Insight: Day Follows Night

ValueInvestor
November 30, 2020
The Leading Authority on Value Investing

INSIGHT
Day Follows Night Inside this Issue
Ben Preston readily allows that there are times in a market cycle when a passive FEATURES
approach to equity investing can make sense. Now, he says, is not one of them. Interview: Ben Preston
I
t's fine with Ben Preston that it’s hard to Considering full cycles the market
INVESTOR INSIGHT might ignore to find value today in
categorize Orbis Investments' basic ap-
such stocks as Anthem, Autohome,
proach after a cursory look at one of its
Vestas and Sberbank. PAGE 2 »
portfolios. “It doesn’t matter to us whether
our clients get their returns from dividends, Interview: Travis Cocke
or earnings growth, or some kind of valua- Seeing upside where others expect
tion re-rating,” he says. “They’re all equally too little, including Nintendo, Avid,
ranked when judgement day happens.” Louisiana-Pacific, Rimini Street and
Extreme Networks. PAGE 10 »
That open-mindedness has paid off hand-
somely for investors in Orbis’ $21.9 billion Strategy: Russell Napier
(assets) Global Equity strategy, of which Contemplating the longer-term
Preston is one of five co-managers. Since its consequences of governmental
inception in 1990 the strategy has earned a monetary and fiscal responses to the
net annualized 11.2%, vs. 6.5% for the MSCI Ben Preston global pandemic. PAGE 19 »
Orbis Investments
World Index. Casting a wide net, he and his
Investment Focus: Seeks companies Uncovering Value: Equinor
colleagues are finding unrecognized value to-
facing any number of temporary headwinds A suggestion for those interested
day in such diverse areas as U.S. health insur- at times when the market appears to be- in braving the elements in a sector
ance, European wind energy, Chinese online lieve those headwinds are here to stay. many choose to avoid. PAGE 22 »
services and Russian banking. See page 2
Uncovering Risk: Five Below
Pondering the downside for an
Changing the Narrative unlikely market darling in bricks-
and-mortar retail. PAGE 23 »
In today's macro-driven equity market, Travis Cocke is finding it an opportune
time, as he puts it, to be “looking under the covers of some very cheap stocks.” INVESTMENT HIGHLIGHTS
W
hile crowd-following tends not INVESTMENT SNAPSHOTS PAGE
INVESTOR INSIGHT to be in any value investor’s Anthem 5
playbook, Voss Capital’s Travis Autohome 7

Cocke would seem to have a particular aver- Avid Technology 14
sion. “We generally want expectations for Equinor 22
our companies to be so bad that reality has Extreme Networks 15
a low hurdle to clear to create the types of Five Below 23
surprises that move stock prices,” he says. Louisiana-Pacific 16
Low expectations have translated into ex-
Nintendo 13
cellent returns for his long/short Voss Value
Rimini Street 17
Fund, which since inception in October
Sberbank 8
2011 has earned a net annualized 15.6%, vs.
Vestas Wind Systems 6
11.6% for the Russell 2000 Index. Focusing
Travis Cocke on businesses that are going through signifi-
Voss Capital Other companies in this issue:
cant transitions, he and colleague Jon Hook BMW, KB Financial, NetEase, Ørsted,
Investment Focus: Seeks companies are finding opportunity today in such areas
whose share valuations indicate that an Par Technology, Taiwan Semiconductor,
ongoing transition for the better is unap- as videogames, digital media production, net- Thunderbird Entertainment, WD-40
preciated or misunderstood by the market. working systems, software support and wood
products. See page 10
November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 1

I N V E S T O R I N S I G H T : Ben Preston
Investor Insight: Ben Preston

Ben Preston of Orbis Investments describes how growth and value coexist logically in the firm's global portfolio, where
geographically he sees incremental opportunity and risk, how his views on the auto industry have evolved, how he's try-
ing to get better at selling, and why he sees mispriced value in Anthem, Vestas Wind Systems, Autohome and Sberbank.
We’re finding this increasingly to be the matter to us where our clients get their re-
case with people we interview, but your turns. To us it makes perfect sense to own
portfolio has both what might be consid- a healthy Korean bank like KB Financial
ered value and growth stocks. Are there [Seoul: 105560] that is priced at 0.4x book
common threads between them to explain value at the same time we own something
why they attract your interest? like Vestas Wind Systems [Copenhagen:
VWS], which makes wind turbines and
Ben Preston: I worked closely with our has a high P/E but also has what we think
founder Allan Gray when I first joined the is the potential to be dramatically bigger
firm. He believed all businesses are cyclical and more profitable 10 years from now.
to some extent and he’d describe the cycle Where we find it hard is with some of
in very simple terms. When things are go- the FAANGs, which are great companies Ben Preston
ing well, money floods into new capacity, and which have obviously created a tre-
new capacity creates excess, excess causes mendous amount of shareholder value. Making It Right
prices to fall, and prices falling causes For those you pay very high multiples for
After graduating in 1998 with a degree in
profits to fall. That goes on for a while un- earnings that are already very high, put-
Mathematical Sciences from Oxford, Ben
til you get the exact opposite. People pull ting the wind in your face on both metrics.
Preston learned quickly that the first step
money out, management teams get more Is Apple going to go from making $100
on his career path, investment banking,
conservative, conditions for undersupply billion to $1 trillion? Maybe, but it’s a lot
wasn’t for him. “I remember working on
are created, prices rise and that usually harder for Apple to grow ten-fold from
an M&A deal in which Day Runner, which
translates into rising company earnings. here versus something like Vestas which is
made personal organizers, bought Filo-
So one common thread is often some sort at a very different part of its cycle.
fax, the ring-binder company,” he says. “It
of naturally recurring economic cycle.
wasn’t obvious there was much of a future
The second common thread is that the On that subject, why does a technology
in either of those businesses, but we sold
cycle is frequently exaggerated on both company seemingly firing on all cylin-
ends by investor sentiment. If you’re in it ders like Taiwan Semiconductor [Taiwan: the deal anyway. It didn’t take long for me
for the short term, as most investors are, 2330] make the grade for you? to realize that was not my life’s calling.”
you will be quick to jump on the band-
He found that calling in joining Orbis In-
wagon when things are going well and BP: One of the many things that has
vestments in 2000, where from London he
quick to jump off when they aren’t. As stayed with me from Warren Buffett is
now leads the firm’s global sector invest-
human beings we all suffer from recency his description of four questions he asks
ment team and serves as a co-manager of
bias. Most sell-side research and other in- about any company. Can I understand it?
its $22 billion (assets) Global Equity strat-
vestment models look back maybe two or Does it have a sustainable competitive ad-
egy. He values the firm's client-first culture
three years in the past and project two or vantage? Is it run by a management team I
– it’s known, for example, for fee structures
three years in the future. That encompass- respect, trust and admire? Is it reasonably
that provide symmetrical refunds during
es maybe five or six years of a company’s priced? If you can say yes to all of those
periods of subsequent underperformance
investment life, which is not an economic four things, don’t overcomplicate it. With
– it’s willingness to give responsibility ear-
cycle. Taking a much longer-term view al- TSMC, the semiconductor industry has
ly, and its focus on individual accountabil-
lows us to consider the full cycle and to consolidated over time to the point where
ity. “From the beginning I felt I could make
take advantage when investor sentiment is there are only two or three companies that
a difference and people listened to what I
out of touch with the fundamentals. That’s can do what it does. Its competitive advan-
thought, which was quite empowering,” he
the bedrock of our approach. tages from scale and expertise are off the
says. “At the same time, there’s nowhere
As for owning both value and growth charts and are manifested in market share
to hide if something goes wrong. But we
stocks, we get that question often, some- and performance. Management runs the
times with a hint of frustration, as if to company for the long term, putting clients measure it over long-enough time frames
say: “Make your mind up already!” We try first, which we think combined with the that you feel the responsibility, and have
to be as holistic as we can and it doesn’t long-term growth potential in the indus- the opportunity, to make it right.”

try translates into considerable long-term ogy. It's not as dominant as Taiwan Semi- from the virtual one because one of these
growth in the company’s earnings power. conductor is in its niche, but it has a good vaccines turns out to be as good as we
With all that you can buy the shares for, long-term record of profitability, a long- hope, again, you want to be in a different
give or take, 20x forward earnings. Put term oriented management, and is the quadrant. There are times when invest-
that next to other great companies with leader in electric cars in Europe. But the ing passively is great, with lower fees and
great competitive advantages and attrac- stock today trades at a 20% discount to guaranteed index performance – the last
tive end markets and we think the math book value. In terms of cars sold, BMW ten years have been brilliant for that. But
works very much in our favor. outsells Tesla by 4:1, but in terms of stock there are also times in the cycle when that
As long-term shareholders we want to market valuation Tesla outsells BMW by can be dangerous and having someone
let companies do a lot of the heavy lifting something like 8:1. That doesn’t make a who’s thinking consciously about value
for us, reinvesting their own earnings at lot of sense to us. and making active decisions can be in your
much better rates than we could. We want favor. We’d argue that’s the case today.
to pay no more than reasonable prices for I’d also mention that this is a common
them, but we care a lot about business ON SURE THINGS: theme throughout history. There’s always
quality and structural competitive advan- a “hot” area that everyone wants to own.
tages that are evidenced by a good historic
There's always a "hot" area In the 1970s it was gold. Then it was Ja-
track record of profitability. If we’re right everyone wants to own. His- pan in the 1980s. Then it was Nasdaq in
about the sustainability of all that, it helps the 90s. Then in the 2000s it was mate-
tory has not looked kindly on
tilt the odds in our favor of it working out. rials, as China was buying up everything
the last to arrive at the party. and was expected to continue to do so for-
We spoke about opportunities you were ever. Now it’s all about digital technology
finding in the auto sector a year ago [VII, and disruption. The problem is that the
December 31, 2019]. One pandemic later, How in general would you characterize big winners only become obvious toward
have your views changed at all there? the investment opportunity set today? the end of each episode. History has not
looked kindly on those who are the last to
BP: What attracted us originally was the BP: We actually think it’s quite exciting arrive at the party.
cycle turning down, first in China and for an active investor. We did an analysis
then globally, which resulted in extremely recently dividing the equity world into Are there any notable tilts in the geo-
low share valuations relative to our esti- four quadrants, with value versus growth graphic breakdown of your global portfo-
mates of long-term earnings power. Even on one axis and cyclical versus defensive lio today?
stress testing against a financial-crisis type on the other. Our global portfolio is pretty
outcome, we were able to find what we well represented across all four quadrants, BP: For some time we have shied away
considered good value. Of course, March which isn’t by any grand design but just from the relatively high valuations in the
of this year blew the financial crisis out of reflects where we’re finding value. The U.S. and this has been costly. We’ve been
the water in terms of the contraction in market has been kind in allowing us to overweight in China, in large part because
car demand. That’s been a bit sobering. build a portfolio where we don’t have to China has such an artificially low weight
We still see a lot of opportunity in the pin our hopes on any one outlook, which in the benchmark, but also because we’ve
sector, but I would say we’re probably is convenient at a time when it’s very dif- found good value in what we think are
expecting more of a divergence than be- ficult to know what the heck is going to excellent growing companies like Tencent
fore in the fortunes of ultimate winners happen next. (through Naspers [Johannesburg: NPN]),
and losers. In the past, auto companies Compare that portfolio composition NetEase [Hong Kong: 9999] and Auto-
could fall back on their status as national with the S&P 500, which is roughly 50% home [ATHM].
champions to ride out the tough times, in the defensive growth quadrant, where More recently we’ve been shifting some
but that’s getting harder in a world where the FAANGs live. People think of an index capital toward Europe, which has been
scale and next-generation technology is as a broad, diverse portfolio and that ac- hit the hardest by Covid. Asia has for the
increasingly important. Even more than tive investors are much more focused on most part controlled the pandemic well,
before, the strong will get stronger and the one or two basic bets. To our mind, it’s the while the U.S. has, so to say, kind of not
weak will get weaker. other way around today – the benchmark let it get in the way. But Europe, including
As a result, we've focused on compa- is what’s lopsided. If you see even a little the U.K., has been slammed economically.
nies like BMW [Frankfurt: BMW], which contraction in the historically wide diver- If you can look beyond that we think it’s
we believe has the brand, scale and tech- gence between value and growth, then creating incremental opportunity in com-
nology to succeed at whatever rate the that’s against you betting on the index. If panies like Vestas, BMW and selected Eu-
world adopts electric drivetrain technol- you see a little return to the real economy ropean banks.

During the throes of the pandemic mar- things is a leading online gaming platform
ket decline, you wrote: “In nearly two de- in China. Most of the upside in its stock
cades at Orbis, this is the third major bear has been from growth in its fundamental
market that I’ve seen. Of all the lessons performance, so the gap between price
I’ve learned, the single most important and our updated estimates of value hasn’t
one is to stay relentlessly focused on the narrowed in a way that would make us
long term. It also happens to be the easi- want to sell.
est thing to say when everything is going We’re also trying to do a better job dis-
well, and the hardest thing to actually do tinguishing between the traditional cycli-
when it really matters.” Why was that top cal company that goes up and down and
of mind then? the secular growth one that is really a big
long-term winner – and being very careful
BP: One of my fellow portfolio managers when considering selling those that may fit
likes to say that when you’re feeling sea- the latter description.
sick, the best thing to do is to focus on the
horizon. That’s hard to do when it feels Describe the bright prospects you see
like the world is crashing down around ahead for American managed-care com-
you, but it’s so important to stay disci- pany Anthem [ANTM].
plined. In March of this year the question
I kept in my mind and the advice I gave BP: Managed-care organizations like An-
to our team was: “What can we buy to- them and UnitedHealth [UNH], which
day that our clients will look back on and we also own, play a critical role in what
thank us profusely for in ten years’ time?” is a complex U.S. healthcare system. They
manage and administer networks of doc-
Value-focused investors tend to be better tors, hospitals and pharmacies, while also
at investing with a long-term focus than designing and administering health-benefit
actually sticking around to fully benefit
from their thesis playing out.
plans for customers. Connecting that mas-
sive network of healthcare suppliers with BRAINSTORM
BP: I’m sorry to say we’re guilty of that
the massive number of healthcare con-
sumers is an essential function that only
WITH THE BEST
in spades. We’ve specifically analyzed this a handful of companies can do. We’d also
and have found that we’re quite good at argue the large-scale MCOs play a leading
picking stocks that are long-term win- role in driving innovation in the system, Through in-depth interviews,
ners, but that we often would have done achieving better outcomes while also re- Value Investor Insight
much better if we’d held on to them lon-
ger. There have been times over the past
ducing costs for the people they protect.
This has translated into a very good
spotlights the strategies and
ten years we’ve found Amazon attractive, business for a company like Anthem. With current ideas of today’s
for example, and we’ve always been right tailwinds from an aging population, ris- most-successful investors.
to buy it and then been wrong to sell it. ing incomes, an increase in the number of
Peter Lynch called it watering the weeds healthcare products and services to buy,
and cutting the flowers and we’ve done and from more people having health cov- See why it’s one of the
that more than we’d like. erage, Anthem’s earnings per share since best “value” investments
What are we doing about it? Awareness 2000 has grown 16% per annum, vs. 6% you can make!
of the problem, we hope, is part of the an- for the S&P 500 in aggregate. The stock
swer. Making sure we’re very disciplined since its IPO in October 2001 is up by a
in updating our numbers and expected re- factor of 15, more than 3x the increase in Sign up now for a
turns is part of the answer. We also want to the S&P 500.
do a better job of distinguishing between We generally believe that the long-term
one-year subscription
a stock’s rise due to growth in the funda- growth drivers are still there. The U.S. pop-
mentals versus an increase in valuation ulation continues to age, which unavoid-
multiple. One stock we’ve managed to ably increases the demand for healthcare.
own to our clients' benefit for more than We believe the trend of expanding health
ten years is NetEase, which among other coverage eligibility to a greater share of

the population will continue, not only be- BP: We consider that a risk and will con- History has shown very clearly that it
cause it’s the right thing to do, but also be- tinue to monitor it. But it’s one thing to is incredibly difficult to make sweeping
cause society will increasingly demand it. say there’s this existential risk and another
changes in an industry that accounts for
As the U.S. grapples with how to provide altogether to actually go through the exer-18% of U.S. gross domestic product and
better healthcare to more people at a man- cise of examining what it would take for a is the largest private-sector employer in
ageable cost, we see the Anthems of the single-payer system to happen in the Unit- the country. The purpose of any health-
world very much as part of the solution as ed States, if it did happen how that would care reform should be to provide better
opposed to part of the problem. ultimately impact Anthem, and then com- and more affordable healthcare, but it’s
bine the probability of it happening with not at all clear the U.S. population thinks
A number of Democratic candidates for the impact of it happening to judge the that would be the result. Individuals with
the Presidential nomination this year specific adjustment to our intrinsic-value employer-sponsored health plans report
might disagree. How do you think through estimate necessary. When we do all that being generally satisfied with their cov-
as an investor what would be an existen- and build it into our estimates of intrinsic
erage. Seniors have a choice between the
tial threat to Anthem from the U.S. mov- value, it has no material impact on our in-government-run Medicare and privately-
ing to a single-payer healthcare system? vestment conclusion. run Medicare Advantage plans – which
are administered by MCOs – and they
have increasingly opted for private op-
INVESTMENT SNAPSHOT
tions because the MCO-run plans have
Anthem Valuation Metrics more attractive benefits.
(NYSE: ANTM) (@11/27/20):
Healthcare reform that doesn’t involve
Business: Health insurer offering network- ANTM S&P 500 a single-payer system still involves risk for
based managed-care plans to employers and P/E (TTM) 16.1 41.3 companies like Anthem. A new Medicare-
individuals, primarily in the U.S. and primarily Forward P/E (Est.) 12.3 25.9
under the Blue Cross Blue Shield brand. for-all type insurance option could put
Largest Institutional Owners pressure on employer-sponsored plans
Share Information (@11/27/20): (@9/30/20 or latest filing): and lead to membership losses. But again,
Price 312.80 Company % Owned based on experience, we believe changes in
52-Week Range 171.03 – 338.20 Vanguard Group 7.3% the U.S. healthcare sector will be gradual
Dividend Yield 1.2% T. Rowe Price 5.5% rather than revolutionary, and that lead-
Market Cap $77.79 billion BlackRock 4.9%
ing MCOs like Anthem and UnitedHealth
State Street 4.4%
Financials (TTM): will adapt and remain an important part
Wellington Mgmt 3.8%
Revenue $117.45 billion of the system, irrespective of who’s in the
Operating Profit Margin 6.9% Short Interest (as of 11/15/20): White House and controls Congress.
Net Profit Margin 4.2% Shares Short/Float 1.4%
The pandemic has proven to be a short-
ANTM PRICE HISTORY
term boon for health insurers as people
350 350 defer treatments for anything considered
elective. Is that a potential problem for
300 300 Anthem post-pandemic?
250 250 BP: What you describe has resulted in a

potential embarrassment of earnings, but
200 200 the company, to its credit, is passing most
of that benefit back to customers in lower
150 150 pricing. We generally believe there will be
2018 2019 2020
enough lead time to adjust prices the other
way as latent demand for services increas-
THE BOTTOM LINE es, so the actual impact on earnings as the
Given that he believes the company has a vital and secure position in the secularly pandemic recedes will not be significant.
growing U.S. healthcare system, Ben Preston doesn't believe its shares should be valued
at a material discount to the average company. Even without a re-rating, he sees attractive
upside just from the combination of free-cash-flow yield and expected organic growth.
Anthem’s shares, now around $313, are up
more than 80% from their lows in March.
Sources: Company reports, other publicly available information
How are you looking at your prospective
returns going forward?

BP: This is a company we consider to be solar are that low, but natural gas at its about climate change. As global energy de-
of markedly higher quality than the av- best costs $44 to $73 per Mwh, and coal mand continues to grow and renewables
erage company, but at only 12-13x con- at best costs around $65. Importantly, this take market share, the demand for wind-
sensus forward earnings the stock trades is without subsidies included. power generation in 10 to 20 years is like-
at a valuation well below that of the av- This totally flips the political dynamic. ly to increase several times over what it
erage company. Forget re-rating for the Renewables are no longer just better for is today. No one is better positioned than
moment, we think at today’s share price the environment and for public health, Vestas to benefit from that.
we’re buying into a long-term buy-and- they’re also better for the economy. Now
hold return well in excess of 10%, from you’ve got China saying it’s going to be How do you see that translating into good
the combination of free-cash-flow yield carbon neutral by 2060. The European news for the stock, now at around 1,235
and organic growth in the business. We Union over the summer approves a green Danish kroner?
think steady-Eddie companies like this are stimulus plan. The U.K. in July announces
unappreciated today. If we’re right about a green recovery plan to rebuild from the BP: This is one of those stocks we were
the business, even if that level of apprecia- pandemic. Even the U.S. under a Presi- able to buy amid the chaos earlier this
tion doesn’t change we should do perfectly dent Biden is likely to get far more serious year, with the view that our clients would
well as an investor here. If it does change,
all the better.
INVESTMENT SNAPSHOT
Explain in more detail your investment Vestas Wind Systems Valuation Metrics
(Copenhagen: VWS) (@11/27/20):
case for Vestas Wind Systems.
Business: Global manufacture and servicing of VWS S&P 500
wind turbines used to generate electricity; more P/E (TTM) 67.1 41.3
BP: Vestas is the world’s largest manufac-
than 70% of the installed base of turbines is Forward P/E (Est.) 35.5 25.9
turer of the turbines used to generate wind
located in the United States and Europe.
power. We believe they have the highest- Largest Institutional Owners
quality products, which results in less Share Information (@9/30/20 or latest filing):
(@11/27/20, Exchange Rate: $1 = 6.22 Danish kroner):
downtime for operators and lower long- Company % Owned
term maintenance costs. That quality di- Price DKK 1,234.50 Fidelity Mgmt & Research 3.5%
rectly explains why they have the highest 52-Week Range DKK 473.00 – DKK 1,252.50 Vanguard Group 2.9%
global market share – roughly 25%, not Dividend Yield 0.6% Swedbank Robur Fonder 2.7%
Market Cap DKK 241.65 billion BlackRock 1.7%
including China – as well as the highest
Baillie Gifford 1.4%
profitability in the industry. They make Financials (TTM):
money when they sell a turbine and then Revenue €12.15 billion Short Interest (as of 11/15/20):
typically lock in a service contract – over Operating Profit Margin 8.3% Shares Short/Float n/a
Net Profit Margin 5.8%
an average term of 18 years – for high-
margin maintenance and repair. VWS PRICE HISTORY
Until recently, renewable energy has
1,500 1,500
been held back in a prisoner’s dilemma
type of situation. The cost of energy is such
an important part of a country’s competi- 1,200 1,200
tiveness that very few countries are will-
ing to put the greater environmental good 900 900
ahead of local economic well-being in the
short term. 600 600
What’s changed is that renewable en-
ergy has now become at least cost com- 300 300
2018 2019 2020
petitive on its own merits against coal,
nuclear and natural gas. The cost of so- THE BOTTOM LINE
lar has come down. The cost of wind has As renewable energy has become cost competitive with traditional sources, Ben Preston
come down. It can vary by geography, but expects the company, and its shareholders, to be primary beneficiaries of the resulting
based on global estimates from Lazard, capacity and profit-pool transition toward renewables. "We may be paying what looks
the levelized cost of producing one mega- like a premium for that today," he says, "but if we're right it won't look that way for long."
watt of wind energy now ranges from $26
to $54. Some applications of utility-scale

thank us in ten years. I don’t think it’s pru- billion in size. If you compare that to Au- they seem to value, what deals they re-
dent to try to put a near-term price target tohome’s current revenues of $1.2 billion, spond to, what colors they like. All of that
on it, but the way we look at it, the com- and to other similar markets where domi- is valuable to both dealers and manufac-
pany today earns, give or take, around $1 nant platforms connect buyers and sellers turers, informing not only how they mar-
billion a year. Several major oil companies in a similar way, there’s significant poten- ket and sell but also feeding back into the
not that long ago were making on the or- tial for the company to capture a larger types of cars they build. Beyond data, we
der of $20 billion a year. I can’t say with portion of the value chain. could also imagine the company building
certainty what Vestas will earn 10 years We also think there’s considerable op- out additional peripheral businesses in ar-
from now, but if we’re right about the portunity to expand the breadth of prod- eas like financing and insurance.
energy transition to renewables and the ucts and services offered. They continue to
profit-pool transition that will accompany come out with new data-based products Are there particular regulatory or gover-
it, that number is likely to be a material of use to both dealers and manufacturers. nance issues to worry about here?
multiple of $1 billion. We may be paying For example, Autohome knows by the be-
what looks like a premium valuation for havior of people on the site what vehicles BP: That’s always something to worry
that today, but if we’re right it won’t look they’re most interested in, what features about in China, but we don’t consider the
that way for very long.
INVESTMENT SNAPSHOT
We spoke pre-pandemic with your col-
league Graeme Forster about Chinese In- Autohome Valuation Metrics
(NYSE ADR: ATHM) (@11/27/20):
ternet services company Autohome [VII,
Business: Provider of online content and ATHM S&P 500
June 26, 2019], which is still one of your
listing information for automobile buyers and P/E (TTM) 25.3 41.3
core holdings. Explain the ongoing poten-
sellers in China; revenue generated primarily Forward P/E (Est.) 20.9 25.9
tial you see in it. by advertising and dealer lead generation.
Largest Institutional Owners
BP: The company’s business is relatively Share Information (@11/27/20): (@9/30/20 or latest filing):
straightforward. It’s the largest online Price 105.89 Company % Owned

platform in China for people who are 52-Week Range 59.54 – 107.92 Kayne Anderson Rudnick 10.0%
looking to buy a new car, where they can Dividend Yield 0.7% Orbis Investments 5.5%
Market Cap $12.61 billion Comgest 4.9%
read reviews, research what’s out there,
Baillie Gifford 2.6%
and connect with dealers who are offering Financials (2019): Lazard Asset Mgmt 2.2%
deals or otherwise have what they want. Revenue $1.21 billion
The primary sources of revenue today are Operating Profit Margin 38.4% Short Interest (as of 11/15/20):
from dealers who pay for leads generated Net Profit Margin 38.0% Shares Short/Float 6.4%
by Autohome and from car manufacturers
ATHM PRICE HISTORY
who advertise on the site.
There are several things operating in the 120 120
company’s favor. It’s the biggest player in
its market, with the most traffic and time 100 100
spent on site. People are buying more on-
line, just with the progress of time but also 80 80
accelerated by the pandemic. We know
that over time advertising and marketing 60 60
dollars of manufacturers and dealers are
going increasingly online. Dealers also tell 40 40
2018 2019 2020
us the site is an extremely valuable source
of new leads, and while they don’t talk
much about this, we believe that value is THE BOTTOM LINE
significantly higher than what the dealers Ben Preston doesn't believe the market adequately appreciates the organic growth in
the company's market or its ability to capture a higher proportion of its industry's value
currently have to pay. In very rough num-
chain. Even if the stock's "run of the mill" valuation doesn't improve, he expects to benefit
bers, something on the order of 20,000 as a shareholder from company earnings that can compound at a 20% or so annual rate.
to 30,000 new cars are sold each year in
China, which at $20,000 each means the Sources: Company reports, other publicly available information
overall market is around $400 to $600

risks particularly high. Regulators have tions were imposed against Russia and we Herman Gref, who used to be in Putin’s
not shown unusual interest in this area, didn’t even know if we’d be able to con- cabinet way back when but has run the
and on the corporate-governance front tinue to hold the shares. company since 2007. He recognizes gov-
we have some comfort from the fact that It didn’t feel like it at the time, but you ernance standards have to be high – even
Autohome is majority owned by Ping An, could see that Sberbank was likely to con- in the recent flurry of U.S. sanctions to-
the big Chinese insurance company. Based solidate its strength. Foreign banks left ward Russia, Sberbank managed to avoid
on its stewardship so far, we consider it a the market. The domestic banks that were being involved – and he’s proven to be
good partner to have as a shareholder. already wobbly fell over. Market share in both a skilled operator and very forward
those situations goes to the strong, and thinking. We once did an offsite in Silicon
How are you looking at potential upside Sberbank came out of all that better posi- Valley and the room next to us was being
in the shares, which after recovering nicely tioned with increased earnings power. used by Sberbank for one of its own off-
from the worst of the pandemic are now But you’re still in Russia. How do you sites. They’ve been quite active in apply-
trading at around $106? make peace with that? I’m not sure you ing the best technology from around the
ever really do, but in our experience with world to power the business.
BP: After subtracting net cash on the Sberbank in particular, corporate gover- So while we can imagine situations
balance sheet, the ADRs today trade at nance has been quite good. The CEO is where we might have to sell our posi-
around 20x forward earnings. We don’t
INVESTMENT SNAPSHOT
consider that a demanding multiple at
all for a company that has the potential Sberbank Valuation Metrics
(Moscow: SBER) (@11/27/20):
for some time to compound earnings at,
give or take, a 20% annual rate. This is Business: Commercial, corporate, retail and SBER S&P 500
investment banking, with operations primarily in P/E (TTM) 7.5 41.3
another example of a company we think
Russia and Eastern Europe; majority owned by Forward P/E (Est.) 6.2 25.9
has considerably more potential upside the Central Bank of the Russian Federation.
than downside, with growth potential far Largest Institutional Owners
better than average and a stock valuation Share Information (@9/30/20 or latest filing):
(@11/27/20, Exchange Rate: $1 = 76.08 RUB):
that’s fairly run of the mill. Company % Owned
Price RUB 251.59 Vanguard Group 1.6%
Turning to something completely differ- 52-Week Range RUB 172.15 – RUB 270.80 Invesco Advisers 1.3%
Dividend Yield 7.7% Norges Bank Inv Mgmt 0.8%
ent, describe your interest in Russian bank
Market Cap RUB 5.63 trillion APG Asset Mgmt 0.8%
Sberbank [Moscow: SBER].
BlackRock 0.8%
Financials (2019):
BP: If you put aside for a moment where it Net Interest Income RUB 1.42 trillion Short Interest (as of 11/15/20):
operates, this is one of the best large banks Return on Equity 20.5% Shares Short/Float n/a
Return on Assets 2.8%
in the world in terms of market position,
financial performance and technological SBER PRICE HISTORY
sophistication. More than 90% of Rus- 300 300
sian households have some involvement
with the bank. Its retail deposit market
share is not far from 50%. It earns a 20% 250 250
return on equity in a market where most
banks don’t earn their cost of capital. This
is the safe, establishment bank in a coun- 200 200
try where that means quite a lot.
As a shareholder that also means we’re
150 150
partnered with the Russian government, 2018 2019 2020
which owns 50% plus one share of the
stock. That along with just being in Russia THE BOTTOM LINE
has its issues. We learned that first hand Ben Preston believes the potential reward of owning shares in this market-leading bank
investing in Sberbank first in early 2014, earning 20% returns on equity significantly outweigh the risks of it being owned and
right before Russia invaded the Crimea. operated primarily in Russia. Especially, he says, given that the stock trades at only 1.1x
Then OPEC later that year sent oil pric- tangible book value, 6.2x forward earnings, and with a trailing dividend yield of 7.7%.
es down, which negatively impacted the
ruble. Then a series of international sanc-

tion in Sberbank at whatever price, we don’t have to have a tight time horizon learn from our mistakes. That’s the only
continue to believe the potential rewards around it re-rating to something higher route to getting better over time.
outweigh the risks. We do, however, delib- than 1.1x book. We believe it will happen, As I mentioned, one of the lessons
erately keep the position size smaller than but in the meantime book value should we’ve learned is that we can be guilty of
it would be if valuation and strength of increase at an attractive clip and we’re selling too early. We’ve also studied port-
business were all that counted. getting a 7.7% dividend. As long as that folio concentration and concluded that
remains the case, there’s no rush to sell. most of our upside comes from core posi-
How cheap do you consider the shares at a tions, so we have cut back on the number
recent price of nearly 252 rubles? Like a lot of value-oriented investors, your of smaller positions we hold. While not
long-term performance is more impressive driven by mistakes, we’ve invested a lot in
BP: The shares currently trade at around relative to the market than what you’ve our data-analytics capability to help us de-
1.1x tangible book value, 6.2x consensus done now for several years. How are you velop new insights in different ways.
forward earnings and at a trailing divi- processing that? Where it gets difficult for us, as intrin-
dend yield of 7.7%. It’s not often you can sic value-oriented investors, is when shares
buy a market-leading bank that earns a BP: We tell our clients that periods of un- go from undervalued to fairly valued. At
20% return on equity at 1.1x book. In the derperformance are the price we pay for that point we step aside, only to watch the
“BRICs” era this traded at 7x book value seeking superior long-term performance. shares go from fairly valued to expensive
– I’m not saying it’s worth that, but we Some of those periods can be painfully and even to very expensive. That’s the part
think it’s worth quite a bit more than 1x. long and they are never pleasant, but we’re of the cycle when we can look foolish for
comfortable with that and the firm’s in- not participating, but we can live with
Do you have a tighter time horizon maybe centives and ownership structures are de- that. Our philosophy is based on the idea
in owning a stock like this? signed so we can stay the course. Still, we that markets don’t always process long-
always view underperformance as an op- term cycles correctly and that investor
BP: The stock has done well since we portunity to improve and we try to avoid sentiment can overshoot. That’s just hu-
bought it, because fundamentals have blaming the market environment. We are man nature and we haven’t seen any need
improved. The nice thing here is that you our own harshest critics and always try to to question it. VII
Your Guide Through

Perilous Seas
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I N V E S T O R I N S I G H T : Travis Cocke
Investor Insight: Travis Cocke

Voss Capital’s Travis Cocke and Jon Hook explain why transitioning businesses can be fertile ground for ideas, how
they get comfortable with extreme negative market sentiment, the big mistake they made when the pandemic hit, and
why they see mispriced upside in Nintendo, Avid Technology, Extreme Networks, Louisiana-Pacific and Rimini Street.
All smart investors are looking to take be wrong and for us to be able to define an
advantage of market mispricing. Can you alternative narrative the market is missing.
generalize about where over time you’ve
learned to look for that? Jon Hook: One thing I’d elaborate on is
that we’re OK with extreme sentiments
Travis Cocke: We believe it’s ultimately as long as we can understand both sides
surprises relative to expectations that of the investment thesis and can see how
cause the greatest moves in market prices, the narrative can shift over time. Our larg-
so we look for that potential on the long est position at one point this year was
side in a few ways. One would be clear Benefytt Technologies – formerly known
evidence of extreme negative sentiment, as Health Insurance Innovations – which
which can manifest itself in things like operates a technology platform for buying Travis Cocke
a significant valuation de-rating versus health insurance and which we believe at
peers, high short interest, or if analysts the time was the most shorted stock as a Starting the Clock
all have a hold or sell rating on a stock. percentage of its float in the entire world.
It was clear fairly early on that Travis Cocke
Sometimes this results from investors fo- We understood the negative bias, which
was going to start his own investment
cusing on one negative, like a legal or reg- centered around past regulatory problems
firm. He “caught the investment bug” in
ulatory issue, which drags the valuation in one of its business lines, but our due
high school, he says, and before heading
down more than we think is justified by diligence found a big disconnect between
off to study finance at Texas A&M had al-
the bottom-up developments in the busi- the negative market perception and the
ready been asked by parents of his friends
ness. Whatever the cause, low expecta- reality that the company had made major
to start a partnership to invest for them.
tions can increase the probability of posi- improvements in its compliance and was
While in college he had internships with
tive surprise. shifting focus toward selling Medicare-
the Teacher Retirement System of Texas
We also really hone in on business tran- related policies where it had had no com-
pension fund and with Leon Cooperman’s
sitions, especially ones that result in short- pliance issues and had hit the ground run-
Omega Advisors.
term optical headwinds but will ultimately ning in the 2019 open-enrollment period.
change the profile of the company if man- The company had also said it was explor- Soon after graduating from college in
agement executes. The trendy example ing strategic alternatives to enhance share- 2009, another friend’s father asked Cocke
would be a shift by a software company holder value, but the market didn’t believe to manage investments for a small family
from a perpetual license/maintenance any sort of transaction was likely. office, and less than a year later he par-
model to a subscription-as-a-service mod- Our contrarian position was vindicated layed that into starting his own firm, now
el, where you lose upfront licensing rev- over the summer when Benefytt was taken called Voss Capital, at the ripe old age of
enue but are building a large, sustainable private by a top-tier private equity firm,
24. Why start so early? “It was a function
revenue stream at high margins. Another Madison Dearborn, at a 60% premium
of a few things," he says. "One, coming
good example would be a company with over its average share price in the month
out of school in the aftermath of the finan-
multiple segments that have different eco- before the deal was announced. They paid
cial crisis wasn’t the best timing for getting
nomics and growth trajectories, where we roughly 9.7x EV/EBITDA – when we first
hired by a top-tier firm. Two, I was always
see the mix changing for the better but the started looking at the stock in mid-2019
entrepreneurial and valued the personal
market appears not to understand what’s it traded at less than 5x EBITDA and at
freedom I had working for myself. Finally, if
going on or just isn’t paying attention. roughly 20% of the valuation of the near-
you’re young and headstrong, you think to
We’re agnostic when it comes to mar- est competitor, eHealth (EHTH).
yourself, ‘I talk to these guys who are con-
ket cap, but our sweet spot has been in the
sidered the best investors in the world and
$500 million to $1 billion range. The com- To highlight how you come across some of
they put their pants on one leg at a time
panies are liquid enough for us to reason- your more obscure names, how and why
and aren’t doing anything I couldn’t do.' I
ably buy or sell, but they’re also typically did you first get interested in Canadian
needed a track record to attract capital, so
underfollowed, which makes it more like- media-production company Thunderbird
why not start the clock?”
ly for the existing narrative on the stock to Entertainment [Toronto: TBRD]?

TC: Their investor relations firm e-mailed struct an alternate, credible narrative that TC: From the beginning I’d say we’ve
me a number of bullet points on the com- can replace the current one and could po- always thought like activists – doing de-
pany in July and asked if I wanted to see tentially cause the stock to at least double tailed segment analysis, thinking about the
its investor presentation. I looked it over over the next three years. portfolio of businesses, putting a priority
quickly and a number of things jumped on capital allocation, thinking about how
out that seemed potentially interesting. JH: Usually there are one or two or three to improve the capital structure. As our
The stock traded at 3.5x EV/EBITDA things that really define the "story" of a assets have grown and we’ve gotten more
even though revenues were growing at a particular stock and the multiples it cur- experienced with board-level discussions,
more than 30% annual rate. The balance rently gets. Maybe the narrative is "nice we’ve done more. We don’t want to be
sheet had net cash. The core business of technology, but too levered" or "the com- activists for activism's sake, running the
producing TV series like The Man in the pany is losing market share in its core same playbook over and over. It’s simply
High Castle for Amazon was booming as business," or "nice company, but terrible one tool in the toolbox that can help gen-
the race to create content to stream was management so the potential won’t be erate returns for our investors.
intensifying. There was also a business-
transition angle. The company was mov- JH: With our core names we typically like
ing from mostly producing shows on a ON EXTREME SENTIMENT: to have developed sort of a nuclear option,
fee-for-service basis to both partnering where if the new narrative isn't develop-
more fully with others on the develop- We're OK with extreme senti- ing as expected we have a Plan B. Perhaps
ment and creation of shows, and on creat- ment as long as we under- the company has followed the strategy we
ing, developing and actively monetizing its would employ, but still isn't getting credit
own intellectual property.
stand both sides and can see from the public markets. In that case we
As we started to dig in, we had multiple how the narrative can shift. might determine the company simply
calls with various levels of the manage- shouldn't be public and would be better
ment team, and each time found they had off working toward a sale. Benefytt Tech-
thoughtful and detailed answers to every achieved.” Most of the time the narratives nologies and Rosetta Stone would be re-
question and were never evasive. We were make sense and are borne out by the evi- cent examples of that.
just very impressed with the management dence as we look into it. Or perhaps the company for whatever
quality relative to the size of the market But in what become core positions for reason isn’t following the trajectory we
cap, which at the time was C$65 million. us, our research leads us to either com- believe will build the most value. In this
This is one where there wasn’t some pletely disagree with the existing narra- case we have no qualms engaging with
extreme negative sentiment on the com- tive, or believe a new narrative has a good management and the board – and eventu-
pany, but we thought it was very much chance to displace it. For instance, if the ally the market if necessary – to try to get
under the radar and that with the discov- narrative is nice technology, but too much the company back on the right course. Par
ery of the story and time for it to play out debt, what happens to that view if revenue Technology [PAR] would be a good recent
it could be a big winner. The shares [at growth reaccelerates and the resulting free example of that. We thought its strategy
a recent C$2.55] have doubled since we cash flow is directed to paying down debt? was unfocused and weighed down by leg-
first started looking at it, but we still think If the narrative is the company’s core busi- acy businesses and legacy costs that were
there’s a lot of upside left. ness is suffering, what happens if another keeping it from capitalizing on an excel-
segment of the business that’s even better lent developing business selling cloud-
In general, once you’ve identified a poten- grows rapidly and accounts for a much based software systems to quick-service
tial idea where does your research focus? larger share of the overall business? If restaurant chains. Ultimately we conclud-
the narrative is management isn’t good ed management needed to change for the
TC: We spend a lot of time talking to in- enough, what happens if new manage- company’s potential to be realized and we
dustry experts to understand a company’s ment comes in and starts to capitalize on engaged with the board to help make that
competitive position and the industry dy- the available potential? If we believe the happen, including having a hand in bring-
namics. We also actively seek out other company can look very different in 12 ing on a board member, Savneet Singh,
informed investors who hold varying fun- to 24 months and that the narrative will who then took over as CEO near the end
damental views on the company to gauge change for the positive as a result, that’s of 2018.
what is well known and already likely interesting for us.
priced into the stock. We’re trying to un- We wrote about Par [VII, June 26, 2019]
derstand what the current narrative on the You’ve in recent years taken a more activ- when the shares were at just under $28.
company is that’s holding back the valu- ist approach with certain of your holdings. The stock's now at around $55 – do you
ation, and then determine if we can con- Explain the rationale behind that. still see upside from here?

JH: We think the best is yet to come and since inception, while at the same time a handheld-only version that is priced at
that the sell side still hasn’t grasped the they have as much or more growth poten- a discount to the original. The goal is to
upside potential here. Par can demonstrate tial than ever. We’re finding a lot of good keep building over a longer time period
that customers using its Brink cloud-based long ideas. the installed base of users, selling them
point-of-sale systems and software are Why would that be? There’s a very high-margin games, downloadable content
selling more and improving cost efficiency high level of business disruption and un- and subscriptions, and avoiding the more
relative to its customers who are using its certainty caused by the pandemic, which boom/bust pattern of brand-new gaming
legacy systems. That type of thing gets is creating a lot of winners and losers and consoles every five years or so where you
people’s attention and the company is see- the market can find it difficult to accurate- start over from scratch. The cumulative
ing demand for Brink systems pulled for- ly reflect rapid changes in fundamentals. Switch installed base is now over 68 mil-
ward, which should result sooner rather There’s also a myopic obsession with a lion, and we think is on the way to over
than later in the type of inflection quarter few macro events. What’s going on with 100 million. The next hardware iteration,
that will get the Street’s attention. We also lockdowns? What’s going on with the rumored to be the Switch Pro, is expected
think Savneet Singh is a gifted capital al- to be released next year.
locator, and after a recent capital raise is The second important shift underway
likely to put that to good use in scaling the ON MARKET MYOPIA: is toward higher-margin digital and sub-
company. scription revenue, which Nintendo up
There's an obsession with until fairly recently has been slower to
How many positions do you tend to hold macro events. It's more likely embrace. The company’s software rev-
at a time? enue comes from five sources: physical
people are ignoring what's video games, downloadable versions of
TC: We usually hold about 35 long po- going on beneath the surface. games that are also offered physically,
sitions, concentrated at the top, with the download-only games, add-on download-
five biggest at around 40% of the portfo- able content like maps, outfits and new
lio and the top 10 around 60%. We want stimulus? Who’s going to win the presi- characters for given games, and Nintendo
our top ideas to move the needle, but also dential election? What’s the latest vaccine Switch Online subscriptions. The last four
try to size positions so that we don’t be- news? That may make it more likely peo- categories make up the digital portion of
lieve we’ll lose more than 2% of total ple are ignoring changes going on beneath software revenue, which is growing rap-
fund net asset value on any one position the surface at companies. We think it’s a idly, up 100% over the last twelve months
if our draconian bear case for it plays out. great time to be looking at those. to around $2.9 billion.
That’s happened over the past 10 years, The company doesn’t break out mar-
but we’ve kept it rare. Turning to some specific ideas, Nintendo gins for the digital segment, but you can
We are regularly rebalancing, scaling [NTDOY] would seem to be quite a bit see the impact on overall margins as digi-
into and out of positions based on how bigger and higher-profile than most of tal becomes an increasingly large contrib-
the risk/reward ratio between our base your holdings. What do you think the utor of total revenue. Gross margins have
case and bear case value targets moves market is missing in it? risen steadily to 53% in the trailing year
relative to other stocks in the portfolio, or and to 58%year-to-date in 2020. Simi-
to new ones we might buy. Another thing JH: Yes, everyone knows Nintendo as a larly, overall trailing operating margins
to mention is that we keep a number of Japanese videogame developer and con- have expanded to 34% and were 36% in
small “farm team” positions in the portfo- sole manufacturer. What we don’t think is the most recent quarter. Software overall
lio that we continue to research and moni- fully understood is the extent of its busi- makes up just under 50% of the compa-
tor while waiting for them to get cheaper, ness model shift underway and the latent ny's overall revenue, and driven by digital
to get closer to a catalyst, or that we’ll sell power it has to unlock the value of its will continue to grow at a faster rate than
if we change our minds as we get further owned intellectual property. hardware.
along in the due-diligence process. We see three fundamental changes Finally, the third big change we also see
happening. One, they are decreasing the is Nintendo capitalizing on its world-class
Are you generally finding plenty worth cyclicality of the hardware business by intellectual-property library, which it’s at
looking at in today’s rather unusual mar- taking a more iterative approach to prod- the early stages of starting to monetize.
ket environment? uct development. The latest console, the The library includes the rights to such
Switch, was released in March 2017 and properties as the Mario universe, Star Fox,
TC: This has changed somewhat in the sold nearly 35 million units in its first two Zelda, Donkey Kong, the newer Animal
past two weeks, but our portfolio compa- years on the market. In the fall of 2019 Crossing and, through a large ownership
nies overall are as cheap as they’ve been the company rolled out the Switch Lite, stake, Pokémon. Among the licensing ini-

tiatives underway is the development of JH: We have a detailed sum-of-the-parts 20%, with 35% margins and deserve a
a Super Nintendo World theme park in analysis that values the Digital, Hardware, 12x multiple. Finally, we think Mobile
partnership with Universal and a Mario Physical Game Sales, and Mobile and IP and IP grows 35%, with 90% margins,
movie being produced with Illumination, parts of the business separately, based on and deserves a 20x EBIT multiple. Add it
which is behind the Despicable Me and our next-twelve-month estimates of sales, all up and we value these four pieces of the
Minions franchises. In a world where en- earnings before interest and taxes [EBIT] business at $93 per share. Adding in net
tertainment content is in increasingly high and what we believe is the appropriate cash and other investments, we arrive at a
demand, especially when it can build on EBIT multiple. total equity value of $112 per share.
an already massive brand franchise, we Breaking that down further, we value If you back out the cash and invest-
think the growth runway in this area for the Digital segment – which we expect to ments on the balance sheet, at today’s
Nintendo is very long. grow at a 45% annual rate with 45% op- price we're paying around 7x our estimate
erating margins – at 22x EBIT. We at this of operating income over the next 12
How are you valuing all that differently point assume no growth for Hardware, months. That’s way too low considering
than the market, which currently puts a believe it earns a 22% margin and we val- the company’s growth, profitability and
$70 price on the U.S. ADR? ue it at 7x EBIT. Physical game sales grow the increasingly recurring nature of its
revenue. This is also just our base case – if
things like Mobile and IP take off over the
INVESTMENT SNAPSHOT
next couple of years, the upside potential
Nintendo Valuation Metrics will likely be considerably higher.
(OTC: NTDOY) (@11/27/20):
Business: Global development, manufacture NTDOY S&P 500 Explain how you see the narrative chang-
and sale of gaming consoles and the games P/E (TTM) 16.9 41.3 ing for digital-media company Avid Tech-
played on them, including franchises such as Forward P/E (Est.) 18.9 25.9 nology [AVID].
Mario, Pokémon, Zelda and Animal Crossing.
Largest Institutional Owners
Share Information (@11/27/20): (@9/30/20 or latest filing): JH: This is one of two dominant players –
Price 70.00 Company % Owned the other being Adobe – making software-
52-Week Range 35.82 – 73.75 Nomura Asset Mgmt 3.1% based tools for digital media production.
Dividend Yield 1.4% Vanguard Group 2.3% It’s the clear leader in sound editing with
Market Cap $66.65 billion Capital Research & Mgmt 1.8% its Pro Tools line, but also sells video-edit-
Daiwa Asset Mgmt 1.4% ing software, media-storage products, and
Financials (TTM): Nikko Asset Mgmt 1.3%
Revenue ¥1.63 trillion has developed a range of collaborative ed-
Operating Profit Margin 33.6% Short Interest (as of 11/15/20): iting tools as part of its Avid Everywhere
Net Profit Margin 25.1% Shares Short/Float n/a platform. The products are particularly
well established in higher-end applications
NTDOY PRICE HISTORY
like big-budget Hollywood movies and
80 80 major television shows, where the overall
demand outlook is quite positive going
70 70
forward.
60 60 We were able to come to a pretty clear
understanding of the negative narrative
50 50 here. There has been significant investor
fatigue with the company’s long transition
40 40
from a hardware and perpetual-license
30 30 software model to becoming more focused
2018 2019 2020 on recurring subscriptions. There’s a per-
ception in the market that Adobe is rap-
THE BOTTOM LINE idly taking market share. There’s concern
The market doesn't appear to be correctly handicapping the under-the-surface changes that the balance sheet is overly levered.
going on in the company's business model and in its hardware and intellectual-property Top management, which has since been
strategies, says Jon Hook. Based on his sum-of-the-parts analysis of its Digital, Hardware,
replaced, had a reputation for overprom-
Physical Game Sales and Mobile and IP segments, he values the shares today at $112.
ising and underdelivering, making poor
acquisitions and burning significant cash.
Layering on damage from Covid, with all

media production basically stopping for gross margins up to the mid-60s, from the Avid’s hardware business in particu-
a time, and we felt we understood pretty mid-50s a few years ago. Third, while our lar took a hit from the pandemic, but we
well the negativity toward the stock. conversations with channel partners and expect that to come back fully and we’ve
When we looked under the hood industry experts did speak to some market also seen some parts of the business pick
more closely, we came to some different share loss to Adobe, we were still able to up speed through the pandemic. For ex-
conclusions. First of all, we believe new identify clear competitive differentiators ample, they have a clear advantage in col-
management under CEO Jeff Rosica is for Avid and thought minor share losses laborative editing tools – allowing mul-
highly knowledgeable of the entertain- in some niche markets were being overly tiple editors to work remotely on a project
ment industry, pragmatic, and has laid magnified by the buyside. Customers can at once – which has been in very high de-
out a sound operating plan with clear and do work with product offerings from mand of late.
and consistent target metrics. Second, we both companies, and they recently an- Finally, we’ve come to see the lever-
believe the business-model transition is fi- nounced a joint effort to make each oth- age situation as quite manageable. They
nally taking hold, with recurring revenue er's products work more easily together currently have about $160 million in net
– for both hardware and software mainte- so customers have even more flexibility on debt, so are a bit over 2x levered against
nance – now at 70% of the total and with that front. the consensus estimate of $72 million in
EBITDA over the next twelve months.
Free cash flow went positive in the most
INVESTMENT SNAPSHOT
recent quarter, to the tune of $15 million,
Avid Technology Valuation Metrics and as that continues to grow the CFO
(Nasdaq: AVID) (@11/27/20): has made clear that the #1 priority is to
Business: Development and sale of hardware AVID S&P 500 pay down debt.
and software used primarily in the creation of P/E (TTM) 27.9 41.3
digital media, with a focus on sound and video Forward P/E (Est.) 12.7 25.9 The shares have shown some life of late –
editing for movie and TV-show production.
Largest Institutional Owners how inexpensive do you consider them at
Share Information (@11/27/20): (@9/30/20 or latest filing): today’s $12.30 price?
Price 12.34 Company % Owned
52-Week Range 4.67 – 12.48 Impactive Capital 15.7% JH: Up until very recently the stock was
Dividend Yield 0.0% Vanguard Group 5.1% trading at pretty distressed technology
Market Cap $545.5 million BlackRock 4.3% multiples: 2x total gross profit, around 2x
Goldman Sachs Asset Mgmt 4.3% subscription maintenance revenue, and at
Financials (TTM): Royce & Associates 3.9%
Revenue $372.5 million around 7-8x estimated free cash flow.
Operating Profit Margin 10.1% Short Interest (as of 11/15/20): We think over the next 18 months the
Net Profit Margin 5.2% Shares Short/Float 4.9% company can be generating cash flow at
an $80 to $100 million annual rate. If they
AVID PRICE HISTORY
pay down debt and continue to increase
15 15 recurring, less-cyclical revenue, we think
the stock deserves at least a market mul-
12 12 tiple on free cash flow. That would result
in a share price of around $25.
9 9 Another way to look at it is to take the
recurring revenue base from software only
6 6 – which is growing 12-15% annually –
and put a 5x multiple on that. That alone
3 3 comes to $19 per share in value. That ig-
2018 2019 2020 nores the hardware and hardware main-
tenance pieces of the business, which are
THE BOTTOM LINE lumpier but still generate about 40% of
The negative investor narrative around the company is increasingly out of date as it's total revenue.
business-model transition takes hold and new management better positions it to take
advantage of a thriving end market, says Jon Hook. Applying a market multiple to his run-
Sticking with relatively beaten up technol-
rate estimate of annual free cash flow, the shares within 18 months would trade at $25.
ogy companies, describe why you’re high
on the prospects for networking company
Extreme Networks [EXTR].

JH: Extreme specializes in configuring ing to coordinate their 5G rollouts with 60% of the total, earns gross margins
large setups for complex wireless network Wi-Fi connectivity. above 50%.
environments, including hospitals, univer- The cloud business is the most exciting,
sities, stadiums, convention centers and but we believe the rest of the business is Extreme’s shares were at $15 less than
subway systems. It sells both network in- well positioned and evolving in a positive three years ago. How are you looking at
frastructure equipment as well as software way. Software subscriptions now generate valuation at today’s price of $5.75?
for network management, analytics and roughly $60 million in annual revenue,
security. but that business is poised to grow at 30- JH: We think with its run-rate revenue
Many elements of the story here are 40% per year, with 85% gross margins. base – assuming hardware sales come back
similar to what I described for Avid. The There’s a recurring hardware-maintenance more or less to pre-Covid levels – the com-
transition underway toward recurring revenue stream that makes up 30% of to- pany is capable of generating $80 to $100
software and services revenues has been tal revenue, generates 60-70% gross mar- million in free cash flow over the next 12
slow to develop and investors have lost gins, and isn’t cannibalized by the grow- months. The CFO has made it clear that
patience. There have been concerns about ing software-subscription business. Even most of that will be used to pay down
leverage, particularly after the pandemic equipment revenue, which still makes up debt. If all that comes to pass – moder-
first hit. Extreme competes with very big
players like Cisco, Juniper Networks and
INVESTMENT SNAPSHOT
Hewlett Packard Enterprise, which have
more complete networking portfolios. Extreme Networks Valuation Metrics
Management has made several acquisi- (Nasdaq: EXTR) (@11/27/20):
tions over the past five years, without a lot Business: Production and sale of wired and EXTR S&P 500
to show for it. wireless network infrastructure equipment and P/E (TTM) n/a 41.3
We think those narratives can flip over software used for enterprise network manage- Forward P/E (Est.) 11.0 25.9
ment, analytics, security and access control.
the next 12 to 24 months, in large part Largest Institutional Owners
due to the potential we see for the com- Share Information (@11/27/20): (@9/30/20 or latest filing):
pany to take share in wireless network- Price 5.76 Company % Owned
ing through its cloud-based offerings. The 52-Week Range 1.43 – 8.00 BlackRock 12.5%
big transition going on in the networking Dividend Yield 0.0% Vanguard Group 6.5%
industry is that all the devices constitut- Market Cap $708.6 million Paradigm Capital Mgmt 5.9%
ing a network – including switches, rout- D.E. Shaw 3.8%
Financials (TTM): Renaissance Technologies 3.6%
ers and access points – are starting to be Revenue $928.3 million
cloud controlled and managed. From our Operating Profit Margin (-3.1%) Short Interest (as of 11/15/20):
research, Extreme’s technology for that – Net Profit Margin (-10.5%) Shares Short/Float 5.2%
mostly coming from its latest acquisition
of a company called Aerohive – is matched EXTR PRICE HISTORY
among competitors only by Juniper. Given 20 20
the size of the addressable market, they
don’t need to win every cloud-networking 15 15
deal for it to have a significant impact on
the business. Management says each 1% 10 10
market-share gain in the entire wireless
networking space would add $200 million 5 5
in annual revenue and $100 million in in-
cremental EBIT.
0 0
They’re starting to log a number of im- 2018 2019 2020
pressive competitive wins. They recently
signed with Major League Baseball to THE BOTTOM LINE
provide wireless connectivity and soft- Jon Hook believes the company has the capability to take market share from much bigger
ware services at all big-league stadiums, competitors as technology networks become increasingly cloud managed. Even without
displacing Cisco. They recently landed such gains, he values its ongoing business at around $8.50 per share. Each additional
1% in market share, he says, could translate into an additional $1 billion in market cap.
a big new contract with Amazon for its
warehouses. They’ve also won major busi-
ness with telecom operators who are try-

ate deleveraging, accelerating sales growth mortgage-related investments as a result a terrible business because the supply side
and higher visibility of revenue – we’d ex- are a large theme in our portfolio. is very concentrated and L-P has done a
pect the stock to earn at least a 12x mul- As we dug in, we found that the compa- good job coming out with more value-
tiple of cash flow, which would translate ny is also going through a transformation added and specialty OSB products, but it’s
into a price of around $8.50. that we don’t think the market is fully rec- not the type of business the market tends
What we’re in this for, though, is the ognizing. It’s known primarily as a leading to value very highly.
potential of incremental market-share player in the market for oriented strand The more interesting product line is
gains. Say they can add 1% in market board [OSB], a common building mate- siding, which now accounts for around
share and that translates into an addition- rial considered an economical and sturdy 40% of annual sales. The company’s sid-
al $100 million in free cash flow. What is plywood substitute. As with most price- ing business is consistently taking market
that worth? Even at 10x that would be an- taking commodities, the OSB market is share in home construction, is rolling out
other $1 billion in market cap for a com- notorious for its booms and busts tied to higher-margin pre-finished products, and
pany whose market cap today is just over housing starts and home remodeling activ- has been able to put through regular price
$700 million. By then you should have ity, with lumpy supply responses reacting increases independent of underlying com-
a full narrative shift and the upside just to market prices on a lagged basis. It’s not modity-price levels. It wasn’t the case in
from re-rating would probably be quite a
bit higher.
INVESTMENT SNAPSHOT
Do you have a Plan B in this case? Louisiana-Pacific Valuation Metrics

(NYSE: LPX) (@11/27/20):
TC: Given our strong belief in the com- Business: Development, manufacture and LPX S&P 500
pany’s technology, its great relationships sale of wood products – focused on oriented P/E (TTM) 20.0 41.3
strand board and siding – used primarily in Forward P/E (Est.) 10.7 25.9
with resellers, and its 60,000-strong cus-
North American new-home construction.
tomer base, we think it’s highly likely Largest Institutional Owners
there would be a number of potential stra- Share Information (@11/27/20): (@9/30/20 or latest filing):
tegic acquirers who could cut costs out Price 33.84 Company % Owned
and make a very accretive acquisition. A 52-Week Range 12.97 – 35.92 BlackRock 10.2%
strategic buyer could offer $10 per share Dividend Yield 1.7% Vanguard Group 9.9%
for Extreme, take out 30% of the operat- Market Cap $3.70 billion Wellington Mgmt 6.2%
ing cost base, and we believe would end Macquarie Investment Mgmt 3.5%
Financials (TTM): State Street 3.1%
up paying only 5x pro-forma EBIT. If the Revenue $2.46 billion
company doesn’t execute, we and prob- Operating Profit Margin 14.8% Short Interest (as of 11/15/20):
ably a number of other investors would Net Profit Margin 7.8% Shares Short/Float 1.9%
likely push for a sale.
LPX PRICE HISTORY
Turning to something quite different, what 40 40

sparked your interest in wood-products 35 35
company Louisiana-Pacific [LPX].
30 30
TC: We’ve been very bullish on housing in 25 25
the U.S.. If you look at rolling, cumulative
20 20
10-year housing starts relative to popu-
lation growth and household formation, 15 15
housing starts are at their lowest level in 10 10
history by far. Believing that corrects over 2018 2019 2020
time, we ran a regression to see which
stocks were most positively correlated to THE BOTTOM LINE
rising U.S. housing starts, and Louisiana- The company is well positioned to benefit from a long-duration U.S. home-construction
Pacific was at the top of the list after ac- upcycle as well as from an ongoing business-mix shift toward siding, says Travis Cocke.
Valuing its various businesses separately and then subtracting unallocated corporate
tual homebuilders. Even with the sharp
overhead, he values the stock at around $57, a nearly 70% premium to today's price.
increase in housing demand from the pan-
demic, we think the duration of the up-
cycle is underestimated and housing and

the latest quarter due to record-high ori- $330 million and have grown at a com- fering right after a mildly disappointing
ented strand board prices, but siding ap- pound 30% per year since the company second-quarter earnings report this year,
pears to have sustainably overtaken OSB was founded in 2005. which immediately made people expect
as the larger profit contributor for L-P. So There are a few elements to the negative more negative news coming in the third
in addition to the tailwind for both busi- narrative here. First, they have a complex quarter. That turned out not to be the case,
nesses from rising housing starts, we think and expensive capital structure, including but the timing of the offering and the lack
the shares can also benefit from re-rating outstanding convertible preferred equity of a clear explanation for it I think has
as siding becomes a bigger part of the that eats up $16 million per year in cash made investors a bit leery.
business. flow for dividends. There are also millions Third, the company has an ongoing
of warrants outstanding that could dilute case against it by Oracle, which claims
The stock is at a 10-year high, so the mar- shareholders at some point, although most Rimini is infringing on its copyrights by
ket appears to have taken some notice. of those have a strike price of $11.50, well providing support services on its prod-
How are you looking at upside from the above the current stock price. ucts. There have been a number of court
current $33.80 price? A second more recent overhang is that cases already which have established that
the company did a poorly timed equity of- it’s legal for Rimini to provide these types
TC: The shares trade at about 6.3x for-
ward EV/EBITDA, which is below the 7x
INVESTMENT SNAPSHOT
10-year median multiple for OSB pure-
play Norbord [OSB] and way below the Rimini Street Valuation Metrics
(Nasdaq: RMNI) (@11/27/20):
18x EV/EBITDA multiple today for the
best siding comp, James Hardie Industries Business: Provider of enterprise software RMNI S&P 500
support and services, typically offering a lower P/E (TTM) n/a 41.3
[JHX]. Hardie, by the way, is growing at a
priced, third-party option for customers with Forward P/E (Est.) 18.9 25.9
slower rate than L-P's siding segment and
installed Oracle and SAP enterprise platforms.
earns a lower EBITDA margin. Largest Institutional Owners
Doing a simple sum of the parts, even if Share Information (@11/27/20): (@9/30/20 or latest filing):
we use a 14x multiple for the siding busi- Price 4.15 Company % Owned
ness and keep a 7x multiple on the OSB 52-Week Range 2.22 – 5.97 Voss Capital 2.7%
business, we arrive at a fair value for the Dividend Yield 0.0% Cannell Capital 2.6%
shares that is more than 50% above to- Market Cap $316.6 million Nokomis Capital 2.5%
Vanguard Group 1.5%
day’s price. If we subtract unallocated Financials (TTM): BlackRock 1.2%
corporate overhead but add in reason- Revenue $315.1 million
able values for the company's engineered Operating Profit Margin 8.6% Short Interest (as of 11/15/20):
wood-products business, its South Ameri- Net Profit Margin 2.9% Shares Short/Float 1.3%
can segments and its prefabricated house-
RMNI PRICE HISTORY
frame business, our estimate of value is
closer to $57 per share. 10 10
Coming back to the world of software, 8 8

describe your investment case for services
company Rimini Street [RMNI]. 6 6
JH: The company’s business model is quite 4 4

straightforward. Big enterprise software
companies like Oracle and SAP tradition- 2 2
ally sell upfront licenses for their products 2018 2019 2020
and then make their real money in provid-
ing ongoing maintenance and service. Ri- THE BOTTOM LINE
mini basically says we can handle that on- The company's business performance has been excellent, but the market has been more
going maintenance with highly qualified focused on capital-structure issues that Jon Hook believes are temporary and a legal
overhang he considers eminently manageable. If he's right about the threats as well as
engineers and highly responsive customer
the opportunities, he thinks the base-case share valuation would be 3x the current level.
service, and we’ll do it for half of what
Oracle or SAP currently charge you. An-
nual run-rate revenues today are around

of outsourced services, but there are still money invested in their existing custom- TC: It absolutely has. One important way
technical issues around their established ized systems and are in no rush to rip them is that ETFs and passive flows make it
processes and procedures that are a source out and go with something new. Gartner harder to realize mean reversion in over-
of ongoing dispute between the two com- actually forecasts that the “third-party hyped, overvalued and even cash-incin-
panies. The current lawsuit is going to trial software support” market, of which Rimi- erating companies on the short side. The
with a date set for mid-2022. ni has about 85% market share, is going stocks keep going up because they’re in
Taking those overhangs one at a time, to grow 30% per year through 2023, to the index and the index has to buy more
we’re confident the company will be able $1.05 billion. as they go up.
to refinance the expensive preferred shares New business has actually been quite This isn’t a cash incinerator, but look at
and materially lower its cost of capital. strong. In the latest quarter, recurring rev- something like WD-40 [WDFC]. This is a
That’s not likely to happen before mid- enue grew 19%, billings grew over 30%, pretty simple consumer-products company
2021, but it’s clearly a management pri- with a limited product line that essentially
ority and if the current financing envi- generates GDP-level growth – revenues
ronment holds, it shouldn’t be an issue. ON SHORTING: since 2011 have grown at a 2.2% annual
As for the capital raise, management has rate – but the stock trades at 50x forward
explained they wanted to err on the side Passive flows make it harder earnings estimates and 35x EV/EBITDA.
of caution because of the pandemic, and to realize mean reversion The 20-year median P/E is 20x and the 20-
results have already shown it wasn’t in- year median EV/EBITDA is 12x. The stock
dicative of future poor performance.
in over-hyped, overvalued, has consistently been acquired by passive
With respect to the trial, we don’t at all cash-incinerating companies. investment funds that continue to buy at
consider it an existential threat for Rimini. any valuation.
At worst, the jury might decide that some I also think quant-driven trading that
of the company's processes put in place EBITDA was up 40%, and they added is style or factor driven can help create
after the last trial didn’t go far enough to 206 net new customers, which is 70 more additional long opportunities because
avoid copyright issues, and it will have to than they’ve ever added in any previous those strategies ignore firms that might
pay some fines and recast some technical quarter. While some enterprises have likely not screen well. A company with nega-
aspects of its process. Based on past his- delayed maintenance spending due to the tive revenue growth due to divesting a
tory, that could result in fines as high as pandemic, we also think the tough envi- less profitable or slower growing segment
$40-50 million, but we think the actual ronment has everyone trying to figure out will screen poorly now, but could look
number will be much less than that. Our how to cut costs, and Rimini offers that. much better when it laps that divestiture a
base case is they owe $10-15 million in year from now. Passive flows also tend to
fines and nothing materially changes in What do you think the shares, now at avoid more illiquid stocks, so that’s where
their process. The market appears to be $4.15, are more reasonably worth? a lot of the better opportunities are now.
pricing in much worse and is just overly If you’re right about the fundamentals, a
focused on this legal overhang. JH: We’re talking about a software servic- company can grow and evolve and the li-
es company, at scale, with 60-65% gross quidity becomes less of an issue.
We’ve talked a lot about software compa- margins, generating solid free cash flow,
nies shifting their businesses away from with growth inflecting upward – and the You were hard on yourself for what you
licensing plus maintenance toward recur- stock trades at 1x our estimate of 2021 considered mistakes made as the pandem-
ring subscription services. As that contin- recurring revenue. A normal company ic crisis was hitting the market so hard
ues, wouldn't that have a negative impact with those characteristics and without the earlier this year. Talk about that.
on Rimini? legal overhang would reasonably trade at
6-10x recurring revenue. Even factoring in TC: Basically I spent too much time in
TC: You’re right that the company ul- the legal overhang, we think 3x recurring front of the computer and over traded. All
timately depends on customers sticking revenue would be the bottom-of-the-bar- the ups and downs led to too much med-
with on-premise enterprise software solu- rel base case. Our bull-case target a few dling and flip-flopping with the portfolio,
tions rather than moving to cloud-based years out we’ll keep to ourselves – I’m al- when what I should have done was ignore
options from companies like Salesforce. most embarrassed to say. the short-term fluctuations, focus on re-
But we don’t consider that a particularly underwriting our really core ideas, and
pressing issue. The shift to the cloud in the Even in the ten years since you started rely on what we believe are rigorous, fun-
areas Rimini focuses on is likely to be a Voss, passive and algorithmic investing has damentally derived and deeply researched
very long, drawn-out affair. Companies expanded dramatically. Has that changed long-term price targets. It was a good les-
have a considerable amount of time and the game for you at all? son to relearn. VII

S T R A T E G Y : Russell Napier
Magic Money Tree

Russell Napier has a clear idea of the potential impacts of the unprecedented measures taken by monetary and fiscal
authorities worldwide to combat the economic effects of the coronavirus. Let's say it's not an overly rosy outlook.
library in his hometown for, as he puts it, sitting on the horses. Governments are
INVESTOR INSIGHT “anyone wishing to learn the lessons of now driving the horses in the direction
the past as a guide to our financial future.” they want them to go. Through a variety
of programs – the Paycheck Protection
As a student of money, credit and finan- Program in the U.S., the Bounce Back
cial history, how are you processing the Loan Scheme in the U.K. – governments
responses by governments to ward off are telling banks, here’s who you’re lend-
economic calamity during the pandemic? ing money to, here’s the rate you’re lend-
ing it at, here’s the term you’re lending it
Russell Napier: I have a very clear idea of for. This is a fundamental shift we haven’t
the massive thing that has just changed seen outside of wartime in America. It
and is likely to impact the economy and means governments control the supply of
financial markets for the next 20 to 30 money and central banks don’t.
Russell Napier years, and that’s the extent to which gov-
Orlock Advisors
ernments are offering credit guarantees Isn’t one hope that they'll just dismount
“I tell my clients that financial repression is to commercial banks. It sounds tedious, the horses when the crisis is over?
not the end of the world, it's just going to
boring and uninteresting, but I think it’s
make your world a lot more difficult.”
transformational. RN: That’s what people tell me who argue
Why is it transformational? The quan- this isn’t a fundamental shift, but I see a
Editor’s Note: Apart from some political titative easing period after the financial lot of evidence already that governments
grandstanding around the U.S. election, crisis was an attempt by central bankers have no intention of dismounting.
government monetary and fiscal responses to use the old model – by buying assets Guaranteeing credit is a very power-
worldwide to the pandemic have largely from financial institutions you create a lot ful tool of policy, particularly with the
had a “shoot first, ask questions later” ele- of commercial bank reserves, which then economy closing down as a result of the
ment to them. This is not without justifi- incentvizes the commercial bank flush pandemic. You have to get money into the
cation, of course, as the magnitude of the with reserves to expand its balance sheet nooks and crannies of the economy, right
economic problems created by the virus through lending, which then expands down to the guy who runs the taco stand.
and the consequences of doing nothing economic activity. In reality, though, that Global quantitative easing probably isn’t
have seemed unfathomably high. The re- didn’t happen. In the U.S. there was only going to do that. But everyone has a bank
sult has been a series of steps taken with- moderate bank credit growth. In Europe account and if you take control of the
out precedent, and without much discus- it actually contracted. The bottom line banking system you can get money wher-
sion of the long-term impacts. was that the central banks failed to get the ever you want it to go.
While equity investors have thus far commercial banks to extend credit. Our U.K. Bounce Back loans are six-
benefitted considerably from govern- The reason that’s important is that year loans, which is one heck of an emer-
mental initiatives to respond to Covid, that’s how you create money. Since the gency loan. The money lent and created
they should at least be contemplating the 17th century, money has been created will be in the system for quite some time.
long-term consequences. For help in that by commercial banks, not central banks. In early October the government launched
regard, we turn to Russell Napier, a long- Think of central bankers as coachmen or a new 25-year, fixed-interest, 95%-loan-
time macroeconomic historian, analyst coachwomen steering with a set of reins to-value mortgage program to incentivize
and consultant who among his many oc- their six horses. The reins running to the first-time homebuyers. That as a commer-
cupations provides global macro strategy horses are interest rates, the provision of cial prospect doesn’t exist in the United
research to institutional investors through reserves – driven by the size of central Kingdom, simply because it’s not commer-
his Edinburgh-based firm, Orlock Advi- banks’ balance sheets – and usually capi- cially feasible. The government is using ex-
sors. He also serves on multiple invest- tal-adequacy rules. Central bankers try to actly the same mechanism as for the coro-
ment-firm advisory committees, teaches steer the horses where they want the coach navirus Bounce Bank loans – we guarantee
a course on the “Practical History of Fi- of money creation to go. the principal to the bank – but no one can
nancial Markets” at the Edinburgh Busi- Central banks are still doing plenty of say this is an emergency or recovery loan
ness School, and curates The Library of quantitative easing, but in March of this related to the pandemic. The government
Mistakes, a business and financial history year they woke up to find someone else frames it in terms of social justice.

Here’s another example. If I live in Italy If not that response, then people say not ginal propensity to consume is proving to
I can get my friend to come around and to worry, governments will just pull back be very high and I don’t believe you get
price out energy-saving investments in my from money creation through guaranteed high unemployment when that’s the case.
home, maybe solar panels, maybe insula- bank credit programs and all this will end. Of course this depends on how long it
tion. We can take that to the bank and the Again, I don’t believe that. takes for us to get to a vaccine – I’m as-
bank under a government program will suming that’s months, not much longer.
lend us 110% of the price my friend made So you’re worried all this leads to inflation. These excess savings are going to explode
up. Governments are discovering what a into the system.
fantastic and wonderful policy tool this is RN: Milton Friedman said inflation is There are other factors at work. I be-
to hand money out to people who admit- everywhere and at all times a monetary lieve the Biden administration will be at
tedly need it. But next time around, it’s phenomenon. The market has come not to least as aggressive against China on trade,
for recovery loans. Then there will be the believe that in recent years because broad which could mean the cheap supply out
green loans. I expect there will be more money growth has been so low it’s been of China that has helped depress inflation
social justice loans. In the U.S. you’re al- hard to link it to anything, let alone infla- over the past 30 years is unlikely to be as
ready overwhelmed with education loans. tion. At low levels of broad money growth important a factor going forward. Also,
All this means a diminution of com- there’s little relationship to inflation. we hear from a lot of business people that
mercial banks as commercial operations inventories today across the board are
and they increasingly become wards of low. If spending velocity picks up in the
the state and arms of policy. There’s a long ON THE IMPACT ON BANKS: first quarter of next year and that’s com-
and not altogether happy history of that bined with low inventory levels, that puts
in Europe and we’re back into it. My fore- There's a long, unhappy his- upward pressure on prices.
cast is that this is the magic money tree for tory of commercial banks in-
governments and they’re not coming out Have you gone out on a limb with an infla-
of it any time soon. That changes what the creasingly becoming wards of tion forecast?
financial system is going to be and the cru- the state and arms of policy.
cial thing about all of this is that it’s not RN: I’ve been foolish enough to put both
fiscal spending, it’s money creation. a magnitude and timeframe on a forecast:
But broad money growth is 18% glob- I believe the U.S. inflation rate will be at
Is that showing up yet in the numbers? ally. In the U.S. it’s 24%. These are big or above 4% sometime next year. That’s
moves. One pushback is that the velocity quite a big number – since 1995 we’ve only
RN: The numbers jump off the page. of money moving through the system has been at that level a few times before com-
The first place to start is to look at how collapsed – you can pour money into the ing off it. I’m waiting before commenting
much more money there is in the world. system, but if people don’t spend it then it’s specifically on where it can go after that,
The OECD produces a total global money not going to result in inflation. That’s true, but it could conceivably go much higher.
supply number, which includes almost ev- but there’s actually quite a lot of evidence I should point out that I haven’t been
eryone but China, and the data series goes that people are starting to spend it, even propagating this notion that inflation is on
back to 1981. The annual rate of growth in the middle of a pandemic. The savings the way for long. My biggest investment
in that number was running at 5-6% year- rate in the U.S. spiked up but is now com- holding coming into this year was 30-year
on-year prior to Covid, but as of the lat- ing down rapidly. People are remodeling Treasury bonds. I watch money, and mon-
est month it’s over 18%. There have only their homes. They’re buying new homes. ey-supply growth has gone through the
been four quarters in the past 40 years Boat sales are through the roof. Classic roof. The second thing is who’s creating
when the supply of money has grown cars are in a bull market. My argument the money. With governments in charge,
more quickly than that. is that money is already circulating faster it’s going to be difficult for them to stop.
And yet we have the lowest inter- than economists think it is, and when we
est rates in history. At the same time we get a vaccine or very rapid testing, pent up What are implications you see of all this
have almost the lowest inflation expecta- spending on a lot of other things comes for investors?
tions we’ve ever had. When I argue money back with a roar. That’s when you start to
growth will create inflation I get the usual have to worry about inflation. RN: Let me speak briefly first about some
response, “Oh well, money supply has nev- People say we’ll have massive unem- of the economic impact, which I refer to as
er had an effect on inflation,” which you ployment next year and if you have that financial repression.
can maybe say if you’ve only been around prices will stay down. I think massive un- Governments becoming more involved
for 20 years, but you certainly can’t say employment is highly unlikely given the in the allocation of credit as their debt-to-
that if you’ve been around for 100 years. pent-up demand in the system. The mar- GDP ratios go sharply up and to the right

changes the very nature of the system. pricing power tend to attract higher valua- control of the supply of money – would
Governments are also having to hold in- tions. Inflation has been no help for a long they really allow a competitor?
terest rates down even as inflation increas- time, so the guy with the competitive moat Again, that’s not to say you can’t make
es – I can’t stress enough how distortion- and pricing power is a more attractive in- money trading Bitcoin. It might become a
ary all that is. If history is any guide, you vestment. That’s not the only factor, but it store of value like gold, but I’ve got no his-
get much more of a command economy, contributes to the great disparity in equity torical data giving me any clue whatsoever
dictating who qualifies for credit and who valuations we’re seeing today. that it can become that. Smart people are
doesn’t. Governments force institutions to But what happens when you wake up speculating on that, but it remains specu-
own government bonds when they don’t and there’s inflation? Everyone has pricing lation given the history of the asset class.
want to. Capital controls become more power. The guys with these low valuations Gold as a store of value isn’t a speculation.
stringent. You might need consumer price because they can't raise prices look awful-
controls. All of this distorts the efficient al- Do you have any good news to report?
location of credit and capital, which can’t
help but repress real economic growth. ON FINANCIAL REPRESSION: RN: While I’m a relatively new convert to
The investment implications? First, you being worried about inflation, I’ve been
don’t own government bonds if the gov- In the early stages, all of this talking about financial repression for
ernment controls the supply of money. If feels pretty nice. It may take four years and my institutional-investor
one ultimate government aim of all of this clients often say, whoa, this is the end of
is to inflate away debts, you don’t want
a long time, but it tends to
the world. My reply is that it’s not the
to own those debts. If I look back at the end up in a very bad place. end of the world, it’s just going to make
last time something like this happened, in your world a lot more difficult. Financial
Britain following World War II, a British repression essentially results in moving
investor owning government bonds from ly cheap when they can. If people are no money from savers to debtors. Debtors are
1945 to 1981 would have lost 82% of his longer incrementally paying up for pric- probably going to love this, and there are
or her purchasing power. ing power because everyone has it, what a lot of them out there.
There are two arguments for precious do they pay up for? In an inflationary In the early stages, all of this feels pret-
metals in the environment I’m describing. period maybe you’re more apt to pay up ty nice. Wages grow faster. Your mortgage
Gold has historically done extremely well for cost control. If one has a large capital- is almost free. Maybe your student loan is
in periods of negative real interest rates, asset base that doesn’t require huge rein- forgiven. All of that isn’t bad for economic
which I believe may be with us for some vestment, if you funded that with fixed, activity. But to the extent it results in in-
time. I’d also argue gold becomes more at- long-term debt that should give you struc- flation and the misallocation of credit and
tractive as governments take a bigger role tural cost control that might become more capital, that’s likely not good at all long
in capital allocation. If the state is going highly valued. Compare that with your term for savers – or for governments.
to increasingly weigh in on what financial asset-light, higher-moat corporate breth- Look at Robert Shiller’s database and
institutions do and the assets they own, it’s ren. The biggest part of their costs may be what happened to corporate earnings from
a good thing that gold is an asset class out- wages, the growth of which has been qui- 1966 to 1982. In nominal terms, earnings
side that regime. You own it and it’s less escent in disinflationary times, but maybe went up threefold over that period. But
susceptible to government interference. that isn’t the case anymore with inflation the stock market came down 40%. As sav-
The nice thing about equities is that rising. They might find it harder to control ers you lost money in bonds and you lost
there’s such a huge range of options that costs, which could be a strike against them money in equities. In the U.K. I mentioned
as an active manager you should be able in the eyes of the market. how we ran this policy after WWII. Well,
to find companies that benefit from an in- in 1976 we went bankrupt and had to go
flationary environment. Your readers will Are you a Bitcoin advocate? to the IMF for a bailout. It may take a long
know more about that than I do. But I time, but it ends up in a very bad place. If
would say generally that the environment RN: I tend to think of virtual currencies you get very inefficient allocation of capi-
I’m describing – relatively at least – could a bit like baseball cards. There are smart tal for a long period of time, you don’t cre-
be a positive one for value investors. people who make really good money on ate jobs and the real economy stagnates.
I’m from Ireland and any time any- baseball cards. It’s an asset class, with bull
one asks for directions they say, well, that markets and bear markets. But baseball Here’s hoping your wrong.
will depend where you start. So it’s worth cards at least haven’t yet become a cur-
pointing out where we start with respect rency and I believe the same will prove RN: If the governments jump off the hors-
to equities. After 40 years of disinflation, to be true about Bitcoin. We’re discussing es, then I’m wrong. I’m with you – I hope
companies broadly speaking that have how governments are taking even further that’s what they do. VII

U N C O V E R I N G V A L U E : Equinor
The Answer, My Friend ...

At a time of considerable uncertainty in energy markets, investors would be forgiven if they decided to take a pass on
the sector altogether. For those interested in braving the elements, Massif Capital's Will Thomson has a suggestion.
Investing in the oil and gas business has what Thomson considers a detailed and oil, an 8% weighted average cost of capi-
been even more harrowing than usual in credible plan for expansion. By 2026 it ex- tal, and production growth and returns on
recent years. On top of typical challenges pects to have six gigawatts of wind-energy both the traditional and renewable sides
in navigating commodity cycles and geo- capacity – industry leader Ørsted [Copen- in line with company expectations. That
politics, add in more competition from hagen: OMX], by comparison, today has yields a fair value for the shares today of
renewable energy, more antipathy toward seven gigawatts of capacity – and by 2035 around $30. If long-term oil prices were
polluting energy producers, and a demand- it plans to have 12 to 16 gigawatts of total $55 per barrel – a distinct possibility, he
decimating pandemic. As many investors wind capacity, likely putting it at or near says, but not his base case – he estimates
have concluded, better to stay away. the top of the industry in size. fair value at closer to $50 per share. “At
Will Thomson and Chip Russell have Looking beyond the less-than-rosy near a time when the future is this uncertain,
taken another tack. They founded Massif term, Thomson sees considerable upside in we want companies prepared to prosper
Capital in 2016 to invest long and short in Equinor’s shares. His base-case DCF valu- in whatever environment there is,” he says.
energy, basic materials and industrial busi- ation assumes long-term $45 per barrel “We think this is one of them.” VII
nesses roiled by disruption. Traditional oil
and gas, in fact, is a keen area of inter-
INVESTMENT SNAPSHOT
est today. “Companies transitioning from
high-carbon-footprint to low-carbon- Equinor Valuation Metrics
footprint business models are some of the (NYSE ADR: EQNR) (@11/27/20):
more intriguing long-term opportunities EQNR S&P 500
Business: Energy exploration and produc-
currently on offer,” says Thomson. tion, primarily on Norway's Continental Shelf; P/E (TTM) n/a 41.3
One example is Equinor, a large explo- two-thirds owned by Norwegian government. Forward P/E (Est.) 16.2 25.9
ration and production company operating
Share Information (@11/27/20):
primarily on Norway’s Continental Shelf Largest Institutional Owners
Price 16.35
but with key assets also in Brazil and the (@9/30/20 or latest filing):
52-Week Range 8.41 – 21.04
Gulf of Mexico. Thomson considers it near Dividend Yield 3.5% Company % Owned
the midrange of big oil and gas companies Market Cap $53.60 billion Folketrygdfondet 3.5%
in how aggressively it's preparing for a Financials (TTM): Vanguard Group 1.0%
lower-carbon future – Exxon Mobil is at Revenue $48.78 billion Dodge & Cox 0.8%
the low end and BP is at the high end – but Operating Profit Margin 9.7%
Short Interest (as of 11/15/20):
he believes it has a well-defined strategy Net Profit Margin (-6.8%)
Shares Short/Float 0.2%
and the assets and capital-allocation disci-
pline to pull it off more successfully than EQNR PRICE HISTORY
the market appears to recognize. 30 30
With respect to its well-located tradi-
tional assets, he says Equinor’s regional 25 25
scale and expertise give it near-industry-
20 20
low costs, with a breakeven point across
its portfolio at between $35 and $40 per- 15 15
barrel oil. (BP’s breakeven is closer to $50.)
It’s bringing on new production at compa- 10 10
rable or better economics and continues to
focus on lowering the carbon footprint of 5 5
2018 2019 2020
the oil it does produce. Its CO2 produced
per barrel is roughly half industry averag- THE BOTTOM LINE
es, lowering the stranded-asset risk faced At a time of considerable energy-market uncertainty, Will Thomson believes the company
by others with “dirtier” reserves. is likely to prosper regardless of how quickly demand for renewable energy increases.
On renewables, the company is playing Assuming $45-per-barrel oil, his base-case DCF value for the stock today is around $30.
to its existing strength in offshore wind,
where it is a top-five global player and has

U N C O V E R I N G R I S K : Five Below
Look Out Below

In today’s market there is no shortage of richly valued companies, and if history is any guide many of them are likely
to stay that way for some time. Charles Lemonides explains why specialty retailer Five Below may not be so lucky.
Success stories in bricks-and-mortar re- He also believes Five Below in the cur- earned in the fiscal year ending January
tail have been few and far between, but rent environment may be getting ahead of 31. Its market cap is more than 5x trail-
Five Below would certainly qualify as a itself in rolling out new stores. It has high- ing-12-month revenues. If quarterly re-
noteworthy exception. Founded in 2002, lighted the great deals on real estate it’s sults underwhelm as the next fiscal year
the company has rapidly expanded in re- currently being offered and is planning to unfolds there could be a very sharp re-
cent years, targeting teens and tweens with capitalize upon. That increases the risk, he versal in those glassy-eyed multiples, he
an eclectic and quickly changing mix of says, that putting the “pedal to the metal” says, meaning at least cut in half. “Listen,
gifts, toys, candy, beauty and fashion ac- on expansion based on recent experience I don’t step in front of growth machines
cessories, low-tech electronics and much will not look nearly as smartly opportu- just because they’re super expensive,” he
more priced generally below $5. Now nistic a year from now as it does today. says. “But when they’re super expensive,
with more than 1,000 stores across the If he’s right, what could happen to there are no real competitive advantages
U.S. – on the way to 2,500, it says – rev- the shares? The stock now trades at 50x and I think the growth is imminently at
enues have grown at an 18% annual clip the peak $3.10 per share the company risk, that’s much more interesting.” VII
over the past five years. The stock price
over that period has increased a heady
INVESTMENT SNAPSHOT
five-fold, to a recent $158.
In a market in which abundant investor Five Below Valuation Metrics
optimism is in some evidence, ValueWorks (Nasdaq: FIVE) (@11/27/20):
LLC’s Charles Lemonides considers Five FIVE S&P 500
Business: U.S. retailer selling an assortment
Below a rather extreme case. He credits of discretionary items typically priced below P/E (TTM) 89.3 41.3
the company with great execution – “It’s a $5, primarily to teen and pre-teen buyers. Forward P/E (Est.) 39.8 25.9
fresh concept, basically teaching kids how
Share Information (@11/27/20):
to shop and have fun doing it in person,” Largest Institutional Owners
he says – but he finds the shares’ valuation Price 158.09
(@9/30/20 or latest filing):
52-Week Range 47.53 – 159.59
head-scratching. Citing just one metric, the Company % Owned
Dividend Yield 0.0%
stock today trades at an enterprise value of Market Cap $8.83 billion Vanguard Group 8.6%
roughly $9.5 million per store, for stores BlackRock 8.1%
Financials (TTM):
that cost $400,000 to $500,000 each to Revenue $1.69 billion Fidelity Mgmt & Research 7.1%
build and outfit. “For a concept with no Operating Profit Margin 7.0%
Short Interest (as of 11/15/20):
real competitive barriers, that’s priced Net Profit Margin 5.9%
Shares Short/Float 9.0%
pretty much for perfection,” he says.
The catalyst for a rethinking of that FIVE PRICE HISTORY
pricing is pandemic related. The com- 200 200
pany’s comparable-store sales upon re-
opening after lockdowns have exceeded
expectations, which Lemonides credits to 150 150
it nimbly shifting its merchandise toward
more-timely products like hand sanitiz-
ers, wireless speakers and inexpensive gift 100 100
items offering pick-me-ups on a budget.
But he also believes that has temporarily
attracted buyers beyond the traditional 50 50
2018 2019 2020
customer base, and that typical customer
spending will not quickly snap back as the THE BOTTOM LINE
pandemic’s impact lingers. As parents are The company has executed well through the pandemic, says Charles Lemonides, but he
slow to bring their kids back to shop as believes the market's excessive regard for the stock sets it up for a sharp correction in
before, he thinks company results in the the not-unlikely event that Covid's lingering effects are more problematic than expected.
first, second and third quarters of next
year are likely to materially disappoint.

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ValueInvestor

November 30, 2020

The Leading Authority on Value Investing

INVESTOR INSIGHT to be in any value investor’s Anthem 5

playbook, Voss Capital’s Travis Autohome 7

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 1

Investor Insight: Ben Preston

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 2

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 3

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 4

250 250 BP: What you describe has resulted in a

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 5

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 6

straightforward. It’s the largest online Price 105.89 Company % Owned

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 7

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 8

Your Guide Through

Want to learn more? Please visit www.valueinvestorinsight.com

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 9

Investor Insight: Travis Cocke

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 10

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 11

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 12

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 13

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 14

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 15

Do you have a Plan B in this case? Louisiana-Pacific Valuation Metrics

Turning to something quite different, what 40 40

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 16

Coming back to the world of software, 8 8

JH: The company’s business model is quite 4 4

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 17

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 18

Magic Money Tree

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 19

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 20

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 21

The Answer, My Friend ...

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 22

Look Out Below

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 23

November 30, 2020 www.valueinvestorinsight.com Value Investor Insight 24

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