Describe the macro overlay behind yourcurrent interest in several NorthAmerican natural-gas-related companies.RR:
Natural gas is a commodity that’snot easily transportable, so market pricesare dictated far more by local supply anddemand than is the case for oil. For sometime now, the significant increase in gassupply in North America from shale dis-coveries coupled with weak demand inthe aftermath of the recession havepushed gas prices extremely low on anabsolute and relative basis versus oil. Ataround $4 per thousand cubic feet [Mcf],North American natural gas is priced atless than one-third the price of oil on anenergy-equivalency basis.While we don’t expect that discountfor North American gas to go away forthe foreseeable future, we believe the dis-crepancy will definitely shrink. U.S. natu-ral gas has many competitive advantagesversus oil – lower cost, plentiful domesticsupply and far less impact on pollution –which we expect to result in incremental-ly higher demand. At the same time,today’s gas prices provide no return onnatural gas drilling, which will keep pro-duction supply in check. We think that a$6 per Mcf price – 50% above today’slevel – will be needed to sustain drillingthat will be necessary to meet even cur-rent production levels.With $6 natural gas the business envi-ronment for related companies should behighly attractive relative to what’s expect-ed. The changes necessary to get theremay take time – bus fleets don’t switch tocompressed natural gas or coal-fired elec-tricity capacity isn’t shifted to gas-pow-ered plants overnight, for example – butwe consider North American natural gasan interesting decade-long play.
More on that later, but still speaking gen-erally about the types of situations thatattract you, how often are you betting onpotential operating turnarounds?RR:
We’ve been successful in the pastwith a variety of special situations,including companies in bankruptcy orhaving to raise capital through rightsofferings. The challenges facing the com-pany may be industry-related or a resultof its own mistakes. One of our bestinvestments over the past several yearshas been PriceSmart [PSMT], which runsCostco-like warehouse stores in LatinAmerica. It overextended itself and in2005 went through a restructuring, whichincluded a rights offering and bringing innew management. One appealing aspectof the offering was that the founder andlargest shareholder, Sol Price, back-stopped the deal and instead of takingwarrants or special pricing in return,actually offered public shareholders a bet-ter deal on the offering than he and hisfamily got. We unfortunately owned thestock before, but bought a lot more in therights offering at $7 per share – it’s nowcloser to $65.
Do you still own it?RR:
We’ve reduced our position as thestock has done extremely well over thepast couple of years, but we still own it.The company has compounded same-store sales in the mid-teens through therecession and now has 28 stores, mostlyin Central America and the Caribbean,but it still has considerable opportunityfor growth. They’re opening their firststore in Colombia, for example, whichhas a population equal to the currentpopulation base served by the rest of thecompany today.
You’ve made a concerted effort to expandyour international investing [
see box, p.11
]. Describe how that’s going so far?RR:
We’ve focused almost exclusively onAsia, where our style of value investingisn’t in common practice and where,because the markets are even moremanic-depressive, you can find dramaticdisparities between public and privatemarket values. It’s been a wild ride, withthose markets going down more andfaster into the financial crisis and thenup more and faster coming out of it. Ourknowledge base and contacts through-out the region are significantly betterand we continue to find plenty of ideasthat should do very well as theseeconomies continue to emerge over thenext ten years.
Give some examples of the quirky typesof things you’re finding in Asia that fityour strategy?Isaac Schwartz:
We see considerablepotential in Mongolia, whose economy isbeing fundamentally transformed bydemand for its natural resources. Roads,railways and processing facilities arebeing built in the country to facilitate theshipping of coal, copper and iron ore toChina and elsewhere. One way we’vefound to play that is through a Japanesecompany called Sawada Holdings[8699:JP], which owns a majority stake inKhan Bank, the dominant bank inMongolia. Khan’s asset base has grown ahundred-fold in the last decade and itnow controls roughly 30% of the coun-try’s total banking assets.Khan in the first half of 2011 had netearnings of $24 million, a 49% return onequity. Put a 15-20x multiple on that onan annualized basis and the bank overallwould be worth $700 to $950 million,making Sawada’s stake worth maybe$400-500 million. But if we value the restof Sawada’s holdings, primarily a Japanese broker-dealer, at book value, itscurrent market value [at a share price of around ¥740] implies a value for Khan of only $130 million at current exchangerates. That’s a pretty nice discount for acompany with dominant market share,great returns on capital and extraordi-nary growth upside.Another bank bet we’re making isthrough Indonesia’s Panin Insurance[PNIN:IJ], the control shareholder of Bank Panin, a leading commercial bankserving the country’s affluent ethnicChinese minority. There’s actually a bank
Value Investor Insight
We’re focused there becauseour investing style isn’t in com-mon practice and the marketsare more manic-depressive.