Thursday, June 16, 2016

Dear Chairman Book Review: Boardroom Battles and the Rise of Shareholder Activism By Jeff Gramm

Jeff Gramm runs hedge fund Bandera Partners and is an adjunct professor at Columbia Business School.  He has written an intriguing book entitled Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism.

Dear Chairman Book Review

When asked why he wrote it, Gramm told us he had an idea to collect original activist letters into a book, but what really got the ball rolling is when he asked Warren Buffett for his 1964 letter to American Express (AXP).  When that arrived in the mail one day, he began chronicling what has now become the archive of activism.

(And speaking of Buffett, value investors might have already noticed that at this year's Berkshire Hathaway annual meeting, Carol Loomis asked Buffett about Dear Chairman.)

Basically, the book is a series of case studies on activist investor situations over the years.  Chapters feature the likes of Benjamin Graham, Robert Young, Warren Buffett, Carl Icahn, Ross Perot, Karla Scherer, Dan Loeb, and BKF Capital.

Many of these managers have been featured countless times on Market Folly, but this account gives a behind the scenes look at many specific situations and underscores the struggle between shareholders and management.

While the first few chapters of the book are admittedly slower and perhaps not as intriguing, it definitely pays off to keep reading as the back half of Dear Chairman is full of interesting anecdotes.  Additionally, the appendix of some never-before-published activist letters offers a rare look into the minds of some of history's great activist investors.

Our favorite was probably Chapter 7 on Dan Loeb of Third Point because he's the most modern incarnation of an activist profiled.  Not to mention, his exploits make for a great story, as the book examines his journey from 'Mr. Pink' on an online message board to the scathing letters he's penned to companies.

Another Chapter later in the book also features Carlo Cannell of Cannell Capital.  He has become more known in recent years as well for his, shall we say, 'choice' words for public company executives (he famously blasted Jim Cramer and recently).

The book is around 250 pages (including all the activist letters), so not a terribly huge ask in terms of time commitment, and it's easy to stop and pick back up after each Chapter given they all detail independent situations. 

So who should read this book?  Well, aspiring activist investors certainly would benefit.  But so too would any investor looking for more insight on the 'behind the scenes' of board rooms.  If you don't like historical situations or aren't terribly interested in activism in general, then this isn't really the book for you.  But realistically, what aspiring investor doesn't like to learn from others?

The book excels at framing the activist situations with specific details and background color.  Rather than merely reading as a boring timeline of historical events, it transports you from the black and white pages into recreations of the sagas themselves.  The stories are actually quite entertaining, but lessons are embedded as well.

Jeff Gramm's Dear Chairman offers a unique entry into a previously underrepresented niche in the library of finance.

To read the book, click here to pick up a copy (physical or digital).

Wednesday, June 15, 2016

Seth Klarman's Value Investing Lessons

Back in 2009, Baupost Group's Seth Klarman talked with the Ben Graham Center for Value Investing and the Richard Ivey School of Business.  In it, Klarman talks about his approach to investing and the timing of the talk (right after the financial crisis) leads to a few interesting tidbits.

Seth Klarman's Value Investing Lessons

Klarman says that, "All people are risk averse, it's a human tendency to be risk averse." He focuses on how the pain people feel from losing money is so much worse than the joy they receive from gaining money.

He gives the example of flipping a coin where heads you double your money, tails you lose everything you have.  Klarman argues almost everyone wouldn't take that trade for the fear of losing everything is so big.

Klarman then outlines Baupost's approach:

"What can go wrong?  How much can you lose?  We don't think of risk in an academic sense of beta, which doesn't make any sense to us at all.  Volatility's not risk, volatility is volatility.  Volatility creates opportunities and isn't necessarily risk at all, unless you absolutely needed to sell the day that prices are really low.  Rather, risk is the probability of losing and how much you can lose if you lose.  So we focus on risk before we focus on return."

He also notes that, "Long term orientation is critically important."

Klarman then goes on to focus on an aspect of the business that's not talked about as much but is just as important:

"Relationships are incredibly important.  In the buyside part of Wall Street, we work really hard to have the best brokers and be really good clients for them.  We don't want to be somebody's 50th biggest client.  Because we'll never get a phone call that says 'we've got a big block of this for sale, are you interested?'  But if we're somebody's first or second client, they're going to call."

On where Baupost looks for ideas:

"We think there are a lot of smart people out there.  We don't think we're the world's best analysts of businesses, we think we're good at that.  We think we're very good at complicated situations, the messier, the better.  We like situations with a catalyst where there's some reason that a pricing irregularity will correct.  But at a discount and something will cause it to correct.  That leads us into interesting places.  One of our favorite areas is distressed debt."


"Spinoffs are an interesting place to look because there's a natural constituency of sellers and there's not a natural constituency of buyers."

On the mental approach needed:

"This business is largely about psychology.  If you're down a huge amount, you're not thinking straight.  If the markets do something that completely surprises you, you can be a deer in the headlights.  It's a huge benefit to not have your own psychology get interrupted."

Lastly, Klarman had an excellent quote on trying to figure out who you'd be buying from and why they're selling:

"Inevitably, you want to buy from people that don't know what they're doing.  Warren Buffett has this saying that if you're playing poker and you look to your left and look to your right and you can't figure out who the patsy is, it's you.  Investing is the same way.  If you are buying something and there's a chance that the person knows more than you, there's a chance you're a sucker.  If you're buying and management is selling, you might want to think twice if you can figure that out.  If you're buying and Steve Mandel at Lone Pine Capital is selling, that's a really bad thing, because Steve Mandel does great analysis and probably knows more than you do."

Klarman is also the author of Margin of Safety, a hard to find book that's no longer in print.  It's revered by many value investors as a prime source of wisdom.

Embedded below is the video of Seth Klarman's talk:

For more from this respected investor, head to Seth Klarman's recommended reading list.

Surprising Habits of Original Thinkers: Adam Grant's TED Talk

Organizational psychologist Adam Grant gave a TED Talk on the surprising habits of original thinkers.  He's also recently written a new book, Originals: How Non-Conformists Move the World.

While this has a wide variety of applications, it can be applied to investing as well.  When evaluating securities, investors typically have to distinguish between the consensus view and their variant perception.  The difference between perception and reality is where opportunities lie.

While some investors are more comfortable in the herd, others will stray from the herd with their investments.

As Adam Grant notes, "The greatest originals are the ones who fail the most, because they're the ones who try the most ... you need a lot of bad ideas in order to get a few good ones."

And in investing, often times all it takes is a few really good ideas to generate the bulk of the returns.  You just have to sift through all the bad ideas first. 

Grant also touches on the notion of procrastination and how some people's most creative ideas come from that. 

He also dives into the concept of first mover advantage and how 'improvers' (companies that come into the market later) had a lower failure rate than first movers.  He says, "To be original, you don't have to be first.  You just have to be different and better."

While this TED talk doesn't frame original thinking in the context of financial markets, it's a useful exercise of thought.

"If we want to be original, we have to generate more ideas."  This principle was basically applied to investing in a post we've previously linked to:  the concept of idea velocity

Embedded below is the video of Adam Grant's TED talk on the surprising habits of original thinkers:

Be sure to also check out both of Adam Grant's books: Give and Take: Why Helping Others Drives Our Success as well as his other title, Originals: How Non-Conformists Move the World.

What We're Reading ~ 6/15/16

Calculating the return on incremental capital investments [Base Hit Investing]

The history of the online travel industry [Skift]

A conversation with Alphabet's Eric Schmidt [Charlie Rose]

Armstrong Flooring: a spinoff with big upside [StockSpinoffInvesting]

Time Warner's Jeff Bewkes fights the industry's urge to merge [Variety]

Why housing is about to eat the US economy [CSen]

Student loans as economic depressant [Across the Curve]

The college debt crisis is worse than you think [Boston Globe]

Thoughts from a recent trip to China [Going Long]

The future of banking is in China [WSJ] 

China's credit card clearing market now open for competition [SCMP]

China is close to having its own Silicon Valley [Business Insider]

Are we in a mattress store bubble? [Freakonomics]

The U.S. is richer than ever [Calafia Beach Pundit]

Welcome to Larry Page's secret flying car factories [Bloomberg]

What's the best management advice you've ever received [Alan Murray]

What's one thing you've learned at Harvard Business School [Medium]

Profile of Nike's CEO Mark Parker [SurfaceMag]

Struggling Ralph Lauren tries to fashion a comeback [WSJ]

Tuesday, June 14, 2016

Interview With Glenview Capital's Larry Robbins: Capitalize For Kids Investor Series

The Capitalize For Kids Conference has recently started an Investor Series of interviews.  Their first issue (Volume 1) features conversations with Larry Robbins of Glenview Capital, Pierre LavellĂ©e of CPPIB as well as the team at Cambridge Associates.  The full document is available here, but we've pulled some select quotes from Robbins:

On how he invests:

"I think one of the challenges that many people have is that, in their pursuit of highly diversified investment strategies, they end up investing their own capital – or capital that they are the fiduciary for – on things that, due to time constraints, they have no contact with. Or of which they don’t have a capacity to develop a deep understanding. The theory, when we started Glenview – and that perpetuates today – is to invest in businesses that we believe we can adequately describe in a matter of minutes. Businesses where we can look at past and present fundamentals and try to predict future fundamentals – including future earnings growth, cash flow growth, shareholder returns, and where we can invest capital at valuations – absolute valuations – that we find reasonable. And the final thing is that, all along the way, we wanted to think and act like owners – which the business has allowed us to do."

On incentives in the hedge fund industry:

"I believe that the reason that hedge funds work over time is because the owner/operator hedge fund has a tremendous and complete alignment of interest between the fund manager and the client – because the fund manager is the largest non-diversified client. And because of that, I am not only well-motivated to drive returns over time, but I’m also extremely well motivated to manage risk. Unfortunately, most people gauge risk based upon the mark-to-market stock price movements or security price movements of the day, whereas in reality those risks are more appropriately measured through a cycle – based upon the certainty of outcomes and the hit rate in which one invests long and short with success. I think that alignment of interest is exactly fair and appropriate, and is the motivating factor by which hedge funds have delivered risk-adjusted returns and alpha over time."

On the unfortunate truth of the business:

"The unfortunate truth of our business is we’re trying to do something that’s very hard, and very unnatural. We were created in order to take advantage of market anomalies, and yet we are also expected to prevent market anomalies from negatively impacting capital balances. I’m not complaining about that dichotomy. We’re not crying about it, but we do recognize that there’s a natural tension between the times that opportunity sets are created and the times that the opportunity sets are harvested. And it is likely, over decades, that occasionally opportunity starts to get created on your watch while you’re holding that security. In order to encourage opportunistic investor behavior, I think you’re accurate in saying that we will go to great lengths to encourage opportunistic investor behavior – because we want to make sure that the clients know that we will do anything we can to support their objectives."

Update on Glenview's Thermo Fisher (TMO) stake:

"Thermo Fisher is an example of a company which is well run and well-managed – from top to bottom. So much of the popular press talks about hedge funds engaging underperforming companies, or entrenched managements, or dysfunctional boards. And yet, if you look at Thermo Fisher Scientific which is the aggregation of four different companies: Thermo Electron, Fisher Scientific, and Life Technologies – itself two different companies, it’s an example of a board and management operating on all cylinders. Number one, their business continues to exhibit the defensive growth characteristics that attracted us to want to invest in the life sciences industry. In the fourth quarter of 2015, they posted their strongest organic revenue growth quarter in five years, posting seven percent organic revenue growth. For a firm like ours, whose average portfolio earnings multiple is 12 times this year’s and 10 times next year’s earnings, it’s hard to find businesses that grow organically more than seven percent, so certainly we’re gratified that the business does that. Thermo has allocated capital extremely well. They repurchased shares and made meaningful acquisitions – the most significant of which in the last several years was their acquisition of Life Technologies, which was also a Glenview holding. At the time we pitched Thermo to your conference [October 2014], our thesis was that Thermo’s organic revenue growth would accelerate not only because Life Technologies was a financially accretive tuck in that offered significant cost savings, but because the platform that Life Technologies owned would actually accelerate organic revenue growth. That certainly has come to pass in 2015, and is reflected in increased optimism with respect to organic revenue growth in 2016 and beyond. Finally, Thermo is an example of what we would call the ‘wash-rinse-repeat trade’. There is much discussion in the market of companies that either employ financial engineering or have a too great reliance on leverage in order to drive financial returns. And yet Thermo, as an investment grade company, has developed enormous credibility with the credit markets and with the rating agencies, as well as with its shareholders, by identifying attractive acquisition candidates and financing them mostly with debt securities – but then using their prodigious free cash flow and the underlying EBITDA growth of the combined company in order to have the balance sheet self-repair over an 18 to 24 month period. As we sit here today, Thermo has de-levered to below three times debt to EBITDA, which puts them in a position in 2016 to again be a significant capital deployer. To date, they have bought back $500 million of stock and have announced the accretive acquisition of Affymetrix. We believe that the company has additional firepower to augment their strong organic top-line growth – and a strong margin expansion with additional accretive repurchases or M&A that'll further shareholder returns."

To read the rest of Robbins' in-depth interview, definitely check out the Capitalize For Kids Investor Series here.

Investing Lessons From KKR's Henry Kravis

Bloomberg has an excellent interview out with Henry Kravis, founder of the well-known private equity firm Kohlberg Kravis Roberts, better known as KKR.

Here are some interesting quotes on investing and hedge funds:

On the difference between hedge funds and private equity:

"So I imagine there will be many more private equity firms than there are today. It’s very hard to kill a private equity firm. You can kill a hedge fund overnight; people pull their money out as fast as they put it in. You can’t pull your money out of a private equity firm as easily. If a firm is bad, all that can really happen is that it won’t be able to raise another fund. Eventually it’ll go out of business. But that can take years."

On who make good investors:

"Because to me, people who are curious are going to be better investors and better stewards of others' money.  If there's no curiosity, you're basically doing something that's already been done by someone else."

On focusing on the downside & learning from mistakes:

"When I was in my early 30s at Bear Stearns, I’d have drinks after work with a friend of my father’s who was an entrepreneur and owned a bunch of companies. “Never worry about what you might earn on the upside,” he’d say. “Always worry about what you might lose on the downside.” And it was a great lesson for me, because I was young. All I worried about was trying to get a deal done, for my investors and hopefully for myself. But you know, when you’re young, oftentimes you don’t worry about something going wrong. I guess as you get older you worry about that, because you’ve had a lot of things go wrong."

On what he looks for in an investment:

"We focus a lot on disrupters.  What they're doing, what they could do..  When we're making an investment in a nonstartup-type company, we ask ourselves, "Who's going to disrupt this company or industry?"

On the birth of the industry-standard 20% fee:

"George’s father and my father were in the oil-and-gas business, and in those days there was something called “a third for a quarter.” If I had a lease and wanted to drill a well, I would go to the money person and say, “I’ll put up 25 percent of the cost, you put up 75 percent, and you’re going to get a two-thirds interest and I’m going to get a one-third interest for my 25 percent.” We thought 20 is close enough to 25. I’m often asked, “Why didn’t you pick 25 percent because that would have stuck and carried interest?” We were just trying to get started, so that was literally what we started from." 

On data that's interested him recently:

"Our most recent (FirstData ~ FDC) SpendTrend reports have shown that consumers’ largest expenditure, by far, has been on health care. It’s funny, you had a big dividend for the consumer with the advent of lower gasoline prices. You would think they’d go out and spend on things, go shopping at Macy’s or whatever. But they have not spent on things, except on essentials. A lot of people are saying, I want to spend my money on experiences. And we can pick that up."

Be sure to read the full interview here.

Jim Grant's Talk at Google

Jim Grant of Grant's Interest Rate Observer recently held a talk at Google.  His presentation focused on his book entitled, The Forgotten Depression of 1921: The Crash That Cured Itself.

He looks at high unemployment, a collapse in commodity prices, surge in bankruptcies and a sharp decline in stock prices.  His talk recreates the scene and deconstructs the situation.

Grant talks about how all of his Wall Street brethren spend every heartbeat focused on accumulating as much money as possible, but very few of them think much about the actual thing they're constantly amassing.

Embedded below is Jim Grant's talk at Google:

You can pick up a copy of James Grant's book here.

For other investors' presentations at Google, we've also highlighted Howard Marks' talk, as well as Michael Maubboussin's talk at Google.

Monday, June 13, 2016

Pershing Square Rolls Valeant Options Exposure From 2017 to 2019

Bill Ackman's hedge fund firm Pershing Square Capital Management has filed an amended 13D with the SEC regarding its position in Valeant Pharmaceuticals (VRX).  Per the filing, Pershing now owns 9.0% of VRX with 30.71 million shares.

The filing also notes that Pershing has closed its January 2017 options positions and opened similar positions in options expiring January 2019.  Basically, they've rolled their exposure back 2 years.

Pershing bought call options and sold put options and you can view the entire list of transactions here.

Other investors have also been active in this stock, as we highlighted how Ruane Cunniff sold half of its VRX stake recently.

For more on Bill Ackman's firm, we detailed how Pershing Square sold some Zoetis as well.

Per Google Finance, Valeant is "a specialty pharmaceutical and medical device company. The Company is engaged in developing, manufacturing, and marketing a range of branded, generic and branded generic pharmaceuticals, over-the-counter (OTC) products, and medical devices (contact lenses, intraocular lenses, ophthalmic surgical equipment, and aesthetics devices), which are marketed directly or indirectly in over 100 countries. The Company operates through two segments: developed markets and emerging markets. The Company's developed markets segment consists of sales in the United States of pharmaceutical products, OTC products, and medical device products. The Company's Emerging Markets segment consists of branded generic pharmaceutical products and branded pharmaceuticals, OTC products, and medical device products."

Elliott Management Writes Letter to CDK Global; Sachem Head Trims CDK Stake

Two activist investors have been active regarding their positions in CDK Global (CDK) recently:

Elliott Management Sends Letter to CDK Global

First, Paul Singer's Elliott Management has sent a letter to CDK Global.  In it, Senior Portfolio Manager Jesse Cohn outlines how they want the company to adopt the steps in the Value-Maximizing Plan 'without delay.' 

Elliott notes they've had discussions with shareholders that represent more than half of CDK's shares outstanding and many of these investors want the company to improve CDK's business operations and capital return program.

The hedge fund believes that, "Reducing product complexity will shorten product implementation times.  Enhanced leveraging of technology and automation will reduce customer response times.  Improved software version discipline will free up funds for higher overall product quality and a better customer experience as a greater proportion of R&D spend would be committed to new features rather than simply maintaining older products.  Implementing an automated contracting system will deliver a simplified, more transparent set of invoices for customers."

Elliott feels that CDK's share price should reach $81 or higher in 14 months if these steps are implemented.

You can read the full letter here.

Sachem Head Capital Trims CDK Stake

Second, Scott Ferguson's activist firm Sachem Head Capital has filed an amended 13D with the SEC regarding their CDK Global (CDK) stake.  Per the filing, Sachem now owns 6.8% of the company with 10.49 million shares. 

The filing also notes they have additional economic exposure to approximately 3.15 million shares under cash-settled total return swaps.  So their total aggregate exposure is actually 8.8% of the company with 13.65 million shares.

This means they've trimmed their position by a little over 1 million shares since the end of the first quarter.  Their trading data indicates they were selling in mid-to-late April, early May, and early June at prices ranging from $47.50 to $57.74.

Per Google Finance, CDK Global is "a provider of integrated information technology and digital marketing/advertising solutions to the automotive retail industry. The Company's segments are Automotive Retail North America (ARNA), Automotive Retail International (ARI) and Digital Marketing (DM). The Company's solutions automate workflow processes from pre-sale targeted advertising and marketing campaigns to the sale, financing, insurance, parts supply, and repair and maintenance of vehicles. Its automotive retail solutions offer technology that helps supply side of the retail value chain. It offers digital marketing solutions to enable its clients to create demand for their products by designing and managing complete digital marketing and advertising strategies for their businesses. The Company, through its DM segment, provides a suite of digital marketing solutions for original equipment manufacturers and automotive retailers, including Websites and management of their digital advertising spend.."

Wally Weitz's Wealthtrack Interview

A few months ago, value investor Wally Weitz of Weitz Investment Management sat down with Consuelo Mack in an episode of Wealthtrack.

In the interview, Weitz touches on the concept of valuable losses, or finding opportunities where others are seeing losses.

He says, "Selling begets more selling; people scare themselves and each other and almost always overshoot."

He has an 'on deck' list of stocks they've researched and are just waiting for the right price to buy.  That said, he says it's easier for him to buy stocks he's already involved with during downswings rather than jump on new names because he's more comfortable/familiar with management and how they will act during downturns, etc.

Weitz says that the fund he particularly runs is long/short but not designed to be market neutral or anything like that.  He noted he's typically 90% long and 30% short, running around 60% net long.  He mentioned they'd been short Sears (SHLD) in the past.

During the interview, Weitz talks about why he likes Liberty Global (LBTYA/K) and why he sold Valeant Pharmaceuticals (VRX).

Other investments Weitz mentions include Liberty Broadband (LBRDA), Charter Communications (CHTR), Berkshire Hathaway (BRK.A/B), Wells Fargo (WFC).

Embedded below is the video of Weitz's interview on Wealthtrack: