Graham & Doddsville_Issue 22_Fall 2014

8/10/2019 Graham & Doddsville_Issue 22_Fall 2014

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Fall 2014Issue XXII

Editors:

Matt FordMBA 2015

Peter PanMBA 2015

Tom Schweitzer, CFA

MBA 2015

Brendan DawsonMBA 2016

Scott DeBenedettMBA 2016

Michael HermanMBA 2016

Inside this issue:

Omaha Dinner P. 3

5x5x5 StudentValue InvestingFund P. 4

Wally Weitz P. 6

Guy Gottfried P. 14

Columbia IICMeeting Ideas P. 22

DevelopmentCapital Partners P. 26

Visit us at:

www.grahamanddodd.com

www.csima.org

Graham & DoddsvilleAn investment newsletter from the students of Columbia BusinessSchool

Wally Weitz

Power of Good Management

Guy Gottfried is the Founder and Managing Partner of

Rational Investment Group, LP, a Toronto-based investment

firm following a concentrated, risk-averse value approach.

Prior to founding Rational, Mr. Gottfried was an analyst at

Fairholme Capital Management. He began his career at

Veritas Investment Research, Canadas largest independentequity research firm. Mr. Gottfried graduated with a BBA

with Honors from the Schulich School of Business at York

University, where he was a Presidents Scholarship recipient.

(Continued on page 14)

Guy Gottfried

Development Capital Partners

The Changing Landscape in Africa

Development Capital Partners (DCP) is a New York-

based investment manager focused exclusively on Afri-

can markets. The fund was co-founded by Paul Tierney,Matt Tierney 02, Gordon McLaughlin 11, and Matt

Magenheim 11.

Graham & Doddsville (G&D): Could you start by explaining how you became inter-

ested in investing?

Paul Tierney (PT):I got started in the investment business with no background ininvestments. I graduated from college having studied philosophy, and then went into


DCP Team

Guy Gottfried

The Value of Capital Allocation

Wally Weitz is the Founder and President of Weitz

Investment Management, an Omaha-based fund manager

with over $5 billion in AUM. Influenced by the value investing

philosophy of Benjamin Graham and Warren Buffett, Mr.

Weitz started his career as a securities analyst in New York

after earning a BA in Economics from Carleton College in

1970. He then joined Chiles, Heider, & Co. in Omaha,

working there for ten years before starting his own fund in


Wally Weitz
http://www.grahamanddodd.com/http://www.csima.org/http://www.csima.org/http://www.grahamanddodd.com/


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Page 2

Welcome to Graham & Doddsville

They think Im a book with acouple of legs sticking out.Indeed, continuous reading and

learning is critical to succeedingas an investor, and we thankyou for counting G&D as partof your reading regimen.

For this issue we spoke withsix investors from three firms,each with a distinct investmentstyle and focus. We believeyou will enjoy our interview-ees diverse set of perspectives.

Wally Weitz, Founder andPresident of Weitz InvestmentManagement in Omaha, NE,

was our first interview. Wediscuss how Mr. Weitzs invest-ment philosophy has evolvedover time, his views on valua-tion, and assessments of hispast and current holdings.

Guy Gottfried,Founder andManaging Partner of RationalInvestment Group, sharessome of his key investing les-sons with us, including theimportance of partnering withstrong management teams andmaintaining a high level of in-vesting discipline.

And as we look for investorswith a global perspective, PaulTierney and his partners at

Development Capital Partnersshared with us the excitementand challenges of investing in

companies across the Africancontinent.

Lastly, we continue to bringyou pitches from current stu-dents at CBS. CSIMAs Invest-ment Ideas Club meets regular-ly throughout the year, includ-ing during the summer, andprovides CBS students theopportunity to practice craftingand delivering investment pitch-es. In this issue, we feature twoideas from our classmates Kev-in Lin 16 and Sisy Wang 16:

long Countrywide PLC (LON:CWD) and short B&M Europe-an Value Retail (LON: BME).

We strongly believe in thevalue of diversity of thoughtand experience. These insightscome from a variety of sources,and we look forward to bring-ing you these unique perspec-tives and fresh ideas during thisacademic year.

As always, we thank ourinterviewees for contributingtheir time and insights not onlyto us, but to the investmentcommunity as a whole, and wethank you for reading.

-G&Dsville Editors

It is our pleasure to bring youthe 22ndedition of Graham &Doddsville. This student-led

investment publication ofColumbia Business School (CBS)is co-sponsored by the Heil-brunn Center for Graham &Dodd Investing and the Colum-bia Student Investment Manage-ment Association (CSIMA).

To recap the happenings sinceour Spring 2014 issue, the Heil-brunn Center hosted the fifthannual From Graham to Buffetand Beyond Dinner in Omaha,held on the eve of the BerkshireHathaway Shareholders meeting

and featuring a panel of re-nowned speakers. Photos of theevent can be found on page 3.

We also proudly announce theformation of our inaugural stu-dent-run Value Investing Fund,made possible by a generous giftfrom Helibrunn Center AdvisoryBoard Member Mr. ThomasRusso and his wife Georgina.Please read more on page 4.

As our fellow students begintheir Fall courses at CBS, we arereminded of a humorous quotefrom Charlie Munger: In mywhole life, I have known no wisepeople who didnt read all thetime...my children laugh at me.

Louisa Serene Schneider06, The Heilbrunn CenterDirector. Louisa skillfullyleads the Center, cultivatingstrong relationships with

some of the worlds mostexperienced value inves-tors, and creating numer-ous learning opportunitiesfor students interested invalue investing. The classessponsored by the Heil-brunn Center are amongthe most heavily demandedand highly rated classes atColumbia Business School.

Renowned Columbia Business Schoolalumnus Mario Gabelli 67 shares his

experiences as a panelist at the May 2014Omaha Dinner

The Heilbrunn Center Team, JuliaKimyagarov, Louisa Serene Schneider 06,and Marci Zimmerman, at the May 2014

Omaha Dinner

Professor Bruce Greenwaldthe Faculty Director of theHeilbrunn Center. TheCenter sponsors the ValueInvesting Program, a rigor-ous academic curriculumfor particularly committedstudents that is taught bysome of the industrys best

practitioners.


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Page 3Volume I, Issue 2 Page 3Issue XXII

From Graham to Buffet and Beyond Omaha Dinner 2014

Tom Russo of Gardner, Russo & Gardner, LLC Bill Ackman, Louisa Serene Schneider 06, Paul Hilal 92,and Alex Rodriguez converse during the reception

Dinner panelists included Bruce Greenwald, WallyWeitz, Bill Ackman, Tom Russo, and Mario Gabelli 67

Wally Weitz offers his thoughts alongside BruceGreenwald and Bill Ackman


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5x5x5 Student Value Investing Fund

Tano Santos, Tom Russo, and Bruce Greenwald at theValue Investing Program Welcome Reception. Mr. Russodonated a generous gift to create the first-ever student

value investing fund: 5x5x5

Louisa Serene Schneider 06, Glenn Hubbard, Tom Russo,and Bruce Greenwald at the official inception of the 5x5x5

Student Value Investing Fund

Columbia Business School is delighted to announce the formation of its inaugural student-run Value Investing Fund.This innovative fund was made possible by a generous gift from Thomas Russo and his wife Georgina. Mr. Russo is afrequent guest lecturer at Columbia Business School, and a member of the Heilbrunn Center Advisory Board. Thanksto Mr. Russos creativity and leadership, this unique entrepreneurial fund is both long-term and aligns with thefundamental principles of value investing, making it unlike any other student-run fund. The Russos gift affordsColumbias value investing students the opportunity to connect value-oriented investment theories to real worldpractice as they apply their classroom learning in the management of this fund.

The 5x5x5 Student Value Investing Fund was introduced by Mr. Russo to the Heilbrunn community at the ValueInvesting Program Welcome Reception on September 12, 2014. In addition to Mr. Russo, the 5x5x5 Fund Board willconsist of five students from the Value Investing Program along with Bruce Greenwald, Robert Heilbrunn Professor ofFinance and Asset Management, and Louisa Serene Schneider 06, Senior Director of the Heilbrunn Center. During the

Spring 2015 semester, students in the Value Investing course taught by Bruce Greenwald and Tano Santos will have theopportunity to submit their investment ideas to the 5x5x5 Board. The Board will then choose among these investmentideas and will articulate five reasons behind each investment. Five of the stocks will then be selected and invested in fora period of five years. At the end of five years, the original amount, accounting for inflation, will be invested back intothe 5x5x5 Fund and the remainder of the gains will be used to support current-use scholarships for students interestedin investment management. As alumni, program students will remain active managers of the 5x5x5 Fund, continuingtheir support of, and connection to, the Heilbrunn Center and Columbia Business School.

Bruce Greenwald provided an overview of the structure ofthe 5x5x5 Fund to students and alumni from the

Columbia Business School Value Investing Program

Tom Russo discussed the details of the newly created5x5x5 Fund with value investing program students and

alumni


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A full-day event featuring keynote addresses and panel discussions

from some of the most well-known investors in the industry.

Presented by:

The Columbia Student Investment Management Association

and

The Heilbrunn Center for Graham & Dodd Investing

Visit our website for updates: http://www.csima.org

For inquiries contact:

Calvin Chan [email protected]

Lou Cherrone [email protected]

James Leo [email protected]

SAVE THE DATE

18th

Annual Columbia Student InvestmentManagement Association Conference

January 30, 2015
http://www0.gsb.columbia.edu/students/organizations/cima/conference.htmlmailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]://www0.gsb.columbia.edu/students/organizations/cima/conference.html


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firm in 1970 when I graduated.I worked at G.A. Saxton, asmall OTC trading firm. It wasa terrific training ground. My

boss, Artie Dunn, followed thefive hundred stocks we actuallymade a market in and you canimagine how deeply wecovered them. Im not sure ifhe knew who Ben Grahamwas, but he was intuitively avalue investor.

It was supposed to be asummer job, but I just didntleave, and nobody reallynoticed. I stayed for almostthree years before gettingmarried and leaving New Yorkfor Omaha. I joined a regionalbrokerage firm and was askedto cover local companies.Fortunately, one of those localcompanies was Berkshire

Hathaway.

One of my mentors in NewYork, Frank Monahan, told meabout Warren Buffett, and myboss in Omaha was a goodfriend of Warrens. He tookme to the Berkshire annualmeeting when it was held inthe National Indemnitylunchroom, and there were

only three outsideshareholders. As you canguess, the meeting has changedover the years.

I have paid attention toWarren over the years. A lotof what I try to do has roots inwhat I've learned from him. Idont claim to do it as well orto be as disciplined, but Ialways feel like hes lookingover my shoulder as I invest oras I write our investor letters.

That brings us to 1983 when Iwas thirty-four years old. I leftthe brokerage firm to start myown investment firm. A groupof clients invested $11 millioninto three partnerships. Wekept it simple with a flat 1%management fee and nocarry. Over time, weconverted the partnershipsinto mutual funds, and, thirty-one years later, we have 11funds, primarily focused onequities.

The firm now has roughly $6

billion in assets with aninvestment team of 11. Werea little unconventional in thatwere willing to hold cash, werun concentrated portfolios,and we dont manage to anyparticular benchmarks.Everybody at Weitz hasvirtually all of their investablefunds and all of theirretirement assets invested inour funds. Eating the homecooking is true for us. We do

our own thing, and I feelfortunate to get paid to do myhobby.

G&D: What was theinspiration to strike out onyour own?

WW:When I was at Saxton,the head of the firm called me


1983 with $11 million in

assets under management

at the time.

Graham & Doddsville

(G&D):We would love tohear about your background.How did you originally becomeinterested in investing?

Wally Weitz (WW):Mymother was a single parent anda social worker so mygrandparents gave her a smalllump sum of money andintroduced her to their stockbroker to make sure she

would not have trouble makingends meet. She and I went tolunch with him, and by the endof it, she was bored stiff while Iwas fascinated.

On the way back from themeeting, I started reading HowTo Buy Stocks by Louis Engel,which you can still find onAmazon. It explained thebasics of what a stock is, whata bond is, and so on. I started

investing two shares here andten shares there. The ideasmainly came from the brokerin New York.

That was when I was 12, and Ibecame hooked. I wentthrough a charting phase, and Iwas keeping 100 charts a dayand trading on them usingtechnical indicators. Tuitionwas cheap in retrospect, butlosing $50 in the 60s seemed

tragic.

Anyway, I stumbled on BenGraham when I was atCarleton College, and I readSecurity Analysis. Then, I took acorrespondence investmentcourse with the New YorkInstitute of Finance, giving methe credibility (as to initiative,not knowledge) to get asummer job with a Wall Street

(Continued from page 1)

Wally Weitz

Wally Weitz

I have paidattention to Warren

over the years. A lot

of what I try to do

has its roots in what

I've learned from

him.


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business model and itscompetitive moat. We try tohave a general sense of theeconomic environment, but we

do not want to depend onmaking correct macro-economic predictions. In short,if the price of the stock is wellbelow what an intelligentowner would pay today for thewhole business, the odds arestrong that something goodwill happen with the stock.That's the basic idea.

G&D:How much of adiscount to intrinsic value orprivate market value isrequired to get you interested?

WW:We always used to say

we wanted a 50% discount,and for years we found thatkind of bargain. In recent years,we have found ourselvespaying 60% or 70%. Valuationshave risen, and its possible ourvaluation methods have beentoo conservative (We use a12% discount rate when we dodiscounted cash flow models.)At any rate, we are wary of

paying up for stocks, becausehistory has shown that whenthe weighted average price-to-value of our portfolios rises,

the returns over the next sixto twelve months tend to belower than when we startfrom lower P/V levels. If thiswere not the case, we wouldhave to find a new investmentmethod.

G&D:Could you talk abouthow your investing philosophyhas changed over time? Forexample, you became morecomfortable paying highermultiples for higher qualitybusinesses. Companies likeGoogle and TransDigm maynot have been in the portfolio25 years ago.

WW:I've been paying veryclose attention to Warren for40 years. I heard him say earlyon that Munger taught him thata great business is worthpaying up for. In one of hisannual reports, he talked abouteconomic goodwill as

distinguished from accountinggoodwill. Economic goodwillmeasures the franchise value,or the ability to chargepremium prices, because ofyour moat.

At an intellectual level, Ivebeen aware of that concept for40 years. Ive also been familiarwith the idea of picking stocksas if you only had 20 puncheson your investing ticket. Being

able to act that way has onlycome gradually over time.Value investors can be drawnto the statistically cheap, likea moth to the flame, buteventually the pain of livingwith mediocre companiescatches up with you. Learningwhere to draw the linebetween paying up for quality


in one day and said, Youredoing fine, were not payingyou much, so there's noproblem, but what do youwant to do with your life?

I said, Id like to managemoney like Harold and Frank.

He said, Great, go get some.

That was the cold slap in theface that helped me realize Ineeded to figure out wherethe capital would come from ifI wanted to make investmentdecisions and manage money.

My wife and I preferred theMidwest to New York so wemoved to Omaha where aregional brokerage firm agreedto let me do research and tryto find accounts to manage.For the next ten years, Imanaged accounts as a broker,but I thought I could do abetter job for clients if I couldpool the accounts and charge afee rather than transaction-

based commissions. So, Istarted Weitz & Co. in 1983.

G&D:Could you talk aboutthe specific style of investing atyour fund and yourphilosophical approach?

WW: We try to think likebusiness owners. We believethat the value of a business isthe present value of the cashthe business will generate in

the future. Investors usevarying definitions of cashflow or free cash flow, butwe focus on discretionarycash flow money that couldbe taken out of the businessbut which the owner mightvoluntarily reinvest in thebusiness. In making estimatesof future cash flows, we haveto make judgments about thesustainability of the companys


We try to have a

general sense of the

economic

environment, but we

do not want to

depend on making

correct

macroeconomic

predictions.

Wally Weitz


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will try to understand thecompanys business model andthe degree to which it hascontrol over its own destiny.

Then they'll start developing amodel. We try to estimate thefuture cash flows that we cancount on.

I think the most useful part of

building the model is makingsure we understand therelationships among thevariables. We need to knowwhat is important to the futuresuccess of the company andhow realistic our assumptionsare. Precise predictions arenot required (or possible). Webelieve in the adage: Itsbetter to be approximatelyright than precisely wrong.

Capital structure is alsoimportant. Is the balance sheetappropriately levered? Howmuch option dilution will weface? Can we expectopportunistic buybacks? Ifwe're dealing with a Malonecompany, I think it's okay toassume some stock buybacksover time. If you're dealingwith many of todays tech

companies, maybe you wouldnot build in much buyback.

Judgment is required. Weeventually get to a model that

we discuss among ourselves.We argue and develop somelevel of confidence that wehave an approximately correctappraisal number for thebusiness.

That might take a month on anew company that no oneknows much about, or it mighttake an afternoon if it's an areawe're pretty familiar with andwe know the people involved.If a stock has fallen out of bedfor some reason that webelieve is temporary, we canact pretty fast on it.

G&D:Is there any part of thatprocess you would saydistinguishes Weitz from otherinvestors?

WW: Our process is probablysimilar to that of other valuemanagers. What mightdistinguish us is temperament.

We are not just knee-jerkcontrarians, but we are willingto be early and out of stepwith the market at times. Itsoften a good sign wheninvestors and analysts agreethat the stock is extremelycheap, but we shouldnt buy ityet because there might beanother bad quarter coming.

G&D:You spoke previouslyabout how you try to poke

holes in an investment thesis.Is there a way to systematicallyapproach that?

WW:I know that others havea process where they assign adevils advocate to look fortrouble. We dont formalizethat. With a group of eight toten of us, each one coming


and accepting a flaw because ofa cheap price is part of the funof investing.

I would also say thatmanagement is a majorconsideration. Warren has saidthat it is good to buy acompany that any idiot canrun, because sooner or later,an idiot will be in charge. Fairenough. But if were buyingcompanies that generateexcess cash, its terrific if wecan trust management to dosomething smartaccretive toper share business valuewith

that cash. Warren Buffett andJohn Malone have donewonders with discretionarycash over the years. Mostothers have not.

G&D:Can you take usthrough your investmentprocess? Perhaps starting fromidea generation throughestablishing a position.

WW: The ideas come from all

over. We don't do muchmechanical screening. We'reaware of a number ofcompanies as a result ofassessing the businesses weown, their competitors, andthe ecosystem. Also,everybody is readinginterviews and thinking aboutcompanies all the time. Wepay attention to a handful ofother investors that werespect. I think the initial idea

may come from any number ofplaces.

When it's a company that'sreally new to our analysts andnew to me, the analysts willread all the filings for the lastfew years as well as transcriptsof conference calls andinvestor days. They will readabout the industry and talk toothers in the business. They


Learning where to

draw the line

between paying up

for quality and

accepting a flaw

because of a cheap

price is part of the

fun of investing.

Wally Weitz

Mr. Weitz discussing hisinvestment experienceswith attendees at the 2014Omaha Dinner.


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make no pretense about beingable to predict the next six ortwelve months. For what itsworth, the view that seems

generally correct to us is thatthe economy is okay, and socompanies have some controlover their destinies.Companies with competitiveadvantages will continueperforming well and becomingmore valuable, so Im notbearishIm actually prettyoptimistic.

However, it seems as if stockprices have moved faster thanunderlying intrinsic values. TheFall of 2011 was the last timeany of us around here werereally excited about pricelevels in general. Since then,almost all our companies havedone just fine, but their shareprices have gone up faster than

their business values. We havegone from 60 cent dollars to90 cent dollars. It seems veryplausible to me that eitherstock prices drop back down

or they go sideways for a whileso that business values cangrow into their stock prices.

Being reasonably optimisticabout the environment, if thestock market dropped 10% to20% tomorrow, we might bewilling to be 90% to 95%invested. It wouldnt take amove like the one we saw in2008 and 2009 for us to getexcited about some of thecompanies we follow.

G&D:How do you define andthink about risk? Is it in termsof volatility, permanent loss ofcapital, or some other way?

WW:It's absolutely notvolatility. Howard Marks haswritten about this extensively.He explains it so well that Ilike to point people towardshis stuff. He has a new essaythat focuses on various typesof risk. It's all about the risk ofpermanent loss as opposed tovolatility.

We love volatility. We try toappraise a companys businessvalue and its likely growthpath. The stock price shouldbe loosely tethered to thebusiness value over time, butvolatility around that valuegives us the chance to buy at adiscount and sell at a premium.

In late '08 and early '09, whatwas then called Liberty Capitalgot down to around $3.50.

That was fabulous. Thesuccessor to that is now about$150. Volatility is terrific.What we don't want is thepermanent loss. In that recentMarks essay, he goes into allthe different ways you cansuffer permanent loss. He talksabout having leverage risk,liquidity risk, credit risk,


from a different place andbackground, we are prettygood at poking at the story.We have that debate and, atsome point, if we decide werecomfortable with our appraisal,we buy the stock. But thereoften may be multiple roundsof research work that comeout of the initial meeting.

G&D:Could you elaborate onhow you view the cash portionof your portfolio? Is itoptionality on futureopportunities or justrepresentative of a lack of

current opportunities?

WW:Well, we would bequick to say its not a markettiming call. Its just a residualthat comes from selling thingswhen they get expensive andnot finding cheap enoughreplacements. We try as hardas we can to be fully invested,and the cash represents failureto find opportunities that wereally like.

G&D:What is the range ofcash that you are willing tohold?

WW:We may hold as muchas 30% cash. We have onefund thats allowed to borrowand sell short, and that fund iscurrently 63% net long. Mostof the funds have around 20%to 25% held in cash at themoment.

G&D:Do you have a view onwhere you think we are in theeconomic cycle? Does thatview impact your portfolio?

WW: Im very skeptical of myown or anybody elses abilityto predict the direction of thestock market. We try to havea sense of whether we faceheadwinds or tailwinds, but we


Its often a good

sign when investors

and analysts agree

that the stock is

extremely cheap, but

we shouldnt buy it

yet because there

might be another

bad quarter

coming.

Wally Weitz


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rates, one popular notion thatmay have been carried too faris buying high quality dividend-paying stocks. High quality

companies that are growing invalue may be good investmentsif bought at reasonable prices,but the success of the strategywill not be based on theirdividend yield. Cynicalmanagements have raised a lot

of cheap capital by using theMLP format to sell over-pricedsecurities that look attractiveto unsophisticated investorsbecause of their high currentyields. The most extreme casemay be those royalty trustswhich will become worthlessin a few years yet sell at highprices, because of their currentdividend payments.

G&D:Are there common

characteristics in some of yourmost successful investmentsover time?

WW:We have done reallywell trading financials when theFed was raising interest rates.We have done very well overthe years with cable TVcompanies. Investors wereskeptical in the early years as

cable companies borrowedhuge sums to build out theirsystems before they had manysubscribers. Interest costs and

depreciation created largelosses in the early years.However, cable is asubscription business with lowchurn rates, and cablecompanies developed newproducts (telephone, pay perview and broadband) that theycould deliver over theirexisting plant. Cash floweventually turned positive andthe stocks went up several-fold. We had a similarexperience with cellulartelephone and benefitted whenthe industry consolidated.

G&D:Speaking of cablecompanies, we noticed thatone of your larger positions isLiberty Global. Could youdiscuss your general thesis onthat company?

WW:I like Liberty Globalbecause they build out cablesystems using a lot of leverage,

generate huge amounts of freecash flow and then buy backlots of stock. Their balancesheet is highly levered, butthey have a very tax efficientway to generate equity valueper share.

That's great when you haveMike Fries who is really a goodoperator and John Malone whois making sure that they'remanaging that balance sheet. I

might not be interested in thesame company if it were runby some other people.Management makes a hugedifference in all kinds ofbusinesses and it is criticalwhen you're dealing withleverage.

They've been very efficient on


interest rate risk, basis risk,and all those things. Those areall variations that can causepermanent damage.

You have people risk too. Youhave situations wheremanagers push too hard on theunderlings to perform. I thinkthat's where you get theEnrons and the Worldcoms:the frauds.

There are all sorts of ways youcan incur permanent loss, butthat's what we're talking about,not volatility.

G&D:Youve mentioned inthe past that you viewdisproportionate overreactionsto stock market selloffs asideal opportunities. Given thereduction in quantitativeeasing, are you positioned totry to take advantage of apotential market reaction?

WW:We joke about that. Atsome point, rates have to go

up. Its inevitable.

When that happens, somepeople will probably besurprised and unhappy. We arenot positioning the portfoliosfor a particular marketreaction to rising rates. Weconsider the likely effect oneach company of future rateincreases, but we are simplytrying to hold companies thatare cheap in relation to the

future values of the businesses.

G&D:Do you have a view oncurrent popular investmentthemes where people think theideas are good, but they areactually just bad ideas indisguise and may be exposed atsome point?

WW:Over the last severalyears of unusually low interest


I like Liberty Global

because they build

out cable systems

using a lot of

leverage, generate

huge amounts of

free cash flow, andthen buy back lots of

stock.

Wally Weitz

Professionals engage witheach other during theOmaha meetings.


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Page 11

They get terrific margins andtheir business is almost like asubscription business. If youare the sole supplier of

seatbelts or some type offastener that has to be bought,it can be a great business.

We like managements that arefocused and demanding, but itcan be dangerous if there istoo much pressure to makethe numbers. Mae West said,Too much of a good thing canbe wonderful. Maybe so, butwe try to be alert to thepossibility that a corporateoverachiever may be pushingtoo hard.

G&D:What is your approachin dealing with managementteams?

WW:We like to invest withmanagers we trust to treat usfairlyto treat us as partners

rather than necessary evils.We want to know if they havea good, long-term businessplan and have a sense as towhether they will execute itwell. We want to trust themwith capital allocationinvesting in the business whenthere are good opportunitiesto compound value and to givecapital back to shareholders

when that makes sense. Wegenerally wont have a lot ofadvice about how to managethe business, but we will let

them know how we feel aboutstrategic direction and capitalallocation.

Management is not going tocall us for advice in times ofcrisis or of great opportunity,so we want to know them wellenough that we will trust themto make the right decisions inthose critical times.

G&D: Youve talked aboutValeant in the past. Could youshare your view of theinvestment case with andwithout the Allergan deal?Would the failure to completethe deal change your opinionin any way?

WW: Well, it would be greatif Valeant is able to acquireAllergan. Given the kinds ofbusinesses they're in, Allerganhas been a natural target forValeant. I don't know what the

odds of success are at thispoint. They are probably not alot better than 50/50.

But if they dont buy Allergan,they will buy something else. Iget a little queasy when acompany announces anacquisition and both the buyerand the target go up. Theimplication is that there's somemagic there. The magic withValeant is that the earnings of

the target company increase,because of Valeants cutting ofbloated cost structures. Thebear case is that they cut toofar and theres no real organicgrowth.

I do feel as if we're riding atiger with Valeant. It's not thesame as Berkshire Hathaway


the cost structure. They arecost conscious operators and,with Malone, you are alsodealing with hypersensitivity totaxes. Their recent mergerwith Virgin Media providemajor tax advantages. Theyhave high debt on a per sharebasis, but the debt iscompartmentalized in thateach part is attached to adifferent system. They hedgedcurrency and the interest raterisk. They have paid up in thelast few years in order to lockin long term interest rates.

We value it in the mid-$50sand the stock is around $40.

G&D: Many of our readersknow about Buffett andMalone, but are there anyother underfollowed CEOs ormanagement teams that youthink highly of?

WW:In the banking worldthe Wells Fargo culture isimpressive. They've had three

or four CEOs since we gotinvolved a couple of decadesago and each has been a strongleader. They have a culturethat's very different from manyother major U.S. banks andthat's served them very well.When certain large banks gotcrushed in the 2008 and 2009period, we were comfortablewith Wells.

Nick Howley at TransDigm is a

very disciplined buyer andstrong operator with a privateequity mindset, but he'scollecting companies to keepinstead of selling them a fewyears later like most privateequity players. He's buyingcompanies that are typicallysole suppliers of aftermarketairplane parts. Then once hebuys them, they just squeezethe costs out year after year.


We like to invest

with managers we

trust to treat us

fairlyto treat us as

partners rather than

necessary evils.

Wally Weitz


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Page 12

other kinds of paymentsystems, but we were just notwilling to pay the price. Maybesomeday we will. It's always a

tug of war between thecomfort of owning a greatbusiness and the temptation tobuy the statistically cheapbusiness. In the '70s, I bought afew things that were literallynet-net Ben Graham stocks.They were cigar butts.Hopefully Ive gotten over that.

G&D:Can you give anoverview of an investment thatdidnt go as anticipated, whatlessons you learned from that,and how it improved yourinvestment process?

WW:Over the years, wehave had a series of successfultradesbuying banks andthrifts after the Fed raisedinterest rates and those stocksfell. Six to nine months later,the Fed always lowered ratesagain and the financial stocksrallied. I now consider thosetrades bad ideas we got awaywith. They were bad ideas

because we took more riskthan we realized in buyingthose stocks. Those bankswere often over-levered and

poor loan underwriters, butthey (and we) got away with itbecause home prices alwaysrose. Foreclosed propertiescould be sold at minor losses(or sometimes gains) and therisks didnt catch up with thebanks. Until they did in 2007-2009. We foresaw trouble inthe mortgage business, but weowned some financials that wethought were strong enoughto survive and take advantageof the problems of theirweaker competitors. Whenlosses came in 10-20x as badas ever before, our strongcompanies were swamped bytheir losses and we sufferedsome permanent loss ofcapital.

From that experience, welearned to be much moreimaginative about what can gowrong with a business.

G&D:Munger has thisconcept of lifelong learningthat he has talked about. Whatdo you do or read to makesure you keep getting better allthe time? Is there some areawhere you think youve reallyimproved over the years?

WW:We read all the time.We travel around and seecompanies, and we read. Ivetilted a little more toward

business history or biographieslately. A book like TheOutsiders is a good example ofwhat I like to read. It useseight case studies to illustratehow unconventional managerscan make a huge difference increating per share value forshareholders.


or a Liberty company.

G&D: Has your team lookedat Allergan on a standalonebasis? Would that be apotentially interestinginvestment even if the Valeantdeal doesn't close?

WW:Our analyst thatspecializes in healthcare hasliked the business, but not theprice. It seems as if thepromises they're making nowabout how they're going to bemore efficient, have bettermargins and grow faster are a

little too late. It makes youwonder why they werentdoing that before.

G&D: What would you say isthe most important factor fora great business?

WW:Well, monopolies aregreat. We also likesubscription businesses. Thecable model is a very goodone. They had local

monopolies on pay TV in thepast and, although they facemore competition today, theystill have great businesscharacteristics. You want thecompany that has the greatasset that everybody has tohave and where you havepricing power. But then thosethings tend to trade at prettyhigh prices. Although we likethe comfort of having the greatbusiness at a fair price, which

Munger talks about, we arereally looking for mispricedassets. The best of the bestrarely look cheap.

We've come close on somegreat businesses like Visa andMasterCard a couple of timeswhen there were fears thatthey would be forced to cutprices or that they would behurt by competition from


It's always a tug of

war between the

comfort of owning agreat businesses and

the temptation to

buy the statistically

cheap business.

Wally Weitz

Tano Santos and valueinvesting program studentsat the 2014 Value InvestingProgram Welcome Recep-tion where the 5x5x5 Stu-dent Value Investing Fundwas announced.


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Page 13

been able to buy it at adiscount to the present valueof its assets, we have. Wedont know what the Ventures

portfolio will own in futureyears, but we trustmanagement, in this case, tomake good investments on ourbehalf.

G&D:This has been great.Thank you for taking the timewith us, Mr. Weitz.

Hopefully by reading about thesuccesses and failures ofothers, and examining our ownmistakes, our investment teamhas learned to be morediscerning and realistic aboutthe companies we research.

G&D:Is there a more recentaddition to the portfolio thatyoud be willing to discuss?

WW: A spin-off of the Libertycomplex, Liberty Ventures, iscomplicated but potentiallyinteresting. Through a series ofacquisitions, Liberty had

accumulated stock positions incompanies they didnt reallywant to keep. In order toextract the value of theseassets in cash without incurringcapital gains taxes, they soldexchangeable securities thatare convertible into thoseshares. The bonds had 25 to30 year maturities and verylow coupons. But, because ofthe optionality involved,Liberty imputed a 9% interest

cost that they deducted fromtheir earnings. So they havemore tax savings than theyhave coupon costs. They gotall the value out in cash byselling these bonds, but theyhave a negative cost-of-carry.In a sense, they receiveadditional zero interest loanseach year from thegovernment. In 20 plus years,Ventures will have to pay offthe principal of the bonds and

the deferred taxes, but in themeantime they can invest thecash any way they wish.

Very few people will want tobother to figure this one out,but I think its an interestinginvestment that is really ablank canvas for Malone andMaffei. There has been somespeculative interest inVentures, but when we have


Wally Weitz


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anything I could get my handson: Greenblatt, Klarman,Fisher, OID, articles andinterviews. At Veritas, we had

access to an article databasecalled Factiva. Any time I'dcome across a value investoror manager that seemedinteresting, I'd search for everyarticle that had ever beenwritten about them and everyinterview they'd ever done and

just devour them.

I also went to the very firstValue Investing Congress in

2005. I paid for the ticketsmyself and flew from Torontoso I could learn first-hand fromthe likes of Klarman, Einhorn,and Ackman. The cost toattend the conference was alot of money for me back then.Like a true value investor, Istayed in Midtown Manhattanat a two-star hotel, which wasreally a quasi-hostel withshared bathrooms. I certainly

wouldn't have guessed backthen that I'd one day be aregular speaker at that veryconference.

In any case, within a fewmonths of joining Veritas full-time in 2004, I was promotedto sector analyst coveringCanadian income trusts. It wasa solid position for a twenty-four year old, but the more Idelved into investing, the moremotivated I became to excel atit, and by 2006 I resolved towork for a prominent valueinvestment firm to furtherhone my skills. Fortunately, Imanaged to join Fairholme asan analyst. Despite having amulti-billion dollar asset base,there were only five of us onthe investment team. Everyoneelse was roughly twice my ageand I learned some valuablelessons there.

G&D:How did you getintroduced to Bruce Berkowitzand the Fairholme Team?

GG:I knew that I wascompeting with Harvard,Columbia, and Wharton MBAswith serious work experience,and here I was with anundergraduate degree from aCanadian school that manyAmericans had likely neverheard of. I recognized that Ineeded to distinguish myselfsomehow. With that in mind,in 2006 I wrote acomprehensive research

report on a stock in order toillustrate what I couldcontribute and sent it to 12 orso firms that I thought wouldbe great to work for, one ofwhich was Fairholme.

G&D:Can you share somekey lessons you learned whileat Fairholme?


Graham & Doddsville

(G&D):Can you tell us aboutyour background and how you

became interested in a careerin investing?

Guy Gottfried (GG):It wasduring the junior year of myundergraduate studies inToronto when I realized I hadto get a good summerinternship in order to land adesirable job after graduating.Everyone at my school wasflocking to accounting,marketing, or investmentbanking, none of whichappealed to me. One of myprofessors that year, AnthonyScilipoti, was (and still is) apartner at Canada's largestindependent investmentresearch firm, VeritasInvestment Research. I workedhard to excel in his class and,through that connection, wasable to summer at Veritas. Iended up parlaying that into afull-time position.

I enjoyed the work right awayand toward the start of mysummer position, I decidedthat, if I was going topotentially pursue investing, Ishould learn as much as I couldabout the discipline. I askedthe president of the firm ifthere were any books he couldrecommend, and he suggestedGraham's Security Analysis. Iread that and followed it upwith every Berkshire Hathaway

letter to shareholders, and bythat point I was hooked onvalue investing. I simplycouldn't fathom how any otherapproach could even beconsidered investing; asCharlie Munger once said, "Allintelligent investing is valueinvestingacquiring more thanyou are paying for."

From there, I gobbled up


I read Security

Analysis, followed that

up with every

Berkshire Hathaway

letter to shareholders,

and by that point I

was hooked on value

investing. I simply

couldn't fathom how

any other approach

could even be

considered investing.

Guy Gottfried

Guy Gottfried


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Page 15

more than the average fund,the need to understand theinsiders' backgrounds,operating style and capital

allocation throughout theircareers and in differentbusiness environments.

G&D:You launched RationalInvestment Group in 2009.What factors led you to launchyour own firm?

GG:I'd always had the desireto start my own fund andhopefully one day become arespected value investor in myown right. I distinctlyremember one day in thesummer of 2005 when I wasthinking about the last fewmarket crashes and the

tremendous investmentopportunities that they

created. I recall reflecting onhow rarely these eventsoccurred and thinking that thenext time something like thathappened, I'd do my best topounce on it.

After Lehman collapsed in late2008, the markets reactionwas so severe, and the fearand irrationality so rampant,

that it was like nothing I'd everexperienced. There was oneweek in particularthe weekof October 6when every

stock I was following fell 10% aday. I decided that thevaluations I was seeing weretoo good to pass up.I launched Rational in early2009 with $500,000 in outsidecapital from one investor. Iknew this would be a difficultclimate in which to raisecapital, but I figured that eitherthe whole world was comingto an end, which was highlyunlikely and in which caseyou'd be screwed no matterwhat you were doing in life, orthis represented anextraordinary chance toexploit some unbelievablebargains and to start building astrong record.

Since inception, we'vegenerated net returns of 21% ayear. That compares to 13%for the TSX Composite Indexin Canada, where the vastmajority of our portfolio has

been invested over the years.We've beaten the index byabout 8% annually whileaveraging 24% cash.

G&D:How would youcharacterize your investmentapproach and philosophy?

GG:One of my favoriteinvesting quotes comes fromBenjamin Graham, who wrotein The Intelligent Investor,

"Investing is most intelligentwhen it is most businesslike."Suppose you were abusinessperson consideringtaking a stake in a privatecompany. What are thequestions that you'd askyourself? Chances are you'dask, do I understand thisbusiness? Is the balance sheet


GG:As I mentioned earlier, Ihad long been a voraciousreader of books, articles, andinterviews by and aboutcountless great investors, goingback decades. I picked up theirunique insights andperspectives on investing andapplied them to my ownportfolio. My time at Fairholmereinforced many of those ideasand gave me the opportunityto be immersed in valueinvesting every day.

For instance, Fairholmereinforced my appreciation for

the value of cash. The firstreason is obvious: it's better toearn nothing in cash than topotentially lose money bymaking a risky investment thatisn't up to your standards.Second, and perhaps lessintuitively, cash is a weapon.When a general marketdislocation erupts or acompelling individualopportunity arises, it is onlythose who have cash

precisely when everyone elselacks it or is afraid to use itwho are able to capitalize. Thiswas an important concept atFairholme, and it's a lesson thathas served me well.

Also, one of the attributes thatoriginally attracted me toFairholme's approach when Iresearched the firm was itsdisproportionate emphasis onmanagement. At Fairholme, we

wanted to understand exactlywith whom we werepartnering and to whom wewere entrusting our capital,

just like any sensiblebusinessperson or privateinvestor would want to do. Ofcourse, none of this came atthe expense of studying thebusiness, industry, accounting,valuation, and so on. But I'd saythat Fairholme prioritized,


Guy Gottfried

When a general

market dislocation

erupts it is only

those who have

cash who are able

to capitalize.


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start by screening for stockswith low multiples to theirearnings or free cash flow. Butthe most attractive

opportunities often involvebusinesses that are under-earning or even losing moneyand that therefore won't befound in a screen. Forexample, when Warren Buffettfirst invested in GEICO forBerkshire Hathaway in the

1970s, it was mired in red inkand was facing financialdifficulties. It is very doubtfulthat GEICO would have shownup on a computerized screen,but it was arguably the greatestinvestment that Berkshire ever

made.

Because the best investmentsdon't necessarily stand out byconventional means, I try tolook for special situations thatare relatively unrecognized andunderexploited. For instance,as I mentioned earlier, Iformerly was a sector analystcovering Canadian income

trusts. Income trustsresembled REITs and MLPs inthat their structure allowedcompanies to avoid taxation.

However, in a Canadian twistthat was subsequently barredby the federal government, anybusiness in any industry couldbecome a trust.

Since income trusts tended totrade at premium valuations,many companies adopted thetrust structure, including somethat had no business paying outall of their earnings. However,if a trust ever reduced or, Godforbid, eliminated its dividend,its shares would be cut in halflike clockwork. When I wasstill at Veritas, I noticed thatthere were almost noprofessional investors whosystematically sought outtrusts that stopped payingdividends or cut themsubstantially. This uniquespecial situation became asource of a plethora ofbargains over the years,including several in Rationals

early days.

Another example involvesdilutive debt recapitalizations.Suppose that a company has anupcoming debt maturity that itcannot pay off or refinance andis therefore forced to settlethat debt with shares. As anequity holder, few things arelikelier to make you cringethan your investment beingmassively diluted. However, a

debt recap is like a built-incatalyst because the eventitself can eliminate the veryproblems that precipitated it. Itwill often leave companies witha clean balance sheet and beaccompanied by the arrival ofintelligent lead shareholdersand the replacement ofincumbent management that


sound? Am I partnering withthe right peopleismanagement capable and doesit allocate capital shrewdly?And, of course, am I getting abargain?

And chances are that as aprivate businessperson, you'dprobably insist on all of thesecriteria being met to yoursatisfaction; it would be toorisky to do otherwise whentying up your hard-earnedcapital for multiple years. If youthink about it, as a long-termvalue investor in the public

markets, that's exactly whatyou're doing. Yet in the publicmarkets, people oftencompromise on one or moreof these criteria. For example,they'll say, "This isn't asundervalued as I'd normallylike, but I really like thebusiness," or they'll invest in ahighly leveraged ormismanaged company becauseit's statistically cheap. Thathappens all the time and it's

arguably due to the illusion ofliquidity. Knowing that you canalways change your mind andsell out of a position creates asubtle, subconscioustemptation to loosen yourstandards, especially when themarket is strong, and that'soften where people go wrong.I've found that it's rarely worthmaking exceptions and that ifyou're going to commit yourcapital to an investment, you

should insist on the completepackage.

G&D: What is your processfor identifying opportunities?

GG:First, you can't do thesame thing as everybody elseand expect different results; itis going to be difficult to findtruly compelling investmentsthat way. Many investors might


Guy Gottfried

Knowing that you

can always change

your mind and sell

out of a position

creates a subtle,

subconscious

temptation to loosen

your standards,

especially when the

market is strong, andthat's often where

people go wrong.

Bruce Greenwald discussescompetitive strategy with asecond-year MBA studentat the 2014 Value InvestingProgram Welcome Recep-tion.


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for $1 billion, for a gain of$800 million. Consequently, Ilooked further into Riddell andfound out that in the prior half

a year, he had bought 15% ofthe outstanding shares ofanother Canadian publiccompany called Newalta onthe open market. Riddell, whohad been a Newalta directorfor 20 years, had spent some$65 million on these purchasesat double or triple the price atwhich it was trading at thetime.

I delved into Newalta andfound that it, too, was dirt-cheap, trading at just 3x to 4xfree cash flow despite having anear duopoly in its corebusiness of outsourced oilfieldwaste management. Rationalultimately invested in both

companies and madeapproximately 170% onParamount in nine months, and175% on Newalta in a year-and-a-half.

In exceptional cases, you'll findone security that exhibitsmultiple special situationcharacteristics. For example,among investments that I've

discussed publicly, The Brickand Holloway Lodgingsuspended their dividends,underwent dilutive

recapitalizations and hadexcellent lead shareholderscome aboard in conjunctionwith their respective recaps.

G&D:These are greatexamples, specifically with howyou identified Newalta. Itreminds us of a recentcomment from Seth Klarmanabout how "pulling threads" onan existing investment leads toadditional investmentopportunities.

GG:That's right, and by theway, there's no shame in usingthe same method multipletimes. It's so difficult to findtruly compelling ideas that youhave to take them any way youcan get them. When I findsome way of simplifying theprocess of locating bargains,I'm unapologetic about reusingit for as long as it works.

G&D:Can you share with us acurrent idea in your portfolio?

GG: Holloway Lodging is oneof the ideas that I presented atthe recent Value InvestingCongress. Holloway is aCanadian hotel company thathad historically beenmismanaged. The company raninto severe problems lastdecade after the financial crisisand had to eliminate its

dividend (Holloway used to bea REIT). That obviously hurt.The situation became evenworse in late 2011 whenHolloway announced that itwould have to pay off amaturing debenture entirelywith shares, diluting existingshareholders by some 90%.The stock traded at $5 at the


got the company in trouble inthe first place. Further, sincefirms that need to berecapitalized tend to alreadytrade at depressed valuationsand the announcement of therecap will cause their shares toplunge further, they can still bequite cheap despite thedilution. So here's another caseof a situation that causesindiscriminate selling and cantherefore be an attractivesource of undervaluedinvestments.

Another example arises when

you identify great owner-operators or controllingshareholders. Brilliantmanagers and capital allocatorsare rare, and when you findone, it can pay to ask, "Whatelse is this person involvedwith?" On occasion, you'll findthat this individual may bepresent at other undervaluedcompanies. For example, in2009, we invested in aCanadian energy company

called Paramount Resources.Paramount was founded andremains controlled by aphenomenal owner-operatorin the Canadian energy spacenamed Clay Riddell. Whatinitially drew my attention tothe stock is that it appeared tohave a single asset that wasworth more than the marketvalue of the company, givingyou the rest of the business forfree.

As I dug into the company, Iwas increasingly impressedwith Riddell's capital allocation.Most notably, Paramount hadleased a significant amount ofacreage in the Canadian oilsands in 2001, before peoplewere even talking about the oilsands. Then, in 2007, when theoil sands were all the rage, itsold a portion of its acreage


Guy Gottfried

Brilliant managers

and capital

allocators are rare

it can pay to ask,

What else is this

person involved

with?


18/39


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assets. Factor this in and youwind up with an estimatedvaluation of 5x free cash flow.Then, beyond Royal Host,

Holloway's management is verycapable and allocates capitalintelligently, as the Royal Hostacquisition attests. You have amulti-year horizon over whichmanagement can continueexecuting accretive deals. IfHolloway can grow itsportfolio from 33 (includingassumed near-termdispositions) to 50 over four

or five years, think about whatfree cash flow will be then.Ultimately, this stock will tradeat a low single digit multiple,which is hard to find in anybusiness nowadays, let alone areal estate heavy companythat's very well run and has

years of growth ahead of it.What'll the stock be worth atthat point? Should it trade at8x, 10x, or 12x? It's hard tosay, but it doesn't reallymatter; the point is that yourmargin of safety is huge andthat it's hard to find a scenariowhere the shares don'tskyrocket. And insiders seemto agree: six of them have

bought 9.5% of the companyon the open market since May.

G&D: How have you evolved

as a professional investor, andwhat are some lessons youhave learned at Rational?

GG: I launched Rational duringa very anomalous time when Iwas only twenty-seven yearsold, so I was bound to learn athing or two. I'd say that oneof my greatest regrets hasbeen not reaping theappropriate rewards on someof my highest-conviction ideas,and that relates to the issue ofportfolio concentration.

It's fashionable to say you're aconcentrated investor, but inpractice it's very challenging.Rejecting an investment thatclearly has a poor margin ofsafety is easy. The hard part isfinding an idea that actually isattractive and still turning itdown because it isn't up toyour high standards and youcan do better, be it by adding

to your current best holdingsor by waiting for futureopportunities whose timingyou can't know, but whichinvariably come around fromtime to time. That takes greatdiscipline.

G&D:What is the size ofRational's team now?

GG:It's just me and our CFO.It's unconventional, but I'm a

control freak when it comes tothe research process and beingentrusted with other people'scapital. I'm very cognizant ofthe fact that just one unnoticedor misinterpreted detail canresult in making the wronginvestment or passing up theright one. Don't get mewrong, our due diligence is


the way it should be run. Ishould also add that these areafter-tax improvements, asHolloway will not be cashtaxable for the foreseeablefuture.

As another case study, foryears Royal Host under-invested in its most valuableasset, the Hilton in London,Ontario, which is nowHolloway's most valuable assetas well. Management estimatesthat by spending $5.5 to $6million renovating the hotel, itcan boost net operating

income by $1.5 million perannum. At a 9% cap rate, you'dget a $17 million increase inproperty value on a $6 millioninvestment.

Royal Host also has numeroushidden assets: it has a hotelnear Toronto's PearsonAirport which only earns cashflow (net operating incomeless capex) of $300,000 to$400,000 a year, but could

probably be sold for $15million due to its real estatevalue. If Holloway can divestthis property and redeploy theproceeds into hotelacquisitions at a 10% cap ratewith a 55% LTV mortgage at6%, it would add $2 million toits free cash flow. And again,we're talking about a companywith $12 million in trailing freecash flow, so each of theactions I've discussed will

provide a sizeable boost.There are likely $20 to $25million in dispositionopportunities in Royal Host'sportfolio.

So you have this huge growthopportunity due to the RoyalHost acquisition that won'ttake anything heroic to realize;it's just cutting costs andcapitalizing on under-earning


Guy Gottfried

...just one

unnoticed or

misinterpreted detail

can result in making

the wrong

investment or

passing up the right

one.


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unheralded is the tremendousfocus and productivity heachieves on a daily basis bystructuring his life so that he

can virtually always do what heenjoys and actually wants todo. I think I still have a longway to go before I perfect this,but that's how I try tried toarrange things here as well.

One of the advantages of notdoing much marketing is thatthe people who do tend tolocate you are more likely tobe like-minded investors. I'mreally thrilled with Rational's

capital basewe haveunbelievable partners. It's veryeasy to take such things forgranted, but it's important tostress that regardless of yourability as an investor, youwon't be able to execute yourstrategy successfully over thelong haul without a stablecapital base.

Imagine that a marketdislocation arrives and insteadof being able to take advantage,you're forced to use your cash

to meet redemption requestsfrom panicky investors whilethe opportunity passes you by.Not only is it counter-productive, but alsopsychologically, the anguish andhelplessness of beinghandcuffed can leave youvulnerable to becomingirrational and making baddecisions. It is much easier tocope with temporary losseswhen you feel that at leastyou're capitalizing on theenvironment.

G&D:We noticed you areone of the key speakers atCanada's Capitalize for KidsInvestor Conference thisOctober. How do you viewthis philanthropic endeavor?

GG:There are countlessprominent investingconferences in the US, so thismay be hard to believe, but

Capitalize for Kids is probablythe first large-scale investmentconference in Canada, letalone one that is devotedentirely to a philanthropiccause. What attracted me toCapitalize for Kids when I wasfirst contacted about it by KyleMacDonald, one of the co-founders, was that it targetedspecific areas within TheHospital for Sick Children inToronto that it identified as

being underfunded or in needof special attention. The folksat Capitalize for Kids put agreat deal of thought not onlyinto organizing the conferenceitself, but also into how to bestallocate the proceeds. I wasimpressed by that.


heavily dependent on theknowledge and insights of anextensive network of people,including management teams,industry specialists, fellowinvestors, and others who maybe familiar with a givenbusiness. You can't attain andsustain the necessaryconviction level in aninvestment entirely on yourown. People are a critical partof the process; it's just that forus, it's been more externalthan internal in the form ofhaving a team of analysts. Thatsaid, I certainly wouldn't rule

out adding an analyst or twoover time under the rightcircumstances.

G&D:Other than yourpresentations at the ValueInvesting Congress, you tendto keep a low profile. What isyour view on publicity as aninvestor?

GG:Actually, even theCongress opportunity came

about by happenstance, after Iwas introduced in 2011 to theorganizer, John Schwartz, by amutual friend. But you're quiteright, I do tend to keep a lowprofile. Rational doesn't have awebsite and it isn't unusual forme to be contacted byprospective investorsapologizing for calling oremailing me directly becausethey couldn't find any othercontact information and asking

me to forward them to our IRperson (which, of course, wedon't have).

I've worked hard to structuremy life and work in a waywhere I can focus on beingefficient, eliminating waste andclutter and being in totalcontrol of how I spend mytime. Of all of Buffett's greatattributes, one of the most


Guy Gottfried

It's fashionable to

say you're a

concentrated

investor, but in

practice it's very

challenging The

hard part is finding

an idea that actually

is attractive and still

turning it down

because it isn't up to

your standards

That takes great

discipline.

Bill Ackman converses withguests at the 2014 OmahaDinner.


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Page 21

sure turns some people off. Icould go on, but you get theidea. You'll go farther in thelong runand have a great

deal more funif you do whatresonates with you instead ofworrying about convention andhow you look in the eyes ofothers.

G&D:That is a valuable pieceof advice and a great way toconclude our interview. Thankyou for your time, Mr.Gottfried.

G&D:Can you share anyadvice with our readers?

GG:In one of his oldpartnership letters, Buffettmakes the important point thatin investing, there's a differencebetween being conventionaland being conservative. Sinceconvention is dictated by thecrowd, following it willfrequently lead you in thewrong direction. This is inkeeping with his philosophy ofhaving an internal scorecardof doing what makes sense toyou and judging yourself by

your own standards ratherthan the standards of others.This has been a guidingprinciple for me in buildingRational. I've often done thingsthat didn't exactly help ourmarketability because theywere right for me and enabledme to create an environmentthat was suited to my investingphilosophy and personality. Forinstance, Rational has neverengaged in short selling. Some

allocators consider thisblasphemous, and there's nolack of managers who shortmainly to justify their fees.Personally, I consider itvirtually impossible to findany short that can come closeto matching a well-researchedlong; not only is the upsidecapped and downsideunlimited, but even those whodo find great shorts tend tosize them so small that they'd

arguably be better off avoidingthem. Sure, shorting canreduce volatility, but over timeit's nearly destined tounderperform. There are manyways to get to heaven in theindustry, but that's what makessense to me.

Similarly, I don't have a team ofanalysts for the reasons Iarticulated earlier, which I'm


Guy Gottfried


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Page 22

B&M European Value Retail SA (LON: BME) - Short

Sisy [email protected]

Thesis

B&M is an over-hyped IPO story stock (Dollar General of the UK,with Tesco management as chairman). At 25x FY14 and 20x FY15EV/EBITDA, the stock price is discounting very bullish assumptionsaround TAM and market share relative to a small and saturated UKmarket. Meanwhile, saturation of the concept will intensify competi-tion and drive down margins (at peak today). There is also a stock

lock-up that expires Dec 2014.

Background

B&M is the #2 UK general merchandise discounter (pound store)

by sales, with a similar operating model as dollar stores in the US.

Pound stores value proposition is price + convenience. They have a small number of SKUs (3000-5000 vs.30K for a discount store), which allows them to sell only the most profitable SKUs (highest turn consuma-

bles, highest margin general goods).

B&M was acquired by two brothers in 2005, and the store base has grown 18x since (21 to 373).

IPOed in June 2014. CD&R bought half of the company in 2013 from management and installed Tescos ex-CEO Sir Terry Leahy as Chairman.

Competitive Landscapewhy B&M is not the next Dollar General

DG benefited from white space in the USsmall, rural populations that were not profitable enough for bigbox. Given the countrys large size, DG and FDO could grow profitably within their own geographies with-out much direct competition. Dollar stores mainly gained share from grocery stores, a fragmented and less-

efficiently run group.

The UK retail landscape is much smaller and moreconcentrated. 50% of the UK population shopsfor non-food items in just 90 locations. Unlike inthe US, the grocer space is concentrated (Big 4

has ~75% share)

Pound stores also face 2 sets of unique competi-tors that US dollar stores didnt have: grocerydiscounters (Aldi, Lidla category that largely

doesnt exist in the US) and the express ver-sions of Tescos (Wal-Mart and Target are later tosmall format convenience stores vs. UK big box

retailers).

Within pound stores, competition is also fiercer.The sector as a whole doubled store count since 2008 (+1,100 stores total), and the main players are plan-ning to double store count again (implying UK pound store penetration at 3x that of the US on a % of retail

sales basis).

Converging geographical expansion: B&M stores are mostly in Northern UK / Midlands, but they are nowexpanding into Southern UK. As they expand, they will face more competition from Poundland (national

player) and 99P (Southern UK focus), who are in turn starting to enter B&Ms geographies.

Recession retail bankruptcies created a one-time land boon for pound stores (around 1/3 of B&Ms leasestoday). However, bankruptcies peaked in 2012 both in number and size. Going forward, B&M will face a lot

more pressure on finding cheap leases (rent at 4% of sales is much lower than older competitors).

Management & PE Cashing Out IPO was 93% secondary with both management and PE halving their stakes.

Although CD&R has a track record of creating value, they held this investment for only 1 year (doublingtheir money). The extent of their value-add seems to include a small German acquisition (to sell a longer-

term international story) and installing ex-Tesco CEO, Leahy, as Chairman.

Leahy (ex-Tesco) holds no shares in B&M. He is a CD&R advisor and owns shares in the 2009 fund. He sits on

the board of 4 other companies (2 of which he actually is a significant direct investor).

US margins from the low-20s to the mid-/high-20s is just now getting started in

Sisy Wang is a first-year MBAstudent at Columbia BusinessSchool. Prior to CBS, Sisy wasan Analyst at DelawareInvestments Emerging MarketsFund and a pre-MBA SummerAnalyst at Plymouth Lane

Capital.

Sisy Wang 16Share Price (10/7/14) 265

Revenue (FY14 - March) 1272M

Adj. EBITDA margin 10.2%

Market Cap: 2650M

Enterprise Value: 3030M

3-month avg. daily volume: 4M

FY15 EBITDA (my estimate): 20x

Key Statistics

Operating Metric Comparisons

B&M PLND DG FDO

Store count 373 458 11,215 7,916

Sq ft / store 14,145 5,143 7,400 7,200

Sales / store 3,410 1,922 $1,561 $1,313

Gross margin 34.0% 36.7% 31.1% 34.2%

EBITDA margin 10.2% 4.9% 11.8% 8.8%

Turns (on Tang IC) 7.4x 19.5x 5.6x 4.5x

PP&E as % sales 5.1% 4.3% 11.9% 16.7%

NWC as % sales 8.3% 0.8% 6.0% 5.5%

CROTIC (EBITDA / Tang IC) 76.0% 95.7% 66.2% 39.6%

Net Debt / EBITDA 2.9x (0.3x) 1.4x 0.4x


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Valuation

Even putting aside issues on competition, the current valuation barely justifies the most bullish long-term growth

assumptions

Valuation methodology: I focus on the time it takes for the stock to re-rate to a reasonable multiple (I use DGs 10xEV/EBITDA from before the M&A talk) and where CROTIC (cash ROIC) will go. I assume 50 stores per year

(managements goal is ~40). High Case: To stretch the bull case, 8 years for the multiple to erode to a normalized level and CROTIC to expand

to 100% (beyond PNLDs 96%). This is a scenario where B&M outcompetes its competitors to become one of the

dominant players in the UK, thus retaining profitability as it grows.

Low case: 3 years for the multiple to erode and CROTIC to mean revert to 60% due to market saturation, increas-

ing competition, and less profitable geographies (still a good return vs. DGs 66%, FDOs 40%).

Catalysts CD&Rs 180 day lock-up expires Dec 2014

Growth slows due to less available space (fewer bankruptcies)

High margins mean-revert due to competition and industry saturation

Risks

Continued strong growth in short-term from new store opening.

Strong return profile / cash flow generationmanagement has set dividend payout at 30-40% ratio

Technical risk: B&M may get added to FTSE 100 index if market cap reaches 3 billion

B&M European Value Retail SA. (Continued from previous page)


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Page 24

Countrywide, Plc. (LON: CWD) - Long

Kevin [email protected]

RecommendationBuy Countrywide (LSE:CWD) equity with a 12/31/18 base case pricetarget of 8.35. This represents ~90% upside from the current share

price, including dividends. The investment thesis has five main points:

1) Countrywide should benefit from a recovery in housing transac-tion volumes in the U.K., which currently sits ~15%-20% below

historical levels

2) The cost structure has changed post recession, with ~40%+incremental margins and long term margin targets well in excess

of prior 2006 peak

3) The business will generate high FCF (~400m over next 5years), and the Company has directed 35%-45% (but up to 70%,barring any acquisitions) of net income to be returned to share-

holders

4) Countrywide continues to find opportunities to roll up rental businesses at 20 -25% return on acquisitions

(within 2 years) and believes there is room to double its market share over time

5) Management incentives are aligned with shareholders, with options based off EPS and TSR targets

Business Description

Countrywide is the largest real estate agency in theUnited Kingdom, operating ~1,370 branches and 47brands. The Company has 6% market share of UKhousing transactions, followed by LSL Property Ser-vices (3%) and Connells (estimated ~3%). The Com-pany was acquired by Apollo in 2007 (Oaktree andAlchemy took stakes in 2009), and IPOd on theLondon Stock Exchange in March 2013. LTM6/30/2014, Countrywide generated 661 million of

revenue and 105 million of EBITDA.

Countrywide is the dominant player in a cyclicalindustry that is operating below historical norms.

Following the recession, the Company restructured,reduced fixed costs, and improved employeeproductivity. In addition, the Company has diversifiedby growing its lettings (rental) business, which iscountercyclical to transaction volumes and now

accounts for ~1/4 of EBITDA.

I believe Countrywide has significant operating leverage and will be able to generate strong earnings growth as themarket recovers. The Company enjoys economies of scope (provides surveying, conveyance, and financing ser-vices in conjunction with real estate brokerage) as well as economies of scale (national back office infrastructure).Combined with low capex requirements, good reinvestment opportunities, and strong shareholder alignment, I

believe Countrywide can compound at double digits over the next 4-5 years.

Investment Thesis

1) Rebound in Housing Transactions

Transaction volumes in the UK were ~1 million in 2013, and are estimated to be ~1.2 million this year. This com-

pares to long term averages of ~1.4 million (after factoring out the number of transactions associated with increas-ing home penetration levels). Residential investments sit at 4.0% of GDP, compared to 4.5%-5.0% pre-recession(7% at peak), and UK household turnover has fallen to 4.1%, versus an estimated 6.9% average since 1971. Thecurrent rate implies households will now move every ~25 years versus every ~14 years prerecession. As UKseconomy recovers over the long run, I believe credit will loosen and the volume of transactions will move closerto the norm. In addition, the government has signaled its support for first time home buyers through its Help ToBuy programs, and UKs own Office for Budget Responsibility forecasts >1.5 million property transactions by

2018. The Royal Town Planning Institute also suggests that there may be a ~375,000 shortfall in UK households.

2) High Incremental Margins

Coming out of the recession, Countrywide has reduced its fixed cost base by closing unprofitable branches, con-

solidating its IT infrastructure, and outsourcing back office functions . Incremental margins over the past 3 years

Kevin Lin is a first-year MBAstudent at Columbia BusinessSchool. Prior to CBS, Kevin wasan associate at SansomePartners, a long only family

fund.

Kevin Lin 16

Market Overview

Stock Price (10/8/14) 4.73

Shares Out (Diluted) 226

Equity Value 1,067

Less: Cash (44)

Plus: Debt 118

Enterprise Value 1,141

Current Valuation (Consensus)

EV / 2014E EBITDA 9.0x

Price / 2014E EPS 11.8x

Dividend Yield 2.4%

Revenue / EBITDA Breakdown (LTM 6/30/14)

660.5

105.2

105.2

Real EstateReal Estate

London &

PremierLondon &

Premier

LettingsLettings

Financial Financial

Surveying SurveyingConveying Conveying

LSH LSH

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Revenues EBITDA


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are in the neighborhood of ~40% (the Company guides to 40%-60%, exclusive of investments in personnel that are cur-rently ramping up). Incremental margins are high since the current infrastructure can support higher transaction volumes ,and only ~half of staff costs (56% of revenues) are variable (though it will begin to fall if volumes come back in such a way

that additional headcount is needed).

3) Free Cash Flow and Shareholder Returns

Countrywide has historically been a very capex light business, but will be ramping capital expenses for the next 2 years toimplement its IT transition (~20m a year). Post this, capex is expected to tail off. I believe the Company will be able to

convert ~90% of its net income to FCF as provisions wear down over time (2014E FCF yield of ~6%).

On the first half 2014 call, Countrywide stated it would return 35-45% of net income back to shareholders, and up to~70% barring any major acquisitions. In July, the Company declared a special dividend from the liquidation of a portion ofits Zoopla stake (recently IPOd real estate portal CWD owns ~4% of). The Company also commenced a 20m share

repurchase program on October 1st.

4) Investment Opportunities

Post IPO last year, Countrywides debt has fallen to less than 1x net leverage. The Company is using FCF and a new termloan to buy up lettings agencies (in conjunction with its own organic growth in existing real estate branches). The Compa-ny made 28 lettings acquisitions in 2013 and 16 in the first half of 2014. Management believes the opportunity to roll up

small lettings businesses will persist for years.

Countrywide targets a 20% to 25% return on acquisitions in the second full year of ownership (and which managementconfirms they are in line to achieve). The Company is able to acquire at such low multiples since 1) it changes the costprofile of the acquired business by stripping out and outsourcing the costs (sometimes the entire business is lifted into anexisting branch), and 2) it has tons of visibility into the lettings market, and acquires businesses that are currently under-

priced and have room to increase rental fees over time.

5) Management Incentives

2/3 of long term share incentive awards (up to 300% of salary) are subject to absolute EPS targets. 25% of this part of anaward will vest for EPS of 57.6 pence increasing pro rata to 100% vesting for EPS of 70.4 pence for the year ending De-cember 31, 2016. The remaining 1/3 is based on relative TSR versus the FTSE 250, with 25% vesting if performance is the

median of the group.

Key Risks

The UK could very well be in a new normal where housing transactions are permanently below historical averages. How-ever, the shares dont appear to be too expensive even at 2014s estimated 1.2 million homes, and both commissions andlettings should serve somewhat as a natural hedge in a lower-level environment. Discount brokers could potentially take

share, but I believe people will inherently want an agent to be involved in the sale of a home (~90% of sellers are fairly/very satisfied with their agents). The UK has already has one of the lowest commission rates (1.5%, vs. the U.S. at 5%-6%)

in the world , so online brokers like Redfin seem to be less economically viable.

In the UK, property portals Zoopla and Rightmove control the market and charge real estate brokers monthly fees to listhomes on their sites. The companies have been increasing ARPA rates at double digit percentages due to their dominantpositions. I believe a 10%-15% increase in rates would increase Countrywides advertising costs by ~1 million. To combatthis, six real estate agents (including Savills) have gotten together to launch an alternative (non-profit) 100% agent ownedportal. The portal plans to launch in January with ~5,000 participating branches, and should alleviate the existing duopoly

pricing pressure.

Valuation

My 8.35 price target is based on roughly 14x 2018E diluted EPS 0.58. I assume transaction volumes return to 1.4 millionby 2018, commission fees fall from ~1.75% to 1.5%, while average prices post 2014 increase at 2% (this compares to OBRand Savills projections at 3.5%-4% pricing growth). For London and Premier, I am predicting 2% pricing and transactiongrowth and flat commission rates. I model incremental margins at 35%, falling to 30% over time, and assume the Company

keeps leverage at 1x net, using FCF to buy back shares and make tuck in acquisitions.Barring another global meltdown, I believe a downside case could involve a new normal of ~1.1 -1.2 million transactions,no growth in price or transaction volumes, and a higher stabilized commission fees. At a 12x 2018 exit multiple, I believe

investors could still achieve a high single digit IRR.

Countrywide, Plc. (Continued from previous page)

Restated Projected

2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E

Revenues 477.9 509.1 524.7 584.8 705.3 730.8 755.8 780.1 803.9

% Growth 6.5% 3.1% 11.4% 20.6% 3.6% 3.4% 3.2% 3.0%

Total EBITDA 63.6 56.4 63.0 86.6 120.2 133.3 146.8 159.6 172.9

% margin 13.3% 11.1% 12.0% 14.8% 17.0% 18.2% 19.4% 20.5% 21.5%

Diluted EPS -0.05 -0.02 -0.02 0.17 0.34 0.40 0.45 0.51 0.58

% growth 104.8% 16.4% 14.6% 12.6% 12.4%

Free Cash Flow -91.6 0.3 -16.0 -38.3 39.6 45.0 54.2 59.6 67.5


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Page 26

neur. I wanted to financiallyback and invest in lots of differ-ent businesses, participating ina whole portfolio of creative

activities, rather than just tak-ing a concentrated shot at one

thing.

That interest continued togrow in the next few stages ofmy career. I went from doingthat with the New York entity,to helping start a merchantbank in London, which in turnfinanced lots of entrepreneuri-al activities worldwide. Then,after spending one year in thefederal government on a quix-

otic venture, I joined WhiteWeld, an investment bankingfirm in New York. I was a jun-ior partner of that firm untilwe were acquired by MerrillLynch, at which point I left tostart my own firm with two

other partners.

That firm was the originator ofa whole variety of investmentpartnerships, which all tendedto have something to do with

corporate reorganizations,activist investing, mergers andacquisitions, risk arbitrage orevent-driven marketable secu-rity purchases. There was alittle bit of private investing,but for the most part it was aprivate investing approach to

marketable securities.

It was pretty successful. In thelate 90s, we decided to shutdown the partnerships that wehad with outside limited part-ners and I began a private of-fice to invest my own capitaltogether with friends and part-ners that I had known. I formu-lated an emerging market spe-cialty investing my own andsome friends capital outside ofthe United Statesusually inconjunction with local partnersor money managers in thosecountries. We spread fromChina to Russia, then LatinAmerica. Then about five years

ago, I started focusing on Afri-

ca.

Part of my reason for beinginterested in Africa was thefact that I had been Chairmanof TechnoServe for a longtime. TechnoServe is a not-for-profit organization that doeseconomic development workin Africa, Latin America, andIndia. It started in Ghana and isnow in 33 different countries,

most of which are in Africa.Ive had a long-standing in-volvement in Africa and an on-

the-ground experience with it.

Due to my long involvement inthe region and what I observedthere, I thought Africa was theplace that had the greatestopportunity and where I had


the Peace Corps for two years.In the Peace Corps, I had in-tended to pursue a career ineconomic development. Whilethere I observed that therewere an awful lot of smart,well-intentioned people in thefield of economic development,but collectively there werevery few practical skills in thecommunity. It was full of PhDsin Economics and Political Sci-ence but had very few peoplewith training or experience,the sorts of things that makeprivatizations work, or thatenabled cooperatives of small,

poor farmers to make a living.

After leaving the Peace Corps,I won a Ford Foundation fel-lowship to go to graduateschool. There were about tenother winners and all of theothers went into programs inPolitical Science and Econom-ics. I chose to go to HarvardBusiness School, which was avery suspect decision to thefellowship. Consequently, I had

to take extra courses and finda mentor at the Kennedy

School.

Through the program, I be-came very interested in entre-preneurship and investing. Istarted a PhD Program at Har-vard, but never finished it be-cause I started working at aninvestment firm in New York.Thats about the time when Igot more interested in invest-

ing.

Since I can remember, I havebeen interested in creativethings: the creation of value,the creation of new entities,the creation of new businesses.At that time I made an im-portant decision - instead ofbeing an entrepreneur andbuilding or starting a business, Iwould be a financial entrepre-


Development Capital Partners

I made an

important decision,

that instead of being

an entrepreneur and

building or starting a

business, I would be

a financial

entrepreneur. I

wanted to financially

back and invest in

lots of different

businesses.

Development Capital

Partners Team(from left to right):

Jason Yang 14,Gordon McLaughlin 11,

Paul Tierney,Matt Magenheim 11,Matthew Tierney 02


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Page 27

were happening in emergingand frontier markets. Ultimate-ly, I decided to go back toschool to try to find an area in

emerging and frontier marketsto apply the security analysisskills that I had been develop-ing. Tha

Graham & Doddsville_Issue 22_Fall 2014

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