Value Investor Insight December 2017

ValueInvestor
December 30, 2017
The Leading Authority on Value Investing

INSIGHT
Adversity to Advantage Inside this Issue
T
FEATURES
hen co-CIO of Royce & Associates, Whitney
George in early 2015 wanted a new challenge, ide- Investor Insight: Whitney George
ally one taking advantage of his contrarian nature. Taking advantage of "moments of
“I like situations where a leader in an out-of-favor sector weakness" to find value in such
stocks as Franklin Resources, Cirrus
turns adversity to its advantage,” he says. “Career-wise,
Logic and Pason Systems. PAGE 2 »
that’s where I wanted my next step to be as well.”
He joined Sprott Inc., where he’s actively involved in Investor Insight: Tom Olsen
managing the precious-metals-focused investment firm Covering all angles to unearth mis-
while continuing to run Sprott Focus Trust, which in his priced opportunity today in recent
15 years at the helm (starting at Royce) has earned a net spinoff Landis + Gyr, Ericsson and
annualized 11.2%, vs. 9.7% for the Russell 3000. Among Salvatore Ferragamo. PAGE 7 »
contrarian bets today, he sees value in asset management, Whitney George

Investor Insight: Richard Cook
drilling equipment and semiconductors. See page 2 Sprott Asset Management
Searching widely for a narrow
opportunity set that today includes
Attention to Detail Anheuser-Busch InBev, Lindley and

Coca-Cola Embonor. PAGE 13 »
T
om Olsen and his analysts at Swiss money manager
A Fresh Look: Fiat/Ferrari
Mensarius will make mistakes, of course, but after Assessing if these investment win-
hearing him describe the firm’s seven-step due-dili- ners have room to run. PAGE 19 »
gence process, it’s hard to imagine them resulting from re-
search neglect. “We simply want to look at situations from Strategy: Robert Vinall
all angles so we don’t miss anything important,” he says. Challenging once-sacred aspects of a
Such rigor has paid off nicely for Olsen’s investors. value-investing strategy. PAGE 21 »
Mensarius manages €1.6 billion and its flagship European
INVESTMENT HIGHLIGHTS
Value strategy has since the firm’s inception in 2008 out-
earned its MSCI Europe benchmark by 260 basis points INVESTMENT SNAPSHOTS PAGE
per year. In what he considers a rebounding Europe, Olsen Anheuser-Busch InBev 15
today is finding opportunity in such areas as luxury goods, Tom Olsen Cirrus Logic 6
telecom equipment and electric meters. See page 7
Mensarius Coca-Cola Embonor 16
Ericsson 11
Liquid Assets Ferrari 19
A
Fiat Chrysler 19
s he looks to expand the analyst corps at the firm Franklin Resources 4
he co-founded in 2001, Cook & Bynum Capital’s
Landis + Gyr 12
Richard Cook puts a premium on what he calls
Lindley 17
intellectual honesty. “It’s very important in this business
Pason Systems 5
not to fool yourself into thinking you understand some-
Salvatore Ferragamo 10
thing when you don’t,” he says. “If you know something
for sure, tell me. If not, don’t pretend otherwise.”
Other companies in this issue:
Cook and partner Dowe Bynum have put their own
Arca Continental, Cal-Maine Foods,
clarity of thought to productive use, earning since 2001 a Coca-Cola, Franco-Nevada, Frank’s
net annualized 8.4%, vs. 7.1% for the S&P 500. Finding International, GameStop, Hugo Boss,
much more to watch closely than buy at the moment, their Kennedy-Wilson, Microsoft, Publicis,
eight-stock portfolio today includes bets on soft drinks, Richard Cook Randgold Resources, Sanderson Farms,
beer and regional bottlers. See page 13 Cook & Bynum Capital
Viscofan, Wal-Mart
December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 1

I N V E S T O R I N S I G H T : Whitney George
Investor Insight: Whitney George

Whitney George of Sprott Asset Management describes his affinity for cyclical businesses, what he’s finding to be unusual
after eight years of a bull market, how he’s applying his expertise in precious metals, what he prefers about managing a
closed-end fund, and what he thinks the market is missing in Franklin Resources, Pason Systems and Cirrus Logic.
You focused almost exclusively on small ments that people hate. I’m basically doing ket, which knocked down prices. How
caps during your long tenure at Royce time arbitrage – finding companies where can you predict something like that?
& Associates, but one fund you brought economic, industry or company-specific What we do with companies like this
with you to Sprott invests in big and small disappointments prompt short-term inves- is arrive at what we believe the business
alike. How did that come about? tors to sell me their shares at compelling is worth, say, on five-year average earn-
absolute valuations based on what I con- ings or some other reasonable estimate
Whitney George: That particular fund, sider normal longer-term earnings power. of normal. If you keep your head while
now called the Sprott Focus Trust, always Two of my larger holdings today are the quarterly earnings game drives people
had a broad mandate, but we didn’t really Cal-Maine Foods [CALM] and Sander- batty, these types of opportunities can be
take advantage of it until 2009 when very son Farms [SAFM], which produce eggs very attractive over time.
large, high-quality companies started to and poultry, respectively. I’ve known and
trade at absolute valuations that were too invested in these companies for a long What other types of situations allow you
attractive to ignore. When you can buy to buy quality on the cheap?
Microsoft, Exxon Mobil or Apple at valu-
ations that you’re only accustomed to see- ON FINDING BARGAINS: WG: In addition to taking advantage of
ing in ignored and out-of-favor small- and time arbitrage, there’s still something to
Cycles are difficult for many
micro-cap stocks, you should do it. be said as well for detailed, fundamental
Also, as a long-term investor in smaller investors, so basic cyclicality research. I’ve owned the real estate invest-
stocks, you can often see ideas grow from that you can understand is ment company Kennedy-Wilson [KW] on
small, to mid-cap to even large over time. and off for fifteen years and consider it
I generally don’t want to have to sell the often a source of mispricing. one of the best real estate asset managers
companies I know best and where I have in the world, with a track record to back
the longest relationships just because of that up. But it’s also organized in a com-
the cap size. time and they both have excellent track plex, not-easy-to-understand way, which
records, fortress balance sheets and scale exacerbates the difficulty of seeing how
You describe favoring high-quality com- advantages. They also fully understand good they are unless they’re selling things
panies, but don’t seem to have any prob- they are in cyclical businesses and manage and it becomes obvious. If you peel apart
lem with very cyclical businesses. How do themselves accordingly, being opportunis- individual projects you can better under-
you define quality? tic at low points in order to reap the ben- stand the company's value and take ad-
efits when times are good. vantage when the market isn’t recognizing
WG: High-quality companies have strong With respect to their businesses, both it. When they start selling more than they
balance sheets, earn high returns on capi- companies should benefit as global popu- buy – which is starting to happen now –
tal through the cycle, and have people lation growth and higher average income the underlying value tends to surface.
running them who allocate capital intel- levels increase secular demand for afford-
ligently and whose incentives are fully able protein like that from chicken and, You own GameStop [GME], the video-
aligned with shareholders. even more so, eggs. But in terms of the game retailer, which has certainly had
But I’m also trying to buy at an attrac- market for the stocks, the sell side hates its share of naysayers. Has your patience
tive absolute valuation, which means a cap them because quarterly earnings are im- been tested there?
rate – our estimate of a company’s nor- possible to predict, and investors gener-
malized operating earnings divided by its ally dislike the random things that can WG: It has. This is also something I’ve
enterprise value – in the low- to mid-teens. happen. Just earlier this month Sander- owned on and off for a long time and to-
Those moments of weakness aren’t always son’s stock was off 13% on the day it an- day there is a well-articulated case that
a function of cycles, but basic cyclicality nounced missing earnings estimates by 20 this will be in video games what Block-
that you can understand is very often a cents a share. The principal reason was buster was in movies, which is kaput as
source of mispricing. Cycles are difficult due to hurricanes in the U.S. that knocked everyone accesses games online.
for many investors to deal with because out production long enough for the birds I can’t make the case that the bears
they often create short-term disappoint- to get fatter, increasing supply on the mar- have it all wrong, but I do believe that

with the stock trading at 5.4x consensus physical gold.) While I very much believe Do any of your gold stocks stand out as
earnings for this year and at an 8.4% in having the hard-asset exposure, because particularly compelling today?
dividend yield, there’s quite a bit more op- of the unpredictability in the sector and
tionality on the upside than the downside. the fact that extractive businesses aren’t WG: Given my approach in holding a bas-
Management has been very clever in how that capital-efficient through the cycle, I ket, I wouldn’t put one or two over the
they handle real estate and in building out generally don’t own more than 2% in any rest. I would maybe point out, however,
complementary businesses in used games one name. I’m also highly unlikely to take that Franco-Nevada [FNV] and Randgold
and equipment, in collectibles, and in sales the overall portfolio exposure past 15%. Resources [GOLD] are unique in that
and service outlets for Apple and AT&T their shares have outperformed the price
products. The company’s loyalty program of gold reasonably significantly going as
is first-rate, on par with something like ON GOLD: far back as 2000. That’s rare, and would
Amazon Prime. I also don’t believe people explain why their stocks are somewhat ex-
Think of it as a less expen-
understand how much content is in video pensive relative to peers at the moment.
games, making them a chore to download, sive alternative investment But that’s probably where I’d go first if
and the loyalty that gamers show for tra- providing a hedge against there were a correction in metals prices.
ditional gaming platforms and equipment.
One thing that worries me is why man- things not going perfectly. In general, are you finding enough to do in
agement hasn’t taken the company pri- today’s market?
vate by now. I probably should be buying
more, but I’m just finding it too hard to What’s your take on the cycle in the gold- WG: I would normally at this stage in a
get the level of conviction that would re- mining sector today? bull market have to be in the weeds with
quire. This is certainly not something for micro-cap stocks to find attractive-enough
the faint of heart. WG: I actually think we’re in a bit of a valuations. But the market seems more
sweet spot. The bear market in gold and bifurcated, with values still showing up
You’ve long been active in precious metals, precious metals exposed a great deal of across the capitalization spectrum. The
probably even more so now that you’re at malinvestment, resulting in a significant valuation of Apple [AAPL] is not chal-
Sprott. Describe why. number of management teams being re- lenging. Western Digital [WDC] trades at
moved and replaced. There is capital 6x this year’s earnings. I can’t make sense
WG: I’ve been using precious metals and discipline in the business now and prob- of those valuations any more than I can at
mining stocks in the Focus Trust portfolio ably even some underinvestment in de- the other end with something like Tesla or
since 1999, and probably have 10% of my velopment. If interest in precious metals Amazon.
personal net worth in physical gold or re- increases, mining companies’ leverage to I mentioned looking to buy when nor-
lated investments. Physical gold in partic- higher prices is far greater than it would malized operating-earnings yields are in
ular I consider a great diversifier over the have been three years ago. the low- to mid-teens. On the other side,
long term because it moves differently at I’m looking to sell when those cap rates
different times from stocks and other as- Most precious-metals investors have scars get closer to 8%, which is typically when
sets. Think of it as a simple, less expensive from ideas gone wrong. One of those for a stock is attracting the kind of crowd
alternative investment, providing a hedge you was Allied Nevada Gold, which went that makes me want to be near the door.
against things not going as perfectly as ev- under in 2015. Lessons? One advantage of having done this for a
eryone expects. long time is that you already know a lot
There’s also a hard-assets angle to my WG: This was a company pursuing diffi- of companies, know where you’d buy and
interest. Developed countries have too cult but potentially lucrative development, where you’d sell, and can just wait for Mr.
much debt to ultimately service or pay with highly promotional management Market to throw you opportunities from
back, but rather than default, the likely that seemed quite credible at the time. time to time. Even with overall valua-
path will be to debase currencies. Gold is a The problem very often turns out to be tions stretched, that usually happens often
way to protect against that and profit from deceitful management, compounded by a enough to keep me busy.
it. There are other things going on with balance sheet that can’t withstand it when Another thing I’ve noticed that’s dif-
cryptocurrencies that are rather scary, but the deceit results in too much cost and not ferent at this stage in the bull market is
this same phenomenon is expressing itself enough revenue. That’s nothing new – if that the companies I own have tended to
today in the excitement over them. you’ve ever invested in gold miners, you be investing rather than hoarding capital.
Around 13% of Sprott Focus Trust's know that’s what can go wrong. Unfor- At the margin they’re looking to enhance
portfolio today is in miners, spread over tunately, knowing it doesn’t guarantee it their businesses while others have been
nine or 10 stocks. (The fund can’t own can’t still happen. more focused on paying dividends and

buying back stock. I don’t know exactly held steady through the fiscal year ending I do believe, however, that the pen-
how to read that, but I generally take it as in September. dulum will swing back in favor of active
a positive sign when well-run companies strategies. The objective of most active
are investing rather than retreating. Is this mostly a bet that active money managers is to reduce risk, and in bull
management has a brighter future than markets reduced risk means reduced re-
You’ve said you typically average in and many expect? turns. The underperformance compounds
average out of positions. Why? with the length of the bull market, espe-
WG: The passive story has been quite well cially when stocks are highly correlated as
WG: It reflects the fact that I generally told and has become a bit of a momentum they have been in recent years. It’s a toxic
don’t believe I have enough clarity to trade. Growth of passively managed assets recipe that has led to the most pronounced
make whole-position decisions all at once. becomes self-fulfilling. Assets flowing into backlash against active managers in his-
For example, Westlake Chemical [WLK] ETFs and index funds inflates stock prices tory. The latest backlash has been partic-
is a long-term holding that has done very and reinforces the perceived efficacy of ularly acute, but this is not the first time
well and has been hitting valuation tar- passive vehicles, which begets more pas- active managers have come under fire. In
gets. I’ll acknowledge when that happens sive flows. the late 1990s when tech stocks were all
and start selling in 5-10% intervals, but I
will also go back and revisit if I’m miss-
INVESTMENT SNAPSHOT
ing something the market seems to think
it knows. I don’t kid myself that I can reli- Franklin Resources Valuation Metrics
(NYSE: BEN)
ably bottom-tick or top-tick anything. (@12/29/17):
Business: One of the world’s largest invest- BEN S&P 500
Explain your broader investment thesis for ment managers, with around $750 billion in P/E (TTM) 14.4 21.8
assets invested primarily in actively managed Forward P/E (Est.) 14.3 20.0
asset manager Franklin Resources [BEN].
stock, bond and alternative-asset funds.
Largest Institutional Owners
WG: Asset management is an industry Share Information (@12/29/17): (@9/30/17):
I understand well and have invested in Price 43.33 Company % Owned
throughout my career. I like that you get 52-Week Range 39.32 – 47.65 Vanguard Group 4.8%
operating leverage without the financial Dividend Yield 2.1% State Street 3.3%
leverage that’s typical of other businesses Market Cap $24.00 billion Massachusetts Fin Services 3.2%
in the financial services industry such as BlackRock 2.6%
Financials (TTM): Highfields Capital 2.0%
banks and insurance companies. A well- Revenue $6.39 billion
managed company like Franklin generates Operating Profit Margin 35.4% Short Interest (as of 12/15/17):
high operating margins and high returns Net Profit Margin 26.5% Shares Short/Float 2.8%
on capital because it requires little capital
BEN PRICE HISTORY
to operate.
The firm manages about $750 billion in
mostly actively managed stock, bond and
alternative-asset strategies. The Johnson
family owns nearly 40% of the shares and
manages the business responsibly for all
owners, returning much of the company’s
cash flow to shareholders through stock
repurchases, quarterly dividends and the
occasional special dividend.
The shares are cheap in my opinion be-
cause assets under management have de-
clined more than 15% since 2014, mostly THE BOTTOM LINE
due to the current popularity of compet- Whitney George believes the market is assuming the company's mostly actively managed
ing passive strategies but also the result assets "will be flat or down forever." If he's right that active managers return to favor and
the company's diverse portfolio of funds again shows solid growth, the shares at an 8%
of underperformance in some of its large
cap rate on estimated operating earnings, plus net cash, would be worth around $68.
funds. This trend has stabilized, and with
the company enjoying strong performance
Sources: Company reports, other publicly available information
across much of its product line, flows have

the rage and the market was very risky, Franklin, Pason has operating leverage age multiple projects from their air-con-
active managers were similarly unpopu- without the financial leverage. ditioned offices. Another product moni-
lar. Redemption ultimately came with a The company isn’t that well known, tors gas levels from the drill bit in order
bear market, as I believe it will again this trading in Canada with a market cap of to keep it in the sweet spot of long, hori-
time. When stock prices begin to decline, about C$1.5 billion. But it’s the dominant zontal resource formations. The company
the poor performance of passive strategies market leader in what it does, which is even installs electronics at the drill site
will also become self-fulfilling. Investors provide technology and electronics that so workers can e-mail their spouses and
will pile out of indexes the same way they collect, manage and analyze oil and gas watch Netflix when they aren't working.
piled in, but probably twice as fast. drilling data that is used to help opti- Pason has roughly 90% market share
Franklin’s diversity of assets, the de- mize performance of drilling operations. in Canada and has captured 65% of the
risking nature of active management, For example, their primary product is an U.S. market since entering it ten years
and the relative outperformance of ac- electronic recorder that monitors wear ago. The hardware is installed on the rig
tive strategies in our envisioned scenario and tear on drills and pumps, collecting by the original equipment manufacturer
should protect and ultimately enhance its and transmitting data via satellite back to and generally remains in use over the rig’s
business. We don’t believe the stock today geophysicists who can monitor and man- life, providing a strong barrier to competi-
adequately reflects that.
INVESTMENT SNAPSHOT
How inexpensive do you consider the
stock at a recent $43.30? Pason Systems Valuation Metrics
(Toronto: PSI) (@12/29/17):
WG: The shares currently trade at about Business: Develops and services technol- PSI S&P 500
14.5x the $3 per share the company ogy systems that collect, manage and analyze P/E (TTM) 133.7 21.8
oil and gas drilling data that is used to help Forward P/E (Est.) 33.1 20.0
earned in its 2017 fiscal year, but if you
optimize performance of drilling operations.
net out $18 per share of cash on the bal- Largest Institutional Owners
ance sheet, that earnings multiple falls to Share Information (@12/29/17): (@9/30/17 or latest filing):
8.4x. We think at these levels investors are Price C$18.19 Company % Owned
ascribing a value to assets under manage- 52-Week Range C$16.65 – C$22.36 Burgundy Asset Mgmt 10.0%
ment that they think will be flat or down Dividend Yield 3.7% Caisse de Depot du Quebec 8.4%
forever. We don’t think that’s going to be Market Cap C$1.55 billion Royce & Assoc 7.4%
the case and if we’re right, the company Neuberger Berman Inv Mgmt 6.3%
Financials (TTM): Fidelity Mgmt & Research 4.2%
will grow again and investors will eventu- Revenue C$228.2 million
ally value it differently. Operating Profit Margin 14.5% Short Interest (as of 12/15/17):
Franklin in rosier times has traded at Net Profit Margin 5.0% Shares Short/Float n/a
an 8% cap rate on operating earnings,
PSI PRICE HISTORY
which is not far from where many peers
that don’t have all the excess cash trade
today. At an 8% cap rate, plus the cash,
the shares would be worth closer to $68.
It won’t be a straight line, especially if
there’s a market break of some kind, but
we believe the value will be there.
Oilfield specialist Pason Systems [Toron-

to: PSI] is certainly not a household name.
What attracted you to it?
WG: As a contrarian, I'm interested in the THE BOTTOM LINE

energy sector when it has just underper- A dominant market leader in a niche energy-services sector, the company should prosper
formed. That is the case now, as it was in as North American rig counts continue to rebound after a precipitous fall since 2014,
says Whitney George. If the shares earn what he considers a warranted 8% cap rate on
2003 when I first invested in Pason. In en-
operating income that is 80% of its prior peak, the stock would trade at around C$30.
ergy, I prefer the far better balance sheets
of service companies over exploration and
production firms. As I mentioned with

tion. I also believe Pason's risk of techno- short order. That would very likely have son’s voice while canceling out surround-
logical obsolescence is limited because of to be done at a premium to my C$30 price ing noise. For Apple to let the company
their commitment to R&D, on which they target. earn 50% gross margins, it must be do-
spend C$30 million annually and which ing something special. Real estate in these
occupies 25% of the workforce. What do you think investors are missing phones comes at a premium and Cirrus
in Apple supplier Cirrus Logic [CRUS]? has proved very good at adding capability
How has the company weathered the en- while reducing power used and the space
ergy recession? WG: Cirrus develops semiconductors that required.
convert sound from analog to digital, and We think the shares are discounted be-
WG: It’s actually quite resilient. Revenues their chips have long been found in the cause Apple accounts for about 75% of
fell nearly 70% from peak to trough in the highest-fidelity sound systems. The driver revenues and it doesn’t allow Cirrus to
latest cycle, but it has maintained positive of their business in recent years has been discuss the product or business pipeline,
cash flow due both to a flexible operat- Apple, which uses what’s called sound- leaving analysts more or less in the dark
ing model and the cushion of operating vectoring technology developed by Cirrus about future earnings. As a result, the
margins that in good times are as high as that allows a microphone to capture a per- stock typically reflects little more than the
50%. The balance sheet is also rock solid,
with nearly C$160 million in net cash.
INVESTMENT SNAPSHOT
What do you think the shares, now Cirrus Logic Valuation Metrics
(Nasdaq: CRUS)
C$18.20, are more reasonably worth? (@12/29/17):
Business: Develops and sells semiconduc- CRUS S&P 500
WG: Revenues here are a function of the tors for audio applications used in smart- P/E (TTM) 12.7 21.8
phones, automotive entertainment systems, Forward P/E (Est.) 10.7 20.0
rig count and of the number of products
security devices and digital-assistant devices.
per rig that clients use. The North Ameri- Largest Institutional Owners
can rig count fell from about 2,300 in Share Information (@12/29/17): (@9/30/17):
2014 to less than 500 last year, and has re- Price 51.86 Company % Owned
covered to just over 1,100. That rebound 52-Week Range 48.61 – 71.97 Vanguard Group 10.4%
in the rig count has had a nicely positive Dividend Yield 0.0% BlackRock 9.8%
effect on Pason’s revenues and operating Market Cap $3.30 billion Fidelity Mgmt & Research 5.4%
profits, but the shares have only modestly LSV Asset Mgmt 5.0%
Financials (TTM): AQR Capital 4.3%
recovered. Revenue $1.60 billion
If operating income gets back to 80% Operating Profit Margin 20.8% Short Interest (as of 12/15/17):
of the C$260 million the company earned Net Profit Margin 17.1% Shares Short/Float 8.7%
at the peak of the last cycle, at an 8%
CRUS PRICE HISTORY
cap rate that implies a per-share value of
around C$30. I don’t think that valua-
tion would be unreasonable at all, given
the company’s market share, profitability
and potential to grow in markets outside
North America and by continuing to pro-
vide additional services that increase rev-
enue per rig.
Is this eventually an attractive takeover

candidate?
WG: I think the size of the market – Pa- THE BOTTOM LINE
son’s revenues peaked at C$500 million The market's apparent concern about overreliance on large-customer Apple gives the
– has kept it from attracting much com- company little credit for either continuing to expand its Apple business or for broaden-
ing the market for its technology, says Whitney George. Applying a 12.5x multiple to
petition and allowed it to gain a big head
estimated forward operating income, plus net cash, he values the shares at around $82.
start. If its market does attract the interest
of other big energy services firms, I would
expect Pason to be acquired in pretty

I N V E S T O R I N S I G H T : Tom Olsen
quarter just reported and the concern that WG: It’s quite straightforward. Excluding Sprott Focus Trust [FUND] trades at a
the company’s dramatic increase in earn- $5 per share in net cash, the stock trades 12% discount to net asset value. Why, and
ings power over the last couple of years at a 13% cap rate on the $400 million of are you trying to do anything about it?
isn’t sustainable. operating income the company should
We disagree with that consensus view. earn in its fiscal year ending next March. WG: The premium or discount of the typi-
Apple used around $5 of Cirrus’ content Again, we’d argue both based on history cal closed-end fund, for better or worse, at
in the latest iPhone cycle, up from $2 in and on the quality and prospects of the least partly reflects the popularity of the
the previous one, and used another $1 of business that the stock will deserve an 8% underlying concept. When we acquired
content in the latest AirPods. So it’s not Focus Trust in 1996 it traded at a 20%
pre-ordained that the Apple business is discount. In June 2007 it was at a 12.5%
going to decline. At the same time, Cirrus ON PERMANENT CAPITAL: premium. After I left Royce, it traded back
continues to broaden its market beyond down to an 18% discount. That’s come in
Apple. Through an acquisition, it now
The closed-end fund is a
a bit, but as you say, it’s still around 12%.
provides similar technology for Android- great platform to manage The closed-end fund is a great plat-
based phones, giving it content today in form to manage money because the crowd
money; the crowd doesn't
all of the top-five mobile devices. The doesn’t have to affect your investing. You
company’s technology also enables voice have to affect your investing. have a stable capital base, so you’re not
interaction used in Internet of Things ap- flooded with capital when you don’t need
plications that will increasingly be found it or losing capital when you do. That’s a
in things like automobiles, security sys- cap rate, which after adding the net cash tremendous advantage over an open-end
tems and smart-home systems. Artificial would value the shares at around $82. mutual fund, with which I also have sig-
intelligence should be another growth I’d add here that Cirrus, especially nificant experience.
market – sound technology is necessary given the current valuation, would also That said, I don't intend to sit here with
for Apple’s Siri and Amazon’s Alexa to make an attractive acquisition candidate. a large discount to NAV. Nearly 25% of
recognize voices, and Cirrus’s chips are a The engineering talent to develop this type the capital in the fund is my own, and it
premium option. of technology is a scarce commodity, so it wouldn’t make sense to leave it chronical-
would likely be cheaper and more effec- ly undervalued. We can tell our story bet-
Walk through how you're assessing fair tive for a competitor or customer to buy ter, but in the end to shrink the discount
value for the stock, which now trades Cirrus outright than to try to develop the I’m going to have to perform. That tends
around $51.90. same technology on its own. to heal all wounds in this business. VII
Investor Insight: Tom Olsen

Tom Olsen of European money manager Mensarius explains the three types of situations that tend to attract his interest,
his detailed research process meant “to identify and avoid the risks we are able to avoid,” his general view on the oppor-
tunity set in Europe and the U.K., and why he sees mispriced value in Salvatore Ferragamo, Ericsson and Landis + Gyr.
You’ve said that your investments typi- Not so long ago, for example, we markets. But starting in 2015 and accel-
cally fall into three general categories. De- bought Viscofan [Madrid: VIS], which erating in 2016 the shares took a hit for
scribe what they are and maybe provide a is a Spanish company that is the world’s more macro reasons, including economic
current example. largest producer of artificial casings for concerns in emerging markets and some
processed meat production – in other foreign-currency issues. We saw that as a
Tom Olsen: The first would be a com- words, sausage making. It also makes the wonderful time to buy an interesting long-
pany that earns high returns on invested machinery to process meat. The company term franchise. [Note: As high as €60 in
capital that we’re able to buy at an attrac- over a long period of time has consistently April 2015, Viscofan shares fell below €43
tive valuation relative to its own history. built its global franchise, exploiting its a year ago. They currently trade at €55.]
These may be in somewhat shorter supply scale and expertise in a way that com- The second category of company we
today, but for a number of reasons even petitors have been unable to do. It also find interesting is the quality cyclical com-
these companies can find their shares out benefits from growth in meat consump- pany with a competitive edge that we try
of favor. tion as wealth levels increase in emerging to buy close to the trough of the cycle.

Here as a current example I’d use Frank’s a strategic plan that is meant to refocus ably well and would have been doing
International [FI], which is incorporated and simplify the company and emphasize much better if not for heavy and what
in Holland but is largely a U.S. operation. value creation over growth at all costs. we concluded were smart investments in
The company provides highly engineered The elements of the plan are clear and its own digital capabilities. Our ultimate
well casings that keep oil and gas wells we can monitor carefully the results. If interpretation is that Publicis will actu-
from collapsing after the hole is drilled. the earnings power is sustainably improv- ally maintain its competitive moat and en-
It’s the market leader in an oligopolistic ing as we believe, then the gap we see to hance its earnings power due to its ability
market, and has an outstanding long-term fair value should continue to close. [Note: to offer broad-based, independent and ef-
track record under three or four genera- Having fallen below €50 in the summer ficient marketing strategies for clients who
tions of family control. of last year, Boss shares currently trade at are looking to get the most out of their
The problem, of course, is that there’s just under €71.] spending. This has maybe some elements
so little drilling activity today in offshore of each of the three types of ideas we typi-
environments, where most of the business cally pursue.
is. We don’t believe that’s a permanent ON TURNAROUNDS:
condition and that deepwater drilling will Once you've identified something as inter-
We're less interested if just
again provide a competitive – and neces- esting, describe your research process.
sary – source of oil to meet rising demand. the need for a turnaround
Given the strength of its market position TO: We have defined a seven-step due
is obvious, but rather when
and its balance sheet, we expect Frank’s diligence process which provides a struc-
franchise and normalized profitability to there's also a path defined. ture that is meant to insure we don’t miss
be fully intact when demand returns. If anything important and which is appli-
we’re right, there should be considerable cable across industries and companies. I
upside in the stock from today’s level. How do you tend to unearth these types could go into considerable detail on each,
[Note: Frank’s went public in 2013 at of ideas? but the first step is a background check,
$22 per share and the stock went above where we study the company’s history and
$30 later that year. It currently trades at TO: Our universe consists primarily of current ownership structure with the goal
around $6.75.] European stocks with market capitaliza- to assess the risk of potential shareholder
Our third main category of investment tions above €500 million and with daily abuse and poor stewardship of capital.
would be restructuring companies that trading volumes of at least €2 million. Out The second step is analysis of the finan-
we believe are increasing their earnings of that, we generate roughly two-thirds cial statements, where we build a detailed
power. We aren’t so interested in situa- of our ideas from proprietary in-house financial model, making adjustments to
tions where just the need for a turnaround screens that are designed to identify com- the reported numbers as necessary to ar-
is obvious, but rather when there is also a panies with returns on capital in excess of rive at the true cash-generating ability of
clear path defined to improve the business. their costs of capital, good profit margins, the company going forward, which drives
We’ll talk later about the case of Salvatore low financial risk and with stocks priced our estimate of intrinsic value. Here also
Ferragamo [Milan: SFER], but another at attractive valuations. we assess how aggressive or conservative
similar restructuring example we own is While our screens catch many of the the accounting is – aggressive accounting
Hugo Boss [Xetra: BOSS]. The company high-return-on-invested-capital and cycli- to us is always a clear warning signal.
in terms of returns had done quite well cal-recovery cases, most of our restructur- Informing our quantitative assessment
over time, but under the influence of a ing cases and various other ideas generally of the business, our third through sixth
private equity investor in recent years the come from external sources, including in- due-diligence steps include assessments
brand was stretched beyond its capability. dustry contacts and referrals. of the industry structure, value chain,
They aggressively expanded retail stores. Our interest in Publicis [Paris: PUB], product lifecycles and external operating
They expanded into new price points in one of the top-four global advertising- environment. This would include a “Five
men’s suits. They spent disproportionately agency companies, started with one of our Forces” analysis as described by Michael
on marketing a women’s line that made analysts hearing company management at Porter to assess competitive advantage,
up only 10% of sales. All that led to dis- a conference talking about the global ad- which is obviously essential in evaluating
appointing results and the stock price fell vertising business and how the company the strength and sustainability of the fran-
60% from its peak. was positioning itself in it. As we looked chise. I would highlight the importance
We got involved when the CEO was into it further, we found an industry that of these particular steps. When I look at
replaced, the Marzotto family that had was out of favor due to concerns about the mistakes that we've made, it has often
owned 7% of the stock upped its stake to the ongoing shift from analog to digital, been because we didn’t fully understand
10%, and the new management presented but the company was still doing reason- the competitive dynamics of the industry

and the impact of external factors over Are you optimistic or pessimistic about
which the company cannot exercise con- prospects for the U.K.?
trol, or we didn’t anticipate how easily
such things might change. TO: The country is dangerously divided
Finally, in the seventh step of our due over Brexit. The central problem seems
diligence, we want to understand the mo- to be that the hard Brexiters view it as an
tivations of the management team. While opportunity to be seized, while for those
experience and track record from previous in charge of implementing Brexit it is a
positions are important, we also want to bomb that should be defused. Meanwhile,
meet with management to gain any insight the Labour party has been taken over by
we can not only on strategy and execu- the most leftist leadership since before the
tion, but also on the extent of their focus Thatcher era. This makes the Brexit nego-
on maximizing long-term shareholder re- tiations very difficult and uncertain. All
turns. In the end, few franchises are viable of that has been a drag on the economy,
long term and probably none will serve which is clearly slowing down.
the best interests of shareholders if man- I still have to believe that the Euro-
agement is incapable, untrustworthy or pean Union and the U.K. actually have
acting more in their own interest rather an interest in finding a reasonable resolu-
than in the interest of shareholders. tion to the problem, but no deal or a bad
Value investing to me provides a struc- deal would clearly hurt the U.K. and its
tured and systematic framework for ap- companies more than it would the EU.
proaching an investment. I personally Is all the uncertainty creating investment
don’t understand why not more people opportunity? Maybe, but we believe it
use such an approach. We’re trying in our might be too early to pursue them. We’re
research and analysis to do everything we strongly underweighted in U.K. stocks at
can to identify and avoid the risks we are the moment.
able to avoid. We think that goes a long
way to having success as an investor. Describe in more detail the “restructur- BRAINSTORM
How would you characterize today's in-
ing” upside potential you see for Salvatore
Ferragamo.
WITH THE BEST
vestment opportunity set in Europe?
TO: The company, still 58% owned by
TO: Valuations in Europe aren’t fantasti- the Ferragamo family, produces and sells Through in-depth interviews,
cally low, but they are not overly stretched luxury clothing, shoes, leather goods, Value Investor Insight
either. On a relative basis, certainly to the watches, perfumes and jewelry. Its prod-
spotlights the strategies and
U.S., things look pretty okay. ucts are sold in more than 90 countries
I would say for the first time since through around 690 company-owned current ideas of today’s
the financial crisis we see a synchronized stores as well as high-end department most-successful investors.
economic recovery, both in Europe and stores. The brand remains well respected
globally. Germany has been strong and re- after nearly 100 years and the business has
mains the locomotive of Europe. Spain is generally been highly profitable, earning See why it’s one of the
improving. Even Italy, despite reforms not 20% returns on invested capital. best “value” investments
taking place as one might hope, is expe- After a decade of investing in its global you can make!
riencing a recovery. One important thing retail footprint, the company is imple-
to watch is France, where President Ma- menting a new strategic plan meant to
cron is implementing reforms that people rejuvenate the brand and improve retail- Sign up now for a
have talked about for decades but never store productivity. That involves things
accomplished. I would say that could be like increasing marketing spending,
one-year subscription
a positive surprise, if France can join Ger- spending money on store refurbishment,
many as a locomotive and help provide a reducing the number of SKUs, investing
broader foundation for economic growth. in information technology, and bringing
The jury is still out, but I would argue in a new generation of designers to ac-
that’s not an unlikely possibility. celerate new-product innovation. All that

is currently weighing on revenue growth August of 2016, Eraldo Poletto, consid- unique brands and closely integrated
and margins, but is intended longer-term ers himself a retailer first, and comes to manufacturing and distribution networks.
to drive annual revenues beyond €2 bil- the company after an impressive tenure As is the case with LVMH, Ferragamo is
lion and increase operating margins, now running handbag maker Furla. His track highly unlikely to jeopardize its brand eq-
around 18%, into the low-20s. record and the fact that the controlling uity for short-term gain.
family is still actively involved gives us
Is there risk that Ferragamo experiences confidence that anything they do will be The shares, now at €22.15, are off more
the same type of growth pains that hurt true to the brand and in the long-term in- than 25% from earlier this year. What up-
Hugo Boss? terest of shareholders. side do you see from here?
I’d argue that a better comparison
TO: We think that risk is low. Hugo Boss would be between Ferragamo and LVMH. TO: As the strategic plan bears fruit, we
opened too many new stores, lost focus Each has key product lines, such as shoes expect a combination of overall GDP
and essentially diluted its brand. Ferraga- and leather goods, which are less exposed growth, increasing disposable incomes
mo’s strategy is a more deliberate expan- to fashion risks and shifting consumer and improved market shares to drive 5%
sion and revitalization. The CEO since tastes. They both have long traditions, annual revenue growth over the next five
years. With operating leverage, improved
retail productivity and a more favorable
INVESTMENT SNAPSHOT
sales mix, we expect operating margins
Salvatore Ferragamo Valuation Metrics over that time to reach 23%. Applying a
(Milan: SFER) (@12/29/17): 16.7x multiple to our five-year operating-
Business: Global design, marketing and sale SFER S&P 500 profit estimate – effectively capitalizing at
of luxury branded footwear, apparel, leather P/E (TTM) 21.7 21.8 6% – adjusting for options dilution and
goods and other related products through Forward P/E (Est.) 24.9 20.0 subtracting a small amount of net debt,
company-owned and third-party retail stores.
Largest Institutional Owners we arrive at a five-year price target in the
Share Information (@9/30/17 or latest filing): high 30’s.
(@12/29/17, Exchange Rate: $1 = €0.83):
Company % Owned
Price €22.15 Allianz Global Inv 1.7% From luxury goods to telecommunication
52-Week Range €20.42 – €29.88 OppenheimerFunds 1.5% equipment, describe your investment case
Dividend Yield 1.8% Norges Bank 1.2% for Ericsson [Stockholm: ERICB].
Market Cap €3.74 billion Mensarius 1.0%
Keva 0.8%
Financials (TTM): TO: Ericsson is the world’s largest manu-
Revenue €1.43 billion Short Interest (as of 12/15/17): facturer, with a roughly 35% global mar-
Operating Profit Margin 18.1% Shares Short/Float n/a ket share, of telecommunications equip-
Net Profit Margin 14.1%
ment. Its equipment carries 40% of the
SFER PRICE HISTORY world’s mobile traffic and serves custom-
ers in 180 countries. The business model
is typically to sell the network equipment
at cost and then make money on service
contracts and software upgrades over the
equipment’s lifecycle.
This became a fairly lousy business
more than a decade ago when the network
infrastructure industry was disrupted by
the entrance of the Chinese company Hua-
wei, which used its support by the Chinese
government to aggressively undercut com-
THE BOTTOM LINE petitors on price. While Ericsson’s core
Tom Olsen believes that the company's new focus on revitalizing its brand and improving business impacted by that has stabilized,
retail-store productivity can over the next five years drive 5% annual revenue growth and the company has been very slow to re-
an increase in operating margins to 23%. At 16.7x his five-year operating profit estimate, structure itself as aggressively as it needs
adjusted for options dilution and net debt, the stock would trade in the high-$30s. to, primarily due to political pressure in
its home market of Sweden, where it is a
major employer.

The impetus for our interest came in we think is a long-overdue and necessary Can Ericsson compete long term against
April, when the chief investment officer of cost-cutting and restructuring plan. Huawei?
one of the company's major shareholders,
Industrivärden, publicly expressed deep What are the key elements of the plan?
TO: There are really only three large play-
dissatisfaction with the company's devel- ers left in the industry, Ericsson, Huawei
opment. As we started to buy, so did Cevi- TO: It’s really a full overhaul of the busi- and Nokia, which bought Alcatel-Lucent
an Capital, one of Europe’s largest activist ness, focused not only on improving the last year. Huawei will continue to offer
investors, which now has a 7.9% stake and profitability of the network-equipment the lowest equipment prices, but upfront
has been agitating for change. The CEO and support businesses, but also on shut- purchase cost is only one of many consid-
was replaced earlier this year and the cur- ting down or selling big loss-making busi- erations that go into vendor selection. We
rent chairman will be replaced early next nesses focused on the media, information- believe Ericsson can compete on product
year by Ronnie Leten, the former CEO of technology and cloud industries. The quality, service and responsiveness, giv-
industrial-equipment manufacturer Atlas ultimate goal is to increase overall adjusting wireless-service customers – who have
Copco. He will work with the new CEO, ed operating margins (excluding restruc- a strong incentive to ensure that all three
Börje Ekholm, to finally implement what turing charges) from 6% to 12% by 2019. competitors stay in business – a perfectly
viable option that is cost-effective over the
life of the relationship.
INVESTMENT SNAPSHOT
Political issues will also continue to
Ericsson Valuation Metrics play a role, to the benefit of Ericsson. It’s
(Stockholm: ERICB)
(@12/29/17): highly unlikely, for example, that Huawei
Business: Manufacture and sale of network would set up large portions of the U.S.
ERICB S&P 500
telecommunications equipment and related
P/E (TTM) n/a 21.8 or European carrier networks, given the
services to wireless and fixed network opera-
Forward P/E (Est.) 30.8 20.0 perceived exposure to Chinese espionage.
tors located in more than 180 countries.
That’s an additional reason we expect
Largest Institutional Owners
Share Information (@9/30/17 or latest filing): long-term industry market shares to re-
(@12/29/17, Exchange Rate: $1 = SEK 8.24):
Company % Owned main fairly stable.
Price SEK 53.85 Cevian Capital 7.9%
52-Week Range SEK 43.75 – SEK 64.95 Swedbank AB 4.8% Does the wireless upgrade cycle to 5G
Dividend Yield 1.9% Dodge & Cox 3.8% technology impact your thesis?
Market Cap SEK 176.56 billion BlackRock 3.5%
Financials (TTM): AMF Fonder 2.9% TO: Some analysts expect there to be a
Revenue SEK 209.32 billion “land-grab” competition for 5G contracts
Short Interest (as of 12/15/17):
Operating Profit Margin 3.0% that will depress margins for equipment
Shares Short/Float n/a
Net Profit Margin (-8.6%)
providers. For the reasons already men-
ERICB PRICE HISTORY tioned, we don’t think that’s likely and
that market shares in 5G won’t be mark-
edly different.
There is, however, legitimate concern
that 5G’s inherent modularity will allow
wireless carriers to gradually upgrade
their networks over an extended time pe-
riod. This is why we’re actually modeling
negative revenue growth for Ericsson over
the next three years, followed by 2-3%
annual growth thereafter. Management's
forecasts are higher, but we prefer to be
THE BOTTOM LINE more conservative.
"The time has come to believe that things can get better," says Tom Olsen, as the com-
pany implements an overdue, broad-based overhaul of its business with the goal of dou- Ericsson shares at a recent 53.85 Swedish
bling operating margins to 12% by 2019. If it gets halfway there, he believes the stock at kronor have been cut in half from their
16.7x his earnings-power estimate of SEK 6 per share could be worth at least SEK 90. highs of three years ago. If the restructur-
ing succeeds, how could that impact the
stock price?

TO: After years of disappointing results, turing, it will take time and will likely be
age their power supply, production and
it’s not surprising that the market is skep- a bumpy ride. distribution. It has the #1 position in the
tical about the company's prospects for U.S. and Asia, and is #2 in Europe.
improvement. But we think the time has Tell us about your interest in electric- The business generally has significant
come to believe that things can get better. metering company Landis + Gyr [Switzer- economies of scale and high customer
Assuming operating margins get to 9%, land: LAND]. switching costs. In markets like the U.S.,
halfway to management’s goal, we think where regulation is more homogenous
the company’s earnings power three to five TO: The company, which has a 120-year and supportive of investment in new tech-
years out will be around 6 Swedish kronor history, was spun out of Toshiba and be- nology, Landis + Gyr earns 20% or so on
per share. Capitalizing that at 6% – or as- gan trading publicly in August of 2017. invested capital. The company does less
suming a multiple of 16.7x – and adding Based in Switzerland, it is the world leader well in Europe and Asia, where regula-
back net cash, we believe the shares on in smart electric meters and integrated en- tion differs from country to country and
that earnings power could be worth 90 to ergy-management systems, used by some regulators have been slower to approve
95 kronor per share. As with any restruc- 3,500 electric utilities worldwide to man- investments in the network-connected
smart meters and systems the company
sells. That’s improving somewhat in Eu-
INVESTMENT SNAPSHOT
rope, but we’re only counting on around
Landis + Gyr Group Valuation Metrics 14% ROICs there. Asia is further behind,
(Switzerland: LAND) (@12/29/17): which has dampened profitability, and for
Business: Develops, manufactures and sells ERICB S&P 500 the purposes of our valuation we’re not
smart electric meter technology and inte- P/E (TTM) n/a 21.8 assuming much improvement.
grated energy-management systems used by Forward P/E (Est.) 17.7 20.0
some 3,500 electric utilities worldwide.
Largest Institutional Owners Is this a growth business?
Share Information (@9/30/17 or latest filing):
(@12/29/17, Exchange Rate: $1 = CHF 0.97):
Company % Owned TO: The rollout of smart meters to re-
Price CHF 77.60 Kirkbi A/S 3.4% place traditional meter technology still
52-Week Range CHF 65.00 – CHF 79.50 Franklin Templeton 3.0% has a long runway ahead. We don’t expect
Dividend Yield 0.0% Norges Bank 2.8% the U.S. market to show signs of satura-
Market Cap CHF 2.29 billion BlackRock 2.7%
tion until around 2025, and it will be
UBS 2.3%
Financials (FY2017): much later than that in Europe and Asia.
Revenue CHF 1.64 billion Short Interest (as of 12/15/17): As grids get “smarter,” the company also
Operating Profit Margin 3.3% Shares Short/Float n/a has considerable potential to grow its soft-
Net Profit Margin (-3.8%)
ware and services businesses, which now
LAND PRICE HISTORY account for 16% of sales.
How inexpensive do you consider the

shares at a recent price of 77.50 Swiss
francs?
TO: The key inputs in our model are or-

ganic revenue growth of 5% annually over
the next five years, 20% EBITDA margins
in the U.S. and 8% EBITDA margins in
Europe. This would result five years’ out
in adjusted operating earnings per share of
THE BOTTOM LINE around 7.50 Swiss francs per share. Capi-
The company has a long runway of stable growth ahead as electric utilities slowly up- talizing that at 6% – again, a multiple of
grade their infrastructures with its energy-saving technology, says Tom Olsen. Assuming 16.7x – and subtracting net debt, we think
organic annual revenue growth of 5%, improving margins in Europe and a 6% cap rate on the shares can be worth 110 to 115 Swiss
operating earnings, he believes the shares five years' out can be worth at least CHF 110. francs per share.
Are you a frequent investor in spinoffs?

I N V E S T O R I N S I G H T : Richard Cook
TO: Investing in spinoff situations is not Wrapping up, how vibrant overall do you that the existence of uncertainty or risk
a theme we regularly play. In this case, the find Europe's value-investing community? is one of the fundamental ingredients for
core of the investment thesis is that Lan- generating good investment returns. Suc-
dis + Gyr is underearning its potential in TO: There are certainly some of us, but I cessful value investors focus on managing
Europe and we believe that will improve. think as is the case everywhere that a dis- risk, not avoiding it.
What is probably more related to the spi- ciplined value investing approach can be Humans also find comfort in consen-
noff is that the company doesn’t appear counter-intuitive to human nature. “Inves- sus, providing confirmation for what they
very well known to investors. That could tors do not like uncertainty” seems to be say and do. Value investors have to resist
certainly help explain why the potential the mantra among most financial experts that, which is difficult. But it’s also neces-
that we see isn’t being recognized by the and market participants. But, of course, sary if you actually want to make money
market. we and most value investors would say in the stock market. VII
Investor Insight: Richard Cook

Cook & Bynum Capital Management’s Richard Cook describes what’s behind the unusual composition of his portfolio,
why he’s spending so much time in emerging markets, one key “error in psychological misjudgment” he guards against,
and why he sees underappreciated potential in Anheuser-Busch InBev, Coca-Cola Embonor and Corporación Lindley.
You have a rather odd portfolio, with Give representative historical examples of emerging-market Coca-Cola bottlers. The
eight stocks and including both the bluest both the “unloved” and “undiscovered.” first one we bought was Arca Continental
of blue chips and companies we’ve never [Mexico City: AC], the best-performing
heard of. How does that come together? RC: Two in the unloved category would be position we’ve ever had. Arca’s primary
Wal-Mart [WMT] and Microsoft [MSFT]. business is bottling Coke products in
Richard Cook: We have a broad man- We paid 11x earnings for Wal-Mart in northern Mexico, Ecuador, Peru (through
date, which is to find good businesses, April of 2010 at a time when the market its controlling stake in Corporación Lind-
anywhere, of any size and in any indus- seemed to think it could do no right and ley), northern Argentina and, in a recent
try. But the ideas must be in our circle of Amazon could do no wrong. The obses- expansion to the U.S., Texas, Oklahoma,
competence, which for us means that we sion with Amazon was fair, but at 11x New Mexico and Arkansas.
can see the prospects of the business far earnings we only had to expect that Wal- We first got interested in the business
enough into the future to get our money Mart could continue to get a few things more than ten years ago. Coca-Cola is the
back. If you pay 15x earnings for some- right in order to grow earnings modestly top-selling carbonated soft drink in nearly
thing, you’re implicitly saying you know over the next ten years and deliver us a every market in the world, creating scale
about enough years in the future that the better-than-10% return on our money. advantages for the company’s bottlers,
investment will pay off. In addition to that We started buying Microsoft in 2011, each of whom have discrete territories. We
we have an absolute-value orientation; we when you could hardly pick up The Wall found scale to be especially important in
explicitly project cash flows in perpetu- Street Journal without reading about how places like Latin America, where beverage
ity and then use the current share price irrelevant it was becoming and how com- distribution is very fragmented with infor-
to solve for our expected annual rate of panies like Apple and Google were going mal, mom-and-pop retailers accounting
return. We don’t assume some greater fool to leave it in the dust. But the stock was for well over half of the individual mar-
will later buy the shares from us at a better at less than 8x earnings if you backed out kets. Bottlers who execute at the point of
valuation. In the current interest rate envi- cash, which basically meant they could sale – and we think Arca is the best in the
ronment, our expected annualized return put the business in runoff mode and we’d world on that front – can sell their prod-
has to be at least 10%. easily get our money back. We thought ucts at premium prices and still maintain
Only a few opportunities meet the crite- the Enterprise and Office businesses were over 70% market shares.
ria of investing in things we can know well stickier than the market recognized and Even with those advantages, when we
enough and that meet our expected-return had earnings power that warranted much first invested in Arca in 2008 the company
hurdle. As for the types of businesses that better than a 7.5x multiple. Any upside was growing earnings in the double-digits
end up in the portfolio, our strategy gener- from things like shipping better consumer and had net debt of less than one year’s
ally leads us to companies that are either products and building out the cloud busi- EBITDA, but the stock was trading at 7x
unloved or undiscovered. That’s why we ness were tremendous free call options. earnings and a 9% dividend yield. That is
have positions in both well-known and In the undiscovered category I’d put not the profile of a well-understood stock.
not-so-well-known companies. what you’ll see as our great interest in It’s still one of our largest positions.

What’s your current take on Coca-Cola You're often on the road looking for op- RC: It’s true that 10 or 15 years ago a Uni-
[KO] itself, also one of your top holdings? portunity in emerging markets. Why are lever, Procter & Gamble or Nestlé could
you taking that path? plant a flag in a foreign country and take
RC: We bought the shares in the depths of market share because people understood
the 2008 crisis when they selling at only RC: With respect first to getting out of the they had higher-quality products. I would
12x earnings. We bought it well, but I office, we believe in immersive research. If argue that’s much less the case today, when
would say we’ve been rather frustrated by you want to authentically underwrite a we’re seeing more sophisticated local
the speed at which the company has taken business, you need to understand the ac- competitors make it much more difficult
advantage of the opportunities we think it tual interactions that happen between that for Western brands to establish themselves
has to improve the business. business and its customers. You have to in a market and take share. That’s inform-
The global growth story is still intact: know suppliers. You have to know coming our views both on the challenges fac-
In countries with between $5,000 and petitors. You have to see how the company ing some multinationals and on the local
$20,000 in annual per-capita GDP, people is set up to repeatedly satisfy its customers opportunities we uncover in our research
start switching to ready-to-drink bever- outside the U.S.
ages, meaning anything pre-packaged in a
can or bottle. A lot of the world isn’t yet to ON EMERGING MARKETS: On the subject of big multinationals, you
$5,000 in per-capita GDP and most of the appear to have concluded Anheuser-Busch
We're seeing more sophisti-
world earns less than $20,000, so as that InBev [BUD] is a long-term winner. Ex-
changes Coke should be in a good posi- cated local competitors make plain why.
tion to benefit for quite some time. it difficult for Western brands
In developed markets, there is a clear RC: This is a position we started building
need for the company to innovate beyond to establish themselves. in March of this year. The company is the
carbonated soft drinks sweetened with world’s largest brewer, with an estimat-
sugar. Management is aware of that, but ed 28% global market share and a wide
we’d argue there needs to be a bigger cul- and whether it’s doing so. That means you range of brands, including Budweiser, Co-
tural shift toward being a broad-based, have to be out in the market. rona, Stella Artois, Brahma, Castle and
marketing/distribution business with less This quarter we’ve been to the Philip- Goose Island. It was formed by combining
bureaucracy. We hear terrific things from pines, Indonesia, Chile, Mexico and Bra- four major brewers – AmBev, Anheuser-
bottlers about new CEO James Quincy on zil, in addition to traveling in the U.S. Part Busch, Interbrew and SABMiller – and is
this front, and we’ve seen some evidence of our interest in emerging markets has controlled by a consortium of families led
that he is pushing management decision- to do with demographic tailwinds. It re- by the founders of 3G Capital.
making to local market experts and is ally matters to the growth you can expect The big story here for us is that we
willing to explore new product categories. if you have a young working population believe AB InBev has among the best de-
At the current valuation we’re willing to and improving governance and financial mographic footprints in the world, and
see how things develop, but it’s fair to say systems that encourage capital formation it is the best on-the-ground at execu-
our patience won’t be unlimited. and business enterprise. tion. Something on the order of 60% of
I’d add here that, unlike many inves- Beyond that, Charlie Munger talks revenues are now generated in emerging
tors, we don’t tend to look at everything about a secret to success in life being weak markets, and it’s not unusual in countries
through the filter of what the Chief Finan- competition. There are a lot of really – particularly in South America and Africa
cial Officer would do to make things bet- smart people, including the entire private – for AB InBev brands to have 80%-plus
ter. For Microsoft, it wasn’t about how to equity industry, trolling around every U.S. market shares. Even in a country like Chi-
perfectly lever the balance sheet; the com- company. But if you do work in non-BRIC na, as difficult as it can be for foreigners,
pany just needed to consistently provide countries and you have value-investing the company is the largest foreign brewer
better and more relevant products and skills, we think you can have a competitive with a 19% market share.
services. The same thing is true of Coke. advantage. It’s not easy, but there’s more We can talk about the craft-beer phe-
It’s not about what they do to the divi- mystery in developing markets, and where nomenon in developed markets, but in
dend or how they should save their way to there’s mystery there’s potential profit. developing markets craft brews have lim-
prosperity. It’s about providing more and ited opportunities. Small breweries simply
better products that meet the needs and Many global-minded investors have ar- cannot get distribution in the markets in
wants of consumers. Whether they can do gued that it’s better to capitalize on devel- which AB InBev has dominant share. In
that or not is ultimately what’s going to oping-market growth through big Western addition, high-end beers aren’t something
matter, especially over our time frame in companies with strong brands and unique consumers pay for in countries with low
evaluating the company’s progress. expertise. Would you agree? per-capita GDP. In Africa, for example,

40% of beer is still non-commercially they drink. Bud Light has been a primary years many will have gone away and it
produced. So AB InBev’s growth potential casualty of that trend, and the inability will be a much more consolidated segment
comes from attracting an emerging global of management to stem the decline in the of the industry.
middle class to its value-priced brands that brand led recently to the head of the U.S.
come in a can or bottle. No other brewer business being replaced. Is it all fixable? I With the ADR trading at a recent $111.50,
comes close to benefitting as much from don’t know, but I do think the company how are you looking at valuation?
that shift over time. has embraced the craft beer trend well, as-
RC: In general, we think the problems
sembling a portfolio in the U.S. – including
Are the company’s market-share problems brands like Goose Island and Blue Point with the legacy brands are overshadowing
fixable in places like the U.S.? – that is growing faster than the craft cat-
the underlying strength in emerging mar-
egory overall. That speaks to AB InBev’s kets. Current earnings also don’t reflect
RC: For decades consumers’ beer prefer- distribution strength in the U.S., which the full $3.2 billion of annual cost syner-
ences were very static, but now roughly I wouldn’t underestimate as an asset. I’d gies the company expects from the SAB-
one-third of U.S. beer drinkers say they also mention that many craft brewers are Miller deal over the next couple of years.
want to try a different beer every time not profitable, and we suspect that in ten When we take into account revenue and
cost synergies still available, normaliza-
tion in depressed markets like Brazil and
INVESTMENT SNAPSHOT
Argentina, and general emerging-markets
Anheuser-Busch InBev Valuation Metrics volume and pricing growth, we believe
(NYSE ADR: BUD) (@12/29/17): earnings can grow at a mid- to high-sin-
Business: World’s largest beer producer, BUD S&P 500 gle-digit annual rate. At the same time, at
with 60% of sales generated in emerging P/E (TTM) 41.6 21.8 the current share price the yield on our
markets. Brands include Budweiser, Bud Forward P/E (Est.) 21.8 20.0 estimate of normalized owner earnings –
Light, Michelob, Corona and Stella Artois.
Largest Institutional Owners calculated as normalized operating cash
Share Information (@12/29/17): (@9/30/17): flow less maintenance capex – is about
Price 111.56 Company % Owned 5%. The sum of the two approximates the
52-Week Range 103.55 – 126.50 Soroban Capital 10.9% low-double-digit annual return we expect
Dividend Yield 3.6% Franklin Resources 5.2% on the stock over the long term.
Market Cap $216.68 billion Fisher Asset Mgmt 4.8% There will also continue to be oppor-
ClearBridge Inv 4.2% tunities for management to create value
Financials (TTM): Bank of America 4.1%
Revenue $56.05 billion through acquisitions. To give just one ex-
Operating Profit Margin 29.9% Short Interest (as of 12/15/17): ample, the largest and third-largest brew-
Net Profit Margin 9.6% Shares Short/Float n/a ers in Vietnam are state-owned and are
slated to be privatized. AB InBev would be
BUD PRICE HISTORY a natural buyer.
Do you think there’s any credibility to the

rumors that AB InBev would try to merge
with Coca-Cola?
RC: There would be many operational,

financial, cultural and regulatory hurdles
to overcome, but from a purely business
perspective, the global distribution advan-
tages of combining these businesses would
be incredible. It would obviously depend
THE BOTTOM LINE on the price, but in theory the potential
Richard Cook believes the challenges facing the company in developed markets inap- for value creation from such a deal would
propriately overshadow its business strength in emerging markets. Adding his estimates be pretty high.
of annual earnings growth and the stock's current earnings yield on normalized owner
earnings, he expects to earn a low-double-digit annual return on the stock over time.
Coming back to Coca-Cola bottlers, de-
scribe your investment case for Coca-Cola
Embonor [Santiago: EMBONOB].

RC: Based in Chile, this Coke bottler

INVESTMENT SNAPSHOT
serves two primary markets, the country
of Bolivia and most of Chile outside of the Coca-Cola Embonor Valuation Metrics
(Santiago: EMBONOR-B) (@12/29/17):
greater Santiago area. Chile is the wealthi-
est and most business-friendly country in Business: Produces, distributes and markets EMBONOR S&P 500
carbonated soft drinks, bottled water, energy P/E (TTM) 24.8 21.8
Latin America, which supports the stabil-
drinks and fruit juices in Chile and Bolivia under Forward P/E (Est.) 19.9 20.0
ity of Embonor’s business there, but per- a license with The Coca-Cola Company.
capita income is already relatively high at Largest Institutional Owners
$14,000 per year so the volume growth Share Information (@9/30/17 or latest filing):
(@12/29/17, Exchange Rate: $1 = 605 Chilean Pesos):
potential isn’t that high. That’s not the Company % Owned
case in Bolivia, which has per-capita in- Price CLP 1,710 Compass Group Chile 9.9%
come of about $3,000 per year and where 52-Week Range CLP 1,300 – CLP 1,800 Moneda Administradora 8.9%
Dividend Yield 1.4% BICE Inversiones 6.8%
the company’s business has been growing
Market Cap CLP 826.09 billion BTG Pactual Chile 5.1%
at double-digit rates. Bolivia is now the
Banchile Administradora 3.0%
bigger market of the two for Embonor, Financials (TTM):
which has a better than 80% market share Revenue CLP 545.16 billion Short Interest (as of 12/15/17):
in the country. Operating Profit Margin 12.3% Shares Short/Float n/a
Are changing consumer tastes away from EMBONOR-B PRICE HISTORY

sweet, carbonated sodas an issue in coun-
tries like these?
RC: The trend is far more pronounced

in the U.S. This may sound strange, but
consumers in low-income countries often
think of Coke as a valuable part of their
diet, a source of energy. That said, some
Latin American governments are impos-
ing sugar taxes, which has prompted the
bottlers to test reformulated products. For
example, Coca-Cola Embonor in Chile is THE BOTTOM LINE
testing formulations of Fanta and Sprite Driven by long-term volume growth in Bolivia and by the pricing and operating leverage
with 30-40% less sugar. If those work, enjoyed by Coca-Cola bottlers, Richard Cook believes the company can increase earn-
margins would improve because sugar – ings at a high-single-digit rate for at least ten years. From the current share price he ex-
the bottlers’ second-highest cost – is re- pects that to translate into a low-double-digit annual investment return over that period.
placed by cheaper artificial sweeteners. It
would also improve sales volumes, as the
cost to the consumer goes down without
the sugar tax. earnings annually at a high-single-digit ating the proliferation of best practices.
rate for at least ten years. Add to that the That’s potentially another way for share-
The company’s shares appear somewhat current 4% yield on owner earnings and holders to win.
more volatile than the underlying busi- here too we’re expecting a low-double-
ness. How attractive are they at today’s digit annual return over the long term. Is the thesis similar for Peruvian Coca-
1,710 Chilean pesos? That’s a more-than-fair return given what Cola bottler Corporación Lindley [Lima:
we believe is a narrow range of possible CORLINI1]?
RC: The shares rose 20% or so recently outcomes.
in response to what was perceived to be a While we like the business as a stand- RC: We started following Corporación
positive outcome in the Chilean presiden- alone and wouldn’t anticipate a sale any Lindley four years ago and were interested
tial election, but we still think they offer time soon, Embonor is probably the most both in the demographic backdrop in the
an attractive return. Driven by long-term attractive acquisition candidate in the Lat- Peruvian market and the opportunities we
volume growth in Bolivia and the inherent in American Coke system. Consolidation saw for a market-share leader to improve
pricing and operating leverage in the busi- makes a lot of sense in a business like this, point-of-sale execution, capital allocation
ness, we think the company can increase reinforcing scale advantages and acceler- and corporate governance. What held us

back from investing was a lack of confi- ing the same economic interest and right costs, insurance expenses and spending on
dence that the controlling Lindley family to dividends as Arca’s shares, don’t have information technology. Looking ahead,
could take advantage of the opportunities voting rights. Given our long relationship we think EBITDA can grow over the next
we saw. with Arca, that didn’t matter to us. three to five years by 50%, driven by an-
That changed in late 2015 when Arca nual volume growth of 4-5%, low-single-
Continental announced that it was buy- How’s it going so far? digit annual price increases, and per-unit
ing the Lindley family’s controlling stake cost improvement from better manage-
and planned to implement a series of op- RC: Arca is doing exactly what they said ment and more-efficient production.
erational improvements that promised to they’d do. They’re overhauling and in-
increase the sales and profitability of the vesting in point-of-sale execution to drive Is Lindley’s relatively leveraged balance
business. To us it was a terrific match of a revenue gains. They have materially im- sheet a concern?
superior management team with great as- proved customer service and materially
sets in a growth market. We were also able reduced delivery costs. They’ve also takenRC: Net debt to EBITDA is nearly 4x,
to buy in at less than half the valuation out costs by using Arca’s economies of which is much higher than the 1x-or-less
Arca paid because our shares, while hav- scale to lower things like raw-materials ratio Arca Continental would prefer. One
reason for the elevated leverage is debt
taken on from the recent construction of a
INVESTMENT SNAPSHOT
state-of-the-art production facility located
Corporación Lindley Valuation Metrics 50 kilometers south of Lima. With that
(Lima: CORLINI1) (@12/29/17): major capital expense behind them, we
Business: Production, marketing and sale of COROLINI1 S&P 500 would expect a steady pay down of debt
Inca Kola, Peru’s top soft drink, and produc- P/E (TTM) 16.6 21.8 through consistent cash-flow generation
tion and distribution of packaged beverages Forward P/E (Est.) 14.0 20.0 going forward.
in Peru under a license with Coca-Cola.
Largest Owners
Share Information (@9/30/17 or latest filing): The shares, recently trading at around
(@12/29/17, Exchange Rate: $1 = 3.2 Peruvian Soles):
Company % Owned 4.10 Peruvian soles, appear to be quite il-
Price 4.08 Soles Arca Continental 57.0% liquid. Is that a worry?
52-Week Range 2.85 Soles – 4.10 Soles
Coca-Cola Co. 34.0%
Dividend Yield 0.0% RC: We are the third-largest shareholder,
Cook & Bynum 2.5%
Market Cap 2.67 billion Soles
behind Arca and Coca-Cola, and the next
Financials (TTM): Short Interest (as of 12/15/17): two largest owners are Chilean families
Revenue 2.76 billion Soles Shares Short/Float n/a with whom we have relationships. In
Operating Profit Margin 10.8% general, we believe one of the other large
owners would be a reliable source of li-
CORLINI1 PRICE HISTORY quidity for us, but we think the shares sig-
nificantly undervalue the earnings power
of the assets in place and expect to hold
on for a long time as the value is realized.
As Warren Buffett has written, "Only buy
something that you'd be perfectly happy
to hold if the market shut down for 10
years." We feel that way about Lindley.
How are you assessing fair value?
RC: If we're right that owner earnings

THE BOTTOM LINE grow and debt is paid down as we expect,
Now under the control of much-larger and better-run Latin American Coca-Cola bottler we believe the fair value is at least double
Arca Continental, the company is improving its point-of-sale execution, customer service the current share price.
and operating efficiency, says Richard Cook. He believes EBITDA can grow over the next
three to five years by 50%, and that that can translate into a doubling of the share price. Your portfolio doesn’t have a lot of posi-
tions to sell, but have you sold anything
Sources: Cook & Bynum, company reports, other publicly available information
recently and, if so, why?

RC: We’ve been reducing our position in nore or misinterpret information that con- We actually made a little money, but had
Microsoft, which is a function of valua- tradicts what they have come to believe. we fallen in love with the original thesis
tion. Today you can hardly pick up the That’s obviously dangerous for investors, and pooh-poohed the contrary evidence,
Journal without reading about how great so we try to be as explicit up front as we it would have been a big mistake.
its Enterprise business is, or how it’s mak- can about identifying the things that if
ing wonderful inroads in the cloud, or they went wrong we would rethink why You’ve been adding to your analyst team.
how smart Satya Nadella is. As Buffett we own the stock. What are some of things you're looking
says, “You pay a high price for a cheery I’ll give you an example. We like a lot for in people to hire?
consensus.” of value investors five or six years ago
We also in our private partnership very bought Tesco, the British retailer that RC: The primary thing is we want people
recently sold our entire position in Wal- was losing market share and margin in its with integrity both in how they conduct
Mart. I talked earlier about how in 2010 home market because it had ill prepared themselves and in how they understand
we thought the market’s expectations for new competition, primarily from dis- information and data. We want analysts
were overly negative, but while it’s taken count grocery chains Aldi and Lidl from who are willing to say “I don’t know”
a while, the strength in the share price has Germany. Our thesis was that if it could whenever that is true. Intellectual dishon-
made that no longer the case. Especially improve the in-store experience, that esty is quite detrimental to successful in-
given the ongoing challenges facing retail- would stabilize the ship enough for us to vestment research.
ers, we just didn’t think we had enough make money on shares for which we only Curiosity and a love of learning are
margin of safety to hold it. had to pay 8x earnings. also important to us. Investing has been
In this case the keys were, first, that called the last liberal art, which I really
You’ve written in the context of selling they could improve the in-store experi- believe. In that spirit, we want people who
about the importance for investors to bat- ence, and second, that it would make a are thinking about a broad range of things
tle “consistency bias.” Describe what you difference. So we knew exactly what to and how they all work together, and they
mean by that. look for that would confirm or disprove need to be willing to work really hard to
our thesis. After 18 months it was be- figure things out. Hopefully every now
RC: Even highly accomplished value in- coming clear that the in-store experience and then all that helps us predict the fu-
vestors struggle with the tendency to ig- wasn’t really getting better, so we got out. ture a little bit better than average. VII
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A F R E S H L O O K : Fiat Chrysler/Ferrari
A High-Class Problem
Value investors are very often not as adept as they would like at letting their winners run. ADW Capital’s Adam
Wyden explains why he’s not planning to let that happen with portfolio holdings Fiat Chrysler and Ferrari.
As the bull market continues to run, Having obviously tapped into some- You’re at such a structural disadvantage
many value investors find their portfolios thing he’s been thinking a lot about, he as an investor every time you sell some-
filled with highly appreciated stocks that continues: “If you’re an investor in my thing you know very well to go and buy
present a bit of a dilemma. The compa- fund would you want me to tell you I’m something that you don’t know as well. If
nies and their shares are likely hitting or selling something like Fiat Chrysler that you think you can continue to compound
exceeding expectations, so it’s difficult I know extremely well, that has best-in- your pre-tax dollar with people who are
to jump out now, especially when table- class insider ownership and that has a well aligned with you and your interests,
pounding alternatives may be scarce. On stock I think can still at least double from the bar is extraordinarily high to sell.”
the other hand, value investors – always here, because I want to take money off With respect to Fiat Chrysler, whose
worrying about what can go wrong – can the table so I can invest in something else? stock now trades around $17.85, Wyden
get edgy sitting on large gains and feel
compelled to take at least some money off
INVESTMENT SNAPSHOT
the table. What to do? Admittedly, it’s a
high-class problem to have. Fiat Chrysler Ferrari
Adam Wyden of ADW Capital faces (NYSE: FCAU) (NYSE: RACE)
just such a happy dilemma with each of Business: Global vehicle and component Business: Designs, develops, manufactures
the four “focus” ideas he discussed in his manufacturer; brands include Jeep, RAM, and sells luxury performance sports cars and
Chrysler, Fiat, Alfa Romeo and Maserati. engines under the Ferrari brand name.
interview earlier this year [VII, March 31,
2017]. The shares of laundry-equipment Share Information (@12/29/17): Share Information (@12/29/17):
company EnviroStar are up nearly 110%
Price 17.84 Price 104.84
since the issue appeared. Fiat Chrysler 52-Week Range 9.01 – 18.56 52-Week Range 57.56 – 121.14
stock is up 63%, while its newly public Dividend Yield 0.0% Dividend Yield 0.6%
spinoff, Ferrari, has increased 41%. Ca- Market Cap $27.48 billion Market Cap $19.81 billion
nadian restaurateur Imvescor Restaurant
Valuation Metrics (@12/29/17): Valuation Metrics (@12/29/17):
Group just this month received a takeover
FCAU S&P 500 RACE S&P 500
offer that Wyden has publicly argued is
P/E (TTM) 7.5 21.8 P/E (TTM) 32.8 21.8
too low, but the stock is still 33% higher Forward P/E (Est.) 5.6 20.0 Forward P/E (Est.) 29.1 20.0
than it was nine months ago.
Prompted for an update on his think-
ing about Fiat Chrysler and Ferrari,
Wyden first offered some deeper perspec-
tive on his approach to selling: “As I’ve
gained experience, I’d say I’m increasingly
trying to get into assets that I don’t have
to sell,” he says. “It’s much better to buy
something that’s growing, run by people
who allocate capital effectively and make
decisions in real-time that are fully aligned
with all shareholders. If you overpay by
two multiple turns but the assets are grow-
VII, March 31, 2017 VII, March 31, 2017
ing and there are people allocating capital
effectively, it’s just a timing issue around THE BOTTOM LINE THE BOTTOM LINE
when you get paid. As Charlie Munger Because the impact of its transformation Were the market to better underwrite the
and the value-unlocking levers it still has to company's still-robust profit growth poten-
says, it’s not about the timing, it’s about
pull have yet to be fully recognized by the tial from here, on his 2018 earnings esti-
getting it right. What kills you is not miss- market, Adam Wyden has maintained his mates Adam Wyden believes the shares
ing something by a year or two, it’s miss- position in the company's shares. would more reasonably trade around $180.
ing something completely and suffering a
permanent capital loss.”

A F R E S H L O O K : Fiat Chrysler/Ferrari
contends that the impact of the company’s actions alone could unlock value worth Lamborghini are selling their SUVs, for
transformation has yet to be fully recog- the current market value of the entire example, he thinks a Ferrari SUV could
nized by the market. Its five-year strategic company, leaving the Jeep, RAM, Chrys- generate $1.2 billion in annual revenue
plan announced in 2014 has revamped ler and Dodge businesses as pure upside. and close to $1 billion in annual EBITDA
the product mix away from low-margin While he doesn’t see the logic in Fiat re- relatively soon after launch. He also sees
small cars toward more lucrative sales of sponding to the expressed interest by considerable potential in increasing sales
Jeep SUVs, Chrysler minivans and RAM China’s Great Wall Motor in buying only of Ferrari-made engines to sister brands
trucks. With much of the transformation- the Jeep brand – I can see why they would Maserati and Alfa Romeo.
related manufacturing and product-devel- want Jeep," he says, "but not why [CEO] Even before some of those longer-term
opment investments behind it, he says, the Sergio Marchionne would be interested in upsides kick in, at the luxury-brand 20x
company in 2018 is poised to deliver on its selling it to them" – he does see additional multiple of EBITDA on an enterprise
plan, which calls for the generation of $5 upside optionality from a potential play value basis Wyden believes the company
to $6 in earnings per share and free cash for the entire company by a larger global deserves on the above-consensus $1.7 bil-
flow that would translate into a 30%-plus competitor like Volkswagen or GM. lion in EBITDA he thinks it can earn in
free-cash-flow yield on today’s equity. With Ferrari, his thesis that the com- 2018, the shares would trade at around
Beyond that, the company has addi- pany has erred too far on the side of limit- $180. That’s still a cool 70% premium to
tional value levers to pull. Fiat manage- ing supply relative to burgeoning demand today’s stock price. Bolstering his long-
ment has made clear its intention to spin remains intact, and he expects it going term case for the company is his belief
off its Magneti Marelli automotive-com- forward to respond by raising production that while Sergio Marchionne plans to
ponents business, which generates around levels, increasing prices and broadening step aside from Fiat Chrysler at the end of
€8.5 billion in annual sales, and is also the product line to include SUVs and addi- next year, he would expect Marchionne to
likely to spin or merge its Maserati and tional “supercars” – all without the need remain very actively involved with Ferrari.
Alfa Romeo units after their own strate- for heavy incremental capital spending. “I think it’s his swan song,” says Wyden,
gic transformations are complete. Doing Based on the prices and volumes at which “and that’s likely to be a truly wonderful
“caveman math,” Wyden believes those other ultra-luxury brands like Bentley and thing for shareholders.” VII
"In this treasure chest of quotes by proven money managers, it is the love of the game and
the joy of meeting the challenges put forth by a very demanding business that captivated
me. The lessons are like scars and they are revealed here firsthand.”
Jeff Ubben, ValueAct Capital
“A must-read for any serious investor. John and Whitney have produced a veritable bible
that reveals the secrets of some of the greatest contemporary investment minds in the
world.”
Jonathon Jacobson, Highfields Capital Management
“I often judge a book by how many times I get my highlighter out and dog-ear pages. On
that metric, this book is wonderful – simply packed with insight from some of the best
long-term investors. Everyone will learn something from this book.”
James Montier, GMO

S T R A T E G Y : Robert Vinall
What I Am Doing Differently

European investment manager Robert Vinall in this recent memo describes how even as a tried-and-true value inves-
tor he has had to consistently challenge once-fundamental aspects of his strategy to avoid being left behind.
Editor's Note: Switzerland-based invest- maturity and the current level of cash flow makes them unattractive to capital market
ment manager Robert Vinall has trounced might be expected to continue indefinitely. participants with shorter time horizons
the market since launching his Business Still others may have negative cash flow and "catalyst-driven" investment strate-
Owner TGV hedge fund in 2008, but like today as they invest to build growing cash gies (the majority).
all successful investors he aggressively flows in the future. Third, it requires thoughtful analysis
fights the temptation to rest on his laurels. At an appropriate price, each of these and thorough due diligence to figure out
The most recent evidence of that comes companies can be considered value invest- which companies are positioning them-
from a memo he prepared for a mid-No- ments. Whilst an undervaluation of the selves correctly for an uncertain future,
vember meeting of the Munich Value In- former two will likely go hand-in-hand versus simply looking up on Bloomberg
vestors Group, in which he thoughtfully what the current multiple of next year's
describes “Five Things I Am Doing Differ- earnings is.
ently Today vs. Five Years Ago,” and why. ON "VALUE": My aim as a value investor is to put
The full memo below is shared with his capital to work in whichever type of com-
I thought only a stock trading
permission. pany offers the most value, i.e. the highest
on a low multiple of earnings present value of future cash flow. Admit-
A t Amazon, employees must present

their ideas in prose (PowerPoint is
banned!). Jeff Bezos thinks prose enforces
was consistent with a value
approach. This is absurd.
tedly, I derive more satisfaction from own-
ing stakes in businesses that invest in fu-
ture growth. Also, it is difficult to envisage
greater intellectual discipline than string- a scenario where mature businesses are
ing together bullet points in a presenta- the most mispriced given the prevalence
tion. Far be it from me to contradict the with a low multiple, the multiple of the of short-term thinking and the ubiquity of
great man, so I wrote this memo and cir- latter will probably be high and even nega- market data. But if this is where the value
culated it prior to the meeting. After the tive. This has no bearing on whether it is is, I stand ready to pivot.
meeting, I refined the memo to reflect cheap or not – only the size and the du-
some of the great points that came up in ration of future cash flows relative to the Invest in "Technology"
the discussion. price can tell you that.
In recent years, I have come to appreci- I started investing in technology stocks in
Be more open-minded about what ate that the latter type of company pro- 2012 when I took the plunge and bought
constitutes a value investment vides a far more fertile ground for finding a stake in Google (now Alphabet). This
undervalued investments. This was a dif- too was a difficult transition to make. My
All businesses are worth the cash that ficult transition for me to make, as clearly investing hero, Warren Buffett, is famous
they generate between now and eternity, some value investors believe that member- for only "investing in what he under-
discounted at an appropriate rate. An ex- ship of the guild is contingent upon only stands." Historically, this meant avoid-
pensive business is one that trades at a pre- ever paying low multiples. Having made ing the "tech" sector. The wisdom of this
mium to the present value of its cash flow, the transition, I think it is obvious why it approach was spectacularly vindicated in
and a cheap business is one that trades makes sense. the dot-com crash in the early 2000s. I
at a discount. This is an a priori propo- First, companies in investment mode sometimes allow myself a wry smile when
sition that presumably all value investors have historically been ignored by value people ask why they should pay me to in-
can agree upon. For a long time though, I investors, by far the most thoughtful co- vest in Alphabet when they can just do it
thought that only a company whose stock hort of capital market participants. As themselves. Trust me, it was not an easy
traded on a low multiple of next year's discussed, this is most likely due to the decision at the time.
earnings was consistent with a value in- above-average multiples such companies From today's perspective, the invest-
vesting approach. command. ment decision was correct, not because
This is absurd. The path that differ- Second, investing in this type of com- Alphabet's share price subsequently went
ent companies' cash generation takes can pany requires a longer time horizon as it up, but because it is now clear that Alpha-
vary enormously. Some businesses may only becomes apparent after a few years bet and many other tech companies were
have outlived their useful purpose and be whether investment in new products, ex- moving into the thoughtful generalist's
in liquidation. Others may have reached panded salesforces, etc. bears fruit. This circle of competence.

Historically, value investors eschewed pany than a tech company, and as such you have a company that can crush the
the tech sector because it was too fast- not so different from some of his famous competition, it is desirable to have a com-
moving. Today's hot, new technology was investments of yore. petition to, well, crush.
likely to be replaced by something better a The conclusion is clear: Our interpreta- Third, it strikes me that the best time
few years down the line. It was the invest- tion of what is within and what is beyond to invest in businesses is before the moat
ing equivalent of a teeny fashion brand. our circle of competence must continue to is fully formed, provided of course there
For the long-term investor basing an in- evolve over time. Nobody demonstrates is sufficient evidence available that the
vestment decision on cash generation 20 this better than Buffett. I wonder which moat will one day be formed. This is the
or more years into the future, the sector period when the market's reassessment of
was un-investable. the company's cash-flow-generating abil-
Clearly, companies like Alphabet or ON TECHNOLOGY: ity will be most dramatic.
Amazon or Apple are far too entrenched This decision to focus more on the di-
Change brought by techno-
in our modern, Internet-driven economy rection than the absolute width of a moat
to be considered un-investable for the logical shifts is fundamentally was closely connected to my growing
above reason. In fact, I would argue that it changing the economic basis interest in the tech sector. Clearly, many
is the traditional media companies and re- mature businesses that have historically
tailers that seem to be moving outside the of nearly every business. been considered wide moat – fast-moving,
generalist's circle of competence. Anyone branded consumer goods companies, for
who claims to have a better understanding example – are seeing their moats steadily
of the future of a traditional department previously taboo sectors will soon fall un- eroded. Parallel to this, many tech compa-
store than of Amazon is, in my view, being der the purview of the value investor. Bio- nies' moats are growing – especially those
disingenuous. tech, perhaps? that benefit from a network effect. No
I frequently hear some members of prizes for guessing which ones have been
the value investing community complain Pay more attention to the direction, and will continue to be the better invest-
that "value investing no longer seems to not the width of the moat ments for the long-term investor!
work." In my view, paying less than some-
thing is worth – the essence of value in- For a long time, I thought the wider the Make management the criterion, not a
vesting – will always work until the laws moat the better. All things being equal, criterion
of mathematics are repealed. I guess what what is there not to like about a wide
these investors may mean is that pay- moat? I have changed my mind on this in Partnering with the right management has
ing low multiples for mature, apparently at least three respects. always been central to how I manage Busi-
"easy-to-understand" businesses no lon- First, it strikes me that the direction of ness Owner. One of just four questions I
ger seems to work. a moat is, broadly speaking, more impor- ask of every investment is "Does the man-
Is it any wonder? The change brought tant than the width of a moat. If you are agement possess honesty and integrity?",
about by the Internet, mobile and, soon, planning on investing in a business for a a question which was recently reformulat-
AI (just to name three major technologi- long time, then it is far more important ed to "Does the management set the right
cal shifts) is fundamentally changing the to know whether the competition is clos- example?" Despite this, even I underesti-
economic basis of nearly every established ing in on you as opposed to the absolute mated the importance of management.
business (just ask the owner of a taxi me- width of the moat. Companies with wide Whilst I have always been enthusiastic
dallion). A refusal to engage intellectually moats are insulated to a considerable ex- about finding a great management, the
with these changes not only means that tent from competition and this tends to main thrust of my research was uncovering
you miss out on the investment opportuni- make them less responsive to potential and subsequently avoiding the dishonest
ties they throw up, but it blinds you to the competitive threats. A wide moat com- managers. Having convinced myself I had
fundamental changes taking place at every pany is like a soccer team that only gets to done this, other factors took centre stage
"easy-to-understand" business. play friendlies. in the investment process, in particular the
To his enormous credit, Buffett ac- Second, the problem with wide moat strength of the competitive advantage and
knowledged at this year's shareholder businesses is that market shares are not the near-term valuation. Today, I will hap-
meeting that Google was well within his up for grabs. The whole point of a wide pily trade a higher multiple of short-term
circle of competence. He too has made his moat is that market entry is exceedingly earnings or a narrower moat for managers
first investments in the tech sector, most difficult. This, of course, has certain ad- that I feel a genuine enthusiasm for.
notably in Apple. Interestingly, he views vantages, but the big disadvantage is that I do this not because I am looking to
Apple more as the modern-day incarna- a great management has only limited op- sacrifice returns for a better social life, but
tion of a branded consumer goods com- portunity to demonstrate its worth. When because I expect this approach to result

in greater long-term cash generation and and dishonest, it is rational for the capital as negative feedback from activists when
hence performance. It is difficult to quan- market to take a pessimistic view of the they drift off-piste. If a manager decides
tify how much, but that does not make the size and timing of the business' future cash to sacrifice near-term earnings to capture
value creation any less real. flows. If the activist replaces the manage- a larger opportunity further down the
For example, in the last financial crisis, ment with a better one, it is rational for road, it is vital that the long-term owners
Wolfgang Grenke and his then CFO, Uwe the capital market to raise its estimate of are more vociferous in their approval than
Hack, bought a bank at a fire-sale price. future cash flows, leaving the activist with holders with shorter time horizons are in
It was a great deal as Grenke gained a a handsome and deserved return. their opprobrium.
deposit-taking capability and could sub- My only problem with activism was The only investor I am aware of who
sequently lower its cost of capital and that my personality was not particularly publicly and frequently praises his manag-
diversify into new product lines. It was well suited to it. The activist is permanent- ers is Warren Buffett. Here, as in so many
impossible to predict this exact transac- ly in confrontation with managers who other instances, I see him as a role model.
tion before the financial crisis, but it was are either dishonest, incompetent, or, in As the capital base of Business Owner
easy to anticipate this type of transaction a best-case scenario, both. As should be grows and with it the stakes in our compa-
should there be a financial crisis. abundantly clear, I much prefer partnering nies, this is an area where I hope to posi-
How on earth do you put a value on with managers I admire and (hopefully) tively impact our investments.
the unquantifiable? You cannot, but it getting rich alongside them as the value
would not be conservative to ignore it. It of their farsighted investments crystallises In a nutshell:
would be plain stupid. over time.
For more detail on how I try to iden- For this reason, I have generally es- 1. Keep an open mind on what constitutes
tify managers who set the right example, chewed activism since I started Business value
I recommend the talk I gave at Bob Miles' Owner. However, I strongly believe that
2. Be alive to the business opportunities cre-
Value Investing Conference in Omaha ear- engaging with management should not be
ated by technological progress
lier this year. (Here is the link.) left solely to the activists. For this reason, I
have increasingly tried not just to be a pas- 3. Prefer widening moats to wide moats
Engage with Management sive recipient of information when I meet
with managers, but to create a genuine 4. Make finding the right managers the
Before I started RV Capital, I worked two-way flow of information. most important criterion
with an activist investor. From this period, I strongly believe that positive feed-
5. Use the growing capital base to promote
I gained an appreciation for the activ- back from owners when managers are
the right behaviours in managers
ist strategy. If a management is wasteful doing the right thing is just as important
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ValueInvestor

December 30, 2017

The Leading Authority on Value Investing

contrarian bets today, he sees value in asset management, Whitney George

Attention to Detail Anheuser-Busch InBev, Lindley and

per year. In what he considers a rebounding Europe, Olsen Anheuser-Busch InBev 15

Liquid Assets Ferrari 19

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 1

Investor Insight: Whitney George

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 2

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 3

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 4

Oilfield specialist Pason Systems [Toron-

WG: As a contrarian, I'm interested in the THE BOTTOM LINE

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 5

Is this eventually an attractive takeover

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 6

Investor Insight: Tom Olsen

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 7

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 8

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 9

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 10

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 11

How inexpensive do you consider the

TO: The key inputs in our model are or-

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 12

Investor Insight: Richard Cook

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 13

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 14

Do you think there’s any credibility to the

RC: There would be many operational,

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 15

RC: Based in Chile, this Coke bottler

Are changing consumer tastes away from EMBONOR-B PRICE HISTORY

RC: The trend is far more pronounced

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 16

How are you assessing fair value?

RC: If we're right that owner earnings

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 17

Subscribe now and receive a full year of

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 18

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 19

Jeff Ubben, ValueAct Capital

Jonathon Jacobson, Highfields Capital Management

James Montier, GMO

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 20

What I Am Doing Differently

A t Amazon, employees must present

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 21

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 22

Value Investor Insight™ is published monthly a

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 23

December 30, 2017 www.valueinvestorinsight.com Value Investor Insight 24

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