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The Phillips Conversations: Thomas Russo

October 23, 2017 in Audio, Full Video, The Phillips Conversations, Transcripts

The following interview is part of The Phillips Conversations, hosted by Scott Phillips of Templeton and Phillips Capital Management.

MOI Global has partnered with Templeton Press to bring you this exclusive series of conversations on investing and the legacy of Sir John Templeton, one of the greatest investors of the 20th century.

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About the interviewee:

Tom Russo joined Gardner Russo & Gardner LLC as a partner in 1989. In 2014 he became the Managing Member of the firm. Tom and Eugene Gardner, Jr. each manage individual separate accounts and share investment approaches and strategies. In addition, Tom serves as the Managing Member of the General Partner to Semper Vic partnerships. Tom oversees more than $9 billion through separately managed accounts and Semper Vic partnerships. Gardner Russo & Gardner LLC is a registered investment adviser under the Investment Advisers Act of 1940, and is not associated with any bank, security dealer or other third party. Tom’s investment philosophy emphasizes return on invested capital, principally through equity investments. His approach to stock selection stresses two main points: value and price. While these would seem to be obvious key considerations in any manager’s approach, it is equally obvious that all too often they are either misjudged or, perhaps more frequently, simply not viewed together. Tom looks for companies with strong cash-flow characteristics, where large amounts of “free” cash flow are generated. Portfolio companies tend to have strong balance sheets and a history of producing high rates of return on their assets. The challenge comes in finding these obviously desirable situations at reasonable or bargain prices. Tom’s investment approach is focused on a small number of industries in which companies have historically proven to be able to generate sustainable amounts of net free cash flow. (These industries typically have included food, beverage, tobacco, and advertising-supported media.) This fairly narrow approach reflects his training and discipline at the Sequoia Fund in New York, where he worked from 1984 to 1988.

Tom tries to limit risk by not paying too large a multiple of a company’s net free cash flow in light of prevailing interest rates. He attempts to broaden this otherwise narrow universe by including companies with smaller market capitalizations and companies in similar industries based abroad. Tom’s goal is one of an absolute return rather than a relative return, and he continues his long-term investment objective of compounding assets between 10 and 20 percent per year without great turnover, thereby realizing a minimum amount of realized gains and net investment income. Tom is the Managing Member of the General Partner of Semper Vic Partners, L.P., and Semper Vic Partners (Q.P.), L.P., limited partnerships whose combined investments are roughly $3 billion, along with overseeing substantially more funds through separate accounts for individuals, trusts, and endowments. He is a graduate of Dartmouth College (B.A., 1977), and Stanford Business and Law Schools (JD/MBA, 1984). Memberships include Dean’s Advisory Council for Stanford Law School, Dartmouth College’s President’s Leadership Council, and California Bar Association. Tom is a charter member of the Advisory Board for the Heilbrunn Center for Graham & Dodd Investing at Columbia Business School. He serves on the boards of the Winston Churchill Foundation of the U.S., Facing History and Ourselves, and Storm King Art Center.

Guy Spier on the Power of “Thank You”

October 23, 2017 in Building a Great Investment Firm, Diary, The Manual of Ideas

This article is authored by Guy Spier, chief executive officer of Aquamarine Capital.

Dear Mr. Pabrai,

Thank you so much for having me as a guest at your partnership meeting. I learned a lot about life, and investing, and I also met some great people.

Warm regards,
Guy Spier

One simple card in the mail, soon forgotten. Three months later, I received an email. Mohnish Pabrai was coming to New York — would I like to meet for dinner? I most certainly did. Thus began a wonderful friendship and research partnership.

“The very act of reaching out rewires my brain to embrace more of humanity into my in-group. I cannot predict how many friendships, partnerships and opportunities will arise from my daily correspondence, but the journey most certainly has been its own reward.”

Compounding that is a deceptively simple but immensely powerful concept that can be applied to much more than just making money. The principle has worked exponentially in my life to expand my connections to the world. Each time I reach out to say “thank you,” it is as if I am inviting serendipity to strike — my only regret is that I did not discover it sooner.

After every conference and gathering I attend, I make the time to send a note to the people I enjoyed meeting. And I always take care to write “thank yous” to great people I’ve met along the way — all the way from the taxi driver and bell-boy to CEOs and Chairmen of major corporations.

Even before this sort of social correspondence began to help my business (which it has, in spades), it began to make my life so much more interesting: I never know, from day to day, what awaits me in my office. Because my hand-written notes generate the desire in others to reciprocate — which comes in all sorts of ways: In response to my notes, I have been invited to dinners, to join clubs, to speak to gatherings of people. I’ve received gifts of photographs, books and even notes of “thanks for the thanks.”

Every now and then, the notes even result in a new investor in my fund. But the best of all is that the responses are always out of generosity, and never from a sense of obligation: In fact, you could say that I am addicted to the process of writing these notes and the occasional responses that they generate, which are invariably a delight to receive.

The real returns, though, come in the form of a sense of interconnection: The very act of reaching out rewires my brain to embrace more of humanity into my in-group. I cannot predict how many friendships, partnerships and opportunities will arise from my daily correspondence, but the journey most certainly has been its own reward.

P.S. I was thinking of writing a longer piece about how “thank you” notes have changed my life, but the brother of a friend, John Kralik, beat me to it. In his book A Simple Act of Gratitude, he describes how a year of writing “thank you” notes took him from failing lawyer to high court judge. The book is a great story, and a great inspiration.

Reflecting on Microsoft and Bruce Lee’s Friend and Associate

October 22, 2017 in Diary

MOI Global member and Zurich Project participant Abdallah Toutoungi wrote the following letter to John Mihaljevic in preparation for their Zurich Project Podcast conversation. It is a profound letter about some of the major influences in Abdallah’s life. We are pleased to share it here with permission.

Taky lived with his parents and siblings on the Olympic Peninsula in Washington State where he went to school, not as a Japanese, but as an American kid. Taky was totally destroyed emotionally when his family was ripped out of society and taken to the internment camps for Japanese Americans during World War II – and subsequently his family got torn apart.When he came out, he had lost all self-worth and was a broken human being – all sense of self-worth destroyed.

When Taky heard about Bruce Lee and his martial arts talents, he wanted to go and see this Asian kid everyone was talking about. Bruce was 18 and Taky was 36. Bruce was studying philosophy at Washington State.

Despite the age gap, Bruce played a big role in mentoring Taky and healing him emotionally while also developing Taky’s physical ability. This sense of purpose through martial arts slowly allowed Taky to recover his self-confidence. Taky was one of the first students under Bruce at the Jun-Fan Gung Fu Club. Even after Bruce left Seattle, Taky continued as an instructor at the Jun-Fan Gung Fu club until Bruce chose to close down all the clubs. This friendship was not only about martial arts; Bruce was also trying to be the best version of himself.

To this day, you’ll find every Monday, Wednesday, and Friday, a select few – chosen by Taky – training in private at Taky’s barn-turned-dojo in Woodinville. The serenity, brotherhood, respect, and ability all on display.

The major lesson I took from my time spent training under Taky, is the value of Loyalty, Humility, Hard work, Perseverance, Brotherhood of man, and Friendship. When I was sick, Taky would take me out to eat Vietnamese Phở, other times when I skipped class, he would call and tell me to “…come and shake-off the spider webs”. His manner of instruction was so refined – I was not that good, so he would say: “You are a working horse, what I want you to be is a race horse.” Those words inspired me. “Stay light on your feet.” he would say. These words taught me how to be eloquent in my instruction to others. We would also go to Chinatown for Dim Sum for his birthday and visit Bruce’s gravesite on Bruce’s birthday at Lake View cemetery.

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Update on EZCorp: Pawn Shops Ripe for Consolidation

October 22, 2017 in Equities, Financials, Ideas

This article by Barry Pasikov is excerpted from a letter of Hazelton Capital Partners.

In July of this year, Hazelton Capital Partners began adding shares of EZCorp, the 2nd largest pawn shop operator in the United States, to the portfolio. The Fund has bought and sold shares of the company over the past three years, but this is the first time EZPW became a top five holding.

Historically, pawn shops have the reputation of being a sleazy business that preys on the disadvantaged by charging high fees to either receive cash or a loan for one’s personal property. Pawning personal property is a short-term loan; a pawn customer exchanges a personal item for cash equal to between 40-70% of the appraised value of the property. In order to get the item back, the individual needs to repay the original loan plus interest, in which rates and fees can hit monthly levels in excess of 25%.

It is important to remember that the majority of the individuals who use pawn shops do so because they do not have access to traditional bank loans due to the size of the loan (average pawn loan is less than $150) and/or because they lack a banking relationship. A recent FDIC survey found that approximately 27% of American Households were either under or unbanked – that equates to nearly 67 million American adults. For these working-class Americans in need of short-term money, pawn shops provide immediate access to cash to cover living expenses.

Today, pawn shops have become mainstream, moving from the back alleys of impoverished neighborhoods to upscale malls and office buildings. The majority of the roughly 13,000 pawn shops in the US are family run, customer friendly businesses that have been designed to resemble a retail store. Instead of eliminating pawn shops, the federal and state governments have chosen to regulate them, recognizing that they provide a much needed financial service.

Increased regulation actually acts as a competitive edge for EZPW, as it is able to spread this growing fixed operational cost across its 517 stores, while smaller operators are negatively impacted. This creates an environment ripe for consolidation. EZCorp is in the process of deploying a Point of Sale system that will not only help streamline store operations but will allow for real-time benefits in managing inventory, and pawn loan pricing. Very few pawn operators can afford this type of dynamic, in-store system that pays for itself in less than three years.

A mixture of declining gold prices (jewelry is the number one pawned item and revenues are highly correlated to the price of gold), bad management decisions, and a non-attentive board created a headwind for EZCorp and its share price. A new management team took over in 2014 and began exiting all of its non-core businesses to focus solely on its pawn operations. The restructuring delayed the quick recovery that the market had hoped for. However, by mid 2016, with much of its restructuring charges, write-downs and impairments already known, EZPW shares began a meaningful recovery.

By late 2016 early 2017, Hazelton Capital Partners had reduced its holding in EZCorp, waiting for an opportunity to either close out the position at a higher level or re-establish the position at a meaningful discount. The Fund got the opportunity to rebuild its position on June 27th, when EZPW announced a $125 million convertible debt offering. The market reacted negatively to the news, driving the company’s share price down over 25% from the Fund’s sell level earlier in the year and providing a nice reentry point.

Hazelton Capital Partners believes there to be a meaningful discount between the company’s share price and its intrinsic value. The contraction in operating margins is directly related to the restructuring of the company’s core pawn business. Starting in 2018, most of the write-downs, impairment and restructuring charges will have been taken, leading to increased profits and free cash flow. The improved free cash flow could be used for future acquisitions or reducing debt, allowing the company to be debt free within the next 4-5 years.

Hazelton Capital Partners has mapped out a bearish, base, and bullish case outlook for EZPW’s business plan execution. The Fund believes there to be a conservative 65% upside to its base case outlook, a smaller return to its bear case and a meaningful opportunity if the company executes above expectations.

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.

Revisiting: Gary Brode on the Paradigm Shift of Amazon Prime

October 21, 2017 in Diary

Less than two years ago, MOI Global featured an insight from Gary Brode, managing partner and portfolio manager at Silver Arrow Capital, on the paradigm shift of Amazon Prime.

Today, it is wonderfully clear that Gary was spot on as we’re watching increasing untapped pricing power and an expanding moat.

Here is Gary Brode’s observation from our exclusive conversation in early 2016:

Amazon Prime started as a way to pay a yearly fee and get free shipping from Amazon.  It was a great deal, but what Amazon started to do was offer their Amazon Prime customers Amazon Streaming which had music and books and video as a way to tie consumers to the Amazon site. What makes Amazon Prime completely different from anything else is that in everything else the programming is the product that they use to sell you commercials.

If you’re watching CBS, they cram 16 to 18 minutes of commercials per hour down your throat and their view is that in exchange for watching the product — their show —  they are going to annoy you for about a third of that time.  You put up with the annoyance in exchange for getting the product.  Netflix says, ‘Okay, we’re not going to annoy you.  Pay us a fee and we’ll give you the program.’  Amazon Prime is different because Amazon is the product.  And the program is actually the commercial.

If you think about it: They don’t charge you for the show. The show ties you to Amazon.  By watching the show, that’s actually the commercial for Amazon Prime, which is the gateway into Amazon.  What they’ve done is they’ve said, ‘The program is not the product and it has zero value. We’re going to give it away for free. Just don’t leave our site.’

It’s completely changed things.

Discuss further, directly with Gary.

Update on Micron: Continued Strength in DRAM and NAND

October 21, 2017 in Equities, Ideas, Information Technology

This article by Barry Pasikov is excerpted from a letter of Hazelton Capital Partners.

Micron has been Hazelton Capital Partners’ best-performing stock year-to-date and has taken over as its top holding. The company has witnessed strength in both its DRAM and NAND segments, leading to an EPS (earnings per share) of $4.86 for 2017 and the market is expecting over $6.50 for 2018. Closing out the quarter just under $40/share, Micron is currently trading at a PE (price to earnings) of 8.2x and 6.2x for 2018 – a true indication that the market does not believe that the current DRAM and NAND average selling price is sustainable.

In the past, the digital memory and storage industry has been a victim of rapid technological change and competition amongst its members, preventing companies from achieving a meaningful return on their invested capital. Today, with 3 major players in DRAM and 5 in NAND, pricing is primarily driven by production capacity and not to achieve market share, as industry players have become more “rational.” Cyclicality will continue to play a role, but as demand for digital memory and storage expands from an increasingly connected data ecosystem, including the cloud, data storage, mobile devices and now the burgeoning IoT (internet of hings), it is expected that the duration of the cycle will be longer with a muted peak to trough pricing, leading to a stronger and more sustainable average selling price.

At the same time that the average selling price of both DRAM and NAND is forecasted to decline over the next year, industry players will be able to leverage recent production advancements to lower production costs, allowing for continued healthy margin.

Even with the significant rise in its share price, Hazelton Capital Partners still sees more upside opportunity.

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.

Yogi Berra and Competing with the Right People

October 20, 2017 in Letters

This article is authored by Matthew Sweeney of Laughing Water Capital.

“You better cut the pizza in four pieces because I’m not hungry enough to eat six.” –Yogi Berra

Since 1999, the S&P 500 has been governed by the Global Industry Classification Standard (GICS), a system that essentially slices and dices the market into its component sectors and industries. [In September 2016,] GICS was changed for the first time since its creation to elevate “Real Estate” from its status as an Industry Group under the “Financials” heading to a starring role as its own Sector.

Common sense dictates that changing how an investment is “classified” should not change the value of the investment, just as cutting a pizza in four pieces rather than six doesn’t change how much pizza there is. However, as I am fond of saying, common sense is uncommon on Wall Street, and according to an article on REIT.com, the change in GICS is expected to result in “$30 billion to $100 billion in new capital coming into [real estate stocks], as equity funds that have been significantly underweight in real estate look to achieve a market-neutral position.”

That billions of dollars are expected to flow into REITs simply because of how they are “classified” is an excellent illustration of why so few investors are able to outperform the market over time. It should be obvious that the ultimate value of the real estate in question will be a function of the value of the cash flows that the properties can generate over their lifetimes, but billions of dollars are expected to ignore the cash flows, and jump into real estate stocks based on classification alone.

These are the people that I want to compete against in the investing world. They are so afraid of under-performing the market in the short term due to under-owning real estate versus the index that they are willing to completely abandon the most basic principles of valuation. Contrast this approach with our own style of ignoring the indexes while patiently digging through the hidden corners of the markets looking for true anomalies, and you will understand why I am confident in the future of our partnership.

Watch an excerpt of our exclusive interview with Matt Sweeney:

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Disclaimer: This document, which is being provided on a confidential basis, shall not constitute an offer to sell or the solicitation of any offer to buy which may only be made at the time a qualified offeree receives a confidential private offering memorandum (“CPOM”) / confidential explanatory memorandum (“CEM”), which contains important information (including investment objective, policies, risk factors, fees, tax implications and relevant qualifications), and only in those jurisdictions where permitted by law. In the case of any inconsistency between the descriptions or terms in this document and the CPOM/CEM, the CPOM/CEM shall control. These securities shall not be offered or sold in any jurisdiction in which such offer, solicitation or sale would be unlawful until the requirements of the laws of such jurisdiction have been satisfied. This document is not intended for public use or distribution. While all the information prepared in this document is believed to be accurate, Laughing Water Capital, LP and LW Capital Management, LLC make no express warranty as to the completeness or accuracy, nor can they accept responsibility for errors appearing in the document. An investment in the fund/partnership is speculative and involves a high degree of risk. Opportunities for withdrawal/redemption and transferability of interests are restricted, so investors may not have access to capital when it is needed. There is no secondary market for the interests and none is expected to develop. The portfolio is under the sole trading authority of the general partner/investment manager. A portion of the trades executed may take place on non-U.S. exchanges. Leverage may be employed in the portfolio, which can make investment performance volatile. The portfolio is concentrated, which leads to increased volatility. An investor should not make an investment, unless it is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits. There is no guarantee that the investment objective will be achieved. Moreover, the past performance of the investment team should not be construed as an indicator of future performance. Any projections, market outlooks or estimates in this document are forward-looking statements and are based upon certain assumptions. Other events which were not taken into account may occur and may significantly affect the returns or performance of the fund/partnership. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. The enclosed material is confidential and not to be reproduced or redistributed in whole or in part without the prior written consent of LW Capital Management, LLC. The information in this material is only current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Laughing Water Capital LP, which are subject to change and which Laughing Water Capital LP does not undertake to update. Due to, among other things, the volatile nature of the markets, an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment. The fund/partnership is not registered under the investment company act of 1940, as amended, in reliance on an exemption there under. Interests in the fund/partnership have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws. The S&P 500 and Russell 2000 are indices of US equities. They are included for informational purposes only and may not be representative of the type of investments made by the fund.

MOI Global Community Update: First Member Dinner in Brussels

October 20, 2017 in Diary

An inaugural MOI Global member-organized dinner took place in Brussels, Belgium last night. I take this opportunity to thank Ivan Kuznetsov for bringing together such a wonderful group of like-minded investors.

Here is a quick summary from Ivan:

The meeting was attended by a range of hedge fund managers and family offices based in Belgium and the Netherlands and several investment professionals. Some participants travelled to Brussels from Ghent, Antwerp, Leuven, Amsterdam and London.

It was a beautiful and private venue and everyone thoroughly enjoyed their time and the format of the meeting. There was no specific company that we have discussed as an entire group at this very first meeting but I have taken note of a good brainstorming on a broad range of questions (identifying opportunities in a current environment, spin-offs in Europe, trends in retail sector and aviation, valuation of biotech companies in different stages of regulatory approvals, sources of ideas, systemic effects of the proliferation of ETFs, etc.).

The next value investing meeting could take place in Antwerp or Brussels towards the end of the year or in the beginning of January.

We’ll keep you posted on future member meetup plans. Also, be sure to tune into our Meetup group.

Pat Dorsey on Moats

October 20, 2017 in Audio, Equities, Featured, Interviews, The Manual of Ideas, Transcripts, Wide Moat

MOI Global members have had the pleasure of learning from Pat Dorsey on several occasions in the past. Below, we share one of our earliest conversations with Pat, an exclusive interview with John Mihaljevic, recorded in 2012. Pat’s timeless wisdom and insights amount to a tour de force on the topic of competitive moats — what they are, how they come about, and what drives their sustainability.

Pat discusses the competitive position of numerous companies in the interview. It’s enlightening to think about how well his comments on those businesses have aged — perhaps itself a statement on the merits of investing in wide-moat businesses.

Pat is a recognized authority on moats, an acclaimed author, and founder of Dorsey Asset Management. Prior to launching his own investment firm, Pat was president of Sanibel Captiva Investment Advisers, where he led the investment team and helped guide capital allocation. Pat was previously director of equity research at Morningstar for over ten years. He is the author of The Five Rules for Successful Stock Investing and The Little Book that Builds Wealth.

Listen to an excerpt of John’s exclusive conversation with Pat:

The following transcript of the full conversation has been edited for space and clarity.

John Mihaljevic, The Manual of Ideas: Please tell us about your background and how you became interested in the topic of moats.

Pat Dorsey: I was director of equity research at Morningstar for about ten years. I basically built the equity research team and process there, starting with about 10 analysts and building it to about 100 analysts when I left. I formed the intellectual framework that we use to evaluate companies. A big part of that is a focus on a competitive advantage, or an economic moat. I became interested in the topic because some companies essentially defy economic gravity and manage to maintain high returns on capital despite competition.

“It’s a fascinating topic because economic theory suggests that all companies should just revert to the mean over time. Competition shows up, capital seeks excess profits, and you drive returns down. But, both empirically and intuitively, we all know that’s not the case.”

It’s a fascinating topic because economic theory suggests that all companies should just revert to mean over time. Competition shows up, capital seeks excess profits, and you drive returns down. But, both empirically and intuitively, we all know that’s not the case. We can all name a dozen companies off the tops of our heads who have basically defied the odds and maintained high returns on capital for decades at a stretch. What frustrated me when I got into the topic is that most of the literature on competitive advantage is written from a strategy standpoint. Most of your readers are familiar with Michael Porter’s Five Forces model, which is very useful and a great starting point, but it’s always from the perspective of a manager of a business. In other words, I manage a company or a unit of a company, and what can I do to make that piece of that company better? So, it’s all about maximizing the assets that you have.

As investors, we have a different challenge. We’re not stuck with a set of assets of which we need to maximize the value; we can choose from thousands of different sets of assets called companies. So we need more objective characteristics by which we can assess the quality of competitive advantage and then make some judgments about whether a company is likely to have high returns on capital in the future or not.

MOI: Let’s start from the beginning. Can you define what you mean by moat?

Dorsey: When you think of an economic moat—and let’s be clear I stole the term from Warren Buffett; he’s the one who coined it. If you’re going to steal, steal from the smartest guy around—a moat is structural and sustainable. I think those are the two key things for investors to think about. It’s structural in that it’s inherent to the business. The Tiffany brand is inherent to Tiffany [TIF]; you can’t imagine Tiffany without it. The switching costs of an Oracle [ORCL] database are inherent to the way databases are used in business. Contrast that with a hot product or a piece of a hot technology that may come or go.

Moats are also sustainable. They are likely to be there in the future. As investors, we are buying the future. Look at the investments we make today. How they turn out will depend largely on what happens three years from now, five years from now, or ten years from now. So, we need to think about sustainability of a competitive advantage. A company with a very hot product and a cool brand right now may have very high returns on capital, but the sustainability is in question. Whereas you can look at a railroad or a pipeline that would not have as high returns on capital as an Abercrombie & Fitch [ANF], but it’s very sustainable because you can predict the likelihood of that competitive advantage sticking around for many years, and that makes the investment process easier.

MOI: So it sounds like, almost by definition, good management would not qualify as a moat. Is that right?

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