The Chiefs of Value – Two In-depth Interviews With Greenberg And Shapiro (Part 1)

Glenn Greenberg and John Shapiro of Chieftain Capital are legends in every sense of the word. Although now split into two firms, Chieftain – when Shapiro and Greenberg were together – had perhaps one of the best long-term track records of all time.

Their strategy was simple: unearth good companies at cheap prices, establish concentrated positions in them and sit on your hands whilst they compound in value. Nothing new. What the strategy lacked in complexity, it made up for in outperformance. From 1984 to 2000, according to Bruce Greenwald’s Value Investing: From Graham to Buffett and Beyond, the pair averaged a 25% p.a. gross returns. Not too shabby!

Whilst I’m unaware of Mr. Shapiro’s performance after the (unfortunate) split, I’m told by friends that Glenn is still trouncing the S&P, with returns north of 17% since inception (inception being the 80′s!). Greenberg is apparently close to Lou Simpson of Berkshire/GEICO fame too (another investor we have covered here).

Here is an article about the firms split: ‘Investment Firm Splits in Two Over Internal Rifts’

Below are two profiles of Greenberg and Shapiro during their heyday. It covers the periods of 1987 and 1988 – i.e. before and after some great stock market hysteria. It details their picks and the thought process behind each stock:

Chieftain Capital Profiles (Part 1) – 1987 and 1988

A Long Interview With A Short Seller – John Hempton’s Hunt for Scumbags

Given this blog’s semi-Australian-base, it was about time we injected some National Pride into our posts. As far as we’re concerned, John Hempton is a true National treasure.

After a long stint at Platinum Asset Management, run by Australian investment legend and billionarie ‘Kerr Neilson’, John Hempton set out on his own in 2009 to form ‘Bronte Capital’ – thereby also creating the always insightful (and often controversial) investment blog of the same moniker.

$10,000 invested in Bronte Capital at inception in 2009 would now be worth around $37,000. Who knew finding pests could be so profitable?

Although Hempton’s succinct and illuminating views are circulated widely, the man himself – and his incredibly successful hedge fund – remain somewhat a mystery.

Without giving any more away, below is an hour-long audio interview with John Hempton (from last year) conducted by ‘The Intelligent Investor’; an Australian stock-market publication:

John Hempton’s Hunt For Scumbags – 2013 Interview with the Intelligent Investor (click for link)

Copyright © 2014 Intelligent Investor Share Advisor

For more on Bronte Capital, go to: http://brontecapital.com/ (tell them how you were referred)

For more on The Intelligent Investor Share Advisor: http://shares.intelligentinvestor.com.au/ (don’t tell them how you were referred).

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From Barron’s Roundtable to Berkshire’s Roundtable – A Meryl Witmer Compilation

So far we’ve shared Lou Simpson and Ted Weschler resources, why buck our own trend?

Meryl Witmer shot to (even more) fame recently after being hand-picked by Warren and Charlie to join the prestigious Berkshire Hathaway Board of Directors. Interestingly, Witmer herself is a very seasoned and astute stock-picker. Meryl ran a successful eponymous asset management firm before joining other legendary value-investors at Eagle Capital.

Witmer is most visible as a regular member of the ‘Barron’s Roundtable’ – a yearly event/column run by the magazine that features stock ideas from value-investing’s “hall of fame”  (the column has featured the likes of Peter Lynch, Mario Gabelli and Bill Gross in the past… often alongside Witmer).

The file below contains a compilation of Meryl Witmer’s stock picks from the 2002-2014 period. Reading through this, two things become very apparent: (1) Meryl Witmer’s stock picks on average trounce the market and (2) Meryl Witmer is smart…. scarily smart.

Meryl Witmer – A Barron’s Roundtable Compilation (2002-2014)

Ted’s Brief Moment of Grace – An Early Interview with Ted Weschler

Ted Weschler is an investor I really admire (for obvious reasons). However, admiring an extremely publicity-shy, yet shrewd investor is incredibly frustrating.

In case you’ve been under an investment rock, Ted Weschler was handpicked by Warren Buffett to manage part of Berkshire’s investments. Weschler’s story and involvement with Buffett/Berkshire is insightfully covered here by our old friends at BusinessWeek (although, I hope the title of this article isn’t too auspicious).

Much has been written about his big winners: DaVita, DirecTV, Valassis and W.R. Grace.  Each one multi-bagged… and then some.

No bigger winner existed in Weschler’s fund than W.R. Grace. Weschler piled into the stock for less than $3 per-share. Today, 12 years later, it’s touching $100 per-share. A $30m investment was transformed into a cool half-billion dollar holding. W.R. Grace has a special connection with Weschler – it was where he landed one of his first jobs. He was also instrumental in it’s bankruptcy (did I forget to mention that W.R Grace was technically bankrupt for most of Weschler’s investment?).

Here is a brief, early interview focusing exclusively on Weschler’s Grace investment. Weschler talks about bankruptcies in general and his simplified valuation of the company:

Ted Weschler – an Interview on W.R. Grace (2002)

Pavlov’s Margins – Thinking, Fast and Slow in Business and Investing

I went to a broker-hosted management meeting this morning with a retailer* (for the usual reasons, I wont disclose the company).

I’m sure non-Australian investors engage in a similar thing too: a broker will wheel out the management team from a particular company in front of a few of their institutional clients. The management team’s hand is held by an Investor Relations person who has gone to the trouble of preparing a glossy ‘Highlights of the Year Presentation’ ahead of time, a document that’s usually long on ‘presentation’ and short of true ‘highlights’. Then, the institutional investors ask some basic questions, the answers to which could have been easily gleaned from reading the annual report. The whole affair is rounded off with an exchange of business cards and hot beverages are provided by our friendly broker (unfortunately, the only person from the company’s side willing to hand over their business card to us investors is usually the aforementioned Investor Relations person).

Sometimes, if a broker really wants commissions, a nice complementary meal is provided afterwards (these meetings are the ones I unashamedly and regularly attend). Sometimes the company will, in an amazing spate of coincidence, use this same broker down the line for a capital-raising or rights issue.

In the relatively few I’ve been to, I’ve never seen a management team forecast prospects downwards (why would they tour the country, informing every investor of the terrible job they are doing?). So, my tactic is always the same: take notes sparingly, listen for comments from management about competitors or the industry or emerging companies/products and observe what other investors are hastily writing notes about.

Occasionally – very occasionally, you get an unintentional insight into a business that you can only understand upon reflection after the meeting. That happened today…

Kahneman’s System I and System II

Daniel Kahneman is the father of behavioural finance. Surely, by now you’ve read his book, Thinking, Fast and Slow – if you haven’t, drop everything, go to Amazon right now and slap yourself after purchasing it for being so slow to obtain this masterpiece in the first place.

In summary, Kahneman states that most of our follies occur because the human brain has two ways of thinking: System I and II. System I is fast, automatic, emotional, frequent, subconscious and stereotypical. It’s the type of thinking we needed to survive as caveman in our prehistoric past. System I is purely instinctive. System II – as you will know, since you’ve now read the book – involves more effort, uses more logic and is, importantly, slower. System II is purely analytical.

The Value Investor’s System I

Investors often use this analogous System I way of thinking too. For value investors, the bias that effects us most arises from Pavlovian conditioning (click for the Wiki page if this term is foreign). Such conditioning has been ingrained into us through years and years of scanning for the ugly, cheap or overlooked. Low P/B, high dividend yield or low EV/EBITDA are all stimulant metrics that ring a value-investor’s Pavlovian bell, causing us to salivate at the opportunity.

This way of thinking isn’t incredibly dangerous to us. Often, our Pavlovian instincts prove to be right. Statistically cheap stocks have been shown to outperform the broader market. However, sometimes it’s flawed. It doesn’t pick up loss-making divisions for example. If one division is earning $12m in EBITDA and another division is losing -$10m in EBITDA, then an Enterprise Value of $30m (15x EV/EBITDA) isnt necessarily expensive. If management  shut down that loss-making division, you’d be left with a business generating $12m in EBITDA (for a price of 2.5x EBITDA).

Business logic has a Pavlovian element to it as well. For example, consider the words ’70% margins’. Anyone, including myself, would be drawn to this if they saw such a proclamation in an annual report. However, purely focusing on high margins misses out on a bigger picture too. For example, high margins are meaningless without considering the degree of operating leverage within a company or the cyclical nature of some industries.

The Gore and Glory of Our System II

Thankfully, both investing and business share a common System II way of thinking: accounting. Accounting is the intricate, logical language of business. Even the most grandiose business strategy must eventually unravel itself in a company’s financial statements. If a company’s is waxing lyrical about it’s “brand”, then it must turn up in the accounts somewhere. Perhaps the company’s yearly advertising expense is higher than competitors, or maybe it can acquire customers for less than competitors, or maybe it’s revenues per-unit (i.e. the average sale price) is consistently higher than competitors – whatever the reason, merely stating you have an ‘excellent brand’ without accounting proof simply isn’t good enough.

Accounting, as much it pains me to say this fellow non-accountants, is also insightful into human behaviour. Every transaction recorded and every assumption used is a gateway into a manager’s mind. If a manager aggressively capitalises an asset today, for example, this assumption must unravel itself through write-downs in the future. Whatever entry a manager tries to dress up today must undress itself tomorrow.

However, this System II way of thinking is hard to adopt for investors too. As an accounting autodidact, this lesson has certainly not been lost on me. Often, converting the nuances of business into what should be seen on the accounting statements over time is a slow, arduous and counterintuitive process.

Translation Issues in the Language of Business

This gets me back to today’s meeting with the retailers (finally… sorry about the convolution). The retailer’s management team boasted that their goal was to stay “the lowest priced retailer” within the particular market they serve. “So far, I think we’ve succeeded”, gloated the CEO glancing up from his deck of powerpoint slides. “As a company”, he continued, “our position is getting stronger as the dominant player within this market… we have managed to implement gross margin increases for three consecutive years. If we continue like this, rapid increases in profitability will hopefully follow”.

The institutional investor’s cheered, congratulating him on his valiant effort. I too was initially impressed – retailing is a tough business and improving margins in the post-bricks-and-mortar world is no small achievement. But it was only on the way back to the office that I realised a discrepancy (ok, I’m sure you’ve picked this up ahead of me).

Basically speaking, gross margins are your selling prices minus what it cost you to acquire the goods from your suppliers (mathematically; Revenue – Cost of Goods Sold). If your margins are constantly improving, then you are selling goods for more and more each year than what it costs for you to purchase them. If your sole aim is to offer customers the lowest prices in the industry, then you have to pass on whatever savings you negotiate straight to your customers. So, ideally, your gross margins should remain the same or decrease every year if you wanted to build a true sustainable competitive advantage.

Low cost retailers drive their gross margins down to the lowest level possible in an attempt to boost turnover. It’s ok not to earn much money per customer, but if you can get the most customers, then you can still be extremely profitable. This is why they often operate from massive, dystopian warehouse-like stores: they can stock more inventory per-square foot and spread their operating costs over a larger floorspace. The customer wins because such a store has the best prices. The shareholders win because the company uses its humungous floorspace, combined with its low-overhead per-square-foot, to drive massive amounts of volume through the store and, ultimately, this rockets it’s returns on capital through the roof.

Further, having the lowest costs drives more volume – since more customers are attracted to the store’s prices – more volume implies more haggling power over suppliers (ok, a lot more haggling power: click for link**). More haggling power, you guessed it, means lower prices still. This business model is an incredibly virtuous cycle.

The somewhat theoretical “lowest-cost retailer” statement from the CEO seemed cognisant of a System I way of thinking and the “increasing margins consistently” seemed completely devoid of any System II logic.

A (Small) Hypothesis Test

I didn’t believe myself (after all, maybe it was me using System I thinking). Could it really be that this retailer’s margin strategy was actually doing the opposite of what they desired? Then I found this graph plotting the margins of ‘the father of all low-cost retailers’, Wal-Mart (taken from www.studentofvalue.com):

WMT-GM

Click picture to enlarge

The top blue line is Wal-Mart’s (WMT) gross margin since it’s IPO. In WMT’s early years of rapidly growing dominance, gross-margins clearly remained stable or fell. If I told you ahead of time that by owning a company which dropped it’s gross margin every other year, Sam Walton would become one of the richest men in history, would you believe me? I wonder how many value-investors, forever swayed by their System I/Pavlovian bells, steered clear of this stock early on?

Interestingly, WMT’s margins started increasing rapidly from, say, 2002 onwards. This margin expansion occurred up until around 2010. Now, I’ve (unfortunately) taken enough statistics subjects in my time to know the difference between ‘correlation’ and ‘causation’. I also know that there are a billion influences on a company over time, but: eerily, between 2002 and 2010 (inclusive of the great market rally of ’03 to ’07) WMT’s stock went nowhere (unadjusted for dividends) as it’s margins increased over the same period.

Ok, enough conspiracy, my basic realisation is this: ‘improving’ margins don’t always mean ‘increasing’ margins… and ‘cheap’ stocks don’t always mean ‘statically cheap‘ stocks. Investing in a world of low-cost brokerage accounts, complex stock screening software, dizzying-Excel-spreadsheets, CNBC’s, Bloomberg phone apps and, dare I say it, investment blogs can often tempt us into relying on System I thinking much more than we realise. Maybe, more often than is actually done nowadays by us new and snobby value-investors, our portfolios would be far better off if we sat down, took deeper breaths, turned off our screens and used our System II tools before rushing out to buy the next low-cost retailer. “All man’s miseries”, explained Blaise Pascal, “derive from not being able to sit in a quite room alone”.

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*after numerous comments, I realise I may have been too vague/inaccurate in my description. This retailer was pursuing a low-price strategy in an “everyday low prices” sense of the word. The retailing industry commonly refers to this as a low-marup, high volume model. Sorry for any confusion

** this link in no way implies that the company I met with today is either Coles or Woolworths.

A Tiger Shows His Stripes – Two Historic Interviews with Julian Robertson

I like interviews with astute and legendary investors. I also love stock-market history. It should be no surprise, therefore, that historic interviews with legendary investors are of particular interest to me.

Julian Robertson is quite literally the ‘Grand-Daddy’ of the funds management world. Moreover, 1987 and 1989 were two monumental years in market and economic history. In this interview, Robertson introduces the ‘Tiger’ investment philosophy and frames some historic trades (including a lucrative, yet long-lasting Japanese Stock Market short):

Barron’s Interviews Julian Robertson – 1987 and 1989

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Whilst ’87 has often been focused on, personally: I’m just as interested in ’89 – the year in which the Japanese stock-market peaked. There have been many things said about the Japanese asset-wide bubble (and subsequent economic black-hole that followed), but there is one word in particular that I find the most interesting:

A (Few) Word(s) on 1989

Nihonjinron: perhaps more than any other, this word sums up the sentiment of the Japanese during their (now distant) economic expansion (which, arguably, begun in the late 1940′s). Nihonjinron, which essentially means “the theory of the Japanese”, refers to the academic body of investigations that took place at the time. These studies attempted to unearth the many reasons as to why Japan was so ‘unique’ and why its people/culture were so ‘superior’. Yes, it’s true: the Japanese literally institutionalised the proverbial ‘this-time-is-different’ mentality.

Over time, conclusions from such studies began to get more and more obscure. Some researchers even claimed that Japanese snow was far superior to American snow and, hence, suggested skis imported from the US (or elsewhere) would be of little use on Japan’s slopes. With this kind of asininity peculating from academia, it’s little wonder why the whole Japanese Stock Exchange was inoculated with similar beliefs (as we know too well, similar ‘academia-translated-to-stock-market’ follies are still widely prevalent in most parts of our financial world).

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‘Radioactive’ Investments – A Mental Model To Explain Many Business Models

This post is about how a single mathematical function can explain many businesses. Those that have done their math homework can skip straight to the “What the Hell Are You Talking About?” Section.

“Invert, always invert”

- Carl Jacobi, Berkshire’s favourite mathematician

Introduction

The quote above is from a legendary mathematician and holds the key to how many famous mathematicians think. It also happens to be Berkshire Hathaway’s favorite way of thinking.

Numerical fluency can help investors beyond just teaching us new ways to think. Patterns already deciphered by mathematicians several centuries ago are common place in business.

Enough jibber-jabber, let’s use an example.

One Mighty Useful Function

Anyone who took mathematics at university would have come across logarithmic functions (perhaps you learnt this in high school). To avoid evoking adverse reactions from insomnia sufferers, let’s skip the gory details (for those who simply can’t resist: here is a refresher). All you need to know is that logarithmic (/exponential) functions are special equations that explain how stuff grows and, just as interestingly, how stuff decays (believe it or not, I’m not a professional mathematician).

Given a rate of growth/decay, a time period and a starting point – these functions can tell you what values growing or decaying variables will take in the future.

Maybe an example will clarify? The most common exponential function should be familiar to all investors: compound interest. Think about a bank account: it has a starting point (the principal that you put into your account), a growth/decay rate (the rate of interest you earn and reinvest) and a time period (how long you leave your money in the bank).

Although today’s real interest rates may seem to suggest otherwise, bank accounts are a growing phenomenon. Logarithmic functions can also be used to model things that decay – i.e. things that are declining from their initial value at a constant rate. For example, this is the mathematical equation that dictates how objects cool (for those boffins that still can’t resist: Newton’s Law of Cooling).

Boiling water doesn’t go from 100°C to 25°C (apologies to our American readers) instantly. It decays in temperature over tiny intervals like this: 100°C  ->  75°C  ->  56.25°C -> 42.19°C and so on until it reaches 25°C – each time declining by 25% of its previous temperature.

Decaying functions also explain how radioactive materials work. Every ten years, for example, a radioactive substance may be half as strong as it was previously (hence, the term ‘half-life’) and then ten years later, it will be half as radioactive again. This is how scientists use ‘carbon dating’ to estimate the age of really old stuff (believe it or not, I’m not a professional carbon-dater).

What the Hell Are You Talking About?

“Ok”, your thinking, “all very interesting, but what do logarithmic functions have to do with my stock portfolio?”

Decaying functions are more common in business than many analysts notice. Think of a hypothetical newspaper operating in a small regional town in the 1970’s. Once this newspaper reaches a critical mass in their circulation, say 70% of this fictitious small town reads this dominant newspaper, their subscription rates (if left unattended by management) follow a somewhat decaying equation. Why? Each year, some small portion of that newspaper’s customers will stop subscribing to it: some customers will move towns, some will perish, some will have a change of preferences etc. Whatever the reason, each year there will be some slippage in their customer base.

In our example, let’s say 3% of the paper’s subscribers don’t renew their subscription the following year. This means that the newspaper in the following year owns 67% of the small town’s readership (70% – 3% = 67%). To maintain their monopoly in percentage terms¸ all things being equal, the newspaper now has to make up for this 3% deficit (by extolling the virtues of their ‘news hole’ to the rest of the unsubscribed population or by capturing new subscribers from those emigrating to the small town). To grow its subscriber base in percentage terms, it has to not only make up for this slippage, but the newspaper has to recruit even more, new customers on top of it. In our example, if the paper wanted a 75% market share, it would first have to make up the 3% natural decay in subscriber numbers and then win 5% more market share (ok, media analysts, this is a very simplified analogy).

This is more or less how all subscription-based businesses work: be it newsletters, Satellite TV companies, database owners (Morningstar, Bloomberg et. al.) or some other service providers.

Banking (Very, Very Simplified)

This principle also applies to mortgages. A bank’s loan book is also a decaying asset in a way. Loans are getting paid-off every day, thereby shrinking the size of the bank’s asset constantly. Banks, therefore, have to make up for this repayment rate through originating new loans or even through refinancing old ones.

The mortgage industry has a term for this; they call it the Conditional Prepayment Rate or CPR for short. The ‘CPR’ is the annualized percentage of the existing mortgage pool that is expected to be prepaid in a year – For example, if each year, 8% of a bank’s loan book prepays their loans earlier than scheduled, then the CPR is said to be 8%. The monthly equivalent to the CPR is the morbid sounding ‘Single Monthly Mortality’ rate.

Personally, I like the irony of the abbreviation ‘CPR’, as it can be thought of percentage of mortgages that the bank has to ‘resuscitate’ back in to their balance sheet to keep their assets more or less unchanged.

Predicting Profitability and Growth

Those of you who have managed to battle through yawns and keep their eyes open thus far might have realised that this has implications for the profitability and growth of such businesses. Newspapers during their Golden Era were not really impacted by this slippage at all. Whatever they lost in market share percentage, they made up for in price hikes. Given their customer captivity and large fixed-cost base, a 5% increase newspaper prices (the impact of which was felt mostly by advertisers within the paper) dropped straight to the bottom line.

Even today’s modern subscription-based businesses barely blink at the thought of customer-attrition. By definition, their customers are somewhat held captive in most cases. The services provided by some of these businesses (niche databases, mission-critical software etc.) are often essential to the customer’s livelihood. So ‘sticky’ are these customers, they often offer to pay in advance for such services.

For banks*, however, the mathematics works differently. To achieve profit growth (all other variables, like interest rates, being equal), a bank pretty much needs credit growth – i.e. has to make more loans next year than this year. Credit growth, by extrapolation, requires more borrowers or larger loans. Thereby, banking growth can be seen as a ‘give out more to get back more’ type of situation.

Now, fellow investors, you’re getting the picture: the worst time to buy a bank has often been when they look the most profitable – often coinciding with an analysts mindless extrapolation of previous profits in their DCF models.

This too explains why, as pointed out by economists like Hyman Minsky, today’s credit growth can lead to tomorrow’s credit decay. Add to banking’s ‘lose-some-then-win-even-more’ business model the aggressive leverage and poor reserving that occurs periodically in the industry. Now you can see why accelerated, industry-wide decay becomes a mathematical inevitability.   Some businesses literally are ‘radioactive’.

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Postscript: A reader of our blog (‘R Ray’) very astutely pointed out the connection between  the CPR rate in banking industry and the ‘Reserve Replacement Ratio’ (RRR) in the oil industry. Oil fields are a decaying asset too. Hence, the RRR measures the percentage of decaying reserves that are replenished by a given oil company. It’s a useful metric to gauge the industry as a whole, as well as evaluating projects/management teams on their ability to find prospects.

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Post-Postscript: Berkshire Hathaway was all too aware of the impact this slippage/churn could have on the profitability of their newspaper, Buffalo Evening News. In fact, one of the primary reasons for Buffalo News’ extreme level of profitability (as stated by Warren in 1983) was:

         "Both emigration and immigration are relatively 
         low in Buffalo.  A stable population is more interested 
         and involved in the activities of its community than is 
         a shifting population - and, as a result, is more 
         interested in the content of the local daily paper.  
         Increase the movement in and out of a city and 
         penetration ratios will fall."

“Stop the music, thats the ‘fella” – A 1987 Profile of Lou Simpson

Most of Berkshire’s subsidiaries send cash to Omaha to be re-allocated. There’s only one subsidiary that Omaha lets handle its own capital allocation: GEICO. In GEICO, there was (up until 2010) only one man that allocated it’s capital: Lou Simpson.

Here is an old, resurfaced profile/interview with Simpson (once heir to the investment throne at Berkshire). It’s from the Washington Post (significant somehow, Berkshire-nerds?) and was written in 1987 (significant somehow, stock-market-history-nerds?):

 Lou Simpson’s Profile in the Washington Post – 1987

 

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First A Dream – Buffett’s Favourite Homebuilder

Berkshire Hathaway owns the largest manufactured home builder in the United States of America, Clayton Homes.

By his own admission, Warren Buffett was only interested in acquiring Clayton Homes after reading Jim Clayton’s autobiography, First a Dream.

Here is a link to Jim Clayton’s biography that Buffett read (Whilst I haven’t tried, I’m pretty sure it can be printed):

Jim Clayton – First a Dream

For those real investment diehards, here is a link to Clayton Homes’ last annual report before being purchased by Berkshire Hathaway:

Clayton Homes Annual Report – 2002

Lampert’s Lemon and Lemann’s Lemonade – The Halo Effect of Business Strategy

One of the things we will frequently do on this blog is to analyse two different sources (annual reports, interviews, articles etc.) and directly compare them to see if we can extract any patterns that can be used as illustrative lessons for our investments going forward (yeah, ok, I know it’s a bit ambitious).

Eddie Lampert and Jorge Paulo Lemann 

This time, lets focus on two admirable investment billionaires: Jorge Paulo Lenmann and Eddie Lampert (despite his recent languish, I still remain a fan of his earlier work). Fundamentally, the similarities between the two stretch beyond their appearances on the Forbes Rich List. Both are considered extremely  savvy investors who take an active, hands-on approach to running the companies they invest in.

In recent years, however, the two have diverged despite their common grounding. Lemann’s firm, 3G Capital, seems to be hitting one home run after another, most recently in it’s mammoth acquisition of Heinz. Lampert’s ESL Investments, on the other hand, has experienced one headache after another, as their gigantic investment in Sears Holdings (a department store conglomerate of which Lampert is the CEO) continues it’s crippling battle to stay alive. Lemann’s 3G Capital is attracting capital like there is no tomorrow, even teaming up with Warren Buffett himself. Lampert’s ESL Investments is reportedly getting redemptions out the wazoo.

No place is this divergence more striking than in the press. Of particular interest are two articles that can be found on BusinessWeek’s website:

1. BusinessWeek’s article on Jorge Paulo Lemann August 2013 (click to view)

2. BusinessWeek’s article on Eddie Lampert July 2013 (click to view)

Here we have two articles from the same publication, published in the same year (published a month apart), both telling a story with the same premise (‘a billionaire investor with an impressive track record takes matters into their own hands in latest investment’) and yet both outcomes read completely differently. Why?

The Jorge Paulo Lemann article paints him as a swashbuckling ‘businessman’ that is masterfully restoring once mighty, now gluttonous American brands. The Eddie Lampert piece seems to tell the tale of a pedantic ‘corporate engineer’, so obsessed with his own economic ideology that he is willing to risk bankrupting of one of America’s oldest businesses just to prove his outdated view of the world correct.

The Devil is in the Details?

I originally thought it would be interesting to compare one article outlining “good” management practices that led to billions in value creation (in the Lemann case) with the other article that exemplified “bad” management practice, leading to billions in value destruction (the Lampert article). “When I come across managers exhibiting Lemann’s characteristics”, I thought, “I’ll load up on their stocks. When I come across a Lampert, I’ll rush for the exits”.

The pattern I actually found when directly comparing the two articles completely surprised me…

Here is an example of one of Lampert’s main management tools at Sears as reported by BusinessWeek:

Lampert runs Sears like a hedge fund portfolio, with dozens of autonomous businesses competing for his attention and money. An outspoken advocate of free-market economics and fan of the novelist Ayn Rand, he created the model because he expected the invisible hand of the market to drive better results…Instead, the divisions turned against each other—and Sears and Kmart, the overarching brands, suffered”

BusinessWeek article on Eddie Lampert July 2013.

This is as opposed to Jorge Paulo Lemann’s team, who, according to BusinessWeek: 

“hired a management consultant named Vicente Falconi, who put in place a system where, instead of basing budgets on the previous year’s, managers started at zero every 12 months and had to make a case for why they should get more. Hees used the same system at Burger King”

BusinessWeek article on Jorge Paulo Lemann August 2013.

I’m no business consultant, but ‘zero-based’ budgeting and ‘autonomous business units’ essentially sound like different terms to describe the exact same thing. The similarities in management-styles don’t end there. Because of Lampert:

” individual business units started to focus solely on their own profitability…Last year less than 1 percent of Sears’s revenue went to capital expenditures, much less than most retailers; even thrifty Walmart invested 2.8 percent of its sales. Lampert and his hedge fund own 55 percent of the company. He defends his decision not to invest in the stores by arguing that Sears’s money is best spent elsewhere—such as the online business unit, which he’s showered with resources”

- BusinessWeek article on Eddie Lampert July 2013.

If this statement is to be believed in isolation, then aggressive cost cutting for a company is bound to result in disaster. Yet, a mere one month later, BusinessWeek identifies Lemann’s success largely resulting from his team’s ability to cut expenditures, aggresively:

“Lemann’s partner Sicupira has a favorite phrase: “Costs are like fingernails: You have to cut them constantly.” …Lemann’s single-minded focus on cash flow explains how, after the takeover of Anheuser-Busch in 2008, AB InBev had little trouble paying down its massive debt amid the global financial crisis.Once they’ve streamlined away a company’s inefficiencies… there’s nothing left to improve

BusinessWeek article on Jorge Paulo Lemann August 2013.

From here, the similarities between management strategies become eery:

Decentralized systems and structures work better than centralized ones because they produce better information over time,” Lampert writes.

- BusinessWeek article on Eddie Lampert July 2013.

“Then he started knocking down the walls between offices to create an open-air plan and promote communication”

BusinessWeek article on Jorge Paulo Lemann August 2013.

“Under the new model, Lampert evaluated the different divisions—and calculated executives’ bonuses—using a metric called business operating profit, or BOP

- BusinessWeek article on Eddie Lampert July 2013.

“[Lemann and his business partners] incorporated some of the Garantia culture, …implementing big, target-based stock incentives”

BusinessWeek article on Jorge Paulo Lemann August 2013. This quote is, interestingly, describing Lemann’s success in turning around a retailer

The more you read each article, the more similarities emerge. BusinessWeek alludes to one of Lampert’s key failures as being the fact that his managers at Sears have lacked prior retail industry experience:

“While he often clashed with retail veterans, Lampert got along better with businessmen from finance and technology. “[Lampert] valued the outsider view,” says Bill Kenney, a former vice president who now runs his own consultancy. “He tends to bring people into the company who don’t have a lot of retail experience.

BusinessWeek article on Eddie Lampert July 2013.

Yet, BusinessWeek pinpoints Lemann’s success stemming from putting in place managers who triumphed  precisely because they don’t have relevant industry experience:

“Their first move was to replace Heinz’s long-serving chief executive officer, William Johnson, with Bernardo Hees, a former Brazilian railroad executive who had most recently run Burger King (BKW)… Hees didn’t know anything about fast food before becoming CEO of Burger King. He started his career as a logistics analyst at a Brazilian railroad Lemann and his partners took over in the 1990s, rising to CEO after just seven years. Putting a railroad guy in charge of a fast-food chain makes no sense at first blush, but this, too, is a typical Lemann move. “What’s important is not knowing hamburgers, it’s knowing how to lead a company,” says Paulo Veras, an Internet entrepreneur who for several years led one of the trio’s foundations. “It’s the kind of intelligence that transcends any specific business segment.”

BusinessWeek article on Jorge Paulo Lemann August 2013.

The Difference Between Value Creation and Destruction?

Ok, I’m sure by now you get the point.

I think the conclusion to draw from this sermon is not how seeking strategic advice from BusinessWeek articles may be a little confusing. Nor am I suggesting that Lampert and Lemann have the same modus operandi – I’m sure there are lots of things Lemann’s managers do that Lampert’s dont, and vice versa.

The interesting pattern I’m focused on is this: In one story, broadly speaking, a cunning, smart capital allocator with a fresh, new strategy in an age-old industry – coupled with an eagle-eyed view on unnecessary costs – whipped a company into reaching unimaginable new heights, whilst creating billions for himself and his investors. In the other story, a cunning, smart capital allocator with a fresh, new strategy in an age-old industry – coupled with an eagle-eyed view on unnecessary costs - strangled a company into reaching unimaginable new lows whilst losing billions for himself and his investors.

What keeps me up at night as an investor is this conundrum: if I just presented you with just the strategic facts of each case (read over each quote again, but only focus on the bolded words – without BusinessWeek’s added journalistic flourishes) before you knew the outcome of each investment or the industries each operated in, would you have picked which manger was sure to make you billions or which one was bound to lose?  Maybe not? Dont worry, not even BusinessWeek could: (click for article)

For me, the main difference between the success of Lemann and the languish of Lampert is simple: the businesses they chose to manage and the industries the chose to compete in. Lampert, perhaps originally focused on other motivations, chose to back a crippling, high-cost business in a perfectly-competitive industry experiencing tough structural change. Lemann chose to practice his brand of management on perpetuity-like businesses that competed in oligopolies. These oligopolies grew by the year and had the potential to be made even stronger by brilliant management. Lampert chose a business whose revenues and cost structures were tied at the hip. Lemann’s businesses have revenues that vary almost independent of their cost structures.

It seems that the stories of Lemann and Lampert, once again, prove the old investment adage: ‘a jockey is only as competitive as his horse’. “We make silk purses out of silk”, explains Charlie Munger, “we dont know how to make silk purses out of a sow’s ears”.

Lemann took lemonade that was already being made and turned it sweeter. Lampert tried to squeeze a lemon.