Berkshire System Summit 2018
Don Wurster- President of National Indemnity
Biggest
mistakes in career
1980 – biggest
mistake, thought that underwriting profits
would be the same, underestimated change in industry
1982 – 60 million
in premium income
1986 – 360
million
Assumed success
would continue, didn’t anticipate the decline in margins of the 80’s
Importance of float
and ROI ßReserves of return Underwriting profit
ß Compensation
Buffett specifically told Don not to compensate people based on sales volume,
there would be a no lay
off policy, so there would
be no pressure to meet
a certain amount
of sales.
The most important thing is
underwriting discipline.
Commercial auto insurance will always work in cycles.
This is especially appreciated by someone
who has been in the industry for over 17 years. This
allows him to take a long term
view.
The
best/highest year on year growth was 70%
Don does not believe in social security. It screws future
generations. It is a pyramid
scheme. “Rip off your
grandchildren scheme”
If you could
put a silver bullet in one company,
which one would
that be? Progressive. Peter Lewis has built a fantastic company.
He has trained
many MBAs with no experience to become great
product managers, and has done great
things for the stock of his company.
Told them to always think in what situations would
benefit shareholders and that all CEOs should
be low profile and not grant media interviews.
How Don hires people—
10 years from
now, will I be happy or annoyed with person X?
Lawrence Cunningham
BRK
Criteria for acquisition
-Minimum
Earnings of 5-75 million
-
Proven Profitability
-
Good unleveraged returns
-
Management in place
-
Basic business at fair price
Commitments
-Permanence
-Autonomy
-Decentralization
Berkshire has more individuals than institutional investors, and even the institutional investors like Tom Russo, are long term oriented
Lawrence is on the board of Constellation
software
Geometric growth is the magic of compounding interest and tax deferred growth Most annual
letters are written
by “ghosts”, not the actual
CEO
Mark O’Hare
Accounting Past
Valuation of the future is uncertain
-
Select attractive, predictable outcomes
-
Sustainable competitive advantage
-
Good price, honest management
Kevin Clayton, CEO of Clayton
Homes
2008 Kevin Clayton
tried to find alternative sources
of capital. He wanted to find cheaper
sources, and thought of Buffett.
Argues
with Buffet on purchase price,
suggested $20, Buffett
said $12.5. He said he would have
to talk with his board of directors.
At the time, 11x in pre-tax
earnings, 157 million
in pre-tax profit,
no debt and had future
cash flows which were predictable with no capital
problems.
Eventually gave in to $12.5.
Sold to BRK for 1.7 Billion.
After being acquired
by Berkshire…
Review balance sheet,
compensation, capital expenditure, cash flow, income
statement Buffett gives him an unlimited amount
of capital for
acquisitions and expansions.
Always think about what would destroy the moat at Clayton Homes.
Kevin has a mature and
engaged workforce. He has provided
them with extra
benefits, cafeteria, and hates staff turnover.
Berkshire is like a community. When
Berkshire needed IT help at headquarters, Clayton
Homes offered their IT team. Clayton homes also had a tax expert who goes up to HQ.
Nation’s
largest manufactured home
lender and financer. An average modular
home – new site building costs about
$400,000. Home ownership is only 63% and this
goes back to 1963.
Greg
Abel stresses long
term planning. Pay
and compensation is based on pre-tax profit,
not ebitda. Clayton homes is not high end or premium.
NPR uses options to own land.
Goal is to become an asset light model
home builder.
6 homebuilders were acquired in the last decade. 2 reached out to them. 4 were approached. All had
best practices of the industry.
60 days
to build without
backlog. 30 days
out of inventory. It takes
2 years to get the
land ready to build.
Why not build for disabled people?
Maybe in the future, but right now,
it would disrupt
assembly line.
Why can’t Clayton
Homes be international? Road infrastructure is not as good in third world nations.
Some countries also
specialize in automation, but they are still not
as affordable as Clayton Homes.
Ron Olson – One of the founders of Olson Tolles &
Munger
Helped with See’s Candy
acquisition
Mayo Clinic, Yahoo,
Google shareholder structure, Google restructuring to ABC, 3G dealings, Heinz
Kraft, etc.
Helps with staged
acquisitions. Buffett lies when he says he goes in with a handshake. He has to draft
and think about all the terms for Berkshire Hathaway.
Makes you really rethink if Buffett really relies on a "handshake" deal when Olson, Tolles & Munger drafts the terms and conditions.
Bad news travels
faster than good news.
Heinz
3G capital Jorge
Paulo Lehman uses
zero based dollar
budgeting – more discipline than
Berkshire, but
pisses a lot of old timers off because they get fired…
Jorge actually doesn’t
have to try to hire and find new talent-- Carlos Rito àAMB Busch has great
managers due to the 1000 scholarships Jorge granted earlier
Google’s recapitalization – dual class
shares- Sergei and
Larry wanted independence and super voting power early
on. They wanted
their shares and insiders to outvote outsiders 10 votes to 1.
During IPO they
had 37% voting power. Today they have even more voting power, 57%.
Does a lot of high tech cases, Intel
and the security
scandal with cloud
storage and the AMD scandal (Lisa Su),
Nvidia’s IP. Out of all tech companies, servers and cloud
storage seems to provide the greatest
margins with recurring profits.
Looks up to Brian
of Intel, but audience still
thinks he’s a crook. Linus
Torvold, the creator
of linux got ripped off. Somehow shares
of a certain company were sold to Brian.
High tech
acquisitions in automation – Acquisition of Israel for automated driving
startups.
Story
about Templeton Whiskey
– Started in hog houses
in the prohibition era. Al-Capone really
liked it and bought them by carrying
them in hearses.
Jeffrey Matthews Berkshire’s
successes and failures
IBM failure not
like American Express
Reasons
not to invest in Berkshire for the next
53 years? Annual value creation
Google is the
leader—3/4 trillion in assets
Berkshire 60Billion in insurance premiums
½ Geico ½ resinsurance
Profitable in underwriting for 14 years
Float
¼ trillion in stocks and bonds
Sales and services
125 billion
3 main
operations—
Manufacturing 50 Billion
pre-tax margins (Matthews claims this is still not great…)
Service and retailing 25 billion
Mclane 50 Billion
Railroad and
Energy 40 Billion
Finance and financial products 8 Billion
For Berkshire to make a dent in share price,
it would need
to increase and
compound in non-insurance group with one or more huge acquisitions
Matthews sees a
6 billion dollar upside for the non-insurance group. Net-net attractive.
Markel Meeting 2018
Tom Gayner Co-CEO Richie Whitt Co-CEO
Anne Waleski CFO
3 acquisitions 2 insurance and 1 on the venture
side Surety
à Flushes distribution systems
Bob Freeman
Critical
strategic deal
Acquisition à culture of buying
and paying for 5-7 times
expectation of EBITDA After tax rates are lower, they
aim for double
digit returns with no leverage Does the business
being acquired have
a runway? Is it non-capital intensive?
Recommends book by Peter Bernstein— Against the Gods Exposure is more than expected value
Danahar model vs Berkshire model
(25 people at HQ)
Incentive System
Time à Longer time horizon, paid over a 5 year basis
Fixed
fortifications & monuments show the stupidity of mankind – Geroge Patton
No assurance of Markel’s success,
“we can only do our
best” Transparency is important for Markel.
Exxon
Mobile—Harder to make money in the long term
All models and
plans are wrong,
some are useful
Plans to build a new office in Munich, Germany.
Appoints Frederick Wolff as officer
of the German division
Paid claims with
cash & 2 other acquisitions
Liquidity is good,
explains and audience’s question about poor
EPS, Gayner proceeds
to give an example
of Home Depot. Home Depot
was bought in 2008. Repurchased stock at market
price. Shareholder’s equity was negative,
yet economic value
is still fine.
So is the cash flow.
He claims that
a situation like
this may make
book value per share and EPS misleading. He claims
that Disney, after
its acquisition of star wars
and marvel, is still cheap.
College
thesis of Disneyland after Walt died and Eisner
took over. Was very pessimistic, could not envision it being what it is today.
Markel’s values—measured in aggregate with
purchase accounting and
amortization 2/3 of the debt in Markel
is owned to other entities
at Markel
Tells
audience to look at the shareholder structure and corporate governance at Facebook and Google
Recommends the book
Chocolate Wars – Deborah and Cadbury
Not for the takeover 1860
Treated employees well like current
Google. Free food,
perks etc. Another book recommendation – In Chocolate we trust.
Recommends Shoe
Dog- Nike Founder Phil Knight
Markel in 1990
only had 6 shareholders come to the AGM.
Admires Brookfield Asset
management, especially in the early
80’s. Talks about the History of Markel.
Markel Family – 4 brothers Valued Markel
at 4 million dollars. 4 brothers
à part of 12 members
Alan Kershner, Steve
Markel, Tony Markel,
all bought common
stock and received coupons from bonds. Tried a leveraged buyout by the 2nd generation.
Gayner
was fascinated by Brooksfield asset
management and the Canadian tax structure. Went
to Toronto to investigate more about turning
ordinary businesses into
Real Estate Investment Trusts. He met George and Brian Watson.
Brookfield use
to be called Brasscan.
An audience member
asks why Markel
is not in Aviation. Richie
says insurance in aviation is always
underpriced.
An LLC with a fixed tax structure and
a 30/70 structure which B-Corps have,
are bad for
shareholders.
After the speech,
an audience member
approaches Richie, asks
why Anne, the CFO, has
not mentioned about her retirement after 26 years.
He says it is personal, and she went
through 2 divorces.
Richie
specifically mentions about not wanting
to write more things with a catastrophe risk. He does acknowledge cyber risk has a potential to be a good field.
He says
insurance is being increasingly commoditized and that the moats are shrinking.
RLI corp was mentioned. He talks about
the importance of acknowledging tail risk and underwriting
profit.
Richie wants
the reinsurance business
to be a smaller part
of the portfolio and goes on to rant
about the subscription market.
Richie has
walked away from a 120 million account.
He says
not everything is given in the annual
report, as they
don’t want to give competitors too much info.
He says that
premiums and invested
leverage is going
down. The cost
is going to be driven
out of insurance.
Cyber, floods,
and drones are going to be potential new fields in the upcoming years.
Berkshire Value Investor Conference 2018
Elevation Capital
Christopher Swasbrook
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Elevation Capital
has been an investor in Tiffany’s since 2011/2012, does not believe they will disappear over night.
Tiffany's has been with a bad CEO in a difficult industry. Chris views 2017 as a pivotal year since the CEO was fired after two years.
They have not capitalized on their heritage and they are making
changes: pop up stores, luggage, fragrances, etc. Brand would be
virtually impossible to recreate.
Jana Partners is now the major shareholder.
Previous
transactions have seen companies like this sell for up to 25x EV/EBITDA.
Chris was surprised that
Buffett loaned Tiffany’s money but didn’t buy it. (Could there be more to this story? Please comment if you know)
Too
expensive for Berkshire...
doing the same thing?
Chris claims this is different because Coach became too
reliant on discount
outlets which ruined
their pricing power.
10%.
JANA Partners
would not want a quick flip. I think they want
to grow EBITDA first.
That’s how I
get to my valuation of USD170 per share.
Procurement and
Advertising.
Cartier.
Your investment seems
to rest on the company
being taken over.
Why should that
happen now?
LVMH has been
busy cleaning its own house.
Richemont was
unprepared to pay goodwill.
Kering wasn’t
able to raise enough cash by selling Puma.
Any threat of substitution?
It’s possible but
unlikely.
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SouthEastern Capital
Stanley Cates
|
The best feature of Southeastern is our client
alignment: employees must do all their stock
investing
through the
company’s funds.
This has made the
employees of the funds the funds’ largest client.
Look at the
title of this presentation: all aspects of Southeastern’s approach are out of
favor:
Common Stocks, Value Investing, Long Term, Active
Ideas which are
being penalized because of short-term headwinds
Comcast
broadband
subscriptions matter much more than short term declines in linear TV subscribers
Mattel
great IP + ability to outsource production
To practice investing this way, you need the right clients. Southeastern’s average client
tenure is seventeen years.
Buying assets
at a discount is out of favor compared to qualitative analysis. And yes,
putting a pin-point valuation on a company ignores contingencies and a
company’s evolution.
Buffett’s comments
have steered investors towards emphasizing qualitative factors in favor
of looking at the price paid - which is a very important
factor.
Paying a low multiple says that we cannot predict
the future and
guarding ourselves against
bad outcomes. Multiples are just shorthand for a DCF,
most of the value of which comes
from the terminal
value. We treat
terminal values very seriously; it’s hard to determine which businesses will
survive.
If you look at “moat investors” and assess their
ability to predict
a moat’s sustainability, their batting
averages have not been good. And they have
usually been bailed out by rising multiples.
It’s hard to find
good ideas which marry qualitative and quantitative. Southeastern
only finds two to three good ideas each year.
Current ideas:
CenturyLink: Metro Fibre Assets, Park Hotels and Resources: Hilton Hawaiian Village, Hikma: Injectables
Private Equity
may have an information advantage but public equity
can have a price advantage when buying from forced
sellers.
Can you comment on cord-cutting?
It’s definitely
important for companies like Comcast.
It represents
10-15% of EBITDA.
But it’s not
enough to damage the whole company or justify the current multiple.
It’s less relevant
for CenturyLink because
Consumer was such a small part of their business
relative to Enterprise.
There are fewer
public companies today.
What’s your take
and how does
it affect your
business?
It’s not good
for us to have a smaller universe.
We were very frustrated when Dell went private; some of the arguments in favor of privatization
were genuine,
some weren’t.
they use cash to pay off debt?
We are aware of
that.The company’s
capital expenditures are very smart-- it only invests if it can add to an existing network.
Management were
confident they could grow and continue to pay a dividend. And the debt is
very cheap, so why repay it?
In South
Africa where I’m from, companies only report every
six months. Would
it be better for US companies
to do the same?
Probably. Quarterly
reporting leads to strange behavior. We prefer our
companies not to give any guidance of any kind.
A lot of
mistakes... we’ve come out OK now. A
lot of the problem was the mis-perception between VIP/Junkets and Mass.
The headlines
only focused on VIP because it was sensational. But it was low
margin business..
We like to find
ideas with massive controversy... but where there really isn’t any controversy.
A
lot of people asked us what insight we had on the Chinese government’s
anti-corruption campaign... but what mattered was Mass, and that was driven by
consumer trends.
Another lesson
was thinking about how quants affect the market.
Quants might
look at historic
multiples and judge
whether the current
price is within
that range...
But the past
was really not a useful
guide to the future because
the mix of business had shifted so dramatically and actually improved
in terms of sustainability...
What’s your view of portfolio
companies’ M&A?
It really
depends on the management team.We trust
Berkshire and Cheung Kong 100%.
But then
there are other
companies where we do test management’s theses... e.g. Comcast bidding
for SKYTV in the
UK.
And it’s
worth bearing in mind that each deal
and situation is unique... as outside investors, we don’t
always have the
full information set.
It’s a new
investment. We’ve followed
United Technologies for a while and it taught us a lot about GE.
GE’s Aviation
business is an incredible operation, as is its Healthcare business. And these are
not the areas where the crazy accounting took place. Furthermore, the new CEO
has made good
progress in the
last few months,
e.g. firing the long-time
CFO.
We see spin-offs
on the horizon driven by Trian Partners - they have a “religious belief” that
conglomerates are
bad. It’s just going
to take a while...
And not many people will be willing to bet on GE because
it’s going to take a few years
for the strengths of the business
to show through... but I think
that’s a very
high probability outcome.
Has it become
harder to make long term projections?
Yes. But we never
put too much emphasis on long term projections.
We own Alphabet
and I would say that it’s got very good odds of surviving.
FedEx is another compounder which is cheap because there
is too much emphasis put on the potential for disruption from
Amazon, even though
that is a very low probability outcome.
What do you think of Buffett’s advice
to use a 20 year
investment horizon?
“We do not work
with a guy who would like that” - Mason Hawkins?
We don’t put much
faith in long term projections.
3-5 years seems to be a reasonable horizon
over which to make forecasts.
But that said,
there have been companies which we’ve held for decades as they keep proving
themselves.
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Giverny Capital
Francious Rochon
An investor can
has four tools:
Science, History, Art, and Finance
But scientists
are trained to use the past as a guide to the future. And scientists
are trained to gather facts, not to judge them.
Finally,
scientists are trained to be precise and right. But investors
must be imprecise and accept that they will be wrong.
Mastering an
art form:
Study the master. As a painter paints,
an investor invests. Find your own voice
What do the
masters have in common?
Stocks are a part ownership in real businesses
Used the stock market’s
irrationality to their
advantage
All had their own ‘style’ - no one’s portfolio was the same
All had a long term horizon
How not to beat
the index?
Think the same way
Own lots of companies
Try to predict the market
What has Giverny
done differently?
Think
for yourself
Own just a few stocks (wow, 25 seems a lot for a few...)
Develop the right behaviours: rationality, humility
and patience
Stock selection
process:
·
Look at financial strength: ROE > 15% + EPS
growth > 10% + Debt/profit ratio n < 4x
Business model: market leader
+ competitive advantage + low cyclicality
Management team: high level of
ownership + constructive acquisitions + good capital allocation
Market valuation: 5 year
valuation model + try to purchase at half the future price
(i.e. aim for a 15% CAGR)
Looking for gems:
Art and beauty are inter-related How can we define
beauty
An example of a
gem: Walt Disney
Mickey is never
going away... and he doesn’t have to be paid!
Great portfolio
of new IP, e.g. Marvel.
Not sure
if it can grow earnings at the same
rate as before... but should be able to manage 8-11%.
Another
example: Constellation Software. Read the CEO’s
letters and thought he was pretty great.
Mark Leonard
is really determined to make alignment work between management and shareholder.
Another
example: Carmax. Bought shares
in 2007, 2011 and 2016.
[Went through
an 80% drawdown in 2008!]
Learning good
behaviours:
We try every year to rank our three best mistakes. It helps our learning.
We try to stay rational. We try not to worry
about market fluctuations.
Patience: the ability to keep a good attitude
while waiting. Focus on what’s
happening to
the company, not its share price
The Rule of
Three:
·
One year out of three, the stock market
will decline by 10%
·
One stock purchased out of three will not perform as expected
·
One year out of three, we will underperform the index
Is Disney
ready for Bob Iger to leave?
When the 21st
C. Fox merger was announced, Iger agreed to stay until 2021.
So we get at
least three more years with him.
How concentrated is your portfolio? How do you size positions?
We have 25
holdings.
We start with a
1-2% investment and then build up.We usually
don’t go over 10%.
One exception
is BRK because we believe that it is very diversified itself.
Does your universe of Gems change
much?
Capitalism
produces change, constantly.
You have to
accept that change is inevitable.
We have
a watchlist of about 120 companies; every
year, 5 or so come
off and 5 or so come on.
Facebook is an
example of a company which has made me change my mind.
When do
you sell?
We sell when
expected future returns get to single digits or below.
But there is a
risk of underestimating a company and selling too early.
Peter Lynch
warned against pulling flowers and watering weeds.
The biggest
mistakes are stocks that I should have bought but didn’t because of valuation.
For example,
SBUX had a 14x PE in 1994... and has since gone up 500x.
I consider it a
mistake when I understand the company; it’s not a mistake when I didn’t.
Yes, it forms
part of our future return expectation. Normally though
we don’t invest for yield.
I buy when I
believe that I can at least double my money in the next five years.
Low valuations
add to the margin of safety.
How do you decide on how much cash to hold?
We try to be
fully invested at all times.
|
|
Professor Sanjay Bakshi
|
Two examples of
why I transitioned from quantitative to qualitative analysis.
Ambika Cotton
Mills:
In the same
industry as the original BRK. It should be
terrible!
Features:
27% OCF / net operating assets
No debt
Stable margins imply pricing
power
No new shares issued
since 2005
1% of industry revenue
but 10% of earnings
How does it do
so well?
It has found a
great niche. India is the
world’s second largest cotton producer but Ambika imports cotton.
It produces
cotton for some of the West’s most well known brands.
The founder is
a reliable partner and is obsessed with quality.
In a commoditised
industry, he has created switching costs in his customers’ minds.
A parallel is
YKK, the zipper manufacturer.
In business,
it’s true: you get the reputation you deserve.
There are brands
in B2B businesses too.
And the B2B
businesses with brands tend to be underpriced compared to B2C businesses.
Read: “Hidden
Champions of the 21st Century” by Hermann Simon.
Think of the formula: A = P * (1 + R / 100) ^ n
Actions which
increase R, the rate of return, might reduce n, the length of compounding.
But you might
wish to accept a lower R in exchange for a longer n.
Compounding
machines should have a good R and a phenomenal n.
BRK has a
reputational advantage which allows it to be the ‘buyer of choice’.
This has saved shareholders billions of dollars
over time, even
if some purchases have resulted in losses, e.g. Dexter Shoes.
So if you buy
BRK, you’re not just buying the businesses they own today.
You’re buying
their reputation and the opportunity it affords them.
It’s an
optionality which should be included in your calculation of intrinsic value.
And if the value
of that option is greater
than the assets
held today, it should be the focus
of your
research... even
if it’s impossible to value.
See the paper,
“Investing in the Unknown and the Unknowable”.
Investors
generally shun uncertainty.
So find people
who are good at navigating it for you.
Shouldn’t we assume that
BRK will continue
to be a ‘buyer of choice’ even
after Warren and Charlie
leave?
Shouldn’t we
give some value to the cash on BRK’s balance sheet?
In the right
hands, cash should be valued at greater than its reported value.
Thomas Cook
India:
Purchased by Prem
Watsa when its parent was in distress.
Fairfax is
using it as an acquisition vehicle in India.
One of their
largest investments is in Quess, a leader in temporary staffing.
Paid the fees
to get the private company accounts to understand what Quess was doing.
It is buying
small companies earning 40% ROIC for 3-4x PE and consolidating the industry.
Quess has
become a ‘buyer of choice’.
And it has a
permanent home in Thomas Cook India - not like private equity.
Its best days
lie ahead.
Success is rare in companies which
rely on inorganic growth but there
is a pattern amongst them.
Quess displays
signs of that pattern.
· Owner operator
·
Master of his game
·
Scalable opportunity
·
A process
·
A pipeline
·
A permanent home
·
Providing more capital
·
Getting incentives right
·
A man/woman of unquestionable integrity
·
A stock market which misunderstands or under-appreciates the significant option
value that the above can create
How do we
quantify this option value then?
We can’t just go
by faith.
Some thoughts:
·
Recognize situations where optionality exists
·
Ensure there is a process
·
Check for a track record
·
Ask for a long runway
·
Look for the right incentives
·
Wait for the market
to offer you the right
price
Reputation is a hard to copy
Good point.The two do not
have the same culture.
Maybe BRK is
doing it the right way by being a financial partner.
But maybe
3G has a point too: there is a lot of fat in these
companies created by agency conflicts.
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Housatonic Partners Wrote "the outsiders"
William Thorndike
There are three
sources of capital: operations, equity and debt.
And there are five uses
of capital: investment, acquisitions, dividends, stock
repurchases and paying down debt.The Outsiders
understood this and used it to their advantage to maximise value per share.
Lack of good
data.
Capital
allocation only works with a long investment horizon.
Look for
younger CEOs with P&L experience but the first time they are earning
equity.
Longer holding
period than the average PE firm.
William focused more on share
repurchases. One-page
templates for investment decisions. It took William eight years to write the book: one chapter a year.
I expected it
to be like ‘Money Masters’-- lots of different ways to achieve success.
But actually,
all eight CEOs have shared a lot in common.
They focused on
opportunistically buying back shares, selected projects with good roi, minimizing taxes
On buybacks, corporate America is horrible
at timing buybacks: companies buy at the top (e.g. 2007 and 2017) and then do nothing
at the bottom (e.g. 2009). Buybacks should
not be a mechanical decision.
Buybacks should
be regarded as investments in their own right and compete for capital against alternative options.
How do we identify a good capital
allocator?
There is no
single sign. But if someone
has a good track record, you can critique their decisions and their results.
In the absence
of a track record, listen for how they describe their business.
Do they look
for ‘per share’ results? Do they talk
about IRRs?
Have they
created any unique metrics showing an understanding of their business?
You mentioned
Bob Iger.
He had good
lineage since he came from Capital Cities.
He is very close
with Tom Murphy. He likes
decentralised capital allocation.
Eisner, his
predecessor had come from Disney’s creative side. Iger was purely
rational.
Capital Cities
owned all the great old media businesses when they were still great businesses.
They were
swimming in free cash flow.
In all of
Capital Cities’ sub-markets, they would have the #1 news franchise.
And
that earned the most money because it attracted all the eyeballs and didn’t
have to split revenue with the network. They were thrifty
but they weren’t cheap.
Charlie’s choice
was Jim Sinegal from Costco.
What did you think?
A very good
capital allocator. Every single
dollar of FCF went into new stores.
He didn’t need to
do anything else.
He didn’t yet
have the tenure at the time. And I was trying
to avoid founders of unique businesses.
Was there anyone
you wanted to include but couldn’t?
Leucadia
National.
We got 80% of the
way through a chapter but the co-founders wouldn’t talk to us.
The process
would probably be the same.
I’d like to
write an expanded edition with an international section.
Please send me
your ideas!
There are some
companies even if they don’t meet the twenty year tenure test.
NVR
Credit
Acceptance Corp
Constellation
Software
Transdigm
Arch REIT
Markel
Fairfax
White Mountains
Brookfield Asset
Management
They were
included in our calculations. But in general,
the group did not pay dividends.
They were
cautious about establishing a dividend because it constrained future decisions.
Interesting
opportunity and I liked the country.
I’ve seen potential Outsiders operating in bad industries. What’s your
advice: should I back the jockey or the horse?
I back the horse,
generally.
But then
there are commoditized or cyclical industries in which great firms emerge that make a moat
out of capital allocation.
National
Indemnity is a great example.
It has to
permeate the culture and the incentives need to match.
Amazon probably
is closest to fitting the bill.
But we probably
need a bit more time to assess it.
And we’d need to
identify its peer group.
What do you think of service companies which are investing a lot but where you see it in the P&L, not the cash flow statement?
This is a new
phenomenon.
Yes, I
recognize its importance.
And Bezos’
letters really help to understand this.
Focus on per
share outcomes.
There needs to
be a mix of short- and long-term outcomes.
Simplicity is a
powerful design principle.
And they need to
evaluate areas over which the subject has control.
A stock price
is a very blunt instrument; it can be hard to gauge correlation.
I think stock
options thoughtfully done can be a powerful tool.
They’re not
evil...
Go and have a
look at Credit Acceptance’s compensation plan... it’s very special.
They believe in
Economic Value Added.
Which candidates were close but didn’t make
the final 8?
It was mostly for
reasons of tenure, i.e. they didn’t have a 20 year track record.
The family
which runs the Boston Globe was close...
Brookfield’s Bruce
Flatt could have
been a candidate but he hadn’t
been in the
job long enough.
For every one
of our companies, we do an annual review over our five year forecasts.
And we look at
our expected returns on a sale from that point.
If it’s
a great business which we understand well and where
we like the management... we tend to hold.
But in the
current market, we’re selling a lot.
Even if the businesses grow, we think
multiples will contract, leaving us with
a similar valuation.
Almost all of
them had a strong #2.
The degree of
decentralisation required a lot of trust.
It
self-selected for entrepreneurs.
And that
entrepreneurial culture tended to outlast the individuals.
An analogy is
comparing the history of former French and British colonies.
The French were
very centralised and their colonies haven’t done well.
The British
were very decentralised and they tended
to have adapted
well to new circumstances.
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Brookfield Asset Managment
Bruce Flatt
How are you similar
to Berkshire?
We are value
investors.
But we differ
in that we are global.
We have a team
which brings in a pipeline of deals.
We don’t have float per se; we use our balance sheet but also bring
in outside capital from institutional investors.
Your portfolio is more Real Estate oriented now. Are you more vulnerable to a down
cycle?
We have four
main areas and thirty countries into which we will invest.
We direct our
investment towards where we see value.
In 2008, we saw
a lot of value in Hydro and Renewables.
After that, we
saw value in US Real Estate.
And of course,
we do look at the financing and debt profile of each asset.
It seems like private Real Estate is very cheap
relative to public
Real Estate. What do you think?
Public valuations
are probably 20-30% off fair value.
So either the
stocks are too cheap or the assets are valued too high.
There are a
couple of things going on in the stock markets for real estate.
Outflows from
REITs are significant.
This has put a
lot of pressure on valuations.
People are
worried about interest rates going up.
But we believe
that the earnings of these assets will go up much faster than interest
expenses.
That said, if
there’s a recession, valuations will be marked down.
We don’t see
any business in the US which show signs of distress.
Actually,
they’re all doing well.
People can get
confused, and often ask, ‘what is the cap rate?’
The greatest
value however is in development or redevelopment.
We are a net
worth investor, not a yield investor.
We want to increase
the cash flows
of the asset over the long term because that will ultimately increase the value of the assets.
We would be willing
to take cash flows on an asset down to zero if it meant that it could increase future value.
We had a mall in
Oakland we bought for USD50m earning USD5m.
We razed it and
are developing residential units.
It will take
years to complete... but should be worth USD500-700m once done.
We couldn’t
have done that if all we cared about was maintaining a yield.
How will you close the discount on Brookfield Properties?
It’s an unusual stock
because a) it doesn’t fit into any normal index;
b) it has been involved
in some complicated deals.
The asset is
compounding along and I’m confident that we hope that the stock’s valuation
will
eventually reach
par.
We buy what’s
cheap and sell what’s not.
We bought
regulated utilities during the GFC because they were cheap.
We’ve recently
been switching from regulated utilities into operational businesses as a hedge
against
inflation.
FX is critical. We now have a
team of FX specialists which manage the risk for the whole company.
It’s
interesting: cheap assets usually coincide with cheap currencies.
So we get a
double-kick.
Which would be a better
investment over the next ten years: an investment in Brookfield or your holding company?
The holding
company is intended
for our partners to invest in the company
in a tax efficient way.
It’s not liquid
and we don’t really care if it trades.
So I’d
recommend Brookfield itself.
The biggest
component people miss when valuing asset managers is the carry.
The carry is
very significant.
But it’s hard
to model and so people assume it won’t come.
But it does and
it’s lucrative: we get 20% of very dollar of profit.
You have to
trust that we will earn profits and that carry will come...
The asset management business will be more valuable
in a few years than it is today “because
of the stacking of our funds”.
It’s getting
harder and harder to raise money... but we can do it.
It’s hard.
We are in some
countries with standards that differ from the US etc.
But have a look at our record: we’ve
been in Brazil
for 25 years and haven’t
been implicated in any
corruption
scandals.
Who is going to buy your assets now that your
industry is so consolidated?
Actually, the industry is still pretty fragmented... even if the
asset managers themselves are consolidated.
Sovereign funds
often invest on their own account.
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