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Ricky Sandler Eminence Capital ValueInvestorInsight-Issue 80

Ricky Sandler Eminence Capital ValueInvestorInsight-Issue 80



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Published by marketfolly.com
Ricky Sandler's Eminence Capital featured in Value Investor Insight
Ricky Sandler's Eminence Capital featured in Value Investor Insight

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Published by: marketfolly.com on Jun 25, 2009
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s CFO of the then 12-person Gabelli& Co. in the early 1980s, BobRobotti got plenty of exposure tothe investment process – if not much inputinto the actual decisions made. “Let’s justsay Mario Gabelli didn’t need me to pickstocks,” he says.Since starting his own investment firm in1983, Robotti’s record as a decision-makerhas been superb. Focusing on unloved orunknown smaller-cap stocks, he’s returnedan average 17.4% annually to investorsover the past 20 years, vs. 10.3% per yearfor the Russell 2000.Great runs by the energy and small-capcompanies on which he focuses haven'tdiminished his ability to find values, he says:“Volatility will likely be up, but we’re find-ing plenty of things to buy.”
Robert Robotti
Robotti & Co.
Investment Focus:
Seeks ignored ortemporarily struggling small-cap companieswith the potential to at least double theirshare price within three years.
August 25, 2006
Quality Control
It’s rare for great businesses in structurally sound industries to get relativelycheap. When they do, Ricky Sandler is quick to take advantage.
ith a highly successful investoras a father, Ricky Sandler hasoften been tempted to join thefamily’s investment firm. “My dad hasasked me something less than a 1,000times, but more than a 100, to come workwith him,” he says. “I've always wanted todo things on my own.”Sandler’s independent streak has paidoff handsomely for his Eminence Capitalinvestors since he started the firm in 1999.Now with $3.2 billion in assets, Eminencehas returned 20% net to investors annual-ly, vs. a 2% annual gain for the S&P 500.Sandler today sees particular opportunityin large-cap growth stocks. “When valua-tions are compressed and everything tradesfor 13-17x earnings, it's time to trade up forquality and growth,” he says.
Inside this Issue
Investor Insight: Ricky Sandler
Seeing bright future prospects forCisco, Applied Materials, Oracleand Arbitron, but clouds on thehorizon for Lexmark.
Investor Insight: Robert Robotti
Finding eclectic mix of unrecognizedvalue in shares of Atwood Oceanics,Drew Industries, Zenith Nationaland Pre-Paid Legal.
Special: SuperInvestor Insight
Our new publication, tracking theactivity of the world’s best investors:
Up FrontPAGE 19 »
What They’re BuyingPAGE 20 »
What They’re SellingPAGE 22 »
What They OwnPAGE 24 »
Stock SpotlightPAGE 26 »
Editors’ Letter
“Why wouldn’t you look at whatother great investors have found?”Why, indeed.
Other companies in this issue:
Not-So-Ugly Ducklings
There are plenty of prosaic companies in his portfolio, but Bob Robotti’s abilityto unearth great values over the past 20 years is anything but dull.
Ricky Sandler
Eminence Capital, LLC
Investment Focus:
Seeks companiesearning high returns on capital which have“tripped” or are in secularly strong butcurrently out-of-favor industries.
The Leading Authority on Value Investing
How has your investing philosophyevolved since you started your first firm,Fusion Partners, with Wayne Coopermanin 1994?Ricky Sandler:
The philosophy is stillvery much the same. We called it then andI call it now “quality value.” MorrisMark, for whom both Wayne and Iworked at Mark Asset Management, hada big influence because of his emphasis onresearch and on owning great businesses– great companies in secular growth busi-nesses with excellent industry structures.Morris was more willing to buy a greatbusiness with less regard for price, but webelieved you could pay too much for eventhe greatest business. We were also moreopen to the fact that there was a price atwhich a mediocre business could beattractive. So our focus was along thespectrum between “reasonable businessat a great price” and “great business at areasonable price”, with the rest beinguninvestable. That’s still what I do today.One thing that has changed is my com-mitment to shorting. Wayne and I spent80% of our time on the long side and20% on the short side. Shorting was moreof an afterthought, we didn’t dig in asmuch on the companies there. But whenthe markets tanked in 1998 – and in sixmonths Fusion went from something likeup 15% to down 15% – I realized it was
uncomfortable to want to buy moreof what you own when you weren’t sureyou were still going to be in business. Weultimately ended up flat on the year, butwhen I started Eminence, I committed tobeing aggressive short sellers and spend-ing almost half our time on the short side.
You’ve said you think actively shortingmakes you a much better investor. Why?RS:
I saw in 1998 that without having acommitment to the short side, it’s difficultto be offensive when you should be. Thehighest-return opportunities are availablewhen markets are in free fall, but if you’regetting shelled, you may not have theemotional conviction to be aggressivelyopportunistic and you may not even beable to do it, because of redemptions.Being able to be offensive when every-body else is defensive, in and of itself, canyield excess returns.A second element is that as true, com-mitted short sellers, we have to beimmensely skeptical, and skepticism is aterrific quality in a value investor. A keyreason for our success is that we have avery high batting average on the longside. We’re better at avoiding mistakesbecause we’re very attuned to those situa-tions where value gets destroyed, orwhere it isn’t really there in the first place,say, because of phony accounting.We employ gross leverage. Typical forus might be to be 120% long and 70%short. We could not be 120% long with-out also being 70% short – there’d be toomuch risk and volatility for our investorbase. People say shorting is a waste of time and you never make money. I’d sayjust breaking even on my shorts allowsme to be 120% long and still not have alot of volatility. Shorting is and should bea profit center, but the benchmark peopleuse to compare against is often wrong.The last element is that we believe thefundamental structure of a long/shortportfolio minimizes the systematic riskyou can’t control, say of a terrorist attackor a Russian debt crisis. If you employ thegross leverage we do, you’re then magni-fying your stock-specific risk – exactly therisk we feel we should be taking.
Do you tend to short specific companiesor baskets of stocks?RS:
We typically like to short individualstocks. Right now, though, we have a
Ricky Sandler
Investor Insight: Ricky Sandler
Value Investor Insight 
Ricky Sandler
Not Far From the Tree
Ricky Sandler couldn't have asked for amore compatible partner when he and fel-low Mark Asset Management analystWayne Cooperman started FusionPartners in 1994. They were both in theirmid-20s, shared a “quality value” orienta-tion and were sons of Goldman, Sachsalumni who had started their own thrivinginvestment firms: Harvey Sandler ofSandler Capital Management and LeonCooperman of Omega Advisors. “Weboth thought we were ready to run ourown portfolio,” says Sandler, “but therewas some comfort in having a partner todo that with.”Within four years, Sandler andCooperman built $28 million in start-upcapital – $10 million from each of theirfamilies – into $350 million in assets. Buttheir investment styles were evolving in dif-ferent directions. “Wayne moved more toa deep-value emphasis, while I wasincreasingly focused on the quality of thebusiness,” says Sandler.Since the partners went their separateways in 1999, Sandler's EminenceCapital and Cooperman's Cobalt Capitalhave both thrived. Says Sandler: “It goesto show you there are a lot of ways to skina cat in this business.”
Ricky Sandler of New York’s Eminence Capital describes why he’s finally gotten interested in technology stocks, why a seriouscommitment to shorting makes him a better investor, what he thinks the market is missing in Cisco, Applied Materials, Oracleand Arbitron, and why he thinks Lexmark is a great short.
bigger than average balance sheet on thelong side – closer to 160% long – becausewe’re finding all these big companies wewant to have 5% positions in. To supportthat, we’re now around 90% short,which is requiring us to use more indicesthan usual. The M&A environmentmakes us hesitant to significantly increasethe number of company-specific shortswe have. We were short Albertson’s. Wewere short Sports Authority. These arestructurally bad businesses that some-body came along and bought. We have tobe aware of that and not add too muchrisk to the portfolio by adding a lot of new individual short positions.
Back to the long side, what situations tendto result in your finding quality value?RS:
One is the good company in anindustry that’s out-of-favor, for whateverreason. Another is the good company thattrips – the disappointment that hasn’timpaired the long-term value of the busi-ness, but the market overreacts in pricingit down. The third would be the goodbusiness that isn’t necessarily in plainsight – it’s obscured, say, by other busi-ness lines or special situations. JoelGreenblatt talking in your last issue [
, July 28, 2006] about American Express isa good example.I’m probably more willing to pay upfor quality than other value investorsmight be. Some of my investor friendsoften tell me my ideas are “too high-qual-ity” for them. I would distinguish some-what here from paying up for growth –I’ll pay more for a high-quality, slow-growing business. I look for companiesthat will grow value, not necessarily rev-enue, at above-average rates.The higher the quality of the business,the lower discount to our estimated valuewe need. We’re happy to buy a greatbusiness at 75 cents on the dollar.Something would need to be at 50-60cents on the dollar for us to buy amediocre business. On average, I’d sayour typical investment is 30-35% cheap-er than we think it ought to be and wethink it’s increasing value at 15-20% peryear on top of that.
Describe how you come up with ideas?RS:
Our best ideas tend to come fromwhat I call “old research, new events”.That’s typically the good company you’vestudied carefully and would love to ownat the right price, that gets marked downafter it trips or its industry goes out of favor. A great example was Yum Brands acouple years ago. Comp sales at one of their restaurant chains, KFC, were wayoff one quarter and the stock crashed35%. It instantly became an idea – I knewit was a good business and now it was onsale at a 35% discount.We also learn a lot from otherinvestors. I go to idea dinners and regu-larly talk to a lot of people in the busi-ness. I’m not afraid of ideas owned byother people, but you obviously need todo your own work and make sure they fitwhat you do.Many of our other ideas just comefrom having our eyes wide open. Youread publications like yours. You talk tocontacts you’ve developed in variousindustries. It’s often just about payingattention to what’s going on in the world.
On the short side, what attracts yourattention?RS:
We primarily look for material dis-connects between our view of economicearnings and the earnings that are report-ed and people are using to value thestock. It could be accounting related, sowe pay careful attention to things like ris-ing accounts receivable relative to totalsales, cash from operations that is notkeeping pace with net income anddecreasing returns on capital.We also look for long-term structuraldeclines – kind of the opposite of what welook for on the long side. Wall Streettends not to fundamentally mark stocksdown until bad news actually shows up inthe numbers. We’ll ignore the supposedvalue today and focus on whether wethink the “E” in a P/E is going to be mate-rially less in three to five years.
Once you’ve identified a potential idea,what do you do next?RS:
We’ll put an analyst on it, who’salways paired on the idea with me or oneof the two other principals in the firm.We’re leveraging the senior person’s time,but also want more than one pair of eyeslooking at things.We’ll prepare a basic two-page write-up after ripping through the 10-Qs, 10-Ksand proxy filings and listening to confer-ence calls. We want to get our armsaround the business both quantitativelyand qualitatively, so we summarize thingslike the company’s businesses, the com-petitive environment, recent financials,earnings quality, management, outstand-ing litigation and valuation.
What jumps off the page for you?RS:
I focus on return on capital and wantto see EBIT compared to invested capitalin the high-teens or better. We’ll look at itwith and without goodwill, to try to sep-arate out the impact of capital-allocationdecisions versus operating decisions.We favor companies with some formof amortization, where we think cashflow is higher than reported earnings andthat may be one reason why the stock isundervalued. We want to understandhow net income plus depreciation andamortization is converted to cash flowfrom operations. Is anything getting lostin working capital or coming from othergains? We also focus on the relationshipbetween capital expenditures and depre-ciation, to better understand how capitalintensive the business is.If we still think the idea is interesting,we’ll set up calls with the company to bet-ter understand how they operate andthink about things like capital allocation.
Value Investor Insight 
Ricky Sandler
We’ll ignore the supposed valuetoday and focus on whether the“E” in a P/E is going to be mate-rially less in three to five years.

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