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Graham & Doddsville

An investment newsletter from the students of Columbia Business School

Inside this issue: Issue XXXIV Fall 2018

From Graham to
Tweedy, Browne
Buffett and Beyond Tweedy, Browne Company Company is a value-
Omaha Dinner P. 3 oriented asset
manager that
Howard Marks
manages domestic,
Book Signing P. 4 international, and
global equity
Tweedy, Browne
portfolios for
Company P. 6 individuals, family
Student groups, and
Investment Ideas P. 17 institutions from all
over the world. The
Scott Miller P. 21 firm was one of the
Clockwise from top left: Roger De Bree; Andrew Ewert ‘07; Frank Hawrylak, few investment firms
Steve Tusa P. 28 CFA; Jay Hill, CFA; Bob Wyckoff; John Spears; Tom Shrager; Amelia Koh ‘16 mentioned by
Warren Buffett in his
(Continued on page 6)
Ryder Cleary
MBA 2019 Scott Miller, Greenhaven Road Capital
Gregory Roberson, Esq.
MBA 2019 Scott Miller formally launched long-biased value hedge fund
Greenhaven Road Capital in 2011. Prior to founding
David Zheng Greenhaven, Mr. Miller was the Co-Founder and CFO/Chief of
MBA 2019 Strategy of Acelero Learning, a Head Start education services
Frederic Dreyfuss company that has grown to over 1,200 employees. He was
previously an Analyst at Litmus Capital, an Associate at
MBA 2020
NewSchools Venture Fund, and has further experience as a
Sophie Song, CFA business owner-operator. Mr. Miller earned a B.A. in Political
MBA 2020 Science from the University of Pennsylvania, an M.B.A. from
Scott Miller the Stanford University Graduate School of Business, and an
John Szramiak
MBA 2020
(Continued on page 21)

Steve Tusa, Wall Street’s GE Bear

Visit us at: RolfJPHeitmeyer Morgan’s Steve Tusa is
Institutional Investor magazine’s
#1 ranked analyst covering the
Electrical Equipment & Multi-
Industry sector. He has covered
the sector since 1998, with lead
coverage since 2005. In 2017, he
gained notoriety for being Wall
Street’s lone outspoken bear on
GE, when the stock was trading in
(Continued on page 28)
Page 2

Welcome to Graham & Doddsville

We are pleased to bring you members of the investment As a sell-side equity research
the 34th edition of Graham & committee: Roger De Bree, analyst at JP Morgan, Steve
Doddsville. This student-led Frank Hawrylak, Jay Hill, Tusa has gained notoriety as
investment publication of Co- Tom Shrager, John the lone bear covering GE.
lumbia Business School (CBS) Spears, and Bob Wyckoff, Since he first recommended
is co-sponsored by the Heil- along with a pair of CBS an Underweight rating in May
brunn Center for Graham & alumni who are currently 2016, the stock has fallen
Dodd Investing and the Co- working as analysts at the more than 60%. Wall Street
lumbia Student Investment firm: Andrew Ewert ’07 commentators have called it
Management Association and Amelia Koh ’16. In the “one of the greatest stock
Meredith Trivedi, Managing (CSIMA). interview, we discuss the calls of all time.” Steve runs
Director of the Heilbrunn legacy of Ben Graham, the through his research on GE,
Center. Meredith skillfully Since our Spring 2018 issue, dynamics of international the legacies of Jack Welch
leads the Center, cultivating the Heilbrunn Center hosted investing, the firm’s invest- and Jeff Immelt, his prepara-
strong relationships with the eighth annual “From Gra- ments in companies like Au- tion for TV appearances, and
some of the world’s most ham to Buffett and Beyond” tozone, WPP, and Baidu, and the importance of patience in
experienced value investors Omaha Dinner. This event is changes in the equity markets an investing career.
and creating numerous held on the eve of the Berk- since the firm’s last G&D
learning opportunities for shire Hathaway shareholder interview in 2010. Lastly, we continue to bring
students interested in value meeting and features a panel of you stock pitches from cur-
investing. renowned speakers. The Heil- We sat down with Scott rent students at CBS. In this
brunn Center also hosted a Miller, the founder of issue, Winter Li ’19 and
presentation and book signing Greenhaven Road Capital, a Shengyang Shi ’19 present
by best-selling author How- long-biased value hedge fund. their long thesis on
ard Marks after the release of The fund’s impressive track (JD), and Michael Wooten ’19
his new book Mastering the record since its founding in shares his long idea in the
Market Cycle. 2011 has drawn notable at- semi-conductor company
tention from the investing Qorvo (QRVO).
Our first interview is with community. Scott discusses
Tweedy, Browne Company, his background as a business We thank our interviewees
one of the few investment operator, the prospects for for contributing their time
firms mentioned by Warren autonomous vehicles, his and insights not only to us,
Professor Tano Santos, the Buffett in his 1985 speech The philosophy on position sizing, but to the investment com-
Faculty Director of the Heil- Superinvestors of Graham & as well as his investments in munity as a whole.
brunn Center. The Center
Doddsville, from which this companies like Etsy, TripAd-
sponsors the Value Investing
newsletter gets its name. We visor, Schein Vineyards, and
Program, a rigorous aca-
demic curriculum for partic-
sat down with six of the seven Fiat Chrysler. - G&Dsville Editors
ularly committed students
that is taught by some of the
industry’s best practitioners.
The classes sponsored by
the Heilbrunn Center are
among the most heavily
demanded and highly rated
classes at Columbia Business

Second-year Value Investing Program Meredith Trivedi with Professor Tano

students chat with CBS Professor Kian Santos, Faculty Director of the Heilbrunn
Ghazi at the 2018 Value Investing Center for Graham and Dodd Investing.
Program welcome reception.
Volume I, Issue
Page 23 Page 3

“From Graham to Buffett and Beyond” Omaha Dinner 2018

Professor Bruce Greenwald presents at the annual Mario Gabelli ’67 addresses the crowd
Omaha dinner and shares some words of wisdom

Professor Bruce Greenwald, Mario Gabelli ’67, Jan Professor Bruce Greenwald signs a copy of his book
Hummel, and Thomas Russo share a laugh

Omaha attendees enjoy some downtime during the

Page 4

Howard Marks’ Mastering the Market Cycle Book Signing and Discussion

Mastering the Market Cycle, the newly released follow-up Howard Marks discusses markets and cycles in a
to Marks’ highly regarded The Most Important Thing discussion moderated by CBS professor Ellen Carr

Professor Tano Santos introducing Howard Marks to an Howard Marks signing a copy of his book alongside his
excited crowd of students and professionals at Columbia associate Caroline Heald

Former Graham & Doddsville editors Adam Schloss ‘18

(left) and Abheek Bhattacharya ‘18 with a copy of
Mastering the Market Cycle
Volume I, Issue
Page 25 Page 5


22nd annual Columbia Student Investment
Management Association Conference

February 15, 2019

A full-day event featuring some of the most well-known

investors in the industry, including keynote speakers:
Jan Hummel of Paradigm Capital,
Susan Byrne of Westwood Holdings Group,
Richard Pzena of Pzena Investment Management
Presented by:
The Columbia Student Investment Management Association
The Heilbrunn Center for Graham & Dodd Investing

Visit our website for updates:

For inquiries contact:
Shara Singh
Matthew Stevenson
Page 6

Tweedy, Browne Company

(Continued from page 1)

1985 speech The Jay Hill joined Tweedy, Institute of Business

Superinvestors of Graham & Browne in 2003 and is a Administration, Drexel
Doddsville from which this member of the Investment Institute of Technology,
newsletter gets its name. Committee. He previously and The Wharton School
Founded in 1920, Tweedy, worked at Banc of at the University of
Browne Company now has America Securities LLC, Pennsylvania.
53 employees. Credit Lyonnais Securities
(USA) Inc., and Providence Bob Wyckoff has been at
Roger De Bree has been at Capital, Inc. Mr. Hill holds Tweedy, Browne since
Roger De Bree Tweedy, Browne since a B.B.A. from Texas Tech 1991. He is a Managing
2000. He is the firm’s University. Director, a member of
Treasurer and a member both the Investment and
of the Investment Amelia Koh joined Management Committees,
Committee. Mr. De Bree Tweedy, Browne in 2016 and Chairman and Vice
previously worked at ABN as an Analyst focused on President of Tweedy,
AMRO Bank and global companies. She Browne Fund Inc. Mr.
MeesPierson Inc. He holds previously worked at Wyckoff previously worked
an undergraduate degree Deutsche Bank Securities at Bessemer Trust, C.J.
in business administration Inc. Ms. Koh holds a B.A. Lawrence, J&W Seligman,
from Nijenrode, the from Macalester College and Stillrock Management.
Business School in and an M.B.A. from He holds a B.A. from
Breukelen, Netherlands, as Columbia Business School. Washington & Lee
Andrew Ewert ‘07 well as an M.B.A. from University and a J.D. from
IESE, the University of Tom Shrager has been at the University of Florida
Navarre Business School in Tweedy, Browne since School of Law.
Barcelona, Spain. 1989. He is a Managing
Director, a member of Graham & Doddsville
Andrew Ewert joined both the Investment and (G&D): How relevant is Ben
Tweedy, Browne in 2016 Management Committees, Graham’s philosophy today?
as an Analyst focused on and President and Director
global companies. He of Tweedy, Browne Fund Tom Shrager (TS): I would
previously worked at Inc. Mr. Shrager previously argue that Graham’s
Equinox Partners, L.P., worked in M&A at Bear philosophy is still fully
Ruane, Cunniff & Goldfarb Stearns and as a consultant applicable today. He was one
Inc., MTS Health Partners, at Arthur D. Little. He of the first investors to create
Frank Hawrylak, L.P., and Bear Stearns. Mr. holds a B.A. and a Masters an investing framework that
CFA Ewert holds a B.B.A. from in International Affairs made sense. Graham came
Emory University and an from Columbia University. from the credit side of
M.B.A. from Columbia investing and, as a fixed income
Business School. John Spears joined investor at that time, your
Tweedy, Browne in 1974. downside protection was
Frank Hawrylak has been He is a Managing Director, either the collateral put up
at Tweedy, Browne since a member of both the against the loan or the bond.
1986 and is a member of Investment and He later applied that
the Investment Management Committees, framework to equity investing
Committee. He previously and Vice President of and argued that the collateral
worked in the investment Tweedy, Browne Fund Inc. value of an equity investment is
department at Royal Mr. Spears previously the intrinsic value of the
Insurance. Mr. Hawrylak worked for the investment business. The value of the
holds a B.S. from the firms Berger, Kent business could be its net asset
Jay Hill, CFA University of Arizona and Associates, Davic value, it could be its book
an M.B.A. from the Associates, and value, or it could be an
University of Edinburgh, Hornblower & Weeks- earnings-based valuation.
Scotland. Hemphill, Noyes & Co. He
studied at the Babson By thinking in terms of
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business value and buying at a companies on EV to NOPAT, do that. You could find a stock
discount from that value, a how does it shape up in that was trading at 60% of net
diversified portfolio of comparison to deal valuations? current assets, and you might
undervalued securities should glance at the annual report –
earn an adequate return. That TS: However, we don't go which used to be 18-20 pages
framework hasn't changed. As much below an 8% owner instead of 250 pages – to get
markets have evolved, there earnings yield. You have to be an idea of what the business
are fewer net current asset reasonable and say, “If did. All you had to do was get
stocks and book value stocks multiples in the market are 20x comfortable with the inventory
Amelia Koh ‘16 that you can invest in today. EBIT, we are simply going to or accounts receivable.
That said, we do find them pass on that because it doesn't
from time to time in places like make any economic sense, G&D: How has this impacted
Japan and Hong Kong, but our assuming some normalization valuation?
current investments are in interest rates.” The analysis
overwhelmingly trading at is both absolute and relative. BW: The valuation framework
discounts to an earnings type remains the same – we’re still
valuation. trying to buy companies at
“It became clear to us
significant discounts from a
G&D: What types of valuation that value investing, at conservative estimate of the
metrics do you use? underlying intrinsic value of the
least empirically, business. We tend to be pretty
John Spears (JS): We look conservative appraisers. Today,
Tom Shrager for “a satisfactory owner appeared to work as we often value businesses at 10
earnings yield.” For example, if -13x pre-tax operating income
you take a company’s well outside the US as it – compared to 6-8x when I
operating income after tax and first started at Tweedy in 1991
did domestically.”
divide that by its enterprise – and try to buy those
value, and that produces an businesses somewhere
owner earnings yield of 8-10%, G&D: How is the process for between 6-9x. The expansion
you’re getting a pretty good earnings-based valuation in our valuation multiples is
return. different? largely due to this march to
the bottom in interest rates. In
Jay Hill (JH): Another recent Bob Wyckoff (BW): 1980, when I arrived in New
change is that tax rates have Earnings are less predictable. In York, the prime rate was
been going down around the conducting our analysis on north of 20%. You see what
world. One advantage of this earnings-based businesses, we has happened since then.
John Spears owner earnings yield metric is spend a lot more time today Interest rates, with a hiccup
that it gives a company some on qualitative factors, factors here and there, have been in
credit for falling tax rates. All that might impact that earnings decline for over 35 years, and
things equal, we believe that stream over time. that has had a significant
lower tax rates lead to higher impact on what people are
net income and higher free We try to estimate the willing to pay for a business.
cash flow. earnings power of the You see it in corporate
business, the sustainability of transactions and the values
G&D: How do you use that earnings power, and what people are willing to pay in
NOPAT (Net Operating Profit the growth of that earnings acquisitions. Debt to EBITDA
After Tax) to EV (Enterprise power might look like over multiples in leveraged buyouts
Value) in evaluating time. It does involve an are very high today. Invariably,
opportunities? Do you evaluation of qualitative factors if interest rates are low, people
compare it to long-term which might not have been as are going to borrow a lot of
Bob Wyckoff government bond yields? prevalent in our analysis 40 or money, and that's going to
50 years ago. inflate multiples.
JS: To an extent. We also look
at it relative to other Frank Hawrylak (FH): We've incrementally increased
companies. If you rank 100 Previously, you didn’t have to our appraisal multiples over
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time, although reluctantly and pressure that were trading at the Amazon of its day, back
with a lag. I think a lot of discounts to book value. when the tech bubble was
people would still consider us nearing its peak in 2000. It was
relatively conservative on that TS: Digital Equipment was the world’s largest company –
front, and we demand a one, I recall. profitable, but trading
substantial discount off those somewhere around 180x
appraisals. BW: Yes, DEC. We bought it earnings. Then the tech bubble
after it had rolled over and burst in March of 2000 and,
G&D: What other recent was trading at a discount to before long, Cisco was trading
changes have you seen in the book value. We didn’t know it at a fraction of its bubble price.
markets? at the time, but we were
basically buying a cigar butt. We got an opportunity to buy
BW: Over the past 25 years Luckily, we bought it pretty our shares in 2011 and 2012
we’ve become more of an cheap and were able to make a when it was trading at roughly
international investor – our little bit of money on it, but 10x earnings with over $40
client portfolios were primarily that isn’t the way investors billion dollars of cash on its
made up of U.S. equities up currently target technology balance sheet. It was still
until the early ‘90s. You may stocks for growth. What has dominant in routers and
have seen a booklet we put changed recently is that we switches at the time, even
together called What Has have found some businesses though growth had slowed
Worked In Investing. That with world-class technologies significantly. It may not have
booklet was a compilation of and long runways for growth – been growing at a Google-type
40-50 empirical studies looking but the key is that we have rate, but we thought that at
at value-oriented investment been able to purchase them at the price we were paying, we
criteria that, when back-tested, prices that fit our valuation were getting a lot of value. We
looked like very good framework. paid an average cost around
predictors of outperformance. $17-$18 a share. Today, Cisco
And about half of those studies We bought Google in 2012 at is trading in the high $40s. We
were done in markets outside a very attractive valuation – still own the stock. That
the United States. It became somewhere around 9-10x investment has worked out for
clear to us that value investing, forward EV to EBITA and 12- us, but again, it’s a technology
at least empirically, appeared 13x forward earnings. It was stock that we were able to buy
to work as well outside the US also compounding its value at at a very attractive valuation.
as it did domestically. over 20%. It was cheap.
G&D: It sounds like you found
Today, most of our assets JS: Especially considering the a solid margin of safety.
under management are cash on its balance sheet and
invested outside the US, as we the low tax rate. BW: We did. We did not
often find greater pricing have to tie ourselves up in
inefficiency in non-domestic BW: And we still own Google knots trying to develop a
markets. Now, that’s all today, despite a higher rationale for owning Cisco.
evolving as the world becomes valuation. It’s what we call a Companies like Amazon and
more global and more people compounder. Google is Netflix are a much harder
begin investing in equities. But I compounding its underlying proposition for us given the
think in general we continue to intrinsic value at a very, very way we value businesses. They
find the most opportunities rapid rate, and in our view, don’t fit our framework. We
internationally. there is still a reasonable also recently bought a couple
relationship between the value of Chinese technology
Another thing that has changed of the business and its current companies, including Baidu,
in the past half-dozen years is stock price. which a lot of people refer to
our increased allocation to as the Chinese Google, and
technology stocks. We have We also bought shares in Sina, which is a holding
owned technology stocks in Cisco – the router and company that owns a
the past, however, they were switching company – about six controlling interest in Weibo,
often businesses under to seven years ago. Cisco was one of China’s most popular
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social media businesses. You the summer of 1993 that products abroad and can
might refer to Weibo as ... hedged its foreign currency compete in the international
exposure, which was quite arena. If you research the
TS: … the Twitter of China! novel at the time. Even today, Japanese market, you'll find a
there are very few lot of cheap stocks that don’t
BW: Exactly. Through our international funds that fit that criteria.
investment in Sina, we own an consistently hedge currency
interest in Weibo at an exposure. Investors tend to FH: Typically, Japanese
attractive price. As with most look in the rearview mirror, companies aren’t as profitable
of our tech investments, Baidu and since the dollar declined as other companies around the
and Sina have advertising-based against most major currencies world based on return on
business models. That makes between 1986 and 1992, the capital. Ben Graham wrote an
sense to us. It's not gadgets general feeling in the summer article in the 1930s about the
and software. of 1993 was that the dollar US stock market when a lot of
was toilet paper. People are companies were selling way
TS: And they're very driven to make investment below book value. Essentially,
profitable – insanely profitable. decisions based on their most the title was, “These
recent experiences. companies are worth more
BW: So that's another thing dead than alive.” Liquidate
that has changed. We have a them. They're not doing
“We own a few more anything for the shareholder.
few more technology stocks
today than we have had in the technology stocks now In Japan, a number of
past, but we haven't had to companies fall into that
abandon the framework or the than in the past, but category, but nobody cares.
valuation discipline to They don't buy back stock
accomplish that. we haven’t had to even though it's trading at a
third of book value, half of
Roger De Bree (RD): I want abandon our valuation which is cash. The culture is
to add another thing that just different.
discipline to
makes it significantly easier to
invest large chunks of our accomplish that.” G&D: How do you get
personal money and our comfortable with international
clients’ money in non-U.S. accounting and auditing?
equities. That is using forward G&D: On the international
currency contracts to hedge side, are there additional TS: Good question. I
foreign currency exposure measures you incorporate into remember when I first joined
back into our base currency – your process? the firm, Will Browne said to
the U.S. dollar – to get rid of me, “Tom, you're a foreigner.
most, if not all, of the foreign JS: Yes. Japan, for example, is Start looking at these foreign
currency risk. Investing globally somewhat unique and has companies.” I was
gives you more opportunities required additional analysis. overwhelmed because almost
to find bargains, and by For one thing, there are fewer every country had its own
hedging, you can eliminate the deals in Japan. accounting standards. Over
risk that movement in time, I began familiarizing
exchange rates could severely TS: You also need some sign myself with the idiosyncrasies.
dilute the local returns earned that they think the When I studied British annual
on your stocks. Our clients shareholders are alive. reports, I was continually
can choose whether to hedge Japanese companies are often struck by how optimistic
their portfolios depending on if under-levered and carry too certain accruals appeared.
they want foreign currency much cash on the balance German accounting was, by
exposure for diversification sheet, which depresses design, very conservative.
purposes. returns. In our international Their income statements and
portfolio, we want exposure balance sheets were presented
TS: We launched an to international markets – in a way that a bank would
international mutual fund in companies that sell their prefer. What you had to know
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was that located at the bottom growth. We gained confidence In some ways, these entities
of the income statement was because we used a similar are the “national champions”
an adjustment to reported valuation framework when we of China. While they are quasi-
earnings that was supposed to previously looked at Google, protected – meaning we can't
reconcile the underlying but we also had to get own them directly – the
profitability with the reported comfortable with Baidu being government does want them
profitability, but the adjusted in a communist country where to succeed, and from a
economic profitability was the government could shareholder’s perspective,
invariably higher than the potentially interfere. perhaps there is a benefit to
reported one. Swiss them being sanctioned
accounting, in the late ‘80s and Andrew Ewert (AE): The monopolies. You just have to
early ‘90s, didn't tell you what Chinese technology live with the compromise of
operating income was. They companies, even though not having direct ownership.
only disclosed revenues and they're listed in the United Maybe those things balance
profits. They didn't even tell States, are deemed strategically each other out, but we also
you what taxes were. important companies by the bought them at what we feel
Chinese government. This were very attractive valuations.
Unraveling international means that non-Chinese These firms have high returns
accounting used to be very citizens can’t actually own on capital. The advertising
difficult. It became a treasure them. The shares listed in the industry in China is more
hunt in the more conservative US represent companies that nascent than in the US and is
countries and an exercise in have contractual arrangements growing at a double-digit rate.
dodging land mines in the with Variable Interest Entities Search engines are a proven
looser ones. Eventually, (VIE) in China. For example, business model, given what
international accounting Baidu has contracts with the we've seen with Google. To be
standards began to converge, VIEs to receive Baidu’s able to buy this kind of
but you still have cultural economic rights instead of company at a low double-digit
differences on a country-by- direct ownership in the operating income multiple –
country basis even today. company. So you, as a after adjusting for some of
shareholder, own a structure their money-losing subsidiaries
As far as your question on with a contract. You don't – helped outweigh some of the
auditing is concerned, it’s OK actually own the underlying compromises we were making.
in the developed world. business. It wasn't easy though.

G&D: What about China? Do TS: Like a non-voting share. Amelia Koh (AK): We
you have any concerns there? thought a lot about the
AE: Or a tracking stock even. Chinese government. Yes, it’s
TS: There have been these big You kind of own a synthetic a communist country, but it's
scandals, of course, and that's company. It’s not the real also a very capitalist country.
one of the risks of investing in business. You’re not a The internet sector is deemed
China. In our case, our shareholder in the true sense strategically important by the
companies have good auditors of the word. This is a legal government, and the
with international experience, construct to attract capital government has recently been
but it’s a different without giving up direct trying to promote Chinese
environment. ownership or control of the technology and their domestic
companies, because the champions. If the government
BW: China is a relatively new Chinese government sees were to take actions that
place for us to invest. We had these industries as strategically would jeopardize the VIE
to get comfortable with the important to their country’s structure, they would severely
different ownership structures. development. It’s obviously limit the ability of these
Andrew and Amelia partnered difficult as a shareholder to companies to raise capital and
on the work in Baidu, which think like an owner when you also undermine their
we thought was trading at an don’t technically own what international credibility. That is
attractive valuation with a you’re buying. not an outcome they want.
terrific runway for future
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G&D: How do you manage worth 12x EBIT. To find the disclosed every quarter, along
the risks of owning Chinese value compound, take EBIT, with all of the determinants of
companies? multiply by 12, subtract the net the numerator and
debt, and divide by the number denominator – signaling that
BW: We manage our risk by of diluted shares outstanding. management understands the
limiting our exposure to China, We apply that same valuation importance of returns.
being very selective in the methodology over say the last
process, and being stingy on 10 years and observe how that Free cash flow is important to
price. We’ve taken a roughly value has changed over that us, particularly free cash flow
1.5-2% position in Baidu. Our period, and how much conversion. One of the things
maximum position size is 3-4%. volatility there was from year we consider is how well a
We like diversification by issue to year. To avoid a flawed company converts its net
so we'll often start with a 1-2% analysis, you need to make income into free cash flow
position. We’re not going to certain that the first year and over time. We all know that
have a significant percentage of the final year of the period do income statements are full of
our portfolio in China, because not represent trough or peak assumptions and accruals. We
of the risks. earnings. What you’re also know that most growing
essentially trying to determine companies, on a multi-year
JH: To add one final point: a is, if you owned this business cumulative basis, generate less
lot of people are drawn to free cash flow than net income.
these internet-oriented At AutoZone, cumulative free
companies for the moonshot “People are driven to cash flow has essentially been
subsidiaries – the businesses equal to reported earnings
that haven’t yet produced make investment over the previous decade,
earnings but could or should at which is indicative of high
some point in the future. Our decisions based on their earnings quality.
valuation of Baidu attributed
no value to those secondary
most recent We also like that they take
investments. We were really experiences.” every free dollar of cash flow
just valuing the search business and use it to buy back stock.
and buying it at an attractive From 1998 through 2017,
multiple. over a long time, how would AutoZone reduced diluted
the value have grown? In shares outstanding from 153
TS: For a real business that AutoZone’s case, if you look million shares to 29 million
made money. over the previous 11-year shares – an 81% decline.
period, its intrinsic value grew Combined with growing
BW: Right. The point we're by 16% per annum, with a profits, these share
trying to make here is that you significant percentage of that repurchases have substantially
can invest in technology growth driven by share increased shareholder wealth.
companies and still be price buybacks. The historical
sensitive. record also revealed a stable G&D: Does AutoZone pay a
and defensive business. Same dividend?
G&D: Can you talk about store sales at AutoZone have
your recent purchase of grown in 19 out of the last 20 JH: They do not. Management
AutoZone? years, including in 2008 and believes they can create more
2009. value, in a tax efficient way, by
JH: AutoZone is the largest repurchasing shares. Avoiding
aftermarket auto parts retailer AutoZone has also historically a dividend is also beneficial for
in the US and has a fabulous produced high returns, with a management’s stock options
long-term track record. When 14% ROA (return on assets) because option strike prices
we study a company, one thing and a roughly 30% lease are not adjusted lower for
we like to examine is the long- adjusted ROIC (return on dividend payments.
term historical value invested capital). The company
compound of the business. communicates in a very G&D: How did you determine
Let's say we think AutoZone is transparent way – ROIC is when to start building your
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stake in Autozone? the urgency of the need. If deliver it to me?” His
your car breaks down and you expectation is to receive the
JH: In the first half of 2017, can’t get to work, you need it part within thirty minutes, not
AutoZone’s stock price fell fixed immediately. Two-day the next day. Even if Amazon
from roughly $800 to $500, shipping from Amazon Prime is has two-hour delivery in major
mostly due to Amazon irrelevant to you. Second is the cities, that is still not going to
concerns. AutoZone even convenience factor. AutoZone cut it, because the independent
reported negative organic has approximately 5,500 stores mechanic cares about turning
growth one quarter – a rarity in the United States. 85% of over his service bays. He wants
for the company. With the the population lives within five to repair as many cars as
stock trading in the low $500s, minutes of a store. That’s hard quickly as possible in a day.
the business was trading 9.5x to beat, especially if your
EBIT, 8x EBITDA and 12x problem is unplanned and your G&D: Are there any
earnings, yet M&A deals in this need is immediate. Third is the contractual relationships
industry had generally been technical assistance AutoZone between mechanics and
done at 13x EBIT. Applying a provides. Most people know AutoZone or are they all one-
12x EBIT multiple to they have a problem with their off transactions?
AutoZone – a small discount car but have no idea how to fix
from observed deal multiples – it. Therefore, the expertise of JH: They’re all one-off
we thought the stock was an auto parts professional is transactions. The goal of the
worth at least $750. highly valued. Moreover, for auto parts retailer is to
some repairs, a customer become the first-call supplier,
The narrative in the industry looking to fix her own car but having the needed part is a
was that growth was slowing would have to buy expensive huge challenge because there
due to Amazon disruption. tools that she’s only going to are so many makes and
Amazon was not a new market use once. AutoZone can lend models. The SKU proliferation
entrant; they had been selling you the tools and provide is unbelievable, so the key to
aftermarket auto parts for a instructions on how to make success is having custom
long time. But we are all keenly the repair. In fact, for many of inventory at every store that
aware of Amazon’s willingness the parts AutoZone sells, an reflects which cars the locals
to forgo profits in the pursuit employee will just come out to drive.
of revenue growth. Further, the parking lot and fix your car
cursory research revealed that for you. To achieve this, you have to
Amazon’s prices were on study the local car market
average 10% to 20% cheaper The remaining 20% of demographics and identify, for
on identical branded products. AutoZone’s revenue comes example, whether people are
from the do-it-for-me segment driving Ford F-150s or Honda
We saw things differently, of its business, which consists Civics. You also need to know
ultimately concluding that the of selling parts to independent the year and make of the
slowdown was more likely the auto mechanics. This portion models. Each store has an
result of weather and car of its business concerns inventory that is customized to
demographics than consumers who don’t want to the local car mix. A large store
competition from Amazon. fix their own car but are network helps. Many areas
Amazon’s major point of looking to save some money have multiple stores that can
differentiation is price. But for relative to what a car share parts. If one store
AutoZone customers, there dealership would charge. doesn’t have a specific part but
are a few factors that are even the one across town does, it
more important than price. In the do-it-for-me segment, will deliver it.
the customer is typically a
Consider the do-it-yourself professional mechanic who G&D: What do you believe
segment which represents 80% cares primarily about inventory were the real reasons for the
of AutoZone’s revenue. In this availability and speed of industry slowdown?
segment, there are three delivery. He calls up AutoZone
things more important to the and asks, “Do you have the JH: Weather was definitely a
customer than price. First is part and how fast can you factor. Mild winters in 2016
(Continued on page 13)
Page 13

Tweedy, Browne Company

and 2017 hurt auto part JH: This summer we looked at learned that following
retailers because extreme the drug distributors: Amazon’s purchase of online
temperatures often lead to AmerisourceBergen, Cardinal, pharmacy PillPack, Amazon
parts failure. The presence of and McKesson. The stocks acquired the ability to
snow and salt trucks is like were down partly due to fears eventually sell generic drugs to
Christmas for auto parts that Amazon would enter the consumers at cash prices
retailers. Those trucks create drug distribution industry or below the cost of a co-pay
potholes, and the salt gets into the retail pharmacy industry. using insurance. When
the underbelly of cars and We knew Amazon was consumers realize they can
leads to rust. The combination planning to enter healthcare in cash buy generic drugs on
of a more normal 2018 winter some fashion – it was already Amazon at prices even lower
and improved growth at the announced that Amazon was than using insurance co-pays,
auto parts retailers led us to teaming with JPMorgan and retail pharmacies are at risk of
believe that weather was truly Berkshire Hathaway to form a losing some volume. In
part of the problem. healthcare joint venture. addition, a growing number of
Amazon was wreaking havoc consumers now have
Another reason behind the among many traditional pharmaceutical deductibles as
slowdown was a car distribution businesses, and part of their health insurance,
demographic problem. The after a good bit of study we which likely means they will
sweet spot for spending on concluded that it was very shop around for the lowest
after-market auto parts is possible that Amazon could price when purchasing drugs
when a car is between 6 and disrupt pharmaceutical for chronic conditions. Since
10 years old. Below 6 years, distribution. drug distributors ultimately sell
the car is probably still under to retail pharmacies, they
warranty and the owner will could be negatively impacted.
go to the dealership. Between “Don’t sell short the
6 and 10 years, the car is likely traditional, long-only Another key profit pool is
not on warranty anymore, but independent pharmacies.
is still new enough to justify way of investing. It’s Independent pharmacies do
repairs. At some point, the car not make up a significant
gets too old, and repairs end not a lost art. As the portion of pharmaceutical
up costing more than the car is distributors’ revenues, but they
worth. If you look at 2017, world becomes more account for an inordinate
cars aged 6-10 years old were share of profits because
cars that had been sold new passive, we think the they’re high-margin customers.
between 2007 and 2011 – a market will ultimately Independents rely on
period when new car sales distributors for additional
collapsed because of the present more services like business
financial crisis. New car sales consulting and insurance
picked up dramatically opportunities for reimbursement support.
beginning in 2012, making it a Independents are already
mathematical certainty that the people like ourselves.” slugging it out with Walgreens
6-10 years-old cohort will and CVS and there is evidence
grow in the next several years, that they are slowly losing
which will benefit all of the Pharmaceutical distributors market share over time to the
auto parts companies. make a lot of money selling large chains. We concluded
generic drugs to retail that Amazon’s recent entry
G&D: Could you tell us more pharmacy customers, but they into online pharmacy will likely
about this idea that some make a disproportionate speed up the demise of the
companies can survive an amount of money distributing independent pharmacy. It
Amazon threat because price products and services to won’t happen overnight, but
is not the differentiating factor? independent pharmacies as we think it represents a long-
Are there any other companies opposed to national chains like term headwind to the
that fit that theme? CVS or Walgreens. With pharmaceutical distribution
respect to generic drugs, we model.
(Continued on page 14)
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Tweedy, Browne Company

AE: Another source of The perception is that agencies short-term profits was another
opportunity is technological sell commercials, but in reality, blow to advertising agencies.
disintermediation. We recently they act more like consultants
invested in WPP, a large in helping clients define their Anheuser-Busch InBev now
advertising firm in the UK. To audience, select appropriate sells 50% less beer in the
some degree, we got this messaging, and target United States than they did six
opportunity from the market’s customers. We think they will or seven years ago. Part of that
fear of Google and Facebook still fill this role in the future, may be due to the rise in
disrupting the advertising but in a different way. A recent popularity of micro brews, but
industry. But after conducting advertising book quotes the their decreased advertising
analysis similar to our founder and former CEO of budget was also likely a factor.
AutoZone research, we WPP, Martin Sorrell, saying, This is a wind that has blown
concluded this idea was a bit “75% of what we do has through the entire fast-moving
overdone. nothing to do with Don consumer goods industry.
Draper. He wouldn’t even Companies lose shelf space,
Still, advertising faces issues on recognize it.” business shrinks, and
two fronts. First, marketing is shareholders are unhappy. We
increasingly moving online, Another issue is that Martin think the pendulum will swing
because that’s where the Sorrell has recently left the back, which will help WPP,
audience is. In the next few company, creating uncertainty whose biggest clients are
years, over half of marketing about future management. As a companies like Unilever,
spend will be digital. Google result, the stock is selling at an Procter & Gamble, and Nestle.
and Facebook are a duopoly in attractive price, and we’re
digital, so advertising is not willing to wait for things to G&D: You are long Unilever
only moving online but it’s improve. Are the threats to and Nestle, right?
moving exclusively to two the industry temporary or
players. Second, the internet secular? We’re betting they’re BW: Yes, as well as Heineken.
has lowered the barriers to temporary. The agencies have They’ve almost become semi-
entry for many companies. A evolved with their clients and permanent holdings. We have
lot of WPP’s clients are are able to go where the owned them for 15-20 years.
consumer branded goods business opportunities are. If They have durable competitive
companies that are currently they’re not able to do this, advantages that allow them to
experiencing increasing then their clients won’t see compound their underlying
competition from smaller them as offering a valuable intrinsic values at an attractive
upstart brands. As a result, service. Mark Read just took and predictable rate. It's a very
these large companies are over as the new CEO and has tax efficient way to invest.
cutting their ad budgets as already announced some
their businesses slow. changes in strategy. Ideally, the We’ll sometimes trade around
management turnover will their intrinsic value, meaning
Due to these headwinds, WPP allow the company to focus we’ll trim the position if the
trades at just over 9x earnings more on making the necessary stock price moves ahead of
with a 5% dividend yield and an changes their clients need and intrinsic value and add to the
almost infinite return on capital want. position if the stock price
(excluding goodwill). These drops below. These companies
financial characteristics are RD: Changes in the consumer also give us exposure to faster
very attractive, provided the goods industry have also growing parts of the world.
current issues are not secular affected advertisers. 3G When growing middle classes
and that clients will continue Capital, which owns Heinz, around the globe get more
to deem agencies as valuable Kraft Foods, and Anheuser- discretionary income, they
intermediaries to help them Busch InBev, moved to a want a better beverage and a
solve modern problems. model where companies better food product. These
Marketing is constantly ratchet up their prices, cut companies are serving that
evolving, yet agencies have costs, including advertising, and demand, which is growing all
always occupied the role of choose the short-term over the time.
trusted advisor. the long-term. The focus on
(Continued on page 15)
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Tweedy, Browne Company

G&D: How do you handle Though we are a small place, hard and challenging work, but
disagreements on your the organization has been the risks are reasonable, and
investment committee? through multiple generations, the stress is manageable. It’s
proving the efficacy of the also incredibly rewarding,
TS: We would characterize value investing approach. This more stable, and allows you to
the decision-making process as firm has lasted so long because have a nice balance between
a consensus building exercise. people with the right your professional and family
The Investment Committee temperament collaborated to life.
says yea or nay, but it’s a implement an approach that
process. An analyst or a works and is sustainable over FH: To echo what Warren
partner starts the process by the long term. Buffett has said to countless
presenting an idea. Following numbers of students: integrity
that initial vetting, the analyst We have nothing against hedge matters. At Columbia, there's
or partner begins the research funds – we think it’s great that plenty of intellectual
process, which culminates in a many investment partnerships horsepower and there’s
written memo that includes a have popped up over the tremendous energy. We have
valuation model, a competitive years. Many are managed by a culture in which honesty and
analysis, a complete very talented investors, and humility are important
examination of the drivers of MBA students are obviously elements of our success.
the business, and any other drawn to them. Yet our advice When you’re given difficult
pertinent findings. The idea is would be to not sell short the choices, take the high ground.
then debated in a respectful traditional, long only way of
and collegial manner with the investing. It’s not a lost art. As TS: Coming back to success.
entire investment team. the world becomes more First, you have to be lucky. It's
passive, we think the market better to be lucky than smart.
People often ask us, “How can will ultimately present more Next comes hard work. It
you be efficient in reaching a opportunities for people like means working as hard as you
decision by consensus?” We ourselves. possibly can, finishing before
believe the process is similar you are expected to, having all
to the College of Cardinals You are coming out of a your t’s crossed and all your i’s
without the Pope. It’s easier to fantastic MBA program that dotted. It means having a
reach an agreement when you firms like ours believe passion for what you do, even
look at the issue through the produces capable and if you may not be initially
same lens. We might disagree passionate value investors. You rewarded.
on price, or someone may have a material advantage over
want additional questions most people in the country in JH: I would add: be persistent.
answered, but we use a getting a job in a value shop. Several of us got to Tweedy,
framework we all believe in. Our advice is to think long- Browne by writing a letter or
Also, most of us have type B term. If you do that, your contacting somebody cold.
personalities. It’s easy to work competition will be more Don’t just contact once. We
together because we respect limited. Think about getting try to make it a point to help
each other’s judgment. If you rich over a lifetime by doing people who contact us, but we
have the good fortune of something that’s repeatable can’t get back to everyone, or
becoming a member of the and sustainable. Investing on a sometimes we forget about it.
Investment Committee, it highly concentrated and But the people who are
means you’ve shown good leveraged basis may allow one persistent, who circle back
judgment and have proven to beat the market by a with the second email or third
yourself over the years. substantial margin from time to voicemail, those are the people
time with great subsequent we eventually call back. Those
G&D: Do you have any advice reward, but the risks and are the people we think really
for MBAs who want to break stress are considerable and want it. I wouldn’t worry
into the industry? sometimes consequential. At about bugging somebody.
firms like ours, you can spend Worry about not being
BW: In 2020, Tweedy Browne a lifetime building wealth by persistent enough.
will celebrate its 100th birthday. doing what you like to do. It’s
(Continued on page 16)
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Tweedy, Browne Company

RD: The greatest gift is just
curiosity about what the
dynamics of the business are.
This keeps you going during
dry patches, instead of simply
thinking that you have to find a
stock to buy or sell. Discipline
is essential. If you can combine
that sort of curiosity with the
right temperament, you’re in a
lucky spot.

G&D: Thank you for your

Page 17 (NYSE: JD) - Long

Winter Li, CFA Shengyang Shi

We recommend a long position on (JD) with a price target of $80 in
2022 or 27% IRR. We believe the recent
sell-off in the stock is an overreaction
and the current risk/reward is extremely
Winter Li ’19 attractive. Our valuation is based on a
Winter is a 2nd year stu- sum-of-the-parts analysis. After stripping
dent at CBS. Prior to CBS, out JD Finance, JD Logistics, other in-
Winter was an Investment vestments and net cash, JD’s core busi-
Associate at MFS Invest- ness is only trading at 5x owner’s earn-
ment Management, where ings (assuming 3% normalized net mar-
he also interned this sum-
mer. At CBS, Winter is a
gin), which grows at 20-30%. We believe
member of the Value In- JD’s core retail and advertising business
vesting program and serves deserve to trade at 15x and 12x EV/
as the Co-President of the EBIT, respectively, at maturity. We sanity checked that valuation against justified multiples and other peers.
investment management
club (CSIMA). JD & Chinese E-Commerce Overview is a $35B market cap B2C online retail company serving the vast and growing Chinese consumer mar-
ket. It is the largest online direct retailer (1P) and second largest e-commerce company in China. Relative to
other e-commerce players in China (e.g. Alibaba), JD has a reputation of selling a diverse selection of authentic
products at competitive prices. JD is differentiated through product quality and its own distribution infrastruc-
ture that results in speedier deliveries. Its main revenue sources are: 1) online direct sales (1P business; main
categories include electronics, appliances, apparel and FMCG), 2) online marketplace (3P business; commission
-based), and 3) advertising (cost-per-click model and long-term brand advertising).
When e-commerce began in China, offline retail had low market coverage and was highly fragmented (53% of
grocery sales were from mom and pop stores vs. 18% in the US; also, the top 20 traditional retailers in China
only had 12% market share). The fragmented nature of the industry paved the way for growth of e-commerce
platforms. Online penetration rate has grown at over 50% CAGR over the last few years and is expected to
Shengyang Shi ’19 grow from 20% today to 30% by 2022. Euromonitor estimates China online retail sales will grow at mid-teens
Shengyang is a 2nd year CAGR over the next five years. That projection is on track as online retail sales grew 29.3% y/y in H1 2018.
student at CBS. Prior to
CBS, Shengyang was an Investment Thesis
Investment Associate at 1) Underappreciated business model: Many investors think that Alibaba (BABA) has already won the e-
Baring Private Equity Asia. commerce war in China and that e-commerce is a winner-takes-all market. From conversations with mer-
This summer, he interned chants and ad agencies, we believe there is room for multiple players. Merchants have a vested interest in
at Mercator Fund and Cath supporting multiple platforms. Additionally, many higher-end and foreign brands prefer to be on JD over BA-
Kidston, a portfolio compa-
ny of Baring. At CBS, BA because of JD’s reputation of selling higher quality, authentic goods with faster distribution.
Shengyang is a member of Investors often pick between JD and BABA to gain exposure to the Chinese online retail growth theme. Many
the Value Investing pro- investors prefer BABA’s asset-light business model relative to JD’s. We believe investors underappreciate the
gram and the Private Equity
value of JD’s business model. JD has spent over a decade building a national logistics distribution network that
Fellows Program. Sheng-
yang also leads the Invest- covers over 99% of districts in China. JD’s logistic network differentiates it from other Chinese e-commerce
ment Ideas Club (IIC) players through faster delivery and superior customer experience, which are important to succeed over the
within the investment long-term. In China, a regular work day is extremely fast-paced with little down time during or after work. As
management club (CSIMA). such, speed of delivery and the shopping experience are crucial, especially in top-tier cities, where JD is the
Primary Research:
preferred online retailer. As China continues to urbanize, we expect even more people will switch over to the
1. Ex-external consultant “JD experience”. While not completely comparable, JD is built similarly to Amazon whereas BABA is more
to Alibaba and JD like eBay.
2. Advertising agency exec-
utive 2) Variant view on margin expansion potential: After its growth stage, JD can raise profitability by in-
creasing margins via multiple methods such as less discounting to suppliers, similar to what Amazon did. A
3. Ex-JD senior executive
more overlooked margin growth driver is advertising revenue growth. We expect advertising to grow faster
4. Expert in Chinese e- than consensus expectations, and the mix shift should contribute to margin expansion. Ad revenue only ac-
counts for 3% of consolidated revenue and is thus often lumped in to “other revenue” and ignored by the
5. Senior executive within a investment community. Given advertising’s margin profile (~50%), it accounts for 11% of gross profit despite
large global merchant
only 3% of total revenue. That deserves a deeper dive, which is what we’ve done in our primary research.
6. E-commerce manager at
an international apparel E-commerce platforms in China are also enjoying macro tailwinds in ad revenue share. We’ve seen e-
brand commerce websites take a bigger share of the growing advertising revenue, mostly at the expense of search
engines, and that trend is widely expected to continue.
Page 18 (JD) - Long (Continued from previous page)

JD’s ad revenue as a % of GMV is at 1.2%, meaningfully lower than both Alibaba’s and Amazon’s. JD only began charging ad fees in 2014.
Per our conversations with ad agency execs, JD’s ad revenue is lagging Alibaba’s primarily because of technological differences in the mag-
nitude of three to five years. But there is no reason why JD cannot catch up. Beginning in the second half of 2016, JD started to invest
aggressively into advertising capabilities including investments in a team of externally-recruited engineers, AI technologies, a real-time bid-
ding platform, and tools and analytics for merchants. Subsequently, cost-per-click revenue has been growing triple-digits over the last few
quarters. There is still low-hanging fruit left. For instance, T-mall of Alibaba requires its merchants to place ads in order to be listed on its
platform. JD initiated a similar initiative in 2017 and is only charging 30% of what Alibaba charges on those ads. JD has set up strategic part-
nerships with Tencent, Baidu, NetEase, Qihoo, and Toutiao to reach 100% of online consumers in China via multiple platforms including
WeChat, search engines, media, video streaming and gaming. JD’s broad coverage makes it an attractive platform to advertise on.

In our base case, we assume JD’s ad revenue as a %

of GMV will increase to 2.1% in five years, still lower
than BABA’s current 2.5% and lower than Amazon’s
projected percentage. Should that scenario play out,
JD’s ad revenue would become 5% of revenue mix
and 17% of gross margin mix by 2022E. The advertis-
ing segment is asset-light and trades at a higher multi-
ple. If JD’s advertising grows, the mix change should
also result in multiple expansion.

3) JD’s core retail business is undervalued after backing out JD Finance and JD Logistics: JD’s long-term competitive advantage
lies in its integrated model of retailing + logistics + finance. However, the market is penalizing the company for its negative profitability and
low cash flow because the latter two segments (logistics + finance) are dragging down overall financials, as the Street has failed to clearly
separate out these two loss-making segments. After backing out JD Finance ($5.0/sh), JD Logistics ($7.6/sh), other investments ($2.2/sh),
and net cash ($1.4/sh), the core retail business is only trading for $8.2/sh (~$10bn). This is very cheap considering the core generates
$70B revenue in 2018E and is growing at 30% a year. For reference, Amazon is trading at 4x 2018E revenue with a similar growth profile.
With an assumed 3% owners’ earnings margin (conservative), JD’s core retail and advertising segment is trading at 5x earnings. We believe
JD’s long-term true earnings power could be even higher than the assumed 3%. Value could be unlocked if the company separates out
segment financials and investors start seeing the true performance of all business segments. Alternatively, JD could spin-out one of the non
-core segments to realize its market value and highlight the mispricing in the remainder of the business. Note: JD management has publicly
discussed divesting JD Finance/Logistics, partly to surface the value of the underlying business.
Metrics Val. JD Val. to JD as % of
Valuation Method Multiple US$/share Comments
(US$mn) (US$mn) stake (US$mn) Total
JD Retail (1P+3P) EV/EBIT 3,321 15.0x 49,821 100% 49,821 34.3 47% Assumes breakeven for 1P and 15x on 3P 2022E EBIT of $3.3bn (62% EBIT Margin)
JD Advertisng EV/EBIT 2,838 12.0x 34,057 100% 34,057 23.5 32% 12x on 2022E Advertising EBIT of $2.8bn (38% EBIT Margin)
JD Core EV/EBIT 6,159 13.6x 83,878 100% 83,878 57.8 80% Blended 13.6x on 2020E EBIT Margin of 2.4%
JD Finance Market Value 20,000 36% 7,200 5.0 7% Financing round in Jul 2018 (CICC Capital, CITIC Capital and Bank of China's Investment Arm) valued it at US$20bn
JD Logistics Market Value 13,500 81% 10,989 7.6 10% Financing round in Feb 2018 (Hillhouse and Sequoia) valued it at US$13.5bn
JD Cloud P/S 110 10.0x 1,099 100% 1,099 0.8 1% 10x on 2022E JD Cloud revenue; Ali Cloud's valuation estimate of $67bn (MS Research) is 33x on its 2017 revenue of $2bn
Minority Investments Market Value 2,623 1.8 2% Farfetch ($0.8), Yonghui ($0.7), Bitauto, VIPShop, Tuniu, Kingdee, Dada Nexus
Net cash 10,937 7.5 10.4% Accumulated $10.9bn of net cash by 2022E; Currently JD has net cash of $3.8bn
Market Cap and Target Price 116,725 80.4

We used sum-of-the parts to value JD as it best captures the value of each segment. For the core business, we assume breakeven for 1P
and 62% EBIT margin for 3P (blended EBIT margin of 2.4%) in 2022E and apply a 15x EV/EBIT multiple. We also apply 12x EV/EBIT on
2022E ad EBIT of $2.8bn (38% margin). These multiples are calculated based on justified multiples and relative to peers, with a conserva-
tive bias. We derive our target price of $80 (or 27% IRR) when we add together JD core’s 2022E value ($57.8/sh) and other parts of the
business in current market value (JD Finance, JD Logistics and other investments) as well as net cash accumulation through the five years.
At the current price of $24.5/sh and based on JD’s current net cash position, JD’s non-core businesses (finance/logistics/cloud/minority
investments/net cash) add up to $16.2/sh, implying JD’s core (1P/3P/advertising) is worth only $8.2/sh (or 5x earnings assuming 3% normal-
ized net margin), which we consider to be meaningfully undervalued.

Major Risks
Key man risk: JD has a dual class share structure, where Richard Liu, Chairman and CEO, controls 80% of the voting rights. The bench
after him is rather shallow. Mr. Liu was arrested in Minnesota on suspicion of criminal sexual misconduct on August 31, 2018. Although he
was not charged with any offense at the time and was released the next day, JD has lost $10bn of its market cap ($7/sh) due to concerns
over losing him if he is convicted. We think a $10bn loss in market cap more than factors in this key man risk and that further downside is
limited. Even if JD loses Mr. Liu, its shareholders might actually benefit with a more returns-focused management team, as Mr. Liu has fo-
cused more on growth and less on returns on invested capital and profitability of the company.
Intensified Competition: Major competitors such as Alibaba and Suning have large offline presences and are competing against JD
across all major categories with the “New Retail” omni-channel initiatives. New competitors such as Pinduoduo compete against JD ag-
gressively in lower-tier cities and rural China. However, we believe JD’s advantage lies in its integrated retail model with powerful econo-
mies of scale. Its logistics and distribution network, which took over a decade to build, cannot be easily replicated.
Page 19

Qorvo Inc. (NASDAQ: QRVO) - Long

Michael Wooten, CFA

Michael Wooten,
CFA ’19
Investment Thesis
Michael Wooten is a 2nd
year student at CBS and a
Qorvo Inc. (“QRVO”, or the “Company”) currently represents an attractive investment opportunity within
member of the Value In- the semiconductor sector given its unique position in radio frequency (“RF”) technologies and idiosyncratic
vesting Program. Previous- operating tailwinds which should drive increased profitability and strong cash flow generation over the next 5-
ly, he worked as an Associ- 10 years. Despite significant sector tailwinds, historical operational issues, customer concentration concerns,
ate at Corrum Capital and cyclicality fears have largely held back investor sentiment. My contrarian view is that the above factors
Management and as an have created an opportunity for a patient investor to buy a quality and improving business 50% below intrin-
Analyst at Reicon Capital. sic value at a time when strong secular growth and industry positioning provides a sufficient margin of safety.
This summer, Michael was
an intern at WEDGE Capi-
Investment Summary
tal in Charlotte.
1. Secular tailwinds in high-growth parts of the RF industry: 5G, 4G LTE, and Internet of Things
2. Idiosyncratic tailwinds: drive margins higher while winning back market share
3. Limited number of true competitors: Oligopolistic market with increasing demand for RF solutions
4. Favorable Risk/Return profile: 40-50% undervalued, 4.1x up/down ratio, and healthy balance sheet

QRVO stands to benefit from its position in high-growth segments of the complex radio frequency market,
which will be primarily driven by 5G adoption, 4G LTE expansion in China, and increased defense spending
(proliferation of gallium nitride), and to a lesser extent, IoT, advanced automotive connectivity and Infotain-
ment, and the development of Smart Homes. 5G represents a global economic catalyst for devices requiring
RF components with data rates 100x faster than 4G, extremely low latency and the capacity to support bil-
lions of networked things.

QRVO has numerous company-specific factors which should drive organic operating margin growth going
forward. These include: 1) higher utilization at its fabs after hiring a new Head of Global Operations, rational-
izing its manufacturing footprint and outsourcing non-core product components; 2) increasing wafer sizes for
its filters (6” to 8”) and gallium nitride (4” to 6”) chips which will expand gross margins; 3) revenue mix shift
to higher margin products; 4) economies of scale/operating leverage given duopolistic/oligopolistic positioning
in a growing industry; and 5) the adoption of Lean practices.

QRVO offers differentiated and integrated connectivity solutions to solve some of its customers’ most com-
plex problems. These solutions are critical functional components in their respective devices and customers
have historically shown a high willingness-to-pay for best-in-class technologies due to rising expectations from
end-consumers and pressures applied by carriers, whose brands are at risk with end-consumers. In high-end
4G smartphones, RF content has replaced the baseband (where Qualcomm dominates) as the most critical
and difficult component of phone development and it now commands premium prices.

QRVO’s early adoption and heavy investment in the development of two key technologies has created a com-
petitive advantage relative to QRVO’s closest competitor, Skyworks Solutions (“SWKS”), who does not cur-
rently have these capabilities, as new wireless devices will require exponentially more RF content that is small-
er, more powerful, more energy efficient, while operating at wider range of frequencies. These technologies
are broad acoustic wave (“BAW”) filters and gallium nitride (“GaN”); both are expected to deliver
strong growth from 5G. Based on recent design wins and consistent quality of customer feedback, I believe
QRVO has a superior technology portfolio and is well positioned to win back market share in next-generation
connectivity products.

QRVO trades at an attractive valuation based on forecasted FCF estimates and current multiples of 11-12x
NTM P/E relative to the broader semiconductor industry. This opportunity exists for three primary
reasons: 1) QRVO has suffered from execution mishaps since the 2015 merger between RF Micro Devices
and TriQuint Semiconductors and investors are skeptical about management’s ability to hit margin guidance;
2) The Company has significant customer concentration risk with approximately 36% of its revenue coming
from Apple (or known Apple suppliers), and roughly 50% of its revenue coming from its top three customers;
Page 20

Qorvo Inc. (QRVO) - Long (Continued from previous page)

and 3) the company operates in the notoriously cyclical business of mobile phones.

Company Overview
QRVO offers a broad portfolio of RF solutions, differentiated analog semiconductor technologies, deep systems-level expertise, and scale
manufacturing to customers in high-growth markets, including: smartphones and other mobile devices; defense and aerospace; Wi-Fi cus-
tomer premises equipment; cellular base stations; optical networks; automotive connectivity; and smart home applications. The Company
focuses its efforts on the most complex and fastest growing segments of the RF market. QRVO competes with SWKS and Broadcom in
the RF space.

The Company operates in two segments, Mobile Products (“MP”) and Infrastructure & Defense Products (“IDP”). MP is the Company’s
largest market (~70% revenue), in which it provides cellular RF and Wi-Fi solutions into a variety of smartphones, notebook computers,
wearables, tablets, and cellular-based applications for IoT. 5G phones are expected to have substantially higher content values than current
premium generation 4G LTE phones. IDP (~30% revenue) is a leading global supplier of RF solutions with a diverse portfolio of solutions
that “connect and protect,” crossing communications and defense applications.

IDP contains six of the Company’s seven strategic end markets: 1) Defense and Aerospace - Capabilities include satellite, radar, electron-
ic warfare and communications systems, such as found on submarines, navy battle ships, or F-35 fighter jets. The DoD has certified
QRVO’s GaN fabrication and production capabilities at Manufacturing Readiness Level 9, the highest in the industry; 2) CPE Wi-Fi; 3)
Cellular Base Stations - 5G network will require exponentially more base stations and RF solutions than previous generations; 4) Optical;
5) Automotive Connectivity - More connected device with the addition of multiple RF-based connectivity solutions such as satellite radio,
in-car infotainment, and LTE connectivity solutions; 6) Smart Home.

The Company was formed by the merger of RF Micro Devices, Inc. and TriQuint Semiconductor, Inc. in 2015 to achieve: economies of
scale; competitive advantages in manufacturing; better financial performance from ~$150M of expected cost synergies and best practices
sharing; and leveraging one another’s unique technologies to create the most comprehensive portfolio of RF solutions to mobile and infra-
structure customers. Since the merger, operating margins for the whole industry have substantially improved due in part to better supply/
demand dynamics.

*Competitor A is Skyworks and Competitor B is Broadcom

Despite having the most complete portfolio of RF technologies, BAW and GaN are expected to be QRVO’s main growth drivers. BAW
demand is expected to escalate in the future as the shift to 4G LTE and 5G will require more band width at the higher end of the spec-
trum above 2 Gigahertz, where surface acoustic wave (“SAW”) is unable to perform. GaN is used in QRVO’s IDP segment in place of
silicon when high-power and high-frequencies are required, and quality performance is more important than cost efficiency. GaN has his-
torically been used in the defense and aerospace sector (fighter jets, satellites, etc.) but is being adopted at a greater pace into other infra-
structure applications like base stations given the increased performance needs at high-power/high-frequencies due to increased data traf-

I arrived at my valuation target range of $100-$110 (40%-54% upside) through a combination of DCF scenarios and a sum of the
parts valuation based on MP & IDP’s 2020E operating incomes. In my base case, QRVO generates a 10.7% topline 5Y CAGR while through
-cycle operating margins expand from the idiosyncratic tailwinds described above. I believe this is a conservative forecast compared to the
10-15% expected industry growth rate and operating margins generated by close competitors.

The valuation implies a 9.0x 2020E EBITDA of $1.5B and 13.0x 2020E EPS of $8.35 vs. consensus $7.11. In the sum of the parts valu-
ation I assign IDP a higher 2020E EBIT multiple of 16x vs. a 10x multiple for MP given IDP’s more attractive fundamentals and sticky busi-
ness. 2020E FCFF of $860M implies a 9.3% FCFF Yield based on QRVO’s current enterprise value. The weighted average of my bear
cases ($60 target) represent a 16% decline while my bull case ($150 target) represents 110% upside to intrinsic value.
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M.A. from the Stanford One of my first tasks there Capital. They actually valued a
University Graduate was to take the Kleiner non-cookie cutter background,
School of Education. Perkins frameworks for took a chance, and hired me.
evaluating investments – Dan and Keith are very
Graham and Doddsville looking at product, market, talented investors and opened
(G&D): Scott, could you start team, and execution risks – my eyes to the opportunities
by introducing yourself, and apply them in a social in special situations.
including how you first got into context to education
investing? businesses like charter school I loved my experience at
management organizations and Litmus. Unfortunately, my
Scott Miller (SM): I majored various educational software timing, yet again, was not great
in political science at the companies. Those frameworks because I was there for the
Scott Miller University of Pennsylvania and were very helpful in organizing financial crisis. Afterwards,
graduated into a recession in a set of investing principles, Litmus didn’t need me
the early 1990s. Between my and I still use them today. anymore, and I predictably
poor job searching skills and couldn’t get a job in a post-
the economic environment, Around the same time, I also crisis hedge fund market with
the only job I could get was started investing in the public too many analysts and far too
managing a small family-run equities market, applying what few job openings.
manufacturing business. Instead I had learned at Stanford and
of doing the typical two-year what I was learning at After some outstanding
analyst program at Goldman NewSchools. I had a fair returns in my personal account
Sachs, I did four years in a amount of success investing my in 2009 and 2010, I finally said,
paper bag factory in Yonkers, personal account. I was “I can do this myself.” So, in
New York. Given my concentrated, owned the right 2011, I cobbled together ten
background, I probably have companies, and was limited partners (so it wouldn’t
more operating experience compounding at multiples of just be my personal returns
than the typical portfolio the market. I remember one anymore) and for the first four
manager. Spending four years year where I was up over 40% years ran the fund on the side
in the retail packaging industry in my personal account while while I had a day job in an
gave me a front row seat to my roommate from college, operating business that I co-
how a bad business operates – then working at a big fund, was founded. While I knew how to
one with low barriers to entry, up 15%. My numbers were invest on the side and was
cyclicality, anemic margins, and basically 3x as good as his, yet having success, I was not
commoditized products. Not he still took home $4 million raising any additional capital
the type of business I would that year – many multiples of while holding an operating job.
invest in today. what I made. That’s when I About three years ago, I
decided I wanted to work at a decided to pull back to an
I eventually helped sell the fund and invest more than my advisory role at my business
manufacturing business, which I own capital. and transitioned to make
guess was a good enough story investing my full-time focus.
to get me into Stanford At this point, I was thinking For students wondering how
Business School, where I went more about investing than my they are ever going to start a
through the value investing main job. I wanted to invest fund: if you invest in a
track with Professor Jack professionally. But even though concentrated manner with low
McDonald. After Stanford, I I had a prestigious business turnover, it is possible to form
worked for a venture degree and an outstanding a partnership on the side for
philanthropy nonprofit called personal track record, I was friends and family and develop
NewSchools Venture Fund, still coming from an operating a track record. You can even
which was founded by John role, and no fund wanted to get this data audited at a later
Doerr and Brook Byers from hire me. I reached out to two date, or at least have it in a
Kleiner Perkins. It was double former Stanford classmates – useful form for any investor
bottom line investing before it Dan Carroll and Keith who wants to do some due
was trendy. Our primary Fleischmann – who had diligence. It de-risks the
mandate was social return. recently founded Litmus process.
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G&D: What was the biggest investors have subscribed to a ownership, recurring revenue,
lesson you learned at Litmus? three-year lock up. The and operating leverage.
arrangement is ideal because
SM: I learned how important the stickiness of our capital Today, there are increasingly
it is for your investor base to allows me to buy low liquidity better tools out there that
be aligned with your investing names with confidence and make it much easier to access
strategy. At Litmus, our two minimal distractions. Many and process information.
primary LPs had very generous companies we own are devoid Communities like Manual of
liquidity terms – they could of short-term catalysts but are Ideas, SumZero, Value Investor
effectively pull their money attractive long-term Club, Corner of Berkshire and
whenever they wanted to. opportunities. I make no Fairfax, and even Seeking Alpha
When the world was blowing promises to my investors have exponentially increased
up in 2008 and 2009, and idea flow relative to when I
people were taking liquidity started. Along with my greatly
wherever they could find it, we “The ability to be expanded personal network of
became very concerned that comfortable with a incredibly talented investors,
the LPs would pull their capital. these resources give me a
This shortened our investment divergent opinion, torrent of idea flow to sift
horizon. I couldn’t present an through – far more than was
idea that I thought would work the ability to not available when I first started
in three to five years because out.
we didn’t feel like we had panic...I think you
three to five years. I started In terms of sizing, my sweet
looking for ideas that could either have those spot is between 12 and 18
work very quickly, such as qualities or you companies. If my mandate
those focused on earnings were to outperform the
beats and misses. The terms of don’t.” market by the most dramatic
our money at Litmus ultimately amount possible, I’d own one
encouraged us to play a very about short-term performance, stock. But I wouldn’t sleep at
difficult short-term game, a instead focusing on longer- night. This is still very
style I am not suited for. term returns and the power of concentrated by most
compounding. The strategy standards, but given that I
The way I set up and have and the capital base are well- generally hold names over
grown Greenhaven Road was aligned. longer time periods, I can be
informed by my reactions to extremely selective about
the Litmus experience. We G&D: Can you touch on your where I actually deploy capital.
don’t have “hot” money. investing philosophy and if
Greenhaven Road has about anything has changed since Overall, I believe that having
140 LPs, a majority of whom you’ve started investing? the right temperament is
are high net worth individuals critical for investors, and I
such as portfolio managers and SM: At my core, I’m a value don’t think that changes over
former portfolio managers. investor. When I first started, I time. The ability to be
We do no outbound loved 50-cent dollars – comfortable with a divergent
marketing, active follow-up, situations where the valuation opinion, the ability to not
capital introduction, gap may close by the dollar panic, the ability to buy more if
networking, or cold calling. declining in value – but as I’ve there is an overreaction to
People read the letters and can evolved, I’ve become more prices – I think you either have
go on our website enamored with higher quality those qualities or you don’t.
( to companies that I can hold for
fill out a form requesting more longer. I’m attracted to G&D: In addition to having
information. They choose to network effects, two-sided your traditional fund, you also
invest because the thought marketplaces, and platform manage a fund of funds. What
process and philosophy companies – these are the is the Partners Fund?
resonate. It’s a very stable modern monopolies – as well
capital base – nearly all of our as businesses with high insider SM: The Partners Fund is a
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boutique fund of funds focused time very well spent. so good for so long, and the
on emerging managers whom I fund has enough AUM.
believe are talented, G&D: Are there synergies for Nobody gets fired for investing
underappreciated, and well- idea generation from the with a billion dollar hedge fund.
positioned for long-term Partners Fund? The incentives are to keep
success. The data suggests that your job and not stick your
smaller managers outperform SM: It was a combination of a neck out for an emerging
larger managers, but the glaring opportunity that I didn’t manager. Interestingly, when
dynamics of capital allocation think others were seizing – people are investing their own
make it so that some really investing with small managers personal capital, the calculation
talented portfolio managers in a fund of funds structure – is different. For example, one
are running peanuts and, for a of my LPs runs a multi-billion
variety of reasons, investors dollar family office. He is
“I often compare
don’t want to take the headline comfortable putting his money
risk. But, ironically, that’s performance and in the fund, but not that of the
where the opportunity is. I’ll family he works for. Part of
take hungry over fat and happy quality of ideas against what we’re doing in the
any day. The Partners Fund Partners Fund is accepting
invests in managers that are AUM and generally find some of the risks that come
similar to Greenhaven Road in with smaller managers in
that they meet the following a disconnect. I don’t exchange for hopefully
criteria: an investment outsized returns. My diligence
believe allocation of
committee of one, process for the Partners Fund
concentrated holdings, assets to fund managers is also much different than that
reasonable AUM, significant of many allocators. It is less
personal investment, original is as efficient as it quantitative and more focused
thinking, and a mindset where on individual ideas and the
getting rich is not the point. should be.” entire thought process. I
would much rather have three
Now, a fund of funds focused an opportunity for years of investor letters than
on small managers is not a very diversification for my family, return statistics.
good business – charging a few and a potential source of ideas.
basis points on relatively It didn’t hurt that I thought it G&D: In general, what’s your
modest amounts of capital is would be fun and interesting. research process like from
not a great set-up. Thus, most sourcing ideas to making an
funds of funds want scale. They G&D: Why do you think the investment?
need hundreds of millions of market for allocating to funds
dollars to make the business is skewed such that larger SM: The research process
work, which means they need funds get the vast majority of depends on both the source of
to invest larger checks in the assets? the idea and how close it is to
larger managers. I didn’t launch something we’ve done in the
the Partners Fund to make SM: I often compare past – effectively how much
money on fees; I launched it to performance and quality of domain knowledge I have. In
formalize my relationship with ideas against AUM and general, I’m trying to get
select other managers and give generally find a disconnect. I comfortable with product,
my LPs access to them as well. don’t believe allocation of market, team, and execution
assets to fund managers is as risk.
For me, the Partners Fund efficient as it should be.
allows me to collaborate I look for certain attributes to
frequently with whom I Part of the challenge is if you filter ideas quickly. For
consider to be some of the are a gatekeeper, the accepted example, I prefer high insider
most promising investors of strategy is to wait until the ownership, asset-light business
my generation. If I get one statistical evidence is models (even though Fiat
good idea a year that finds its incontrovertible – when the Chrysler – which we own – is
way into our main fund, that is performance of a manager is not asset-light) recurring
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revenue, expanding margins, platform, as the 5% rate is still and have an asset-light model
and the potential for operating very competitive compared to with real barriers to entry.
leverage. alternatives. A potentially
greater than 50% increase in G&D: What are some other
The other piece is what revenue with no associated examples of under
Murray Stahl calls invisible expense increase is a great set- monetization?
companies – companies that up. However, the increase in
don’t screen well, aren't revenue won’t immediately SM: TripAdvisor only
necessarily telling their story drop to the bottom line, as monetizes somewhere around
well, and aren’t covered by Etsy will reinvest a significant 1% of their traffic. Now, some
analysts. In those cases, the portion of the revenue into of that traffic they can’t
research process is initiated by building out the demand side monetize; for example, if a
other people explaining the of the platform. traveler searches for best
idea to me. Then it becomes, places to take a hike in a
“What are the pieces I have to At the end of the day, Etsy has specific destination. But
fill in?” a very attractive, niche TripAdvisor is working hard to
business that can grow many get bookings – restaurants,
G&D: What are some themes multiples of where it is today. museums, attractions – done
you’re seeing in the market There is room in the world for directly on the site, so I think
today, and where are you an Amazon alternative. Last it’s quite likely they’ll succeed
finding opportunities? year, I needed an outfit for an in increasing monetization
rates with attractions.
SM: We’re nine years into a
bull market – it’s expensive. “The opportunity for Like Etsy, they sit between
However, I’ve found improved earnings consumers and businesses. It’s
opportunities in companies a very valuable resource, and
that are under-monetizing without massive TripAdvisor has an excellent
either assets or transactions in ecosystem with the most
some way. Under-monetized spending—taking downloaded travel app and the
companies can be attractive deepest reservoir of content
because you can have earnings what you have and related to travel. The question
growth without a significant is: can they get more booking
increase in capital spending or just monetizing it—is activity on their site? If they
SG&A. Success is dependent attractive and can improve the monetization
on making tweaks to existing of their existing traffic, I think
products or pricing. carries less execution the investment will work out
Additionally, fixing quite nicely.
monetization generally has risk.”
lower execution risk. G&D: Is under-monetization
‘80s costume party. Naturally, I the main theme in your
G&D: Your Etsy investment searched “’80s costume” on portfolio?
aligns with this under- Amazon Prime and received
monetization theme. Can you my shipment in two days. It SM: Since I have the vast
discuss your thesis there? couldn’t have been more majority of my life savings in
convenient. The only problem the fund, my interests are
SM: Prior to this year, Etsy’s was that every other guy at the highly aligned with my
commission fee has been set at party did the same thing. One investors, so I don't want to
3% of sales since the guy had the exact same only own companies that are
company’s launch. A big part of costume as me, and I under-monetizing.
the stock’s appreciation this recognized the costumes of a
year was driven by the dozen other people. I don’t I see value in diversification
company’s decision to raise its shop on Etsy for every across investment theses,
commission fee from 3% to 5% purchase, but if I want market caps, and even
with no expected decline in something special, I go there. geographies, but I do think
the number of sellers on the They operate in huge verticals under-monetization is one of
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Greenhaven Road Capital

the current main themes. The Lancias to high margin Jeeps clearly prefers asset-light
opportunity for improved and Alfa Romeos. The margins businesses as he has invested
earnings without massive on a Fiat Panda are sub-5% in media, reinsurance, and now
spending – taking what you while the margins on a Jeep startups. I don’t think Elkann
have and just monetizing it – is Wrangler – although the ultimately wants to own Fiat
attractive and carries less company doesn’t disclose them Chrysler or its parts unit
execution risk. – are probably around 35%. If because it’s not a great
you focus solely on car volume business—it’s cyclical, and over
We own Scheid Vineyards or top-line and don’t want to the cycle it should have
which is a growing sum-of-the- focus on the mix of what those relatively low returns on
parts story. It is a family- cars are going to be, you miss capital. I think spinning off the
controlled wine company a major part of the parts business makes it easier
where the land value is worth opportunity. Fiat Chrysler is to sell the entire company.
2x the share price. So, this is reducing the low margin fleet
an example of a 50-cent dollar, business by getting out of Charlie Munger discussed that
but what’s interesting is that sedans and focusing on SUVs, over a 40-year period, returns
they are transitioning from aligning themselves with start to mirror return on
selling grapes to selling their customer preferences and invested capital, regardless of
own branded products. They higher margins. They are also what you pay for the company.
have gone from a standing going to either spin off or sell I think Elkann wants to reset
start to selling 600,000 cases of their parts division. If you back what they’re invested in. He
finished goods per year. They out the parts business, you're won’t give Fiat Chrysler away,
have the capacity to produce getting the core business for but I suspect that over the
approximately two million less than 3x earnings excluding next couple of years, Elkann
cases with minimal incremental net industrial cash and the will be out of the parts
capex. If they are successful in parts business. That’s an business and will sell the core
their continued path towards attractive multiple for a auto business to another OEM
selling more branded products, growing earnings stream and a so that he can redeploy the
the economics should work business that should remain capital at higher rates. Keep in
out well for shareholders. profitable even if US new car mind – combining large OEMs
sales decline by 30%. will yield enormous savings.
G&D: Fiat Chrysler is one of
your top five positions. Can G&D: You mentioned in your G&D: You mentioned that
you walk us through your last letter the importance of you really admired late Fiat
thesis? understanding the motivations Chrysler CEO Sergio
of key actors. Can you expand Marchionne. What specifically
SM: Let me start by saying this on that in the context of Fiat did you like about him?
idea lacks some of the criteria I Chrysler?
discussed before in terms of SM: To me, Sergio was like a
recurring revenue, but it does SM: A large part of this job is five-tool player in baseball.
have high insider ownership trying to put the puzzle Those are the guys that can hit
and operating leverage. I have together – trying to for power, hit for average, run,
owned Fiat Chrysler since it understand what the key throw, and field. At Fiat, he
was just Fiat and traded only in players’ incentives and executed at the highest level.
Italy. Despite returning preferences are. Fiat Chrysler He led the acquisition of
multiples of our original is controlled by the Agnelli Chrysler without having large-
purchase price already, I still family. Their holding company, merger experience. He spun
believe it is very attractively Exor, holds 30% of the stock. off Ferrari and articulated a
valued. This is a company that vision for increasing volumes
has a portfolio of valuable John Elkann inherited the Fiat and expanding margins. He
brands yet is also a turnaround holding from his grandfather. created so much value over his
story with legs. They are However, the investments that time. Shareholders got over a
making a very accretive shift in John has initiated during his 30x return. I also found his
manufacturing capacity away time as chairman of Exor are speaking on conference calls to
from low margin Fiats and decidedly not industrial. He be operatic. He was
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enthusiastic, dismissive, and competitor was the Yellow advertisers as well as the
honest in a way that felt Pages, which was sold on lifetime value of those
authentic. You don't see that twelve-month contracts. advertisers. They have a long
very often. He would be on my Initially, Yelp matched this time runway.
Mount Rushmore of CEOs. frame and went to small
businesses saying, “Don't G&D: That’s the type of thing
G&D: Given your position in a quant model would not pick
CBS students Matthew the auto industry, do you have up on, as you discussed in your
Stevenson ‘19, Jade Hu any views on autonomous “If you’re just letter, because the historical
‘19, and Victoria Gu ‘19 vehicles? data doesn't give any indication
socializing at the 2018 investing to make that it’s occurring. How do
Value Investing Reception SM: I’m very skeptical about you evaluate a business that’s
autonomous vehicles. People money, the guy who growing intrinsic value per
have this vision that eventually share that doesn’t show up in
we are not going to own cars loves investing and is
GAAP financials?
because there are going to be
thinking about his
on-demand fleets. As it stands, SM: In general, most of the
autonomous vehicles don’t portfolio while he’s in companies we invest in have
work except for in the most progress that doesn’t
mundane conditions, such as in the shower and while necessarily show up on the
Arizona where there are no earnings line. We own a
pedestrians, snow, or rain. In he’s walking his dog is marketing automation software
additional to the technical company SharpSpring that is
challenges, there are also probably going to acquiring customers at one-
economic challenges because sixth of their lifetime value. I
kick your ass.”
the LIDAR (Light Detection think the most rational way to
and Ranging) components are operate that business is to
not currently cost-effective. advertise in the Yellow Pages. acquire customers. The ROI
Assuming you solve the Give us $3,000 or $4,000 and on marketing is fantastic. As
technical and financial issues, advertise on Yelp for the long as marketing efficiency
there are still regulatory year.” That's a fairly big ask does not deteriorate, they
hurdles, consumer depending on the size of the should acquire, acquire,
preferences, and execution business. Eventually, Yelp acquire. In fact, I would
risk surrounding production. started testing month-to- borrow money to acquire
Last year, the former head of month and even day-to-day customers, which is what they
Waymo (Alphabet’s advertising and found that eventually did. However, this
autonomous driving subsidiary) shorter, more flexible time company will screen poorly on
forecasted no legal periods returned greater traditional value metrics.
autonomous level-five vehicles customer lifetime value than Earnings? They have none.
before 2030. annual contracts. This Book value? Their main asset is
effectively reduced the cost their customer base, which is
I’m currently teaching my 16- and risk of a trial period and, not valued on the books at all.
year-old daughter how to not surprisingly, more But, there is enormous value in
drive. Believe me, I wish we businesses turned to Yelp. the customer base if their
had fully autonomous today. They knew that churn would lifetime values are anywhere
Fiat Chrysler will be sold long go up, but bet that would close to right. With these
before the autonomous fleets ultimately be outweighed by technology companies, I end
are swarming our streets. the increased number of up looking more at customer
advertisers. Yelp has also retention rates, net dollar
G&D: Can you run through started rolling out a non-term retention, customer acquisition
your Yelp thesis? model this year. As costs, and growth rates.
penetration increases, I think
SM: The thesis on Yelp is there is an ongoing G&D: I notice you’ve been a
straightforward. When Yelp opportunity to radically lot more active on the long
started, their primary increase both the number of side in recent years. How do
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Greenhaven Road Capital

you allocate your time, in important thing to do is to
terms of idea sourcing, invest your personal account.
between long ideas and short You learn far more from
ideas? Is there a systemic owning stocks than anything
reason why you’re not as else.
involved on the short side
recently? I would also say, quite frankly,
that there are higher callings in
SM: We’ve historically had a the world. If investing doesn’t
long bias. Our longs can be really compel you and keep
15%+ (as a percentage of the you up at night and excite you,
portfolio) positions. For an go do something else. There
individual company short, we are a lot of ways to make
tend to take a 1% or 2% money. If you’re just investing
position. The upside on a long to make money, the guy who
can hopefully be 5x, while the loves investing and is thinking
upside on a short is a double – about his portfolio while he’s
at best – if it goes to zero. We in the shower and while he’s
end up spending a lot more walking the dog is probably
time on the longs. I’m not going to kick your ass. Only do
trying to be market neutral. it if it absorbs and compels
G&D: Do you short indices? If
yes, can you talk about why G&D: Thank you so much for
and how? your time.

SM: There are a couple

reasons why we may short
indices. Sometimes we want to
take risk off without triggering
a tax event. We are heavily
long-biased and own many
positions with large embedded
gains. It’s not a perfect hedge,
but shorting indices versus
selling and going to cash allows
me to sleep better. We don’t
take on a lot of leverage – we
might be 110% long and 12%
short. It’s pretty slim; it’s not
our core business.

G&D: Any advice for students

who are trying to get into the
investment industry? How
would you suggest they
develop their investment

SM: In my experience, the

hiring process is very
idiosyncratic, so I would not
read too much into inevitable
rejection. If you think you
really like investing, the most
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Wall Street’s GE Bear

(Continued from page 1)

the $30s. After the stock the shackles are off.” The bulls EPS through cost cuts, capital
dropped by more than were saying that the deployment, and end market
60%, some Wall Street divestiture was going to growth. The stock was in the
commentators labeled the unmask all the great things high $20s at the time, and the
call “one of the greatest about GE Industrial. bull case applied a 20x P/E
stock calls of all time.” multiple to $2 in EPS to get to
Note: This interview We went on restriction $40. What we noticed was the
occurred on September 5th, because of the deal. You're not industrial cash flow was not
2018. allowed to do much when growing as fast as the earnings
you’re on restriction because suggested.
Graham & Doddsville of the wall between banking
(G&D): In May 2016, you and research, but you can At that time, our tagline was,
Steve Tusa went from having a No Rating watch the stock and you “Estimates are too high and
on General Electric to an continue to maintain a model. cash is too low.” We basically
Underweight rating. Can you You certainly don't send that thought that their EPS would
talk about your research model out, and you certainly come in closer to $1.80 than
process and what prompted don't talk to clients, especially $2, of which cash flow would
the call? about things other than pure be closer to $1.50-$1.60. That
facts. But it was instructive may not sound like a big miss,
Steve Tusa (ST): Absolutely. being on the sidelines and just but in the context of my
I got the senior position [at JP watching for the better part of coverage universe, where a lot
Morgan] in 2005, and we have a year. of companies were beating
been covering GE since then. numbers and many had above
We went on restriction After GE unloaded GE Capital, 100% conversion of cash flow
because JP Morgan Investment the company started talking a on earnings, we thought that
Bank helped them divest most lot about their digital platform either the stock was dead
of GE Capital, so that's why we – that’s when IOT started to money on a modest earning
didn't have a rating in 2016. emerge on the scene, and GE miss, or it could drop by 10-
Actually, right before they was making a big pitch around 20% on a more significant
announced the GE Capital IOT – which many investors earnings miss.
divestiture, we put out a were buying into. Since we
presentation that was one of were on the sidelines, we got Our process for GE was not
our “Where we could be to really step back and absorb typical for most of the Street.
wrong” reports. The report what was going on with related Our initiation report was 200
basically said, “Look, we're expectations. Yes, they were pages because a) a lot had
negative today. We understand losing a lot of earnings and happened between the time
the stock is cheap. We’re cash flow with GE Capital, but we went on restriction and the
trying to get positive, but here they said they were going to time we came out
are the reasons why we can’t.” backfill some of those earnings Underweight, and b) when
and cash flow with buybacks making a call like this, it’s
A few weeks after we put out and capital deployment, important to be extremely
that report, GE announces the meaning less dilution, while open and honest with clients
GE Capital transaction. The their positioning in IoT would and the company. Lay it all out
stock goes up a lot because drive a higher multiple. there. Show them your work
the negative thesis on GE in so they can agree or disagree.
the past was that they have a What we saw was a growing
big finance arm that nobody discrepancy between a) That 200-page report was just
understands, which is a big earnings expectations and what the start. You start by pulling a
risk, and therefore the stock the end markets were little bit of string, but soon you
deserves a significant discount suggesting, and b) earnings try to pull as much as you can.
on earnings. That had been the expectations and cash The more you pull that string,
drag on GE forever. When generation. Back then the big the more your knowledge base
they announced they were expectation was $2 in earnings enables you to understand data
getting out of GE Capital, the per share (EPS), and everybody points and news flow and put
market reaction was, “Okay, believed GE could get to $2 in them in the proper context.
(Continued on page 29)
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Wall Street’s GE Bear

For example, we had a couple our research and cut his price people, “No! Here’s how you
meetings with financial services target by 20%. The key is to be walk to my free cash flow
people regarding GE Capital out in front of those guys. numbers.” I wasn’t even talking
and its downturn, and I could about a dramatically
tell right away that its scope G&D: Was the rest of the differentiated view, I was just
was beyond me. But I had Street bullish when you came explaining the numbers and
enough of a background to out with that first Underweight reporting structure. I mean,
know exactly where to dig and rating in May 2016? even as recently as last year,
go deep, and soon enough I there were competitor reports
became like a financial services ST: Everybody was, yeah. showing historical free cash
analyst. With GE and the size flow conversion that included a
of its legacy financial services G&D: What kind of pushback GE Capital dividend.
business, mastery of the did you get?
balance sheet becomes crucial; The other big pushback was
you have to understand the ST: The pushback was that I was too negative on the
complexity of how it all fits interesting because there were oil and gas market. Looking
together. As you go through a lot of generalists in the stock, back, that was probably the
the process – we’ve written and generalists don't tend to easiest layup in this whole
1500 pages on GE in the last dive as deep as the analysts do. analysis. The rest of the stuff
two years – it allows you to Our initial call was on cash was a little more nuanced.
recognize the next step of the
process because you’ve done “Understand that this G&D: When a company is
the work. But again, the point cutting costs, how can you tell
is that we didn’t know is a very long game. if they have cut too far?
everything in 2016. You begin
to see the whole picture as Nothing comes in the ST: You have to know the
you work through it, and this business well enough to be in
time, probably the biggest first several years. I touch with the channel.
swing factor has been the think it takes six years, Feedback from the channel will
Power business. Here, because either reveal a dip in service
of the work we’ve done, almost a full cycle, for quality or a lack of buzz
executives from GE’s around new products. Often,
competitors like Mitsubishi somebody to really you’ll see it in growth rates
Heavy and Siemens will read versus peers, sales per
our work, and they actually learn the business.” employee versus industry-
start emailing and calling us to specific peers, and SG&A as a
talk about the industry. flow. When GE sold GE percentage of sales. GE was
Capital, they sent all the cash pitching SG&A reductions, but
The research builds on itself in from those sales up to the their SG&A was around 12%
so many different ways. The parent as a dividend, and their while peers were around 20%,
key to it all is learning; if you're cash flow guidance included and a big part of SG&A was
still learning something, you those dividends. If you were pension expenses which is not
keep going. You don't know just looking at Bloomberg you really something you can cut.
when it's going to pay off, but would’ve seen about $25 Again, if you know the
the depth always pays off at billion dollars of free cash flow, channels you're going to hear
some point. For example, a but that included the massive feedback regarding the quality
bunch of Power data points dividends from GE Capital. of the service, and you can
have come out in just the last Inherently, that was a one-time judge from that whether they
three or four months, and item. So, if you were a need to spend more money.
we've written three reports in generalist and you were
the last three months about looking at GE on Bloomberg, G&D: What were Jeff
how Power is going to get you would’ve checked the box Immelt’s major missteps before
worse before it gets better. on free cash flow and said, he stepped down?
And just today a competitor “Yeah. Okay. Fine.” I
came out essentially reiterating remember explaining to ST: I think everybody would
(Continued on page 30)
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Wall Street’s GE Bear

agree that when you come in about GE’s lack of external company with structural
as a new CEO and replace a hires. It’s hard to change a overcapacity, mostly in Power,
legend like Jack Welch, it's culture with people that have oil and gas, and
very hard to walk the fine line been there for decades. I’m transportation.” Can you
of not “resetting.” I don’t think skeptical that they can change expand on that?
there was a real reset. He quickly without some fresh
must have known that Welch’s blood. Now, 30% of the board ST: At GE’s peak in 2000 –
performance was is new, so they've got fresh when Jeff took over – GE was
unsustainable. A wise man blood there. And I really trading at around 40x earnings.
once said that being CEO of admire Larry Culp – I think That was clearly unsustainable.
GE is like being a head of state. he's the best CEO our sector How do you take a $150
It’s a very hard, complex job has ever had – but I think it billion company and grow it
with many different takes more than a couple of into something that can
constituencies. board members to change the actually sustain that multiple?
culture of a large organization. They started moving further
I think one of the big issues That's going to be a long, long out on the risk curve by
was the culture. Most people process. placing bigger bets in very
who worked there will tell you visible ways. Typically, those
that bad news was not G&D: Didn’t they reduce the bigger bids are going to be
tolerated, and if bad news size of the board too? more competitive. GE went
were to arise, they would try into Saudi Arabia to try to help
to do something to make it ST: Yes, they reduced the size them build their Power
look better. For example, GE’s of the board as well. It’s hard infrastructure, but Mitsubishi
Alstom purchase, as part of the to make quick decisions with a and Siemens were there in the
Power business, was not a board of 18 people. The old same conference room,
good strategic decision – $10.5 bidding for the same projects.
billion of cash they really could “The point is that GE GE winds up announcing a $5
have used is currently billion deal to build the facility,
generating negative cash flow. went everywhere to and they hire 700 locals to get
Same thing, quite frankly, with the deal done.
their Baker Hughes acquisition. grow revenue just to
Baker Hughes cost them $7 Now what happens to that
billion of cash to try to patch justify the multiple. business? If there’s no follow-
up the oil and gas segment as on order in the next two
that market collapsed on them.
When you do that, you years, or if there are a bunch
I think those moves are move further and of follow-on orders followed
probably a result of the by a collapse in oil, you know
cultural mindset. I wasn't further out on the risk that they have set up shop for
covering the company when 50 years but ultimately
Jack Welch was there, but the curve.” probably only have enough to
culture probably needed to fill up half of it. You have to go
change over time. Their new board had some very through each press release and
management has acknowledged legendary people on it, but I understand what the makeup
that. They’re working to think the new board is much of each deal is, and then you
change it, but it’s a hard more lean and agile. have to watch to make sure
problem to address with a there are follow-on orders,
300,000 employee company, G&D: Here’s a quote from and you have to track the
and it's especially hard to one of your reports: “Put returns over time. The Middle
address over a nine-month simply, poorly timed East was 35% of demand for
period when you are investments to catch up in gas turbines for several years,
constantly putting out fires like emerging markets, optimistic while GE is sitting there with
internally-sourced CEO John growth assumptions for this plan to build and service
Flannery was. resource-rich countries, and a gas turbines that suddenly
corporate imperative for aren't being ordered.
I've been vocal in our research market share have left the Again, you have to track
(Continued on page 31)
Page 31

Wall Street’s GE Bear

everything. Everybody is businesses. They’re leaders, ST: Yes, 100%. They’re a very
probably bullish when that and they're optimistic people good marketing company –
press release comes out. But by nature. But you’re in a seat ecomagination is brilliant, right?
you put that in the back of to take a differentiated view, Those leading digital industrial
your mind and say, “Saudi and if the numbers show you TV commercials are great.
Arabia, is that really something different, go with it. Outside of marketing, you
sustainable? Is it dependent on Don't worry about what other have this financial beast with
oil prices?” And ultimately, people are saying or what's three different balance sheets.
when oil prices go down and driving the stock’s initial When you combine
people are worried about return. If your thesis is right, complexity and marketing – I
selling Schlumberger, you think the stock is going to go where don’t think we'll ever see this
in the back of your mind, it's supposed to go. confluence again. Look at
“Wait a second, didn’t GE have Apple – they’re not that
to build that plant and book When you have a better base complex, right? You just need
that order in Saudi Arabia? of knowledge than anyone else, to predict how many iPhones
How much demand was that go all in and be as vocal as they will sell. Stock going down
for them?” You start possible. I don't want to in a company the scale of GE –
connecting the dots and overstate the drama, but that's this has been a confluence that
realize, “Wow! That’s probably it. And by the way, GE’s stock I don’t think I’ll see again in my
not going to end up looking didn't go down until about one lifetime.
like a good investment.” And year into the call. But by the
sure enough, there was an time something finally started G&D: How do you prepare
announcement in the press happening in the second for a media appearance on
two months ago that Saudi quarter of last year, we had CNBC where you only have
Arabia is now bidding out the already developed a honed-in three minutes to deliver your
service work on GE’s gas view of the power market and pitch? What is your mindset?
turbines in the Kingdom, which were able to see through the
is the more profitable part. noise. When they made ST: Well, I’m supposed to
cautious comments on the wear a suit and tie, but I always
The point is that GE went second quarter 2017 call, we change into a golf shirt and
everywhere to grow revenue knew right away what the issue vest. Just kidding. No, I just
just to justify the multiple. was. I remember pinging my make sure I have the talking
When you do that, you move associate Rajat, saying, “Wow, points in my head. When you
further and further out on the this is it. It’s happening.” talk about something that you
risk curve. Meanwhile, most of the people know, you don't need to
recommending the stock prepare. This job is a lifestyle.
G&D: What are your big probably just asked the It doesn't consume me all the
takeaways from covering GE company about it and were time, because I love my family
for the past two years? told something like, “Well, and there are other things I
we’re still in good shape, and like to do, but it does fill the
ST: Read everything you can. this is temporary.” But we gaps. I was a radio host in
Know the balance sheet and knew exactly what was college and like to talk, so that
the cash flow statement inside happening. Again, we had read also helps.
and out. Most companies are through utility filings to figure
not this complex and don’t out what they were doing with I interviewed at another bank a
have this many moving parts. their Power upgrades and how long time ago, and the product
GE’s 10-K is 270 pages, the accounting works. manager there had a great
whereas most 10-Ks are closer Fundamental research – in- saying: “Make ‘em think, make
to 100 pages. Talk to depth fundamental research – ‘em laugh, make ‘em money.” I
everybody in the channel. absolutely works. think that’s the key to this job.
Learn about the business and There are a lot of people who
do your own work. G&D: Do you think GE was are fun who you wouldn’t
ripe for a differentiated view mind grabbing a beer with.
Management teams are going because of how complex the Then there are some people
to be bullish about their company was? who do really good work who
(Continued on page 32)
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Wall Street’s GE Bear

can make you think. But there managers, all that stuff. I really job in front of him is nothing
are very few who can really do believe though, that if you like the one he had at
make people money. work hard for a long period of Danaher. That was all about
time in this business, it’s how effective he was at
But if you can do all three of worthwhile. deploying an abundance of
those? That’s what I try to do. available cash from operations
I didn’t go to an Ivy League and the balance sheet, as well
school which I think gave me a
“When they made as building on good businesses
little bit of a chip on my cautious comments on and a great operating culture.
shoulder. That kind of drives This is the exact opposite –
you to work harder than the the second quarter essentially a work out situation
other guy. And I do believe with 50% of the businesses
this GE call has been about 2017 call, we knew highly challenged and
hard work. It’s not about me generating negative cash flow,
being brilliant – you should see right away what the and a highly levered balance
how I handle my personal sheet that needs to be
financial statements. It’s not
issue was… unwound from years of
pretty. Meanwhile, most of cultural financial engineering.

G&D: We usually close by the people Once again, the Street is

asking for general advice for getting bullish simply because
MBAs heading into the recommending the there’s a new CEO. We
investment management haven’t even seen how bad the
stock probably just numbers are, and we have to
note that GE further cut
asked the company already-low guidance when
ST: Wow. Pray that fees
stabilize. Just kidding, don't and were told announcing the new CEO.
write that. I think intellectual Weak free cash flow and high
curiosity is key, because that’s something like, “Well, leverage is a bad combination
ultimately what will drive you. that we think will ultimately
Be intellectually curious, but we’re still in good resolve itself in a dilutive way
also understand that this is a for shareholders. The new
very long game. Nothing shape, and this is CEO is a start to the healing
comes in the first several process, but unwinding this
temporary.” financially engineered
years. I think it takes six years,
almost a full cycle, for ecosystem is going to require
somebody to really learn the [Editor’s Note: The initial more than just cost cuts. It’s
business. I got the senior job at interview occurred on going to take time, and
JP Morgan in 2005 and have September 5th, 2018, probably much more capital. In
been covering this group since before Larry Culp was the end, we think things get
1998. It would have been very named CEO. The following materially worse before getting
hard to make a call like this in comments were provided better.
2008. So, don’t sacrifice the to G&D on October 15th.]
long term for the short term, G&D: Thank you.
and build a strong base of G&D: What are your
knowledge so that when the thoughts on the recent
time does come, you’re development of Larry Culp
dangerous. I can look back and replacing John Flannery as GE
think about all the different CEO?
paths I could have taken, but
this is the only path that would ST: As I highlighted back in
have led me to this call. It September, Larry Culp is one
comes down to your body of of the best CEOs ever in our
knowledge, the team you build, sector. However, this is a big,
the support from your complex ship to turn, and the
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Contact Us:
Graham & Doddsville Editors 2018-2019
Ryder Cleary ’19
Ryder is a second-year MBA student. During the summer, he worked in Equity Re-
search at JP Morgan. Prior to Columbia, he was a Captain in the Infantry branch of
the US Army. Ryder graduated from the United States Military Academy at West
Point with a BS in Systems Engineering with a mathematics concentration. He can be
reached at

Gregory Roberson, Esq. ’19

Gregory is a second-year MBA student and a member of Columbia Business School’s
Value Investing Program. During the summer, he worked in the Investment Banking
Division at Goldman Sachs & Co. LLC. Prior to Columbia, he worked as a corporate
attorney specializing in mergers & acquisitions and corporate finance. Gregory stud-
ied finance and economics at the University of Cincinnati and received both his JD
and LLM (Taxation) from Georgetown University Law Center. He can be reached at

David Zheng ’19

David is a second-year MBA student. He spent last fall through this summer working
as a Consumer Analyst at Balyasny Asset Management. Prior to Columbia, he was a
Portfolio Manager at Peak6 Investments focused on single-stock volatility and special
situations. David studied economics, political science, and business institutions at
Northwestern University. He can be reached at