Peter Gustafson on Long-Term Co-Ownership of Great Businesses

September 23, 2022 in Audio, Equities, Full Video, Wide Moat

Fellow member Peter Gustafson of Denmark-based Prospect Family Office has kindly agreed to share his talk on implementing Warren Buffett’s investment principles with the MOI Global community. Peter gave the talk at Bob Miles’ Value Investor Conference in Omaha in 2022.

The presentation answers the following key questions:

  • What is a possible “end goal” of a private investor?
  • What are the characteristics of great businesses?
  • How do we know those businesses will give us the results we need?
  • Where do we find such companies?
  • When should we actually invest in those companies?
  • How long should we hold on to those investments?
  • When is the right time to sell?
  • What is the most important success factor of all?

Throughout the talk, Peter addresses the most common mistakes investors make at each stage of the investment process.

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Peter Gustafson is the founder of PROSPECT Family Office. Since 2008 he has been a full-time investor and co-owner of a small number of businesses. The track record for his family office set-up has been an average return of about 18% annually after all costs and taxes. Prior to his investment career, Peter spent sixteen years as an entrepreneur and business owner. To prepare for working as a full-time investor Peter spent two years studying Warren Buffett and then implemented Buffett’s investment principles and values in his own investment activities and portfolio. Earlier in his carrier Peter held the position as business editor at Berlingske, one of Denmark´s leading newspapers. Peter holds a master degree in finance and capital markets from Copenhagen Business School and also studied under Professor Bruce Greenwald at Columbia Business School. Peter lives in both Denmark and Singapore.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated herein.

Automotive Industry: Attractive Medium-Term Investment Case

September 16, 2022 in Equities, European Investing Summit, Letters, Transportation

This article is authored by MOI Global instructor Ole Soeberg, founder of Nordic Investment Partners, based in Copenhagen.

Ole is an instructor at the upcoming European Investing Summit 2022, to be held fully online from October 11-13. Members enjoy complimentary and exclusive access.

It’s a well-known fact that component supply for the automotive sector has been under tremendous stress in the last two years. Shortage of semiconductors and closure of production in spring and summer of 2020 caused global light vehicle sales to drop from 90 million in 2019 to 78 million in 2020 and only to make a partial recovery to 81-83 million units in 2021-22. Hence, there’s pent-up demand for up to 30 million units.

There are several factors at play that could be a game changer for the automotive industry. And looking at past periods of slumps in unit sales those periods are followed by three to five years of solid performance for the sector. The 2003 version MSCI World Auto incl dividends outperformed until 2006, while in the version since 2009 outperformed significantly until 2015.

So, will the current slump result in a period of solid outperformance from 2023 to 2028? No-one has privilege to know the future, however there are a few facts and observations that provide direction:

1. Current estimates are for unit sales suggest 100-million-unit sales in 2025 or and CAGR from 2022 of 8% per year.

2. The share of electric or hybrid electric will rise to at least 25 million units in 2025 from 5 million units in 2021 or a 50% CAGR.

3. Consumers in general are in a financially healthy position with good employment situation and spare cash after the lockdowns, so a new light vehicle is within reach.

4. The average age of light vehicles in large markets like USA and parts of Europe is 11-12 years versus average life time of 15 years, hence there’s an increased potential for replacement sales.

5. Automotive penetration in emerging markets is still relatively low and leaves a long run-way for future light vehicle unit sales.

The skepticism towards electric vehicles, i.e., range angst, lack of charging infrastructure and unclear resale prices held back consumer appetite some years ago. Those arguments for being reserved has changed in the last couple of years and electric car adoption is rising fast. Simple micro-observations from friends and family now show that a two-car family have or are in process of changing to at least one electric car. And once you get comfortable with the convenience of the home charger, there’s no turning back.

How will the carmakers perform in this upswing?

The carmaker landscape is in constant change and has been from the early days. The new players like Tesla, Nio, and Fisker are challengers to the traditional players like Ford, Toyota and Volkswagen. The incumbents have been a bit slow on their feet to embrace the future of electric mobility. By now the incumbent carmakers have woken up helped by Tesla and the transition to electric is now in the fast lane.

A new production line for a new model is estimated to costs €0.5 to 1.0 billion, while a facelift and engine/interior upgrade is estimated at €100 million. The incumbent car makers know their Internal Combustion Engine (ICE) cars have limited future, so those models will not see much more than required engine improvements and other changes to live up to regulation and some customer appeal. All new models will be electric and lots of the new instrumentation features will not be available even in the facelifted ICE cars.

As all the big capex plans are directed towards electric, there’s a big productivity opportunity. Car making is a very complex system of “just-in-time”. An ICE car has 25,000-30,000 components that need to at the right place at the right time, while an electric car has only 11,000-12,000 components. Less components means faster assembly and hence better productivity.

Carmakers’ gross margin runs around 20% and R&D, sales, marketing, and administration at 12-15%. Tesla gross margin is closer to 25%, so first movers from the incumbent side should be able to transform the simplicity advantage of electric vehicles into a gross margin improvement. This is not reflected in current consensus forecast.

How to invest in this opportunity?

When Apple launched the iPhone in 2007 close to nobody guessed unit sales would jump to more than 200 million per year and in that process Apple and Samsung would take down the king of the hill at the time, Nokia.

I don’t think the automotive industry will see a similar dominance by one player that is able to sell its product at a significant premium simply due to its looks and easy user interface. But you never know.

People’s relation to automotive brands goes from indifferent to “would never set foot in any other vehicle” and is embedded over several decades. Smartphones is after all only 15 years old, so it was a brand-new category.

One investment road is simply buying the give largest automakers measured by unit sales or revenues, buy an ETF can gives general exposure. Either will give exposure to the expected volume growth for the next three to five years.

Another investment road is to find a car maker with a clear vision of the future and yet not priced insanely or at least out of reach for investors that consider valuation as part of the investment criteria.

I have been looking through the sector and will present my best pick at European Investment Summit 2022.

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S3E01: The Cyclicality of Malthusianism

September 13, 2022 in Audio, Podcast, This Week in Intelligent Investing

It’s a pleasure to share with you Season 3 Episode 1 of This Week in Intelligent Investing, co-hosted by

  • Phil Ordway of Anabatic Investment Partners in Chicago, Illinois;
  • Elliot Turner of RGA Investment Advisors in Stamford, Connecticut; and
  • John Mihaljevic of MOI Global in Zurich, Switzerland.

Enjoy the conversation!

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In this episode, co-hosts Elliot Turner, Phil Ordway, and John Mihaljevic discuss the cyclicality of Malthusianism, and related investment implications.

“Malthusianism is the idea that population growth is potentially exponential while the growth of the food supply or other resources is linear, which eventually reduces living standards to the point of triggering a population die off.” (source: Wikipedia)

Related Link

Malthusianism – Wikipedia

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This Week in Intelligent Investing is available on Amazon Podcasts, Apple Podcasts, Google Podcasts, Pandora, Podbean, Spotify, Stitcher, TuneIn, and YouTube.

If you missed any past episodes, you can listen to them here.

About the Podcast Co-Hosts

Philip Ordway is Managing Principal and Portfolio Manager of Anabatic Fund, L.P. Previously, Philip was a partner at Chicago Fundamental Investment Partners (CFIP). At CFIP, which he joined in 2007, Philip was responsible for investments across the capital structure in various industries. Prior to joining CFIP, Philip was an analyst in structured corporate finance with Citigroup Global Markets, Inc. from 2002 to 2005. Philip earned his B.S. in Education & Social Policy and Economics from Northwestern University in 2002 and his M.B.A. from the Kellogg School of Management at Northwestern University in 2007, where he now serves as an Adjunct Professor in the Finance Department.

Elliot Turner is a co-founder and Managing Partner, CIO at RGA Investment Advisors, LLC. RGA Investment Advisors runs a long-term, low turnover, growth at a reasonable price investment strategy seeking out global opportunities. Elliot focuses on discovering and analyzing long-term, high quality investment opportunities and strategic portfolio management. Prior to joining RGA, Elliot managed portfolios at at AustinWeston Asset Management LLC, Chimera Securities and T3 Capital. Elliot holds the Chartered Financial Analyst (CFA) designation as well as a Juris Doctor from Brooklyn Law School.. He also holds a Bachelor of Arts degree from Emory University where he double majored in Political Science and Philosophy.

John Mihaljevic leads MOI Global and serves as managing editor of The Manual of Ideas. He managed a private partnership, Mihaljevic Partners LP, from 2005-2016. John is a winner of the Value Investors Club’s prize for best investment idea. He is a trained capital allocator, having studied under Yale University Chief Investment Officer David Swensen and served as Research Assistant to Nobel Laureate James Tobin. John holds a BA in Economics, summa cum laude, from Yale and is a CFA charterholder.

The content of this podcast is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this podcast. The podcast participants and their affiliates may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated on this podcast.

Thesis Updates: Deutsche Bank, Holcim, Lanxess, Swatch

September 11, 2022 in Equities, European Investing Summit, Letters

This article is authored by MOI Global instructor Samuel Weber, founder and portfolio manager at Samuel S. Weber Vermögensverwaltung, based in Switzerland.

Samuel is an instructor at the upcoming European Investing Summit 2022, to be held fully online from October 11-13. Members enjoy complimentary and exclusive access.

The world is constantly changing, and my human brain has an extraordinary ability to create stories and explanations in hindsight that often bear little resemblance to what was actually happening in real-time. Therefore, one of my primary objectives for presenting my favourite European investing ideas on MOI Global is to have a well-documented account of my own thinking at the time of making some of the most important decisions of my investing career.

As I currently have no new investment to present to the MOI community, I decided to update my previous ones. Since presenting Deutsche Bank in 2017, the world has faced a global pandemic, the outbreak of a war in Europe, and the resurgence of inflation, among other things. These are highly significant events in global history that are reshuffling the cards for many investors. It is therefore of prime importance for me personally to see how my investment theses are holding up in this new environment.

I will not repeat what I said in the past on this platform. Enough has changed to focus on providing relevant, timely and new information. For readers interested in hearing my past presentations, they can be found on moiglobal.com. Also, this short article gives a preview of what will be a more detailed presentation next month. I will start with my most recent idea, first reviewing the investment case for Lanxess that I presented last year, then Swatch Group (2020), Holcim (2018) and finally, Deutsche Bank (2017).

Lanxess

Since presenting Lanxess last October, the economic environment has taken a dramatic turn for the worse. As a diversified chemicals group with a significant industrial footprint in Germany, the company is heavily affected by the war in Ukraine. It needs a lot of natural gas to fuel its operations and suffers from the commodity’s high price and possible lack of supply. More generally, inflation imposes significant working capital needs that lower operating cash flows, increase capital invested and decrease the returns on that capital.

Despite facing this tremendously disadvantageous operating environment, the company performs reasonably well. During the first half of 2022, it was able to fully pass on material and energy costs to its customers and increase operating profits by more than 20%. It has published an analysis of the potential costs of factory shutdowns due to a lack of gas, showing that even this adverse and so far hypothetical scenario could be managed with limited profit impact, because the most gas intensive plants are also the least profitable ones. Also, when it comes to gas supply, Germany is divided into two parts, with the East being supplied mainly by Russia, and the West (where Lanxess is located) by LNG from global markets and pipelines from the Netherlands.

Most importantly, the company – under the supervision of a superb management team – continues to deliver on its transformation towards a specialty chemicals company. While there has been some sobering news about Standard Lithium, Lanxess recently announced a joint venture with Advent, allowing it to partly monetize one of its four segments (the weakest one, in my opinion) within the next 12 months and fully monetize it within the next 4 years at attractive valuations, allowing it to deleverage its balance sheet and refocus on more profitable segments. Furthermore, it closed two sizeable acquisitions in its Consumer Protection business, catapulting it into the world leader in biocides and a strong global player in flavour and fragrances.

The valuation of Lanxess is dirt cheap. The company is currently valued at less than EUR 3 billion. After fully monetizing its joint venture and given the current level of leverage, assuming no further acquisitions, the company should be debt free in a few years. On a projected EBITDA of around EUR 1.2 billion, it would then trade on an EV/EBITDA ratio of 2.5 times. The ultimate valuation depends on the competitive strength of the group, i.e., how sustainable its pricing power is and how much free cash flow it will generate. As far as I can tell, an EV/EBITDA ratio of 10 times seems achievable, indicating significant upside.

Swatch Group

When I presented Swatch Group in 2020, two years ago, it was suffering from the effects of the global pandemic and, more importantly, from government-imposed lockdowns. Since then, the company has increased its revenues and profitability significantly. Even during the pandemic, it achieved a healthy level of operating cash flow by selling down inventories, releasing accumulated working capital.

In my presentation, I identified the company’s capital allocation as a material weakness, and this has not changed. Indeed, it got worse. A few years ago, the company engaged in a share buyback to avoid paying negative interest rates on cash assets, giving me hope that, besides statements to the contrary, the CEO, who is a significant shareholder, has a rational eye towards capital allocation. However, today, I am much less optimistic.

Out of total balance sheet assets of CHF 14 billion, inventories account for CHF 7 billion and cash & equivalents for over CHF 2.5 billion, amounting to a total net working capital of CHF 9 billion. Theoretically, the company could monetize its gold and jewellery assets, and, together with its cash assets, buy back more than a third of its outstanding shares, dramatically increasing its earnings per share, return on equity and shareholder value. On a recent earnings call, however, the management team showed no willingness to do such a thing.

Given the size of the amounts involved and the unsatisfactory level of profitability during the past 5 years (which is mainly related to the company’s capital intensity, much of it unnecessary for operational purposes, in my opinion), I can’t defend this observed unwillingness to engage in rational capital allocation any longer. The company’s financial performance could still be bailed out by strongly growing revenues. But relying on such growth to generate reasonable returns isn’t a responsible strategy, least of all considering that first-half-year revenues haven’t grown during the past 10 years!

A lot of economic crimes have been committed in the name of capital efficiency. And I support a reasonable safety buffer. But no amount of safety buffer can provide operational safety in the long-term. Only watch-loving and -buying customers can do that, and no amount of assets on the balance sheet will compensate for a lack thereof. Meanwhile, the seriously depressed capital returns destroy shareholder value with no concomitant benefit.

Holcim

When I presented Holcim in 2018, Jan Jenisch, its CEO, was in the process of significantly transforming the company. He joined in 2017, and today, has accomplished much of what he set out to do. Holcim achieved all its 2022 targets one year in advance. It reset its profitability, doubling free cash flow to over CHF 3 billion, deleveraged its balance sheet and laid the basis for the fourth segment, Solutions & Products, to become a significant profit centre.

The company recently announced the sale of its India subsidiary to Adani Group at twice its own valuation, meaning that it will receive more than 20% of its current market cap in cash while selling only around 10% of its earnings power (and even less of its free cash flow). The proceeds will mainly be used for further acquisitions in the Solutions & Products segment. This divestment is particularly attractive given the significant hurdles the Indian government imposes on repatriating cash from India and the current CO2-related discount that Holcim suffers from in the stock market due to its cement activities (the Indian subsidiary accounts for more than 20% of Holcim’s total cement grinding capacity).

I expect Holcim to continue executing on its transformation, significantly outperforming its 2025 plan, and to generate significant and growing free cash flows in the future based on its hundreds of local monopolies. Jan Jenisch has a proven track record in capital allocation and a massive firepower to finance acquisition, so the majority of Holcim’s activities will soon consist of products and solutions unrelated to cement. Importantly, I also view its cement activities as highly valuable. Not only do they provide the company with significant cash flows that fuel its transformation, they also enable Holcim to get into contact with its customers very early in the life cycle of a building / an infrastructure, allowing it to cross-sell other products & solutions. The valuation of less than 10 times free cash flow and 8 times owner earnings is highly attractive, compounded by a tax free dividend yield of around 5%.

Deutsche Bank

Of all my investment ideas, Deutsche Bank was by far the most controversial. How could I possibly consider investing in a European, unprofitable and criminal bank? Didn’t I know that this company is already insolvent, the value of its assets significantly overstated, its risk management broken and its business inherently unprofitable?

While predictions of an imminent downfall can’t be falsified, I am happy to report that five years after my analysis, I turned out to be mostly correct. In the first half of 2022, Deutsche Bank achieved its targeted level of profitability with a return on equity of 8% and net profit of more than EUR 2 billion, despite absorbing significant costs from its capital-release unit and facing a global pandemic and the recent outbreak of a war in Ukraine. The company is benefitting from a sustainable recovery in trading revenues, the quality of its asset base, rising interest rates and improving efficiency across all business units.

There are still a lot of doubts about Deutsche Bank’s ability to keep up and further build on its recent performance. Europe’s financial industry resembles a construction site, and its banks suffer from material competitive disadvantages (mainly related to their size) compared to internationally active U.S. banks. Many European banks are significant holders of sovereign debt from their home countries that are much less credit-worthy than Germany. And some banks on the continent are in a seemingly never-ending restructuring with no clear solutions in sight.

Despite that, I feel very well about the Deutsche Bank’s prospects, having observed closely its management team, risk management and operational progress during the past 5 years. The return on equity may soon surpass 10%, powered by its sizeable deposits franchise, leading to a yearly net profit of around EUR 6 billion. On this basis, the bank is currently trading at a price-earnings-ratio of 3 times. Furthermore, it will pay out significant dividends and engage in meaningful share repurchases during the next few years, which will further enhance shareholder value.

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September 2, 2022 in Twitter

Kochouseph Chittilappilly on Building Two Public Companies in India

September 2, 2022 in Asia, Equities, Interviews

We are delighted to share with you the following interview with Indian business magnate Kochouseph Chittilappilly, founder of V-Guard Industries (India: VGRD), an electricals and home appliances manufacturer, and Wonderla Holidays (India: WONH/F), an operator of amusement parks.

Kochouseph Chittilappilly began his journey in the world of business with initial capital of just Rs. 1 lakh ($1,400). As of 2022, the businesses he had started were worth in excess of $2 billion.

Rohith Potti hosted this conversation.

You started your business when, probably, there were not that many successful entrepreneurs in Kerala. And no one in your family was from a business background. But over time you have developed quite a unique business model in both V-Guard and Wonderla. Who were your peers or mentors who influenced you in your business strategies and approach? Who did you go to consult when you were stuck with a problem given?

Telling frankly, nobody was there. And now when I look back, even I feel scared. To be honest, I don’t know how I became successful. For example, I have no business background. My parents, uncles, and entire family were into agriculture. The whole village where I was brought up was involved in agriculture. But I don’t know how I became successful. My ambition then was to resign my job and start something. My idea was to earn through my business an amount which was more than my salary then. In those days I used to earn Rs. 850 per month ($12) which was not a small amount then; a gold coin cost Rs. 400 then (~$6) and so my salary equaled two gold coins. Nowadays two gold coins is equivalent to Rs. 45,000 (~$60). My ambition was to earn better than the salary I was earning. And I was confident that it was quite possible.

Basically I am a technical person. In school, or even in college I never showed any leadership quality or marketing skills. I was always oriented to technology. So maybe because of that I thought I could create and sell a better product than what was available in the market. I think I did some calculation – if I sold 50 stabilizers at Rs. 40 profit per piece then things would be fine. That was the level of thinking I had then. I never thought about failure. When I look back I think I had a blind belief that things would work out. If I failed the only idea was that I will go to the Gulf for a job, I would disappear. Because of my classmates were there in Gulf and so it was easy. So in case of any failure I would escape to Gulf. That was the plan B. But I never thought too deeply about such a situation. Failure was a situation I never, never seriously envisaged. But now when I look back at the young man at the age of 27, I don’t know how I survived.

Anyway, that time my ambitions were very limited – every month I have to sell a specific number of stabilizers. But once I achieved that particular quantity, my ambition for the next time would be to reach a higher target. It was a gradual process. I used to say that my success is not a big thing, because it took me 41 years to reach this level. Dhirubhai Ambani started much later than me – he started in 1982 I believe – I started in 1977. In that context, I have not reached that far. My aspirations were limited. It was a steady growth – each month, each year, or each quarter. In fact I did not know about the concept of quarterly results. The only focus was – what is the income? what is the expenditure? What is the net profit? It was all a mental calculation – What is selling price per stabilizer? What is the cost of production? What is the net realization per piece? That was the only thing on my mind.

So later when you had issues, the decision what to do next was a decision taken by you along with your employees?

Not along with my employees because they were quite ignorant. I employed two SSLC (Grade 11 equivalent) failed boys in the business. I knew that if I employ diploma holders they won’t stick to me as their aspiration levels were high.

My factory was in a tin roofed shed and so a diploma holder then would have considered it beneath his status and would not stick to me. So I selected two SSLC failed candidates who I believed would stick to me. So no one was there to consult, no one was there to discuss as well. There was nobody there who knew the technology. People in fact used to ask me whether there would be enough demand for the stabilizer product. They told me every house would need only one stabilizer and so how could I increase the turnover? How would I scale up? My thought was that in addition to TV, refrigerators were also being sold by large brands which meant extra demand for my product. And I used to say that the poor performance of the electricity department of the government helped me in my growth.

One of the key problems faced by all entrepreneurs is scaling up of their businesses. Most businesses stop growing at a certain level – some at 2cr ($300k), some at 200cr ($30 mio) – because of lack of systems, or delegation or some other reason. What were the difficulties you faced in scaling your organization? How did you deal with them?

About my growth, as I said earlier, it took a long period to grow to this level. So I did feel any sort of burden at any stage. The growth was gradual, it was steady. At no point of time there was a huge fall. There were crisis situations like labour and such. There again I don’t know – I think my overconfidence helped – I always believed I would overcome any crisis. When I look back I believe that thinking was always there.

Similarly, in the initial stages my wife used to complain as well. I used to tell her my first, second, third priority were all my business. She asked me where the family was in the list of priorities? I replied that came later in the list. See, I believe that unless you have a footing and provide well for your family, it would be difficult for them to stick to you. That means, as an entrepreneur you have to deal with everything. You cannot depend on anyone else.

This business was a technology related one; if it were a trading or distribution business there were many people to consult. But in this field there were not many people to consult. I was competing in the market with giants like Keltron and Nelco (a Tata group company). I believed the buck stopped at me.

How did you develop your skill of delegation then? I recall Mr. Vijayan was appointed in 1982 or 83, and after his appointment in a few months you left everything in his hands went holidaying with your family also.

I introspect a lot in life. I used to keep assessing – what is my strength? What am I good at? In school or college days I was never a top student, neither was I very poor – I was only above average. So my thought was if I could do something, many others could do much better than me. And I noticed that if we delegate properly to somebody with proper explanations, instructions and enough guidance, they will perform better. Initially everything used to be managed by me. Later on, slowly I started delegating some work to others. I saw it was working, and working quite well. This is what allowed me to expand my business.

Vijayan joined us in 1982 or 83 – that was the first time we appointed a full time factory supervisor. Before that I tried hiring one or two young diploma holders. After one year, they used to leave for a better job. Third time, I put a small ad in the paper and that is how I got Vijayan. When I went through his resume I noticed he had some technical experience – he was previously in Indian Air Force where he started as a radar technician and graduated slowly to higher levels. So it was a good combination to see and I believed he would be good for the factory. Similarly I tried somebody in marketing – that person is still there in V Guard. Even after his retirement, my son Mithun is compelling him to stay. I hired another person – Anotny Sebastian – in the technical department after Vijayan, and he is still there with V Guard. When I look back, I believe I had an aptitude to train people, to delegate to them, to guide them when necessary, and to motivate them. That may be the reason for my success.

How did you get so many people to stick on for so long? They would have had many other opportunities in their career. Why do you think they stuck to you?

Employees are ambitious. Every year I was able to show steady expansion or growth in turnover. For example, we slowly covered entire Kerala and when we began expanding to Tamil Nadu, we chose Coimbatore as the first point of entry. And Coimbatore is the city at the border of Kerala and Tamil Nadu. I did not go to Chennai, the capital city of Tamil Nadu – Chennai was too far for me at that time. Similarly for Karnataka I chose Mangalore first because of its proximity to Kerala. Every year there was some expansion activity, some growth, some increase in turnover which the employees saw. And I believe this might have motivated them. I believe people do not stick to a company for money or salary alone. First they must be comfortable with the environment and the working atmosphere. Next we must be able to meet their ambitions and aspirations.

When we did the public issue, before the issue was opened, I took 5% of my personal shares and distributed to everybody in a matrix. For senior management with long years of service, higher number of shares was allotted. It was nothing but my desire to share my happiness with employees. So when the employees look back they realize they have grown along with the company. You can ask Vijayan what is the value of the shares he holding of V Guard. I guess my employees’ class mates and contemporaries might not be as well off as they are. That too might have been a reason for employees sticking on for so long. I don’t think there are any major gimmicks in this.

You have mentioned in the past that they should be allowed to make mistakes and that is how they learn. Can you explain that further? What mistakes are fine? And which ones should not be tolerated at all – well, other than strikes that is? Can you give examples? – as a follow up : What remedial measures do you take?

First, I believe that I have committed quite a number of blunders. So why can’t they be allowed mistakes then? So, I used to tell them that if they committed a mistake once then it is ok. But if they repeat the same or similar blunder then it is their carelessness. Once can be forgiven, but similar blunder should be avoided. That I cannot tolerate.

For example, if they do a mistake, I used to sarcastically explain to them what went wrong. I am not a saint; business has to run and every penny is important. So when mistakes are committed and if the costs are heavy, then it can become quite serious. But I believe if you give them the authority backed by proper guidance things will work out. Proper guidance is more important. Many people complain that they delegate but it does not work. I believe that they are not giving proper direction along with delegation. You should give proper direction. Even to my driver if I want him to buy a particular item for me, I explain, explain, explain till he gets bored. My wife sitting next to me laughs at this and tries to tell me that he understood. But I won’t stop there. I will ask him to repeat what I said. After some time – one or two years – I noticed I need not explain so much. If he is reasonably intelligent, he will grasp quickly. For example, my driver is more like a secretary to me even though he is illiterate. For example if I am invited to a function to speak I tell the organizers to speak to him about the location of the venue, the time when I should be there, etcetera. I do not want to know all those details. Even that small burden is also delegated. Once he gets the details, it is his responsibility to get me at the right location on time.

Once an employee commits a mistake it is our duty to bring him back on track at the earliest. There is no meaning in blaming somebody in one particular crisis situation.

In an interview you mentioned you want all stakeholders in the chain of business – suppliers, employees, distributors, end-customers – all to be happy. You insist on that. And only then is a business sustainable. It is easy for the person at the top to desire that. How do you ensure this vision is implemented across all employees in the organization – even at the lowest level? Especially when the company grows. As it grows it might become more difficult. How did you deal with this?

Today V Guard has thousands of people from different culture being part of our value chain. Some are from Bihar, some from Maharashtra, some from Calcutta, etcetera. To understand how we maintain culture, it might help first to take the analogy of a family. The members of a particular family will have a certain culture that is part of them, a set of values that define them. You go to another family in a different place, there will be another set of culture and values.

Similarly certain values and beliefs will be there in an organization as well. So in V Guard and later Wonderla, I was following one set of practices. And I insisted that the next-in-command to me- for example Vijayan- follow the same set of value, same set of beliefs. And then, the next level of employees also slowly started migrating to this value system observing his / her superior. The employee may have his or her opinion about other things, but he will have to fit into our culture. Otherwise he has to quit. There are so many who resigned and left. There are many who we terminated. Most of this happened because their culture did not fit ours. They may be extraordinarily brilliant, but no, we do not want them.

So we cannot judge anyone before hiring. We hire someone for a particular role in the anticipation that the candidate might be suitable for the organization. I believe no interviewer or a psychologist can correctly measure the depth of a human being. So based on a leap of faith we hire, we let him work with us. After few months, we will know if the man does not fit into our culture. And if we see that we part ways at the earliest.

We do have training programs for our employees but I think the culture is slowly adapted by the employee over a period of time. For example, let us take the example of arranged marriages that happened in the olden days in India. During those times, after marriage, the wife stays in her husband’s home and has to adapt to the culture of his family. She might have been part of a different way of living earlier, but if she wants to be happy, she has to follow the principles of her husband’s family.

This might explain the reason why the legacy is continuing in my companies even in my absence. For example V Guard follows certain practices. Now the senior managers there, they believe that they know the founder’s attitude which they thought was a successful style of management. So they are also following the same style. Once in a while, when contemplating certain situations, they might recall how the founder tackled the similar situation in the past to guide their action today. For example, let us say a vendor met with some crisis. The management is faced with various options – How do we help the vendor? Whether we help them or go only go according to agreement? How lenient an attitude should we take?

I think this way of working or taking decision in situations is a legacy passed on over the years. And this is not only for V-Guard but it exists also in TVS or Murugappa Group or Tata. We say Tata has a culture; Godrej has a different culture which also a successful culture.

For me, the values, culture, ethics are the binding force of an organization. Otherwise how can people from Calcutta, Maharashtra, Chennai and Kochi follow the same principle despite different backgrounds.

When V Guard was listed, its market cap was probably around 250-300cr. The balance sheet was quite strong. However, around the same time in 2005-06, the Bangalore park which was completed cost around 100cr. For me this is quite stunning. How did you get the courage to do this? How do you define risk?

To be honest, many things I did in the past, even I cannot answer it properly. So sometimes, I get a blind belief. So even the Wonderla business that I started in Kochi, now when I look back I cannot believe what a risk I took at that period. That time, V Guard profits were quite small. But I took a big risk at that time in a totally different line of business. Why I did it, what compelled or motivated me to do it? Well, at that time I used to travel abroad and I was fascinated by the amusement parks there. At that time, I believed there was a market for a right park in India, and it helped that V Guard was run well by the people I delegated responsibilities to. So I thought why can’t I replicate one in a small level, a miniature level in Kochi? So that was a blind belief that it would be successful. I don’t know why I had this conviction.

I believe Kochi was the riskiest thing I did. Even though the investment was Rs. 22cr ($3 million), my knowledge was absolute zero when I started the park. But given the technical mindset that I had and with support of some employees, we spent considerable time researching before we launched the park.

Within two years of running Kochi Park I noticed that this was a good business to be in and I wanted to replicate it. So I immediately bought some land in Bangalore. And given Bangalore is a much bigger city than Kochi, we had to invest more as the park had to be bigger. This, along with the inflation meant the 22cr became ~Rs. 100cr ($14 million).

An entrepreneur is focused on growth, but he should be careful not to overextend himself. How would you define your balance between growth and risk, between being fast and slow?

I think the definition of fast or slow growth is subjective and relative. The same rate of growth may be referred to by different people as fast or slow depending on their viewpoint. I think I was moderately fast and that is why it took me 41 years to reach this level. At the same time, others may say I was very slow, because it took me 41 years to reach this level. But one thing is for sure, my businesses never witnessed any sharp fall in revenues. That is an advantage for me. Many businesses rise and fall multiple times. That never occurred in my business. At each stage, we ensured the foundation of the business was strong to move to the next level.

It’s not to say things are perfect. Still there would be miscalculations. For example, Kochi actually broke even very fast. Money was scarce when we started Kochi and so we spent only $3 million. It succeeded beyond our expectations and we recouped our investment quickly. However, when I invested $14 million in Bangalore, I simply thought Bangalore is 5x larger than Kochi. But that was a miscalculation. It took more years than Kochi for a breakeven. The collection was not commensurate to the spending we did on the park. Later one can do some postmortem and find the reasons. In this case, the reasons were a few. In Kerala, V-Guard group was well-known, in Bangalore we were not that well-known. At the same time, there were many small time players who had created a bad reputation for amusement parks. There were some accidents which happened at the competitors’ parks including a few deaths. So people had a bad opinion about amusement parks in general, and they had thought we were just another amusement park like others. And so we took more time to break-even there. Anyway, what I mean to say is there will be miscalculations even today as well.

In an interview you mention one of the reasons you got yourself listed was so that there would be external oversight on the businesses you created. You mentioned you wanted a strong board. How do you go about selecting members for the board? What are the other reasons you listed your businesses?

When I was listing many people asked me why we were doing it. It was easy for us to get loan, and just before the issue we had spent 100cr on Wonderla without any public issue or private equity. And V Guard did a public issue for only 68 cr.

V Guard at that time was a popular brand across South India. I do not know the intricacies of how to do a public issue or the stock market. I never followed the stock market at the time. Once the company started growing, I started comparing us with other companies out there. I began thinking about our valuation, in comparison to other companies in South India. I noticed that other entities which were listed had more visibility as compared to a private company like V Guard.

Also, I thought my sons have completed their education and have joined the business. And so I decided there was nothing wrong in doing a public issue as I was ready to be answerable to anyone, even to the independent directors. Even otherwise we were quite transparent and paying our taxes correctly and on time. We were not hiding anything. I believed we had goodwill and public issue was a good option. And public issue is a good way to judge our value over the long term, for if we remained a private company how can we judge our valuation? More than that, the second generation was entering the business and I felt it was good if they were answerable to somebody else other than me.

For your information, the Chairman of the Board of V Guard during its time of listing was PGR Prasad, who is no more today. But at that time, he had just retired from his position as the MD of SBI Mutual Fund and was settled in Thiruvananthapuram (capital of Kerala, a province in India). CJ George from Geojit Securities is a friend of mine. In fact, George had some influence on me in making V Guard public. He had listed his business Geojit Securities. He was also an independent director in V Guard, because I believed he knew in and out of the share market. In fact, I met Mr. Prasad through George. George told me that Mr. Prasad was an eminent person who had just retired from SBI and why invite him as our Chairman. I want people with credibility on my board; people with the same attitude, that is, straightforward, quality conscious, transparent type of people. I wanted people who are excelling in their respective fields and who can help us in different ways. When you invite someone to your board, first of all, you must be happy with them. More than that, he has to contribute something to us. For example, we had Mr. Ramachandran of Jyothy Labs on the Wonderla board. I know that Ramachandran did a better job in scaling up Jyothy Lab than I did in V-Guard, and I have great admiration for him. He did a public issue much earlier, is based out of Mumbai and has scaled up his business better. Also, we are good friends. Now, he is not on the board because the schedule was difficult for him. At the same time, we have Ullas Kamath, who is the Joint MD in Jyothy Lab, on the V-Guard board. For me, even Ullas is also enough. This way, I think I will get some idea of how Jyothy Lab is doing things from him. Similarly we appointed Gopal Srinivasan of TVS Group onto the Wonderla board. I have great admiration for the TVS Group. In South India, Murugappa Group and TVS Group are few companies which have survived for long. So I invited Mr. Srinivasan. They are happy being the independent directors of the company.

One of the other things which I came across while reading up was that even when you were very small, in mid 1990s, you had one of the top audit firms auditing V-Guard. I don’t remember the name. What I found interesting was this. You are in a state not known for its industrial friendliness. Even in this scenario, even when you were a small company you chose to go for a top auditor. I believe you were even awarded as one of the highest taxpayers. Most people take this as the excuse to cut corners. What led you to be so transparent since so early in your journey?

So the auditor you are referring to was Billimoria and Company, who later merged with Deloitte, the global firm. From the very beginning, I used to pay proper taxes. I was very clear. I do not want to bow my head in front of any government officer. Maybe it might be a false prestige because probably I could double my turnover and profit when I was a private company. For some reason, I was adamant from about this from the beginning – things must be transparent and clear. That was my attitude. If things were transparent at my end, why can’t I engage the leading audit firm available then? So at the same time, Billimoria started an office in Kochi, and I went ahead with them. So I invited them because I had nothing to hide. I do not want any leniency or hide from my own auditors. There are people who I know who hide many things from their auditors as well. So I sometimes make fun of my auditor friends (laughs) – ‘you do not know the exact thing. You can see whatever records we are giving. The underlying things you may not be able to find out.’ ’ But if I could I saw no reason why I should not appoint the best auditor I could. It also helped that Billimoria appointed a friend of mine as a partner there. And so we went ahead with them.

You have about 40 years’ experience in running a business now. If you knew 40 years ago what you know today what would you have done anything differently? Any advice you would have given the young Kochouseph Chittilappilly?

No, no. I believe at that point of time, with the available knowledge, I did something in the best possible manner I could do – I could not have done better probably. I have no second thoughts about whether I should have gone in some different direction. Any beginner has to go through his journey. Who knows? If I had more knowledge I might not have started V-Guard only. Sometimes the lack of knowledge is necessary to start a business. For example, I never had an MBA, never any finance background. Later on, I tried to acquire knowledge in marketing, in finance and in other areas. Initially I told myself that I was good in technology and that might be enough. Later on, I came to realize that technology is just one part, only one-fourth. There are other areas like marketing, finance, general management, especially people management – these are all big areas equivalent to technology. I remember I attended number of courses to improve my skills. For example, I studied in a Malayalam medium school and speaking in English was difficult for me. So I purposely attended some spoken English classes to improve that. Similarly for public speaking as well – I wanted to address my dealers in conferences well. For example, if were doing a conference in Chennai, I had to address a large audience in English, and convince them. I took basic finance courses as well. I hated finance and actually I still do. I used to joke to my auditor friends- unless we make profits I don’t want you people. Finance comes at the end is what I believe. First of all profit must be there. To have profit technology is important, marketing is important, people management is important, then only finance will come. Without the business making a profit, what is the point of auditing or finance.

So the Kochouseph Chittilappilly you are seeing now is very different from the one 40 years back. I was shy-natured then. Over a long time, I deliberately put effort into improving myself step-by-step, taking each perceived defect one-by-one.

Because you are talking so much about finance, I want to ask this. At least your listed business seem like they do not like to have debt. This is despite huge expansions 10 years back with the Bangalore park and V Guard factory expansion with some loan. They have strong balance sheets. How did this come about?

That is a result of my delegation I believe. If someone is good in Finance, I used to give him authority to talk about Finance. For your information, initially I was fond of technology. Later on, I lost my track even in technology because I was too busy with managing the business. I was eventually zero in technology as well. This is because for any and every activity we had somebody good. If it is technology, we would keep someone good in that division – be it R & D or production. Delegation reached a level in the organization I became a broiler chicken (laughs)- there was not much role for me. The only thing I had to do was give strategic directions on the way we could move. Later on I involved myself only in the peripheral level. I never needed to go in depth as time passed.

So basically, the finance decisions for the organization are taken by the finance department as you believe it to be the safest decision for the organization?

Of course. It is their duty to advise me in the best possible manner. I believe them and I do not see any reason why they should misguide me.

Can you name a few entrepreneurs or businesses you admire, and why?

I do not have any single person as my role model. I used to follow people and read a lot of biographies. I listen to a lot of talks on youtube. Nowadays, when you travel you can switch on the speech of somebody and use that time effectively. Nowadays I am interested in history. I follow entrepreneurs, political leaders basically successful leaders in any field. In India, I have great admiration for the Tata Group and Godrej Group because I can relate to them. When I say relate, I do not mean in terms of size, but in terms of values, ethics, etc.

There is a saying, “The first generation creates wealth, the second generation enjoys it, and the third generation destroys it.” In your case what is uncommon is the fact that both your children have taken the respective businesses to the next level. What do you think the reason is? How would you advise other first-generation entrepreneurs on this aspect?

So the answer to that is related to something we discussed earlier. It is a mix of ethics, discipline, transparency, values, etcetera. Also, the public issue of the business helped a lot here as well. If we were a private entity, there would be no oversight. Any disagreement between me and my sons will just be a family argument and might not have been resolved in the best possible manner for the business. Of course, there were no major arguments between us. But because we listed ourselves and we had a strong board, my sons have to be responsible to them. It creates discipline. Having shareholders and a strong board and that, I believe, helped instil a sense of responsibility in them.

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Kochouseph Chittilappilly is the Chairman Emeritus of V-Guard Industries Ltd. He is the founder of V-Guard and has driven and motivated the Company to succeed in its business. He had been the Managing Director of the Company since its inception and taken the Company to newer heights and recognition with his experience and vision. In April, 2012, he passed on this baton to his son Mr. Mithun Chittilappilly. In 2017 he assumed the position of Non-Executive Chairman of the Board and continued as such till March 2020. As Chairman, he had been instrumental in adoption of best governance practices and upholding the Company’s core values. He has assumed the office of Chairman Emeritus from April 2020. Apart from his business acumen, Mr. Chittilappilly is a humanitarian par excellence. “K Chittilappilly foundation” (KCF) founded by him undertakes public charitable activities in India without any discrimination as to religion, caste, creed or gender. The Foundation’s key focus is in the areas of healthcare, education and development of social infrastructure. He has been bestowed with numerous awards for exemplary performance in business. Noteworthy among them are Samman Pathra Award for top income tax payer from Honourable Union Minister of State for Finance, Business Man of the Millennium 2000 from Rashtra Deepika and Tourism Man of the year from “Destination Kerala”.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated herein.

Vinay Rao on Managing the Portfolio of Tata AIG General Insurance

September 2, 2022 in Asia, Audio, Equities, Financials, Full Video, Interviews

We had the pleasure of speaking with renowned Mumbai-based investor Vinay Rao, Chief Investment Officer of Tata AIG General Insurance, about his investment philosophy and path in investing.

MOI Global contributor Rohith Potti hosted Vinay for this exclusive conversation. To our knowledge, this is Vinay’s first published interview ever.

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Vinay Rao serves as Chief Investment Officer of Tata AIG General Insurance, managing an investment portfolio of around Rs 20000 crs as of June 2022, with a six-year average mix of 88:12 fixed income to equities. The portfolio size has grown by 30+% annually over the five-year period from July 2016 through June 2022 while achieving total returns of 9.8% annually over the same period. The fixed-income book reported a total return of 8.4% annually. This was achieved with zero credit loss, zero provisions and two downgrades in a period that was characterised by large credit events in the market. The equity book delivered total returns of 12.5% annually over the stated period.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated herein.

Finding Value in European Banks and Other Old Economy Sectors

August 31, 2022 in European Investing Summit, Letters

This article is authored by MOI Global instructor Stuart Mitchell, investment manager at S. W. Mitchell Capital, based in London.

Stuart is an instructor at the upcoming European Investing Summit 2022, to be held fully online from October 11-13. Members enjoy complimentary and exclusive access.

“Old economy” earnings continue to impress. Whilst just over a half of all companies surprised in the second quarter, a whopping 100% of energy, 69% of materials and 68% of financial companies beat expectations. And… those sectors make up 40% of our fund today. If we include our shipping investments, “old-economy-beaters” make up just under half of the portfolio.

Our highest second-quarter-earnings-beaters were as follows:

Deutsche Bank +30%
Lloyds +29%
Commerzbank +26%
Intesa +25%
BP +24%
BNP +18%
Legrand +18%
Maersk +16%
VW +11%

The Great Technology Bubble has resulted in the squandering of trillions of dollars of capital in the quest to find the next Amazon or Google. So great has been this squandering of capital that we are now in the situation where many older economy industries such as oil & gas and shipping have been so starved of capital that their supply-demand dynamics are now tighter than anything that we have seen for decades. Indeed, many hitherto well supported companies have been so shunned by investors that they have invested significantly below depreciation rates for well over a decade.

European Big Oil’s capex to remain slightly below $50 billion by 2024E

Sources: Kepler Cheuvreux, S. W. Mitchell Capital.

But perhaps the sector most detested by investors is the banks. The Global Financial Crisis led to significant write-downs of mortgage backed securities, and many were forced to seek aid from their governments.

Write-down ($bn)

UBS 38
HSBC 28
RBS 15
Credit Suisse 9
Lloyds Bank 8
Deutsche Bank 8
Landesbank Bayern 7
Crédit Agricole 5
Dresdner 3
IKB Deutsche Industriebank 3
Barclays 3
Soc Gen 3

Source: S. W. Mitchell Capital.

But at the same time as banks were struggling to meet minimum capital requirements, the industry was then forced to double Tier 1 equity capital to over 13%… And all this happened at a time when interest rates were falling, squeezing net interest margins significantly.

But this is changing. The industry is now benefiting from higher interest rates. As you know, European banks’ funding costs are largely fixed; extra income generated from rising interest rates passes directly to the bottom line. The impact is most dramatic for the German banks: in the case of Commerzbank, a 1% rise in rates will lead to a doubling in net interest revenues.

In addition, banks have also worked hard since the Global Financial Crisis to cut costs through branch closures and digitalisation. And crucially, banks’ balance sheets are now much stronger whilst bad debts have come down significantly and lending standards have been greatly tightened. We have written previously in some detail about this in the recent past. Our thoughts can be found here.

And yet, investors remain reluctant to invest in the old economy. Most investors remain wedded to technology and “growth-at-any-price”. As interest rates fell, many investment managers rushed to brand themselves as growth managers, unaware that they were feeding the bubble further. But the bubble has now finally burst…

At first it was the impact of higher interest rates on the valuation of these fantastically rated companies. But now earnings expectations are also beginning to drop. The result of the wanton throwing of vast quantities of capital at a number of new industries such as food delivery has led to “unexpectedly” fierce competition. This has already resulted in many 70%+ share price falls. But this is just the beginning. In areas like semiconductors the recent doubling in capex spend by the industry could lead to a return to losses for many; most investors find this hard to imagine…

So hard that old economy companies continue to trade at extraordinarily compelling valuations.

2022
PER (X) FCF yield (%) Yield (%)
Oil, metal and shipping 4 24.2 15.5
European IT sector 25 1.8 1.8
Valuation premium/discount (%) -84 -92 -88

Source: S. W. Mitchell Capital, Kepler.

* * *

Finally, I urge you all to read Piers’s new thought piece, The future is on our plate, a thought-provoking examination of the future of how the world produces and consumes its food, and how this will change, with surprisingly drastic investment impacts.

And we will be publishing a further two thought pieces in the autumn. Lukas will be writing on the various fuel options for the next generation of ships, and I will be writing on the level of copper prices needed to generate new investment in the industry.

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August 23, 2022 in Twitter

Kevin Durkin on His Investment Philosophy and Process

August 21, 2022 in Audio, Equities, Full Video, Ideas, Interviews, Invest Intelligently Podcast, Member Podcasts, Podcast, Transcripts

We had the pleasure of speaking with Kevin Durkin, Chief Investment Officer of Ballina Capital, about his path in investing, his investment process, how he generates ideas, how he thinks about portfolio concentration and manages risk,  as well as some of the books he has found most influential.

This conversation is available as an episode of Invest Intelligently, a member podcast of MOI Global. (Learn how to access member podcasts.)

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About:

Kevin Durkin, Chief Investment Officer of Ballina Capital, was a founding member of Causeway Capital. He served as a Portfolio Manager of Causeway Capital Management from 2001-2015. Kevin has a long history of successful stock selection.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated herein.