In the fall of 2017, John Mihaljevic sat down with Guy Spier, chief executive officer of Aquamarine Capital, at the Aquamarine offices in Zurich for a wide-ranging conversation on value investing in Europe and beyond.

The audio replay and full transcript are available to members of MOI Global.

The following transcript has been edited but may contain errors.

John Mihaljevic, MOI Global: Guy, it’s always a pleasure to be with you here at the Aquamarine offices in Zurich. I look forward to getting your wisdom and insights into the investment landscape, specifically in Europe. The markets have been going on for quite some time. Are you still finding bargains?

Guy Spier, Aquamarine Capital Management: John, thank you for having me. The audience should know that even though I live in Zurich and John lives in Zurich, we haven’t seen each other I think since The Zurich Project several months ago. So, I haven’t seen you for a long time. It’s great to see you.

You know it’s always very flattering when you say that I have wisdom because I don’t feel like I have any; I’m just in the business of acquiring wisdom. I just came back from about a two-week period where I was doing three annual partnership meetings in Zurich, London, and New York. I can remember the things that I said at the partnership meetings.

I don’t look just in Europe. I’m looking around the world. What I said at the partnership meetings is that I really feel like it’s never been more difficult for investors. The new technologies that are ripping through the world are having a huge impact on old businesses. The new technologies, to the extent that they’re public, have nosebleed valuations and we have an environment over and above that where enormous amounts of money are going into ETFs and indices. It’s not an easy or happy environment.

In spite of all that, in spite of not thinking that the portfolio was particularly cheap, I still prefer to be fully invested because in the event that we get inflation, we don’t know what would happen faster – stock prices going up, which is what they do in inflation, or stock prices going down because interest rates have gone up.

In Europe it turns out and I never would have expected this so the amazing thing is that I going into this had basically I would argue two kinds of stocks in my portfolio. The vast majority of them or a significant number of them were inflation-protected stocks so basically in and around financial services. I was happy to be there because I wanted to be protected from inflation which hasn’t shown up and you know in Japan inflation hasn’t shown up for twenty thirty years, so we don’t fully understand the central bankers don’t fully understand central banks owning vast proportions of the public debt which is basically sort of self-dealing by the government.

There are two European companies in the portfolio that have performed extraordinarily well. One is Fiat Chrysler and the other is Ferrari. While I knew it was extraordinarily cheap, it caused me a lot of discomfort. I’m different than Warren Buffett, Mohnish Pabrai, and various other great investors—when I find something I know is a good buy, I still throw up every time I issue the buy order. There was a certain amount of discomfort owning Fiat. It’s one of the stocks I would have conceded was not inflation-protected, and it’s worked out even faster than I expected it to work out.

Europe is the site of some extraordinarily good businesses, Ferrari being one of them. If I had gone to people three years ago and said, “Ferrari is not an automobile stock, it’s a luxury brand”, people would not have agreed. Ferrari and Maserati had a cloud over them because Fiat was a hated European automobile stock. Suddenly, people perceived Ferrari differently and “re-rated” it from an automobile company to a luxury brand. It’s hard for us in Europe and North America to understand [because to us] Ferrari is an automobile brand. But it turns out the rest of the world is developing, and they want stuff like that. Suddenly, the demand for Ferrari cars from places like China, in spite of luxury taxes, is through the roof. New rich people are being minted on a daily basis, and some of them want a Ferrari. What Europe has, the rest of the world wants, whether it’s Hermes scarves, Patek Philippe watches, or Ferrari automobiles.

If you look at Fiat, a similar phenomenon is becoming apparent to the analysts. It was fun to invest in Fiat when I was investing at roughly 5% of sales. Fiat was an also-ran European company fighting with the likes of Volkswagen, Mercedes, and BMW. Nobody really thought of Fiat as much of a company, but then they went and bought Chrysler. Everybody knew Chrysler had gone bankrupt, but nobody understood some of the powerhouse brands in there. Great Wall Auto was very interested in buying Jeep — they make Jeep knockoffs right now, but it’s not the real thing. Jeep has been converted into a blockbuster brand. People needed to dig below the surface to realize that Fiat Chrysler had these blockbuster brands in there. Another one that’s doing extraordinarily well is Maserati, which has all this European cache, and people around the world want it.

Fiat and Ferrari are two European stocks I’m pleased I own in the portfolio. I continue to look at smaller caps. While many of the “uber-compounders” have come out of the U.S., not all of them will come out of the U.S., and Europe has a very fair shot.

The environment in Europe and North America is difficult because most things are very highly valued. I discovered at the Pabrai Funds meeting that a very small proportion of Mohnish’s portfolio is now in the U.S. He has a tremendous advantage over many of us, as he has been spending a lot of time in India. I have accompanied him on one of those India trips, but I don’t have a license to invest in India, and I don’t have the same in-depth cultural knowledge of India to make the kinds of calls he’s likely able to make. So that’s a tremendous advantage for Mohnish.

MOI Global: You invested in Fiat when it was extremely cheap, so part of it has been other investors catching onto that. How much has it also been the management, which was part of your thesis, continuing to execute and create value intrinsically at a pace you’re happy with?

Spier: There are two extraordinary personalities at the head of Fiat, which makes it special. I have to credit Mohnish — I did a lot of the work alongside him, but it’s Mohnish who had the original insight. People see an also-ran European brand and compare it with Volkswagen, which is part-owned by a German Bundesland [state government] and has a very corporate management.

When you look at the people who run Fiat, chairman John Elkann is a significant family holder and represents the Agnelli family, which is about as close as you would get to royalty in Italy. This is a different kind of royalty as compared to British royalty, for example, because they are industrialists. John Elkann is ten years younger than I am and was carefully selected by his dad. He runs Exor and is an extremely thoughtful guy — you can read his letters.

Sergio Marchione was the perfect guy to run Fiat. He grew up as an Italian in Windsor, Canada, where much of the automobile production takes place — and even some Fiat plants. He has a broad range of industrial and financial experience and was behind the turnaround of a Swiss company called Societe Generale de Cerveyonce, based in Geneva. He was also a director of UBS. I met another guy who was also a director of UBS, who had some interesting things to say about Sergio and the differences between running an industrial company and a bank. Sergio as an industrial manager is extraordinarily capable.

The stock was deeply undervalued, and people hated it. I remember only three years ago on a conference call the auto analyst from Sanford Bernstein giving Sergio Marchione total grief. It was fun to give him grief, but the pace with which he went into Fiat, saw what needed to be changed, and focused resources on what was going to work. The old management of Fiat had this idea of Fiat as an Italian company. Think of Land Rover, a British brand owned by an Indian company. Fiat is no longer an Italian company. It is actually headquartered in Amsterdam and the main corporate office is in London. [Sergio] was able to see that this was an Italian brand that owned some American and other brands, and then to reallocate resources — “Do we need to be producing these brands in Italy, or can we produce them in Brazil or the U.S.? And, actually, which of our portfolio brands is going to take the company forward? The Fiat brand on an auto may not be so powerful. The Jeep brand on an auto? Very powerful. Alfa Romeo? Very powerful.”

The ability to see the brand portfolio differently and then to put the right resources behind it — that’s capital allocation. It’s pretty hairy capital allocation because you’re making some big bets. Sergio Marchione made sure on the conference calls that we knew that every now and then one of those big bets, e.g., a $1 billion new automobile platform, might not work out. So far, they seem to have worked extraordinarily well.

How many automobile companies are still run by a family who were able to put in a very smart CEO? I guess Ford still has some family management in there, but it’s not the same kind of dynamic management willing to make big, gutsy moves. So, Fiat was undervalued, with great capital allocators. In a market environment that was pretty fully valued, this was sitting right in front of everybody. I’m pleased with how fast and how well it’s worked out.

MOI Global: Both Fiat and Exor are publicly traded. Do you ever look at which of those two might be the better long-term investment? Do you ever consider Exor instead of Fiat.

Spier: Exor is a really interesting company. I’m going to be attending their annual meeting, and I’m looking forward to going. John Elkann writes in their annual report that they see themselves as builders of businesses. Not so long ago they divested their stake in C.B. Richard Ellis, the real estate company, and they bought control of an insurance company called Partner Re.

I understood the cheapness of Fiat Chrysler, so I wanted to be fully exposed to Fiat Chrysler. When you go to the “mothership” you expose yourself partly to Fiat Chrysler and partly to a few other businesses. One may or may not like those businesses and the valuations at which Exor bought into them. I can’t say I understand the mothership as well as I felt I did Fiat Chrysler. However, Exor and John Elkann are certainly a group of people to watch. I would put Exor up there with companies like Berkshire Hathaway and Markel Corporation, where you can invest your money alongside an owner family and leave it there for a very long time.

MOI Global: Looking at the auto business itself, there are lot of concerns around technological advances and what they might do to established companies. How do you assess those risks?

Spier: Charlie Munger has said that the moats, even of some businesses described as “inevitables” by Warren Buffett, have narrowed a bit. Charlie said he’s pretty sure American Express will be around and will have an excellent business in twenty years, but he is less sure of it now than he was, because of all the dynamic changes happening.

That’s true of the automobile business. I don’t think I could honestly say that I had squared off all those risks and had put them away so they were nonexistent. The risks of electrification and self-driving cars are out there, but some risk of technological change is out there for so many other investment ideas as well. Here’s what I could tell: The world is super-excited about electrification, autonomous driving, and car-sharing or “Uber-fication”. While the world certainly should be excited, we know what happens when the world gets excited: Things get “thrown out with the bathwater”. So we know the crowd is over there. How likely is it that things are going to be as bad as they are expected to be for the Fiat Chryslers of the world?

My wife has a new car with some self-driving features, but all of the evidence is that self-driving is far away, at least at least a decade or, I would argue, two decades. It’s exciting to think about a self-driving world, but on a moral level — I’m not saying this is right but an observation of the truth — the public is willing to allow humans to kill other humans on the road on the order of 40,000-50,000 people killed on U.S. roads every year, but they’re not willing to have computers do it. Somehow if one human kills another human, that’s acceptable, but if a computer does it, it’s unacceptable. To come to people and say, “self-driving cars are killing 30,000 people” is not going to be acceptable. We are not going to accept the same error rate, and street driving is extraordinarily complex.

I know I’ve regularly underestimated the rate of technological change. The people who are bold say, “You think it’s ten years away, but ten years becomes three years, and so on.” Sergio Marchione’s point is that Fiat can buy in the technology as well as anybody else. So, when the technology is there, and it’s proven and works, Fiat will be buying it in. It will be just like installing a different battery or a different seat system in the car, so it won’t affect the automobile business.

Similarly with electrification. We are still in that first part of the curve, where we overestimate the impact of the technology. Things like Tesla soar, and at some point we become disillusioned with the rate of technological adoption.

Did you know there’s an electrified Formula One series? That technology is being tested out in Formula One; they’re figuring it out. There are also many electric cars coming onto the market.

We all love Uber, but how many of us are giving up our car in our hometown? Cars are so much more than just a means of transportation. [I don’t agree with] this argument that the car is being commoditized and the iPhone is what gives us our identity. Cars are not just an expression of our identity; they’re also our personal space. Many people, when they have their commute in the morning, want to be inside a personal space; they don’t want to be in a space they’re sharing with somebody else.

The impact of technological innovation on the economics is further off than people think. Most importantly from the standpoint of the MOI Global community, it’s pretty clear that people are impressed with the new technologies they think are around the corner. That’s where the exuberance is. Old-line car companies that are not at the forefront of technology are considered to be in the backwaters. If you know that people’s attention is over there, then where it isn’t may be where the opportunity is. That was the case with Fiat Chrysler.

MOI Global: Switching gears toward the financial stability of the system in Europe… Even though the markets in general are quite highly valued, some large banks are not highly valued. What are your thoughts on their capital position and the future for equity holders?

Spier: I have not looked at European banks recently, so I can’t comment too strongly, other than to say that Basel III, local regulations, and the requirement for banks to increase capital were massively pro-cyclical. In the exact period in which you wanted banks to be extending credit, they were all pulling their haunches, because they were being regulated by local banking authorities, through Basel III requirements, and the credit rating agencies. So, I have not looked at individual banks in Europe – it’s harder for me to understand that environment.

Forgive the political commentary, but an interesting development from Brexit is that the “Brexiteers” in the U.K. thought that Britain voting to leave the EU would weaken the European system. I actually think that it strengthened it. Countries like France and Germany as well as other countries in Europe have seen the fickle desire of the British to leave the EU, and they are more committed now than ever to European institutions and to making them work. Even guys like the former Greek finance minister, Varoufakis, even though he’s so happy to get on TV and talk about the “thugs” in Brussels, there’s never any question in his mind that Greece should be a part of the EU.

We’ll see a strengthening of commitment, both on a political and popular level, to the institutions that make Europe work. It’s likely that in the future we’ll see appropriate bailouts of banks if necessary. I have not followed up on specific banks and what their capitalization looks like, how cheap they are, and what they look like in a unified European financial market, which is what I expect will happen.

MOI Global: You mention Brexit. Does that make you more or less likely to consider UK equities?

Spier: Unfortunately, I have not found anything I particularly like in the UK. I have looked from time to time.

Give the British economy twenty or thirty years to adjust and the UK will do absolutely fine, if they actually go through with Brexit. But those thirty years “ain’t gonna be pretty”, and we don’t even know what the environment will be like. It’s inevitable Britain will do well, but they may be delayed by thirty years. It will be like Britain’s National Rail – you eventually get into London, but you may spend some significant time waiting on the railway yards before you get there.

The picture is murky, but there will be some extraordinary globally active businesses in the UK. They are figuring it out right now. A company like Ryanair, which flies in and out of the UK, has pretty big uncertainty regarding how that new system will be regulated. They can retool for it, but I haven’t seen the valuations go down [enough] to get excited.

MOI Global: In terms of what does get you excited, are there business models or industries that you feel are particularly interesting?

Spier: We all understand the economics of bundling in cable TV, but [until recently] I didn’t understand the economics of bundling on the iPhone. The MOI Global community probably already understands this, but the simple idea is, the more useful apps you have on your iPhone, the more valuable the iPhone becomes. The more you can bundle into it, the better.

What’s a supermarket? It’s a bundling of stuff. Think about bundling on Amazon and all the stuff you can get in one space. Who would have thought that the time to move from one website to another is enough for the bundling effect on Amazon to be significant? You have the same checkout and your credit card stored there.

Bundling effects are huge, and network effects are huge. The businesses that have taken advantage of those effects have been important, such as Amazon and Facebook. There will be more industry verticals where it’s going to be a winner-take-all market in the way Uber has been.

Consider the dynamics of competition between Facebook and Snapchat. Facebook, through its ownership of Instagram and Whatsapp, is undermining Snapchat at every turn. Snapchat may not succeed in breaking through to build a niche and be a “winner take all”. Even Twitter may not be succeeding the way it ought to be. All new advertising revenue is divided between Google and Facebook.

There are other industry verticals where it’s different enough to get people’s attention and sell advertising to them, and those companies could be in Europe, they could be anywhere in the world.

With businesses I research, it comes down to whether I have confidence in the business model, the concept of bundling, economies of scale, and network effects. For every Amazon there are twenty companies that looked like Amazon twenty years ago. The enormous problem I have is you have to pay a very high valuation.

With an investment like Fiat, [we were] paying 5% of sales in terms of the market cap and maybe 12% in terms of enterprise value. Even for a cyclical automobile company, 50% of sales would be more reasonable; 5% or 10% is just an extraordinary number, and they’re making physical stuff. It was obviously cheap by the kinds of metrics we understand.

Then, we have this whole world in which companies trade at two-digit or higher multiples of any number you want to consider and at a multiple of revenue. The only way you can argue they are cheap is to look at a five- to ten-year horizon and say, “If this business grows the way I expect it to grow, it could multiply fivefold. Then, when we fast-forward three years, we will look back and see that it was cheap.”

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