Friday, July 31, 2015

ValueAct Capital Discloses Rolls Royce Stake; GreenWood's Thesis on Rolls

Jeff Ubben's activist firm ValueAct Capital has filed a regulatory disclosure in the UK regarding shares of Rolls Royce (RR.L)

ValueAct Starts Rolls Royce Stake

The filing indicates that ValueAct now owns 5.44% of Rolls Royce's (RR.L) voting rights.  The filing was made due to activity on July 29th and their are now the largest shareholder.

Per the FT, Rolls Royce in a statement said that, "ValueAct has been an investor before and we constructively engaged with them before.  We welcome any investor who recognises the long-term value of our business.  We look forward to engaging with ValueAct, just as we do with all investors."

Just last week, we highlighted how Steve Mandel's Lone Pine Capital is short Rolls Royce.  So now we have a bit of a battleground stock with prominent investors involved on both sides.  However, given the investment timeframes of longs versus shorts, both sides could still potentially end up winning.

Lone Pine is plausibly betting on the near-term pain at Rolls as some of their business units suffer from oil and gas exposure amidst the decline in oil prices and their Trent 700 engine sees a dip as purchasers wait for a newer, more efficient engine and airplane (Airbus A330neo).

ValueAct, as a long investor, is probably looking to capitalize on a turnaround in Rolls' business under new CEO Warren East.  They're typically long-term holders anyways and would seemingly be fine with riding out any turbulence in the near-term. 

Ruane Cunniff's Sequoia Fund is also a long-term holder of Rolls shares.  In their 2014 annual letter, they lamented that, "Management and the board seem stubborn and entrenched, and it may take a tough-minded activist to force strategic change."  Well, now they have both: a new CEO and an activist in ValueAct.  Sequoia feels that "Rolls' wounds are self-inflicted and reversible."  They also really like the company's "world class business making engines for wide body jets" due to the high barriers to entry.

ValueAct seems to be bullish on the aerospace industry in general and engines in particular.  During the first quarter of this year, they also initiated a new $119 million stake in Precision Castparts (PCP). 

Numerous other prominent investors were buying PCP shares such as Berkshire Hathaway, Lou Simpson's SQ Advisors (he previously worked at Berkshire as well), Soroban Capital, Vulcan Value, Farallon, Third Point, and Eminence Capital, among others.  Sequoia also owns PCP and bought more in Q1 as well.

PCP makes castings, forgings, fasteners and more, and many of their parts go into aircraft engines.

GreenWood's Thesis on Rolls Royce

Steven Wood of GreenWood Investors also recently took a stake in Rolls Royce and posted his investment thesis on the name.

You can quickly get up to speed on the name and see his suggestions that the company should perhaps vertically integrate more to follow in the footsteps of their competitor, GE Aviation, to play catch up in margins.

Embedded below is Greenwood's investment thesis on Rolls:

You can download a .pdf copy here.

For more from ValueAct, you can view some of their other recent portfolio activity here.

Hedge Fund Links ~ 7/31/15

Hedge fund investors looking to maintain, increase allocations [P&I]

The latest thinking from Omega Advisors [ValueWalk]

Citrix bends to Elliott Management [NYTimes]

Hedge funds retain their value proposition [Investment Magazine]

7 messages family offices give emerging managers [All About Alpha]

Wednesday, July 29, 2015

What We're Reading ~ 7/2915

Charlie Munger: The Complete Investor [Tren Griffin]

Daniel Kahneman on eliminating overconfidence [Guardian]

The biggest gamble: can Macau beat the odds? [Bloomberg]

Roundtable on the virtues of capital allocation [Barrons]

The drop in commodity prices is destroying Canada's economy [BusinessInsider]

A look at Crossfit's business plan [Quartz]

How Beijing intervened to save China's stocks [Caixin]

Winning in industrial services [Bain]

Frenzy around harks back to dot-com boom [WSJ]

A model for investing in enterprise IT [Lenny Pruss]

A quick look at Softbank [Investing Sidekick]

Amazon's Hollywood shopping cart secrets [Hollywood Reporter]

Why walking helps us think [New Yorker]

Lei Zhang's Lecture at Columbia Business School (Hillhouse Capital)

Below are notes from Hillhouse Capital's Lei Zhang's lecture at Columbia Business School courtesy of Zong Z. Peng.

Notes From Lei Zhang's Lecture at Columbia Business School

In the high flying world of investing, Lei Zhang maintains a relatively low profile. Yet since he was seeded by David Swesen of Yale Endowment with $20 million in 2005, he has achieved a ~40% compounded annual return (28x not adjusting for inflation), making him one of the best performing investment managers. To put it into perspective, Warren Buffet has achieved a compounded annual return of ~22%, albeit for the past 50 years!! Today, Lei Zhang’s Hillhouse Capital, named after a street nearby Yale where Lei received his MBA and master’s in public policy, manages ~$18 billion. Thought not just focused on tech, Lei is best known for backing several most successful Chinese internet entrepreneurs and start-ups (e.g. Tencent, On April 29th, Lei paid a visit to the “Temple of Value Investing” Columbia Business School to share his investing and life lessons. Below are my synthesis of his wisdom:

For those who crave for brevity, here is the essence of the lessons that Lei Zhang shared:

  • Being a long-term investor gives you a big advantage from the starting line.
  • Do deep fundamental research, make few bets instead of keeping on chasing ideas. This way you simply your life and your business. 
  • Hillhouse invests in changes and strives to help create value through entrepreneur-like thinking and problem solving. “We are entrepreneurs so happen to be investors” 
  • Spend quality time with quality people, doing quality things. Hopefully part of the outcome is making money. 
  • Stay connected to reality and everyday life, do not become a victim of your own success. 
  • Four most important traits in people that Lei looks for: intellectual curiosity, intellectual independence, intellectual honesty, and empathy.

For those who want more details and articulations, read on:

1. Investment Strategy

Flexibility – Lei only had one investor in his fund when starting out Hillhouse – David Swensen from Yale Endowment seeded Hillhouse with $20 million. He could have raised more money with Swensen’s endorsement but did not. He wanted to start with a solid foundation, a strategy that allows him 100% flexibility to invest in whatever he believes in and is passionate about, be it public equity, venture capital, or private equity. In Lei’s words “it’s not about the format but about the essence.” To him the essence is to invest in companies that he thinks make sense, truly believes in, run by people who he respects and are open-minded, and could compound capital over a long stretch of time no matter what stage the company is in. In terms of his investment team, Lei believes in a generalist model and prides himself on being one of the analysts.

Long Term Orientation – Hillhouse is a long-term investor. Lei thinks that when you have a long-term orientation, from day one you have a huge advantage over most people – it’s what he calls free option value of time arbitrage. His view on the Chinese stock market at the time of this speech? “It’s like 1999 all over again, but times three.” The environment is so bubbly that any company that changes its name into something internet related could get an elevated multiple on their valuations. Some say long-term investing does not work in China because everybody trades so much. Speaking at one mutual fund conference, some managers asked Lei “how do you make so much money despite being a long term investor” (everyone in the room laughed really hard on this comment). Some Chinese mutual fund managers complain to regulators, “I know you want long term investors, but we need to make money, we have a fiduciary duty.” The understanding of long-term investing in China is so distorted, people think there is a cost to being a long-term investor.

Note: Lei’s comments on China looks squarely on mark in hindsight, given the on-going chaos in the Chinese A shares market, which just had its biggest single day drop (8.5%) since 2007 at the writing of this post.  

Bias Toward Inaction – But how does Hillhouse find high quality names? The way is to do deep fundamental value research and only research things that could potentially compound value over time. There are many people in China that are successful at trading, but traders have capacity issues because they have to trade all the time. In China, an average portfolio manager has 600% annual turnover, Lei’s public equity portfolio has only 15% turnover and he continues to own his private equity portfolio. Hillhouse does not attempt to constantly chase different horses. In a given year, Hillhouse takes on 2-4 positions at best and sometimes only one. By taking away the action, Lei believes you simplify your life and the investment business, and you let the portfolio compound for you instead of you doing the work. By being patient and not too active, he was able to accumulate a portfolio of high quality names.

Note: All these principles are pretty much the  the bias toward inaction is very similar to another value investing legend Monish Pabrai, whose book “The Dhandho Investor” I highly recommend. 

2. Deviation From Traditional Value Investing Philosophies

Investing in changes – Lei Zhang is a big believer in value investing, but where he deviates from the traditional value investing philosophy is that he likes investing in changes. He believes that it is change that derives value and he would like to invest in people driving them. In particular with China, and globally as well, technology has become a bigger part of the game, either in traditional or new industries. Changes are driving forces for creative destruction and value creation. He spends a lot of time understanding the changes and the people behind them. Lei says that one thing about investing in early stage company is that some companies look distracted on the outside, but if you look at the core they are intensely focused. On the other hand, the traditional sense of value investing represented by Warren Buffet dislikes changes and prefers long-term stable businesses with strong moat, hence why Warren ends up with big positions in names like in Coca Cola, Amex, Wells Fargo, and IBM.

Note: the above differentiation may be an over-simplification as Warren also has a much larger capital base to deploy.  

Example 1: Blue Moon and Blue Moon is in a traditional business, liquid laundry detergent. Hillhouse would never have invested in it if everything is done the same way, as there is P&G and Uniliver, which you invest in for their brand value and moat. After investing in Blue Moon, Lei arranged its executives to meet with those from JD, having Blue Moon learning about ecommerce from JD and have JD learning about merchandising from Blue Moon. Subsequently, Blue Moon redesigned its detergent packs so that they could fit into JD’s delivery bins. Leveraging social media and ecommerce, Blue Moon achieved the largest brand build up in years and now is the largest liquid detergent brand in China.

Value Investing Taken to the Next Level – Lei believes his approach is value investing taken to the next Level. In addition to investing in changes and long-term fundamental value, he also wants to compound that value by participating in the value creation process via deep research. The traditional Ben Graham value mismatch alone is not good enough (current price vs. intrinsic value), he wants to grow that value mismatch over time, not just to take advantage of an arbitrage opportunity. To this end, Lei thinks his approach is more like constructive (or suggestive) activism, though Lei rejects the notion that he is an activist. For him, the traditional sense of activism falls into the category of “life is too short” (too much work and headache? Ackman’s battle with Herbalife comes to mind).

Example 2: Strategic partnership between Tencent and

Lei is an early investor in both companies and brought many senior executives to JD, Tencent was one of one of Hillhouse’s earliest investments and remains in the portfolio. In 2013, Lei saw a new trend – JD had a great retail gene, but was having difficulty confronting mobile commerce on the technology front. On the other hand, Tencent had just acquired an ecommerce business. The core problem is that Pony Ma had never dealt with inventory before and suddenly had lots of physical goods on hand. Lei brought the two companies together, summarizing their problems with one word each, mobile vs. inventory. The solution is for Tencent to hand inventory to JD and JD to hand mobile to Tencent. Pony and Richard hated each other and had been fighting to win the ecommerce war, but the deal just makes all the sense.

Through research, Hillhouse was able to present and close the biggest ecommerce deal at the time. In the process, Hillhouse did get diluted, but got a lot of certainty for both companies out of it. The idea is through research, you could present to founders compelling ideas and add value in the process. Through this example, Lei conveyed that he loves entrepreneurs that are confident, open-minded, and willing to learn from competitors.

Example 3: WeChat moves into Southeast Asia

In Indonesia, for example, Lei helped create a joint venture between Tencent’s WeChat and Global Mediacom, Indonesia’s largest media, television and pay TV conglomerate. At the time, WeChat was behind Facebook Messenger, WhatsApp, and Line in user count, and today has surpassed the first two and is on par with Line. Again, Lei emphasized that he found the opportunity through “research.”

Note: In this sense, I think Lei’s approach is not just deep research, it is thinking as entrepreneurs. Focus the research on seeking truth, finding solutions to cracking business problems, and analyzing how value could be created instead of focusing on coverage and fishing for the next stock picking idea. In his own words, “we are entrepreneurs happen to be investors.”

3. What Hillhouse Looks For in Entrepreneurs and People?

Lei finds the most impressive people are the people who have deep passion and execute that passion with discipline, instead of people who exhibit habitual behavior. Specifically Lei looks for four qualities:

- Intellectual curiosity - driver of passion.  Have seen really smart people who are No. 1 in whatever they do, but in the end do not necessarily have the capacity to realize their full potential.  The reason is that they are No. 1 not because they want to understand how things work, it's because they are in the habit of being No. 1.  This makes life miserable.  If there is no passion in what you do, you will get burned out early on or reach a plateau soon.

- Intellectual independence - this allows a person to grow over long-period of time (I say this is the compounding value of knowledge and wisdom)

- Intellectual honesty - being authentic and intellectually honest is so important.  Lei also does not like people who are overly promotional and who are focused on organizing bureaucracy.  At Hillhouse, the team does not do 150-page presentations and sell internally.  Repeat your lies 100 times you believe in it yourself.

- Empathy not sympathy - the most powerful tool to be a successful entrepreneur or investor is to understand the pain points of consumers, employees, analysts, and entrepreneurs.

If you have the above qualities and a long-term oriented mentality, the rest of it is luck and law of large numbers, do what you are passionate about over and over again, and enjoy doing it over and over again, success will follow in time.

Note: I would like to put my own spin on the above comment, "even if you do not achieve exceptional success in the end, I bet you will have a heck of a lot of fun along the way."

4. Other Lessons From Lei

- Don't say I am going to work for this firm or that firm, don’t get into the argument with yourself. Just ask the simple question, are they the quality people you want to spend time with, who are you working with, working for, what kind of people are they, are they the kind of people who give “positive energy.”

- The world has already evolved way beyond the traditional employment relationship but to a more partnership model. It’s all about in what capacity and in what environment you could bring the best of yourself.

- Don’t wait for the opportunity to analyze your mistakes, spend 10x more effort trying to analyze your mistakes than success.

Thanks again to Zong Z. Peng for the notes.

Carlyle Group's David Rubenstein on Wall Street Week

Anthony Scaramucci's rebooted Wall Street Week this time around interviewed Carlyle Group's co-founder David Rubenstein. 

Embedded below is Wall Street Week's interview with David Rubenstein:

Be sure to also check out Wall Street Week's interview with Steve Einhorn, who recently said there's 'more years' left in the current bull market.  We've also posted up Byron Wien's interview as well.

Tuesday, July 28, 2015

Top Hedge Funds Short Neopost

Last week we highlighted 2 stocks that prominent hedge funds were short.  And this week we have another: Neopost (NEO.PA).  Per regulatory filings in France, the following hedge funds have short positions in the company.

Hedge Funds Short Neopost

Pennant Capital: Net short 1.55% of Neopost's shares as of July 1st.  This is slightly down from the 1.63% they were short back on April 1st.

Och-Ziff Management Europe: Short 0.7% of shares as of July 20th.  This is up from 0.61% on June 23rd and 0.5% on June 19th.

GLG Partners:  Net short position of 0.59% of Neopost shares as of July 9th.  This position has slightly fluctuated from 0.62% of shares on April 14th and 0.52% of shares on March 18th.

Tiger Legatus: Short 0.58% of shares as of June 29th, down slightly from the 0.61% of shares they were short on June 26th.

The company is "engaged in producing and selling mailroom equipment" per Google Finance.  This has been a popular short among hedge funds and we even highlighted hedge fund short positions in Neopost back in 2012.  Pennant Capital had a short on at that time as well.

While this could be a hedge to some of their long positions, it seems more plausible that this is an alpha short given that Neopost is considered a secular decline story.  As the world transitions from paper/print to digital/online, the thesis is that pages/documents will be printed and mailed, instead being stored and transmitted digitally.  Neopost shares are down around 29% over the past year.

A US-traded company, Pitney Bowes (PBI), is involved in the same industry.  While we've heard some hedge funds were short in prior years, there's no way to know for sure who's short (if any) these days since there's no rule of public disclosure of short positions in the US.  Not to mention, the company has shifted its focus to include digital offerings as well.

You can view more of the latest hedge fund short positions here (scroll through).

Lone Pine Capital Starts Horizon Pharma Stake

Steve Mandel's hedge fund firm Lone Pine Capital has filed a 13G with the SEC regarding shares of Horizon Pharma (HZNP).

Per the filing, Lone Pine now owns 5.4% of Horizon Pharma with over 8.35 million shares.  This is a newly disclosed equity position for the hedge fund as they previously didn't report ownership as of the end of the first quarter.  The filing was made due to activity on July 17th.

For more from this hedge fund, we recently posted about one of Lone Pine's short positions.

Per Google Finance, Horizon Pharma is "formerly Vidara Therapeutics International Public Limited Company, is a specialty biopharmaceutical company focused on identifying, developing, acquiring or in-licensing and commercializing differentiated products that address unmet medical needs. The Company markets a portfolio of products in arthritis, inflammation and orphan diseases. The Company's the United States marketed products are ACTIMMUNE (interferon gamma-1b), DUEXIS (ibuprofen/famotidine), PENNSAID (diclofenac sodium topical solution) 2% w/w (PENNSAID 2%), RAYOS (prednisone) delayed-release tablets and VIMOVO (naproxen/esomeprazole magnesium). The Company developed DUEXIS and RAYOS/LODOTRA, has the United States rights to VIMOVO, has the United States rights to ACTIMMUNE and has the United States rights to PENNSAID 2%."

Eton Park Capital Short Burberry Group and J Sainsbury

Eric Mindich's hedge fund firm Eton Park Capital has recently disclosed updated short positions in Burberry Group (LON:BRBY) and J Sainsbury (LON:SBRY).

Eton Park Short Burberry Group

Per regulatory filings in the UK, Eton Park has disclosed it is net short 0.7% of Burberry's shares as of July 13th.  This is up from a 0.62% net short position back on May 11th.

Institutions are required to publicly disclose when they build a short position above the 0.5% of shares threshold.  Keep in mind that this could either be an alpha short or a hedge to one of their long positions.

Last week we also highlighted 2 stocks that prominent hedge funds are short.

Per Google Finance, Burberry Group is "a United Kingdom-based manufacturer, wholesaler and retailer of luxury goods. The Company designs, produces and sells products under the Burberry brand. The Company’s product categories include women’s and men’s apparel and accessories and beauty. The Company owns distribution network consisting of: 497 directly operated stores and concessions, offline and, a digital platform active in 11 languages, online. The Company’s Licensing revenues are generated through the receipt of royalties from the Group’s partners in Japan and global licensees of fragrances, eyewear, timepieces and European children wear. The Company’s retail/wholesale engages in the sale of luxury goods through Burberry mainline stores, concessions, outlets and digital commerce as well as Burberry franchisees, prestige department stores globally and multi-brand specialty accounts. The Company has subsidiaries in Europe, Middle East, India, Africa, United States and Asia Pacific region."

Eton Park Also Short J Sainsbury

Per a separate regulatory filing in the UK, Eton Park has disclosed a net short position in 0.69% of J Sainsbury's shares as of June 29th.

Per Google Finance, J Sainsbury is "engaged in supermarkets and convenience stores, and an online grocery and general merchandise operation. The Company also has two property joint ventures with Land Securities Group Plc and The British Land Company Plc. Sainsbury’s Bank provides a range of banking and insurance products."