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Graham & Doddsville

An investment newsletter from the students of Columbia Business School

Issue XXX Spring 2017

Inside this issue:

CSIMA ARGA Investment Management

Conference P. 3
Pershing Square A. Rama Krishna, CFA, is the founder and Chief Investment
Challenge P. 4 Officer of ARGA Investment Management. He was previously
A. Rama Krishna P. 5 President, International of Pzena Investment Management and
Managing Principal, Member of Executive Committee, and
Cliff Sosin P. 14 Portfolio Manager of its operating company in New York. He
led the development of the firm's International Value and
Student Ideas P. 28 Global Value strategies and co-managed the Emerging Markets
Chris Begg P. 36 Value strategy, in addition to managing the U.S. Large Cap
A. Rama Krishna Value strategy in his early years at Pzena. Prior to joining
Pzena in 2003, Mr. Krishna was at Citigroup Asset
Editors: (Continued on page 5)

CAS Investment Partners

Eric Laidlow, CFA
MBA 2017
Cliff Sosin is the founder and investment manager of CAS
Benjamin Ostrow Investment Partners, LLC ("CAS"), which he launched in
MBA 2017 October 2012. Immediately prior to founding CAS, Cliff was a
John Pollock, CFA Director in the Fundamental Investment Group of UBS for five
years where he was a senior member of a team analyzing
MBA 2017 equities and fixed income securities. Prior to UBS, Cliff was
Abheek Bhattacharya employed as an analyst by Silver Point Capital, a hedge fund
MBA 2018 which invested in high yield and distressed opportunities, as
well as by Houlihan Lokey Howard & Zukin, a leading
Matthew Mann, CFA investment bank best known for its advisory services with
MBA 2018 Clifford Sosin respect to companies requiring financial restructuring. Cliff
Adam Schloss, CFA (Continued on page 14)

MBA 2018
East Coast Asset Management
Christopher M. Begg, CFA, is the Chief Executive Officer, Chief
Investment Officer, and Co-Founder of East Coast Asset
Visit us at: Management. Prior to co-founding East Coast, Chris served as Rolf Heitmeyer
a Portfolio Manager and Research Analyst at Moody Aldrich Partners and a Portfolio Manager at Boston Research and
Management. Chris is currently an Adjunct Professor at the
Heilbrunn Center of Graham and Dodd Investing at Columbia
Business School, teaching Security Analysis during the fall
Semester. Chris received his BS degree from the University of
New Hampshire and holds a Chartered Financial Analyst (CFA)
designation since 1998. Mr. Begg is a member of the Boston
Chris Begg Security Analyst Society and the CFA Institute. Chris is
involved in environmental conservation serving as a Corporate
(Continued on page 36)
Page 2

Welcome to Graham & Doddsville

We are pleased to bring you the kets portfolio in Russia when the Tenth Annual Pershing
30th edition of Graham & other investors were fleeing Square Challenge in April 2017.
Doddsville. This student-led the region. Windsor Cristobal 18, Anji Lin
investment publication of Co- 18, and Isabella Lin 18 share
lumbia Business School (CBS) is Clifford Sosin of CAS Invest- their winning pitch of Yum
co-sponsored by the Heilbrunn ment Partners shares his highly China (YUMC); Chris Waller
Center for Graham & Dodd concentrated and long-term 18, SK Lee 18, and HK Kim
Investing and the Columbia Stu- approach. He discusses two of 18 discuss Alaska Airlines
dent Investment Management his investment ideas in depth; (ALK); Griffin Dann 18, Joseph
Association (CSIMA). anyone following Herbalife OHara 18, and Vikas Patel 18
(HLF) or World Acceptance share Corning (GLW); Gustavo
Meredith Trivedi, the Heil- In this issue, we were fortunate Corporation (WRLD), especial- Campanh 18, Gilberto Giuizio
brunn Center Director. to speak with three investors ly short sellers, will be interest- 18, and Thiago Maffra 18 pre-
Meredith skillfully leads the who provide a range of perspec- ed in this discussion. Addition- sent Dollarama (DOL).
Center, cultivating strong tives and investment approach- ally, Cliff provides some unique
relationships with some of es. All three apply variations of career advice for aspiring inves- We are honored and privileged
the worlds most experi- value investing and fundamental tors. to have continued the Graham
enced value investors, and research to find overlooked & Doddsville legacy, and we
creating numerous learning opportunities. These invest- Christopher Begg, CFA, of look forward to reading the
opportunities for students ments could be stable businesses East Coast Investment Manage- next generation of issues,
interested in value invest- in turbulent geographies, misun- ment discusses the benefits of helmed by three outstanding
ing. The classes sponsored derstood businesses engrossed investing in compounders, individuals in Abheek
by the Heilbrunn Center in controversy, or compounders transformations, and Bhattacharya 18, Matthew
are among the most heavily that are hiding in plain sight. workouts. The adjunct profes- Mann 18, and Adam Schloss
demanded and highly rated sor of Security Analysis at Co- 18. We want to thank Abheek,
classes at Columbia Busi- A. Rama Krishna, CFA, of lumbia Business School shares Matt, and Adam for their com-
ness School. ARGA Investment Management his thoughts on Sherwin- mitment and dedication to
discusses the application of value Williams (SHW) and other high Graham & Doddsville.
investing globally, especially in quality businesses that are
emerging markets. His time sometimes overlooked. Chris As always, we thank our inter-
working with valuation-focused also emphasizes the benefits of viewees for contributing their
firms helped inform ARGAs multi-disciplinary learning, both time and insights not only to
approach and the goal to find for life and for investing. us, but to the investment com-
value anywhere. Rama discusses munity as a whole, and we
the challenges and opportunities Lastly, we continue to bring thank you for reading.
of this strategy, including the you pitches from current stu-
decision to invest nearly a quar- dents at CBS. In this issue, we
ter of ARGAs emerging mar- feature ideas from finalists of - G&Dsville Editors
Professor Bruce Greenwald,
the Faculty Co-Director of
the Heilbrunn Center. The
Center sponsors the Value
Investing Program, a rigor-
ous academic curriculum for
particularly committed stu-
dents that is taught by some
of the industrys best practi-

Student volunteers at the 20th annual Bruce Greenwald with keynote speaker
CSIMA Conference, February 2017 David Abrams of Abrams Capital (right)
Volume I, Issue 2 Page 3

20th Annual CSIMA Conference February 3rd, 2017

Keynote speaker David Abrams, Abrams Capital Samantha McLemore, LMM, and William von Mueffling 95,
Cantillon Capital Management, speak on the Behavior
Finance panel

Thomas Russo of Gardner, Russo & Gardner, speaks on Attendees networking and discussing stocks after the
the Finding Value: a Global Perspective panel Best Ideas panel

From left: William Strong of Eschaton Funds, Dominique Mielle of Canyon Partners,
Andrew Wellington of Lyrical, and Ryan Heslop of Firefly Value Partners offer their
best ideas. Ellen Ellison of University of Illinois Foundation (right) moderates
Page 4

10th Annual Pershing Square Investing Challenge April 19th, 2017

The first-place team, which pitched Yum China, poses The Yum China team (from left): Anji Lin 18, Isabella
with Bill Ackman (left) and the other judges Lin 18, and Windsor Cristobal 18

The second-place team, which pitched a short on J.M. Last years winning Couche-Tard team (from left):
Smucker, poses with the judges Melody Li 17, Joanna Vu 17, and Thais Fernandez 17

Students and alumnus discussing the pitches (from left):

Vik Patel 18, Mahmud Riffat 14, Eric Laidlow 17, and
Lilia Noack 18
Page 5

A. Rama Krishna
(Continued from page 1)

Management, where he A. Rama Krishna (ARK): investment decisions. First, as

was Chief Investment Until I went to business school investors, we think of investing
Officer and Head in the 1980s, I didn't know that in companies, not stocks.
Institutional and the role of an investment Second, we think the value of
International, and research analyst even existed. companies is determined by
represented the asset Then I learned you actually get their long-term earnings power
management business on paid to analyze and critique and dividend-paying capability.
the Citigroup Management other people's businesses. Third, our research analysts
Committee. He also Well, that seemed like a lot of focus on understanding long-
directly managed the funand I wanted to apply the term company fundamentals,
Global Emerging Markets many useful learnings from not analyzing investor
Equity strategy. Prior to business school in an sentiment. And fourth, our
A. Rama Krishna Citigroup, Mr. Krishna was intellectually rigorous portfolio construction reflects
Director of International profession. the magnitude of the discount
Equity Research, Portfolio to fair value at which we buy
Manager, International I started out on the sell side in, as well as the risk that the
Equities and Chief because I wanted to forecasts may not be correct.
Investment Officer, understand businesses. After
Emerging Markets Equities about five years, one of my By incorporating these
at AllianceBernstein in clientsnow concepts into ARGAs
New York, London and AllianceBernsteinasked me valuation-based investment
Tokyo. He has also worked to join them to help build their process, we take emotion out
at Credit Suisse First research and manage of investing. The process often
Boston, first as an Equity portfolios in global, results in our investing in
Research Analyst and international, and emerging currently unpopular companies
ultimately as Chief market strategies. Based first and industries. The long-term
Investment Strategist and in New York, then in Tokyo benefits of this contrarian
Director Equity and London, I built and led approach have been
Research, in New York, Alliances international documented by a number of
Tokyo and Singapore. research team, along with studies.
Mr. Krishna earned a joint managing investment
M.B.A./M.A. in Asian portfolios. I found my instincts G&D: How does ARGA
Studies with a Japan about the profession were implement its investment
Specialization from the rightinvesting was very approach?
University of Michigan in dynamic and challenging.
1987 and a B.A. (Honors) ARK: One of ARGAs core
in Economics from St. Much later, when I had some beliefs is that pricing anomalies
Stephens College, The career flexibility, I decided to are created by emotions in
University of Delhi in 1984. return to what got me into the investment decision-making.
Mr. Krishna received the business: investment research. These anomalies provide
Prize Fellowship in All I had learned reinforced the opportunities for investors
Japanese Business and the importance of research in who can capitalize on them.
University Fellowship at building client portfolios. I Our valuation screens and our
the University of Michigan knew I wanted to bring proprietary dividend discount
as well as the Middlebury together a team of people with model provide a systematic
College Scholarship. He the same investment beliefs. way to uncover these
was on the MSCI Editorial Thats why I started ARGA. anomalies and measure them.
Advisory Board and is a By sticking to our disciplined
Chartered Financial G&D: How would you investment process and staying
Analyst. describe ARGA and its the course amid short-term
investment philosophy? pressures, we remove emotion
Graham & Doddsville from investing.
(G&D): Can you tell us how ARK: ARGA is organized
you got into the industry, and around some enduring We do only one thing at
how you founded ARGA? concepts that drive our ARGA: valuation-based
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A. RamaSawikin
investing. The pond that we Theres an important people from Japan, mainland
fish in is deeply undervalued behavioral reason: we see China, and India. Our India
businesses. Our process begins ourselves as business analysts. office has had people from
by running several screens to When you start thinking about Korea, the U.K., the U.S., and
identify companies long-term companies as stocks and try to Singapore.
value: price-to-book, price-to- time their purchase, you end
earnings, dividend yields, up not owning the stocks While ARGAs global team
normalized earning yields. Our when they may in fact be most brings diverse perspectives, it
screens are only the starting attractively valuedwhich is is highly consistent in how we
point. They simply give us a probably when theres the look at industries and
rich universe of companies on most amount of stress and accounting across geographies.
which to focus our research. controversy associated with This consistency is critical in
them. By focusing on the comparing company valuations
The companies that rise to the business analysis, we detach across the world on an apples-
top of our screens, generally ourselves from emotion. Our to-apples basis. We follow a
speaking, have some sort of investment process tells us strict set of rules to adjust
issueotherwise, they when to buy and when to sell. different accounting standards
wouldn't be so cheap. The in different parts of the world,
portfolio construction team Our analysts spend nearly 95% so we can reflect the
for each investment strategy of their time developing inputs companies underlying
reviews the screens, focusing that go into the investment economic value. We are also
on the top quintile, then works process. The inputs are all consistent when we evaluate
with research management to about company fundamentals global market shares and link
assign companies to analysts. and related risks. revenue forecasts for
companies within an industry.
At this stage, the analyst has While making all these
one week to come back with When you start thinking consistency adjustments is
answers to two questions: 1) about companies as time-consuming, it is core to
"Why does the valuation look our investment process of
attractive?" and 2) How are stocks and try to time comparing company valuations.
the fundamentals of the
business likely to evolve over their purchase, you end Also at our core is completely
time? up not owning the stocks aligning ourselves with the
interests of our clients. We
To implement this process when they may in fact know most firms claim this,
well, you need to have the but we have actually turned
right kind of people. A number be most attractively down several institutions that
of analysts who joined during valued. offered to take a stake in
ARGAs early stage were ARGA, give us assets to
people who I had worked with manage, or even pay for our
in the past so they were A unique aspect of our firm is operating expenses. We flatly
familiar with the investment we started on day one as a turned them down because we
approach from day one. The global firm with two knew at some point, their
new analysts that we hire often locationsone in a developed interests and those of our
have experience working in market, the U.S. (in clients would diverge. We're
analytical roles at various Connecticut), the other in an proud to be 100% privately
businesses such as insurance emerging market, India. We owned, with many employees
companies, management felt that in today's world, you sharing in ARGAs earnings and
consulting, and private equity. cannot look at any business value. Yes, ARGAs business
We haven't recruited much without having both developed has grown rapidly. But what's
from the typical Wall Street and emerging-market most important is that we do
sell-side analyst pool because perspectives. We then staffed what we truly believe in:
we view our research team as both locations with a very unconstrained investing, where
business analysts, not stock global team. ARGAs the sole focus is valuation
pickers. Connecticut office includes backed by research. The only
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A. RamaSawikin
way to do that without company forecasts if they equity, non-U.S. or
interference is by being didn't believe their colleagues international equity, and
completely independent. The industry forecast. Theres a emerging-markets equity. Each
only people we answer to are level of quality control even strategy today has
our clients. before an analyst brings a approximately 50 to 60
company to the research holdings. We do have a highly
G&D: What are some of the management or the portfolio concentrated version of our
adjustments you make for construction teams for global strategy that has 15 to
valuation or accounting across discussion. 20 holdings, but most
geographies? strategies are in the 50-60
ARGAs teamwork philosophy range. In constructing these
ARK: Lets take China also ensures our businesses portfolios, we do not consider
Resources Power in China, are well understood by the regional, industry, or stock
which uses steam turbines to persons beyond the industry weights of the market
generate a portion of its expert. The two or more benchmarks. Of course, our
electric power. The company analysts with related coverage clients compare us against
depreciates its turbines rapidly hold frequent discussions on benchmarks for long-term
over roughly 16 years. The sector businesses, often performance but benchmarks
same steam turbines in travelling together to visit are non-factors in our
Germany or the U.S. would companies. We believe this portfolio construction. We
probably depreciate over 25 teamwork leads to better focus purely on owning the
years. So China Resources business insight, and, in turn, most attractively valued
Powers reported earnings better investment decisions. businesses in the world.
seem much lower than if you
adjusted the turbines G&D: Could you talk about G&D: What is your process
accounting life to reflect their some of the lessons youve of generating ideas? Could you
true economic life. If you didnt learned from investing over walk us through one of those
make such an adjustment, you the past couple of decades and ideas?
could miss a company with how thats influenced what you
greater earnings power than its do today? ARK: It goes without saying
reported numbers imply. that most investors want to
ARK: What has stuck with me buy a good business. But the
G&D: How do you organize most is that no matter how reality is, for a company with a
your analysts given the multiple great the operating leverage in solid management, a strong
locations, various markets, and the business, if you have a lot balance sheet and good growth
need to constantly adjust for of financial leverage, you might prospects, it's extremely
such nuances? never reap the operating difficult to get those
benefits. A big lesson for me characteristics at an attractive
ARK: We organize our was how to manage financial valuation. Were very realistic
research team by global risk. Even if the financial on what we can buy for our
sectors. Typically, more than leverage doesnt seem high at clients. Almost every candidate
one person has responsibility first, if the operating leverage tends to be a company that has
for a particular sector, which is high and the business some issue.
encourages and facilitates deteriorates faster than you
collaboration, both across and expected, then financial What we're doing through our
within offices. While it may not leverage starts to grow research is figuring out
seem efficient for two people exponentially. Be very wary of whether the issues are
to cover a smaller sector, it financial leverage. transitory or permanent. If we
ends up being more effective. believe the issue is transitory,
These analysts build industry G&D: Tell us about your and the business is attractively
models together, and also link portfolio strategies. How many valued on our dividend
their individual company positions do you usually target? discount model (DDM), then
models. This helps ensure best we consider buying the stock.
possible inputs, as the analysts ARK: ARGA has three We invest with a three-five
would object to linking primary strategies: global year view at ARGA. We want
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A. RamaSawikin
to ensure any downside risk For Samsungs DRAM business, firm, except that we invest in
over that timeframe is limited. our analysts thesis was unique. public markets at ARGA. We
We think about downside risk Unlike most analysts who at behave as though the New
as permanent loss of capital that time were saying the York, London, or Shanghai
What is the downside risk of DRAM cycle would go through stock exchanges will close for
losing money when we sell the its typical boom-bust rotation, the next three years, and we
stock in three years' time? our analyst pointed out that wont have the liquidity to exit.
the number of DRAM players We leave no stone unturned in
Take Samsung Electronics. It had gone from as many as ten our research. Otherwise, we
came to the top of our a decade ago to currently only wouldnt have the confidence
screened list around early three. Its now an oligopoly. to own the business. We go to
2014. Our analyst spent a The third largest player, work on building detailed
week researching Samsungs Micron, barely made money in industry and company models.
business and came back with the best of times and would We talk to company
answers to our two questions. set the floor for pricing during competitors. We develop the
First, Why is the stock the next downturn. So even income statement, balance
cheap? A key reason was that though DRAM volumes might sheet, cash flow forecasts by
Samsung was losing market be off, our analysts view was segment and full company.
share in smartphones to Apple. that pricing would not collapse.
Its share had tumbled from That meant Samsung or even
around 32% to the mid-20%s. peer SK Hynix would end up We behave as though
The smartphone business was making 20%, possibly 30%,
a huge cash generator, about margins during the next the New York, London,
60% of Samsungs profits. downturn. He believed that
Concerned that this profit would surprise the investment
or Shanghai stock
stream was under threat, many community when it happened. exchanges will close for
investors had sold off. We thought the analysts thesis
was plausible, and decided that the next three years, and
Additionally, Samsungs DRAM Samsung justified a detailed
we wont have the
semiconductor business was research project.
facing an end-market liquidity to exit.
slowdown as PCs slowed and At this stage, we usually reject
smartphones became about 80% of companies under
saturated. For these reasons, consideration. Companies can As we're doing all this, we
almost every analyst covering be rejected for any number of come up with questions for
Samsung issued either a hold reasons. It could be structural. management. When we talk to
or a sell rating for the stock. If the business faces structural management, we arent there
The stocks valuation challenges, we pass, as we to hear a presentation on the
collapsed. The second question know the stock will appear parts of the business that are
our analyst addressed was, expensive on our DDM once doing well. Were there to talk
How are the fundamentals of we input our forecasts for about their strategy for
the business going to evolve growth and profitability. If the business recovery. We come
over time? The handset business has huge financial back and update our models.
business is a consumer leverage, we may pass knowing Then, we talk to an analyst in
business. We can't really it may not survive stress over the brokerage community who
forecast which smartphone our three-five year time may have a different view of
model is going to be successful, horizon. The point is we the company to see if we have
so we treat it as a commodity proceed with detailed research a structural flaw in our
business, where scale matters. on only 20% of companies. analysis. If we have a structural
In that light, even if Samsung flaw, we go back to the
margins tanked to 10%, the G&D: What does this next drawing board.
stocks valuation still looked step of research involve?
attractive. In the case of Samsung, the so-
ARK: This is where we start called flaw we heard from
behaving like a private-equity brokers was, why would you
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A. RamaSawikin
not want to wait until you see already declined so much, our shareholders in the desire for
the handset business pick up base case upside was very good returns in the long run, if
again, or the DRAM business significant, while our stress not outright cash returns. We
go through the next up-cycle? case showed little downside. It felt theyd be forced to do
That's music to our ears. was one of those good skewed something about the more
Because if you waited for the outcomes that we generally than $60 billion in cash as the
good news to come through, look for at ARGA. If were business matured. Our analyst
you're going to miss the best right on our forecasts, we noted that Samsung rarely
part of the upturn in Samsungs make a lot of money for our made acquisitions, as these had
stock price. clients, and if were wrong, not delivered great returns in
theres very little risk of losing the past. Viewing management
The point is, were almost money over time. as good stewards of
always buying stocks pre- shareholder capital, the only
catalyst or pre-good news. We G&D: One concern that option left as cash builds to
all read the same newspapers. investors have had about over $100 billion is to begin
The difference at ARGA is we Samsung and the Korean returning cash to shareholders.
have a disciplined process from conglomerates is how their
which we never deviate, no managers allocate capital, If management did anything
matter how we might feel overspending or engaging in right with the business, or if
emotionally about the outright related-party capital allocation turned out
company. Once we put the transactions. How did you just a bit better than expected,
numbers into our DDM, if the think about that when you it would be a big, positive
stock valuation looks attractive were evaluating management? surprise. This is an example
relative to our computation of where everything in our
the companys intrinsic value, ARK: That was a big concern. analysis pointed to an
we consider the stock for our In fact, one of the reasons incredibly undervalued
portfolio. For Samsung, our Samsung was so cheap was business for this kind of
process indicated more than related to concerns about franchise and strong free cash
100% upside in our base case capital allocation. We had no flow generation, relative to the
scenario. crystal ball to forecast what market cap. At ARGA, it
management was going to do, always comes down to
In addition to a base case that so we focused on obtaining a valuation.
normally tilts conservative, we very clear understanding of its
do a stress case for every underlying businesses. Our G&D: How do you think
company we research. The analysis showed the industry about the politics of Samsung?
analyst sometimes finds no dynamics had changed The broader conglomerate
downside risk. When that dramatically in DRAM and controls so much of South
happens, as it did in the case of even in NAND, becoming very Koreas economy. Plus, the
Samsung Electronics, we pay consolidated. All players now heir to the Samsung empire
very close attention. From a appear very focused on was arrested earlier this year
balance-sheet viewpoint, we returns, not just growth. It for his alleged connection to a
found a company with little became apparent that even if corruption scandal.
risk. We saw more than $60 Samsung didnt act in the near
billion of cash that would allow term, management would ARK: Governance is an
ample financial stability. Our eventually realize that with its explicit part of the research
analyst had pointed out that a cash-generating handset for any company ARGA looks
few of Samsungs smaller business and flexibility to rein at. We even have a checklist
businesses were losing a lot of in capex, it was building excess that helps analysts understand
money. We concluded that if cash on the balance sheet, companies governance issues
the core business ever came which depresses returns. and associated risks. Yes, we
under serious threat, Samsung identified a large risk with the
could immediately shut down We felt the interests of Samsung group that they
these two smaller businesses Samsungs management, the probably have a finger in every
to boost profitability overall. controlling family, were at least area of the Korean economy.
Because Samsungs stock had aligned with minority At least in Korea, it's not just
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A. RamaSawikin
the Samsung group that is In emerging markets, there are and China that are as well-
exposed to Korean political always going to be situations managed and have as good
winds and economy. Other where you could be surprised corporate governance as
conglomerates have had similar by risks. Even with Big Four companies in India. Our view is
issues. Governance at the audits, there are cases of fraud. that governance is company-
larger Korean groups hasn't This is something you do your specific, not geography-specific.
been positive in general. best to minimize through Every part of the world,
Nick Briody 18 pitches a serious due diligence. You talk including China, India, Korea,
short on Smuckers at the
The Samsung group has never with management and peer and Russia, has outstanding
Pershing Square Challenge
willfully destroyed value at the companies, seeking to businesses and outstanding
Samsung Electronics level. It's comprehend managements managements running those
their flagship company. Theyve backgrounds and motivations. businesses, along with
done an incredible job of Still, its a risk you always attractive valuations.
building a fabulous franchise by worry about. Of course, those
taking a long-term view of the very risks can also make stock G&D: Have you ever run into
business over the last three valuations very compelling. situations where you find a
decades. The good thing about Thats why its worth doing good, undervalued company,
Samsung Electronics is you deep research. but because of its location, you
can't build and run a big, global dont invest?
company unless you have
professional managers in each ARK: At ARGA, its never a
The reason value
of the business lines who know macro view. The only reason
what theyre doing. Samsung investing works in the we wont invest somewhere is
Electronics certainly has its if we believe well never get
share of high-quality managers long run is because it our money backif theres the
who we believe will continue doesnt work all the risk that some country like
to run the business well Argentina expropriates our
despite the detention of the time. capital. Beyond that, our focus
Samsung heir. is owning attractively valued
G&D: When youre looking at Interestingly, state-owned
emerging markets, how do you companies mostly have a Typically, the only time
get confidence in the financials greater degree of scrutiny. businesses get to the valuation
and that the business is being Though there are cases of levels that make them
properly represented? corruption, with most state- incredibly attractive is when
owned firms, there are at least there are all kinds of concerns
ARK: There are certainly processes and probably more at the country level. For
groups or companies, government oversight in the example, a couple of years ago,
particularly in emerging form of regular audits. The less we had 24% of our emerging-
markets, where ambiguous regulated countries have markets portfolio in Russia.
financials are an issue. These potentially higher risk. Thats a pretty significant
typically tend to be private- weighting, especially given all
sector or smaller companies. G&D: India is often the news you were reading
What we do in these cases is considered as the one regarding sanctions, or about
try to understand if the emerging market where Russia going into a massive
company has a history of private-sector firms are of recession for a year or two.
questionable practices. Have higher quality. In your Our research showed there
they changed auditors often? experience, is corporate were businesses in Russia that
Do the auditors have governance better in India than would survive a major
qualifications? Were in China or Korea? economic downturn in very
constantly on the watch for good shape, even if that
these and other early warning ARK: Not necessarily. We downturn lasted for a couple
signs. dont think its any better, or of years. Further, when Russia
any different, in India. We can would eventually recover,
identify companies in Korea those businesses would
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A. RamaSawikin
emerge stronger than ever mode. They were very G&D: When you were
because its peers would have methodical and prompt about looking at Russian investments,
been wiped out. this to get maximum money was there a focus away from,
back, way before other Russian or towards, some of the
We embrace stress and banks even thought about natural-resource players?
uncertaintynot because we doing this.
love them. Our investment ARK: We did have some
process forces us to consider The company was not only natural-resource exposure,
such businesses because they able to survive a massive particularly Russian oil-and-gas
are probably the most Russian recession, but more businesses. These had U.S.
attractively valued just when crucially, it emerged stronger. dollar-denominated revenues,
theyre subjected to perceived It turned down the Russian very clear agreements on tax
or real stress of a significant governments offer of capital and royalty payments to the
degree. By the way, this infusion because their view Russian government, and fairly
process is not for everybody, was, once you take that good transparency on capital
as you can imagine. It is not fun assistanceas some of the allocation. If oil prices went
for most people, even for us at other weaker Russian banks down, their payments to the
times. The reason value didthe government could Russian government would
investing works in the long run then influence you, like also go down. Theyre less
is because it doesnt work all demanding you lend money to leveraged to oil prices than
the time. If it did, everybody unappealing groups. Sberbank most other oil and gas
would do it. wisely wanted to stay companies worldwide and
completely independent. We theyre also fairly well-managed
G&D: Could you give us an think Sberbank management is operationally.
example of one of those as good as at any bank in the
Russian businesses that you felt world today, maybe better. A company like Gazprom has
was solid enough to weather Theyve come out of the perhaps among the most
the downturn? recession nicely. Theyre undervalued energy assets
already making ROEs in excess youll find anywhere in the
ARK: Look at Russias largest of 15%. You can imagine how world. It has decent corporate
bank, Sberbank, which has theyll perform when the governance processes, despite
close to 50% market share of Russian economy actually picks concerns by some investors.
Russian retail deposits and is up. Most other banks are still Yes, capex is high because its
also Russias largest corporate burdened with problems from seeking ways to reduce
lender. Pre-recession, this bank the recession. dependence on Europe, so it is
was extremely well capitalized spending billions of dollars
and, in our view, could G&D: We see that Sberbank building multiple pipelines. The
withstand a big increase in still trades below consensus Russian government, as the
NPLs. Keep in mind, when you estimates of forward book controlling shareholder, has
have a bank that has close to a value. Would you still think its the same incentive as minority
50% market share in retail attractive? shareholders to ensure
deposits, chances are good Gazprom pays dividends. The
that returns will be high. ARK: Its still a good franchise. government wants those
Sberbank had an average But the stock became less dividends too. We like that
return on equity of 20% over undervalued than it used to be. Gazproms earnings are mostly
the past decade. Valuation is always the driving in U.S. dollars. If the local
force and there were better currency weakens, theres little
As soon as Sberbank saw what valuation opportunities. We dollar impact. In contrast, local
was happening with the did sell out of most of our -currency earnings and
Russian sanctions and Sberbank position last year and dividends went up a lot when
slowdown, the management used the proceeds to invest in the ruble fell.
made sure they could pull back higher-return opportunities.
every single loan or credit line Declines in the stocks G&D: Going back to your
possible. They went into a very valuation may make us lessons of being wary of
severe damage assessment reconsider the business again. leverage, would you
(Continued on page 12)
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A. RamaSawikin
automatically reject companies could differ), its sold from the probably isnt. As Ben Graham
that seem cheap because they portfolio. We dont even once said, In the short run,
are having issues with debt? discuss it. We just sell it. We the stock market is a voting
sell even if the stock has strong machine. In the long run, it is a
ARK: No, this depends on momentum at that time. weighing machine.
whether the business can
handle the leverage under our The reason we sell At ARGA, we happen to favor
stress case scenarios. Our immediately is that our valuation-based investing. That
stress scenarios help us assess strategies are solely focused on doesnt necessarily mean we
whether, no matter how low owning the most undervalued think the value framework is
profitability may go, the businesses in their universe. any better or worse than
company we are considering No matter how great the momentum in terms of
can still support certain levels stock price momentum at the delivering investment results.
of leverage. You make sure the time of sale, there should be Theres a long history of value
stress case truly reflects a other more attractively valued strategies and of momentum
worst-case scenario. You companies in the portfolio or strategies performing well.
cannot forecast events, and in the universe that should do Theyve performed almost
there could be a situation a lot better on a three-year identically over the last 45
where things get to that view. years or so. Its more a
extreme worst-case scenario. question of you finding what
You always want to make sure To continue the Samsung you believe in and what you
your companies can survive. Electronics example, the stock find most stimulating. So its a
hit the midpoint of the ranking question of temperament
In the case of energy stocks, in our universe in August of how you look at data and
for example, when we built last year. At that moment, we figure out how a business
our stress case scenarios, we automatically sold Samsung might evolve in the future.
assumed $30 oil prices for two from our portfolios. We didnt
years in a row, both 2016 and even discuss it. We just sold You need to determine what
2017. Consequently, we ended the entire position. kind of an analyst you are.
up dropping a lot of companies What do you like doing best?
that looked really cheap on G&D: Any advice for students Is it trying to forecast whether
our initial screens because they who are trying to get into the a fast-growing business can
wouldnt have survived at sub- investment industry? How sustain its momentum? Or
$30 oil prices for two years. would you suggest they trying to understand what the
develop their investment business should earn over the
G&D: One dilemma for a lot philosophy? long run? A career in value
of value investors is deciding investing can be stressful. The
when to exit an investment. ARK: All of us at ARGA are rewards of exploiting
Do you sell when its gratified that many investors behavioral anomalies
successful, or when some have entrusted us with the compensate for that stress
negative news has come out? responsibility of managing their over time, but do you have the
financial assets. Heres my patience to wait for them?
ARK: Everyday, we get a list parting advice to students Depending on that, find a place
of exactly where every stock in interested in the investment that can serve as a home for
the portfolio ranks on profession. First, remember you to develop your industry
valuation with respect to our you are purchasing companies, expertise and analyze
universe. In a very real sense, not pieces of paper. Second, be businesses. The great
thats a daily reminder of the patientjust because you opportunity for Columbia
discipline we need in figured out that a company is MBA students is that you are
implementing our valuation- underpriced doesnt mean that in close proximity to a large
based approach. The moment the day after you buy it, all number of firms in the New
a stock in the portfolio hits the investors will agree. Third, be York area with a variety of
valuation midpoint of the prepared to go against the investment approaches. Once
universe (depending on the crowd. If everyone thinks a you figure out your investment
strategy, the midpoint rank company is attractive, it temperament, you can identify
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A. RamaSawikin
a number of firms that are three-five year horizon. If
closely aligned with your someone had a 12-month
objectives. horizon, and that's how they're
going to evaluate us, then
G&D: How did you figure out were probably the wrong
what your temperament is? manager for them. We know
there will be some 12-month
ARK: In my first corporate periods when we do poorly, by
finance class in business school, virtue of the fact that ARGA
the first thing the professor focuses on the most
said was that the value of any undervalued businesses. Value
business is the present value of investing doesn't always work
future cash flows. As soon as I in the short run.
heard that, a light bulb went
off. It became very clear how G&D: Thank you so much.
to value a business. From day
one, my focus has always been
trying to forecast what
businesses should earn in the
long run, then coming up with
the present value of that.

G&D: Do you think other

investors lose sight of this
fundamental aspect, of having
an idea of what the company
should look like in the long
run? Or is it apples and
oranges because different
people have different styles?

ARK: Even though there is

convincing evidence that highly
undervalued companies should
do well over time, most
investors are not interested
due to the anxiety associated
with owning them. This
behavioral dynamic is why
ARGAs disciplined process
and deep fundamental
research, which leads us to buy
out-of-favor stocks, should
yield good returns in the long

Time horizon is an important

factor in investing. It depends
on the clients you have and
whether they share your time
horizon. We know we cannot
outperform every single year.
We tell all our clients that
upfront. ARGA is the right
choice for clients who have a
Page 14

Cliff Sosin
(Continued from page 1)

earned both a B.S. in I learned a lot at UBS, met The key is finding businesses
Engineering (High some great people and really we understand, buying them
Honors) and a B.A, in matured. I also was fortunate for less than they're worth,
Economics from to have some very good and hopefully holding for a long
Swarthmore College. investing results. At a certain time. We try to marry that
point though it became clear long-term outlook with a
Graham & Doddsville that at a more traditional long- degree of accountability. We
(G&D): Cliff, can you tell us short business such as UBS I try to identify why a business is
about your background, and wouldnt be able to invest the going to be successful and try
how that led to CAS way I want to; however, I was to formulate that idea into a
Investment Partners? trapped at UBS because of my clear hypothesis, enumerate
deferred compensation. the predictions of that
Cliff Sosin Clifford Sosin (CS): I went hypothesis, and then we look
to Swarthmore College and Eventually, the Volker rule for disconfirming evidence to
studied Engineering and required the bank to get rid of kill the hypothesis.
Economics. I worked for two its proprietary investing
years at Houlihan Lokey business. They transferred us To understand our approach,
focusing on restructuring. I to UBS O'Connor. That you must appreciate that in
wanted to be on the buy side created an opportunity for me this framework a stock price
because I didn't like being an to leave and continue getting going down never constitutes
advisor. I preferred seeking my deferred comp based on disconfirming evidence. We
truth as opposed to seeking an the vesting schedule. I wasn't spend no time worrying about
argument. I went to a place rich, but I wasn't poor, so I had stock prices bobbing up and
called Silver Point, which is a space to start a business and down in the short to medium
distressed lending business. I know that if I didn't attract term. We are indifferent to
was in a private lending part of much in the way of assets, I stock price volatility.
the business, but negotiating could still eat.
private loans didn't suit my G&D: You have five positions.
temperament. Part of it was I left UBS in July of 2012 and Is that the level of
environmental. It was 2006, so started CAS Investment concentration you want going
there wasn't a spread that was Partners the week of October forward?
too thin or a company too 9th. People ask, Why the
risky. I found doing these ninth? The eighth was CS: There is no ideal. Thats
private sales very frustrating. It Columbus Day; we were probably towards the higher
wasn't a good fit. aiming for the first, but we end of concentration. I think
missed. We started with a very about it in two ways. First, if
A year later, I started to look small amount of capital and you think about concentration
for another job and found my have been fortunate to get in terms of how big a loss
way to UBS. There were 35 bigger since then. would you be able to
people in the group, mostly withstand and not interrupt
split into industry groups. My G&D: Could you walk us some decade-long
job was to look at high yield through the CAS philosophy performance, you can come up
and distressed, but I also got and strategy in more detail? with a third or a quarter of
to spend time looking at your money, which is a lot.
generalist stocks. Fast forward CS: It's simple in concept. We That puts an upper bound on
a year and a half and the group try to invest in businesses that individual position sizes if you
shrank from 35 to nine. I was we can understand and that we recognize that no matter how
fortunate to keep my seat. We can get for less than they're much you think you know,
also stopped investing in high worth. We're not going to find there's always some probability
yield and distressed so I a lot of them because we're of something you never
focused on stocks. That's not that clever. We find a few imagined that causes that
where I started thinking full- from time to time. Right now, position to be a zero.
time about stocks and began, we have five positions of size.
from 2008-2012, developing Of those five, three of them You can also analyze the
my investment philosophy. date to the inception of CAS. problem empirically. I dont
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Cliff Sosin
think that managing volatility is limited to the excess that's going to get hit by a
a worthwhile thing, but lets performance of the new idea truck. Something bond-like
use this lens for a second. The over the old idea. There is or better yet a bond. The
idiosyncratic mark-to-market opportunity cost. problem is that is really hard,
volatility declines so we don't find many. There's
proportionate to the square Conversely, if we short a certain amount of looking
root of the number of something, we dont have to and not a lot of finding. To
positions you have. If you have sell something so there isnt make matters worse, the
four, you get half the benefit of much opportunity cost. It's a positions we find tend to be
having infinity. To get 90% of very small opportunity cost small since you can only
the benefit of infinite from the balance-sheet reasonably be short a small
diversification, you need 100 perspective. To the extent that percentage of a companys
positions. You get 50 points we can find things to short that shares without taking too
for the first four positions and go down, we stand to make much squeeze risk. We've
it takes you another 96 money. The question is made a little bit of money over
positions to get another 40 whether finding shorts is time but it's certainly not been
points. It's just not worth it. A worth it from a time worth the time to date.
handful of positions is enough. perspective. The jury is still
It forces you to think hard out. So why do we do it? The
about the trade-offs you're theory is that every decade or
making and allows you to take two, you might come up with a
advantage of the handful of A handful of positions is great short, a la the subprime
truly good ideas you have. short or something else with a
enough. It forces you to
skewed risk-reward. If you're
G&D: How do you think think hard about the not looking, you probably
about exiting a position and won't find it. If you can maybe
entering a new one? trade-offs you're making make a percent every year or
two nibbling on berries and
and allows you to take
CS: I consider opportunity then occasionally, come across
cost. You want to own a advantage of the handful an elk, it's worth it. Honestly, I
position for the next five-to- don't know whether we'll get
ten years. What's a reasonable of truly good ideas you it right. Weve never taken
range of outcomes for both have. down an elk. I'm not wired to
investments? Is it similar? If yes, like shorts. It's hard for me to
then more diversification is see them.
better. If it's worse, then no. Our shorting is different
Why sell the good for the because we're not doing it to G&D: How do you think
new? The basic idea is you hedge. We dont have to do it; about risk and how do you try
think about how much money it is intended to make money. to get comfortable with a long
you make and how sure you Also, I think over time we have time-horizon given your large
are over a long span of time. a pretty good shot at decent exposure with each
You try to figure out the best returns from the long side investment?
portfolio. Easier said than alone so I tend to be quite risk
done. averse with regards to shorting CS: Let's think about risk in
because I dont want to muck two different ways. The risk I
G&D: Is your approach up what should be good long- think youre thinking about is
different on the short side? term performance on the long path dependency risk. It's this
side. idea that, sure, the business
CS: The benefit of shorting is flourished, but along the way
that the capital opportunity We have a narrow window of you went broke. I am fairly
cost is very low. What I mean things we want to short. We averse to any significant degree
by this is that when we buy won't short dreams or of path dependency risk. It's
something, we need to sell pyramid schemes, nor highly not to say that we cannot have
something to make room so shorted stocks. Were looking some investment in the
the wealth gains over time are for some sleepy company portfolio that's over levered,
(Continued on page 16)
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Cliff Sosin
provided it has the right risk- safety is key. Investing is hard. you want to know about the
reward. You just can't have As it should be. company before it even enters
five of them. You certainly the portfolio?
can't have a lot of portfolio G&D: Holding positions over
leverage. Youve got to make the long-term, how do you CS: There's no sense in
sure the investments you're protect against thesis drift? putting on a starter position.
making are resilient and your
structure is resilient. If you CS: It's a risk. You should I've been impressed over the
think about our business, the update, refine and improve years how I think I understand
whole business is predicated your thesis with time but you something well and then I
on the idea of finding investors probably shouldnt allow learned something I never
who are looking for long-term yourself to come up with an knew. But before we buy a
compounding. They're willing ever-increasing litany of single share I want to have a
to have volatility and not going excuses for a business where hypothesis I've exhaustively
to call me every day if we're your understanding is clearly attempted to invalidate, and if
down 20% in a month. Youve not as good as you thought. our hypothesis is right, its
got to attract the right probable that the returns will
investors and build the right You can't judge the be high enough to justify the
economic model. We can't probabilities of something opportunity cost of whatever
have an economic model unless you can understand the we sell. I've found that with
where I'm struggling to keep underlying mechanism. You investing, there's one thing that
the lights on if assets are down have to form a view of what must be true and everything
30% or 40%. We've got to would change your mind on else is just noise. There's one
have an economic model that the mechanism upfront and thing that matters. Once you
works in the worst of times. you look for that. If you find it, nailed that, you can still learn a
Weve got to be flexible. you shouldnt own that asset. lot more.
Inevitably, there will be bumps But it is okay to refine and
in the road. enhance your understanding of G&D: Are there industries
the mechanism and it is that you avoid or ones that
The second way to think about certainly okay to update your your team focuses on?
risk is the risk that the understanding as the business
investment thesis was wrong. evolves. CS: We try to think about
We try to be careful about mental models. Investing is the
that. We try to lay out our G&D: Given your applied social science. We try
hypothesis in an unvalidatable concentration, how much to develop these tools to
form, outline what would adjusting of positions do you break down how complex
constitute disconfirming do, particularly if things run or social organizations perform
evidence, look for that struggle? and behave in our market-
disconfirming evidence, driven economy. Well look at
enumerate, question and stress CS: We reallocate capital so anything where we can use
our assumptions. Pre-mortems we have more invested in these tools but not at things
are a good idea; writing down positions we think have a where we cannot. The classic
and revisiting any evidence that higher rate of return. Our example of something we
doesnt fit with your margin of error is broad wont look at is biotech. The
hypothesis is a good idea too. enough that 20% up or down ability of some new
You also have to watch out for doesn't matter here or there. compounds to cure cancer is
all the usual cognitive and If one stock goes up 30% and just not something to which
decision-making biases. When the other goes down 30%, we bring any particular
you only have five positions there probably is something to expertise. Whereas, an
and you're in them for a long do. We adjust for large understanding of loyalty effect
time especially, all these biases movements, but not for small economics applies to a broad
come into play. ones. range of different industries,
from wealth management to
In the end you are going to G&D: When you're looking at insurance brokerage to
make mistakes and you are a new position, how much do subprime lending. If you were
going to get unlucky. Margin of (Continued on page 17)
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Cliff Sosin
to think about a circle of spent a lot of time talking work if people try to sell, can't
competency, if our tools about the product and the sell, become stuck with
explain it, then it's in our circle $100 MSRP. He showed that product and then eventually
of competency. on eBay, the same product throw it in the garbage when,
trades for 65% of MSRP. That at the same time, there is a
I don't have a tool for making a sounds bad. He used that to secondary market where the
lot of useful predictions about show how there's no stuff trades above the
the future development of significant retail profits. The wholesale price. People are
technologies. As far as I'm weird thing is that if you're a not that ignorant. It's not like
concerned, technological distributor and you have any one dollar of the stuff trades
innovation is drawn out of a volume, you buy at 50% of on eBay; millions of dollars
hat. My ability to forecast that MSRP. So that seemed to worth is traded on eBay.
is very limited, and so if your imply that distributors were Herbalife sells billions so it's
business is one predicated on making money even selling on this teeny little piece, but it's
how the web architecture eBay. millions of dollars in a
works, it's improbable that secondary market.
we're going to figure it out. If I knew the name
on the other hand, your That was the string in the
business works because people [Herbalife], and watched sweater that I started pulling at
love coming to your meetings so to speak. I was also
and being part of the the Ackman presentation fortunate to have a friend who
organization socially, that's a week or two after it had done some work on it and
something that we can figure believed it to be a good
out. had been done for business, so he steered me the
right direction. John Hempton
G&D: We saw, in prior roughly the same reason also put out his somewhat
letters, that Herbalife is one of people stop to stare at famous blog post. He wrote
your biggest long positions. about going to an Herbalife
Can you walk us through the car accidents. club and guess what? It was
research process with that filled with customers. They're
idea? If I told you that there was a drinking shakes. I started to
loan and nobody wanted it and put it together.
CS: It was always on my radar. it was worth virtually nothing,
If you did a Magic Formula what would the market I spoke to people who are
screen, it always showed up clearing price be? The answer experts in the space (lawyers
cheap. It was this company that isn't 65 cents on the dollar. and such) who say Herbalife's
always grew and had great The answer is closer to two not just a legitimate company,
economics, but I had never cents on the dollar. In the case it's the white gleaming example
bothered to grab the 10-K. I of Herbalife, you can compare of multilevel marketers in the
knew the name [Herbalife], it to furniture. Used furniture industry. They call it the gold
and watched the Ackman trades at a much bigger standard. Herbalifes turnover
presentation a week or two discount at MSRP than is the lowest in the industry.
after it had been done for Herbalife product. Herbalife's a People love it. It's been around
roughly the same reason food. When you're buying food forever. I started noticing all
people stop to stare at car on eBay, it's a little weird. these things.
accidents. I originally thought There probably should be
the Ackman presentation was some discount. This bugged Finally, I sat down and revisited
great and I even wrote to one me. It was inconsistent. the section of Pershing
of my friends that I thought Squares presentation where
Herbalife was a pyramid You can't have a situation they were quoting this paper
scheme but a very profitable where large numbers of people from the SECs former
pyramid scheme. are buying the product they economic consultant. I read
don't want because they want the paper. The legal precedent
However, there was something to participate in a money from the Koscot case for
that bothered me. Ackman transfer scheme. It doesnt multilevel marketers is that the
(Continued on page 18)
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Cliff Sosin
companies must sell to product is either sold at the It was also very, very cheap so
ultimate users. retail price or not sold at all. there was enormous margin of
The problem is, we know for safety, and conversely we were
Dr. Peter Vander Nat tried to Herbalife that anyone can sell being paid very well for the
put some math to the legal it on eBay for 65 cents on the risk.
standard. Its a very sensible dollar. That is different than
paper. He says, let's imagine the embedded assumptions in G&D: If multi-level marketing
that we consolidated the the model. If you were to just is successful and legitimate,
economics of the distributors make that change you can't why do so few brands choose
with the multilevel marketer. come up with any way that to operate this way?
There'd be a certain amount of Herbalife is a pyramid scheme
gross profit, there'd be a in the Vander Nat model. CS: I spent a lot of time trying
certain amount of overhead, to understand why this
and then there'd be a certain Also, let's look at this in a business works. We are going
amount of sales and recruiting Bayesian sense. Just ignore to venture out on the bleeding
commissions. If the gross everything you know about edge of what I think I know.
profits less overhead cover the Herbalife. Imagine some We are going to enter the
sales commissions then the company that's lasted for 37 realm of more conjecture
organization is clearly not a years, is publicly traded, exists where I have much less
pyramid scheme after all, it in 90 countries, and has been evidence. If you look at the
could work as a consolidated in regulated markets all around sphere of human activity, there
entity. Conversely, he posits the world. Is it or is it not a are some activities, such as
that if the gross profits dont fraud? The answer is it may be buying a jet engine, that are
even cover the overheads then a fraud but the prior very rational. There are other
all the commissions paid are probability that its a fraud is activities, such as participating
essentially wealth transfer quite low. in your local church, that
among the sales people so it is economists would say should
a pyramid scheme. Somewhere When I finished going through not exist.
in between, there'd be some the Vander Nat paper, I added
percentage of the amount paid that to the mosaic of things I might argue that members of
out to distributors that comes and decided I was reasonably successful long-term multi-level
from gross profit and some confident that it wasn't a marketing organizations are
percentage that comes from pyramid scheme. I essentially participating in a social group.
new distributors coming in and looked at it in a Bayesian They're identifying themselves
going out. He said 50% would sense. The prior probability is as good people through the
be an interesting tipping point. low. Ackman presents participation in a social group.
evidence it is a pyramid They are doing it for other
This is the way that Dr. scheme but we have people and they are doing it
Vander Nat tried to put some determined that much of that for themselves. Volunteer fire
math to the legal standard, and analysis is faulty (and there departments, church
there is an equation that falls were a lot of other issues organizations, and civic
out. In Shane Dineens part of beside the ones I mentioned). organizations are all
the Pershing Square Then you layer the availability organizations where people
presentation, he tries to fit of returns, the high price on participate, but not in a strictly
Herbalife into this equation. eBay and the perception of this economic sense. What makes
Ackmans team used a bunch as a class act among industry Herbalife special, and what
of assumptions and shows veterans, and you come away makes a great multilevel
Herbalife's a negative number, thinking it is vanishingly likely marketer special, is that you
ergo a pyramid scheme. that Ackman is right. build a belief system around
these products.
The problem is that the At the time, I definitely did not
original paper starts with a understand why it was a good Herbalife is not a purveyor of
bunch of implicit assumptions. business, but I was willing to protein powder. Herbalife is an
Among the implicit take the trend of 30 years of organization that people
assumptions is that the performance at face value. participate in because they
(Continued on page 19)
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Cliff Sosin
view themselves as healthy, identification is fundamental to setbacks. If you focus on the
active people. They want to people. There's social good you are doing it helps a
lose weight, be healthy and cohesion. lot in terms of working
active, and share their through the setbacks.
experience, the lifestyle, and its Of course, there are varying
benefits with other people. levels of passion. On the The most common failure
Think of it as analogous to a lowest level, you've got people mode within Herbalife is for a
religious movement or to a who don't know anything happy consumer to try his or
political movement. It's very about the mission and lifestyle. her hand at selling only to
hard to build these things. In They bought Herbalife learn that it isnt for them. So,
the early days, they die like products once and they used they stop selling and simply
fruit flies. Once they grow up, them. Youve got a whole lot consume the inventory they
they last forever; but it takes a of people who make a little bit might have purchased and go
lot to get one up and running of money and spend some time back to being a happy
and you cant just start one doing it because they enjoy it. customer. It's like me buying
at least not easily. They like the people involved, five boxes of Cheerios because
they think it's important. Then I thought I was going to sell
there are the real money Cheerios. Then I decided that
What makes Herbalife makers. For them, it's a job selling Cheerios is not for me.
and a mission. It's like being I'll just eat the Cheerios.
special, and what makes the priest.
a great multilevel Keep in mind Herbalife has a
G&D: People dont just join return policy. If you were truly
marketer special, is that Herbalife to try to make duped in this manneryou
money? bought $5,000 worth of
you build a belief system inventory, tried to sell it, and
around these products. CS: I think people join for a you couldn'tyou could
lot of reasons. The vast return it to the company. This
majority of members are really is a big problem with the bear
We came to appreciate that, just discount customers. They argument. It's like if a bank
within Herbalife, while there's join so they can buy the robber left a business card,
an economic incentive engine products at a discount. Some Please call if you want your
that motivates some, that only join because they like the money back. Many hedge
explains part of the social aspects, the fit camps, funds have bought Herbalife
phenomenon. If you think the nutrition clubs, the other products and returned them.
about Daniel Pink's work on members to support and This has been well-tested.
what motivates people, it is reinforce their nutrition goals,
purpose, independence, and etc. Some join with modest G&D: Does the stigma of
mastery. In Herbalife, you give income aspirations in addition multi-level marketing deter
people a huge purpose. If you to their health and weight-loss investors?
sign up for Herbalife and you aspirations, selling a bit to
help one person lose 50 friends and family. Some join CS: There are multi-level
pounds, the odds are good with the goal of building a big marketing scams that promise
that you want to keep business. Some of them the world and die quickly. A
participating. You want to find succeed and some of them, new multi-level marketer is a
the next person. That would just like any other business, risky proposition for an
be a big thrill. dont. Undoubtedly some investor. What makes
people try to make a business Herbalife interesting is that it
If you think about it, social out of Herbalife and fail, so has very low attrition,
organizations are all over the some of them lose money but compared to other such firms,
place. It's only natural that usually not very much. It helps and it's been around a long
through natural selection, a lot for those who are trying time. Herbalife's results are
companies would realize that to build a business to also love going to be volatile, particularly
these mental pathways exist the mission. It is hard to build in small, new markets. It can
and you can use them. Group a Herbalife business. There are have attributes that look like
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Cliff Sosin
the ice bucket challenge, the pan. business over the span of ten
where it takes off and then it years. You have to like it. You
collapses. You've got people who have have to work at it.
been doing it for ten, twenty
Lets say you and I both go years. They have built real A common Herbalife success
into business. You decide that organizations with real story goes something like:
youre going to go on a diet customers that have real "Hey, I started with Herbalife
Antonio Lequerica 18 and challenge your friends on durability to them. ten years ago because my
speaking at the Pershing Facebook to do the same diet. friend had just lost 30 pounds
Square Challenge Let's say you have a virality G&D: If someone in your on it and I knew I needed to
coefficient of greater than one family thought joining a multi- lose weight. I lost 20 pounds
because you've got some hip level marketer was a great and my wife lost 40 pounds.
twist on this idea. You're going business idea, what would you
to see this exponential growth. tell them? Then I got into the business. I
But then you're going to see didn't think I could, but Joe
this exponential decline. You CS: They should go for it. The told me that I could. I started
stop your diet and run out of only catch is, like any business: talking to people. It was hard
friends, then they stop and so it is not easy. If you watch any at first, but I learned how to
forth. It's this flash in the pan Herbalife video, often the first do it and that I didn't have to
business. thing they say is, "It's not easy. be afraid. There were times I
You've got to work really hard didn't think I could ever get
Lets say my business is to at this." Id also encourage there but eventually I did. Now
organize walks near where I them to start slow. Make sure I work full time at Herbalife, I
live in Westport. Im going to they like it and can do it before have a big organization and
spend time every day inviting signing a lease on a nutrition make a great living. Last
people to these walks, on club for example. Thats just month my check was $7,568."
social media but also any other common sense but sometimes
way I can, especially in person. people can overcommit. That That's not impactful when one
Were meeting at 9am on is the only way you can actually person does it. But if you get a
Sundays and we're going to go lose any real money in lot of people coming up it's
for a two-mile walk. Then Herbalife. You quit your job, very motivational.
after the walk, which, say, lease a nutrition club, then
costs $5, I find a comfortable discover that you cant sell any. Theres a woman I met in Los
place and serve shakes. We're Not wise. Angeles. She was the sort of
going to have a talk about attractive, personable woman
nutrition and health. I'm going If you look at Herbalife people, that everyone wants to be
to have people who lost they often start out selling to friends with. She knew the
weight tell how they lost someone like their brothers-in school bus schedule. She
weight using the product. You -law. That's very common. If would go ahead of the school
can see how that is much you look at Herbalife's four buses and chat up all the
more durable. People make million members, three million moms. Women would come
friends with each other, come basically just buy it for back to her club and they
back week after week and do themselves. Of the remaining would have a shake and gossip.
the walks. They buy product million, half or more basically A lot of the women wanted to
for home use. They lose just sell to people in their lose some weight and would
weight and tell their friends. social circle. buy the product for home use.
Eventually, I'll get the people She would motivate and coach
who were doing my 9am walks The big step you make in them. Some of these women
to organize another one at Herbalife is talking to needed extra money around
1pm because I cant make it. strangers. You need to talk to the holidays so she was able to
One of them starts walks in a 40 people a day. Ask 40 people say, "Why don't you go and hit
neighboring town and so forth. a day, strangers, of whom at these bus stops. I can't do all
So the model duplicates. You least 39 are going to say, No. of them." You can see how it
can see the difference between If you do that every day, you turns into a nice business. You
a durable strategy and a flash in could build a nice Herbalife end up with this amazing group
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Cliff Sosin
of dedicated, talented, gritty, mobility. Compare the role of who really suffer; nobody lends
sales people or entrepreneurs. these lenders in society to the to them.
importance of chewing gum
I think some of people's manufacturersI think Then, WRLD makes a loan to
discomfort is a lack of subprime lending is a far more the remaining 100 of them.
familiarity. It wouldn't be important business. Those people get money and
uncommon for a Herbalife solve their problem. Sure, they
member to want to make an pay for it with an interest rate
It's an incredibly
extra $300 around the holidays of 60% on average. But that is
selling retail to people they difficult, risky, and a lot better than the
know. alternative of not having a car
thankless business, but to go to work. Over time,
G&D: What about the rest of providing this ladder, some people will renew that
your portfolio? loan. The average person
from the very bottom to renews twice and is in debt for
CS: Herbalife is our biggest 24 months. Almost 80% of
position. Everything else is a notch or two above the them will eventually exit the
roughly equal. We own very bottom, is incredibly repayment door as opposed to
Cimpress N.V. (CMPR), Credit the charge-off door and their
Acceptance Corp. (CACC), important for social credit is improved.
World Acceptance Corp.
(WRLD), and two rental mobility. Who are the victims here?
companies, predominantly When the customer repays,
Ashtead Group (AHT.L), Some people don't like the WRLD makes a healthy profit
which owns Sunbelt rentals. industry because the interest but the customer got the cash
rates are high. But as an he or she needed and his or
G&D: Could you walk us industry, there are not reams her credit improved. Tough to
through the WRLD thesis? of profits to be made. If you argue that those borrowers
look at a typical installment are victims.
CS: WRLD gets a bad rap. lender, they are not making
Subprime lending, in general, money hand-over-fist. The When customers default, they
gets a bad rap. I think that prices are covering their costs experience the discomfort of
people tend to confuse their and their losses and create a having debt collectors call
desire not to have a society modest profit. These loans are them and further degradation
with any desperate people with expensive to originate and to their credit score. But
the fact that once people are service, and they have a lot of otherwise, they are better off.
desperate, WRLD is a lender embedded loss due to the risk. WRLD gave them more
of last resort. I think the role They're also small and have money than WRLD received
of lender of last resort is short duration. To make a back. This is different than
extremely important. It gives reasonable dollar profit, you many payday transactions
people with nowhere else to need to have a high implied where the lender can often
turn an opportunity to borrow rate. profit even when the
money to solve urgent needs. borrower defaults. Its hard to
In performing on those loans, Another way to think about argue that the borrowers were
individuals can improve their WRLD is to consider 200 victimized. And even if you
credit scores, which will people, all of whom have large could, you can't make the
ultimately improve problems. They need to repair other 80 loans without
creditworthiness in the future. their water heater, or fix their experiencing the twenty who
car or, less practical but don't repay although they sure
It's an incredibly difficult, risky, emotionally important, they do try.
and thankless business, but can't buy Christmas gifts or
providing this ladder, from the travel to a friends funeral, etc. I'll add one more piece. WRLD
very bottom to a notch or two All come to WRLDs office and is an installment lender, which
above the very bottom, is WRLD sends half of them is fundamentally different than
incredibly important for social packing. Those are the people a payday lender. Payday
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Cliff Sosin
lenders charge very high average duration of a portfolio Washington. They found that
interest rates, typically 400%, of twelve-month, linear indicators of financial suffering,
for very short-term loans, two amortized loans is three including phone disconnections
weeks on average. Payday months. and job loss, were higher after
lenders have an ability to reach payday and installment lending
into someone's bank account G&D: What do you think were removed on the Oregon
and pull money out. With about increased political side of the border than just a
these two features, payday scrutiny and regulation of the few miles away on the
lenders can and often do make industry? Washington side of the border
money on loans where the where payday loans were
borrower defaults. WRLD is CS: A variety of politicians will available. So these studies
an installment lender. They paint these guys as evil. It's not support the idea that payday
give people longer-term loans hard to find someone who had loans are good for society.
with fixed payments. A typical some really bad experience.
loan might be $900 payable in Yet WRLDs net promoter Evidence supports both sides.
twelve $100 installments. score is 68%, which is amazing. What I think is clear from the
WRLD has no ability to WRLD is very popular with its research is that whether
enforce repayment if the customers. payday lending is good or bad,
person doesn't voluntarily it is not very good or very bad.
repay. The academic work on payday Economists have studied this
loans is mixed. There is a too closely and had too many
G&D: How does WRLD wonderful piece by John conflicting findings for the
collect from customers? Caskey that summarized all the impact to be very strong one
academic work and makes this way or another.
CS: The most common point nicely.
method is paying in cash in Installment lending is far more
person. WRLD has expanded On the negative side, there is user-friendly than payday
the payment options, and work that shows that the lending. So if payday lending is
there are people who pay with career performance of Air at worst a little bad for social
check. The customers are not Force members stationed at welfare, I think it's highly
all under-banked. There are places with access to payday probable that installment
people who pay by phone. loans is worse than ones lending is very good for
There's debit card. But WRLD without access. Of course, society. All those people who
has no ability to take money that's bad. There is also need cash are served by these
out of people's accounts. evidence that different businesses.
disclosures about sustained use
In the vast majority of charge- of loans by borrowers can Still, obviously, despite the
offs, WRLD loses money. The importantly reduce their logic and evidence this is an
incentives are well aligned. propensity to borrow. So industry that is under a lot of
WRLD wants to make loans those would indicate that scrutiny. The CFPB is clearly of
that people can repay. The perhaps payday loans are bad. the view that high-cost short-
only way WRLD can get term consumer loans are
people to repay them is if the But there is also research that probably bad for consumers.
borrowers income less shows that counties in There is a very lengthy legal
expenses is enough to service California with access to discussion we could have
the debt. payday lending have reduced about all this but it is too
rates of suicide and robbery involved for this interview. I
G&D: How long are the loans after earthquakes than other think though it would leave
on average? counties which have banned you thinking the risk isnt as big
the product. Similarly, when as it might seem. But it is a big
CS: The average loans are Oregon put in place a ban on risk.
twelve-month, but they're payday loans, economists used
monthly installments. The the occasion to study how the G&D: What evidence would
average duration of a twelve- change impacted people right indicate that your investment
month loan is six months. The on the border of Oregon and is wrong?
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Cliff Sosin
CS: Not an easy answer. Lets avoid getting ripped off. issue two years later. Half of
start with what the economic their new customers are
mechanism is. The managers are also likable former borrowers who return.
people because they treat you The largest source of first-time
Our hypothesis is that the well. If you are in a Walmart customers is referrals.
business has what we call break room and someone says
loyalty effect economics. It's they have a problem, someone The key to making the business
an economic phenomenon in else in the Walmart break work is having this branch
The Loyalty Effect by Fred room might say, You should manager who's ensconced in
Reichheld. It describes how in go to WRLD. They treat you the community and can
some industries a business in well. Theyre friendly. They underwrite carefully. Knowing
the upper-right of a 2x2 matrix treat you with respect. the community is a big
of customer retention and advantage because you know
employee retention is the When customers have trouble who to avoid. You also have
most lucrative. If you can paying, WRLD managers treat this big base of former
establish an organization with them well. WRLD runs on borrowers who are both your
long-tenured employees and kindness. The way they collect best customers when they
long-standing customers, you is to call repeatedly until they have a need and a great source
will be much more profitable get the client on the phone. of referrals. It sounds so
than your competitors. Eventually, they'll get through simple but these are the
and say, "Come in. That's all I loyalty effect economics.
Installment lending is ask." You'll come in and they'll WRLD's financial performance
say, "Tell me about what over the past 30 years is
far more user-friendly happened," and you tell your unbelievable.
than payday lending. So So, how would we know that
if payday lending is at Depending on the this thesis is wrong? Well,
circumstances, they can often when we first postulated it, we
worst a little bad for say, "I'm looking at your file didnt have all the facts I
and because you've made three shared above, but I learned
social welfare, I think it's payments you have some about the importance of
highly probable that equity in your loan. If you manager tenure and of
renew today, you'll be current referrals and so forth when we
installment lending is with us, you can walk out of looked for these attributes as
here with $50 and you won't part of attempting to invalidate
very good for society. have any negative impact on our hypothesis. At this point, I
your credit score. cant think of any more ways
Now lets look at the to test the hypothesis. So if we
installment lenders. WRLD has They dont force anyone to are wrong or things change,
been very successful at this. take out a new loan, but it well probably first detect it if
WRLDs average branch sounds like a pretty good the financial performance got
employee has five years option for many. The whole worse. A decline in repeat
experience. This is business works on friendliness. business or an increase in
tremendous. Way higher than The branch manager has been employee turnover would be
most other front-line there a long time and knows concerns. Most likely though,
employees in most companies the community. People trust to the extent that the
or industries. These aren't big you as someone to borrow economics break down, we
communities. They know who from because they know that if would see it in the financial
is who in town. They know something goes wrong you will performance.
your mother. They go to be reasonable. You get this
church with you. People come whole base of former G&D: In terms of
in and if they're good at it, borrowers who are your performance, WRLDs traffic is
WRLDs people have some referral sources. They also declining. How much of this is
reasonable ability to come back because they might related to competition,
underwrite your loan and have some sort of cash flow especially online?
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Cliff Sosin
CS: Declining traffic is a issue was primarily attracting help to drive a lot of volume.
problem. There are two key new customers who had never They havent been tested yet,
risks with WRLD. One is the done business with WRLD but there are a lot of shots on
regulatory risk. We talked before. goal so to speak, a number of
about that a bit. The other is which have been meaningful
declining new customers per Now there is a new CEO who for competitors. I am
branch. If you look at number is making a lot of progress optimistic that WRLD can
The winning team, Windsor of new customers per branch, turning things around. The first return to some of the robust
Cristobal 18, Anji Lin 18, it declined from 2011 to 2015 initiative was building a website growth of their past. It looks
and Isabella Lin 18, pitching although it has recently been as a driver of branch traffic. like by modernizing its
Yum China at the Pershing increasing. There are two Half of customers at some operations, WRLD has been
Square Challenge possible arguments for the competitors find the company able to restore volume, so this
cause of the decline. through the web, fill out an is inconsistent with the secular
application online, and finish disruption concern.
One is that instant-decision the transaction in the store.
online lending is winning in the WRLD is the only industry
marketplace and store-based So WRLD put up a website participant I am aware of with
lending is losing. This would be and it helped. Month over volume problems. Everyone
a secular disintermediation. month, it gets better, but it else is doing fine. This is
The other argument is that hasnt been a panacea. consistent with the theory that
WRLD hasnt been run very it is not an industry problem
well and thus is Then management evaluated but a WRLD problem.
underperforming. direct-mail, historically
WRLDs only form of Also, I think it is likely that
Two and half years ago, the advertising. Management online underwriting is still a lot
company didn't have a website. experimented and found that worse than in-store
It had an IR site, but that was shutting off the direct mail in underwriting. If you look at any
because the SEC required it. If certain geographies had no online subprime lender, the
you were a retail customer impact on new customer rates they charge are far higher
who wanted to find a branch applications. Thats how bad it and their charge-offs are far
and went to the Internet, that was. higher. The Internet has some
information wasn't there. speed and convenience
How could this be? Well, it benefits, but as of now I dont
The lack of a website was just turns out that the direct-mail think it is nearly as good at
the tip of the iceberg. The program was completely underwriting or collecting.
business was undermanaged outdated. I wont bore you
for years. It was basically with the details, but WRLD All of this is evidence that's
running in 2015 exactly the was sending the wrong letters inconsistent with the thesis
same way it was run in the to the wrong people at the that the Internet's killing the
1990s. In some sense, its wrong time of the month. business. At least today.
success without evolving at all Management revamped all of
for two decades is a testament WRLDs direct marketing, and G&D: How sensitive is the
to the quality of the business. it helped a lot. WRLD business to
But it started to catch up with macroeconomic changes?
WRLD, and starting a few Now between the web and
years ago, new customers per enhanced direct mail, it looks CS: We think about economic
branch began to fall. like WRLD has turned the sensitivity with everything.
corner. It looks like it is People think a lot about
Importantly, we think that bringing in more customers economic sensitivity when they
returning customers, referrals than it is losing so it should be think about credit. Let's start
and quality underwriting and returning to growth. But we with that mental model for
collections by seasoned will see. The good news is credit. You start out with
employees in the branches, the there are a whole host of everyone. You use reputation
economic engine, continued to other initiatives that it is in the data to get two thirds of
be a source of strength, the middle of which should also people that are prime credit.
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Cliff Sosin
What does it mean to be increase charge-offs across-the seen mixed performance from
prime credit? What it means -board and is probably a bigger this.
to be prime credit is your risk than changes in
probability of defaulting is employment. For a long time, that governed
almost entirely a function of my thinking. On average, teams
whether you get sick, G&D: Can WRLD potentially are average, but certainly don't
divorced, or lose your job. benefit in a downturn, invest in crooks. I thought
especially in increased loan about the business first, price
Sickness and divorce occur volumes? second, and then management
steadily. Losing your job is a distant third. That is changing
cyclical. As a consequence, CS: Potentially. If I were to a little bit. Through
lending to the two thirds of give you WRLDs earnings-per- experience, I discovered that it
people with good credit, is share growth numbers through matters more than I
effectively an actuarial 2012 but scramble the order, appreciated.
exercise. It's like insurance. you would not be able to
Companies compete price detect the financial crisis.
down as low as possible, make There was some harm from I thought about the
a modest spread. Whether rising fuel and energy prices in
prime lenders make or lose 2008, but there was good business first, price
money on the vintage is largely volume. second, and then
driven by whether there is
something that causes the job- All told, it was a non-event. In management a distant
loss expectations for that pool fact, if I gave you quarterly year
to be meaningfully different. -over-year EPS growth from third. That is changing a
Namely a recession. Its pretty the IPO in the early 1990s little bit. Through
analogous to P&C insurance through 2012 you wouldnt be
and catastrophe risk. able to pick out any experience, I discovered
macroeconomic events.
The subprime population is, by Normally, the business is very that it matters more
definition, hard to underwrite. under-levered and right now than I appreciated.
So you can create loans with they're profoundly under-
substantial margin of safety if levered. WRLD normally runs
you do a good job with three dollars of assets and If you read Daniel Kahnemans
underwriting. Also the loans one dollar of equity. At book, Thinking, Fast and Slow,
are short in duration so you present, theyre running with he explains why you can better
replenish the portfolio with three dollars of assets and two judge people, in fact any
new loans fairly quickly if your dollars of equity because they complex issue, by subdividing it
original assumptions prove haven't bought as much stock into smaller pieces. The Israeli
faulty. So the net of this is that as they usually would. military subdivides personal
when unemployment rises, performance into smaller bits
WRLDs credit worsens but G&D: How do you assess in order to find officer
the impact is small compared management? When you're candidates and that works a lot
to its overall economics. looking at ideas, how better than making overall
important is the management assessments, in fact making
Interestingly, a shared common team? overall assessments doesnt
factor for WRLD and its work at all.
customers are the prices of CS: I'm not very good at
food and energy. WRLDs judging people. I haven't I've tried to use this approach
borrowers are on the haggard thought much about in assessing managers. I want
edge and that's the whole management, historically. I've managers who are smart,
reason why they're coming to watched a lot of investors energetic, honest, humble, and
the company. Adding $50 a come to very strong opinions good capital allocators. Those
month to their expenses from about management teams. I've are the five sub-attributes of a
rising gas and food prices never understood how they good manager that I want. So I
impacts all of them. That can had such conviction and I've try to assess them along each
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Cliff Sosin
dimension. The resulting it turns out he said it 40 years giant game where they are just
assessment is becoming more ago. betting against one another.
of an important factor. I put
more weight on it now than I It's brutally hard to come in Nor does it do anything for
used to because I've watched every day, do a lot of work social welfare to connect
good investments do worse and then throw it out. You can Chicago and New York with a
than I hoped because bad make money investing because perfectly straight fiber line, like
decisions were made. But I am it doesn't suit people's Michael Lewis describes in
still a business- and price-first temperament. It's not natural. Flash Boys. My advice, which I
investor. If people really want to do it give to everyone and nobody
and they recognize how listens, is don't do what I'm
I should add, that I have difficult it is to do, then God doing. Go do something really
increasingly focused on overall bless them, but it isnt for most useful for the world.
culture within a firm. By that I people and I have no useful
mean the combination of advice if you want to do it.
organizational habits, social We have armies of our
norms and incentives that But, if I were to allocate the best and brightest
dominate day to day life and resources of society, we'd have
decision-making within an way fewer people doing what I wasting their time in
organization. Senior do. We'd have lots more
management influences culture people doing useful things. It's what is basically a giant
but is also an expression of a huge waste. The fundamental game where they are just
culture. So you have to assess issue is this: there are limits to
them as guiding the system but the amount you can forecast betting against one
also a product of the system. the future. Nonlinear dynamic
systems are subject to inherent another.
You want an organization that forecasting limitations. Think of
prizes frugality, where weather forecasting, because it There's a great book you can
individuals feel safe sharing is nonlinear you just cant read about entrepreneurship
their views and making forecast accurately more than through acquisition called HBR
mistakescalled psychological a few days in advance even as Guide to Buying a Small Business
safetyand where people the amount of computing by Ruback and Yudkoff. For a
freely help and support each power and the data quality young person coming out of
other. You also want to know explodes. The economy and business school, thats just a
what a firm is optimizing. businesses are even worse brilliant idea. I think it's
Sometimes great things emerge because they are under- perfectly reasonable not to
when an organization centers specified nonlinear dynamics want to work in a big
itself entirely around systems. Its totally impossible corporation. I can also
optimizing one thing. to refine your predictions past understand why people don't
a certain pretty rough point. want to go work for some new
G&D: Any advice for students startup. Its too uncertain. But
or other young people trying If you have a million, brilliant you can raise some money to
to build careers in investment people trying to predict the buy a small robust company
management? future of a nonlinear dynamic and then create value by using
system using all kinds of your immense talents to run it
CS: If you really, really like it computers the outcome you better. One of the best
and you're nuts, you can get get wont be much better than examples in this book is the
into this business. I, for one, if you just had a few thousand. acquisition of the leading fire-
enjoy it despite its difficulty, For the purpose of capital hose testing company. Using
but it's really a waste of your allocation, connecting savers to your brilliance to figure out
talents. This is the Charlie investments, we only need a how to do a better job testing
Munger view on this. He's few thousand. But we have firehoses helps society use
right. He's so frustratingly tons more. We have armies of fewer resources and is an
right. Every time I think Ive our best and brightest wasting incredibly important and
thought of something brilliant, their time in what is basically a essential task. If you are
(Continued on page 27)
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Cliff Sosin
successful, of course you can
expand the business and bring
your talents to making society
more efficient in even broader

You guys could be very

competent at almost whatever
it is you choose. If you choose
a small enough niche, you
could be the best in the world.
My point is that if you pick a
small niche and bring your
talents to it, you can do well
and make the world a better
place. You can earn a fantastic
living and hop, skip, and jump
to work every day.

G&D: Great. Thank you so

much for the time.
Page 28

Yum China Holdings, Inc. (NYSE:YUMC) - Long

2017 Pershing Square Challenge - First Prize
Windsor Cristobal, CFA Anji Lin Isabella Lin

Recommendation Key Financials

We recommend a long on Yum China Holdings (YUMC) FY16 Result Trading Statistics
with a 2-year price target of $45, offering 35% upside from In USD millions Share price $32.99
Windsor Cristobal 18 todays price of $33. We see a bull-case upside of 61% and Revenues $6,752 Market Cap $12,678
an attractive upside/downside ratio of 2.7x. We project a Rest. Margin 15.3% Net Cash $964
Windsor Cristobal is a first EBITDA $1,112 EV $11,714
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EBIT $640 Target 2019 P/E 20.0x
lumbia Business School. comparable sales growth and margin expansion opportuni-
EBIT (%) 9.5% 19E EPS $2.23
Prior to CBS Windsor ties. FCF $428 2Y Price Target $44.64
worked as a Senior Repre-
ROE (LTM) 22.7% Upside 35.0%
sentative in the M&A and
Investments team of Wes-
Business Description Key Financials
YUMC is the leading operator in the $150B Chinese QSR Bear Base Bull
farmers Limited, Australias
largest diversified conglom-
market. It was spun-off from Yum Brands in October 2016 SSSG (Average Next 3 Yrs) (2.8%) 3.6% 4.6%
following a recommendation from the activist fund Corvex Unit Expansion (Avg Next 3 Yrs) 3.5% 4.5% 5.5%
erate. Restaurant Margin (2019E) 15.1% 17.0% 17.8%
Management. The company operates the KFC, Pizza Hut, EBITDA Margin (2019E) 19.4% 19.8% 20.7%
Taco Bell, Little Sheep and East Dawning brands in China EBIT Margin (2019E) 10.4% 12.4% 13.4%
across 7,663 restaurants in over 1,000 cities. YUMC owns EPS 3-Year CAGR 1.2% 17.9% 21.1%
2019 EPS 1.41 2.23 2.42
and operates 80% of their network and pays a 3% royalty on P/E 18.0x 20.0x 22.0x
net sales to Yum Brands. Price Target 25.41 44.64 53.18
Upside / Downside (23.0%) 35.3% 61.2%
Implied EV/2019E EBITDA 6.6x 8.6x 9.5x
Investment Thesis Implied P/E (excl. Cash)1 14.8x 15.8x 18.0x
1) Ample Growth Runway in an Underserved Note: 1) Includes Balance Sheet leverage upside
Chinas restaurant industry is highly fragmented with Chained QSR formats accounting for only 9% of the
Anji Lin 18 market. This is compared to an Asia Pacific average of 18% and Taiwans average - which we view as compara-
ble market with China in terms of culture and food - of
Anji (Andrew) Lin is a first- 39%. QSR store penetration also remains low in China: in
year MBA student at Co-
2016 there were approximately 270k people per KFC store Population served per KFC store
lumbia Business School.
Prior to CBS, Anji had two in China compared to ~180k in Taiwan and 110k in Hong
years of experience in Kong.
investment banking and Long term growth
more than four years in We believe there is also a large opportunity to expand into
private equity in China. lower tier Chinese cities given the significantly lower QSR 113,117
Anji holds a Masters De- 72,836
penetration in those markets. Taking KFC stores as an ex-
gree from Peking Universi- ample, lower tier cities average around 500k people per Tier 1 Tier 2 Lower Tier
ty, China. KFC store compared to 73k and 110k in Tier 1 and Tier 2
respectively. We believe further penetration into lower tier Chained vs Independent Food Service Stores
cities present an opportunity for YUMC to almost double Chained Independent

its current store base of 7,663 stores in the long-term. 9%

Adam Xiao 17 35% 36% 39% 48% 53%
In addition, major transport hubs are also a high growth
area and according to discussions with QSR executives in 91% 82%
China, YUMCs national brand status allows them to secure 65% 64% 61%
52% 47%
the most critical sites. With the number of major transport
hubs in China growing at approximately 25% CAGR in the China Asia Singapore Hong South Taiwan Japan USA
next five years, YUMC has an opportunity to add 700-900 Pacific Kong Korea
Isabella Lin 18 additional stores in these locations, based on our estimates.
Stores in major transport hubs also typically have sales per store that are double the network average.
Isabella is a first-year MBA
student at Columbia Busi-
2) High-Return Cash Cow with Attractive Unit Economics
ness School. Prior to CBS, YUMC has strong unit economics in both of its major brands. For new unit builds in 2016, KFC and Pizza Hut
Isabella was an Associate at
CIM Group, a $20bn real
cash-on-cash returns were 40% and 26% respectively. Management has done a solid job of keeping returns
estate private equity firm. high despite difficult operating conditions - namely following successive food scandals in 2013 and 2014.
Before CIM, she worked at
Dukes endowment office, YUMCs strong cash generating ability has also allowed it to maintain a high ROIC in difficult times. ROIC in
responsible for fund invest- 2013 and 2014, when comparable sales declined to as low as negative 20% in some quarters, was 17% and
ments and co-investments 19% respectively. In addition YUMC was able to completely self fund its capital expenditure requirements
in private equity globally. during this time.
Page 29

Yum China Holdings, Inc. - Long (Continued from previous page)

The companys scale is another driver for continued high returns.

Our primary research suggests that YUMC has a distinct cost ad-
vantage to McDonalds due to its scale (3x more stores than
McDonalds). We estimate YUMC as having a ~700bp advantage in
costs as a percentage of sales relative to McDonalds in Food and
Paper, the largest cost item, and believe this will continue to drive
high returns in the future.

Post the spinoff management is now 100% aligned to YUMC, and

they are incentivized to focus on KPIs that will drive returns such as
same store sales growth and profitability. We are also very encour-
aged by the CEO buying ~$3M worth of YUMC shares after the Q1
2017 results and after the share price rose by ~20%.

3) Unique Buying Opportunity to Capitalize on Same Store

Sales Growth Recovery
We believe the company is at an inflection point and presents a
unique buying opportunity. After four years of volatile performance,
recent quarters show a stabilizing trend for SSSG. We project faster
recovery relative to the street for three main reasons.

i) Reduced Risk of Future Food Scandals

From our conversations with supply chain experts at large QSR
companies in China, we are comfortable that YUMC now has the
best processes and systems in place to prevent future food scandals.
YUMC has tightened their supplier selection, cut the number of
suppliers by half and introduced more transparency giving them
direct line-of-sight to primary producers. They have also built an independent team of 200 quality control experts and a dedicated PR
team in each city to reduce the risk of future outbreaks.

ii) Strong Consumer Brand and Loyal Customer Base

We believe that customer loyalty to YUMCs brands remains high. Our primary research survey with over 700 respondents suggest that
customers continue to return to YUMC banners for its convenience, taste and safe food. We think its reputation makes it resilient to
short-term fads and trends and will support its continued SSSG recovery.

iii) Secular Tailwinds from Delivery and Digital

Digital and delivery trends will be a major driver for comparable sales growth. Delivery as a percentage of online sales for Chinese QSR
overall was 8% in 2015 and 11% in 2016. During the same period KFCs digital sales percentage moved from 7% to 10% and Pizza Hut, by
our estimates, moved from 14% to 18%. With YUMC targeting a 25% overall digital share of total sales, this new channel will continue to
drive SSSG. We also believe that YUMC can leverage its 100M loyalty members and the data they generate to drive SSSG in a similar way
to Dominos Pizza (DPZ).

Based on our 2019 EPS estimate we believe that YUMC remains
undervalued and offers an attractive risk / reward. Our 2-year
base-case price target is at $45, offering a 35% upside.

We have assumed no P/E multiple expansion from the 20x level

today. As the company has almost $1B of net cash, we believe
that excluding cash and adding moderate leverage (~2 turns debt
to EBITDA) the P/E ex cash is around 16x. We have a bull-case
upside of 61% and a upside/downside ratio of 2.7x.

Key Risks
Key risks to our thesis includes future unforeseen food safety scandals; shifting consumer preferences to new healthier concepts; labor
and rent cost inflation; and a failure to turnaround the Pizza Hut brand which has been in SSSG decline in the last 10 quarters (except Q1
2017). We are comfortable that these risks are being addressed by the company and we have run downside scenarios that support our
view that the risk-reward profile remains attractive.
Page 30

Alaska Airlines (NYSE: ALK) - Long

2017 Pershing Square Challenge - Finalist
Chris Waller SK Lee HK Kim

We recommend a long position with a 5-year price target of
$218.1, giving 154% upside.
Chris Waller 18
Chris is a first-year MBA Business Description
student at Columbia Business ALK operates Alaska, Virgin America, and Horizon Air, mak-
School and the Co-Founder ing it the 5th largest carrier in the US. Its strategy is to be the
of plural, a small hedge fund. national carrier for west coast customers. Along the west
Prior to CBS, Chris worked coast, they have 57% passenger share in Alaska, 52% in Wash-
in a global equity fund at
ington, 39% in Oregon, but just 11% in California. California is
Goldman Sachs Asset Man-
agement. He graduated from a huge opportunity, with 2.4x annual passengers than the
Oxford University with de- other 3 states combined. ALKs low cost structure gives it the
grees in Economics and Man- highest ROIC and EBIT margin among its peers.
Investment Thesis
The street underestimates how much market share Alaska
will profitably gain in California over the next 5 years as it
becomes the dominant west coast carrier. We think this is an
up to $3bn incremental revenue opportunity on current com-
pany revenues of $7.6bn.

1. Alaskas costs for the same economy class seat

are lower than the street realizes and this will
enable it to gain more market share.
Seung-Kwang Lee 18 Reported Cost per available Seat Miles (CASMs) are
SK is a first-year MBA stu-
misleading: Our Normalized CASM figures include only
dent at Columbia Business mainline flights and adjusts for flight length and
School. Prior to CBS, SK space allocation to first, business, and econo-
worked as an auditor at PwC my classes. This shows that for the same
New York, covering compa- economy class seat on the same distance
nies in financial services in the flight, Alaska has a 7% cost advantage over
US, HK, and the UK. He Southwest, 22% over American, 33% over
graduated from NYU Stern Delta, and 37% over United. We have not
School of Business with de-
grees in Finance and Ac-
seen any research that adjusts for all of these,
particularly allocation to different classes. We
think this is because this allocation adjustment
has to be estimated due to the lack of compa-
rable data. Nevertheless, it is crucial and is
why the street misunderstands Alaska. For
example, Alaska typically allocates 74% of its
space to economy seats, while Southwest
allocates 93% of space. Since First and Busi-
ness class seats take up more space, Alaskas
cost per seat will naturally be higher. This does
not necessarily reflect an input cost disad-
vantage. Our normalized CASM adjusts for
this and shows that Alaska actually has a cost
Hyung-kyoon Kim 18 advantage for the same economy seat. Com-
paring economy ticket prices for different airlines on the same routes shows that Alaska is indeed able
HK is a first-year MBA stu-
dent at Columbia Business to undercut its rivals and take market share.
School. Prior to CBS, HK
worked as an investigator at Alaskas cost advantage is sustainable and comes from its homogeneous and young fleet, which order
Korea Stock Exchange, evalu-
ating corporate disclosures
books show will actually increase, as well as its labor deals and higher productivity. These give it lower
and delisting distressed com- Normalized CASMs vs the Big 4 carriers of 0.8 on fuel, 1.7 on crew, 0.3 on maintenance, and 1.0
panies. He graduated from on others.
Korea University with degree
in Business Administration.
Page 31

Alaska Airlines (ALK) - Long (Continued from previous page)

2. The street underestimates how much capacity Alaska could gain at key airports (LAX and SFO).

Our primary research reveals that while LAX is considered gate-constrained, Alaska is in Terminal 6 and it would make sense for
them to lease Deltas 4 remaining gates in T6 or the 3 gates American has temporarily leased from United in T7 as it undergoes its own
renovations. Both Delta and United are struggling because of their higher cost structures, and this is how Alaskas lower costs translate
into higher market share. Our Base case includes one of these and is worth an additional $511M revenue over the next 5 years on top
of $256M organic growth. In our Bull case, Alaska secures 13 new gates by building the Terminal 9 that LAX is looking for over the
next 5-6 years.

At SFO, we model Alaska gaining 3 gates by 2019 at the expanded T1 based on our
primary research. This adds $349M of incremental revenues over 5 years on top of
$235M of organic growth.

3. Railroads Mark II: Industry consolidation and growing demand could

lead to much higher profitability.

Like in railroads, 9 major carriers have consolidated down to 4. In our Bull case,
we model less capacity meaning industry load factors (utilization) increase by 5pp
over the next 5 years from 84% today to 89%. The higher revenues drop through
to a 37% increase in EBIT. Costs are fixed as the margin cost of an additional pas-
senger on an empty seat is close to zero.
We also think that while Alaska was too small for Buffett, it is the natural acquisition target for American or Southwest.

4. An activist investor could help Alaska realize its unique potential to become the dominant West Coast player.
Alaska has hinted they are looking to expand the east coast. This is a mistake as they do not have as big a cost advantage there. Focusing
on California should be the top priority. There is the opportunity to: i) Swap gates - Gates in California are more valuable for Alaska
than other airlines, and the opposite is true on the east coast where other carriers fly routes like New York/London. United, for exam-
ple, recently gave 3 gates at LAX to American in return for gates in Chica-
go. Alaska should look to do these types of deals now that it has gained
50 slots in a very slot-constrained New York through the Virgin America
acquisition. ii) Alaska now has slots at 3 New York and 3 Washington
airports. It is more cost efficient to have these at one airport. iii) Alaska
should explore opportunities to feed Delta in Seattle.

Alaska is the low cost provider in a commodity industry. It has the unique op-
portunity to become the dominant player on the west coast. Risk/Reward is
skewed very much in favour of a long position.
Page 32

Corning (NYSE: GLW) - Long

2017 Pershing Square Challenge - Finalist
Joseph V. OHara Vikas Patel R. Griffin Dann
Key Statistics Key Financials & Ratios
Monday, April 17, 2017 Actual Actual Actual Actual Est. Est. Est. Est. Est.
All figures are Core accounting except where noted 2013 2014 2015 2016 2017 2018 2019 2020 2021
Revenue $ 7,948 $ 10,076 $ 9,800 $ 9,710 $ 10,264 $ 11,132 $ 11,822 $ 12,522 $ 13,481
Fiscal Year-End December Gross Profit 3,368 4,348 4,212 4,128 4,434 4,778 5,115 5,474 5,875
Joseph V. OHara 18 Ticker
Current Price
Operating Income

Joseph is a first-year MBA Diluted Shares Out

Market Cap
Net Income
1.23 $
1.44 $
1.41 $
1.57 $
1.70 $
1.95 $
2.27 $
2.60 $
student at Columbia Busi- Cash & Equivalents (5,291)
ness School. Prior to CBS, Total Debt
Enterprise Value
Adj. Op. Cash Flow
Capital Expenditures
Joseph spent four years Adj. Free Cash Flow 1,860 3,868 2,211 1,602 2,050 2,300 2,512 2,824 3,171
working at T. Rowe Price
as a US Equities Associate Base Case
2-year Price Targets & Total Returns
Analyst. He graduated Total Return 51.4% EV/EBITDA 10.2x 7.6x 7.8x 8.0x 7.6x 7.0x 6.5x 6.0x 5.7x
Swarthmore College with a Bull Case
Total Return
Revenue Growth
EPS Growth
B.A. in Political Science and Bear Case $19.50 FCF/Share Growth 36.9% 111.2% -40.3% -14.9% 35.4% 18.9% 14.9% 18.1% 17.7%
Total Return -20.8% ROE 8.5% 9.2% 10.0% 9.9% 10.5% 11.8% 13.2% 14.4% 15.5%
Ancient Greek. ROIC 6.7% 13.7% 8.0% 6.2% 8.3% 14.9% 11.0% 12.7% 14.3%

Corning is a high-conviction long because the market is undervaluing the core earning assets of the enterprise,
misunderstanding the drivers of returns on capital, and overlooking the organic growth potential in optical
fiber and Gorilla Glass. Sector-dedicated analysts on both the buy and sell-side routinely undervalue Corning
at moments of product cycle inflections with a mature display market, secular growth in optical, and new
markets in Gorilla Glass, Corning is at an inflection. Corning has $2.27 of 2019 earnings power of per diluted
share and should trade at 17x that number for a $38.50 price target for a 51.4% total return over two years.

Vikas Patel 18
Vikas is a first-year MBA
student at Columbia Busi-
ness School. Prior to CBS,
Vikas spent three years as
a Senior Analyst at Millen-
nium Management. He
earned his B.B.A. from the
University of Michigan with
concentration in Finance &

Investment Thesis
1. The markets valuation of Cornings cash-generating assets
is cursory and indefensibly low
Corning has publicly committed to returning its excess
cash over the next 3 years via a capital allocation plan
announced in 3Q15. From FYE 2016 through 2019 Cor-
ing is set to return $7.4bn through share repurchases
and double-digit annual dividend increases in total,
GLW is returning over 27% percent of the current mar-
Griffin Dann 18
ket cap.
Griffin is a first-year MBA
student at Columbia Busi- Cash on a balance sheet is less valuable than earning
ness School. Prior to CBS,
assets this is not a revolutionary statement. A private
Griffin worked as an Ana-
lyst at Birch Grove Capital equity buyer could pocket Cornings cash and realize a
and in the Financial Re- purchase multiple on the actual cash-generating assets of
structuring group at Houli- just 13.5x. This approach is still justified for public mar-
han Lokey in London. He ket investors because of managements commitment to
earned his B.S.C. from the returning their excess cash. Because we know excess
Wharton School with a cash will be returned, we also know that the market will
concentration in Finance. be forced to re-evaluate the multiple it is putting on
Cornings cash-generating assets.
2. Cornings ROIC is inflecting upward and justifies a P/E
Page 33

Corning (GLW) - Long (Continued from previous page)

multiple in the high-teens
Based on our expectations for a continued ROIC inflection and the historical relationship between GLWs returns and its P/E multiple, we
believe GLW deserves a multiple in the high

This ROIC expansion has three core drivers.

On the balance sheet side, returning cash and
earning into the DTA account for roughly a
third of the expansion. The remainder is driv-
en by Cornings unique ability to grow sales
without incremental capex spend. For exam-
ple, Cornings first $400m in auto glass sales
require no capital investment in new tanks
due to their patented fusion manufacturing
3. The market is overlooking significant secular
growth opportunities in optical networking and
Gorilla Glass
Secular growth in demand for optical fiber:
Cornings first fiber opportunity was long haul that passed in the 90s.
As the creation of data and demanded speed of access have grown ex-
ponentially, there is significant demand for back haul fiber to replace
copper wiring. As you can see in the bottom right of this slide, Corn-
ings value proposition in back haul is powerful. For a higher up front
cost, Corning offers a lower total cost of ownership, a longer life-cycle,
vastly improved network security, and virtually unlimited bandwidth.
Based on widespread market commentary, carriers will continue to
shift their mix of capex spending toward Cornings value-added product
offering. As this has happened historically, Corning gained market share
among carriers like Verizon, AT&T, and others. We believe this trend
will only accelerate going forward because Corning is the high-quality
supplier in a highly inelastic market with little spare capacity. Validating
this non-consensus view, Corning recently announced a major deal with
Verizon to supply 12.4 million miles of their optical fiber for a $1.05bn
minimum commitment as an initial stage in their 5G rollout.

Free-option in Gorilla Glass for autos: We believe the market has not
factored this into their estimates at all because of the sheer size and com-
plexity of the opportunity. The auto glass market has not seen major
innovation in over 65 years and Gorilla Glass is vastly superior vs. tradi-
tional soda-lime glass it can cut a cars weight by 1.5%, double window
strength, and triple clarity and visibility for the driver. Gorilla Glass is
already in 6 cars, and OEMs have been actively considering where to add it in their lineup for a
number of years. Full penetration will result in a doubling of Cornings total consolidated reve-
nues. While that sounds like a mind-boggling statement, there are two key things to remember:
(1) auto glass is a free-option for current investors, and (2) everyone we spoke to throughout
the entire auto supply chain expected Corning to ultimately succeed in penetrating this market.
If youre only focusing on the display market and iPhones, youll never see this coming.
Page 34

Dollarama (TSE: DOL) - Long

2017 Pershing Square Challenge - Finalist
Gustavo Campanh, CFA Gilberto Giuzio, CFA Thiago Maffra, CFA

Recommendation KEY METRICS

We recommend a long on Dollarama (DOL) with a Price as of 04/14 C$ 117.00 Div Yield 0.4%
price target of $225 (92% upside potential in 5 years, 52w range C$ 86.57-118.11 Buyback LTM 5.4%
Gustavo Campanh 18
14% IRR), a compelling investment opportunity with 5 ADTV $43 M Consensus P/E (NTM) 26.7
Gustavo is a first year MBA times reward to risk. We believe EPS can triple to Market Cap C$ 12,523 B Our Estimated P/E (NTM) 22.8
student at Columbia Busi- ~$10 over the next five years due to new store open- Debt C$ 1,328 B 3y average 25.2
ness School. Prior to CBS, ings, same-store-sales (SSS) increase from higher priced EV C$ 13,851 B EV/EBITDA (NTM) 17.9
Gustavo was an Equity 3y average 17.3
Trader at Verde Asset
products introduction, and buybacks from the strong
Management, a US$ 10 cash generation from legacy stores; at 19x forward EPS
billion hedge fund based in contracting from current 26x DOL is worth $225
Brazil. This summer he will in YE 2021. WITH STOCK REPURCHASE ENABLES EPS TO
be interning at Somar
Business Description
York. DOL is a high-growth Canadian based discount retail
EBIT Margins: Earnings growth 2016YE 2021YE
chain with 1,100 stores, C$ 3 B in sales, that com- stable at current
1.65 10.19
pounded EPS at 32% CAGR over the last 5 years. DOL level 22%
stores are appealing to both low and middle-class con- Number of Stores: 2.07
Store count up from
sumers, with clean and well-stocked stores, selling 1,095 to 1,700 in 5 2.60
products priced from C$ 1.25 to C$ 4.00 with a low years 21% CAGR
reliance on lower-margin items such as consumables, a SSS growth: 3.87 vs. 16%
key component of the American dollar store model. 5.0%/year
(Nominal GDP +1%)

DOL has consistently doubled sales and tripled EPS Share buyback:
and 32% EPS
CAGR since
every five years since it was founded in 1992. 5%/year 2010

Current New SSS Buybacks Projected

Investment Thesis year Stores Growth 5 Years
Gilberto Giuzio 18 1) DOL has a superior business model that is
Gilberto is a first year MBA misunderstood by many, who label it as another dollar
student at Columbia Busi- Dollarama has almost a monopoly: big-box retailers
store. DOL has a 15% net margin, vs. 5-7% of Compa- dont carry the same cheap but good assortment, and
ness School. Prior to CBS,
Gilberto worked with Oil
rables, explained by (i) upstream integration: product other dollar store chains are dwarfed by its scale and
& Gas for Schlumberger developer, importer, and retailer; (ii) operational effi- dont carry many categories due to pricing
Business Consulting and ciency, with focus on the finest details; (iii) price points GRILL CLEANERS
worked in the treasury of up to C$ 4.00 allow inflation pass-through plus a
department of Ita. C$ 8.00
more flexible mix to drive traffic.
This summer he will be During our field trip to Canada to visit stores, competi-
interning at BofA Merrill tors and talk to customers, DOLs efficiency was visible:
Lynch in So Paulo, Brazil. C$ 4.00
taller shelves, inventory on top of them, frequent re- (same item as Canadian Tire)
stocking, consistent shopping experience, and conven-
ient locations. Margins are driven by such details. Amer- C$ 2.00
ican dollar store chains make $15 EBIT/sqft on average
while DOL makes $56 EBIT/sqft.
2) Market underestimates DOLs growth runway, focusing on aggregate Canadian demographics
instead of local statistics. Our variant view is 3,000 stores in the long run vs. the 1,700 long-term store guid-
ance. Worth noting, this target was raised by the company from 1,400, in the last week of March. Management
has been consistently guiding conservatively along companys history. Canada has half the number of dollar
stores per capita compared to the US and the market thinks this difference cannot be closed entirely because
Thiago Maffra 18 Canada has a lower population density, but this lower density is due to its huge non-populated area with people
concentrated in four small regions. The US, on the other hand, is more of a small town country as only 52%
Thiago is a first year MBA of the US population lives in cities larger than 20 thousand people, whereas in Canada this number is 67%. Given
student at Columbia Busi- how the Canadian population is distributed, you need logistics and scale to cross the distance among urban ag-
ness School. Prior to CBS, glomerations, but you could operate even more dollar stores per capita than the US penetration suggests (an
Thiago was the Proprietary assumption we do not factor in our thesis). We believe management can reach 1,700 stores in 5 years, a level
Desk Manager at XP Inves-
that would represent an increase from 50% to 70% of comparable US penetration levels. Aside from new store
timentos, the largest inde-
pendent broker-dealer in openings, for the next 5 years, we are confident on a 5% SSS growth. Historically, management has delivered
Brazil. This summer he will from 4 to 7% SSS and we believe they will continue to do so, by improving product mix.
be working at XP Inves-
timentos office in New 3) High barriers to entry due to double cost advantage (on scale and sourcing) protects DOLs cur-
Page 35

Dollarama (DOL) - Long (Continued from previous page)

rent high profitability. It would be hard for other players to compete DOLs margins SSS GROWTH
away without enduring a long period of pain. Any contenders would have to deal
with an 800-pound gorilla that has: (i) 1,095 stores across all Canadas provinces, Ticket Size
almost an oligopoly if you factor that the second player, Dollar Tree, only sells C$ Traffic Increase 7.1%
1.25 products and has around 224 stores (up only from 210 last year, not a significant 5.4% 5.6% 5.7%
growth given their more aggressive plans some years ago); (ii) international direct
4.4% 3.8% 5.2%
sourcing of more than 50% of merchandise, that avoids the middlemen, combining
margins along the chain; and (iii) five distribution centers to support efficient invento- 5.2% 5.5%
ry management. 4.0%
2.1% 1.4% 1.9%
Even for an established American chain, the barriers to entry in Canada would still be 0.2% 0.2%
high, as one must: (i) relabel all its product assortment to include French; (ii) adapt its
assortment to please the educated but relatively low-income Canadian consumer 2011 2012 2013 2014 2015 2016
(even Walmart is a little fancier in Canada); (iii) find convenient real estate locations SSS growth of 5% (vs. 6.2% hist) sustained by improvement
as DOL has; and (iv) establish cross-border logistics. For instance, Dollar Tree still of product mix (inclusion of higher value products)
uses third-party distribution centers, leaving margin on the table. Expanding to Cana-
da would take a long time and would burn a lot of cash (lets remember how Target
failed miserably trying to accelerate its expansion in Canada). About some more STORE COUNT GROWTH
differences, US chains have different mixes, with a higher proportion of consumables
to (i) attract traffic, and (ii) comply with food stamps SNAP rules (50%+ consuma- Consensus
bles or carrying select products including perishable foods). More consumables 9% vs 5% cons.
Above consensus
artificially improve metrics as SG&A as % of sales, but weigh in more square feet 1,694
needed to carry these lower margin items. 9%

4) Meaningful downside protection with compelling cash flow generation 1,095

provided by strong new stores unit economics, which have 38% IRR and a 3-year
payback. We still see ample room to further increase store count while maintaining 704
profitability. In addition to the new stores unit economics, DOL has an efficient capi- 1,095
tal allocation: with such high returns, it is not surprising that the company has been 704
able to grow while generating solid cash flows, which have been returned to share-
holders via stock buybacks, as evidenced by the 22% reduction in shares outstanding 2011 Today 2021
since 2011. DOL grows with low capital needs, and if the company halts expansion, Our expectation of 1,700 stores represents 9.1% 5Y CAGR (vs.
the legacy stores would continue driving sales and profits with very low CAPEX. 5% consensus), a number in line with the past five years

Given the high cash flow conversion, we valued the business based on earnings mul-
tiples. We modeled our Base Case with 1,700 stores in 202, what still holds room 350 DOL RETURN SCENARIOS
for growth in the future, as we have a 3,000 stores TAM. This growth represents 300 Bull Case: C$308.00
9.1% 5Y CAGR (vs. 5% consensus). We also assumed a SSS growth of 5% (in line
with the 6.2% historical average) and kept EBIT margin constant at 22%. Even with a 250
Base Case: C$225.00
good long-term growth perspective, we compress the exit forward PE from 26x to 200
19x, a conservative assumption given the compounding nature of this stock. 150
For our BULL CASE we considered 2,000 stores in 2021, with a SSS growth of 6%
100 Last: C$117.00
(which is still below historical level) and a multiple compression from 26x to 21x.
In the BEAR CASE, we model a 30% downside. This is with forward PE coming from
26x to 16x, and cutting EBIT margin from 22% to 18%, with zero store count












growth, and only 2% of SSS growth (GDP nominal growth is projected at 4%).

Key Risks and Mitigants

Competition from dollar stores & big-box retailers: DOL has 4x the combined number of stores and lower COGS compared to other
dollar stores who have not shown capacity to grow facing DOLs competitive advantages. Also, DOL has a relatively low product overlap with
big-box retailers and better price for the small number of similar products.
Competition from online retail (e.g. Amazon): DOLs products have a low unit price, making it more difficult for online retailers to
compete. Its average basket is C$ 13 while Amazon requires C$ 35 per purchase to qualify for free delivery (C$ 25 for Prime members). Be-
sides that, DOL has been increasing its low-cost white label merchandise from 20 to 25% of SKUs, making it difficult for customers to find
similar products elsewhere with competitive prices, even online. Moreover, DOLs brick & mortar locations are a key defense from online
competition as they have convenient locations that attract high levels of foot traffic.
Other risks: Vulnerability to FX fluctuations (that DOL hedges the next 12 months of imports, and for permanent level shifts, DOL has the
ability to increase prices due to its multiple price points); Labor cost increases; Import taxes (that would impact all other retailers, and DOL
could pass through via price points flexibility); Key managers leaving (what is a low risk given managers have a lot of skin in the game, owning
10% of the company, with the Rossy family having 50% of their C$ 2 B wealth in stocks of Dollarama).
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Chris Begg
(Continued from page 1)

Trustee of the Trustees of me. I read and reread ready to take a leap and start a
Reservations and co- everything I can that both company in order to be more
founder of Humans for Warren and Charlie put out in control of my own destiny. I
Oceans (H40), a nonprofit there. There were probably had assets that were willing to
organization created to ten to fifteen other investors come with me from my earlier
support ocean that were instructive and I relationships, and Amory really
conservation. would attempt to reverse supported my decision, so in
Chris Begg engineer what they did, and try 2008 we launched East Coast
Graham & Doddsville to understand how they Asset Management, and its
(G&D): Can you tell us a little achieved their superior results. been almost nine years now.
about your background and What was their edge? What
what led you to where you are was the one thing that they G&D: I know you said you
today? were particularly good at? I had assets that were willing to
tried to get to the point where move with you, but in taking
Chris Begg (CB): I got into I was able to deduce, "Okay, I the plunge and starting your
the investment business in see how their thinking own fund, how did you know
1994, after undergrad. I started produced that investment idea you were ready?
working for a small and does that align with the
investment firm in Cape Cod, way that I think?" That was my CB: I guess the hardest part of
where I grew up, and I knew process. I spent ten years just starting, whether it be a fund
right away that I loved the honing my temperament and or an investment management
challenge of investing and all the while figuring out what firm, is having trusted partners,
solving puzzles, but I wanted to kind of investment philosophy clients, and assets that are
find an analyst position and process made sense for going to support your effort.
somewhere near Boston. me. Certainly, value investing There are a lot of great
was the logical outcome of investors that just don't have
I had an opportunity to join a that, and then more the track record or the assets
firm called Boston Research specifically, what made a lot of to make that leap. I am grateful
and Management where I spent sense to me is buying great that my circumstances leading
ten years. It was a great businesses that you can own up to the launch helped pave
opportunity and afforded me for a long time, and allow the way. I had worked with a
the time to read a lot, study compounding to do the heavy handful of partners and clients
businesses and business lifting. That was an important for over ten years and as soon
models, and most importantly realization. as I was ready, they said,
learn what kind of investor I "We're coming with you,
was. During those formative I eventually wanted to move wherever you end up. That
years, and this is advice I on to keep learning and was really the added comfort
always give my students, it is growing so I was looking to level that I needed, and I felt in
important to have a mentor take the next step. I was my heart I had the investment
and/or great heroes. If you introduced to a company management background to
don't have the former, the called Moody Aldrich Partners. run what I thought would be
latter is really important. Pick They were looking for an intelligent strategy. Looking
the right heroes in investing, someone to work with Amory back it has really been the
and in life, and then learn as Aldrich as part of a longer- journey that continues to be
much as you can from them. term succession plan on the the reward. Even the
Over my career, I have been strategy he had stewarded for challenges have enriched the
lucky and grateful to have over thirty years. Amory is a pathI remember that first
mentors, but heroes are great investor with an year in 08/09 was pretty
available to everyone and the impressive long-term track harrowingboth to get things
reservoir of their wisdom is record so the opportunity to set up operationally just as the
infinite. learn from him was a logical market was dropping
next step. precipitously everyday. So my
As for heroes to emulate, advice for students that feel
Warren Buffett has and However, after a little over a this is your callingstay lean
continues to be that light for year it was clear that I was
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Chris Begg
and as Joseph Campbell has tough environment? The into compounders, but they
said, Follow your bliss. fourth is the system advantage: currently are average
Is it adaptive? Does it foster businesses that have an
G&D: Can you talk about persistent incremental average return on invested
your investment philosophy? improvement? The fifth is the capital. Something is changing
commander advantage. Ideally, or transforming in the business
CB: There are three we want a founder. We want a or the industry, however, and
categories of investments that founder or a founder-like we think it is going to produce
I've thought about, and it's leader that's running the better returns that aren't
how Ive structured the business, and running it like an currently priced in.
Security Analysis class that I owner. We found most
teach at Columbia. They are success with founders, but if
compounders, transformations, we find a leader that has been What we're looking for
and workouts. Two-thirds of groomed to steward the
advantaged business and act
are businesses that are
our investment ideas have
come out of the compounder like an owner, that works too. getting better, where
category. What we're looking The ownership leadership trait
for are businesses that are needs to be deeply imbedded they have some type of
getting better, where they have in the culture and is not always
model thats sustainable
some type of model thats portable.
sustainable for a long period of for a long period of time,
time, and where the moat is We find that most companies
going to widen. Because of that are either playing a finite game and where the moat is
moat, they earn high returns or an infinite game. James going to widen.
on capital that we think will be Carse wrote a wonderful book
sustainable in the future. on this very topic called Finite
and Infinite Games. The infinite We focus on three types of
What we're looking for with game is where the time transformations. Secular
compounders are upstream, horizon is very long, if not transformations are going to
often invisible and intangible eternal, for the way the be where you have a post-
advantages that lead to a visible business is being run. It's being industry consolidation, where
downstream propensity to run for the next generation, the remaining players are going
achieve superior economic versus some quarterly or five- to enjoy better pricing power
returns. The upstream year objective. Certainly, there and more rational decision-
advantages we focus on are is a plan and there are goals, making around competition,
five-fold. In The Art of War, Sun but there's a big difference and the returns are likely to
Tzu rote that the five most both in the culture and how get better. The market
important parts of assessing they think about the business struggles to see around these
the potential of an army on a when the business is run for corners and struggles to value
battlefield are the the infinite game. Think them effectively. Systemic
topographical advantage, the Berkshire, Colgate, and transformations are where
morale advantage, the Danaher. There's something there's a true system change in
meteorological advantage, the very different about those the organization, typically
system advantage, and the businesses than what you'll find driven by a new process or
commander advantage. Those where the leaders are trying to new leadership. Like Danaher
five are perfectly suited for solve something over a shorter with their Danaher Business
what we're looking for in a horizon. That's what we're System. The third is
business. looking for in the compounder separations. Separations are de
category. -mutualizations or spinoffs,
The topographical advantage is where there's a real inflection
the moat. The morale With transformations, these point in both how the owners
advantage is the culture. The are businesses that are going are being incented and how
meteorological advantage is through an inflection point of capital is being allocated.
resiliencehow have they change. Our best Usually, there's a real
done and will they do in a transformations eventually turn mispricing that exists with
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Chris Begg
separations where there are years. The frictionless ideal is maybe everyone is ignoring?
some forced sellers because the one-decision type. Why is this business hiding in
the company is too small to be plain sight? That's the hardest
owned by a large institutional G&D: In your 2015 letter, you one to answer because
owner. We saw this recently spoke about the power of sometimes we don't know, but
when LiLAC Group came out compounding, and the we try to understand why we
of Liberty Global, which was a difference between logarithmic have this opportunity to own
forced sale for a lot of growth and linear growth. Do this mispriced asset. Or maybe
institutions. you think that compounders we don't and we're wrong.
are underappreciated? Do you
Workouts are what we call, think there is a market I think it's important to our
60-cent dollars. This is not misperception there? efforts that we're constantly
just about grabbing net-nets, learning and building our
where there is a true value CB: In that letter, I talked reservoir of knowledge on
proposition and existing about what we call the twin great businesses, businesses
margin of safety, but where we lights of the investment that are transforming and
cant definitively answer if the process: the quality of the getting better, so that we can
dollar is growing. We don't do business and the quality of the value them on a process-driven
a lot of workouts internally. investment. We're always basis. If weve done the work
They've always been a small looking to understand the best on the business quality side we
proportion of the portfolio, businesses in the world, can act when the price is
and now they're almost non- regardless of price. We want there.
existent in our concentrated to know them well so that
portfolio, because it's harder when there is a potential To answer your question as to
to get the time horizon right opportunity, whether it be an if I think compounders are
on businesses that aren't overall market sell-off or underappreciated and do I
getting better. Also, the something specific that might think there is a misperception
declining businesses are likely be temporary, were aware. therethe short answer is
to get worse more quickly. yes. I think many investors
focus where there is a strong
Many of our mistakes have contrast and ignore businesses
We find three-decision
been where we thought we that are getting better
bought something with a stocksbuy, sell, and incrementally without a lot of
significant margin of safety noise.
while knowing that it might be then figure out what to
a melting ice cube. We thought do with the proceeds G&D: Is there a company that
it might weaken, but not for a fits the situation you just
long time out. But then it are not as ideal as described?
accelerated a lot faster than
we thought it would. That's finding businesses that CB: Well sure, we have been
one of the big lessons we've we can thrive with over talking recently internally
learned over the last five years. about Sherwin Williams, which
We dont play much in that many years. after reviewing some of the
space, although it's a well- numbers continues to impress
travelled space for the hedge me. Sherwin Williams is a great
fund community as often there Now, the quality of the company that has compounded
can be the perception of investment has a lot to do with at 22% or so since the
catalysts that help serve price. The price you pay will recovery of 2009. You go back
investors looking for shorter- determine your rate of return. over, say, a thirty-year period,
term payoffs. We find three- But also, with the twin lights of you're looking at a company
decision stocksbuy, sell, the quality investment, we're that's compounded at around
and then figure out what to do looking at margin of safety. 15.5%. High returns on
with the proceedsare not as We're looking to understand invested capital of 30% or
ideal as finding businesses that why it might it be mispriced. better, and a great distribution
we can thrive with over many What do we understand that system. A product where
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Chris Begg
regulation makes it difficult to CB: If I could have one idea. Price is going to
transport impedes e- superpower as an investor, it determine that rate of return,
commerce players from would be revealing IRRs. which is going to drive our sell
entering the competitive There's an inherent IRR for discipline.
landscape. They are a local every single investment that
champion as Bruce Greenwald you can look at based on your Most of our sales are where a
has written about in time horizon. That is the target compounder that was playing
Nick Briody 18, Fernando Competition Demystified. They investments essence. The job an infinite game becomes more
Concha Bambach 18, Vy continue to win with the of the analyst is to reveal that finite and their moat appears
Huynh 18, and Daniel Le- professional painter in the local return expectation within to be weakening because of
Blanc 18 posing after the market. some type of acceptable sector-related and
Pershing Square Challenge probability range. environmental-related
That should be in your innovation. Maybe a
universe of great companies, The job of the portfolio competitor is reducing the
and it's just that valuing it manager is to allocate capital entropy and friction costs that
today is a challenge when you to those IRRs that are most exists in their vertical and they
look at a company that's deservingmeaning most are going to be exposed to a
grown earnings from $4 in asymmetric. It's just as simple threat that they cannot
2009 to $12 now. Where is as that. Now, in practice, this compete effectively against.
that $12 going to be in that proves very difficult because Think of brick and mortar
next year or so, now that you're dealing with lots of retail; anything that a scaled e-
we're nine years into a unknown information. We're commerce player can do will
recovery. Valuing companies not talking about deterministic likely be at a lower cost.
deep into a recovery, outcomes. We're talking about GEICO has been devouring the
particularly if they're cyclical, probabilistic outcomes. But entropy of higher-cost auto
becomes more challenging you can build a range of insurance sold through brokers
right now. probabilities, a range of IRRs for over 80 years.
that are within your comfort
The questions for me on level and that can prompt you G&D: You had mentioned
Sherwin have a lot to do with to take action or not. that so much of finding a great
where are we in the cycle, and compounder is related to
what's this look like? Are we Back to your question about qualitative and intangible
buying something at more than sell discipline. If we're revealing features. How do you assess
20x earnings? Are earnings the IRRs, and a true IRR of them and test their resilience?
peak earnings? Or are we mid- anything we own is sub-
cycle, and with this acquisition optimum, meaning it's CB: As we take an idea
of Valspar, the company can appreciated to a point where through the process, the first
gain more synergies and the future IRRs will be low, or thing we do is a first-principle
extract the next five-to-ten below something else we can exercise of trying to
years of additional growth? It's own, it might be deserving of a understand what the business
an interesting one to solve. sell. With companies that we is solving for. What entropy
Recently, some of my students like and we've been involved in exists today that they are going
pitched Sherwin Williams and I for a long time, we'll allow to reduce for the benefit of
think this is just the kind of them to stay in the portfolio a their customers and all
compounder business we love, bit longer. In other words, counterparties of the
one that is found hiding in plain we're comfortable with some organization? MasterCard and
sight. lower IRR investments that we Visa have been devouring the
know and like as anchor entropy of cash toward more
G&D: Earlier you mentioned positions. For example, efficient credit and debit
waiting for the right price. As a Colgate may get expensive transactions. That's the
corollary, when do you think from time to time, but it number one thing that we ask
about selling these great provides some asymmetry to ourselves.
businesses? the portfolio, meaning very
little downside despite the If the company we are looking
upside not being our best IRR for is the entropy point and
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Chris Begg
has a fortunate pricing much further out. Ideally, we underappreciated how big
umbrella, we typically will start we've found a business that the market opportunity was
right there and focus on why thinks outside of time. for what theyre doing, but we
this advantaged moat should Managers feel like they're continued to follow it.
persist. We prefer to own stewards of the organization
businesses that deserve the and they're going to hand it off We got back involved in 2014,
right to win because they are to the next stewards. It's a but over the last year, we've
fostering a win with all their very different mindset. Look at been increasingly
counterparties, including Berkshire, or Danaher, or the uncomfortable with our checks
society at large. Liberty businesses, or Amazon. regarding the companys focus
Bezos said it recently, it makes on shorter-term profitability at
Now, the second thing we do a huge difference when you're the expense of long-term
is gather evidence through talking seven-year numbers resilience. The culture felt like
primary research. Here we talk versus the time horizons on it was getting more fragile in
to counter-parties to get which competitors focus. the sense that they were being
answers around business more vocal around their
quality. Customers, former leverage and their pricing
employees, competitors, ...we're looking at the power. Today we feel there is
people that are somehow a large observation effect that
involved in the vertical in some qualitative factors that exists and creates additional
way. Its all very important. fragility that was not there in
we think are going to
They can be anecdotal, but I 2014. We still believe this is a
think collectively once you've drive the long-term great business run by
done all your work, it fills in a competent management, but
very clear picture. At that success of the business. we have chosen to step aside.
point, we're building a model. We're looking much Given the polarization on both
We're also reading the typical sides of this argument, I would
10-Ks and 10-Qs. You're further out. Ideally, prefer not to say much more.
starting to build the bottoms- We are fortunate as investors,
we've found a business particularly in public liquid
up picture of the company.
that thinks outside of markets, to change positioning
The third thing we do is to reflect changes in our inputs
categorize the investment. time. and not to get hung up with all
Does it look like anything that the behavioral biases and
we've looked at in the past? friction that come with
Then we take it through the G&D: Are there any names defending ones ego.
steps of our twin light process, that you would like to explore?
looking at the quality of the Youve discussed TransDigm in G&D: Speaking of behavioral
business and the quality of the the past, there is a lot of biases, how do you guard
investment, to finally arrive at tension in the stock right now, against them?
some range of IRR that we and wed love to hear your
have confidence around. thoughts. CB: It's a good question. I
recently talked about this at
G&D: You're typically looking CB: Sure. We got involved in the CSIMA Conference. There
five to ten years out. Does that TransDigm in 2009. We were are a couple of valuable
depend on whether managers fortunate enough to speak resources when it comes to
are playing a finite game or an with someone that had been behavioral biases: Cialdini's
infinite game? involved in bringing TransDigm work on the influence of
public and knew the business psychology in human decisions
CB: Yes. Although we assess well; we understood the and Charlie Mungers speech
IRRs at the five-year duration, business model. We owned it on the Psychology of Human
we're looking at the qualitative through 2012 with an Misjudgment. I believe there
factors that we think are going extraordinary return, but we are three big systems or
to drive the long-term success sold in 2012 because we felt it phases in regards to this. The
of the business. We're looking was fully-priced. In hindsight, first one is instincts, the
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Chris Begg
second is reasoning, and the you remove the obstructions well, anything we sell could go
third is insight. of the instinct and misjudgment on to be a perfectly good
process. That's how I think investment. We only have a
With instinct, the big thing about that decision framework few slots in our portfolio and
you're trying to solve for is and therefore the objective is from time to time, the bar we
how do I remove the obstacles the perfection of insight. set is higher than for what we
that impede my ability to get already own, and therefore we
to the second phase, which is move on.
What we're all looking
what Kahneman calls system-
two thinking. Many things get for is a differentiated Phillips 66 is the other one.
in the way: ego, self- Since we got involved in 2012
preservation, hierarchy, insight that comes when it's been a very good
territorialism, and ritualism. you get through the investment for us. However,
These all impede your ability we feel the next ten years are
to make rational decisions. reasoning process, when less clear on a decent
proportion of their business,
What we try to do is think you remove the particularly, refining. I think
about the many obstacles that obstructions of the there is a lot of uncertainty
get in the way. It can come around energy and what that
down to lots of behaviors that instinct and will look like in the future,
impede good behaviors. Are because companies are finding
you taking lots of meetings misjudgment process. a very real technological cost
with the same people and curve coming from solar.
youre exposed to groupthink? G&D: In what other instances Phillips 66 has a great business
You can make a very, very long have you had to reverse your in chemicals and likely will be
list, and I think it's a very good thinking like you did with fine, but we think there are
process to go through to TransDigm? Are there flags other places to allocate capital
constantly re-check where you that help you recognize when where the probability range is
are obstructing your ability to you need to reconsider? going to be more attractive for
be rational. us.
CB: We recently sold two
In the second phase of businesses which we owned G&D: Youve mentioned
reasoning, youre also trying to for years. The first one is IBM. probabilistic outcomes and
remove blind spots in your As we understood Amazon asymmetries, could you discuss
process. I think about it almost AWS more and more, we how you think about risk and
in terms of a hologram: you're became increasingly less position sizing in the portfolio?
trying to create this view to comfortable with IBM's
see the entire question or competitive advantage long- CB: In our Partners Fund, we
investment idea from every term in enterprise. We felt we own anywhere from eight to
angle, so that you're viewing owned it cheap enough; fifteen positions. Ideally, it'd be
this hologram three- especially with the buyback, on the lower end of that if we
dimensionally with zero blind there were multiple ways to had a high confidence in a few
spots. It's hard to do, but win. But the problem with IBM number of asymmetric ideas,
building a reasoning process to is that its become more path- but we typically own more
help achieve this outcome is dependent around how ideas as we move through a
one of the most important successful they will be in AI. cycle and things become more
parts of decision-making. We don't like path-dependent expensive. That's where we
outcomes. We'd rather have are today; we are balancing a
Then you want to get to the many ways to win. There are few more names as prices have
final stage, which is a true, still some path-dependent moved higher and margins of
differentiated insight. What outcomes that could be very safety have been reduced.
we're all looking for is a good for them.
differentiated insight that But I think the most important
comes when you get through It is important to note that if thing when you own a
the reasoning process, when we have done our initial work concentrated portfolio is to
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Chris Begg
understand the probability space. That's what an insight is. improvement. We think there
range of the outcomes and You're going into the realm of are a lot of outcomes that
what the low end of that range the unknowable by reasoning could happen in their end
looks like. We will bypass through it and assessing all the markets, but because their
many great investment ideas if probabilities, and realizing that system is completely adaptive,
we think there's even an it's not path-dependent. There resilient, and moving, they're
infinitesimal potential for a are a lot of outcomes where able to continuously react,
zero, because it's just not you can win. Thats how you change course, and get better
something we can underwrite. get comfortable. That is how every day. That's what gives us
We prefer downside you look beyond the worlds the confidence that they're
probabilities where if it is a fixed limitations and your own, going to continuously solve for
zero it means it is a 0% IRR, those finite outlines and their end-markets. They have
but a 0% IRR still keeps our boundaries. done that for over 30 years.
capital intact.
When you think about the G&D: How do you think
The importance of seeing the investors that understood about cash in the portfolio, and
world through a lens of Amazon in 1997 and the years do you look at it as an asset
probabilities is something that that followed, that investment class or as dry powder for
has been reinforced by didn't look like anything where future opportunities?
studying the quantum world. a value investor could
When you look at quantum recognize a pattern. It was CB: For our partner strategy,
mechanics, there's a whole different. It was a scale which is an institutionally
world that, to me, seems so economic shared model. oriented strategy, we think
well-aligned with investing. The Maybe it looked like GEICO or about our portfolio as a fully
big take-away is that this whole Costco, but it didn't look like invested mandate. Now that
world of quantum mechanics is the kind of things we were told being said, at any one time, we
a probabilistic world. You to look for as value investors. could be 0% to 20% cash, but
dont know where any sub- cash is not a strategic
particle is located, you just As you go into the field of investment where we're trying
know the probability of where investing, your best insights, to time the market. Yet if the
it might be. I think you'll find your best ideas are not going world goes crazy, as it
the uncertainty that physicists to look like what some of your inevitably does, we will not
deal with is very similar to the heroes had invested in before. make uneconomic or irrational
uncertainty that we face in You're going to have to find investment decisions for our
investing. We're dealing with new ways to think about it. partners. Therefore a larger
so many things that are The map will not be found in cash holding may be warranted
unknown and unknowable, and any book on investing but temporarily.
we're building these more likely found in the book
probabilistic scenarios based of nature. Sometimes we don't have a
on all that information. replacement for a position that
G&D: We've focused a lot on we're selling. We want to keep
G&D: You mention in your compounders. Could we buy and sell decisions very
letters making rapid, highly discuss some positions that fit separate. We recently had a
consequential decisions with your other models for couple of sales in the portfolio,
incomplete and potentially investing? which frees up more cash than
erroneous data. How do you we have good ideas to put to
get enough conviction around CB: Of course. We've work. We can reallocate to
an idea? recently added Danaher. You existing ideas, or we can hold a
could argue that Danaher is a little bit more cash in the
CB: The Harvard Professor compounder, but we look at meantime until we finish
and bridge-playing expert Danaher as this constantly working on something thats in
Zeckhauser stressed the evolving, systemic the final stretch.
unknown, unknowable, and transformation. We love the
unique; I think you want to be mindset of the culture with G&D: Sounds like you find
able to build a bridge from that regard to continuous inspiration across many
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Chris Begg
disciplines. How do you put Also, how does what you've lot of important and timeless
things on your reading list, and taught us relate our decision- insights in Eastern philosophy.
how has this shaped your making framework and What you find when you start
ability to frame investments? investing? to contrast Eastern versus
Western philosophy is that
CB: I started a process almost It's something we do weekly Western thinking is where
ten years ago where I set aside and it's fun because it's a multi- we're trying to project a model
a quarter's worth of ancillary disciplinary habit that fosters onto the world, and we're
reading material around one some creative thinking. trying to see how our model
topic. During that three-month Throughout the week between or our projection aligns with
period, I would read as much conversations about business- the way we think things should
as I could on a subject, and do specific objectives we will tend be. Oftentimes, the reality is
a deep-dive around one to revisit further questions and far off. In contrast, Eastern
particular topic. I also allow insights somebody has read on philosophy is much more
myself to touch the other the subject. Subjects are about aligning yourself with the
mediums that are related to typically in the large data sets constancy of change, and
that subject, especially in the of physics, biology, and human looking at things from the
arts. Whether it be fine arts or history. potentiality and the propensity
visiting libraries and museums, of the outcomes.
I fully immerse myself in that G&D: It would be great to
topic. I think it allows one to hear any advice you may have We added Amazon to the
slowly build both breadth and for students or for people portfolio this year, and it was
depth. interested in the industry. one of those investments that
we were fighting our own
The quarterly letters I have CB: What I love about the biases versus understanding
written at East Coast have Columbia students is that you the propensity and the
been an output that came from have a lot of fanatics and potentiality of the outcome
this process and that quarter's individuals that are similar to that was staring us in the face.
reading. Over the last year, I've us and approach learning with My advice is that there's just so
switched the quarterly letters enthusiasm. Many of the much important information in
to a year-end letter just from a students have such a deep level Eastern philosophy that you
time management standpoint of curiosity and I think that's can contrast against the basic
and will reignite an interim just so important. It was what scientific-method-reasoning
memo writing process in attracted me to teach there process and arrive in a very
between year-end letters. and feed off that energy of different place from your
learning. Curiosity is the first peers. That's something that
The other thing that we do bridge. has helped me a lot. If I had
here is something we call known earlier, I would have
"What I Learned This The second bridge is creativity. had many more years of these
Weekend," where analysts Fostering curiosity, but also important books memorized in
submit a brief write-up on creativity in how one should my head.
Monday morning on a subject think, because it's going to be
where they take the team building these mosaics of G&D: That's great. Thank you
through the ADEPT information that leads to so much for taking the time to
framework. ADEPT stands for: creative insight. Anything that talk with us today.
Analogy, Diagram, Example, can help foster those two
Plain English, and Technical things is really important. The
description. Then we added arts and sports are a great way
BE ADEPT, which we call to practice creativity and hone
Be memorable and Evolve that creative spirit toward
our process. That translates mastering some craft and
to, Have we memorized what entering a flow state.
you've now taught us in some
mnemonic or other way On the reading side, over the
some memory palace way? last couple of years I've found a
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Contact Us: Graham & Doddsville Editors 2016-2017 Eric Laidlow, CFA 17
Eric is a second-year MBA student and member of the Heilbrunn Centers Value Investing
Program. During the summer, Eric worked for Franklin Templeton Investments. Prior to
Columbia, he was an equity research analyst at Autonomous Research and a senior port-
folio analyst at Fannie Mae. Eric graduated from James Madison University with BBAs in
Finance and Financial Economics. He is also a CFA Charterholder. He can be reached at

Benjamin Ostrow 17
Ben is a second-year MBA student and a member of the Heilbrunn Centers Value Invest-
ing Program. During the summer, Ben worked for Owl Creek Asset Management. Prior to
Columbia, he worked as an investment analyst at Stadium Capital Management. Ben gradu-
ated from the University of Virginia with a BS in Commerce (Finance & Marketing). He can
be reached at

John Pollock, CFA 17

John is a second-year MBA student. During the summer, John worked for Spear Street
Capital. Prior to Columbia, he worked at HarbourVest Partners and Cambridge Associ-
ates. John graduated from Boston College with a BS in Finance and Accounting. He is also
a CFA Charterholder. He can be reached at