Highly regarded value investor Tom Russo, managing member of Gardner Russo & Gardner, joined the MOI Global community at the Latticework 2017 summit, held at the Yale Club of New York City in September. Up-and-coming value investor Josh Tarasoff, general partner of Greenlea Lane Capital, joined Tom for the keynote Q&A session. Josh was credited at Latticework 2017 by Tom Gayner of Markel Corporation for having drawn Tom’s attention to the superior business model of Amazon.com.
Having Tom and Josh together in one session was a great privilege, as they are among the finest minds when it comes to understanding the evolution of brand-based businesses in a rapidly changing world. We are pleased to share an edited transcript of the keynote Q&A session.
The following transcript has been edited for space and clarity.
Shai Dardashti, MOI Global: I’d like to welcome Josh Tarasoff to the stage. Josh was mentioned this morning by Mr. Gayner. Josh is managing a relatively small but also particularly unique partnership, which is getting attention for the right reasons.
Josh Tarasoff: This has been an amazing day. Very grateful to be here.
I feel like Mr. Russo is someone who needs no introduction, but ever wary of extrapolating my own views too broadly, I’m going to give an introduction anyway. Thomas Russo joined Gardner Russo & Gardner LLC in 1989. He serves as Managing Member of Gardner Russo & Gardner and Semper Vic Partnerships, which oversees two global value, long-only equity investment partnerships, the first of which Mr. Russo founded in 1983. He oversees more than $12 billion distributed between Semper Vic Partnerships and separately managed accounts in parallel fashion.
Mr. Russo looks for companies with strong free cash flow characteristics, produce high rates of return on their assets and have strong balance sheets. These have typically included branded food and beverage, tobacco and advertising support in media. In particular, he commits capital to leading global consumer products companies whose brands enjoy growing market shares in parts of the world undergoing economic growth and enjoying increasing political stability. Mr. Russo believes managements of family-controlled companies have the capacity when investments intended to build long-term wealth are ill received by short-term-focused Wall Street analysts. Accordingly, he often invests in public companies where the founding families still retain control in significant investment exposure to reduce management agency costs and align owner interests. On a personal note, Tom has been an inspiration and a role model for me for as long as I can remember. So many people talk about being a long-term investor and so few do it, so it’s a real honor to be here with you today, Tom.
Tom Russo: Thank you very much, Josh. You were introduced properly as having a fantastic partnership under management. I expect enormous thing to continue to come from that. I’ve enjoyed learning about your investing as well. I enjoyed the chance to hear the last speaker and I was reminded of one of the early lessons I had for value investing was through Warren Buffett’s comments about Gillette, so it’s interesting the Gillette example was given. I wrote in an investor letter that in this Amazon-oriented world you have to be careful that assets don’t become liabilities. Gillette had won the razor war at some point. There was absolutely no way anybody could have dislodged Gillette from its franchise. Wilkinson tried, Schick tried. Unilever tried in partnership with Target to go after them. They may have spent $500 million doing a frontal campaign, but none of that could budge the market share success Gillette enjoyed.
The trouble was Gillette, because they fell prey to the standard game on Wall Street, which is quarterly-earnings-driven, short-term-results-driven, they asked too much of the brand. They charged too much for the product. Somebody reminded me the other day and I’d forgotten about this, but it had come to pass at some point that the price paid for the razors were so much they had to keep them locked up behind screens behind the checkout place. If you’re trying to sell fast-moving consumer products, the goal isn’t to lock them up behind the checkout stands, but the problem is they needed to get those prices to sustain the reported earnings to give themselves a chance to have the options, which they use for compensation, vest and retire rich. That whole model can be undone, and in that case, the asset Gillette had was they owned the traditional route to market, but along came these kids from a fraternity and they created a business called Harry’s Razor and then another guy came along and he did Dollar Shave Club.
The core value, the essence of that business is it’s cool. It’s cool to get your razors on a regular basis from somebody who you don’t know, knocks on your door and drops them off. It’s such a different approach and, of course, Gillette couldn’t respond to that whatsoever. They were trapped in the model that had served them so well for so long, but the game had changed and they missed the memo. They were waiting for people to go out and buy the blades behind the locked cabinets. The management of Gillette was following the wrong model, which was trying to extract as much from their business as possible and another example of that, the world I operate in is in businesses like Gillette and so I look for companies that have great franchises, but I hopefully find them that are a bit more sensitive to the consumer.
The other example is General Mills, which has over the years been a company that’s perfected the art of delivering steady quarterly earnings exactly to the plans Wall Street has for them. Some years back their plans were such that they were going to earn a certain amount per share and one of the businesses inside the company was called Yoplait Yogurt and Yoplait Yogurt had the distinction of having won the yogurt war in North American and they were earning something like $350 million a year. If you add that to the rest of the operations and divide by X, you get $5.12 a share of earnings. That’s what they were expected to earn and, gosh darn it, that’s what they’re going to earn.
During the middle of the year some time back, they heard about an upstart yogurt launch in upstate New York a Turkish guy had started in an old Kraft factory. He was going to make something they hadn’t explored, but it was called Greek yogurt by a Turkish guy. A bit odd, but they went to take a look and, sure enough, they saw the business, a fledgling startup. For about $10 million they could have gone after the niche and they would have had a running start on the brand. If it had worked, they would have been able to immediately squelch the Turkish Greek yogurt maker, but instead they went home and they said to their superiors it was fine, “You’ll make the numbers. We won’t spend the money.” You fast-forward to today, Chobani is the Greek yogurt that was the byproduct of it. They never should have avoided confronting it at the start. It should have been put out of business within the first year by aggressive tactics and it wasn’t. It wasn’t in some ways with the same reason why Gillette leaned too heavily on its core business for profits that were above the rate they should have had. They should have redeployed capital into ways to continue to delight the customers.
Both of those express the thing you have to avoid the most is the long-term investment, which I’ve said I am, which is the managements respond too much to Wall Street’s short-term quarterly earnings pressure and, increasingly, to the activist pressure on public companies. By contrast, I find in our portfolio we celebrate businesses that tend to invest more upfront and report less upfront than they ought to or could, but they do so in pursuit of long-term investment returns. Increasing wealth over time and they’re allowed to do it largely because they have the ability to reinvest. Consumer brands we own tend to be internationally-based, they tend to have strong presence in developing and emerging markets. The population there is vastly underserved and they have a long runway, a lot of white space to invest their mature market cash flows against and so by deploying mature market cash flows into developing markets, they guarantee themselves upfront losses because the early returns from investment spending is bad.
It’s what Chobani forced General Mills to think about and even General Mills is a global partner with Nestlé around the world in cereal, they’ve adopted Nestlé’s approach, which is more long-term-minded for cereal, but they blew it with Chobani because of their short-termism. We do the opposite. We look for businesses that overspend upfront to develop more competitive advantage for later on and the one difference across the portfolios is most of our companies are family-controlled, and if the families say they’re prepared to back a business for the future, for three generations out, that’s probably going to be consistent with our time horizon. It’s unusual, but that’s how we do it. It’s an expression that came about through early meetings with Buffett at Stanford Business School in the early 1980s where he said, “The critical thing to remember as investors is there’s only one thing the government gives you is the tax deferral of unrealized gains and you should invest your money in a way that will allow you to best take advantage of that.”
That means find things that reinvest and you don’t sell. It’s become vastly harder because all of the businesses we own have had impregnable moats and all those moats are filling in and getting narrower and shallower and they face the same fights the consumer products industry generally faces, which is a lot of upstart and fast moving Dollar-Shave-Club-like assaults to their franchises. The only difference we’ve enjoyed is we’ve been more international than many investors in this room and that’s given our company’s outlets away from the mature markets in the US where the competitive activity’s so strong and the businesses have adopted a longer term mindset. I oversee mainly funds on behalf of taxable investors and so they’re aligned with us, that if we can find things to compound deferred tax — we’re better off than trading around the portfolio.
Tarasoff: Excellent. In your recent interview on the Latticework podcast, you talked specifically about three ways in which the environment is changing. Amazon is steering demand by managing availabilities and through suggestion, people being able to find new products and brands in ways they never have before through services like YouTube and, finally, generally diminishing brand loyalties. I was hoping we could pick up where you left off in that discussion and talk about…
Russo: Those are bad enough.
Tarasoff: Talk about the specific ways you’re seeing your portfolio companies respond to the new environment. You broke it down in terms of product innovation and communication.
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