Sunday, March 30, 2014

Lessons learnt from value act capital

“We prefer No. 2 or No. 3 in consolidated industries with stable, predictable cash flows”
-          Jeff Ubben, Value Act capital

Active value investing:
Jeff Ruben sums up in this interview sums up his approach in fairly easy terms:
  •  Buy from an uniformed seller at a significant discount in the public markets
  • Clean up the business and improve public perception
  • Sell the whole or parts of the business with the support and co-operation of management

How his approach is different from others?
Public shareholding, private actions

  • Low profile: Unlike other activist investors like Carl Icahn or Bill Ackman, who are in the headlines practically every day, Jeff Ubben has maintained low profile and believes a lot more in silent, behind the scenes dialogue with the board and management. Having been a private market investor, I quite like this approach.
  • Co-operation with passive investors: Unlike corporate raiders like Carl Icahn, whose views are typically the diametric opposite of the existing management and the passive shareholders, Jeff Ubben and his team have a unique ability to build rapport with everyone.
  • Team orientation: Unlike other hedge funds which are helmed by a public, visible superstar, Value Act has six partners, four of whom have been together since the beginning. This also shows in the rapport they build with the rest of the board members

Investment thesis:
  •  Underdogs in consolidated industry: Prefer to focus on mature industries that are consolidated with stable free cash flows.  This allows for even small movements to result in a disproportionate movement in profitability, cash flows and consequently, shareholder value. This was quite a revelation to me - think of pepsi (not coke), think samsung (not apple) - for all you know the No.2 might be better at execution and hence at growing shareholder value - since there is no pressure to keep up market leadership and often this means, the tougher, costly lessons of innovation could be left to the market leader.
  •    Focus on IP/brands: Jeff Ubben likes strong franchise businesses that have minimal SG & A costs year after year.  Case in point being, Microsoft (Value Act is bullish on the Microsoft enterprise business that includes servers and tools). This operating leverage ensures that turnaround is quick and adds to disproportionate increases in profitability and cash flows - FCF, especially.
  •  Patient accumulation of stake:  It takes more than a year for them to accumulate a 4-5% stake (which necessitates filing a 13-D).
  • Focus on getting “welcomed” into the board room:  This allows them to focus on getting information only privy to the board which helps make informed, evolutionary decisions that carry the stakeholders along.  

Post investment Action:

Separation/restructuring leads to value creation:

Often a lot of companies are bucketed into different categories – For eg., in Value Act’s own words, Microsoft has been branded as a “PC growth led” business. The market completely ignores the value attached to its Enterprise division – Servers, sharepoint, software which is an incredibly sticky, high margin, recurring revenue business.

Value Act, in my opinion, simple provides for better visibility into the crown jewel  - this could be done through spin-offs, selling the loss leaders (that drag down the profitability of the overall company) or restructuring the management (grapevine has it that Value Act pressured the board to find a replacement for the legendary Steve Balmer).

Sample portfolio companies:

Name of company
Value Act’s action to unlock value
Leader in breast implants
Professionalize management
Sell urology business
Catalina marketing
Monopoly in gather Point of Sale promotions – coupons, mobile apps. Undervalued because of accounting issues related to revenue recognition

Created strategic interest for the company and resulted in company getting bought by Hellman & Friedman – a digital marketing firm
Allison transmission
Market leader in the automatic transmission space for large CV’s, mining, fracking and buses
Non activist thus far- play on the revival in heavy commercial vehicle markets in North America

Lessons to learn from Value Act:

The interview and the consequent research I did on Value Act was quite an eye opener to me. It made my universe that much smaller - a No. 2 or No.3 in a consolidated industry has everything to gain and much less to lose,making the risk-reward equation asymmetric. Also, hopefully, given the learnings from the leader, the No.2 or No.3 should have an easier job of execution resulting in superior capital efficiency. The lessons I learnt are:
  •  Focus on the No. 2 or No.3 in  consolidated industries – such companies trade a significant discount to the leader  and often, offer better value
  • Look for strong franchise businesses that can grow with very little incremental capital

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