ValueAct Capital Takes KKR Stake

Jeff Ubben's activist firm ValueAct Capital has taken around a $750 million stake in private equity firm KKR (KKR).  Partner Mason Morfit talked about the position at 13D Monitor's Active-Passive Investor Summit in New York, according to Business Insider.

This is yet another prominent firm that has jumped on the private equity train.  We've highlighted recently how Tiger Global has been building a position in Apollo Global Management.

At the presentation, Morfit called KKR a "50 cent dollar" and thinks that big firms will get even larger.

ValueAct recently returned a chunk of capital to investors as they were having trouble finding ideas in a market with stretched valuations.  But apparently they've at least found one place to park some capital in KKR.

You can view other recent portfolio activity from ValueAct here.

Per Google Finance, KKR is "a global investment firm that manages investments across multiple asset classes, including private equity, energy, infrastructure, real estate, credit and hedge funds. The Company's business offers a range of investment management services to its fund investors, and provides capital markets services to its firm, its portfolio companies and third parties. The Company conducts its business with offices across the world, providing it with a global platform for sourcing transactions, raising capital and carrying out capital markets activities. The Company operates through four segments: Private Markets, Public Markets, Capital Markets and Principal Activities. It operates and reports its combined credit and hedge funds businesses through the Public Markets segment. The Capital Markets segment consists primarily of its global capital markets business. Through its Principal Activities segment, the Company manages the firm's assets and deploys capital."

Notes From Sohn San Francisco 2016: Morfit, McGuire, Palihapitiya & More

Below are notes from the 2016 Sohn San Francisco investment conference where investment managers presented their latest ideas to benefit charities.  We also posted up notes from the Next Wave Sohn San Francisco conference as well that featured emerging managers.

Notes From Sohn San Francisco 2016 Conference


Mason Morfit, ValueAct Capital

• Idea: Long Morgan Stanley (MS)
• Try to find businesses with enduring franchise value
• 3 defined business units
• 7 defined revenue types
• Did a lot of work to understand the unit economics
• 75% of the revenue and 85% of the profit come from asset light fee based businesses (not capital intensive businesses)
• Long term trend is very positive
• MS has maintained and in some cases grown its share in wealth management and investment banking advisory 
• Risk factors: earnings decline, principal loss, liquidity/access to capital

Mick McGuire, Marcato Capital Management

• Idea: Long Buffalo Wild Wings (BWLD)
• Owns 5% of the company
• Differentiated concept focused on wings, beers, sports
• ~1,200 units with potential to grow to 1,700 units
• Long history of industry leading same store sales (SSS) growth
• Central component of investment thesis:
• Differentiated concept with long runway for growth
• SSS declines and capital allocation missteps have hurt shares
• Opportunity to create shareholder value by: transitioning to a 90%+ franchised model by 2020, improve 4 wall margins (several hundred bps opportunity), and optimize capital structure
• Multiple has compressed as traffic has slowed and costs continue to rise
• When growth slowed, BWLD acquired franchised stores for high multiples
• Average replacement cost is ~$2.3mm per unit but in 2015, spent $3.5mm per unit - overpaid; bad use of capital
• Incentives are weighted singularly towards growth, not ROI
• While unit volumes have increased significantly since IPO, ROI has decreased because the cost to build a unit has increased
• Franchised businesses command higher multiples; higher franchise mix correlated with higher multiples
• BWLD is 50/50 today but recommending that they go to 90% franchised model by refranchising units at multiple of 6.0x EBITDA
• Valuation: if they can move to a higher franchised model range of value from $218 to $311 (versus ~$141 today)

Chamath Palihapitiya, Social Capital

•  Primarily invests in fast growing private tech companies
• Multi-trillion dollar opportunity hiding in plain sight
• Retail will be a $1T business by 2025
• Every company succeeds based on three factors: build a great product with great market fit, develops adjacent products in deep verticals, invests in features to drive ARPU
• Amazon (AMZN) thesis based on AWS and outsourcing infrastructure spending and moving it to the cloud; reshaping economics by taking out costs
• Similar concept for software that will move to the cloud

• Idea: Long Workday (WDAY) 
• $100bn opportunity in 10 years; 20% IRR
• Workday is the system of record for HR and is viewed as the best in class product among CIOs
• Leading market share supporting the largest global employee bases including Samsung, McDonalds, IBM
• HCM product manages 19mm employees on behalf of its employers
• Adjacent products in deep verticals: Workday Financials - system of record to manage financials; now manages financials for global companies
• Invest in features to drive ARPU (payroll and many other features)
• Rapid pace of innovation
• Workday competes against Oracle (ORCL) and SAP (SAP)
• Lowest spend on M7A over the last 5 years
• "M&A is what you do when what you do doesn't work anymore."
• Done< $0.3bn over last 5 years, SAP and Oracle have had a lot of M&A
• Netflix ability to close the books and file with the SEC went down significantly with Workday versus Oracle
• Workday is an enterprise product company
• Best management team in software
• Fully aligned, long term oriented
• 97% customer satisfaction; very high consistent with consumer tech like Facebook, Google, Apple but this is enterprise tech
• Following the Salesforce playbook but doing it better
• $100bn company in 10 years

Carson Block, Muddy Waters Capital

• Idea: Short Tutor Perini (TPC)
• Construction company
• Nearly all analysts have the stock as a buy
• FCF is the Achilles heel - the company bleeds cash in working capital driven by growing accounts receivable
• Loan agreement has been amended 6 times in 5 years and there is a chance that banks could pull RC facility; Business has $94mm of cash on BS but 79% of cash sits in JV so it could run into a major liquidity problem
• 4 CFOs over 9 years
• Summary: business can't consistently generate cash, projected earnings growth highly questionable, lack of management credibility, and liquidity could become challenged

Mihir Wohra, PIMCO

• Idea #1: Rates trade - Hawkish Fed
• Market is currently underpricing the possibility of a Fed hike or that there will just be one hike
• Buy a pair: buy a put on the 1 year rate

• Idea #2: Dovish Fed - Buy REITs
• REIT prices tend to be correlated to equities over the short-term but underlying economic factors prevail over the long term
• Will do well if Fed doesn't raise rates or cuts

• Idea #3: Commodities trade: Long call options on 2018 Natural Gas - No Fed correlation
• In the midst of global price convergence that will pull US natural gas prices higher while lowering global prices; US is opening new LNG export terminals and US nat gas is the cheapest in the world so there are buyers
• Buying 2018 at a discount to 2017 is attractive given US LNG exports are only increasing over the next few years

• Idea #4: Bonus trade: sell puts / buy calls on October VIX Futures
• Volatility should rise towards long term averages if election stays close
• Volatility could rise more if Trump probability of winning increases

• Idea #5: Bonus trade: Currencies - works if Trump win probability decreases
• Mexican peso has significantly underperformed other EM and commodity currencies in 2016 due to possibility of Trump victory and tougher US policies toward Mexico

Jeff Osher, Harvest Capital Strategies

• Idea: Long Echostar (SATS)
• Global provider of satellite services, video, delivery solutions and broadband satellite technologies
• Echostar Technologies: set top box business with $1.3bn revenue; $100mm EBITDA, 7.6% EBITDA margins
• Satellite services: $445mm revenue; 84% EBITDA margins; very good business with long dated contracts
• HughesNet: $1/4bn revenue; provide consumer broadband for households that can't get wired broadband
• Duopoly: Hughes and Viasat
• Hughes has 1mm subscribers with 30% EBITDA margin
• Business is capacity constrained
• 2016 launches will drive 50% revenue growth for Hughes within 3 years.  Given higher incremental margins, EBITDA should nearly double
• Sum of the parts valuation results in target price of $71.76 (versus today at ~$44)
• Other actions could result in homerun scenarios: Echostar Technologies divestiture, Echo Mobile, Dish Mexico, Sling TV, Brazil orbital slot, Pay TV, positioning for opportunistic M&A

Joseph Lawler MD, JFL Capital Management

• Idea: Short IP Group (IPO.LSE)
• Publicly traded fund that invests in healthcare companies
• Most publicly traded investment firms trade at a discount to NAV but IPO trades at a premium
• Adverse selection process - they seem to invest in companies that other VCs have passed on
• Investments are overvalued especially investment in Oxford Nanopore.  It's a DNA sequencing company; the cost of DNA sequencing has gone down significantly and has become commoditized

Arjun Divecha, Grantham May Van Otterloo & Co

• Idea: Investing in Indian financials (non state-owned banks)
• Never think of an emerging market as a place to permanently put capital
• India from a long term point of view looks pretty good as a place to invest - well positioned for economic growth over next 5 years
• Private sector financials are taking market share away from state owned banks
• Dependency ratio looks pretty good in the future versus other countries like US, Japan, and China.  Dependency ratio = ratio of non-working to working people
• India looks good because of improving fiscal discipline, improving inflation, current account benefiting from oil windfall (big importer of oil), capacity utilization is very low
• India is massively under-urbanized
• Household debt to GDP is 9% versus US where it is ~100%
• Huge scope for increase in consumer loans
• Pitch was about investing in non state-owned banks, like publicly traded ones such as HDFC Bank, Axis Bank, IndusInd Bank and Yes Bank; State owned banks can't make loans anymore due to loan issues
• The private banks are very well run; 3-6-3 banks
• Not easy for foreign investors - must have access to local market
• HDFC Bank (HDB) and ICICI Bank (IBN) are listed on the NYSE 
• 4-5% net interest margins
• Valuations are high but earnings growth has historically justified high valuation
• HDFC trading at 4.5x price to book
• 26.7% earnings growth over 20 years
• Thesis summary: well positioned for economic growth, low penetration of financial sector, well run financials are taking market share from well run banks

Peter Palmedo, Sun Valley Gold

• Idea: Gold: data and dogma
• Discovered Summers-Barsky Gold Thesis: price of gold is driven by the real return in capital markets
• From 2002 to 2015 gold real return was 7.9% versus a blended real return of 4.5%
• China gold demand in excess of domestic supply
• Most PMs hold unsubstantiated beliefs about gold but the algorithmic, data driven models will get it
• Own gold in the simplest form
• Cheap, safe and stable; think about gold in the context of portfolio insurance and risk diversification 
• Buy gold if you think we are in a low real return world

Be sure to also check out the presentations from the Next Wave Sohn San Francisco conference as well, which featured emerging fund managers.

Mason Morfit on ValueAct's Approach and Microsoft

Mason Morfit of activist investment firm ValueAct Capital sat down with Larry Larsen at Microsoft's Channel 9 to talk about his background, ValueAct's approach, and his thoughts on Microsoft (MSFT). 

Morfit notes that ValueAct was founded with capital from the family of the founders of The Gap.  And ValueAct wanted to think like an owner and own stocks for a long-time and develop relationships with the management and board to help the company grow.

MSFT is ValueAct's top holding and was worth over $3.4 billion at the end of 2014.  ValueAct takes an active approach with most of their investments and Morfit sits on the company's board.  Morfit says ValueAct likes to invest in some of the world's best businesses and MSFT fits that category.

"Our perspective was that lost in this negativity around what was going on in PC's and the disruptions that were coming from mobile and cloud, is that Microsoft was much more than just a Windows or PC's company." 

"I've been really happy with the progress the company's made" since ValueAct originally acquired stock in 2013.

Morfit says he's paying most attention to Office 365 (especially commercial) and subscription numbers, as well as the businesses in the servers and tools group. 

Additionally, he talked about the management transition and the company's openness to accept criticism and to openly discuss ideas and to face facts whether they're good or bad.

Microsoft was also recently pitched as a long investment by Lone Pine Capital at the Sohn Conference this week too.

Embedded below is the video of Morfit's interview:



For more on this fund, you can scroll through our past posts on ValueAct Capital here.

ValueAct Capital Discloses Armstrong World Industries Position

Jeff Ubben's hedge fund firm ValueAct Capital has filed a Form 4 with the SEC regarding shares of Armstrong World Industries (AWI).  Per the filing, ValueAct has revealed they own 9,2000,000 shares of AWI.

The filing indicates that between July 29th and July 31st, ValueAct bought cumulatively 1 million shares at prices ranging from $48.73 to $49.28.  Shares of AWI were not listed on ValueAct's last 13F filing which detailed holdings as of the first quarter of 2014.  As such, it appears this is a newly disclosed position.

ValueAct is now one of the largest holders of AWI shares.  For more from this hedge fund, head to Jeff Ubben on activist investing.

Per Google Finance, Armstrong World Industries is "a global producer of flooring products and ceiling systems for use in the construction and renovation of residential, commercial and institutional buildings. The Company designs, manufactures and sells flooring products (resilient and wood) and ceiling systems (mineral fiber, fiberglass and metal) globally. The Company segments includes: Building Products, Resilient Flooring and Wood Flooring. The Company’s Building Products, Resilient Flooring, Wood Flooring and Cabinets segments sell products for use in the home. Its products are used in new home construction and existing home renovation work. Its products, primarily ceilings and Resilient Flooring, are used in commercial and institutional buildings."

London Value Investor Conference Notes 2014: Morfit, Hawkins, Yacktman & More

Today we're pleased to present notes from the London Value Investor Conference 2014 that just took place benefiting School Aid to improve the quality of education in Africa.  Enjoy! 


Mason Morfit – ValueAct

Mason Morfit is a partner with activist manager ValueAct Capital.  ValueAct has held 75 core investments since inception in 2000.  Roughly half of these core investments (37) have resulted in a board seat. Unusually in the activist world, 36 of the 37 board positions have come via invitation rather than a proxy contest.  Mason Morfit has recently resigned his seat on the board at Valeant Pharmaceuticals.  Valeant was the highest returning investment in ValueAct’s history. 

Morfit is now focusing his energy on Microsoft where he took up a board seat earlier this year. The networks that ValueAct has built up over the years by sitting on boards has been a major contributor to their success.  Morfit said that gaining the Microsoft board seat while owning a relatively small amount of the company’s equity was the culmination of this work.  He mentioned that their contacts with people at Seagate and AT&T were particularly important in landing the seat. Interestingly, Morfit talked about ValueAct’s investment in Adobe which they started in 2011. Morfit seemed to suggest that there were similarities between the Adobe and Microsoft cases.  ValueAct has had success at Adobe partly due to the introduction of annual subscription charges for its leading software, Photoshop.  Is it possible that the subscription model could be pursued at Microsoft with, for example, Microsoft Office?

Executive compensation is a very important lever for ValueAct. Morfit said that their research shows that executive pay is not well connected to company performance. One of the key strategies they pursue is to put pressure on companies to directly tie CEO pay to shareholder returns. ValueAct are happy for CEO’s to receive high levels of compensation for high shareholder returns but they should only receive small sums for average and poor shareholder returns. ValueAct prefer CEO’s to own a significant amount of the company’s stock and in the Valeant case they succeeded in getting CEO, Michael Pearson, to borrow money to buy Valeant shares.

Another interesting fact that came out of Morfit’s presentation was that whilst he thinks the activist space is getting very crowed at present they have only bumped into another activist once and that was recently with Carl Icahn at Ebay.  ValueAct subsequently sold their stock quickly and moved on.

Morfit said that the UK offers a very good environment for activists to operate in as there are no regulations against large investors talking to one another. In the past, ValueAct has been involved with Misys and Invensys in the UK.  He admitted that they find mainland Europe a harder nut to crack but that he expects them to do more work there during the next ten years.

For more from ValueAct, we've previously posted Morfit's lectures on activist investing.


Mason Hawkins – Southeastern Asset Management 

Mason Hawkins said that if you want to outperform you must invest in companies with good leadership.  Finding high quality partners is even more important now that there is less value in the market.  He finds it relatively easy to identify investments at a good price but picking great business leaders is harder. Getting the people right is the hardest part.  He recommended William Thorndike’s book the “The Outsiders” as an excellent guide to how to identify successful CEOs. 

He pointed out that Southeastern has sometimes misjudged managements and in those cases they are prepared to get involved to put things right.  Southeastern has taken an activist stance many times over the years, filing twenty four 13Ds.  In the last year alone it has been involved in activist campaigns with four companies in the US: Level 3, ACS Group, Texas Instruments and Chesapeake Energy. In the previous year they were involved in gruelling battles with Dell and Olympus in Japan. 


Donald Yacktman – Yacktman Asset Management 

Perhaps the biggest piece of news from Don Yacktman was that during the Q&A he said they had recently been out buying Samsung Electronics.  He said the stock is currently very cheap. Yacktman talked about valuing stocks as bonds, a subject he has covered before. He sees value as a function of future cash flows. His funds like to invest in predictable businesses as this allow them to more accurately project cash flows into the future.  They like high returns on tangible assets at a reasonable price. Another interesting snippet from Yacktman was that they always vote against stock options as remuneration for management. 


David Samra – Artisan Partners 

Samra said that it is hard to find good ideas at the moment and that his best idea and largest holding was cash. Long Compass Group (LON:CPG). The company has a dominant position in the contract food and support services market. Great management, good growth, potential margin upside. They bought in 2009 at 11x earnings. Compass now trades at 19x earnings.

Long Samsung Electronics.  Samra said that he thought that Samsung was cheap compared to US companies like Apple.  Samsung is trading on a PE of 6.6 with a strong balance sheet and lots of cash. He likes the management team and is not worried that the company is family controlled.

Long Aker Solutions (OSL:AKVER). An oil services company which is going through restructuring. Sells for 0.6 of 2013 revenues and 11.6x 2013 operating income. The company is protected by entry barriers.

Long Chubb Corporation (NYQ:CB). A property and casualty insurer with low leverage, disciplined underwriting and a good track record over time.  It trades at 1.5 book value and 2013 10.7x PE.  It should trade at x2 book value. 


Aled Smith – M&G Investments 

Long: Ingredion (NYSE:INGR) Ex-quant, Aled Smith argued that the secret sauce for stock picking is not to be found in numbers and spreadsheets but in the qualitative aspects of today’s complex businesses.   He pitched Ingredion, formerly Corn Products International, a global manufacturer and supplier of starch and sweetener ingredients to food and beverage producers. Smith particularly rates the CEO, Ilene Gordon who he argues has increased innovation, cut waste, reduced injuries and introduced a continuous improvement culture. Ingredion is moving away from sugar to higher value added products.  Smith also likes the oligopolistic qualities of the business.  M&G own 1m shares which they purchased in March this year. 


Tim Hartch – Brown Brothers Harriman 

Tim Hartch focuses on high quality and resilient businesses with a durable competitive advantage. He requires a margin of safety in the region of 75% of intrinsic value.

Long: Zoetis (NYSE:ZTS) Zoetis was spun out of Pfizer in early 2013. Hartch purchased shares in Q1 2014 between $28-30. He values the company in the low $40s.  Zoetis is the world’s leading animal health company. They sell products to poultry farmers, ranchers, vets and cat and dog owners.  Sales relating to livestock account for 65% of the business whilst the animal companion market accounts for 35%. The pet and livestock market is growing driven by global population growth and growing global wealth. Unlike human health care, governments are not exerting downward pressure on costs. The customer base is loyal. Zoetis has the largest R&D budget in animal health. The company is diversified with over 300 different medicines, vaccines and services and is not dependent on a few big drugs. 

Long: Svenska Handlesbanken (Sweden).  This is a Swedish based bank that provides services for private and corporate customers.  The bank has been run conservatively and had a good financial crisis. Hartch likes the simplicity of the way they do business.  They make money from traditional banking. Local managers operate what they refer to as the 2church tower model “ where  local managers get to know their local clients.  Most Swedish towns have a church with a tower and the idea is the bank only serves the local community that can be seen by climbing to the top of the tower. Despite the traditional approach, Svenska Handlesbanken has the highest return on capital amongst banks in Sweden. Unusually, the bank does not pay bonuses but instead staff are rewarded via promotion. Capital ratios are good. The bank has entered the UK market over the last 12 years, opening 25-30 branches per year and now has 170 branches in total. Many customers in the UK are dissatisfied with the performance of British banks and Hartch thinks that the UK could become Svenska Handlesbanken’s most profitable market.


Andrew Cormie – Eastspring Investments 

Andrew Cormie argued that Asia Pacific region (excluding Japan) is currently cheap at 1.6x price/book.  He noted that historically when Asian markets have been priced this way returns have been positive over a one, three and five year time horizon.  Long: Bank of China (BoC) and Noble Group (Singapore) 


Philip Best & Marc Saint John Webb – Argos Investment Managers 

Best and Webb are deep value, Graham and Dodd style managers that specialise in buying things that most fund managers would not touch. Since inception in Dec 2007 they have returned 331% compared to the Euromoney European Smaller Companies index return of 192%  They like small, illiquid stocks, family owed stocks, orphan stocks, failed IPOs, fallen angels (once high flying growth companies that have fallen to earth and become hated).  They are not necessarily afraid of value traps and actively look for situations that make other investors fearful. Long: Donegal  Investment Group (Ireland); Camellia (LON:CAM); Les Nouveaux Constructeurs (France); Biesse (Italy); Hochdorf (Switzerland). 


Jonathan Mills – Metropolis Capital 

Jonathan Mills said that he agrees with Warren Buffett that it is better to buy a great business at a reasonable price but in the current market he is finding it a challenge to identify wide moat businesses with a margin of safety. Mills' answer to the problem is to consider a narrow moat business if it is what he calls “owner occupied”.

An owner occupied company is one where the founder has a significant ownership stake. Mills said that public markets do not distinguish between companies that are owner occupied and those that are not.  Yet a study by Bain & Co has shown that between 2002 and 2012 companies with founder traits outperformed the S&P 500 by three times. Mills says that founders tend to have long time horizons, be good capital allocators, are customer focused, restless innovators and keep costs down.

Long: Admiral Group (LON:ADM).  Admiral floated in 2004 and the founders Henry Engelhardt and David Stevens are still there. Since the IPO it has paid out dividends of over £1.4bn (current dividend yield 7%).  Admiral uses a capital light model and therefore should not be valued on book.  It is trading at 2013 13x PE – at the lower end of range for Admiral historically. 


Andrew Hollingworth – HollAnd Advisors 

Long: Buckle( NAS:BKE). Buckle is a retailer of casual apparel, footwear, and accessories. Return on Net Tangible Assets, last ten years avg 47%. Sales per share growth last 10 years 10.2% compounded. Management shareholding approx. 40%. Around 90% of net income has been returned to shareholders in the last 4 years. All growth has been organic (no acquisitions). 2013 13.4x PE. EV/EBIT 7.8x.  Eleven analysts cover the stock but there are no buy ratings at the moment. 


Charles Heenan – Kennox Strategic Value 

Long: Fujikon Industrial Holdings (Hong Kong).  Founded in 1983.  Heenan likes to see a long-term track record. Fujikon is primarily a manufacturer of headphones and headsets. Historic yield of 10%.  Strong balance sheet, 50% cash holding and no debt. In terms of historic PE values Fujikon has a 5 year average PE 11x and 10 yr average of 9x.  2014 10.13x PE. 


This concludes the notes from the London Value Investor Conference 2014.  If you missed it, we've also posted up notes from the Sohn Conference, that took place recently as well as the Next Wave Sohn Conference.

ValueAct Capital Acquires More Microsoft Shares

Jeff Ubben's hedge fund firm ValueAct Capital has filed a Form 4 with the SEC regarding their stake in Microsoft (MSFT).  Per the filing, ValueAct has acquired over 2.9 million shares on May 8th and 9th at prices ranging from $39.49 to $39.59.

This comes in addition to the 66.8 million shares ValueAct already owns.

Recently, we highlighted that ValueAct's Mason Morfit stepped down from Valeant Pharmaceuticals' board and the hedge fund will also likely be reducing their stake.

Morfit is now on Microsoft's board as they look to push the company in the right direction after new CEO Satya Nadella has replaced Steve Ballmer.

Per Google Finance, Microsoft is "engaged in developing, licensing and supporting a range of software products and services. The Company operates in five segments: Windows & Windows Live Division (Windows Division), Server and Tools, Online Services Division (OSD), Microsoft Business Division (MBD), and Entertainment and Devices Division (EDD). The Company’s products include operating systems for personal computers (PCs), servers, phones, and other intelligent devices; server applications for distributed computing environments; productivity applications; business solution applications; desktop and server management tools; software development tools; video games, and online advertising."

ValueAct Steps Down From Valeant Board, To Trim Position

ValueAct Capital filed an amended 13D with the SEC regarding their position in Valeant Pharmaceuticals (VRX).  Per the filing, they note that Mason Morfit will be stepping down from the board of directors.

The key takeaway here is that ValueAct says they're doing this in order to trim their position size because they have a "practice of reducing portfolio weightings in companies where we no longer serve on the board of directors."

Their current stake is valued at approximately $2.5 billion and the letter specifically references that they'd like to still maintain "more than $1 billion in shares."  As far as the timetable of their sales, the letter hints that they might choose to sell some of their stake "later this year."


Mason Morfit's Letter to Valeant

Here's the full letter of his resignation:

"Dear Mike, 

I am hereby resigning effective today as a director of Valeant Pharmaceuticals International. 

As you know, ValueAct Capital has been a shareholder of Valeant Pharmaceuticals since 2006 and I have been a member of the board of directors since 2007. My team and I are proud to have worked with you and to have been a part of tremendous value creation for all shareholders. As I have told you, after seven years on the board of directors, and with my new position on the board of directors of Microsoft, the time has come for me to reallocate my time to other board work. The company is in an extremely strong position and I feel good about the future of Valeant. 

Due to the company?s strategy, there have been very long periods during which we have not been able to buy and sell shares. Most recently, ValueAct Capital has been restricted from selling any shares in Valeant since June 2013, during which time the stock has risen from $85 to $135. Beginning in February 2014, I expressed to you and the board my desire to manage down this position in our fund (currently approximately $2.5 billion out of our $14 billion in assets under management). By resigning today, with the Allergan transaction in the public domain and with Valeant?s earnings report later this week, this will create an opportunity for ValueAct Capital to sell if we choose (of course depending on stock price) later this year. Serving out the remaining term of my board service, could potentially create additional delays and complications, particularly if Allergan enters into negotiations with Valeant. 

To reiterate, we are making a portfolio management decision, not a decision about Valeant?s fundamental business, future performance or the merits of the Allergan deal.  ValueAct Capital has a practice of reducing portfolio weightings in companies where we no longer serve on the board of directors. We have done this consistently since our inception in 2000. That being said, after my resignation we still plan to be large Valeant shareholders for some time. We currently plan to hold more than $1 billion in shares and Valeant should remain one of our top positions. I wish you, your team and my board colleagues all the best and look forward to many more years of extraordinary performance.  Sincerely,  /s/ G. Mason Morfit"


For more on ValueAct, head to Jeff Ubben on Valeant in his recent interview as well as Mason Morfit's lecture on activist investing.

Mason Morfit (ValueAct Capital): Lectures on Activist Investing

Mason Morfit of ValueAct Capital gave three lectures on activist investing a few years ago with Abe Friedman at the Stanford School of Law.  They were a part of the Stanford Rock Center Series on Shareholder Activism: How it began and how it's reshaping today's investment landscape.

The entire videos are below, but here's some takeaways:


- The academic literature on activism only captures the tip of the iceberg of what really goes on behind the scenes

- Morfit and Friedman really push the idea that changes in corporate governance have increased the amount of activism.  They argue that the sector will continue to grow in the future.

- ValueAct did not have its current model of engagement worked out at the beginning in 2000.  Even they floundered around, finding their way.  Morfit's account of ValueAct's interaction with Martha Stewart (lecture 1) and Chiron and Acxiom is entertaining (lecture 3) as Morfit admits various errors.

- In lecture 2, Morfit talks about how a 32-year old can move a room full of experienced managers.  He says that ValueAct tries to bring information into the boardroom.  They've met with everyone in the industry, inside and out.  They've met with customers, suppliers, gone to trade shows, met all the CEOs, weeded through everyone's strategies, and listened to all the conference calls.  He says it's amazing what can happen when you give the board good information as they rarely have this info.


Mason Morfit Lectures on Activist Investing

Lecture 1: Activist Investing: Background, Impact and the Players


Lecture 2: Non-contested Situations in Activism


Lecture 3: Contested Situations: Proxy Fights, PR Wars and Activist Defense




For more on this hedge fund, we've posted ValueAct's recent portfolio activity here.

Notes From Excellence in Investing San Francisco 2013: Burbank, McGuire, Billick & More

The 4th annual Excellence in Investing: San Francisco conference took place this week and MarketFolly was there to cover the event.  Excellence SF partners with the Sohn Conference Foundation and is dedicated to the support of education and other children's causes.

It's not too late to make donations and here's a link to do so,  The success of the event has grown over time and this year marked record attendance.  Since inception, more than $1 million has now been raised in support of these causes.


Notes From Excellence in Investing: San Francisco 2013


John Burbank III -  Passport Capital

Idea: Long Digital Garage (TYO:4819) 

Thesis:  Things seem frothy now.  Like plays linked to innovation.  The QE fueled rally is likely coming to an end.  Stay away from growth coming from and derived from QE.  Tech is less sensitive to GDP.  Innovation is not EM activity, it is DM activity.  In Japan Abe says follow Abenomics.  Likes Digital Garage.  It has around a 20% stake in Kakaku (TYO:2371).  Owns small stake in Twitter (possibly $100M).  CEO owns 14% of the company.  Stock just split.  Thinks it has a 22% upside to current value PLUS optionality on the future.  Can hedge out Kakaku if you want given that company's high valuation.   Burbank also recently had a macro discussion with Kyle Bass that we've posted as well.


Kurt Billick -  Bocage Capital

Idea: Long Domestic Oil Refineries (specifically Tesoro (TSO) & Marathon Petroleum (MPC))

Thesis:  Likes Malcolm's presentation on CF (below) as his idea has a similar theme, but with refineries.  North American oil business was thought of as mature and in structural decline.  Gulf coast's ability to refine oil will be overwhelmed with supply.  Discount in price of oil for US refineries is less than that of all of the margin for many refineries in rest of globe.  Other advantages are processing costs lower due to cheaper natural gas and financial arbitrage.  Likes all refineries (ALJ, DK, HFC, MPC, PBF, TSO, VLO and WNR).  His favorites are Tesoro (TSO) and Marathon Petroleum (MPC).  TSO is still in early stages of getting discounted crude.  Dan Loeb's Third Point has also written their thesis on TSO in a past letter.  MPC is a recent spinoff with management just now getting in tune with running as a standalone refiner.   Billick also recently appeared on a best ideas panel at another conference that you can read about at that link.


Mick McGuire -  Marcato Capital Management

Idea: Long Sotheby's (BID) 

Thesis:  Owns 7% of the stock.  These are their first public comments regarding the investment.  Capital has not been allocated well.  Core business is good.  Lots of opportunity to unlock value of real estate.  There are under-utilized assets.  Thinks stock is worth $68 which is more than 30% above current price.  One of two major auction houses with Christie's.  Has been falling behind Christie's in some areas.  Opportunity for improvement there with the income statement.  Regarding the balance sheet, opportunity to unlock value with the real estate holdings.  They've been growing the lending business with after tax profits from the auction business.  Instead they should be funding this with other facilities like securitization or receivables.  Dealer segment not big, but performance there is symbolic of poor capital allocation.  $1.3B in trapped equity with poor opportunities for reinvestment.  This money should be returned to shareholders through buybacks, etc.  You can view McGuire's slideshow presentation on Sotheby's here.  


Mason Morfit -  ValueAct Capital

Idea: Incentive Based Investing

Thesis:  Many companies have perverse incentives in place right now.  He prefers to reward to performers, not caretakers.  One of the problems with financial metric based performance is that management sets targets.  They have implemented changes at Valeant Pharmaceuticals (VRX) and Adobe with significant increases in price after the changes.  Note that ValueAct recently trimmed their ADBE stake.


Christopher James -  Partner Fund Management

Idea: Long Adobe (ADBE) 

Thesis:  Mobility is impacting marketing and advertising.  Spending is migrating to mobile, social and online marketing.  Emergence of "Marketing Cloud".  Closed Loop Marketing... key players are becoming SalesForce (CRM) and Adobe.  Both are focusing on this trend and building platforms and making acquisitions to establish dominant platforms.  Adobe has been moving from traditional software model to SAAS.  Better economics with this newer model as acquisition costs are low and renewals are high.  Thinks they can do $3 in FCF in 2015 and $4 in FCF in 2016. 


David Herro - Harris Associates

Idea: Long Select European Equities (Credit Suisse, BMW Group, Diageo) 

Thesis:  Looks for opportunities from Mr. Market where price is significantly below intrinsic value.  Use a discounted cash flow model to calculate intrinsic value.  Likes European equities.  Fixed exchange rates caused distortions.  Very different micro-economic policies by country in EU create bottlenecks to adjustment.  Unit labor costs in Europe declining.  Debt yields are dropping.  Competitiveness is increasing.  Europe trades at a discount.  Consider European companies based there, but with global or US reach.  Europe is good at luxury.  Likes Credit Suisse as it is trading at less than 10 times normalized earnings.  BMW Group has over 20% of profit from China.  EV to EBITDA is less than 6.  Weathered the recession very well.  Diageo (DEO) is the world's largest premium spirits and beverage company.  Yield is over 3%.  Great business for the long, long term.  


Malcolm Fairbairn -  Ascend Capital

Idea: Long CF Industries (CF)  

Thesis:  Based largely on dynamics relating to natural gas and nitrogen.  China is the largest producer and user of NatGas.  Nitrogen demand growing 2% a year.  Futures suggest price doesn't break $5 until 2020.  CF benefits from low prices.  CF has leading margins but trades at discount to peers.  Recently increased dividend.  Thinks price could be $250 based on the peer group's 3.8% yield with a 50% earnings payout.   We've also posted Third Point's thesis on CF from their past letter.


Christopher Lord -  Criterion Capital Management

Idea: Long Tower Companies (American Tower (AMT), Crown Castle (CCI) and SBA Communications (SBAC)) 

Thesis:  Last years pick was Google.  Things look frothy now.  Likes "Towers".  Seen a 35x increase in mobile traffic the last six years.  Estimates the increase will have been 430x for ten year period ending 2017.  Towers are winners.  The US is going from 2 top cell carriers to 3 or 4.  Tower companies build towers and cell carriers pay most of the other costs.  These businesses can't be replaced.  Best real estate is already taken.  There are also restrictions on new towers.  Contracts also have automatic price escalators.   Given that models have high operating leverage, much of the price increases go straight to bottom line of the towers.  Picks are AMT with a target of $110, CCI with a target of $100, and SBAC with a target of $110.  Right now these companies are trading at lower multiples to other types of REITs, but they have higher growth rates.  Bonus thoughts: likes shorting 3D printers, Cree (CREE), SAAS Cloud Companies trading at greater than 20x Revenues, Cisco (CSCO), EMC (EMC), VM Ware (VMW).


Brian Zied -  Charter Bridge Capital Management

Idea: Long Brunswick (BC) 

Thesis:  Charter Bridge runs a long/short fund.  Prior to founding the firm, Zied was at Maverick Capital.  He focuses on consumer driven small and mid-size businesses.  Brunswick focused on Marine, Fitness, Bowling and Billiards.  Strong in engine business.  Attractive investment with many ways to win (depressed boat cycle, marine innovation, restructuring opportunity).  There is a 40 year history of boat sales.  For a long time new boat sales were between 300K and 500K boats a year.  Boat cycle was at 120K at the bottom of recession, now at 150K boats a year.  Participation in boating is at an all-time high.  Boats have a 25 to 30 year life.  There are 200K boats being scrapped per year.  Obviously, these trends are going to run in to each other with new boat sales rising.  Revenues still haven't come back from pre-crisis levels.  Innovation in GPS sky hook anchoring and joystick controls.  Precrisis boat revs were greater than $2B, now only at $1B...the recovery is inevitable.  Typically new boat sales are 25% of annual boat sales, right now they are only 16%.  Largest position in their portfolio.  Brunswick is currently at 7.4x EBITDA and 14.9x PE whereas most peers average 10.5x EBITDA and 17.4X PE.  Sees a free call option with 50% to 80% upside.


Carl Kawaja -  Capital Research Company

Idea: Long EADS (EAD) 

Thesis:  Flight is still a modern miracle that many don't appreciate.  Likes companies that solve problems.  Planes are BIG.  This business has a moat that won't get disrupted by three kids in a dorm room (like social media).  Majority of world flies less than once a year.  Air travel won't revert to mean, it will just continue to grow.  The business of airlines is getting better.  Fuel efficiency is driving sales of new planes and will increase profits for manufacturers.  Thoughts on valuation:  1) Earnings will grow... a lot.  Many of the upfront costs already incurred for R&D.  2) They will get more orders...addressable market is more than $1T with a $800B backlog.  Market cap is $51B... PV of future ops alone is worth more than $64B.  Sees stock doubling over time.


Michael Moe -  GSV Capital

Idea: Long Twitter (TWTR)  

Thesis:  From 1991 to 2000, there were 550 IPOs per year.  Following decade has seen an average of 113 IPOs per year.  Before market caps were around $100M at time of IPO, now they are on average over $1B.  This means VC firms must invest longer before firms go public.  In 2013, IPOs are performing very strong.  GSV is a public vehicle for VC stage companies.  Twitter is his idea.  They currently have a position in it.  It is 15% of the fund.  Ad growth of 124%.  There are 620 million shares outstanding.  At $25 a share the market cap is about $15.5B.  Positive cash flow the first half of 2013.  Participating in multiple trends including:  Social, Personal Branding, Mobile, Second Screen Watching TV, Next Gen Devices.  Mobile usage has now surpassed desktop usage.  Vine (Twitter owned) is #1 App.  Thinks it could go as high as $160 a share.  


Christopher Balding -  HSBC Business School  

Idea: Macro Call of Short China 

Thesis:  He's an Associate Professor of Finance and Economics at the HSBC Business School of Peking University Graduate School.  A lot of data from China is manipulated.  China is a huge bubble.  Example of bad reporting is growth numbers.  Growth reported from provinces aggregates to 10.8% growth whereas official GDP from China is 7.8%.  Another example: official CPI housing price inflation up 14% while real estate prices up 111%.  Price in income ratio for real estate in San Francisco is 9.4.  This seems high, but it is 32 in Shenzhen.  The official numbers say that steel companies in China have $500B in debt and only $300M in profits.  Would be very careful before simply taking financial and economic data at face value.  Banks in China are starved for capital right now.  There is risk dispersion.  2/3rds of the stocks in China have been really hurt while 1/3rd are trading at a premium.  Example is BYD trading at a P/E of 1,100.  If you don't want to short China directly, another option is shorting China derivative plays like companies in Australia heavily tied to China. We've also posted up Jim Chanos' short China thesis as well for those interested.


That wraps up notes from Excellence in Investing: San Francisco 2013.  For more coverage on top hedge funds, scroll through the hedge fund letters we've posted up recently.