45% long. That's where we
things. Perrigo has real brands. been more conservative? usually run. We go as low as
Give me a year to make this up 80% gross and 20% long.
to you. Just give me that year CE: No, it was a product of We’re always long. You guys
and, if I don’t do something in me being on the trading floor should know one thing: the
that year, I’ll get another and realizing what can happen. markets go up over time.
buyer." They bought into it. All Leverage is a two-edged That's just how it is. If you try
the institutions, which are the sword. It’s wonderful when the to play the short game at the
main voters, all voted his way, trade is going up, but you’re wrong time, you'll lose money.
and all turned on the day out of business quickly when it
before the vote. We all had goes the other way. I have You don’t want to be short
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Craig Effron
markets over a long period of the tax inversion. It was What students miss a lot is the
time. We all watched the ten- because AbbVie was scared of practical matter of the stock.
year period from 2000 to getting yelled at by Obama. So For some of the short ideas, I
2010. That was a flat period. I they blew it up. They traded ask, “Do you realize the short
had never seen that before. from $250 to $150. Settled interest in this thing?” They
Remember, I saw gigantic around $180 for the next two realize there's not just a
periods. The ’90s grew at or three months, then went downside of losing X amount
around 20% a year, the ’80s back to $260. Now it’s back to in an upside case. When you
averaged 10% or 15% a year. $220. What we have learned and the whole world are short
So 2000 to 2010 was an here is, “Don't be so big where a stock, you go out of business
interesting period. But, yes, your eyes are bleeding and too many times. People your
we're low-leverage guys. you’ve got to get out.” Size age often don't understand
your positions so that you can technical aspects of the
G&D: Building on the topic of withstand what happens if you market. They understand that
risk management, let’s are wrong. In Perrigo, we only a stock is not worth $20—it’s
consider a situation like lost 50 basis points on that only worth $10. Okay, that
Perrigo where what you break, because I knew I didn’t doesn't mean it’s going to $10.
thought would happen did not want to be selling it badly. It could go to $50 before it
occur. Can you talk about how goes to $10 and does that
you think about the next Normally, if we’d been up for mean you made a good
steps? the year we probably would decision or not?
have risked 1.5% on that trade,
CE: I’ve learned over my many that’s how good I thought it Some people will say in
years doing this that you never was. It was an overnight binary interviews that their best idea
sell the first day of a bad event. bet. That is not a big bet if it was long Apple. I ask, “Ok,
That is for amateurs because was 1.5%. But it is when you’re when did you buy it and for
there are guys that are so big making a bet on red or black. what price did you buy it? Ok,
that their eyes are bleeding $220. Did it go up or down
and they have to get out. If you G&D: How concentrated are first?” They usually say, “Well,
look at where the stock is on your positions? it went down first.” I say, “Oh,
day one versus day 30, 99% of okay. Where did it go to?” If
the time every sale you made CE: We have about 20, maybe he says, “To $85 or $90,” that
was bad. You wait a month and 30, positions, and our biggest guy is not getting hired
then you can reassess. Perrigo are between 5% and 7%. We because he thinks that is okay.
is no different. Perrigo opened have nothing smaller than 1.5% He lost half his money on the
at $135. I closed my eyes, I or 2%, and we average way to making three times his
didn't do a thing. It's now probably 4%. We’re very money. Well he’s out of
$150. Now we're getting out. focused on protecting against business at that point. There is
We made our $15 back. So the downside, and that drives no more company. It’s easy to
now we broke even on the our risk management approach say, “Yeah, I owned Apple at
trade, but we lost the $20 we and portfolio construction. $200.” But there is a middle
would have made. People have this view of hedge chapter there. It went to $80
fund guys, that they are like first, when Jobs was dying, then
People that sold on day one magicians and that there is $600. I don't look at a good
and day two and three, are voodoo going on. There is no investor as a guy who has lost
kicking themselves. Last year, voodoo. You guys are as good half my money first; that’s
AbbVie blew up the big deal as I am at this. Your opinion is terrible. It’s very important to
with Shire. Shire went down as valid as mine is. I’ve been understand that every idea
$100. If you waited one year, it doing it longer; that is the might be worth five times at
was higher than the bid. difference. I’ve seen the some point, but if you lose half
examples of ideas from your first, it doesn't really matter.
G&D: Is that because of the classes. There are brilliant Hedge fund managers that are
tax inversion? people. My analysts are not any good understand that and they
more brilliant than you; they have stop-losses where they
CE: That’s what it was—it was just have experience doing it. don’t let that happen. Some
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Craig Effron
people go out of business worth X and is trading half of killing us.
because they say, “Well, it’s X, you’re wrong. Something is
worth $200. It is trading now missing. You find out later G&D: When you generate
at $120. I’m not getting out what it was. The market is high returns do you typically
here. It was just $150.” Then it always right and it tells you it is have a few big winners?
goes to $90, then the next right. Once in a while, you’re
crash comes, and then you’re smarter than the market. Not CE: Out of our 30 positions,
out of business. So we have a much. So my analysts all realize ten are meaningful, and of the
pretty hard stop on things they need to have a stop point ten we hope to have three or
here. because if they don’t, they'll four that are home runs. A
get married to it. home run means up 50% to
When one of my analysts 100%. Year to date, three out
comes up with an idea I say, I will revisit something after of our top five positions are
“First of all, one to ten, how I’ve got out of it, because you down 50%. We didn’t ride it all
much do you like it?” If it's not find, when you have sold a the way down, but that’s
at least a seven, I don’t do it. If where they're down now.
it’s a nine or a ten I say, “Okay, Micron Technology was at
I want to know right now at “If I can't trade $36. It’s trading at $15. YPF is
what price you’re selling it and an oil company in Argentina,
at what price you’re admitting options and limit my down from $27 to $15. The
you’re wrong.” I want to do last one, Applied Materials, was
this when we are unemotional. losses, I've got to bring an arbitrage deal that blew up.
Investors have a tendency, and Three of our biggest positions
so do I, to marry positions. my gross down got destroyed. That’s never
You think a stock is your wife, because I don't want happened to me during all my
your girlfriend. It’s not. Stocks years of investing.
don’t know you own them. to get caught in being
They really don’t. But when G&D: What do you think
you own a stock, it’s like your long common stock went wrong with the Micron
girlfriend, you can’t get rid of investment? Was it increased
that stock. It’s true, and that is that can go down a lot competition?
an emotional response that we
all have. more than the options CE: Micron is crazy. We
can. Options are owned it two years ago. We
If I said on day one, “Hey, you have owned it for a long time.
like this stock ABC? Our wonderful vehicles.” We bought it at $15; we sold
target is $70, it’s trading at half at $30 and kept half. Up
$40. Where are you admitting until three years ago, there
you're wrong?” I want to position, whether it’s been were many players in this
know. There’s no discussion good or it’s been bad, that you space. They always competed
that way. If it goes down that have a liberated feeling. You on price, and they always blew
amount, whatever it is that can look at it objectively. You everybody up. It got down to
they say, I get the message, and are no longer married to it. three: Samsung, Micron, and
at that moment I’m getting out But when hope becomes a Tsinhgua Unigroup. We said,
because I don’t want to think, strategy, you’re lost. “Finally. Price rationality.
“Well, stay with it because, There’s no way they're going
they’re wrong. The market is This year, the times that we to break price. They’re having
getting it wrong.” I hate that lost, it hasn’t been one name. a great run here. They’ll just
comment, “the market is That’s the crazy thing. It’s been keep price and it’ll be good.”
wrong here.” The market is a menu of things that have Then Samsung ruined it for
never wrong. gone wrong. So, I can’t say I’ve everybody. Once Samsung
I learned it in the commodities been killed in one name. I lost started a price war everybody
business and re-learned it in 80bps here, 60bps here, and all joined in and now prices in
the stock market. When you of a sudden we’re down 10%. MRAM and DRAM have gone
own a stock that you think is And the hedging has been down by half. We figured,
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Craig Effron
“Finally, three rational pricers.” buy those options because I CE: Yes, all the time. For
We were wrong. There are was paying way too much for example, in SunEdison, people
only two. That was a big them, a dime more than did not understand the
problem for us. they're worth. A dime on ramifications of this deal. If
$0.38 is a gigantic move. But SunEdison does not go
G&D: How do you decide I’m playing for dollars here. So, bankrupt, it means they’re
when to sell? You mentioned I bought thousands and going to be okay. They may
asking analysts for stop losses. thousands of Bank of America, have a 10 or 20 year life now.
$4 or $5 calls, while the stock The stock is a long term
CE: Micron is a good example. was trading at $4. Then luckily, option. It is worth much more
We bought one- and two-year a month later, Bank of America than they think it is worth.
LEAPS in 2013, because it was went from $4 to $7 overnight. Today, Sun Edison changed the
very volatile stock. We had All the calls at $0.48, which deal with Blackstone on its
already bought shares before were worth only $0.38, were debt, so the stock is up $1.00.
at $7 and it was up 100%. The now trading at $3, and the Options players didn’t
LEAPS that we paid $3 for guys who gave them to me got appreciate that this is no
were trading at like $17 or destroyed. Options are always longer a candidate for
$18. We sold the LEAPS and mispriced to some people who bankruptcy. When that
bought short term options don’t understand optionality. happens all the calls are long
struck at $25. So we use term options and they should
options a lot to limit our risk Another good example, be priced higher.
when they’re priced SunEdison is in the news right
appropriately. now. We bought a boatload of I have a lot of notional
$3.00 and $3.50 calls last exposure sometimes, but I’m
When the VIX is trading at 11 week. The bet was very simple: only risking X. When we are
or 12 for the general market, half the world is betting it is invested in a stock that has
you can do tons of wonderful going to go bankrupt, while vols in the high teens or low
things with options. When it is half is betting it isn’t. The short twenties, we will almost always
trading at 19 like it is today, a interest in it was forty percent. use an in-the-money call. If we
lot less so. It's hard. If I can’t I might be wrong here, but I’m get a terrorist attack one night
trade options and limit my saying the option is mispriced. I and DuPont goes from $70 to
losses, I’ve got to bring my can buy calls that look really $60, we are in the money $5. I
gross down because I don’t expensive, trading at one know what I'm risking and I’m
want to get caught in being hundred vol again. And, again, still controlling all the shares
long common stock that can they’re a dime more than they because there is about ninety
go down a lot more than the should have been. So we percent delta to the stock. It
options can. Options are bought a boatload and just sold gives you a lot of sleeping
wonderful vehicles. about half of them for about ability. I don’t need to go out
I took courses in Wharton on $1.00 profit on a $0.40 call. and hedge my book when I
options pricing, I learned all know all I can risk is $5, but I
the theoretical models. That’s It’s a great risk/reward. We have an upside of infinity if
not what I’m talking about. I’m were risking $0.40 to make $1 DuPont does well. Mega-cap
talking about actually versus paying $3.20 for the stocks have very low vols.
understanding what they mean. stock and maybe losing $3. Another crazy thing regarding
In 2008, Bank of America had Now one hundred vol is really options: where in the world, as
traded down to $4/share, like high, but they still did not a value of an asset goes higher,
it was going to go bankrupt. understand that if it didn't go does insurance cost go lower?
They had calls that were bankrupt it was going to be a If your house doubles in value,
trading at one hundred vol, long term option now on they require double the
which is humongous. The $5 SunEdison. insurance payment to insure
call was trading at one hundred your house. In the S&P, and
vol. That meant, instead of G&D: Do you use options a stock markets in general, as
paying $0.38 I was paying lot in the event-driven space prices go higher, vols go lower
$0.48. People were thanking because option pricing cannot and the price of options get
me for putting in an order to effectively price a future event? cheaper. It’s totally counter-
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Craig Effron
intuitive. which we do all the time, and they’re even less appropriately
that saved our month. We priced? We were talking about
So, my Nirvana was during didn’t lose any money in how options are priced, but
2012 – 2014 when the market August because we had puts LEAPS are multi-year.
was going up slowly every day. that went from $1 to $20 from
Vol was 11, I could go long all both the volatility aspect and CE: LEAPS are a wonderful
the stuff I liked and buy the price aspect. That hadn't vehicle. The problem that guys
Attendees at the Graham &
protection on the market for in my world have is liquidity,
Dodd Breakfast
cheaper than it was a year quarterly or annually. What
earlier when the market was “Another crazy thing you have to be careful of is
lower. It’s insane. How can the having a mismatch of what you
market be less risky at today’s regarding options: own versus your liquidity
price than it was 20% lower? terms. Long-term, locked-up
where in the world, as money doesn't really exist
That’s how I made all my a value of an asset much in my world anymore.
money, by getting very long in Also, LEAPS have different
stuff that I loved, and being goes higher, does taxes. There’s a dirty little
short the market an equal secret about our business. You
amount through very cheap insurance cost go should ask managers what
puts because they were their after-tax returns are. For
mispriced. What happens to lower? If your house example, if I talk about making
vol when the market goes 17% net, I'm a fraud. I made
down?
doubles in value, they 17%, but it was almost all short
require double the -term in those days. Now, Joel
G&D: It goes up. Greenblatt was always an after
insurance payment to -tax guy. He traded LEAPS all
CE: A lot. So you get the vol the time because he said, “I'm
expansion and the delta insure your house. In not paying taxes at short-term
expansion by the market going rates.” He made more than I
down making your puts more the S&P, and stock did because he was paying 20%
worthwhile. It’s like a triple and I was paying 50%.
whammy in your favor, and yet
markets in general, as
it happens. prices go higher, vols G&D: His stated number in
his book is 40%.
G&D: Maybe if it was a go lower and the price
situation where earnings were CE: You're right, and he's the
growing more quickly than the of options get best there ever was. It was
market was appreciating? But 40% on a long-term basis. The
that wasn’t the case in 2012 cheaper. It’s totally guy’s a tax genius. He was a
and 2013. Wharton five-year guy and he
counter-intuitive.” learned about accounting. I
CE: Even if that’s the case, I said, “Oh, making money is
don’t care. The minute the happened to us since 2008. great.” I was a dumb guy, and
market blows up, for whatever Remember that insurance is he always said to me, “You're
reason, delta expands and vol cheaper as the market goes not tax efficient.” I just wasn’t
expands. You have a 2x reason higher, not more expensive, thinking because I was making
why it works. Your puts, which which is a wonderful thing. these very good headline
were at 12 VIX go to 22 VIX. numbers.
That alone is a home run. Plus G&D: With respect to
you have it working because incentives, people get paid on a When you play in my world,
the market is going down. yearly basis, so managers only which is event-driven, if there’s
When the market blew up in look out on a yearly basis. Do a takeover tomorrow I can’t
August that was the prime you think that creates an even be long-term. It’s over. What
example. We were long a ton more skewed incentive am I going to do about it? A lot
of puts for August expiration, structure for LEAPS, so that (Continued on page 14)
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Craig Effron
of what I did wasn’t my world is beyond what I than Bill, but equally
decision. I’m not a stock understand now, but I know impressive. Dan is a great guy
picker, remember. I’m an event one thing: there’s going to be who has done extremely well.
picker. We’ve done more an end to this. I thought it But permanent capital would
stock picking in the last few might’ve been this past fall, but be a great thing for me
years because it’s been the I was wrong. It is going to be because I would have a much
place to be. But, generally, our ugly. longer term view of the world.
holding period, unless it is
distressed, is less than a year. G&D: How does that factor G&D: Would you consider
Lately we’re about 70% short- into your and your investors’ creating your own family
term, 30% long-term which is risk appetite? office?
about as good as I can get.
I’m at a point now in my life CE: One day that may end up
G&D: Is there anything else where my investors are all risk happening. For instance, there
you find challenging in this averse. None of them need to are bonds out in the distressed
environment? get rich; their goal is to stay world that are literally
rich. It’s a big difference. unbelievable, but I can’t buy
CE: Before 2008, the risk-free Business school students can them because they were
rate was 5%. That’s a fair risk- afford to be risky, do what I unbelievable a week and a half
free rate and we were making did, play options, and live to ago and now they are three
about 15% net. We were three make money. Once someone points lower. I don’t have the
times risk-free net and I was turns 40 or 50, has kids, and a luxury of being down 6% in a
considered a hero. What’s risk house, they need to make a month trying to make my
-free rate now, you think? Call nice living and avoid going money next year. Firms like
it 1%? If I make 8%, I'm eight backwards, and I did the wrong Oaktree and Apollo with
times the risk-free rate, and thing going backwards this longer term money are buying
I'm getting yelled at. What it year. hand over fist right now.
means is that we are doing They’re all suffering near term
things that are much riskier G&D: Have you considered losses because energy bonds
now than it was before 2008 pursuing something similar to have gone down considerably,
to get eight times. Investors Pershing Square, where you and continue reaching new
don’t get that. Guys making establish a permanent capital lows, but they know that over
15% are either highly vehicle so you can have more time, over their investment
leveraged, or crazy lucky and flexibility or take a longer term horizon, it’s going to be fine.
good. view? My horizon is quarterly or
yearly, so I don’t have that
But sometimes you’ve got to CE: There are only a few Bill ability, I have to be more on
accept the fact there’s no Ackmans out there. I cannot top of things and hope I can
money out there. There are do that. Dan Loeb did it, Bill catch the bottom. That can be
times to reap and sow. This is did it, and David Einhorn did it. difficult.
not a reaping time; this is a Those are the three guys that
crying time. We see the created permanent capital. G&D: Do you have the ability
markets doing what they’re They deserved it. We don't to set up separate portfolios?
doing now because of the deserve it. Bill is the smartest
Federal Reserve and Europe, guy I’ve ever met. There is CE: Some of our larger
Japan, and China taking on the nobody smarter in this world, investors have set up separate
mantle of the US Fed. It’s very in my opinion, in what we do. accounts, and in those we’re
scary. There is nobody more buying. The accounts are
impressive to hear a story longer term, lower fee, but
I’ll tell you what’s going on from. He's the best presenter there’s a two year lock-up, and
here: asset inflation, whether I’ve ever met. He deserves in those we are buying. In
it’s bonds, or real estate, even permanent capital because, those accounts we’re
more so. Residential real over time, he will make a lot of interested in oil and Puerto
estate is trading at one caps in money. David Einhorn is also Rico bonds. They have long
New York. A one cap! The very impressive—different (Continued on page 15)
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Craig Effron
tails to them, and we believe advantage to the new rigs? internally. They are running
they are smart investments. It’s out of reserves to support
great for all of us. That’s why I CE: Yes. That's exactly why themselves. Their currency is
don’t really mind charging a we love them. We can buy begging to be de-pegged. They
lower fee. There are things out these bonds knowing they're can't have that, so they've got
there that are being worth at least double what to do something.
misunderstood and being we’re buying them for today.
thrown out with the bath We will probably see a bottom G&D: What do you think
water. soon. Oil is probably near about Iran's supply coming on
bottom too. It's trading at $37. now?
G&D: Any examples you’d be Could it go to $30? Yes, but
willing to share? remember last year, at this CE: Well, the market is
time, it was $67. I thought that oversupplied by a million
CE: A good example is was cheap, and then, before barrels right now. That'll be
Vantage Drilling (VTDG). They that, it was $107. It's down another million, so it'll be two
own the newest deep water 70%. That's a big move. All you million oversupplied. That’s
fleet in the country. There are have to do is shut the spigots bad news. On the flip side,
a hundred deep water drilling off, have production cuts, and Putin is now very involved in
platforms in the world. They the Middle East, and he and
own seven of them. They're Saudi Arabia are now allies.
the seven newest and they “I think having a Putin’s country is going
have a 30-year life. They were bankrupt because it is oil-
built from 2012 – 2013 at a sounding board is an based. He is probably
cost of $800 million each. The negotiating with the Saudis,
company is going through
important thing. You offering to go after ISIS if they
bankruptcy and the bonds, have an opinion and elevate the price of oil. Saudi
which we are buying now in Arabia holds the keys here.
the high 20s to low 30s, are you start believing it, They can be the balancer, and
valuing these drilling platforms that’s all it takes. Russia is
at $180 million each. In the because it's your going out of business. It’s
depths of the 2008 oil worse than Brazil. The whole
depression, platforms traded at opinion. But, if you economy is oil, so I’m sure
$300 million. These platforms Putin is making a very hard
are three years old. They are
have a good partner plea, hoping to get oil back to
the most efficient, and they are who’s your friend, and the $50s. My suspicion is
platforms people want to own you're going to see a surprise
and lease. If you believe oil will loves you and tells OPEC meeting in February and
not be $37 forever, which I they'll raise the price about
tend to believe, at least in 27 you, "Hey, here's what $20. We're long oil now,
years, this is not only money- actually, having bought it the
good, but they’re also turning you're missing," and last few days.
into equity, and could be a ten
bagger. These bonds were 105
does so in a nice way, An oversupply of two million
on April 1st this year; they’re it's a very good thing. barrels is not significant either
now 30, going to be bankrupt, on 90 or 100 million barrels,
and we're getting the equity. And you have to be with frackers stopping
That's an example of what's production. By the second
being given. We have bought a willing to do the same quarter, we can have it where
position of about 4%. We we’re undersupplied by two
cannot go any larger. We for him or her.” million—it wouldn’t be
started buying at 44, they're surprising. That’s what we’re
now 28, 27, and I can't buy you'll get a $20 rally overnight, thinking.
anymore. and it’ll come soon enough
because, I think, Saudi Arabia is G&D: We would love to get
G&D: Is there a big cost starting to feel pressure (Continued on page 16)
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Craig Effron
into your process for idea make it, how to express it, the was at $200. While I don't feel
generation and also hear about time frame, and other details. that bad now, I felt bad at
your process for deciding We start discussing whether it $250, but that was me getting
when to put on a position. should be a pair trade against a out early. I had bought it at
comp, options, bonds, CDS, or $140, and I made $60, which
CE: Let me correct a any number of ways. looks good now. I never got
misperception. Most funds back in, and I never shorted it
don't author many of their I'm the risk manager; I put the either, but that was selling too
own ideas, and we’re one of trades on. I can tell you every soon.
them. We have an idea or two position we own, the number
that we generate ourselves, of shares, and why we own it; Another adage to keep in mind
especially in credit, but most but, I may not know the math is that you can’t like a stock as
are in The Wall Street Journal, behind it. I know the thesis. I much at $100 as you did at
or they come up in discussions am the guy who does the sizing $20. I don’t care what it’s
at dinner with friends of mine. and the risk, and I also know earning. It’s just the way it is.
The idea that we’re sitting in a when positions start getting Look at Apple. Apple went
room, and then are suddenly too big. I can sell at any time from $200 to $700 back to
all like “I got it! Let's buy without consulting the analyst. $300. That’s just what
XYZ.” That's not how it They know that I have one happens. I’m not saying to go
works. Bill Ackman is a rule, don’t get mad at me if I to zero, in position and size,
different guy. Bill does do that sell your idea one day, because but you can’t like it as much as
and he's unique. John Griffin we may buy it back. you once did. Instead, an
does that as well, especially in option may be to keep the
Japan. Generally, though, we all There’s a very good amount of same position the same size. If
talk to each other and share money to be made by trading, it's 3%, keep it 3% don't make
ideas. Ideas are not generated what I call, around the edges. If it 12% because it’s rallied;
out of thin air. They come to you're long a company at 5% that’s just dumb, and that’s
me from Barron’s, The Wall and it rallies more quickly than how you go out of business.
Street Journal, Financial Times, you thought it was going to You have to “feed the ducks
idea dinners, brokers, etc. rally, if we sold 1% of that 5% when they're quacking,” and
That's how they come. on a rally, hoping to buy it that's what I do because I
back, it’s a win-win. If I’m know when I want to sell to
The differences inside each wrong and it goes higher, them, they’re not going to be
fund is how they take the that’s okay. If I’m right, I can there for me. You have to sell
information, and we do it very buy it back, and create a little when you can, not when you
simply. Before 2000, I was the alpha and nothing bad has have to. Some very smart,
sole generator, with Curtis, of happened. large managers ended up
every idea. I didn't use any of forced sellers of things they
the analysts’ ideas. I was the I’ve taught my analysts that if love. Why? Because they
guy who gave all the ideas and things happen quicker than we received redemptions and had
they would generate the expect, take some money off to sell. What a horrible thing,
numbers, but they were my the table and look to buy it selling things you love at the
thoughts. back. Things don’t go in a bottom because you have to
straight line. That’s been a sell.
Now the division of labor is good lesson. There’s a
probably one-third my ideas gentleman named Bernard G&D: Any other
and two-thirds theirs. They’re Baruch, whom you may have recommendations?
much better than I am now heard of, who famously
and I’m not as good as I once responded to the question, CE: I recommend
was. They’re smarter than I am “How’d you get so rich, partnerships, even though
and a lot of ideas are theirs. Bernard? By selling too soon.” most managers like to be lone
When they come to me and It’s a great line, and I am the managers. I think having a
say, “I love this idea” we rank quintessential sell-too-soon sounding board is an important
it one to ten, then we discuss. guy. I was long Valeant, and I thing. You have an opinion and
My job is to decide how big to was selling the stock when it (Continued on page 17)
Page 17
Craig Effron
you start believing it, because Amazon. People never get out teachers than I see hedge fund
it’s your opinion. But, if you on the way up. They get out managers. Hedge fund
have a good partner who’s when they have to and not managers have a habit of being
your friend, and loves you and when they want to. very competitive. They’re all
tells you, "Hey, here’s what alpha people. They would
you’re missing," and does so in G&D: Do you think value will rather be flat and have their
a nice way, it’s a very good have its day soon? competition down 10% than
thing. And you have to be everybody be up 10%. It’s a
willing to do the same for him CE: I hope so. I'm not an crazy world.
or her. Amazon player. Value has it’s
time but it’s always less than Don’t be like that. Understand
Lastly, we are unusual. I am an what you think it's going to be. there's room for everybody to
old school investor from the make money, number one, and
’80s, and there are only ten G&D: Has the crisis and its number two, when you make
investors left doing this with aftermath changed your that money, don’t say, “I
funds the same age as ours. perspective at all? should be happy, but I'm not.”
There are only ten guys still It’s not a happiness factor. It
around from the ’80s from the CE: I have this little program means you can do things.
300 people I started with, and every year for college That's all it means. You need
the rest have all gone out of sophomores going to be to find happiness by loving
business, because as I juniors, and my opening salvo what you’re doing, and a lot of
mentioned, the average fund always says, “Do not confuse folks don't love what they’re
folds every seven years. happiness with money.” I know doing. They hate competition.
more unhappy billionaires than It’s a very stressful business. I
G&D: Joel Greenblatt talks get yelled at a lot. This year I'm
about how the stock market getting phone calls from an
doubles and halves every seven “‘Do not confuse investor I’ve had for 20 years
years, or thereabout. Is that yelling at me. I never get calls
part of it, is it just part of that happiness with money when I'm doing well, that say
cycle, when everyone goes out “Great going.”
of business? […] You need to find If you get into this business—
and I don't recommend it right
CE: People start believing happiness by loving now—the government has
they’re really good at it really made it difficult. Young
because they have a good run. what you're doing, investors can't open a fund.
They forget that a large part of and a lot of folks don't You have to go to a place and
it is luck. We’re lucky to be in spend a lot of time learning
this world, where people buy love what they're how to do it, and maybe you
stocks for no reason. The get good at it and maybe with
market is fragile. We’ve taken doing. ” that expertise, you can go and
our book down dramatically. open a fund when you're in
We are focusing on credit, your 30s. I did it when I was 28
which I think is more I can count on all my hands. because there was no barrier
interesting, and that’s our bet. I Having money’s a great thing, to entry. You didn't have any
can’t play a stock market that I and I would never not want to compliance officers; you didn't
think is destined to be a have it—I’m not saying that— need to have big, heavy-duty
debacle. The S&P might very but it does not make you accounting groups. Now, if you
easily be overvalued by 25%. happy. It takes away one run $500 million dollars, day
Energy is important, but retail, element of problems: how are one, you can't be in business.
semiconductor, hospitals, I you going to eat, are you going Why? You can't get the right
don’t know what’s keeping be able to go on vacation, or people. You can't have a
them up. They are going to put your kids in private school? robust back office to make
blow up, mark my words. It is your investors comfortable,
going to be ugly when it starts It doesn’t create happiness. I and you can't get the
to hit Facebook (FB) and see more happy kindergarten (Continued on page 18)
Page 18
Craig Effron
compliance people you need.
They’ve made the business

either get big or get out, and
that's what we see happening.
There’s nobody left in the
hundreds of millions of AUM
anymore. It’s sad, because
there’s real value there. If
you're running $500 million,
it's much easier than running
$5 billion.

for Columbia students?
CE: I don't want to say you

shouldn't enter the industry.
I’m just saying have your eyes
wide open. I would pursue
private equity at this point.
Private equity is one place
where they give you hope that
you can still make money, and
they can’t pull their money
out. An investor can see three
cycles in an eight year period.
Over that eight year period,
investors are going to have
one chance to pull their
money. For hedge funds you
have eight months. If you start
a hedge fund and lose 10%
your first year, you’re out of
business. In a private equity
firm, if you lose 10% on paper
your first year, you've got
seven years to figure it out. I
like that model better now.
Long term assets are much
better.
G&D: Thank you for your

time, Mr. Effron
CE: I have enjoyed this

immensely. I don't want to tell
you not to be in this business.
It's a great business, but I'm
worried that it's not what I
remember anymore. Maybe it'll
become more normalized, but
throughout there will be
hurdles.
Page 19
Jeff Gramm
Chairman: Boardroom G&D: Was there a time in unstructured.

Battles and the Rise of Security Analysis where you
Shareholder Activism” realized that value investing, The analysts had a lot of
published by that orientation, was right for leeway in what they looked at
HarperBusiness. you? and what we got to do. Pretty
It is a riveting history of quickly I got to do this activist
shareholder activism that JG: I remember Greenblatt did campaign on Denny’s. We
has garnered advance an in-class case study of were bond holders, then we
praise from Arthur Levitt, Munsingwear and I remember bought the distressed equity
Alan Greenspan, Fred getting it very quickly. I'm sure and I wrote a 13D protesting
Smith, Charles Schwab that I didn’t know what the the company’s rumored plan
and Tyler Cowen. The hell I was doing back then, but to equitize the debt. Then we
book features an appendix the case clicked in a way that led a PIPE to recapitalize the
with original, never-before- made me think I could be good company. It was a fun and
Jeff Gramm ’03 published letters written at value investing. I wasn’t exciting time in the business.
by Warren Buffett, especially confident in business
Benjamin Graham, Ross school. I stuttered badly, I G&D: No new management
Perot, Carl Icahn, and didn’t have any business though?
Daniel Loeb. experience, I was very
unpolished, and then along JG: No new management. The
Graham & Doddsville comes this class where I felt I management at that time was
(G&D): Could you provide really was getting it faster than good for a turnaround but had
some background on your many of my classmates. That a hard time after the
journey and how you came to was really important for me at turnaround. There have been
investing? an important time in my life. several new CEOs since then.
Jeff Gramm (JG): I really G&D: Who besides Joel At HBV, I was lucky enough to
learned about investing at Greenblatt would you say have a very good mentor. The
Columbia. I went to the were major influences on you head of research, Greg Shrock,
University of Chicago for and developing your style of had been an M&A lawyer with
undergrad. I played music after investing? Wachtell Lipton for many
college, so I was a career- years and then a bankruptcy
transitioner when I got to JG: Definitely my boss Greg lawyer at Milbank. He and I left
Columbia Business School. Shrock. He gave me all of the to launch a long/short
That was before the whole Berkshire letters and the distressed fund called Arklow
value investing program, so Munger speeches and that kind Capital where I was the junior
Joel Greenblatt just taught a of stuff. Also, Bruce partner. We were seeded by
regular Security Analysis Greenwald’s Economics of Protégé Partners in 2004.
section. I was lucky enough Strategic Behavior class. It
that his class was the one that really helped me understand I left Arklow to form Bandera
fit my schedule and I just felt competitive advantages and in 2006 with my current
like it clicked for me. Instantly, how to think about business partner Greg Bylinsky. It’s a
the whole thing resonated with strategy. much more traditional value
me and I got extremely fund: highly concentrated, long
interested in investing. G&D: How did you decide to biased. I got away from long/
launch your fund? short diversified and distressed
Before my first year core investing.
classes, I had never really JG: My first job out of business
known about accounting, I had school was at HBV Capital. It G&D: Why were those the
barely even heard of Warren was a multi-strategy hedge right decisions for you?
Buffett and so I came to the fund owned by Mellon Bank. I
whole thing fresh. After Joel’s worked on their distressed JG: I was always interested in
class, I just began to consume fund from 2002 to 2004. It was concentrating in my best ideas.
everything I could. a billion dollar fund, but at the I’ve always thought that was
same time it was pretty the best approach for getting
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Jeff Gramm
good returns. I didn’t enjoy have a dispositional fit for this them, so they added capital at
being a part of a long/short business. I think I have a few the lowest points. That helped
fund with a two man team. The areas of expertise, but us a lot. We also had a large
short side is extremely labor ultimately, there are a lot of hands-on investor that was a
intensive. Greg Shrock was people out there that are former bank owner who kept
very keen on shorting the doing exactly what I do and us very honest when we
subprime bubble. It ended up what Bandera does. looked at financial stocks.
working out incredibly well for
him, but having a short book When you go to the Berkshire Launching a fund is very
was a lot of work and it didn’t Hathaway meeting, you meet difficult, and it’s easy to make
leave a lot of time for doing dozens of other smart people mistakes right at the beginning
what I wanted to do. that are doing exactly the same as you are trying to build a
thing. It always gives you pause. portfolio. If the market is going
I also didn’t love distressed It’s easy to talk about your up, as it was in 2007, there’s a
investing, and especially during hedge fund’s process and your tremendous amount of
those years, there weren’t a edge. But ultimately, I think a psychological pressure to get
lot of actual workouts. There lot of that is overstated and your cash invested.
weren’t that many distressed that value investing is mostly
bonds even. Everyone was about keeping sane and using There were lots of investors
looking at the same good judgment. with great reputations that
opportunities. I’ve always were pounding the table and
thought distressed investing is saying things like, “Fannie Mae
an industry where there are “It’s easy to talk about (FNMA) or Freddie Mac
lots of economies of scale and (FMCC) is the best idea that
I thought it was hard to be a your hedge fund’s I’ve ever seen in my entire
little guy in the space. Big, career.” It’s hard to be a young
established firms have lots of
process and your edge. fund manager and hear Rich
advantages in deal flow and But ultimately, I think Pzena and Bill Miller, or
trading, that aren’t as prevalent industry experts like Tom
in more classic value investing. a lot of that is Brown pound the table, and
then watch Lampert pile into
G&D: You say that Bandera is overstated and that Citigroup (C), and not follow.
extremely long biased, that
you’re concentrated. Do you value investing is G&D: Were you seeing
have any sort of structural opportunities where stocks
advantages that allow you to
mostly about keeping were just selling off for
do that, which maybe other sane and using good uneconomical reasons and you
people don’t? were able to make the best of
judgment.” that opportunity?
JG: We are very lucky to have
a good capital base of long- JG: Of course. It was an
term investors that have been amazing period. I think my
in the fund a long time and G&D: What was it like biggest mistake in that period
have seen us in good years and launching in late 2006 right was passing on the extremely
bad years. before the crash? good businesses we always
knew we’d want to buy
G&D: They’re all high net JG: I’m not going to lie, it was whenever the market tanked.
worth individuals? exciting but also very scary. In We looked at Costco (COST)
some senses the sky actually and Google and other great
JG: Yes. They know what we was falling in 2008, but we had companies and we passed.
are doing and how we think, two incredible strokes of good
so to the extent that we have luck. A contingent of our G&D: You own Google now
any kind of edge, I think it’s investors are high frequency though, correct?
our investor base. I think I'm traders and that was an
good at what I do. I think I extremely good period for JG: We do. We have owned
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Jeff Gramm
Google since 2011. But during other thing that I regret is not throw the financial crisis in
the crisis we mostly bought establishing our back office there!
cash-at-a-discount type stocks. operations. I think it was last
We bought Hilltop Holdings year at the Columbia G&D: Can you talk a little bit
(HTH) at a huge discount to conference where Seth more about your process? Idea
cash. We bought the Hilltop Klarman talked about the generation, then the
preferred which was a money- importance of getting good investment process, specifically
good preferred at a huge operations people and a good having a co-portfolio manager
discount. We bought into a CFO to be sure that you can model? Last year we
company called Peerless concentrate on your investing. interviewed Jay Petschek and
Systems (PRLS) at very big We definitely took the Steve Major at Corsair. We
discount to cash. We joined opposite approach. We had a heard from them about their
the board and pushed the processes as co-managers.
company to return capital to
shareholders. We viewed all of “[2008 and 2009] was JG: Idea generation is the least
those as very low-risk process-driven thing we do.
an amazing period. I
investments with a lot of There are always ideas floating
upside. We did buy a few think my biggest across your desk; I think the
operating companies, including most important thing is having
Popeyes (PLKI), which we had mistake in that period a good two-to-three minute
been closely following and was internal filter to help you
in the early stages of a was passing on the decide which ideas to dig
turnaround. deeper into. As for our co-
extremely good portfolio manager model, we
G&D: You’re still involved require written investment
with most of the stuff you
businesses we always write-ups. We each have our
were buying in 2008 and 2009? knew we’d want to buy own research process, and
then we pitch our ideas to
JG: Not all of them, but we whenever the market each other both in person and
still hold many. Of our top five then with a written memo. It’s
holdings today, we owned four tanked. We looked at harder to cut corners in
of them, Star Gas, Tandy writing.
Leather (TLF), Hilltop Holdings Costco and Google and
and Popeyes, in 2009. The G&D: What do you look for
other great companies
financial crisis, for any fund in that process because there
manager, was an incredible and we passed.” are a lot of good ideas that
learning experience, but also a might not fit within your
test of what you do when short-term lease and we ran a strategy? If someone pitched
markets get scary. I think we bare bones operation. you Amazon, two years ago
passed the test, but I certainly you probably wouldn’t have
don’t think we got an ‘A.’ I think there are lots of been interested.
sensible reasons to do that,
G&D: You mentioned one of but I do wish that we had JG: I first try to understand if
the lessons that you learned hired a CFO from the bat. We it’s a good business. Then, if I
from starting your own fund ultimately over-complicated don’t understand the business,
was don’t push to invest things for ourselves can I do the work to
everything right away. Is there operationally. understand it? Those are the
anything else you would key things that we think about
recommend? The early years of a fund are first. If you can get there, even
hard. Having business partners if the valuation looks not that
JG: The big thing is to try to is hard. We’re a 50/50 business great, it might be worth a look.
stay rational that first year, partnership. Learning how to
because there is a tremendous manage a portfolio where It’s funny, in the class I teach at
pressure to out-perform early there’s no boss is a real Columbia, we no longer teach
in the life of the fund. The learning experience. Then you idea generation. I feel like one
Page 22
Jeff Gramm
of the goals of my class is to a year, a miserable sleepless companies. But since then
improve your quick filter. I year. The initial idea for the share ownership has re-
want the class to teach you book was to collect a bunch of concentrated into the hands of
how to think about businesses “Dear Chairman” letters with fiduciary investors like pension
and then how to value them. short explanatory funds.
That’s really about it. introductions. This evolved
into a more narrative book G&D: In the introduction to
G&D: Switching topics to about the history of “Dear Chairman” you talk
your upcoming book, “Dear shareholder activism. about how so many documents
Chairman,” could you start have been lost. You had to
with an overview of the book G&D: You did a great job of write to Buffett direct to get a
and how you came up with the categorizing the shift in copy of that letter. Do you
idea in the first place? attitudes and approaches of all think that’s beginning to
these activist investors. What change with more SEC
JG: When I teach I’ll always do you think are the main disclosure and the fact that all
get a few students that ask me drivers of these changes? the SEC filings are online?
for book recommendations. I’ll Where do you see it going
tell them I like the Greenblatt from here? JG: I was surprised at how
book. I’ll send them an email hard it is to find old business
with a bunch of the Buffett JG: I think one of the most documents, like annual reports
letters, the Buffett articles, the powerful forces in activism has from small companies. I think
Munger speeches, Klarman been the change in the that will change not just
letters, you know, just the shareholder bases of public because of EDGAR, but also
classic value investing stuff that companies. Activist investors because people care more
everyone passes around. And I are ultimately just a group of about business history. I credit
always include a bunch of 13D economic actors out to make a Warren Buffett with that. Look
letters. I’ve always enjoyed buck. It’s the evolution of at how popular Thorndike’s
them. I came of age in the passive investors behind the “The Outsiders” CEO book is!
industry at a time when there scenes that has changed the Many of the CEOs profiled in
were a lot public 13D letters. attitudes and approaches of that book were completely
We swapped them like bootleg activists. under the radar even at the
tapes, so I still have a lot that I height of their powers. Now
share with my students. At The book begins with Benjamin there are eager young students
some point I thought, “there Graham in the 1920s, when, reading a book about them.
must be a book that collects except for the big railroads,
these things.” most public companies had G&D: Going back to the
very concentrated ownership. 1950s and the “Proxyteers,”
I looked for it and there wasn’t Ben Graham had to go directly we were struck by Robert
one. I thought, “I can do that. to the Rockefeller Foundation, Young’s fight against New
That will be pretty easy.” I had a 30% owner, to plead his case York Central and how
that idea for a few years and at that Northern Pipeline needed involved both sides were in the
some point, I decided to write to distribute its liquid assets to popular media. It seems really
Buffett to ask for the letter he shareholders. By the 1950s interesting given the limited
wrote to American Express many concentrated public number of channels that were
(AXP) in 1964. company owners had passed available at the time. Can you
away, and their stakes had talk about the strategy for
I got to work one day and it been sold off. Companies had choosing those channels and
was in the mail and I said, very diffuse shareholder how they were able to get so
“Holy cow! I should probably ownership which was much access when, today,
do this book now.” It makes exploited by the “Proxyteers.” some important fights are
you understand the power that They ran entertaining proxy rarely discussed in the media?
Buffett has over all of his campaigns to win public
CEOs. I felt this compulsion to support, and that allowed them JG: In 1954 the ownership of
write the book and to do a to infiltrate the boardrooms of the New York Central was
good job with it. It took about a lot of big, established extremely diffuse. There were
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Jeff Gramm
basically no large holders, so JG: They have a fiduciary duty quite hard to find a real
both sides were forced to to shoot for the best financial disaster outside of BKF
advertise in the newspaper to outcome. People have long Capital. The two most famous
win proxies. You had to get been concerned that entities disasters are BKF and
the votes of the “Aunt Janes,” like CalSTRS and CalPERS JCPenney (JCP), and I’d argue
as Young called them. It was a could begin to operate in a that the intervention at JCP
dynamic that you never see way that is pro-labor. Peter wasn’t as bad as people make
today. If you’re trying to win a Drucker even wrote that the it out to be. It’s easy to point
proxy fight now you’re usually United States is the first to the failure and blame
courting 15 to 20 key socialist country because of Ackman, but he helped the
shareholders and trying to get the control that the labor board lure one of the
those votes. force has over industry industry’s biggest stars to be
through pension funds. That’s the company’s CEO. That’s
This difference in ownership always been a thing some what boards are supposed to
structure also played out in the people are concerned about, do.
campaigns’ messaging. Activists but it hasn’t really played out.
used extremely populist The only case I remember was G&D: Potentially Target?
rhetoric to collect votes. It when CalPERS ran a proxy
was essentially a political fight against Safeway shortly JG: Not really. Target (TGT)
campaign and that’s the reason after the company had a labor was a disaster just because
the battles were so dispute and strike. The [Ackman] bought LEAPS, but
entertaining. Back then, the PR CalPERS’ chairman was quickly the actual activism there didn’t
representative was an removed because of fiduciary hurt the company.
important person. You had to conflicts.
get the best people to write When I started doing research,
your copy, now your PR is G&D: Why did you choose to I thought that I would find
usually an afterthought. include the Robert Young something really black and
activist campaign against New white. Like an activist investor
G&D: Young was also skilled York Central in “Dear calling for Apple (AAPL) to
at getting organized labor on Chairman”? liquidate when the stock was
his side. Is there a chance to at $8. I didn’t find too many
do that going forward? JG: I picked Robert Young cases of blatantly misguided
versus New York Central activism. Activism can fail long-
JG: Could organized labor flex because it best depicted the term shareholders when
its muscle? Well obviously the “Proxyteer” movement and companies are sold at the
public pension funds have been Young was probably the most wrong time, but those cases
very active investors. You famous of all the “Proxyteers.” don’t make for good drama
could even argue that some of But there were lots of other like BKF or JCPenney.
the largest public pensions interesting proxy fights that I
funds are downright could have chosen. I talk about G&D: Michael Dell did say
progressive as far as Ben Heineman in the book as that that's what he would have
shareholder activism is well. There's also Louis done if he had been the CEO
concerned. Wolfson who was extremely of Apple at that time, but he
charismatic; he was a lot more didn’t go activist.
G&D: Thinking about labor in colorful than Young was, but I
general, let’s consider an ultimately felt that I had to go JG: Yes. I thought there would
activist fight where a pension with the most important have been that kind of a
plan for labor in an entirely battle. smoking gun from someone
different industry is a major reputable and there really
shareholder. They are G&D: In your research, did wasn’t. The majority of the
unrelated, but is there any the activist campaigns mostly cases that I looked at did tend
solidarity with labor that lead to positive results or to work out for the activist
would get in the way of negative results? and shareholders, with a few
activism? blunders here and there. In the
JG: It was interesting, it was book, there's BKF Capital
Page 24
Jeff Gramm
which was an unmitigated chapter I wanted a classic G&D: Just because if it did go
disaster. New York Central angry 13D letter, so I had to poorly, they had big positions
was in trouble anyway, it’s not go with Dan Loeb. Star Gas is in their funds or do you mean
like their problems were not the best case, but I think it the public nature of the
caused by activism. is the best letter. It’s really campaigns?
over-the-top, calling out the
G&D: You can maybe even CEO’s mother and stuff like JG: No, I mean actual material
say the GM one, because Ross that. In “Dear Chairman” the personal financial and career
Perot didn’t really get what he original letters are all included risk. Look at Carl Icahn: he
wanted. He got a lot of money, in the appendix. If I were leveraged up to do those early
but he didn’t change the reading the book, I would start deals. He had fifteen deals in a
company. by devouring the original row where each new deal used
letters. a large portion of his capital.
JG: You have to wonder what And they all worked out! It
would have happened if he had G&D: How has researching was also interesting to learn
actually been installed as the and writing “Dear Chairman” more about the 1990s hedge
CEO. It’s a tantalizing thought. shaped you as an investor? fund era. It certainly drove
Ross Perot’s letter to Roger home that the glory days were
Smith is the best thing in the a little bit before my time. You
book. “I was surprised at had guys like Carlo Cannell
that had a billion dollar fund.
Also, GM (GM) played a key how hard it is to find I’m not sure that would
role because they basically old business docu- happen now. He deserves it.
invented the modern pension He’s a great investor, but he’s
fund. Then they proceeded to ments, like annual re- definitely an outsider. The
run their company into the industry is much more
ground for 35 years until the ports from small com- institutionalized and mature
pension funds revolted. now.
panies. I think that
G&D: How did you end up I also found writing a book to
deciding which cases to will change not just be an incredible exercise in
include? because of EDGAR, learning to be more
productive. I have a full-time
JG: There were some that but also because peo- job, I was teaching, I have two
were obvious, like Benjamin little kids. So to make time to
Graham, Ross Perot, and ple care more about write a book and to have it
Warren Buffett. There were come out well taught me a lot
some where I had to depict business history. I about how much you can get
movements like the done if you turn off your
“Proxyteers,” the corporate credit Warren Buffett phone and your email.
raiders, and modern hedge with that.”
fund activists. G&D: We had Bill Ackman in
an issue last year. He talked
For the corporate raider era, I about his evolution and now
picked Carl Icahn’s battle with What have you learned and for almost every position he
Phillips Petroleum because I how has that affected your wants it to involve some
thought that it had a lot of investments? elements of activism. It doesn’t
important elements. It had a seem like you necessarily want
very early poison pill. It had JG: It really drove home the all of your investments to be
the first highly confident letter. big career risks that many of activist positions. Is that
It had Icahn and Milken and these guys took. They all were correct?
Boone Pickens, all in peak in comfortable positions, but
form. proceeded to take massive JG: I think that’s a dispositional
career risks. thing for me. I don’t enjoy
For the hedge fund activism activism that much. I definitely
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Jeff Gramm
think it works. If you’re right can improve the operations or create a lot of value for
that a stock is undervalued, the capital allocation, activism shareholders. If they’re paid
activism is a great way to is very powerful. according to the value that
improve your IRRs by having it I think activism is a good thing they create, it will be a scary
play out more quickly. Ackman overall for passive looking number that’s hard for
is good at activism. I think he shareholders, because a lot of the public to digest. On the
enjoys it. these boards need to be other hand, a lot of CEOs are
shaken up. It’s incredibly simply not that good and don’t
I’m not that good at it and I frustrating to be invested in an deserve mammoth paychecks.
don’t enjoy it that much. I undervalued, poorly-managed, It is a very hard thing to
think I’m a decent investor, but and poorly-governed company reconcile.
it takes a particular mindset to which allocates its capital
be able to go onto a board and badly. To the extent activism, This is something that activism
tell hardworking, usually or the threat of activism has not really solved. Activism
honest people, who in some improves that dynamic, it is a sometimes rids companies of
cases dedicate every waking great thing for investors. underperforming CEOs, but
hour to the company, that Activism fails when it forces activists usually give the new
they’re wrong. That’s just hard good companies to sell CEO a pretty good package.
to do. I’ve had to do it when themselves at the wrong time. Remember, many of the
my back was against the wall, And now, as activism has shareholders who become
but it’s not pleasant at all. evolved, you are seeing arbiters in these situations are
shareholders who are more overpaid as well. I’d love to
G&D: How do you think and more focused on tinkering see more creative approaches
activism plays out in general with operations. So we’ll to executive comp. One
for shareholders in the long probably see a few more failed unfortunate side-effect of the
term? Have you come across interventions in the coming Valeant debacle is that
anything that convinced you years that look like JCPenney. Pearson’s comp package got a
one way or the other that We should be willing to live lot of criticism. But I really
activism is actually in the best with those if it improves liked how it was structured. I
interest of shareholders for overall governance. liked that he had to risk his
the long term as well? That money, and I like that the
activism is not, as some people G&D: Talk about passive board installed an interesting,
criticize the industry or the investing and indexing versus atypical compensation scheme.
practice, just to chase short- pension funds and the shifts in
term returns? shareholder bases. What Regarding the shift to indexing
impact will that have for and ETFs, it is completely
JG: If every company were governance and activism fascinating from a governance
well-governed, and all activist broadly? Can you speak about standpoint. These votes
campaigns did was to force a pay packages and say-on-pay matter, and you have to worry
company sale to take votes? As companies get if the right incentives are in
advantage of the disconnect bigger, it seems like place to make sure these big
between the market valuation management teams get paid passive institutions vote wisely.
and the valuation in the sale, more and they’re all getting
then I think that you would paid the 75th percentile of all Vanguard is taking an active
have to argue activism would their peers and pay keeps role in the governance debate
be a negative, because escalating. and they are dedicating
ultimately you are giving up meaningful resources into their
your long-term value—or a JG: Those are two huge proxy voting. But you have to
portion of it—to the buyer. topics—executive worry about how much power
But the dirty truth is that compensation and the growth is accruing to these places. It’s
governance is terrible, and in passive investing—that I do a little scary if you think too
there’s a huge opportunity out not cover as much as I’d like to hard about it.
there to shake up public in the book. They are tough
company boards. If you’re issues. A great CEO is The industry tried to deal with
correct on valuation and you incredibly valuable and can this problem by creating ISS.
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Jeff Gramm
But ISS has devolved into one case, then it is possible to an interview where he
big best practices checklist. perform an aggressive suggested that there could be
You need to have good takeover of a company that bad managers and bad boards,
judgment and that’s the danger screws the shareholders. If the but that they’re not necessarily
of the checklist. I wrote about pill is put in for the right bad people who are
some classic examples in the reasons, and not to protect a deliberately negligent; rather
book, including ISS’s bad management team, then it they could benefit from
recommendation that Coca- can actually protect working with them. Have you
Cola shareholders withhold shareholder value. taken a view as to the
their vote from Buffett because evolution of activism and
he owned Dairy Queen. That You have to acknowledge that, where it might be going—
is totally insane. If you’re an as a device, it’s not inherently perhaps to “shareholder
actual shareholder of Coke, evil. Lipton obviously has a advocate” instead of “activist,”
would you vote for Buffett on reputation as a defender of to work with management
your board? Of course you corporations and he has a teams to make the companies
would. business that is built around better and to keep these men
that. So he always takes the and women in their jobs?
G&D: Who is your primary anti-activism side, but I think
audience for “Dear Marty’s a smart guy and if you JG: First of all, when I say “a
Chairman”? bad CEO” or “a bad board,”
“... The dirty truth is I’m not saying that they’re bad
JG: I really wrote the book people. The power of
that I would want to read. So I
that governance is incentives are at play here.
think the people that would terrible, and there’s a When your livelihood is on the
get the most out of it are value line, it’s easy to convince
investing fund managers, which huge opportunity out yourself of the rectitude of a
is a pretty small target position that happens to
audience. But ultimately, I there to shake up support your personal
wrote the book for fun and employment and enrichment.
because I wanted to. If you’re public company It’s not that all these people
an investor, if you’re into value are bad.
investing, if you’re interested in
boards. If you’re
governance, I think you will correct on valuation Could activism evolve into a
enjoy it. Beyond that I don’t more constructive, positive
know, it does get a bit nerdy in and you can improve engagement? I think that the
parts. threat of activism, as pervasive
the operations or the as it is now, is resulting in
G&D: One other character companies beginning to be
that’s really important to the capital allocation, more conscious of their weak
development of activism is spots. They are forced to play
Marty Lipton. Can you talk a
activism is very defense before they’re even
bit about his role and how powerful.” attacked, which is a good thing.
your view of him has changed, Managers are being mindful of
if at all? get him off the record he the areas where their
obviously knows there are bad companies struggle, and they
JG: I always understood the boards out there and bad communicate better with
poison pill and I’ve always CEOs. shareholders about it. That’s a
thought that in the right good development.
circumstance, the poison pill Marty Lipton and Joseph Flom
can be effective in protecting are very important figures in But in terms of constructive
shareholder value. Ultimately, the development of corporate engagement, when the battle
if you are a value investor, defenses so they’re key parts lines are drawn constructive
then you understand that of the story. activism will only get you so
markets can be very inefficient. far. Often, replacing the CEO
So if you believe that to be the G&D: Carl Icahn recently did and changing the board is a lot
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Harvey Sawikin
Jeff Gramm
more effective than trying to activism. Yet the bigger public players
compel them to do what you used a lot of leverage and
want to do. When companies True long-term decision basically marketed themselves
play defense, they usually do making is hard, both for to investors as utility-like,
the bare minimum required to shareholders and for dividend paying companies.
keep shareholders happy. It’s management teams. No one The original Star Gas was a
better than nothing, but it wants to sit through two or financial roll-up run by an
often doesn’t go far enough. three poor years for the investment banker named Irik
promise of something better. Sevin, who’s in my book
G&D: One of the themes in because of his battle with Dan
investing is the G&D: Are there any Loeb. Sevin rolled up a bunch
democratization of investment ideas that excite of heating oil dealers,
information. People have more you and you want to share? accumulated a lot of debt, and
access to information now, so tried to centralize the business
that’s led markets to be more JG: We have an investment in as if it were a propane
efficient. Given the threat of Star Gas Partners (SGU). It’s a distributor. But, heating oil
activism and people finding heating oil distributor; they distribution is a service-
information more easily, would deliver heating oil to 450,000 oriented business, Star Gas
that drive managers to be households in the Northeast. pissed off their customers, and
more short-term in nature just Heating oil distribution is a the company was
to avoid an activist campaign? mature, declining yet overleveraged. When things
surprisingly good business. It's got ugly, management began to
JG: I’d question your premise true there are low costs of make some directional bets on
that because of all this switching and it's easy to the price of oil that went
information markets are change your dealer, but good against them.
becoming more efficient. We heating oil companies have
still have tremendous lapses in consistently generated quality A private equity fund,
collective judgment. I’m not returns on capital. Every time I Yorktown Energy Partners
sure that the extra information meet someone who runs a took control in 2006.
helps. If markets have gotten small, private heating oil Yorktown founded a heating
more efficient, it’s probably dealer, they are rich. oil company in 1981 that it ran
because so many smart, very successfully until selling
motivated people are At times, the market seems to out to Star Gas in 2000. They
becoming professional misunderstand the quality of generated a fantastic return
investors. the business, maybe because with Meenan by doing what
the few public companies that Star Gas is doing now,
But to the rest of your distribute heating oil have been allocating capital extremely
question, everyone is paying disasters. This includes the old well into acquisitions and
attention to shareholders now Star Gas, Heating Oil Partners, opportunistic share
because they know the threats and Superior Plus, a Canadian repurchases. So here we have
of activism. Companies are propane company that a deceptively good business
going to try keep their overpaid for some US heating controlled by extremely good
shareholders happy. If the oil assets several years ago. But capital allocators. The
shareholders are short-term the truth is that heating oil company has bought back 25%
oriented, does that lead to distribution can be a very good of the stock since Yorktown
short-term decision making? It business if you operate well. took control in 2006 and it’s
certainly can. It’s the job of still cheap at a very low
shareholders and the board to G&D: Why have there been multiple of its normalized
put management in a situation disasters if the underlying earnings power. The market
where they can make the right business is so strong and there values Star Gas as if it is in a
operational decisions, even if is quality return on capital? death spiral. Its enterprise
it’s painful in the short-term. value is about $400 million, in
This is always going to be a JG: It's a volatile business, a normal weather year the
challenge for any management sometimes in the Northeast company should make about
team in an era with or without we just don’t get a real winter. $100 million in pre-tax
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Harvey Sawikin
Jeff Gramm
operating income (backing out cetera. liquidation value because
its amortization of acquired they’re not going to liquidate.
customer lists). Earnings are And, the availability of If the industry goes away, then
volatile. Last year Star Gas acquisitions is important. we’re hosed because there are
made $160 million pre-tax; in When you talk about the no assets there aside from
2012, when there was basically valuation, Star Gas trades at 4x trucks. That’s actually why Star
no winter, it made $66 million. the normalized pre-tax Gas is a good business; it is a
But the stock is entirely too earnings power, but that's very low CapEx business. They
cheap. Since we’ve owned misleading because it is a generate a lot of cash, but
SGU, they’ve bought back $85 declining business if there is no there's no asset protection if
million worth of shares and ability to make acquisitions. the business deteriorates.
paid $130 million in dividends. Every so often some clown will
waltz into the space and G&D: You mentioned short
G&D: For Star Gas, can you overpay for heating oil dealers. selling is not a big part of
talk about the corporate That really hurts us, because Bandera’s strategy, but it
structure and shareholder Star Gas is the natural acquirer seems like the short of Famous
rights? in the industry. Over the past Dave’s worked really well.
five years, they’ve grown their Could you talk more about
JG: SGU is a Master Limited customer base by 10% through that?
Partnership, but it’s kind of a acquisitions. If you take their
weird, vestigial MLP. All of the pre-tax operating income and JG: We will short
assets of the business are held subtract the cost of the opportunistically, but it's quite
at the C-corp level. If they acquisitions, they're generating rare. We usually only do it if
could easily unwind the MLP $60 to $80 million a year. So it we know the company
structure then they would, as really trades at 5x to 7x pre- exceptionally well. Famous
it serves no purpose and has tax if you adjust for Dave’s (DAVE) was our only
higher administrative costs. acquisitions. short position this year. We
Plus, it’s a pain for investors. used to be the largest
Regarding governance, the G&D: What does the balance shareholder in 2010 and 2011.
investors could technically sheet looks like? We got to know the board
replace the general partner if and management very well.
they wanted to, but it's a very JG: They have a $100 million
well run company, so that is term loan offset by about that A succession of activists
not something that we would much in cash. investors rolled into Dave’s,
like to see. and the market got extremely
G&D: We were talking earlier excited about the future
G&D: What are the big risks about doing some Graham and prospects of the business in a
to the business? Are changes Dodd investing and buying cash way that we thought made no
to interest rates or the price at a discount. How do you sense. We sold our position to
of oil big drivers? think about the downside the activists on the way up. It
here? is hard to short a company like
JG: The big driver for them in that, where there's a lot of
the long-term is the speed of JG: SGU is working capital- optimism, a lot of smart people
conversion to natural gas for intensive business so you have involved, and they are
heating. It's basically been 1% to normalize the working repurchasing a lot of shares. I
to 2% for a long time, and that capital for seasonality. There have a very high opinion of
could accelerate to a higher are times in the year where it Patrick Walsh, one of the first
level. Over time, conversions seems like SGU has a mountain activists to get involved, but
have been pretty stable, but of available cash, but it’s not the valuation just got too crazy
various external forces could really freely available cash. and we shorted about 5% of
change that, such as new Ultimately, Star Gas is going to the company. Even without
regulations, government keep on doing acquisitions. obvious catalysts, you had a
incentives to convert, changes They’re going to continue to struggling brand and a
in the relative value of natural operate the business. It’s not shrinking company suffering
gas versus heating oil, et that useful to look at the nine years in a row of declining
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Harvey Sawikin
Jeff Gramm
traffic. Yes, they are buying desk?” I tell students to write a Your judgment is important,
back shares. Yes, there's cover letter that’s very short and if you do good work it will
optimism about the future. But and include an investment get better. But at your first job
the market’s valuation was write-up. Put it on fancy paper. in the industry, your boss
totally disconnected with the Either drop it in the mail or really wants you to gather
reality of the situation. We courier it to them. information and to work hard.
knew the situation extremely
well, having been the biggest If your research is on a I think a lot of the standard
holder for several years. It was position in their portfolio, clichés about performing at
a painful short for a while, but they’ll probably read it. If work, get there first, stuff like
we knew that no one would you're looking at ten funds, it’s that, are true. You'd be
buy the business at $35 a a lot of work to do a report surprised at how few people
share. [Editor’s note: Famous on ten different companies, but actually do it.
Dave’s has since fallen to under if that’s what it takes to get a
$6 per share and Bandera filed a G&D: Jeff, thank you for your
13D disclosing a new position in time!
the company in January.] “Most hedge funds I
G&D: Do you have any advice know do not have a
for students trying to start
careers in investment system for hiring, so
management?
you need to be as
JG: If you want to work at a
hedge fund, you need to be
creative about the
creative about your job search. process as you would
A lot of the funds that might
possibly hire you don’t actually be in your investment
know that they might hire you!
Most hedge funds I know do research.”
not have a system for hiring, so
you need to be as creative
about the process as you great job, you should try to do
would be in your investment it. If I get a write-up on my
research. desk about Star Gas, I've got
to read it.
I'll get these e-mails that read,
“Dear fund manager. I want to You have to put yourself in a
work at your fund.” You have position for people to pay
to do better than that. You attention to you. It also helps if
have to decide who you want your write-up includes actual
to work for and then target research you have performed
them. Most hedge fund rather than just opinions. It
holdings are publicly available sounds harsh, but I find that
and you can figure out which students often overvalue their
funds invest in the type of own judgment.
companies that interest you.
It’s easy to find out who runs At your first job outside of
the fund, but don’t just send a business school, even if you do
generic email with a resume. great work and you're
extremely smart, don't
If you have identified the fund underestimate the fact that
manager you want to work for, you're also there just to
then think, “Okay, how can I perform work. Don't
get my stuff onto his or her overvalue your own judgment.
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Shane Parrish
Graham & Doddsville Buffett, Kaufman, Bevelin, and are associated with their
(G&D): Can you discuss your Munger have already figured investment success. I think
background and the origins of out. In fact, that’s our tagline. It what they've done is they've
Farnam Street? reminds me of something taken other people's ideas,
Munger said once when asked stood on the shoulders of
Shane Parrish (SP): Farnam what he learned from Einstein, giants, so to speak, and applied
Street started as a byproduct and he replied, only half- those ideas in better ways than
of my MBA. As I was going jokingly, “Well he taught me the people who came up with
through that program it relativity. I wasn’t smart the ideas. For example, with
Shane Parrish became evident that we were enough to figure that out on regards to psychological biases
being taught to regurgitate my own.” That seems like a bit and Kahneman’s work, Munger
material in a way that made of a wiseass remark, but and Buffett have found a way
marking easier. We weren’t there’s some untapped wisdom to institutionalize this to a
honing our critical thinking there. point where they can actually
skills or integrating multiple avoid most of these biases.
disciplines. We couldn’t G&D: What are your
challenge anything. motivations for Farnam Street? Whereas Kahneman himself
Eventually, I got frustrated. I just says something along the
didn't give up on the MBA, but SP: I want to embrace the lines of, "I've studied biases all
I did start using the time that I opportunity I have, which has my life, but I'm not better."
was previously investing in been created largely through Yet, these two guys from
homework and started to luck, and I want to give readers Omaha actually figured out
focus on my own learning and and subscribers enormous how to be better.
development. At first it was value in three ways.
mostly academic. I started It’s not just Kahneman and
going back to the original First, I want to help them make human biases. They’ve done it
Kahneman and Tversky papers, better decisions. To do our in a variety of disciplines like
and other material that was best to figure out how the Michael Porter’s work on
journal based, because I figured world really works. Second, I Competitive Strategy. They
I'd probably never have access want to help people discover separately derived the same
to such a wealth of journals new interests and connections basic ideas, except in a way
again outside of school. across disciplines. Finally, I that gives them an enormous
want to help people explore investing advantage. To my
So I started the website and it what it means to live a good knowledge, Michael Porter has
was really just for me, not for life and how we should live. I not done that. Of course, he
anybody else. The original url hope by sharing my intellectual may not have been trying to
of the website was the zipcode and personal journey I can help do so. Another great example
for Berkshire Hathaway. I people better navigate theirs. is Ben Graham. He provided
didn’t think anyone would find the bedrock that Warren
it. It eventually grew into a G&D: It seems pretty clear Buffett built his brain on, but if
community of people that you have a profound you really think about it,
interested in continuous admiration for investors. Buffett was and is a much
learning, applying different Farnam Street is the street better investor. And lastly,
models to certain problems, Berkshire Hathaway is located regarding Munger, in my
and developing ways to on, and you discuss Charlie opinion his method of
improve our minds in a Munger's views quite a bit. organizing practical psychology
practical way. The strong What appeals to you about is a lot better than the actual
reception surprised me at first, investing? residents of that discipline,
but now the community has even the people who “taught”
become very large, stimulating, SP: For Munger and Buffett him the ideas through books.
and encouraging. I should point specifically, it's not necessarily
out that I don’t come up with that they're just investors, it is Returning to investing, the
anything original myself—I’m that they've modeled a path of field resonates with me
just trying to master the best life that resonates with me. I because investors have skin in
of what other people like also appreciate the values that the game. Investors have clear
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Shane Parrish
accountability and measurable about learning from books, as SP: I fell into a trap with
performance. That contrasts opposed to simply reading reading. It almost became a
with many other types them. Seems simple, but most personal challenge that you can
organizations. For the most of us never really pick it up. easily get wrapped up in. In
part, investors are searching 2014, I was basically reading a
for the truth and constantly Today we are bombarded book every few days. I think I
looking for ways they could be constantly with information, ended the year with over 140
wrong and that they could be and we often read all types of books read, but I must have
fooling themselves. There’s a material in the same way. But started at least 300. I realized I
pretty clear scoreboard. that’s pretty ineffective. We was reading just to finish the
don’t have to read everything book. That meant I wasn’t
G&D: Are you an investor the same way. Adapting your getting as much out of it as I
yourself? reading style to consider the should. I ended up wasting a
type of material you are lot of time using that approach
SP: Yes. I used to be involved reading and why you are and it also impacted what I
with a small registered reading it makes you much read. You have these subtle
investment advisor based in more effective at skimming, pressures to read smaller
Massachusetts. I still invest understanding, synthesizing, books and to digest things in a
personally and hope to return and connecting ideas. If you really quick way. I wasn’t
more of my focus to investing take the same approach to spending enough time
in the future. Right now I’m reading everything, you will synthesizing material with what
focused on Farnam Street, end up tired and frustrated. I already knew and honing my
which I see as the biggest understanding of an idea.
opportunity ahead of me and
the opportunity that I'm most It's not about how many books
excited about. There’s a lot to “Adapting your reading you read but what you get out
do. of the books you read. One
style to consider the great book, read thoroughly
G&D: Can you talk about and understood deeply, can
what you have planned for
type of material you have a more profound impact
Farnam Street? are reading and why on your life than reading 300
books without really
SP: I just hired somebody to you are reading it understanding the ideas in
help out at Farnam Street for depth and having them
the first time. His name is Jeff makes you much more available for practical problem
Annello. He’s amazing. solving.
It's become more of a effective at skimming,
sustainable business. We are G&D: Can you discuss some
developing products. We have
understanding, of your techniques for
two courses coming out next synthesizing, and absorbing and synthesizing as
year that we're incredibly much information as possible?
excited about. I think we have connecting ideas.”
put over a year's effort into SP: There is a lot that can be
one of the products, and we're done after simply finishing a
just starting the other one chapter. I like to summarize
right now which will be the chapter in my own words.
released next fall. G&D: Reading is something I also like to apply any
you seem to know quite a lot learnings from the chapter to
We are launching "How to about, but in a recent post, my life, either by looking
Read a Book" early in the year. you discussed that you are backward to see where
That course is aimed at purposefully reading fewer concepts may have applied, or
adapting Mortimer Adler's books. What is your thinking by looking forward to see if it
theory of reading to the around that decision? might make sense to
modern age, and giving people incorporate something into my
a structured way of going daily routine. I think the reason
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Shane Parrish
to do that is twofold. One is to background knowledge. When think you do. It doesn't mean
give me a better understanding you're learning something new, you don't understand it, but
of that learning, and two is it's all about going back and the inability to articulate it is
really a check and balance, and making sure you understand it. definitely a flag that it's
a feedback loop. Have you Can you explain it in simple, something you need to circle
ever watched TV and jargon free, language? Can you back to, or pay more attention
somebody comes in on a explain it in a way that is to.
commercial and says, “What complete and demonstrates
are you watching,” and you're understanding? Can you take G&D: It seems like feedback
like, “I have no idea,” but an idea and apply it to a mechanisms are a key part of
you've been sitting there 20 problem outside of the original your approach.
minutes? Well, we can do that domain? Take out a piece of
with books, too. You'll start paper and find out. SP: I think at the heart of it,
reading, and paragraphs will fly you want to be an active
by, and then you'll have no idea reader. You want to selectively
what you were reading. It's fine “The Feynman be an active reader, and not a
if you're reading for passive reader. These types of
entertainment, you might be technique is essentially activities make sure that you're
able to catch up later, but if reading actively. Writing notes
you're reading for explaining a concept in a book, for example, is really
understanding, that's or idea to yourself, on just a way to pound what
something you want to avoid. you’re reading into your brain.
a piece of paper, as if You need engagement.
Part of what I want to do is
develop a feedback process to you were teaching it to G&D: In a recent post, you
make sure that I'm not doing brought up Peter Thiel's
that. someone else with concept of a “secret”.
Essentially, what important
I try to make extensive use of little background truth do very few people agree
book covers for notes about knowledge. When with you on? I'd be really
areas to revisit, potential curious if you have something
connections to other concepts, you're learning in mind that would fit this
and outlining the structure of concept.
the author's argument. After something new, it's all
I've finished a book, I usually SP: Ever since I came across
put it on my desk for a week about going back and this question I’ve been toying
or two, let it sit, and then I with it over and over in my
come back to it. I reread all of making sure you head. I’m not sure I have a
my margin notes, my understand it.” decent answer, but I’ll offer
underlines, and highlights. Then one of the things that I run
I apply a different level of into a lot but couldn’t really
filtering to it and make a I think that being able to do describe until Peter Kaufman
decision about what I want to this at the end of a book is pointed me to a quote by Andy
do with the information now. really important, especially if Benoit, who wrote a piece in
it's a new subject for you. The Sports Illustrated a while back.
G&D: You also talk about the process of doing that shows Benoit said “Most geniuses—
Feynman technique in some of you where your gaps are; this especially those who lead
your posts. is important feedback. If you others—prosper not by
have a gap in your deconstructing intricate
SP: Yes, the Feynman understanding, you can circle complexities but by exploiting
technique is essentially back to the book to better unrecognized simplicities.” I
explaining a concept or idea to understand that point. If you think he nailed it. This explains
yourself, on a piece of paper, can't explain it to somebody Berkshire Hathaway, the New
as if you were teaching it to else, then you probably don't England Patriots, Costco,
someone else with little understand it as well as you Glenair, and a host of amazing
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Shane Parrish
organizations. I’ve long had a SP: If you were a carpenter Multidisciplinary thinking also
feeling about this but couldn’t you wouldn’t want to show up helps with cognitive diversity.
really pull it out of my for a job with an empty In our annual workshop on
subconscious into my toolbox or only a hammer. decision making, Re:Think
conscious mind before. Benoit No, you’d want to have as Decision Making, we talk about
gave me the words. I think we many different tools at your the importance of looking at a
Student volunteers enjoy generally believe that things disposal as possible. problem in multiple dimensions
themselves at the Graham & need to be complicated but in to better understand reality
Dodd Breakfast essence there is great value Furthermore, you’d want to and identify the variables that
into getting the simple things know how to use them. You will govern the situation—
right and then sticking with can’t build a house with only a whether its incentives,
them, and that takes discipline. hammer. And there is no point adaptation, or proximity
As military folks know, great in having a saw in your toolbox effects. But the only way
discipline can beat great if you don’t know how to use you’re going to get to this level
brainpower. it. In this sense we’re all of understanding is to hold up
carpenters. Only, our tools are the problem and look at it
I know of many companies that the big ideas from multiple through the lens of multiple
invest millions of dollars into academic disciplines. If we have disciplines. These models
complicated leadership a lot of mental tools and the represent how the world really
development programs, but knowledge of how to wield works. Why wouldn’t you use
they fail to treat their people them properly, we can start to them?
right so the return on this think rationally about the
investment isn’t even positive world. One important thing, for
it’s negative, because it fosters example, we can learn from
cynicism. Or consider These tools allow us to make ecology, is second order
companies that focus on better initial decisions, help us thinking—“and then what?” I
complicated incentive plans— better scramble out of bad think that a lot of people
they never work. It’s very situations, and think critically forget that there's a next phase
simple. If you relentlessly focus about what other people are to your thinking, and there's a
on the basics and develop a telling us. You can’t over- second and third order effect.
good corporate culture—like estimate the value of making I’ve been in a lot of meetings
the one Ken Iverson mentions good initial decisions. Nothing where decisions are made and
in his book Plain Talk—you sucks up your time like poor very few people think to the
surpass people who focus on decisions and yet, perversely, second level. They get an idea
the complex. Where I might we often reward people for that sounds good and they
disagree with Benoit a little is solving the very problems they simply stop thinking. The brain
that I don’t think these are should have avoided in the first shuts down. For example, we
unrecognized as much as place. It’s a little weird, but in change classification systems or
under-appreciated. People some organizations you’re incentive systems in a way that
think the catechism has to be better off screwing up and addresses the available
more complicated. fixing it then making a simple, problems, but we rarely
correct, decision the first time. anticipate the new problems
G&D: You discuss the power Think about portfolio that will arise. It’s not easy.
of multidisciplinary learning. managers trumpeting how This is hard work.
Do you have any example they’ve “smartly sold” a stock
where the multidisciplinary at a loss of 20%, saving them a Another example is when a
learning has been especially loss of 50%, but which a wiser salesman comes into a
powerful for you? Munger has person never would have company and offers you some
a number of examples of him purchased in the first place. software program he claims is
arriving at a solution faster The sale looks smart, but the going to lower your operating
than an expert in a field as a easier decision would have costs and increase your profits.
virtue of Munger using been avoiding misery from the He’s got all these charts on
concepts from other fields. get-go. That kind of thing how much more competitive
happens all over the place. you’ll be and how it will
improve everything. You think
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Shane Parrish
this is great. You’re sold. Well functioned horribly? You’d investment organizations
the second order thinking is to make it so complicated that pursue investment excellence?
ask, how much of those cost few people understood it.
savings are going to go to you You’d make everyone SP: I think it’s important to
and how much will be passed measured on individual and not focus on getting better at
on to the customer? Well to a team success. You’d have making decisions over time. It
large extent that depends on different variables and clauses is about making the process
the business you’re in. and sub-clauses. No one would slightly better than it was last
However, you can be damn understand how their work time. These improvements
sure the salesmen is now impacts someone else. To compound like money. You
knocking on your competitors’ make it even worse, you’d really have to flip it on its head.
door and telling them you just offer infrequent and small What’s likely to not work well?
bought their product. rewards. You’d offer a yearly
We know thanks to people bonus of maybe 5% of salary or Generally speaking, analysts
like Garrett Hardin, Howard something. And of course, tend to have a focused view of
Marks, and disciplines like you’d allow the people in it to the world and they stay in
Ecology that there are second game the system and the their lane. Specialization
and third order effects. This is people running it to turn it certainly helps develop specific
how the world really works. into politics. I think we can all knowledge, but it also makes it
agree those are not desired hard to learn from the guy or
Munger’s got a brain that I outcomes and yet that is how girl next to you who has
don’t have. I have to deal with many incentive systems work. knowledge in a different
what I’ve got. I’m not trying to industry, so you're not
come up with the fastest improving your intuition as
solution to a problem. It’s “If you think you’re much as you’d probably want.
great to have a 30 second It’s like chess. People once
mind, but it’s not a race. Part going to come up with thought great chess players
of the issue I see over and were great thinkers, but
over again is not that people
good solutions to they’re not any better at
don’t have the cognitive tools, complicated problems general problem-solving than
but rather they don’t have the rest of us. They’re just
time to actually think about a in 30 seconds and your great chess players. Investment
problem in a three dimensional analysis is often the same way,
way. If you think you’re going name is not Charlie especially if you’re siloed in
to come up with good some industry analyst position.
solutions to complicated Munger, I wish you It’s probably not making you a
problems in 30 seconds and great thinker, but you are
your name is not Charlie
luck. The rest of us learning more about your
Munger, I wish you luck. The should learn to say ‘I industry.
rest of us should learn to say “I
don’t know” or “Let me think don’t know’ or ‘Let me In order to have the
about it” about ten times more organization learn and get
frequently than we do. think about it’ about better, we need to expose our
decision making process to
G&D: It makes sense that ten times more others. One way to do this is
second-order and third-order to highlight the variables we
frequently than we
effects are underappreciated. think are relevant. Start making
do.” clear why we made our
SP: I think a lot of people get decisions and the range of
incentives wrong and it has outcomes we thought were
disastrous implications on G&D: Do you have any possible. It needs to be done in
corporate culture. Let’s look at thoughts on particularly advance. A lot of people do
it from another angle – how powerful concepts or process this through a decision journal.
would you intentionally design implementations that can help Some accomplish this through
an incentive system that a discussion that flushes out
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Shane Parrish
which variables you think will How do they do that? Well, up-to-date with all the latest
dominate the outcome and part of the reason is that neurosurgery papers, academic
most importantly, why. Not Buffett and Munger are articles, books, and talks
only does that facilitate an continuously learning about because I'm very specialized in
environment where others can companies that do not change that one particular area and it's
challenge your thought rapidly. They're learning about relevant to my job and relevant
process, but over time it companies that change slowly. to my livelihood.
enables them to get a good That in and of itself is a major
feel for what you think are the advantage. They also are If you look at investing
key variables in that particular operating in industries in which holistically you can't do that
industry. That helps me expand they know the key variables of for every company in every
my circle of competence. You determining an organization’s industry. In my understanding,
don’t want an organization success or failure, and more part of the reasons Buffett and
where the automobile analyst importantly, ignoring the Munger have accumulated so
knows nothing about banking industries where they don’t. much knowledge is that they
and the chemicals guy knows It’s a huge step to be able say focus on learning things that
little about consumer to yourself “Look, I’m going to change slowly. That makes it
products, and then a portfolio miss some enormous winners easier to identify potential
manager with a little surface that were incredibly hard to outcomes and determine the
knowledge of everything is see ahead of time. I’m OK with relevant variables.
pulling the trigger. I have never that.” Buffett and Munger can
seen that work, but I’ve seen a do it, but most struggle. So David Foster Wallace had this
lot of people try. The they stretch and invest in great quote, “Bees have to
“everyone’s a generalist” things where they really cannot move fast to stay very still.”
approach has its own accurately predict the odds of And that’s what most of us do.
limitations, like a crippling lack success or failure, all forces We move a lot to stay in the
of specialized knowledge. considered. Probabilities being same place. Buffett and Munger
what they are, if you are getting further ahead each
So, obviously, any investment consistently invest in things day.
organization has to find a with middling odds, you’ll have
middle ground. How could it middling results. Again, how Unless physics changes, for
be otherwise? You must start could it be otherwise? The key example, it’s unlikely that we’ll
with this basic and obvious is knowing the difference see the development of more
truth to solve the problem. between an obviously efficient way to move bulk
attractive situation and a freight. It doesn’t seem subject
Another challenge in the difficult-to-predict one and to technological disruption, but
investment world is dealing being able to act on the former instead will likely be aided by
with the sheer volume of the and sit on the latter. Of technology. Technology helps
information. I get questions course, I’m over-simplifying a improve the management of
from portfolio managers all the bit, but you can’t get around your rail network, but it’s not
time about how best to keep the fact that reality is reality. going to replace the entire
up with the information flow. You have to find a way. And network anytime soon.
They say “I get 500 emails a this will help you solve your I think that Berkshire is
day. I have researchers’ work information flow problem, actually moving away from
come to me at all hours. I have because you’ll be tossing a lot uncertainty by pursuing
thousands of pages of material of ideas out very quickly. companies like this. If you
to read.” don't know the range of
G&D: It seems like you would outcomes, you will have a hard
Clearly Berkshire Hathaway prefer the Buffett and Munger time assessing probabilities.
has done a really good job with model over the approach of One of the things that decision
this, with basically two guys the average hedge fund with journals help identify is
doing all of the information specialists? outcomes outside of what we
processing—two really smart expected. That's a very
guys, but only two. SP: If my job is being a humbling experience. After
neurosurgeon, I need to keep identifying possible outcomes
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Shane Parrish
and applying confidence levels, importance of a management Also, some of these innovation
its humbling to get it so wrong. team versus the underlying projects get done for the
business. wrong reasons, and with the
G&D: You have also studied wrong incentives. If my boss
an investment firm that's It makes sense that they would asks me for ideas to help the
probably as different from have different approaches. I company innovate and I give
Berkshire Hathaway as think it's important to him an idea that sounds good,
possible with your most recent understand that there are one that subconsciously
podcast with Chris Dixon of things that we want to have in reminds him of an article he
Andreessen Horowitz. What our mental tool box. But part read in Fortune about
are your thoughts on good of being an effective craftsman innovation, isn’t that basically
decision making as applied in is knowing when they work good enough for me as an
the venture capital world and and when they don’t. You can’t employee? Does it even matter
how is it different than just pull our random tools and if it works? In most
Berkshire Hathaway? expect them to work. organizations, am I really going
to be held responsible for the
SP: Chris was an excellent In 2013, I did some consulting success or failure of my
guest to have on The work on improving innovation innovation prescription? The
Knowledge Project. He in organizations and the most organization might suffer, but
operates in Venture Capital—a common thing that people will I suffer personally?
world I don’t get much were doing at the time to Probably not. My lack of ability
exposure to. He has insight on solve the innovation problem to think the problem through
things I know very little about: was copying Google’s 20% of will probably be forgotten in
venture funding, how to time spent on independent time if the idea sounded good
structure a venture capital firm innovative ideas. and relevant at the time. If it
so that you are adding value, was defensible via Powerpoint.
etc. And they’ve been very I found this interesting for a This is one reason hiring
successful. number of reasons. It consultants rarely works as
surprised me that every well as hoped.
I think we're largely operating executive had it on the tip of
in unprecedented territory their tongue, but there's no So, we copy Google's twenty
given the magnitude of private large sample size for a percent innovation time.
valuations. In past decades, successful innovation like this They’re an innovative
companies IPO’d at much 20% idea. Google and, I think, company; they're hip; they're
lower valuations so public 3M are the two most cool; we’re going to copy
market investors could more prominent examples. Google, them. Okay, well, we can do
easily participate in their at the time, I think they had that. It’s a good story.
success. I don't know how this only been around for15 years. What gets lost is a potentially
plays out, but talking to Chris That’s a pretty small sample useful discussion like, “Maybe
was fascinating. size for continuous innovation. we should remove the things
Also, you need to understand in our environment that take
Andreessen Horowitz has a how that fits with the company away from natural innovation,
very different operational culture, and why it works even like all these meetings.” That’s
approach as compared to if you're seeing it work. Why a much tougher conversation,
Berkshire Hathaway. As I does it work at Google? Is it but just like taking away sugar
understood it, they are trying because of how it fits in the works better than adding
to add value to the overall culture? The problem I broccoli to your diet, taking
entrepreneurs. Also, they’ve see is that people are taking things out of the corporate
moved away from a business one piece of a large puzzle and culture is often a better
or idea based sourcing process thinking that it’s going to solve solution than adding new stuff.
to one that is almost their problem. It might help. It Munger has us paying attention
exclusively focused on the might not. It’s just a tool. It to incentives because they
entrepreneur. That directly reminds me of the group of really are driving the train. You
contradicts some of Buffett’s blind people touching the have to get it right.
thoughts on the relative different parts of the elephant.
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Shane Parrish
G&D: One big theme for you wonder with you into life and G&D: With regard to Mental
is the concept of life-long try to understand why things Models, you spend a lot of
learning. What is your are happening and why success time discussing their
motivation to pursue it? or failure happens. importance, but you also
Munger has called it a moral highlight their shortcomings.
duty. Do you have similar Avoiding stupidity is better Can you discuss your view of
feelings? than seeking brilliance. But that the value of mental models?
by itself is suboptimal. You also
SP: I wish I were as eloquent want to copy models of SP: It's important to
as him. I've always had to work success. We don't necessarily understand how we are likely
harder. You just have to keep have to come up with all of to fool ourselves. Aside from
getting better everyday. You this stuff ourselves. We can the psychological factors,
have to keep learning. If you're see a better model and adopt which Munger and Bevelin talk
going to accomplish what you it or, the parts of it that will about extensively, there are
want to accomplish, it's help us along. Giving up on other ways.
probably not through going holding on to our own ideas is
home and watching Netflix really important. For example, we run
every night, right? You have to organizations based on
learn how the world works. dashboards and metrics and
We have a huge statistical “Avoiding stupidity is we make decisions based on
sample size of things aren't better than seeking these numbers. Investors look
changing. There is an excellent at financial reports to make
letter by Chris Begg at East brilliance. But that by investment decisions.
Coast Asset Management that
discusses Peter Kaufman’s itself is suboptimal. We think that those numbers
thoughts on this. Physics, math, tell a story and, to some
and biology are things that You also want to copy extent, they do. However,
change very, very slowly, if at they don’t tell the full story.
all. Learning things in those models of success. We They are limited. For example,
disciplines is good. It’s don't necessarily have a strike-out can be a good
practical, because that's how thing in baseball. Players who
the world works. Those are to come up with all of suck statistically in one system
things that don't change over can thrive as a part of another
time. this stuff ourselves. – the whole “Moneyball” idea
lives here, and the Patriots
I think that, for me, it's just We can see a better have been extremely successful
become "How can I pass with a wide variety of talent.
people that are smarter than model and adopt it, or In business, reported
me?" I think if I can get the parts of it that will depreciation can be widely off.
incrementally better every day, The accounting could be
compounding will kick in and help us along.” gamed. A tailwind could be
over a long enough time, I'm benefitting a business
going to achieve the things that temporarily, soon to dissipate.
I want in life. I don't come up with almost Many companies look their
anything that's original. I absolute best, on historical
What could be better than aggregate and synthesize other figures, just before the big
constantly learning new things people's thoughts and put it denouement.
and discovering that you're still into context for people. I think
curious? Most of us forget that those are things that I like There is a great quote by
what it's like to be six years to focus on, I have a passion George Box who said “All
old and asking "why?" all the for doing that. I'm doing it models are false but some are
time and trying to understand anyway because I get a lot of useful.” Practically speaking, we
why things operate the way value out of reading, learning, have to work with
they do. It’s hard to still do and exploring the world, and I reductions—like maps. A map
that, but you can still carry that share that with people. (Continued on page 38)
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Shane Parrish
with a scale of one foot to one G&D: Do you have any other an updated report of the major
foot wouldn’t be useful, would investors or companies outside drivers and then tell us what
it? Knowing that we’re of Berkshire Hathaway that happened. Leave out the fluff.
working with reductions of really have some profound You don’t need to write essays
reality, not reality itself, should thinking or you really love like Buffett. Just help us
give us pause. We recently reading their shareholder understand the business and
wrote a piece on Farnam letters or you've learned a lot what’s going on.
Street called “The Map is Not from? Anything like that that
the Territory,” which is a we can talk about? G&D: This has been great,
more in-depth exploration of Shane. Thanks so much for
the nuances behind this. SP: Berkshire has an incredibly your time.
unique model of writing to
Knowing how to dig in and shareholders, and frankly no
understand these maps and one else is as good. One that’s
their limitations is important. A slightly off the beaten path,
lot of models are core – they although it’s become a lot
don’t change very much. Social better known over the past
proof is real. Incentives do few years, is a Canadian
drive human behavior, financial company called Constellation
and otherwise. The margin of Software (CSU). The CEO
safety approach from there is truly doing God’s
engineering works across work as far as how he reports
many, many practical areas of to shareholders. Very clear
life. Those are the types of presentation of the financial
huge, important models you performance of the business,
want to focus on as a part of and a lucid and honest
becoming a generally wise discussion of what’s going on.
person. You need to learn
them and learn how to There are two key
synthesize with them. components to reporting to
From there, you layer in the shareholders well, as I see it.
models that are specific to One is presenting, in as clear a
your job or your area of way as possible, the results in
desired expertise. If you’re a the prior periods. Presented
bank investor, you’re going to consistently and honestly over
look to attain a deep fluency in time. The second is being
bank accounting that a extremely forthcoming about
neurosurgeon wouldn’t need. why these figures came out the
But both the analyst and the way they did; good or bad,
surgeon can understand and warts and all. When Blue Chip
use the margin of safety idea Stamps was still a reporting
practically and profitably. company, Munger would write
about See’s Candy. What did
G&D: Essentially, they can be his summary table show every
powerful if used correctly, but year? Pounds of candy sold,
we can also over apply them in stores open, total revenue,
some ways? total profits. The key variables.
Then he explained in clear
SP: They work sometimes and language why See’s was a good
not other times. You need to business and what had
be aware of limitations. The occurred in the most recent
point here is just to be period, and if possible, what he
cautious—the map is not the foresaw in general for the
terrain. It doesn’t tell the full following year. That’s what we
story. need more of: give investors
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Jon Salinas
Jonathan earned an MBA professors were passionate behavioral aspects of investing

from Columbia Business about special situation are really important for
School. While at investing, helpful, and thinking about investing on
Columbia, he completed thoughtful. They were really both sides, but they are
the Value Investing inspiring early mentors that particularly important on the
Program administered by motivated me to stay involved short side.
the Heilbrunn Center for in the program.
Graham & Dodd Investing. After business school I went to
He received a BA with a The seminal experiences I had work at Festina Lente for
Jon Salinas ’08 degree in Political Science were studying under Bruce David Berkowitz, who had run
from Rutgers College, Greenwald as well as a seminar Gotham Partners with Bill
where he graduated with at Blue Ridge Capital taught by Ackman. It was a very
high honors and was John Griffin and David concentrated long-only fund
elected to Phi Beta Kappa. Greenspan. In Bruce that had about six investments
Jonathan is currently an Greenwald’s classes, I learned in total. They focused on very
adjunct professor at the “economics of strategic high quality, durable businesses
Columbia Business School behavior” and how to truly with great management teams
where he teaches Applied analyze competitive dynamics and capital allocation
Security Analysis and has of a business. strategies. This experience
previously taught Distress taught me how to think about
Investing. concentration, and what does
“The seminal and doesn't work. It was also
Graham & Doddsville experiences I had 2008, so I got to see the
(G&D): Could you start off by financial markets collapse.
telling us about your were studying under Being in a concentrated long-
background? only fund during that period
Bruce Greenwald as was definitely a learning
Jon Salinas (JS): I started off experience in terms of how
in a rotational capital markets well as a seminar at you think about the impact of
program at UBS where I got a market de-leveraging.
broad-based background in Blue Ridge Capital
equity, credit, and derivatives, taught by John Griffin From there I went to work at
which has influenced the way I Ziff Brothers where I worked
invest in that it allows me to and David with Yen Liow. Yen’s a very
look for investments across thoughtful investor who is very
the capital structure. I also met Greenspan.” focused on framework-
a lot of people who had oriented investing. This
different approaches to involves thinking through
investing, both modern and old In the Blue Ridge seminar, it certain qualitative processes
-school, and learned the hard was the first time I was and pattern recognition
and soft skills of investing. exposed to a really associated with great
After UBS, I attended phenomenal process for investments, both long and
Columbia Business School and conducting primary research as short. I spent some of my time
was a part of the Value well as investing in a really there focusing on energy which
Investing Program. I met a differentiated way. We also was helpful to get a base
number of incredible learned about short selling as understanding of how all
influencers there including well as the behavioral aspects companies are impacted by
Professors Bruce Greenwald, of investing. I studied commodities. I realized it was
Joel Greenblatt, and the other philosophy, political science, an area where you had to be
adjuncts. David Rabinowitz and economics, and psychology in specialized so we avoid
Eddie Ramsden taught my college, so the behavioral investing in energy. As a
Applied Value Investing aspects of investing and generalist, I think it's important
section. They were markets dynamics have always to understand which areas
concentrated, special situation intrigued me. It was nice to see require some real expertise.
oriented investors. Both that overlay. I think the
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Jon Salinas
After spending some time at really how I tend to filter the been very upfront with our
Ziff Brothers, I joined Marble world. investors about concentration
Arch, which was a Tiger- and the by-product of
oriented fund seeded by Julian G&D: Can you walk us volatility, which I think helps
Robertson. The two founders through your decision to filter for an investor base
were from Tiger Management launch Plymouth Lane? comfortable with volatility,
and Hound Partners. I joined understanding that it is often a
Marble Arch in 2009 as a JS: I launched Plymouth Lane byproduct of differentiated,
generalist when it was a young in May 2013. I had always high absolute returns over
organization, about a year and wanted to try and express my time. It's very hard for an
a half into its life. It was a small style and my voice. I thought I investment manager to reduce
team, and we had a really great could have success investing in volatility and still get abnormal
run in the four years that I a concentrated manner, both returns. I'd say having those
spent there, and we were able long and short, focusing on types of conversations with
to grow the organization. They very high quality businesses investors have been very
were very opportunistic, that would compound for helpful.
investing both long and short, many years, and evaluating
with the ability to look at special situations that could We've also tried to spend a lot
distressed credit when it offer attractive risk-adjusted of time helping investors learn
offered more attractive risk- returns whether it was about us, our team, and our
adjusted returns. They were through distressed credit, spin- process. We think that type of
very dedicated to absolute offs, or some other subset of transparency has given our
returns on the short side. It special situation investing. I investors comfort along the
was where I was able to really was really driven to achieve way. We also try to align
expand my skillset as a short high returns on a standalone interest. For example, in
seller. basis, to try to build a high return for a multi-year
quality team, and to commitment, we earn our
The generalist approach is one qualitatively embrace certain incentive fee over a multi-year
that I gravitated toward things like volatility and period. If we're not generating
because I enjoy being able to concentration that most returns over the long term,
always look at new investors don't typically we're not getting paid, which I
opportunities. Now, I'd say embrace. think is a little bit different
most generalists end up than how most tend to
specializing in some way. For G&D: What have you done structure their business in the
me, I specialize to some degree for your capital structure to industry.
within TMT and consumer, but enable you to embrace
I’m also willing to look at volatility? We felt like we were building a
financials and industrials. I’m business for the partners. Our
willing to look at any business JS: One lesson I learned along structuring was very partner
in which I can truly break the way from investors was friendly. The underlying
down the business, assess the that if one is going to invest in thought I have is that duration
durability of the moat, and the a concentrated manner, you of capital is very helpful for
quality of the business. I’m also have to build the business investing and outperforming
open to evaluating special structure to allow for volatility. over time. We try to be
situations where it's easy to As a result, we primarily focus thoughtful in structuring our
analyze the assets and on partnering with very long- capital base as long duration as
liabilities. In some cases, there term oriented investors, those possible. It makes the job of
might be complexities that think about investing out generating returns easier if you
associated with the situation, over multiple year time have a longer time horizon to
which is leading to the horizons. The majority of our invest.
inefficiency. The ability to capital is under multi-year
break down the inefficiency commitments, which lets us G&D: One of your big
and understand it while also think about the long-term, and investments that allowed you
thinking through the margin of not necessarily focus on short to break into the industry was
safety and the intrinsic value is term volatility. We've also a credit investment, but not
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Jon Salinas
many long/short managers (GGP), one of the largest business and began to
spend that much time on regional mall REITs that understand that regional malls
credit. Why do you think existed at the time. It had been tend to be pretty high quality
credit is interesting and what funded using short term debt businesses. Regional malls own
are you seeing today? to reduce its overall interest some of the premier Class A
expense. That was a positive commercial real estate across
JS: When I was entering while the debt markets the United States. It's very
business school, I wanted to remained open but created a hard to construct a regional
understand the bankruptcy problem when debt markets mall. There are real “NIMBY”
process, which is a critical area seized after Lehman collapsed factors in that malls tend to be
of traditional value investing. and they could not rollover massive structures, so it's very
Some of the best investments their short maturity debt. difficult in a town or a city to
have tended to result from a GGP was in a strange limbo for add a new mall. Therefore, if
bankruptcy process. I also like a few months after it had you own a regional mall, you
that it creates a catalyst for defaulted on its debt but not have a bit of a regional
value realization, and there is a yet filed for bankruptcy. It was monopoly.
certain amount of complexity about a four or five month
involved. Because of my period where no one was G&D: In 2008, ecommerce
background in the social willing to foreclose or force a penetration was much lower
sciences, I had an interest in bankruptcy on the company. than it is today, right?
understanding the law in the
overlapping business JS: It was low and it was
implications. I started learning “[GGP] had three starting to increase slightly, but
under Harvey Miller at what was interesting was GGP
Columbia Law School. At CBS, companies that had had an incredibly diversified
I studied under Dan Krueger portfolio, so no tenant
’02 and worked at Schultze been combined in a accounted for more than 2% of
Asset Management, which is revenue. They were incredibly
run by another Columbia
REIT structure, with diversified with very high
alumnus. an incredibly complex occupancy rates, and remained
very stable after 2008, so you
I met Mark Kronfield, one of capital and corporate saw really no degradation in
my partners at Plymouth Lane, occupancy at all for the
while he was a Senior Analyst structure. It had over business. The operating
and I was an intern at Schultze performance never really
Asset Management. He taught 100 different deteriorated.
me a lot about distressed
investing. Distressed investing
properties, each with What was interesting was their
is a great way to invest in its own debt and complex corporate structure.
special situations, like complex GGP had acquired Rouse Co.
litigations. For example, some profitability. I think about a decade prior to the
of the energy investments we bankruptcy. Before that, Rouse
are invested in now are that complexity had acquired the Howard
situations where we are Hughes Corporation, which
thinking about how cash will created an was another commercial real
be distributed and the estate and mall operator. You
inefficiencies that may exist.
opportunity.” had three companies that had
been combined in a REIT
Distressed investing is also a structure, with an incredibly
way to invest in really high There was a lot of preparation complex capital and corporate
quality businesses during that was done ahead of time by structure. It had over 100
periods of financial distress. Weil, Gotshal & Manges, run different properties, each with
The investment I think you by Harvey Miller, who was its own debt and profitability. I
alluded to in your question is representing the debtor. I think that complexity created
General Growth Properties started doing an analysis of the an opportunity. The value-
Page 42
Jon Salinas
added research task was sitting purchased it. JS: Historically we entered
down and taking every media investments with an
property and trying to G&D: Was that a situation assumption that cord cutting
estimate what the profitability where you had an appetite for was exaggerated or not
of each property was and distressed credit but you necessarily evidenced. I'd say
thinking through its private hadn't spent a lot of time in that's still the case in that
market value. commercial real estate and as a aggregated cord cutting
generalist you were able to numbers are not accelerating
Using very conservative recognize the mental model as dramatically. That being said,
multiples on the profitability of a situation you'd seen before, we think cord cutting is a
each property and then and then figure out the reality that impacts the
subtracting the debt you could business model? economics of the business in
get a sense of the equity value. that it gives content providers
The sum of the positive equity JS: Exactly. I think that's a less leverage than they've had
in the properties was what perfect example how you historically.
GGP was worth. You had to attack this and how you think
overlay the corporate about value. The big Our favorite investment in the
structure in the appropriate inefficiency was everyone was media content space at the
way. Doing that analysis took a thinking about the moment is DHX Media
lot of work. It was very consolidated profitability and (DHXM). It's a really
tedious but it allowed me to slapping a cap rate on that to interesting investment
get comfortable under value the enterprise, and then opportunity. DHXM is a $700
conservative assumptions that I subtracting the debt to arrive million market cap in the U.S.
could walk away with a 50-60 at the equity. With that and about a billion in Canada.
cent recovery with the portion method, the selection of the It's Canadian and U.S. dual-
of the debt I was focused on. cap rate impacted how listed but primarily trades in
The exchangeable notes were recoveries flowed through the Canada. As a Canadian-listed
trading at 10-20 cents on the debt structure, which is the and domiciled entity it has a
dollar at the time, suggesting a wrong way to think about it structural advantage. Canada
3x to 5x return in conservative because in a bankruptcy you has significant dedicated media
scenarios. If things worked out tear apart the corporate funds and tax incentives for
reasonably well, it was very structure and you really build production and creation of
easy to envision a recovery to the value from the bottom up. content within its borders. It's
par, which would be 5x to10x You don’t think about very important culturally for
return, which is what consolidated profitability Canadians to remain leaders in
happened and happened very unless it's deemed that that's producing video content and
quickly. necessary. That was one risk it's a real niche they've carved
to try and evaluate because out. For players like DHX,
I felt even if you liquidated the this was different businesses these subsidies allow them to
company under very, very that had been pieced together. produce new content while
conservative cap rates in the I felt like it was highly unlikely taking less risk than they would
low teens, you could walk they would do that unless it outside of Canada. Often they
away with a multi-bagger was to the benefit of the entire can have 75-100% of content
outcome. I was using low teen entity, which likely implied a cost covered from government
cap rates even though pretty robust recovery. funding or some private
historically they had never dedicated media funds, which
gone that high. What G&D: You've had a long bias allows DHX to put less capital
ultimately happened was towards media and content at risk when starting a project.
shortly into the bankruptcy over the years. Are there any
process, liquidity began to businesses that are ownable in They've also been very smart
improve for commercial real your mind given the hard-to- in that they've focused on
estate. Then Simon and answer questions around cord doing only one thing and trying
Brookfield got into a bidding cutting and changes in the to do that one thing very well,
war for the asset, and industry landscape? and that’s producing content
Brookfield ultimately for children. If you study the
Page 43
Jon Salinas
world and the way things are Also, interestingly, they the revenue. They own their
changing, as we move from pursued vertical integration in own production studio in
linear television to an over-the Canada. They cheaply Canada so they produce all
-top format for video purchased the Family Channel their own events and they also
distribution, kids’ content is which is the number one kids do third party production
very much subjected to and family-oriented linear which helps them utilize their
disruption because kids prefer television channel in Canada. capacity better.
on demand viewing. Children Historically it had been the
like repetitive viewing, and Disney channel in Canada. G&D: It sounds like you like
they don't really care about They actually let the contract the business units. What
the freshness of content so with Disney expire and they makes it especially interesting
you could potentially pushed their own library to you today?
repurpose older content. This content while also licensing
would be very disruptive for content from Hit JS: John Malone has been very
legacy players with scale Entertainment, which is owned vocal about the importance of
economics like Nickelodeon, by Mattel and DreamWorks. content to serve as a
Disney, and others. differentiating factor for
distributors on a go-forward
DHX has been a low cost basis. He’s demonstrated this
disrupter. They built up a very
“From my perspective, thesis with his movement to
cheap library of kids’ content. the DHX Media thesis invest in Lions Gate. From my
They figured out early on what perspective, the DHX Media
translated well in an over-the- is very similar to the thesis is very similar to the
top video environment. They Lions Gate thesis but may
can license this content to Lions Gate thesis, but represent a better way to
Netflix, Hulu, Amazon, and express the theme.
others very cheaply and may represent a better
generate attractive returns on With DHX, you avoid the
the library content that they
way to express the concentration and cliff risk of
acquired, which is very theme.” the Hunger Games franchise.
disruptive for other players. You have a clean business
Content in their library model focused only on kids’
includes Caillou, Yo Gabba!, content, which is incredibly
Teletubbies, and Degrassi. So essentially they rebuilt this important in an over-the-top
They have no real ties to the linear television channel in a world. Most of our diligence
traditional linear television cheap way, passed on some of suggests that 30% of SVOD
ecosystem. Most of the the cost savings to distributors viewing is kids’ content, if not
distribution is monetized over- to keep DHX in a really strong more. Any SVOD operator
the-top, positioning them really position, and they get an that I’ve talked to continually
well for how the industry additional benefit in that they highlights the importance of
landscape is changing. They're can monetize new content that kids’ content. I also think there
growing that business line they produce first via Canadian is greater optionality on a
organically at approximately 20 linear television before takeout. If you think about this
-30%. distributing it over-the-top in business, it is so small relative
other regions. to the value it can offer to a
They're also a very large player distributor, we think it is the
in Advertising Video On They also have a type of thing that can easily be
Demand (AVOD), which merchandising and licensing purchased at some point.
universally is primarily business. Merchandising and
YouTube. About 10% of their licensing is a great business. Lions Gate tends to trade at
distribution revenue actually They basically take the kids 2x the valuation multiple of
comes from YouTube which is content and partner with a toy DHX Media despite DHX
one of the larger distributor and toy having higher organic growth.
concentrations of any player manufacturer. When toys are We think high organic growth
that I know. sold, they receive a share of can persist as well. DHX just
Page 44
Jon Salinas
signed a deal with signs are very positive. It's G&D: You mentioned a
DreamWorks to co-produce taken about two-thirds share concentrated portfolio, and
130 new episodes of kids- of the 0-3 age demographic on this seems like a very
oriented animation over the CBeebies, which is BBC kids, compelling idea. How big
next five years. They’ve and it's taken about a one-third would something like this be?
partnered with all the main share of the 3-6 age
SVOD players globally without demographic. It's going to JS: Our larger positions tend
having too much revenue launch in Canada in January to be about 10-15% of capital.
concentration to any single and then in the US. This is one of our larger
SVOD player. positions so it is in that range.
At its peak in the late ’90s
On our numbers, it trades at Teletubbies had the largest G&D: Could you tell us about
10-12x earnings on a 12 month annual sales of all kids-oriented how you think about portfolio
forward basis and a high single merchandise. It sold almost $2 construction? Do you have
digit multiple of EBITDA. We billion in retail merchandise in exposure targets? How do you
tend to focus on EPS or cash the late ’90s in a single year, think about shorting?
EPS, so I think it's really not over a multi-year period. If
attractive to own this business you adjust that for today's JS: We try to do exactly that.
at a high single digit to low dollars and you assume even a Our net exposure tends to be
teens yield when it's growing fraction of that success, it will between 40-60% and that
organically 15-20% with a ton be very significant. DHX on a flows from the bottom up. We
of optionality on a takeout or standalone basis in Canadian cap our largest shorts at about
Teletubbies growth. dollars is a 100-120 million 3-4% of capital. We focus on a
CAD EBITDA company. It's few different buckets on the
It’s underfollowed as it is only very easy to envision a short side.
covered by Credit Suisse and a scenario where Teletubbies
few Canadian banks. I think it's can increase EBITDA by 25%- We look for really challenged
really interesting. 100%. businesses where there may be
really negative competitive
G&D: Can you describe the G&D: Do you have thoughts dynamics. Competition short is
option value on Teletubbies? on management? the typical name for that
framework. It's the classic
JS: DHX purchased JS: Michael Donovan and Steve Greenwald-style analysis
Teletubbies very cheaply and DeNure are the two founders. where the company may have
they've just relaunched it. They are chairman and COO, a first mover advantage that is
Teletubbies is preschool respectively, and they unsustainable and the research
content with no real spoken effectively run the company. process involves understanding
words, so it translates really They've both been involved in how new competitors are
well internationally. This is a kids’ content, and content going to attack the business,
benefit I learned about with production overall, for many undercut pricing, and capture
Discovery. When content can years. They basically were in a market share. Reduced
be easily re-dubbed and strong position a few years ago profitability is a key focus area
distributed globally, you can to slowly build the company, for us. Also, we focus on
earn really high returns on and build the company for frauds, fads, or businesses that
content investment. today's environment, so they we think are overearning and
Teletubbies is even distributed have no legacy economics unsustainable. Separately we
in China, which is pretty big they’ve needed to sustain. look for credit bubbles—for
because China is pretty businesses that have
restrictive in terms of Western DHX has been a pretty smart experienced some type of
content that they're willing to acquirer of content. They've enormous debt-driven growth
distribute domestically. In purchased library content where leverage will be reduced
November, DHX partnered typically at about 5x EBITDA or impaired in some ways. In
with the BBC to re-launch the and they've historically traded these situations, you can have
series. BBC was the original at a multiple that is twice as a real asymmetric downside in
producer and distributor. Early high, creating value. the equity.
Page 45
Jon Salinas
G&D: You mentioned earlier Martha Stewart can be thought Also, it was under the radar
that you also invest in of as a combination of a good with a sub $200 million market
derivatives. Can you share how business and a bad business. It cap, almost $50 million of cash
you think about using has a publishing business with and no debt at the time, which
derivatives? premier titles like Martha was also interesting. The
Stewart Living, which is one of licensing business did almost
JS: On the long side, options the preeminent female $40 million in EBITDA and
can be an interesting way to publications, and Martha most of that was offset by
use non-recourse leverage to Stewart Weddings. The publishing and corporate
protect capital at risk but publishing business is overhead. We felt if you could
augment returns. It's basically challenging because it is facing just move publishing to break
non-recourse leverage that macro headwinds. In addition even you could unlock $20-25
you can use. On the short side, to publishing, MSO owned a million in operating profit from
we focus on terminal shorts— licensing business which is the licensing business for a
businesses that we think could incredibly strong and highly business that had about $150
be worth zero. In the later profitable. I am attracted to million enterprise value at the
stages of a terminal short, licensing businesses because time.
volatility and squeeze risk they are high margin, capital
become quite high, so we may light, and tend to be strong Martha Stewart branded
use puts to protect our capital consumer businesses overall. products are the number one
at risk while still being able to selling item in Macy's for their
participate in the downside if Corporate overhead was high wedding registries, and Macy’s
there is a terminal outcome. because it was a founder- has the largest wedding
The last thing we use options owned company. Martha registry business in the US.
for is to hedge volatility or Stewart had gone through a Martha Stewart historically has
squeeze risk in some of our number of CEOs over a very been one of their top selling
later stage terminal shorts. In short period of time but failed products. MSO has a number
these positions, we may short to effectuate a turnaround. of other licensing deals: a deal
the equity and buy a small Then in late 2013, a for Martha Stewart Pet
amount of short duration call restructuring executive, Dan Products with PetSmart, a deal
options that protect us from Dienst, was brought in. He had with JC Penney, a deal with
upside risk. This lets us previously restructured a scrap Home Depot for Martha
augment positions at higher metal business. We thought Stewart Furniture, and there's
prices and use squeezes to our the fact that Martha Stewart now Martha Stewart Office
advantage. had brought in a scrap metal Products licensed with Staples.
restructuring advisor to run We thought there were
G&D: Any other ideas you'd her business was a really opportunities to expand
like to talk about, long or interesting development and licensing. Interestingly there
short? that she was serious about the are no food products, so
turnaround. there’s an opportunity to
JS: An interesting special develop Martha Stewart brand
situation right now is Martha Stewart owned 25% of food items. International was
Sequential Brands Group the business and a little more also a whole new opportunity
(SQBG). We came to SQBG than 50% of the voting control. as nothing was being done
through our special situation There was a founder share internationally.
investment in Martha Stewart class with super voting rights.
Living Omnimedia (MSO), as In our view we thought it was The first move to trim
SQBG recently closed on MSO really interesting because we corporate overhead and
a few weeks ago. MSO was a assumed she likely wanted to reduce losses in the publishing
classic special situation where turn around the business, business was successful. They
consolidated profitability did improve profitability, and cut a deal with Meredith
not appropriately reflect the ultimately sell the business. She Corporation where Meredith
true economic value. is in her early 70s so we effectively took over the
thought it was reasonable to publishing business and then
think about a sale as a catalyst. turned it into a revenue share
Page 46
Jon Salinas
agreement. This reduced most remain the chief creative G&D: Do you have any advice
of the losses associated with officer for the business. We for students looking to get into
publishing and started to think since Martha Stewart had the industry?
unlock the profitability of really no research coverage
licensing and merchandising. and no following, that it's very JS: I think it's a great industry,
Then what ultimately happened under the radar. People don't but a challenging industry, and I
was there was a bidding war realize how profitable that think you have to really enjoy
for the asset and SQBG won licensing business was, how the job of analyzing businesses
the bidding war and just closed powerful the international and thinking about what makes
the transactions a couple of opportunity can be, and all of a great business and a bad
weeks ago. that will unfold within SQGB. business. If you enjoy doing
that, then I think it will be a
SQGB is run by Bill Sweedler, really great career. My advice
who has been involved in would be to spend as much
licensing businesses for many
“I think [investment time as you can studying
years. Bill Sweedler originally management] is a different types of businesses,
sold Joe Boxer to Iconix and analyzing different ideas, and
has been involved in a bunch of great industry, but a doing different case studies.
other brands. At SQGB, they You should be trying to
own a portfolio of licenses: challenging industry, understand why certain longs
Avia; And 1; Ellen Tracy, which or shorts have worked well as
is pretty prominent female and I think you have well as understanding how
brand; Jessica Simpson’s great management teams have
business; and William Rast,
to really enjoy the job acted and created value over
which they bought from Justin of analyzing businesses time. Pay attention to
Timberlake. Greenwald’s teachings on what
and thinking about are the characteristics of a
They're one of the largest great businesses. Seek out as
distributors for Walmart. what makes a great many mentors as possible, try
What’s interesting to and learn as much as you can
understand is their athletics business and a bad from other investors and from
business in Walmart with Avia people who are willing to just
and And 1. Most street-
business.” spend some time chatting with
oriented shoe companies students. That's my advice.
won't sell in Walmart because On our math, it's very
they don't want to cannibalize conservative to estimate, on G&D: Great, and take your
pricing in other channels. This pro forma basis, that SQBG class, right?
puts Avia and And 1 in an could earn $0.80-$1 per share.
enviable position because they The stock trades under $8, so JS: Yes, definitely. Take my
have brand cachet but can sell you can buy SQBG at 8-10x class, and spend some time on
lower priced products that earnings with upside short selling.
they replicate from more optionality from a pretty
expensive sneaker providers durable licensing business. It G&D: This has been really
like NIKE, Reebok, and Adidas. has about 4x net leverage, but great. Thank you.
will de-lever quite quickly. It's
They can be a low cost Carlyle and Blackstone-backed
provider within Walmart. so they have real investor
Obviously, this gives them a backing. SQBG has a $500
huge base to sell and distribute million dollar market cap and
to. They'll partner with a $1 billion enterprise value, so
manufacturer and collect a they have little bit more
licensing fee. With the Martha research coverage, but it is still
Stewart acquisition, they will an underfollowed situation.
have a whole new homes and
lifestyle vertical. She's going to
Page 47
Dexcom, Inc. (NYSE: DXCM) - Short

2015 Darden at Virginia Investing Competition - First Prize
Marc Grow, CFA Benjamin Ostrow Evan Zehnal
MGrow17@gsb.columbia.edu BOstrow17@gsb.columbia.edu EZehnal17@gsb.columbia.edu
Executive Summary
 Wall Street darling with misunderstood competitive dynamics provides skewed 4.1x upside to downside ratio
Marc Grow ’17  Primary research supports thesis that perceived patient benefit is higher than actual
 Overestimation of total addressable market
Marc is a first-year MBA
student in Columbia Busi-
 Insiders have been selling the entire way up – last purchase was in Q1 2013 around $15 per share
ness School. Prior to CBS,  Short interest of 2.5% with 50bps cost of borrow
Marc worked as the CFO
of a family office after
spending two years as an
equity analyst at a value-
oriented hedge fund. He
holds a BA in Accounting
from Whitworth Universi-
ty.
Benjamin Ostrow ’17

Benjamin is a first-year
CBS, Ben worked as an Investment Thesis
Investment Analyst at Dexcom is a short today for three reasons. The market is underestimating the competitive dynamics within the industry
Stadium Capital Manage- along with overestimating the patient benefit associated with using the product. These aggressive assumptions have translat-
ment for four years. He ed into the perception that CGM devices will have widespread adoption among the entire diabetes population, which dra-
holds a BS in Commerce matically overvalues the TAM for this product. This combination has materialized into an extremely aggressive valuation.
from the University of Competition is moving towards an integrated device and longer life sensors, which means market share and pricing pressure
Virginia McIntire School of for pure-play CGM provider Dexcom.
Commerce.
Company Overview
Dexcom designs and develops
continuous glucose monitoring
systems for patients with diabetes.
Currently 29m people in the US
are affected by diabetes but CGMs
are primarily used for patients with
Type 1 or Juvenile Diabetes, which
only represents approximately 5%
of the diabetic population. CGM
systems are made up of three
Evan Zehnal ’17 components: sensors, transmitters,
Evan is a current first year and a display device. The sensor is
student at Columbia Busi- inserted into the skin and remits
ness School. Prior to CBS, glucose data back to the display
Evan worked within the device. Patients use this data along
opportunistic credit invest- with data from finger pricks in
ment team at Canada Pen- order to dose their insulin therapy.
sion Plan Investment Board This is a razor/razorblade model as
and in investment banking the hardware lasts for years but
at TD. Evan graduated the sensors have an FDA approved life of 7 days. Each sensor costs approximately $70. It’s important to note that the utili-
from McMaster University zation of sensors is actually much longer. Primary research suggests the average life of current sensors is actually double the
with a Bachelor of Com- FDA recommendation. The sensors get smarter the longer you wear them; patient feedback indicates the most accurate
merce. days were 5 through 14.
Page 48
Dexcom, Inc. (DXCM) - Short (Continued from previous page)

Market View Variant View
Type 2 diabetes market represents larger and Primary research suggests this is largely overdone. A very small percentage of T2 patients even
faster growing opportunity monitor their glucose levels like T1. There could be some initial benefit to monitoring in early
stage of T2 diagnosis but the revenue/customer profile would be a fraction of T1.
Historical market share gains translates into Given Medtronic’s market share in pumps and their salesforce size, an integrated device that
future market share success combines CGM & pump technology with a single insertion site is likely to become the industry
standard.
Revenue growth is the key value driver Q3 was the first quarter in three years where SG&A growth outpaced year-over-year revenue
growth, suggesting the cost to acquire new customers is accelerating and the low-hanging fruit
has been picked.
Valuation & Scenario Analysis

The model was constructed with a top-down approach. The total addressable market was developed and then market share assumptions were made along
with pricing in order to construct a revenue profile. The base case assumes: market adoption of CGM technology of 51%, DXCM achieves 50% of the mar-
ket, and revenue/customer remains flat at $2,500. High gross margins were sustained but industry operating margins of 25% were assumed as DXCM ma-
tures. A discount rate of 8% and terminal growth of 3% achieves a price target of $20.00.
Catalysts:
Innovation: There is a tremendous amount of innovation in the product pipeline with regards to therapy for patients with diabetes. Specifically, Med-
tronic’s integrated device that combines CGM technology along with pump therapy with a single insertion site along with companies like Senseonics that
have an implantable sensor with a 90-day life spell trouble for pure-play CGM player DXCM.
Revenue Miss: Management has kept their revenue targets consistently low but acceleration in SG&A spend suggests customer acquisition cost is acceler-
ating. Next generation sensors coming out in 2016 also extend sensor life by 3 days; fewer sensors = less revenue/customer. The market is clearly not
valuing this business on earnings or cash flow but rather market opportunity, so we see this as the key catalyst.
Risks:
DXCM realizes price increases over time: It’s more likely that Dexcom could maintain current prices on sensors but sensor life continues to improve;
further reducing annual spend per customer. Management commentary suggests pricing pressure over time, especially if they want to increase adoption.
Greater adoption of CGM technology: Base case assumes 51% adoption which is greater than current adoption of insulin pumps. Primary research sug-
gests meaningful price concessions would need to be made in order to achieve more significant adoption.
DXCM gets bought out: Likely player would be a larger pump company. But Medtronic has 65% market share in pumps. DXCM has been public since
2005 so there has been plenty of opportunity for a takeout. Major competitors are developing their own technology.
Page 49
Quest Diagnostics (NYSE: DGX) - Short

2015 CSIMA Stock Pitch Challenge (Columbia Business School) - First Prize
Nielsen Fields Joanna Vu Adam Xiao
NFields17@gsb.columbia.edu JVu17@gsb.columbia.edu PXiao17@gsb.columbia.edu
Recommendation
Quest Diagnostics represents an opportunity to Capitalization Other Metrics
short the independent diagnostic testing lab Current Share Price $67.42 Short Interest 5.16%
Nielsen
JoannaFields
Vu ’17’17 market which we believe is facing secular pres- Shares Outstanding 143.35 52-Week Low/High $60.07 / $89.00
Nielsen is a first-year MBA sure due to commoditization of service, unfavor- Market Cap $9,682
student at Columbia Busi- able regulation, and increased buyer bargaining EV/FY'15 EBITDA 8.8x
ness School. Prior to CBS, power resulting in persistent pricing and volume
pressure. Quest Diagnostics, in addition, has Less: Cash $123 EV/FY'16 EBITDA 8.5x
Nielsen was a Co-Portfolio Plus: Debt $3,731 Price/FY'15 Earnings 14.2x
Manager and Senior Ana- experienced cost inflation in it’s high labor-
intensive and fixed-cost structure, which the Enterprise Value $13,290 Price/FY'16 Earnings 13.3x
lyst at Summit Global Man-
agement, a long biased company has failed to fully offset through it’s “Invigorate Cost Savings Program”. Quest has been disguising the revenue and
hedge fund. cost pressures by making $1.5B of acquisitions, which have only served to offset the profit decline and should be considered
a form of maintenance capital expenditure. After adjusting free cash flow, we believe a truer picture of free cash flow is
significantly below consensus expectations and arrive at value using a DCF methodology of $35 per share, which represents
~50% downside from DGX’s current price.
Quest Diagnostics provides diagnostic testing services such as routine testing, esoteric testing, and drug testing through it’s
national infrastructure of approximately 2,200 patient testing centers, 3,000 courier vehicles and 20 aircrafts that collectively
make tens of thousands of stops daily. The company serves one in three adult Americans and about half of the physicians
and hospitals in the United States. Consensus view is that Quest operates in a duopoly structure with competitor LabCorp,
both of which have built moats of national scale in a highly fragmented industry that has seen steady consolidation of smaller
independent regional labs. However this duopoly represents just 25% of the total diagnostic testing industry if hospitals are
considered as part of the market.
Joanna Vu ’17
Joanna Vu is a first-year Investment Thesis
MBA student at Columbia 1) Pricing & Volume Pressure 2017E 2018E 2019E 2020E
Business School. Prior to Visiting hospitals and via conversations with hospital Maximum PAMA Cuts 10% 10% 10% 15%
CBS Joanna was an associ- staff, we found there was little differentiation independ- Out Estimated PAMA Cuts 5.0% 5.0% 5.0% 7.5%
ate at Colony American ent labs offered in routine testing. The only dimension
that labs truly compete on is price. Based on our re- DGX Resulting Rev Decline 0.71% 0.71% 0.71% 1.07%
Finance.
search, we foresee pricing, which has already been a significant headwind, as a greater issue in the future. As more baby
boomers enter retirement, Medicare's bargaining power as a customer increases. The Protecting Access to Medicare Act
(PAMA) takes effect in 2017 and will lower reimbursement of diagnostic tests by enforcing market-based pricing – potential-
ly leading to pricing cuts of up to 10% per annum – and potentially much more after 2019.
In addition to this, non-Medicare insurers who decide which lab vendors to

reimburse have been consolidating over recent years with 2015 being a banner
year as the big five providers will become the big three – covering nearly 60%
of the US population. We believe regional players covering the remaining popu-
lation will likely continue to merge to remain competitive under the Affordable
Care Act (ACA). As private insurers become larger, their bargaining power
with service providers increases which limits Quest’s ability to raise prices.
Adam Xiao ’17
Adam Xiao is a first-year Quest does recognize that price will continue be a headwind and in 2012
MBA student at Columbia launched a new strategy to grow esoteric test revenue which commands a
Business School. Prior to higher margin. Since that time however we have seen no evidence of growth in
CBS, Adam was an equity esoteric revenue. In fact, esoteric revenue decreased by 11% and increased by
research associate at just 1% in 2013 and 2014 respectively. In general we believe the strategy to
Dodge & Cox. grow esoteric revenue to be flawed as growth is driven by external factors out
of Quest’s control such as testing equipment capabilities and the physicians’
decisions to order these uncommon tests.
In addition to pricing pressures, Quest has been and will continue to face vol-
ume pressure. Just as ACA has decreased profitability for insurance providers,
physicians and hospitals are experiencing the same effect. Several physicians
explained to us that because of ACA they find it difficult to remain profitable
independently and are joining hospitals. In addition to hospitals gaining diagnos-
tic testing volume through the acquisition of private practices, hospitals are
merging thereby gaining regional scale and will have enough testing volume to
profitably insource testing rather than outsource to Quest.
In addition to losing volume to hospitals, Quest has lost testing volume to their biggest competitor, Labcorp. Although or-
ganic growth in revenue has declined for both companies, organic growth in volume has increased for LabCorp and declined
Page 50
Quest Diagnostics (DGX) - Short (Continued from previous page)

for Quest, which suggests that Quest has lost vol-
ume to LabCorp. Through personal interviews,
physicians indicated that they prefer sending tests to
LabCorp because pick up times are better, test
results are provided within 24 hours, and are easier
to view online.
2) Failed Cost Savings

Beyond Quest experiencing downward pressure on
revenue the company is also experiencing rising cost
pressure. In 2012 Quest initiated a cost savings program with a target of $1.3 billion in run rate savings by
2017 and claims to have hit $700M run-rate cost savings thus far. However upon closer inspection, we find
that after accounting for acquired costs, there is a cost gap of $343. The gap implies there is cost inflation
and that the savings program is simply a way to keep operations at steady state. This is a classic case of the
“Red Queen” syndrome as Quest has to run as fast as they can to stay where they are. To run faster, Quest
continues to acquire and invest in a troubled diagnostic industry, an industry that LabCorp is diversifying
away from with the $5.6b acquisition of Covance, a company which operates as a contract research organiza-
tion.
3) Overstated Free Cash Flow

Over the past 5 years Quest has spent over $1.5b in net acquisitions (including sales of nearly $800m), how-
ever both sales and NOPAT have changed very little over that timeframe. We believe acquisitions have been
used to fill the hole created by a declining core routine testing business. Capital IQ’s stated unlevered FCF
fails to exclude $250m in stock based compensation expense, which we consider a real expense, and over
$400m in restructuring and acquisition integration charges, items we also consider to be ongoing as Quest
will continually have to restructure operations to offset ongoing cost inflation and acquire new volumes
through lab acquisitions to offset price and volume
declines in its core business.
This is an important point regarding Quest’s need to

pursue acquisitions. Quest buys smaller regional labs
for the book of lab testing business, not the fixed assets.
The majority of the purchase price, some 85%, is
booked as either goodwill or intangible assets and
therefore rarely hits the income statement as D&A.
These maintenance acquisitions can be thought of as
customer acquisition costs incurred in order to main-
tain current levels of revenue and NOPAT. These costs are essentially capitalized on the balance sheet but never depreciated over time — we make the
correction of subtracting the acquisition costs from free cash flow. These acquisitions come with diminishing levels of potency which is evidenced by the
declining return on net operating assets over the period, falling from nearly 12% to ~8.5%, driven by a growing asset base yet a stagnant level of NOPAT.
Valuation Present Value of Cash Flows 2016E 2017E 2018E 2019E 2020E
We believe the appropriate methodology to value Quest is Unlevered Free Cash Flow $682 $722 $779 $681 $588
by discounting our adjusted free cash flows. Our base case
Discount Rate 8.25% 8.25% 8.25% 8.25% 8.25%
valuation of $35 assumes flat revenue over the ensuing five
year period driven by half the allowable PAMA cuts to Discount Factor 1.08 1.17 1.27 1.37 1.48
Medicare and Medicaid reimbursement rates. We do not PV of Future Unlevered Free Cash Flow $631 $617 $615 $497 $5,920
model pricing pressure from private health insurers despite
evidence that suggests otherwise. We believe we are being Enterprise Value
$8,281
conservative in these estimations. We estimate lost volume
similar to the prior five year period in which Quest faced Less: Net Debt ($3,170)
similar pricing pressure that was offset by acquisitions to Market Value $5,110 Terminal Growth Rate 1.00%
keep revenue flat over the period. We assume that similar Shares Outstanding 144 Enterprise WACC 8.25%
cost inflation of 1.4% experienced in the prior five years is
Intrinsic Value $36 Effective Terminal Multiple 13.79x
more than offset by savings from Quest’s Invigorate pro-
gram which peak in 2018. At a nearly a 14x unlevered FCF multiple, which incorporates
an 8.25% WACC and 1% terminal growth rate, and is in line with the average multiple Terminal Growth Rate
DGX traded at over the prior 5 year period, we arrive at a value of $35 per share. 31 0.00% 0.50% 1.00% 1.50% 2.00%
9.50% $24 $26 $28 $30 $32
Key Risks $27 $29 $31 $34 $37
Risks to our valuation & thesis are PAMA cuts being less significant than outlined driven 8.88%
by hospital inclusion into sample pricing. Quest follows LabCorp by diversifying away WACC 8.25% $31 $33 $36 $39 $42
from its declining core diagnostics business. Hospitals sell their lab business to Quest or 7.63% $35 $38 $41 $45 $49
LabCorp in order to focus on their core business of patient care. Quest is purchased by
7.00% $40 $43 $47 $52 $57
private equity, or less likely, a strategic purchaser. In fact it was rumored this summer
that Quest had received an offer, however nothing materialized.
Page 51
XPO Logistics (NYSE: XPO) - Long

2015 Alpha Challenge @ UNC Kenan-Flagler - Second Place
Justin Hong Zachary Rieger Cristóbal Silva
JHong17@gsb.columbia.edu ZRieger17@gsb.columbia.edu CSilva17@gsb.columbia.edu
Recommendation Key Trading Statistics
XPO is strong BUY with a target price of $48 per share (~115% upside). XPO has a
Sha re Pri ce (01/11/2016) $22.58
phenomenal CEO (Bradly Jacobs), a performance-driven culture, sticky relationship
with customers, growth opportunities (organic and inorganically), a cash generative 52W Hi gh $50.96
Justin Hong ’17
core business overlooked by the market and attractive valuations (10.9% and 15.7% 52W Low $21.33
Justin is a first-year MBA FCFE yield 2017 and 2018 respectively). Avg. 3-Mo Da i l y Vol ume ($MM) $29.92
student at Columbia Busi-
ness School. Prior to CBS, Short Interes t (% of DSO) 24.2%
Justin worked in the High XPO Logistics (“XPO” or “the Company”) is a top ten global provider of supply Sha res Out (MM) 132.91
Yield Bonds group at chain solutions. XPO enables customers to operate their supply chain more effi- Ma rket Ca p ($MM) $3,001
Oaktree Capital Manage- ciently and at lower cost. Net debt 2015E ($MM) $5,800
ment. This summer he will
Adj. Mi n. Interes t ($MM) $836
be interning at Carlson Bradley Jacobs consolidation the fragmented logistics market started in 2011, with
Capital. EV ($MM) $9,637
the purchase of Express-1, a express carrier that operated an asset-light model with
almost $200 million in revenue. Today, XPO has more than $15 billion of revenue Revenue 2016E ($MM) $15,758
and $1.1 billion of pro forma 2015E EBITDA. Its integrated network includes appro- Adj. EBITDA 2016E ($MM) $1,198
ximately 84,000 employees at 1,469 locations in 32 countries serving over 50,000 EV/EBITDA 2016 8.04x
customers.
XPO Logistics
Freight (27.0%) Transportation (36.5%) Contract Logistics (36.5%)

Asset-heavy (Acquired from Con-way) Asset-light (Freight brokerage) Non-Asset (New Breed, Norbert and Menlo)
(%) % Consolidated Revenue 2015E Pro forma
Zachary Rieger ’17
Investment Thesis
Zach is a first-year MBA 1) CEO with a phenomenal track record of consolidating industries, management team with substantial indus-
student at Columbia Busi- try experience, incredible alignment of incentives with shareholders, and significant insider ownership
ness School. Prior to CBS, Jacobs founded and led four highly successful companies, including two public corporations that he grew through successfully
Zach worked in private consolidating historically fragmented industries:
equity at PineBridge Invest- i.) United Rentals (1997 – 2007): Built world´s largest equipment rental company. United Rental stock outperformed S&P
ments after spending two 500 by 2.2x during his tenure.
years in BAML’s technology ii.) United Waste Systems (1992 – 1997): Created 5th largest solid waste business in North America. United Waste
investment banking group. stock outperformed S&P 500 by 5.6x from 1992 to 1997.
He holds a BA from the iii.) Hamilton Resources (1984 – 1988): Grew global oil trading company to $1 billion.
University of Pennsylvania. iv.) Amerex Oil Associates (1979 – 1983): Built one of the world´s largest oil brokerage firms.
Management compensation includes elements that are heavily weighted to variable compensation. The performance-based
equity grants to XPO NEOs are subject to the achievement of two performance goals:
i.) Stock price must trade at or above $60 for 20 consecutive trading days prior to April 2, 2018.
ii.) The company´s fiscal year 2017 adjusted cash earnings per share being at least $2.50.
Jacobs and the rest of the management team own 14.5% and 1.5% of XPO, respectively.
2) XPO is uniquely leveraged to powerful secular trends in the 3PL industry. XPO’s scalable technology plat-
form and management’s history of successful integration make it an ideal consolidator of an industry that is
highly fragmented
There are more than 12,000 3PL providers. Many are smaller local providers that mostly offer one unsophisticated service,
Cristóbal Silva ’17 truckload brokerage. Through 17 acquisitions, XPO is now a true one-stop 3PL shop. The company multimodal capabilities
help solve shippers’ increasingly complicated supply chain problems interacting with just one counterparty. This generates
Cristóbal is a first-year sticky relationships with customers as they share strategic data with XPO and XPO co-locates workers and assets at customer
MBA student at Columbia sites (retention over 90%).
CBS, Cristóbal worked in The infrastructure that XPO put in place in 2011, 2012, 2013, building the company like a tank in the back-office, is what sepa-
Bancard (family office of rates XPO from roll-ups that have failed. XPO overinvested in its technology platform upfront with the vision and capability of
Mr. Sebastián Piñera) co- taking on future acquisitions and quickly integrating them without disruptions. In fact, customer satisfaction has improved after
managing a $1B portfolio of acquisitions.
equities, fixed income
securities (High Yield and 3) Two transformative deals in the past six month have raised concerns in the investment community around
Distress) and derivatives Mr. Jacobs´ strategic view and XPO´s leverage. This triggered the sell-off, which we believe is a buy opportuni-
invested in Latin America. ty.
On April, 2015 XPO announced the acquisition of European Logistics Provider Norbert Dentressangle. The price paid
(including debt) was $3,530 million (EV/EBITDA pre-synergies of 9.1x). The market reaction was “Jacobs went too far too
Page 52
XPO Logistics (XPO) - Long (Continued from previous page)

quickly. It would be difficult to increase profitability”. In our opinion, the deal made economic and strategic sense. XPO became the leading transatlantic
logistic provider. Cross-selling opportunities raised immediately (XPO signed a contract with Zara to execute their e-fulfillment in North America within 22
days after closing). Within the first 6 month, XPO applied its proprietary technology platform, changed the compensation plan and shut-down unprofitable
business. Results speak for themselves, European transportation and logistics EBITDA increased by 26% and 17% respectively in the 3Q 2015.
Then, on September, XPO announced the acquisition of Con-way for $3 billion. When the acquisition was announced, the reaction of the street was: “This
acquisition does not make sense. This is a departure from asset-light strategy”. We believe the acquisition is a response to what is changing in the industry:
i.) Shippers are increasingly looking to 3PL not only to help them design supply chain solutions but also to execute.
ii.) Increased complexity in execution with the need for same-day and next-day delivery.
iii.) Tight LTL capacity due to regulatory constraints and to spill over demand from tight Parcel capacity.
Regarding cost savings, our primary research confirms Con-way was not run efficiently. As a matter of fact, Con-way consistently obtained EBITDA mar-
gin below its competitors (by 200-400bps) in the last three years. We estimate XPO will achieve $200 million on cost saving within the next 24 month
(management range is $170 - $210 million). Incorporating this, the effective multiple paid was 4.2x EBITDA which is below the 6x peers market multiple.
4) One-time costs associated with acquisitions mask a

profitable and attractive core business
In fact, organic revenue growth has stabilized at 10%. Post
integration, free cash flow conversion approaches to 70% and
return on invested capital (ROIC) to 16%.
XPO is now entering an “integration phase” in which organic

revenue growth will translate into free cash flow generation
and ROIC expansion. This wIll trigger a multiple re-rating and
serve as a catalyst for the stock price.
Valuation
Valuation Method Base Case No Margin Expansion Bear Case
Our $48 target price is based on the average of a DCF (WACC 10% and Exit DCF $52.44 $29.48 $23.70
multiple of 8.0x in 2022) and sum-of-the parts exercise (XPO´s EBITDA 2017 Sum-of-the-parts $45.32 $32.72 $23.92
for each business line @ listed peers´ EV to fwd EBITDA multiple). Price Target $48.88 $31.10 $23.81
Upside 116.5% 37.7% 5.4%
Our projections assume negative 5% and 0% revenue growth for Con-way in Multiples (@ Market Price $22.58)
2016 and 2017 respectively (economy is cooling down and new management EV to EBITDA 2016 8.04x 8.51x 8.51x
EV to EBITDA 2017 6.82x 7.95x 7.95x
would shut down unprofitable business). We also assume an one-time ex- EV to EBITDA 2018 5.67x 6.93x 6.93x
pense of $150 million in cash on 2016 related to Con-way integration.
Multiples (@ Price Target)
EV to EBITDA 2016 10.96x 9.51x 8.66x
The company´s low-base scenario is 200 bps EBITDA margin expansion over EV to EBITDA 2017 9.29x 8.89x 8.09x
the next three years. Although XPO has delivered on every financial target it EV to EBITDA 2018 7.73x 7.74x 7.04x
has set for itself, the market is not giving credit for this new target. 3PL Providers LTL Carriers TL Carriers
Peers EV to fwd EBITDA multiple 10.72x 5.85x 5.77x
Based on XPO’s core business quality and meaningful growth opportunities, Weighted Average Multiple* 9.78x
We believe XPO should trade at least in line with its peers (9.8x EV to fwd Note: EBITDA 2016 does not include one-time expense of $150 million related to the integration of
EBITDA). At market price, XPO trades at 10.9% and 15.7% FCFE yield 2017 Con-Way. However, this expense is considered in the valuation.
and 2018 respectively, which in our opinion is a compelling valuation for a *Weighted by segment EBITDA contribution to XPO´s total EBITDA
company with double digit EBITDA growth (19% CAGR 2016-2018).
Our bear case valuation (it assumes no margin expansion and 10% discount on peers multiple for the sum-of-the-parts valuation method and 10% discount
on exit multiple for DCF valuation method) is $23.85/share (~5.4% upside). This represents an attractive margin of safety in case the turnaround of Con-
way turns out more challenging than expected.
Key risk to thesis and mitigants

(-) XPO is running at 5.0x net debt to EBITDA 2015E and the Company just added cyclicality to its results with Con-way´s acquisition when the economic
outlook is deteriorating. Mitigant: Asset-light business accounts for 77% of free cash flow. Highly cash-generative business allows deleverage to 3.8x in two
years. Debt has no hard-covenants. In the case of a recession, margin in freight brokerage and contract logistics increases (evidenced in 2009) and capex at
the LTL business can be cut to almost zero (2009).
(-) A shortage in available drivers could limit XPO Freight´s to fully utilize the company´s fleet and pressure margins through wage increases. Mitigant: Real
driver´s problem is in the truckload business, not in LTL. TL driver turnover is 95% versus 12% in LTL. Annual driver compensation in the LTL industry is
$64,000 versus $50,000 in TL. In addition, Con-way´s LTL drivers turnover is 7.5%, way below industry average (12%).
(-) Startups aim to leverage drivers´ smartphones to quickly connect them with nearby companies looking to ship goods. If successful, it would disinterme-
diate third-party brokers (CH Robinson, XPO, ECHO Logistics, etc). Mitigant: XPO spent $115 million and $400 million in technology in 2014 and 2015E,
respectively. Our primary research confirms XPO´s superior IT capabilities. “Mario Harik, the CIO, is a terribly talented guy. He is literality a genius IQ” –
Former XPO employee. “We are likely to be the disrupter rather than the disrupted” – Bradley Jacobs
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Contact Us:
bdawson16@gsb.columbia.edu Graham & Doddsville Editors 2015-2016
sdebenedett16@gsb.columbia.edu
aphilipp16@gsb.columbia.edu Brendan Dawson ’16
Brendan is a second-year MBA student and member of the Heilbrunn Center’s
Value Investing Program. During the summer, Brendan was an investment analyst at
Thunderbird Partners, a London-based global long/short fund. Prior to Columbia, he was a
member of the investment team at the UVA Investment Management Company as well as
an investment analyst intern at Slate Path Capital. Brendan graduated from The University
of Virginia with a BS in Commerce. He can be reached at bdawson16@gsb.columbia.edu.
Scott DeBenedett ’16

Scott is a second-year MBA student and member of the Heilbrunn Center’s
Value Investing Program. During the summer, Scott was an investment analyst at Maverick
Capital, a New York-based long/short equity fund. Prior to Columbia Business School, he
worked at Lightyear Capital, Citigroup, and Morgan Stanley. Scott graduated from Prince-
ton University with a BA in Comparative Literature. He can be reached at
sdebenedett16@gsb.columbia.edu.
Anthony Philipp ’16

Anthony Philipp is a second-year MBA student and member of the Heilbrunn Center’s
Value Investing Program. During the summer, Anthony was an investment analyst at Blue
Ridge Capital in New York. Prior to business school, Anthony worked as a private equity
associate at Flexpoint Ford in Chicago, and before that as an investment banking analyst at
Centerview Partners in New York. Anthony graduated from the University of Illinois at
Urbana-Champaign with a BS in electrical engineering. He can be reached at
aphilipp16@gsb.columbia.edu.
Graham & Doddsville
Issue XXVII Spring 2016

Inside this issue:
CSIMA Confer-
ence & Pershing John Phelan of MSD Capital
Square Challenge P. 3
John Phelan P. 4 Mr. Phelan is Co-Managing Partner of MSD and Co-Founder of the
firm. Prior to forming MSD, he was a Principal from 1992 to 1997
Alex Magaro P. 14 at ESL Investments, a Greenwich, Connecticut based investment
firm. At ESL, Mr. Phelan was responsible for ESL’s Special
Adam Wyden ’10 P. 25 Situation Investments and helped grow the firm from $50 million
Marc Cohodes P. 33 to over $2.0 billion in assets under management. Prior to ESL, Mr.
Phelan was Vice President in charge of Acquisitions (Western
Pershing Square Region) for the Zell-Merrill Lynch Real Estate Opportunity Funds.
Challenge Ideas P. 44 John Phelan Mr. Phelan began his career at Goldman, Sachs & Co. where he
Editors:
Brendan Dawson Alex Magaro

Adam Wyden ’10
MBA 2016 of Meritage
Scott DeBenedett
of ADW Capital
Group
MBA 2016
Anthony Philipp Alex Magaro is a Adam Wyden founded
MBA 2016 Co-President of ADW Capital in January
Meritage Group, a Adam Wyden 2011 and acts as sole
Brandon Cheong Alex Magaro fundamentally- portfolio manager to
MBA 2017 oriented the Fund. The Fund is
Eric Laidlow, CFA investment firm, managing focused on maintaining a concentrated
approximately $10B primarily on portfolio of high-quality and high-
MBA 2017
Benjamin Ostrow
MBA 2017
Marc Cohodes formerly of Rocker

Partners/Copper River
Visit us at:
www.grahamanddodd.com Marc Cohodes is a formerRolf
General Partner of Rocker Partners/
Heitmeyer
www.csima.info Copper River from 1985-2009. He began his career at the
Northern Trust Company in 1982 after graduating Babson
College with a BS in Finance. He has been profiled in the books;
Reckless Endangerment, Selling America Short ,The Most
Dangerous Trade. He was the subject of a Harvard Business
Marc Cohodes
School Case study on his efforts to expose Mortgage Fraud at
Novastar. He resides in Cotati, California, where he runs Alder
Lane Farm.

Page 2

We are pleased to bring you the ment horizons across asset When we inherited Graham &
27th edition of Graham & classes and the return potential Doddsville as editors last year,
Doddsville. This student-led in- of businesses with durable we wanted to continue the
vestment publication of Colum- competitive advantages. tradition of providing our read-
bia Business School (CBS) is co- ership with high quality inter-
sponsored by the Heilbrunn Adam Wyden ’10 of ADW views and investment ideas.
Center for Graham & Dodd Capital discusses the influence We sought to provide diversity
Investing and the Columbia Stu- of an entrepreneurial spirit on of thought and experiences via
dent Investment Management his firm and investment pro- our interviews. We hope we
Association (CSIMA). cess. Adam walks through past have lived up to those objec-
ideas such as IDT and Imvescor tives.
Meredith Trivedi, the In this issue, we were fortunate Restaurant Group (IRG.TO) as
Heilbrunn Center Director. to speak with four investors well as current theses on Fer- We are honored and privileged
Meredith skillfully leads the who offer a range of perspec- rari (RACE) and Fiat (BIT:FCA). to have continued the Graham
Center, cultivating strong tives based on their unique paths & Doddsville legacy, and we
relationships with some of to and careers in investing. Mark Cohodes shares his look forward to reading the
the world’s most experi- experiences from a lifetime of next generation of issues,
enced value investors, and John Phelan of MSD Capital short-selling. He offers his per- helmed by three outstanding
creating numerous learning discusses lessons learned over spective on the discipline and individuals in Brandon Cheong
opportunities for students decades of investing with men- temperament required as well ’17, Eric Laidlow ’17, and Ben
interested in value invest- tors such as Richard Rainwater, as the intellectual rewards of a Ostrow ’17. We want to thank
ing. The classes sponsored Sam Zell, Eddie Lampert, and career in short-selling. Marc Brandon, Eric, and Ben for
by the Heilbrunn Center Michael Dell. John offers insights discusses ideas such as Home their commitment and dedica-
are among the most heavily into the development of MSD Capital Group (HCG) and tion to Graham & Doddsville
demanded and highly rated Capital as well as his own devel- Tempur Sealy (TPX). over the last year.
classes at Columbia Busi- opment as an investor and PM,
ness School. while shedding light on challeng- This issue also highlights pho- As always, we thank our
es he sees today in the invest- tos from the 19th annual interviewees for contributing
ment management industry. CSIMA Conference as well as their time and insights not only
the 9th annual Pershing Square to us, but also to the invest-
Alex Magaro of Meritage Challenge. ment community as a whole,
Group discusses his many expe- and we thank you for reading.
riences, from running a business Lastly, we are proud to include
as an owner-operator to invest- in this issue finalist pitches from - G&Dsville Editors
ing in early stage companies, current students at CBS who
which led him to co-manage competed in this year’s Per-
Meritage Group. Alex talks to shing Square Challenge.
G&D about long-term invest-
tioners.
Howard Marks from Oaktree, pictured Columbia Business School students help
here giving the keynote talk at the CSIMA at registration for the 19th Annual
Conference in January 2016 CSIMA Conference
Columbia Business School Events:

CSIMA Conference and Pershing Square Challenge
Keith Meister of Corvex Management LP delivers his Howard Marks of Oaktree with Bruce Greenwald after
keynote address at the 19th Annual CSIMA Conference their keynote interview at the 19th Annual CSIMA
Conference
1st Place Finalists Joanna Vu ’17, Melody Li ’17, and Thais Paul Hilal ’92 and Bill Ackman listen and judge student
Fernandes ’16 pitch Alimentation Couche-Tard at the 9th pitches at the 9th Annual Pershing Square Challenge
Annual Pershing Square Challenge
Judges deliberate at the 9th Annual Pershing Square Bill Ackman and the winning team at the 9th Annual
Challenge Pershing Square Challenge
Page 4
John Phelan
worked as an Analyst in encouraged me to go find good second years at business

the Investment Banking mentors. She said one of the school I worked for Richard
Division. things about good mentors is Rainwater, and that's where I
you can learn on someone met Eddie Lampert. Richard
Mr. Phelan received his else's nickel. It's something you introduced me to Eddie. Of
M.B.A. from Harvard don't realize when you’re those ten weeks that summer,
Business School and younger. But it struck me at a I spent about three or four
graduated cum laude with very early age to try to go find with Richard and the rest with
distinction and Phi Beta people that were the best in Eddie.
Kappa from Southern their particular businesses, and
Methodist University with I think my mother pushed me G&D: How did you connect
a B.A. in Economics and towards that. with Richard?
Political Science. Mr.
Phelan also holds a In my real first job, I worked JP: I had been hoping to get
John Phelan General Course degree with an uncle rehabbing back to Texas after business
with an emphasis in apartments in New York. I was school and I wrote Richard a
Economics and doing that during college. That letter. In that letter I told him I
International Relations was an eye-opening experience would be willing to work for
from the London School of that forced me to focus on free and one of my professors
Economics. cash flow every minute of the at Southern Methodist
day. It was a very tough University had suggested I
Graham & Doddsville business and I was doing a contact him. I told him I just
(G&D): To start off, talk number of different things. The wanted to learn from one of
about your background and work ranged from running the the best and was willing to
your path to investing, numbers to actually doing invest in myself.
including mentors and construction work. That
influences along the way. teaches you a lot. I also Richard called me on a Friday
learned I didn't want to break at like 4:00pm. He said “Hey
John Phelan (JP): My mother my back doing that for my John, this is Richard
was a very big influence on my entire career. Rainwater.” I thought it was
development as an investor. one of my classmates playing a
My father was a doctor and, I was fortunate enough to get a joke on me. I used a curse
like most doctors job with Goldman Sachs, which word I shouldn't have and just
unfortunately, not a very good was really the first big hung up the phone. A minute
investor. My mother, on the company I worked for. At the later the phone rang again: “I
other hand, came from a real time, Goldman was still a think we got disconnected.”
estate background and focused private partnership. I learned a I'm thinking, “Oh my God, this
very much on cash flow. My ton and I had a number of is Richard Rainwater. I cannot
parents gave me a Disney great mentors at Goldman believe I just hung up on this
stock certificate for a birthday Sachs. I worked with truly guy.” I said, “I'm really sorry,
present when I was five years exceptional people there. but my classmates have been
old. That got me hooked—I playing jokes on each other,
was fascinated by numbers and As great as my experience at and I thought you were one of
seeing something trade every Goldman was, it did make me them.” “Oh that's a pretty
day. That's what got me into realize that I did not want a good one,” he laughed—he
stocks. career in investment banking. was very good about it.
Instead of being the person
I initially went into real estate, who is on call 24/7 to serve my I flew down to Fort Worth on
where my mother taught me client I wanted to be the client. my own dime and met with
quite a bit, including two I preferred being a principal as Richard. He said, “Meet with
principles: make sure you can opposed to an advisor. I these different guys. You can
always pay your bills and debt decided to attend business work with me for a bit and see
service and the importance of school and was accepted into if one of them will take you as
free cash flow for levered Harvard Business School. The well.” I met with Eddie and a
assets like real estate. She also summer between my first and couple of other guys who were
Page 5
John Phelan
with Richard at the time. I investment fund and was one our firm without leverage and
didn't know a lot about risk of the few people who had have only been 100% invested
arbitrage, but I knew they capital. It was a good time to once in our 18 year history,
were analyzing stocks and that have capital. The RTC was the first quarter 2009. I
was something I really wanted formed after a number of actually consider cash to be an
to do. It was a tremendous S&L’s failed, there were a lot asset class.
learning experience. I really of distressed loans, the trading
enjoyed working with Richard market for loans was just About nine months into the
and Eddie that summer, and I starting to develop, and the job, Zell through his Zell-
fell in love with the risk illiquidity was incredible. Chilmark fund started taking a
arbitrage business. One of the Having capital at that time and hard look at Executive Life,
things you have to be good at being a liquidity provider to which had a large junk bond
in the risk arbitrage business is the banks was a unique and portfolio. I was asked to work
valuation: you need to be able good place to be. on credits that had large real
to understand your downside. estate components: RiteAid
(RAD), Carson Pirie Scott,
I graduated in 1990—not a “...my mother taught Charter Medical—any
very good year to graduate company that had a big real
from business school, as you me quite a bit, estate component to it. We
can imagine. The markets were were trying to value both the
bad, the RTC/bank crisis was including two real estate and going concern
accelerating and most money value as that was what the
managers were having a bad principles: make sure debt was secured by and the
year. It was a rough year. Eddie real estate provided your
said, “Listen, I don't know if I'm
you can always pay downside protection. We lost
going to be in business much your bills and debt the Executive Life auction to
less have a job for you. It's not Apollo. It was a fascinating
clear. You should go find service and the experience and I really learned
something.” a lot. I remember looking at
importance of free Charter Medical debt which
G&D: Did you end up was secured by a large number
working with Eddie? cash flow for levered of hospitals. I called Chase
Manhattan and said, “Hey, we
JP: I actually graduated
assets like real estate. see you guys are the lead bank
without a job. It was She also encouraged on this.” They said, “We've got
depressing because I didn't plenty of debt for sale, we can
expect to be jobless, in debt, me to go find good sell you at 20-30 cents on the
and living at home with my dollar.” We came to the
parents after graduating from mentors.” conclusion we could've sold
Harvard Business School. I four or five hospitals and
knew I did not want to go back gotten all our money back at
to banking, so I did not do If you go back and study the that price. That's how bad and
that. Luckily a couple of the great investors throughout illiquid the market was.
guys I had worked with at history—the Medicis, the
Goldman in Chicago left the Morgans, the Rothschilds, and Understanding where you are
firm to go work for Sam Zell. recently Buffett—these great in terms of seniority in the
Bob Lurie had died and he was investors with terrific records capital structure and identifying
really Sam's right-hand man— share a common trait: they the fulcrum security was
they were partners. Sam hired were always in a position to be critical, so I started auditing a
Randy Rowe, who was the liquidity providers. Each was bankruptcy class at University
main person I worked with at willing to hold cash until of Chicago because I wanted
Goldman in Chicago. Randy someone was in distress or to learn bankruptcy law. I
was kind enough to offer me a under duress, and they could thought it was an important
job. Sam had just raised his provide liquidity at very aspect of the work I was doing.
second distressed real estate attractive prices. We have run I put together a business plan
Page 6
John Phelan
on the side, while I was still Glenn Fuhrman. All those guys really great macro thinkers out
working at Zell. I pitched Sam have been very influential for there. He's very good at
on the idea of setting up a junk me. And they all have very looking at excesses and
bond operation to buy the different approaches. They all thinking through the
debt of distressed companies. go about things very implications of them before
We had done a lot of work on differently, but I've tried to they happen, when they
Pershing Square Challenge
over 100 companies. Exec Life take nuggets from each one of

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Compiled by Venkatesh Jayaraman

Volume 1, Issue 1 December 2006

Graham and Dodd 3

Contact us at: Welcome to “Graham and Doddsville”

Welcome to Graham And Doddsville (continued from page 1)

for Graham & Dodd Invest-

Please feel free to contact us

Richard Pzena (continued from page 1)

A Value Approach to Global Equity Investing

Introducing The CBS Best Ideas Club

Richard Pzena (continued from page 2)

Richard Pzena (continued from page 4)

Richard Pzena (continued from page 5)

Richard Pzena (continued from page 6)

Richard Pzena (continued from page 7)

Richard Pzena (continued from page 8)

Columbia students are known for searching the universe of

Richard Pzena (contnued from page 9)

they all tell you they’re going to

They’re very clear about it: 60

they can do about it. And you

11/21/2005 2/19/2006 5/20/2006 8/18/2006 11/16/2006

Richard Pzena (continued from page 10)

International Coal Group

Eastern Coal Producers Reserves

International $ 4.2 $ 641. $ 750. 60 32 8 91 0.82x $ 16 4.5x

Strattec Security Corp. (NasdaqNM: STRT) BUY at $42

These are my answers:

Strattec Security Corp. (Continued from page 14)

(Continued on page 16)

Strattec Security Corp. (Continued from page 15)

Richard Pzena (continued from page 11)

commodities (e.g. zinc, brass); bad uses of cash (e.g. acquisitions).

You’ve got to really be turned on

Details and updates will be posted on our website

When: Friday, February 2, 2007

Where: Columbia University

For additional information contact: Ahmar Ahmad (AAhmad07@gsb.columbia.edu) or

William Von Mueffling (’95)

Top Buys 52 week

Top Sells 52 week

Top Holdings 52 week Share

Top Buys 52 week

Top Sells 52 week

Top Holdings Change

Stephen Mandel, Jr.

Top Sells 52 week

Top Holdings Change

What’s Happening at CBS

February Mutual Fund Panel

9/14/06: Panel Discussion: “An Overview of Various Hedge Fund Strategies.”

10/10/06: Stock Pitch 101

10/12/06: Mutual Fund Panel

10/27/06 16th Annual Graham and Dodd Breakfast

10/27/06 Golf Outing

11/2/06 Fidelity Investments Stock Game

11/3/06 Mutual Fund Trek

11/7/06 Stock Pitch 201

11/9/06 Distressed Investing Panel

Please visit http://www0.gsb.columbia.edu/students/organizations/cima/ for details and updates

The Heilbrunn Center for Graham & Alumni

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