The Investor's Consigliere

Family Foresight Hall of Fame: The Wallenberg Family

Amazingly, per this Economist article the Wallenberg family is in its fifth generation and remains on top of Sweden Inc.--and in a socialist country no less.  Investor AB, the Wallenberg's investment holding company, is in its way one of the most successful family offices, with actively managed interests in listed companies, private equity, and hedge funds. 

And if you'll permit me to get personal, the family gets much extra credit for producing this man.

By the way, although the Swedish stock market is down 58.1% in dollar terms since Dec 31, 2007, it is the unlikely holder of the highest real return record of all the major stock markets in the 1900-2000 period, at 8.2% annualized.

Inflation Hedge Trade

Tyler Cowen blogs about the market's inflation expectations as reflected in the spread between Treasuries and TIPS.

I'd be more likely to take the other side of that trade: go long TIPS and short Treasuries, maybe on the 10-year (see the comment from "fusion").  Down the road--whenever that is--I fear inflation could be the cost of the many government bailouts, maybe very bad inflation.  If you can finance it properly, it looks like a cheap hedge.

Ticketmaster Update

In September I blogged about the ongoing strategic chess game between Ticketmaster and Live Nation, in particular Live Nation's attempt to use its dominance of the concert promotion business to build its new ticket sales business.

Ticketmaster just made its latest move, buying Front Line Management, considered the most powerful artist-management company. 

Like the entertainment industry itself, this fight will be more fun to watch than to invest in, so I don't have a position.  I predict lots of overpaying, ego clashes, and shareholder-unfriendly actions.

More on Ticketmaster

In July I blogged about Ticketmaster as a potential investment idea.  Today's WSJ has an article on the company and its client-turned-biggest-competitor Live Nation. 

Live Nation's competitive strategy in a nutshell:

People close to the situation said Live Nation pressed an advantage it has over Ticketmaster and other competitors during the negotiations. As the largest purveyor of concerts at major venues, it is in a position to offer more events to venues that sign up for its new ticketing service -- and potentially to steer big shows away from venues that don't cooperate.

That sounds like tying and it's not nice.  Where is Judge Thomas Penfield Jackson when you need him?

Ticketmaster's competitive strategy in a nutshell:

Ticketmaster has long-term contracts with venues, giving it exclusive rights to sell tickets. The company makes its money on service charges and other fees. It has been able to maintain its dominant position by paying its client venues a portion of the fees it collects, and by installing proprietary technology that would be difficult to replicate.

Who wins?  I don't know enough yet to make a bet.

Ticketmaster

I'm going to look at Ticketmaster when it spins off from IAC/InterActiveCorp.  I think there is a potential for a Joel Greenblatt-type undervaluation (see ch. 3 of this book).  The thesis is:

1. Spun-off companies in general tend to trade down.
2. Ticketmaster will be saddled with $750mm in debt as it starts its independent life, which may scare away investors but, conversely, provides upside leverage.
3. Ticketmaster is dominant in its industry, unlike most spinoffs.  There appear to be high barriers to entry due to scale and required technology investment.  I need to do more work on this
4. Live Nation has announced it will start to compete with Ticketmaster beginning next year.  This may also scare away Ticketmaster investors.  It will be a good test of Ticketmaster's competitive position though.  Bernard Arnault's struggles with the art auctioneer Phillips, de Pury confirmed the dominance of Sotheby's and Christie's.  Live Nation may do the same.

Did you know that Jay Pritzker owned Ticketmaster from 1982 to 1993?

Pzena and Fannie Mae

Richard Pzena is a well-known value investor.  His firm, Pzena Investment Management, Inc. (Ticker PZN) is one of the few value shops that's public.  Joel Greenblatt, a very very well-known value investor, is on the board and is a big shareholder.  I attended the company's annual meeting a few weeks ago and was impressed with Mr. Pzena and his team.  He does not pay himself outlandishly, unlike some public "value investors", redefined as:  you the shareholder do the investing and the CEO gets all the value. 

PZN's stock is way down recently.  This is because its AUM is way down, which in turn is because its performance is way down.  Its performance is way down largely because it has made a big bet on financials. 

I'm very intrigued by PZN and plan to do more research.  If all goes well there is the potential for a "quadruple dip" in the stock price:

1. Its performance record improves, increasing its "organic" AUM and revenue
2. Improved performance attracts new AUM and revenue
3. The inherent operating leverage of the asset management industry produces disproportionate gains in income--you get more than a dollar of increased income per additional dollar of revenue generated
4. The market re-evaluates PZN's future earnings potential based on its new and improved AUM and income profile

I know in some ways PZN follows a "naive" value investing strategy.  In this case I don't use the word "naive" in the sense of being unintelligent, but rather in the sense that their first filter is to look only at stocks that are statistically cheap, without paying much attention to the type of business they're looking at.  Having done that, they then zero in on the business itself.  I believe you can probably beat the market by following only a naive value strategy--I think Fama and French showed this--but before I'd invest in PZN I'd like to get a sense of how well it does the second part: the analysis of businesses.

Fortunately for me, PZN has "gone public" with its business analysis on a number of occasions.  They did a presentation on Citigroup for a conference a few months ago (you can ask Whitney Tilson to email it to you), and they wrote this letter to Barron's on Fannie Mae in March, back when it was trading at $22 a share.  If I can convince myself PZN is a smart business analyst, even if it ends up being wrong on FNM and C, then I'd likely invest. 

 

El-Erian and Family Offices

The first three-quarters of Mohamed El-Erian's regular FT column are devoted to how terrible things are in the markets.  In the last part, however, he addresses where he thinks the opportunities lie:

So much for the summary characterisation of today's highly dualistic investment outlook. How about the implications for investment strategies? Interestingly, they differ significantly depending on where your investible capital stands with respect to some key structural attributes - an insight that also speaks to why we are likely to see more market volatility.

The answer lies in a phased, multi-quarter approach by investors that benefit from the following structural attributes: a high degree of capital permanency that steers clear of the need to finance sudden withdrawals; a willingness to take long-term views that can be sustained through wild market swings; and a process that accommodates opportunities that, in some cases, do not fit well into traditional classifications of asset classes.

If you possess these structural attributes, today's markets offer opportunities that are high up in the capital structure and that, in a few years, will be looked on as having constituted incredible bargains. If you don't, you are well advised to stay on the sidelines, focused on the probability that these same markets will also be treacherous for at least the remainder of this year.

El-Erian used to manage the Harvard University Endowment, an entity that fits perfectly his description of the kind of investor that can profit greatly from today's turmoil.  The fundamental attributes are 

a) The ability to invest with a long-term outlook and endure interim volatility

b) Permanent capital not subject to lender calls or temporary asset value declines

c) The ability to look at things that don't fit neatly into one investment category

I believe that family offices also fit this description.  It's a good time for them to take advantage of the structural advantages they and university endowments and Berkshire Hathaway have, and which the vast majority of investors--those currently setting market prices at the margin--lack.

Given you have these structural advantages, where should you look?  El-Erian states the opportunities are "high up in the capital structure" so I don't think he means equities.  More likely he means corporate senior debt which offers the best combination of high near-term misery and volatility and low risk of permanent capital loss--in other words, they either won't default or are well-covered in the event of default.  To find the first, go where the most trouble is--companies exposed to housing, high oil prices, weak consumer spending.  To find the second you just have to do some credit analysis homework.  I've got a company in mind right now that I'm doing some work on.  Stay tuned.

Another possibility is to honor the late John Templeton, who made a lot of money by buying 104 of the lowest-priced stocks he could find on the eve of WWII and just holding them for a few years.  Look for the most beaten-up sectors or asset classes, maybe even the more esoteric ones like CLOs and CDOs tied to subprime housing, hold your nose and close your eyes, buy them without any leverage, and wait five years. 

How to Defeat the Tyranny of Growth

Forget about the bear market.  Let's keep the focus where it belongs--on beer.  Today's WSJ has an article on the troubles family-owned Mexican brewer Grupo Modelo S.A. is facing in today's beer industry.

I get a little annoyed by this article--and others like it, which I read all the time--because while its premise is pretty clear--that Modelo's days as an independent company are numbered, it never clearly states why.  Instead it uses vague statements like the following:

• "He and his tradition-bound company are struggling to adapt to sweeping changes in the beer industry."
• " . . . fewer and bigger players in the capital-intensive industry."
• "The world is changing around them . . ."
• "Modelo is going to face more and more pressure to go beyond its Mexican-centric view . . ."
• "Modelo's independence is threatened by deals they didn't do."

without any further explanation.

Why doesn't the article simply say "Modelo cannot remain independent because of XYZ, and if it does here is what will happen."  In my opinion there is nothing in the article that proves that a company like Modelo, 45% owned by its founding families, with a dominant market share, has to sell out to a consolidator like InBev or SABMiller or else.  If scale is all-important then say so.  If InBev could come in and take away share with its superior capital resources and new brands then say so.  If size is necessary to deal with big box retailers like Wal-Mart de Mexico (one of the main factors behind the P&G--Gillette merger, for instance), then say so.  If Modelo is being mismanaged and would be worth more in other hands, a la BUD, then say so.  The article does none of this.

As far as I can tell the best argument is the following:  Public companies, even those with huge inside ownership and that are performing well, must all make a devil's bargain.  In exchange for the benefits of public ownership--greatly enhanced liquidity and the ability to have tomorrow's profits travel back in time to today's stock price (what the modern Adam Smith called "supercurrency")--companies must submit to the demands of "spotty-faced youths who live on another planet where growth-at-any-price is the only deity" (that's Felix Dennis, and he has a point.  I'm a former spotty-faced youth myself).  Public companies must grow, their stock prices must rise--even well-run companies whose very success means they've grown all they can--otherwise someone will come along to take them out in the belief that they can do what existing management could not. 

Does this have to be so?  Is there no way for a successful but no-longer-growing public company to escape the tyranny of growth?  Couldn't it turn itself into a kind of industrial master limited partnership and simply pay out all of its earnings as dividends?  It would then trade at a yield commensurate with its excellence and low risk, shareholders would be rewarded--perhaps with bond-like returns, but with bond-like risk, and the family management would maintain its independence while enjoying the liquidity and supercurrency benefits of public ownership. 

Until that day comes, of course, the best thing for such a company to do is sell to Berkshire Hathaway. 

Investment Idea: Private Equity and Japan (and a Book Review)

Though my background is in hedge funds, I've been training my consigliere muscles to see if they can be useful in the world of private equity.  My working hypothesis is that the private markets/public markets distinction is kind of an illusion, that my ability to evaluate a business and its management, make sure it's behaving like a long-term owner, and avoid overpaying can be applied to public companies as well as private ones, or even to VC investments.  If you look at it this way, Wal-Mart under Sam Walton was essentially a private equity investment, even though the company was public.  Conversely, a PE deal like Hertz in hindsight looks more like a stock trade.  The point is, its the skill set that matters, not the label.

So I'm trying to learn about private equity and the people who do it well.  Coincidentally, I'm also interested in Japanese private equity in particular:  There is this chart on page 23 of the 5/20/08 edition of Outstanding Investor Digest that tracks the Nikkei 225 Index vs. Japanese 10-yr government bonds since 1986.  It basically shows that stocks have gone nowhere, while bond yields have trended down.  If you assume that the earnings of Corporate Japan have been increasing, albeit slowly, throughout this period, then that implies that the earnings yield (the inverse of the PE ratio) of the Nikkei has been trending up.  It also implies that the spread between the corporate earnings yield and corporate borrowing rates (which key off government bond interest rates) is historically high.  PE firms make their living by borrowing at low rates and investing at high earnings yields, so this should be a good time for PE in Japan, right?

So I have two projects:  a) Studying the great PE investors and b) investigating PE in Japan. 

This book helped me do both:  Saving the Sun:  How Wall Street Mavericks Shook Up Japan's Financial World and Made Billions by Gillian Tett of the FT.  A lot of it is specific to Japanese banks but it's interesting nonetheless.

By the way, here's an FT profile of Flowers by Tett from October 2007.

Here's a short announcement about Morgan Stanley strengthening its Japanese private equity business.

Thai Bev

This one is for the future, maybe the distant future:

An article in today's WSJ about political protests in Thailand reminded me of a company I've been watching from afar, Thai Bev.  It's the dominant brewer in Thailand but it's listed in Singapore. 

I see this model in a bunch of other countries where beer is not a "native" product: one company manages to become "the national beer of ______" and makes a lot of money:  Think of Quilmes in Argentina or Bavaria in Colombia, or South African Breweries (Castle), or Efes in Turkey, or the Fix brewery in Greece going back a ways (although Fix may have been granted a monopoly by the King of Greece, himself a German import, in which case never mind).  It's usually lager beer, and everyone complains how it tastes like water and/or something worse, but it has a 50%+ market share, tastes really good on a hot day in the tropics or on the beach, and its owner winds up selling out to InBev or SAB/Miller and showing up on the Forbes List.  Like this guy:

So a dominant beer in a given country can be a very good business.  By the way, why is there a tendency towards natural and stable monopoly in beer?  I think there are two "tipping points" that create increasing returns to scale which, once established, confer more or less permanent competitive advantage.  The first is in distribution, which is a big cost.  The company that establishes the lowest distribution costs per unit of volume has an advantage, which tends to increase over time as volume grows.  The second is in marketing and promotion.  Anheuser-Busch made the following point in its 2005 annual letter:

Anheuser Busch sells 2.5 times as much beer as our nearest competitor in the United States.  We are 4 times as large as the third-ranked brewer.  This allows us to maintain the leading share of voice with our advertising, including a powerful array of major sports marketing and media properties. But we are still able to keep the lowest media cost per barrel.

Back to Thai Bev.  It's already dominant in Thailand so it can't really grow much more there, but its position is extremely strong.  It earns high returns on equity and assets, has been deleveraging, is committed to shareholder transparency, and pays out over 50% of earnings as cash (think of Buffett and PetroChina).  According to its web site it currently yields about 5.6%, which is good but not great for the "equity bond" that I see it as so I'll keep watching.  It's expanding overseas as well, which I'll call a free option worth something between zero and a lot, but won't pay anything for.