Presenters: David Marcus, Evermore Global Advisors
Hosts: Rajat Jain, Scott Jones
Date: September 10, 2019
S: Good day, everyone. I would like to thank all of you for joining us for today’s webinar. Our topic today is the Litman Gregory Masters International Fund. Joining us on the call is Evermore Global Advisors, one of the subadvisors for the International Fund.
Before we begin, I would like to provide a few key points about the International Fund. The International Fund is designed to be a core holding for investors. The fund comprises experienced managers with strong track records. Each runs a differentiated strategy of their highest-conviction stocks, holding between 8 to 15 stocks.
Even though each manager runs a concentrated portfolio of his favorite ideas, the fund – as a whole – is diversified by industry, country and stocks. This is because each manager has a different investment approach and style. The fund draws on Litman Gregory’s three decades of performing rigorous manager due-diligence.
Today we are joined on this webinar by Rajat Jain, Partner at Litman Gregory and Portfolio Manager for the International Fund. We also have with us David Marcus – cofounder, CEO and CIO of Evermore Global Advisors. David is also the portfolio manager for the Evermore sleeve of the International Fund.
I would like to bring on Rajat Jain, Portfolio Manager for the Litman Gregory Masters International Fund.
Rajat – perhaps you could begin today’s call with a discussion of Europe and the fund’s positioning, there.
R: Sure, Scott. Thanks.
Thank you everyone for joining us today. We appreciate your time very much. Firstly I’ll have the agenda for today’s presentation, and then get into it.
Our focus today will be on Europe, as Scott mentioned. Litman Gregory International Fund is currently overweight this region, versus our peers and benchmark. As of the end of June, the fund had 60% in the region, which compares to the benchmark and peer allocations of 45% and 55%, respectively.
The fund’s allocation to Europe is solely driven by bottom-up stock-selection. Even though as a firm, in order to service our wealth-management clients, Litman Gregory does its own independent analysis of asset classes, and has a top-down view. We’ll discuss some of it today.
We do not influence our managers at all, though. The fund’s performance is 100% driven by our five managers’ stock-picking skill. This is how we designed this fund over 20 years ago.
Europe’s debt-deleveraging, as we all know, has not gone as well as that of the US. Reasons for this are many, but the key one relates to its debt-crisis that followed soon after the Great Financial Crisis and the resulting very poor economic growth in the region. This has resulted in almost no sales growth for European companies in aggregate.
QE, or Quantitative Easing, didn’t work for Europe as it did for the US. Part of the reason relates to the Euro construct, where it’s not as easy to administer fiscal stimulus, or clean up the banking system. In addition, there have been other unanticipated events or developments that have had a material impact on European markets this cycle, such as Brexit and trade-wars have impeded global growth in recent years, as we all know.
Europe is particularly susceptible to slower global growth, so its relative poor performance is somewhat understandable. Today we want to discuss why Europe has not wasted its debt-crisis. By that, we mean that it has planted the seeds that will help it outperform the US; especially given where US valuations are today, in our opinion.
I’ll start with sharing some broad macro observations related to reforms that are taking place in Europe before I hand it over to David, who will then share his bottom-up insights. I’ll end with our top-down valuation-analysis of Europe versus the US.
As I mentioned earlier, our analysis has no influence on our managers’ stock-picking. Next slide, please.
This slide, we can spend a lot of time on. As you can see, this cycle has been pretty unique versus the historical data we have available for Europe earnings and the US; the common timeframe.
The key point from this slide is that Europe’s earnings-performance has been very, very poor – in both absolute and relative terms – in this cycle. The main culprit, as you can probably guess, has been the debt-crisis, which hit them right after or soon after the GFC. There has been basically no growth.
In such times, the basic human survival instinct kicks in, and it leads to improvements that in normal times would be hard to implement. France and Spain are good examples. They have enacted significant labor reforms that remind us of Germany’s Hartz reforms in the early 2000s – setting the stage for broader Europe outperformance versus the US market, at the time.
Today, for instance in France, someone who is unemployed can get benefits as long as they do not refuse a job that offers pay that’s within a range of their previous salary. In Spain, companies with fewer than 50 employees can offer a contract to new hires that includes a one-year probationary period.
Broadly speaking, the point is, these reforms are now making it easier for companies to terminate employment. So companies are better able to manage their cost structures and stay competitive. We can see this improvement being reflected in broad economy-wide numbers.
For example, the next slide is basically charting, in aggregate, the GIPS countries’ unit-labor costs. Now, GIPS is an acronym for countries in the Eurozone that were regarded as the epicenter of Europe’s debt crisis. Relative competitiveness was one of the major issues.
Of course, with large debt levels and inability to depreciate currencies as these countries were part of the Eurozone, ultimately all these factors led to the crisis. But this chart shows that at least one imbalance has been corrected quite a bit.
As always, there are many factors to consider. The austerity policies Europe has pursued since the debt crisis of 2011 and 2012 have without doubt been painful for the region. This was a time when it was deleveraging. But it’s a good sign to see that their competitiveness is improving.
We should also mention some shorter-term catalysts that could be positive for European stocks. Brexit risks. I know that’s a big unknown, still. But they have been well-telegraphed, widely. It seems reasonably well-priced into stocks, we think. For example, UK stocks appear relatively attractive, relative to history and other European countries, on a normalized basis.
Second, Germany has expressed greater willingness for fiscal stimulus – something that has been lacking in this cycle. It may be surprising to some that Europe has gone through zero-to-negative fiscal stimulus , an example of austerity.
The reason Germany seems more open, and it’s not certain that they will, but part of the reason is that their own economy is going through a cyclical downturn. Also, partly because Germany has achieved some of the goals related to pension and labor-reforms, and wage-adjustments they wanted to see in countries like Greece and Spain, in order to have a long-lasting union.
Lastly, any positive trade-war resolution is likely to spur global growth and Europe’s earnings-performance, as a result. Our top-down analysis suggests Europe has high operating leverage to global growth – even with significant growth headwinds, operating margins in aggregate have held up relatively well, indicating to us companies are doing a good job of cutting costs.
I’ve talked enough for now. Let’s hear more from our guest – David Marcus of Evermore Global. David? Welcome and thanks for being on the call, today.
D: Thank you, Rajat. I appreciate the opportunity to be part of it.
For my presentation, I’ll touch on an overview of how fears on macro-perspectives and headlines impact investors’ views; what factors are creating these opportunities in Europe. Then we’ll touch on relative-valuations of Europe versus the US, the growth of European private-equity and shareholder-activism, and finally a discussion of some of the holdings that we have selected for our portion of the Litman Gregory Masters International Fund.
Before I kick it off, I think it’s important for you to know that Evermore Global Advisors is a special-situations manager. That means we focus on cheap stocks with catalysts, which can be breakups, spinoffs, restructuring, management changes; all kinds of strategic change. We’re not looking for cheap stocks and hoping they go up. We want to know there is a path to get the value from the stock to the shareholder.
This is our first slide, here. It’s interesting – I talk about how international investing is becoming a “today story,” after 30 years of it being a “tomorrow story.” The fact is, Europe has especially been so almost-there — over and over, over many years. Yet something always happens to set it back.
The reason we’re so excited today – more than ever before – and I’ve been investing in Europe for about 30 years now – is that you have this real confluence of events because of the confluence of issues. As we point out on the left side of the chart, trade-wars – protests in Hong Kong. Brexit. No-deal Brexit. What’s happening in Argentina. Germany. Is there an economic slowdown there? Globally? Throughout Europe? What’s happening to the yield curve?
Investors are just in fear, throughout. That’s just generally. But when you get specific to the European market, the headlines are really bad. The negative headlines relate to the political environment, economic conditions, low growth – it just scares people.
They say, “Hah. I don’t need to be in Europe.” Well, my view is, you do need to be in Europe. When you look past the headlines, you realize that they’re addressing the issues. They’re dealing with these problems. They’re not kicking it down the road.
In fact, as we point out on the right-hand side of the chart, many of the problems that investors have always highlighted as to why they’re avoiding Europe – these are exactly the reasons why this is the time for Europe. Because of the reaction by companies.
To be clear, we’re not buying “Europe.” We’re buying companies that are based there, that are taking advantage of the opportunity to transform themselves. Many of these – basically all of our companies in the portfolio – are global businesses that are based in Europe. They’re not just Europe selling within Europe.
We’ve seen everything from cost-cutting – companies going through refinancings of their balance sheets. Really cutting costs across-the-board. Refocusing. So they don’t need real growth.
But in this period where you’ve had virtually no revenue-growth, you’ve seen just a wave of this going on a diet. Companies really taking the fat out of their systems, so they can actually be profitable with no topline growth. As slowly growth comes back, it really can be explosive to their earnings at the bottom-line.
We’re excited by it. It’s phenomenal to see it happening. To get on the ground and talk to managers. To really hear it in their voices and just see the results starting to come through.
I’ve been talking about this forever. The fact is, it’s been bits and pieces of it. You’ve had the one-offs over the years. Now as I said earlier, it’s this confluence of it coming together. As I say on the bottom of that page, “Fear plus desperation plus catalysts equals compelling opportunity.”
Maybe we can move onto the next page here of the slide.
Here, I’m showing that the valuations have come down dramatically over the years. The relative valuations. This chart shows the Euro-Stock 600 versus the S&P 500. This is on an EV-to-EBITDA basis. We’re looking at cashflow estimates for these businesses.
You can see that we’re at lows we have not seen since the financial crisis here in the US, and going further back before that.
If you can go to the next slide, the next slide is the same metric, but on midcaps. We’re looking at the Euro-Stocks Mid versus the S&P, to just get a sense.
We can’t always get the various indexes that we want to line up, but I think that was an S&P midcap, as well.
You see again, we’re at lows we have not seen in really an enormous period of time. While some investors will say, “Oh, well how do I know this just won’t continue on for another 5 – 10 – 15 – 20 years?” We don’t know. But what we do know is that the stars have lined up so well, with so many of these one-offs.
If you go to the next slide, I’ll show you how we get there.
Look at this on the left-hand side. The shareholder-activism. You’ve seen an explosion of shareholder-activism over the last decade. This is a number of Activist Campaigns in Europe. The growth is exceptional.
Europe has gone through a change. When I first started doing this, you had what we called the “Old Boys’ Network.” These boards were not responsive to shareholders. They didn’t care. Today there are the same issues that you have in the US.
You have activism that has moved across the ocean. They’re taking big stakes in these companies. They’re pushing boards for change. The boards are pushing management for change. If they don’t change, the managements are out. They’re very aggressive investors. They’re tired of the “Tomorrow Story.” They push aggressively for this rebounding view of, “Get Value Out.”
Some of these activists, I’ll say, are very selfish. They only care about their returns. We don’t care. As long as they’re creating value for all shareholders, that’s the key.
If you look on the right-hand side, this is the increasing amount of private-equity activity in Europe. This underpins the story we’re talking about here. The amount of capital-raised for deployment in European take-privates is substantial. It’s really exploding over the last few years.
This is KKR. Carlyle. Blackstone. All these guys raising fund-after-fund. If you just even Google “Private Equity in Europe,” you’ll see so much of this happening.
They’re piling up the cash, and they’re going in. Why is it so special? Because on the previous slide, we talked about valuations being low. The fascinating issue is that the private-equity guys can come in and make a substantial premium-bid to where the stock’s trading. The shareholders get a very nice rate of return. Yet the buyer’s really only paying a fair price; not an over-price.
We’re seeing all kinds of winners; buyers and sellers. Most times, it’s usually one or the other. Here, you can have a period now where you’re seeing everybody seems to be a winner. We’ll see how those deals go, down the road. But the fact is, you have this private-equity growth.
Now you can layer in the other things. What are the other things? Strategic buyers. Companies now have been cleaning up their balance sheets so much over the last few years that they now have very strong balance sheets. They’re using that.
In a no-growth environment, what does a company do? They buy growth. They’re buying their competitors. They’re buying ancillary businesses or services to offer more product-line or service to their existing client-base. They’re being very strategic.
We see it when we talk to managements. If the US exported one thing very well, we exported capitalism. You talk to these management teams and just feel it. You feel when you talk to them – they’re so aggressive versus how it was even just less than 10 years ago. It’s just a complete sea change.
I think a lot of investors sitting here in the US are just not feeling this change – this wave – that’s growing underneath it all. If you think about it, you have activism and private-equity growth. You have strategic buyers and record-low interest rates that help fuel activism, but also help the companies refinance their balance sheets. There’s just so much of this going on.
We can move on to the next slide, here. Here, I’ll showcase – this page highlights what the characteristics are of special-situations. I list them here on the side. I’m not going to read them to you, but I’ll touch on a few of them.
On the right-hand side, we talk about holdings that are in the Litman Gregory Masters International Fund that we have selected to be in the sleeve or portion than we manage of the fund. You can see we’ve touched on a number of the issues – breakups and spinoffs.
Let’s touch on a few of these.
Breakups and spinoffs. One of our holdings is Vivendi. You can see it right in the middle of that section of “Breakups and Spinoffs,” on the right. Vivendi is one of the largest media companies in the world. They also own really one of the great assets. They own 100% of Universal Music Group, which is the largest music company in the world. They’re in the process of selling between 10% and 20% to a group in China, called Tencent. It’s finally showcasing the value, here.
Every single person that goes from getting free music – listening to it on the radio – your kids want it on Spotify or Apple or Tidal or whatever – everybody that starts paying for music is a customer of Vivendi, through their Universal Music business.
The business has exploded. This is a conglomerate; exactly what we look for. It’s a conglomerate that’s breaking off non-core assets. They’re buying more focused areas that fit their core operations. They have the video-game business. They have the music business. They make movies and TV shows in Europe through Canal+. This has been a fantastic investment for us that has quietly transformed itself from an ugly conglomerate-behemoth into a more-focused conglomerate-behemoth; yet somewhat smaller.
We don’t think all conglomerates are horrible. We just think that when they get a little TLC and are focused and are managed properly, actually you can peel out lots of different kinds of value. That’s just one sample from the “Breakup and Spinoff,” category.
If we move on to the next one, which we call “Restructurings,” here I’ll just touch on Fagron. Again, the logo. These are all company logos.
Fagron is a pharmaceutical compoundings business. They make everything from eye-creams that Suzanne Somers might sell on late-night Home Shopping Network, to injectable drugs. They work for pharmaceutical companies, where they put together all kinds of products for healthcare; sterilized medicine – which again is through injectables and so forth.
They are the largest in Europe. They’re Number-One in Brazil, for example. But really, to make this a very tight point, we discovered this company just under three years ago. It really was a company that had good businesses but had overextended its balance sheet. When it was refinancing the balance sheet, in the meantime, the stock had gone from €40 per-share to just under €6. It had collapsed.
We always look for these restructurings and changes and said, “Let’s get our arms around this.” We valued the US business at zero, because they had a lot of problems, here. We said if it’s still cheap without the US, there’s something interesting here.
We did it. We helped them refinance by participating in a capital-restructuring. Just to wind it down, the stock has done very well, because they brought back the original founders of the business, who brought back the old style of doing business. Today it has a clean balance sheet. The US has now been approved by the FDA. Since we counted that as a zero, it’s added huge value to this story.
Restructuring is an area where a lot of people don’t like to look. We look at them. When others are dumping stocks, we can find areas where we find situations that are less competitive, and we really can get our arms around the businesses. Europe, again, is just chockfull of these that were forgotten stories over the years that are now being dusted off and refocused on.
Compounders – the next section.
Compounders are generally family-controlled businesses. They’ve cranked out huge total-return to shareholders over many years, yet trade at a discount. For compounders, we’re looking for leaders at the top that are exceptional talented at creating value. As I say, compounding the total-return for us as shareholders, yet the market has valued them at a discount.
Let’s take Exor as a quick example. Exor – you probably know more of their products than you think. This is the holding-company for the Agnelli family; one of the wealthiest families in Italy. Through which they control Fiat, Ferrari, Chrysler, they own Maserati – Alfa Romeo – they own big insurance businesses.
During the US financial crisis, when Chrysler was really in bad shape, they bought Chrysler from the US Government. They were able to really take advantage of a company — making a bid for almost nothing – to buy Chrysler. Today it’s the cornerstone of the cashflow generation there.
It’s really smart guys that buy assets on the cheap, who can do it and grow it. This has compounded extremely well for us. The same for the other two holdings in the portfolio.
If we had much more time, I’d be happy to take you through every single position. We don’t. But just touching on the last box, here – other special-situations. These are ones that kind of just don’t fit into the other buckets.
Here, I’ll talk about Frontline. Frontline is basically – if it’s not the Number-1, it’s the Number-2 – largest oil-tanker business in the world. As a firm, we own about 3% of this company. It’s one of the largest holdings within our sleeve, within the Litman Gregory Masters International Fund.
Here, again, we started buying it when all kinds of shipping and transportation were considered completely the wrong place to invest. The wrong place to look at. There were all kinds of concerns with shipping.
The good news is, that means that the industry went through a radical transformation where older ships were being scrapped. New regulations have come in for how fuel-emissions are done. What that means is that if you have older ships, they’re not economical to keep going. So they’re scrapping the old ships.
So many companies got burnt over the years, they ordered fewer and fewer new builds. You have this interesting time where you have fewer new ships coming into the system, and more scrapping than ever before. We’re seeing the valuations and the pricing and the cash-generation here growing exceptionally well. We’re really at the front-end of that. It’s been a good investment so far, but we’ve seen a lot more value, here.
The key for us is looking for critical characteristics. We’re not just looking for any cheap stock. We want stocks that we really think can add a lot of value to this portfolio.
I don’t think I have any more slides. I’m happy to keep talking, or I’ll hand it to Rajat.
R: No, this is good to learn. We want to get into the q-and-a. Let me, if we may, go to the next slide. I do want to wrap up with final thoughts before we formally get into it.
I wanted to briefly touch upon what our top-down analysis and modeling is suggesting about Europe versus the US stocks, valuation-wise. Really, we could spend a whole separate call on this topic. But in the interest of time, I wanted to make a few points that I believe are key.
In the US, as this slide has written, the odds of good-return outcome are very remote in our view. In order to eke out any reasonable gain from here, an investor would have to assume that history is largely irrelevant when it comes to margins and valuations. Said another way, what the investors would be willing to pay for a dollar of earnings.
Even in what we’d say are generous assumptions, we are getting very-low single-digit returns. Whereas, in the case of Europe, even after making what we think are significant haircuts to their normalized earnings power, and also the valuation-discount that they traditionally always have had versus US stocks, we have increased that,we are getting expected returns over the next 5 years of about six percentage-points higher than US stocks.
This number is on an annualized basis. So over the five years, which is our time-horizon for this kind of analysis, we can expect or we expect a cumulative excess of over 30%.
We are factoring in these haircuts Europe’s many structural issues. Of course, there’s always a risk that these haircuts are inadequate. At the same time, though, I’d point out we are not factoring in any of the reforms or restructuring improvements that David and I just discussed. So there’s a good chance, we think, our haircuts turn out to be overly conservative, and expected returns are higher than what our analysis suggests.
One final point – just from a cyclical standpoint – the Bureau of Economic Analysis recently revised down US economy-wide corporate earnings. Essentially, there’s been really no growth in earnings the past few years, going back to 2016 or late 2016.
Meanwhile, we’ve seen some data that suggests US companies have been the largest buyers of their own stock. More than ETFs and mutual funds combined.
So it begs the question that US companies have been providing technical support for their own stock, while fundamentals are really not that strong.
It should certainly raise a question, it does in our minds.
I think with that, we can –
There’s actually one more question. I think, David, I did want to ask you. Can you maybe talk about how you’re able to get access to management? Just based on your recent trips, what are you hearing?
I know you touched upon it already. But if you could give some color on what you’re hearing, and how managements are adjusting to this almost zero-growth environment. You talked about how they’re buying growth.
But what are their concerns and what are their hopes? Can you provide some more color on that?
D: Sure. Yes.
We spend a lot of time visiting these companies there. We go to Europe quite a bit. A lot of them are coming here, as well. We get as many meetings as we can throughout the year.
Most companies, we’re trying to meet with them multiple times. To be clear, we’re never looking for secrets. We’re just trying to understand how they think about their business. How do they think about creating value for shareholders or if they’re even thinking about it at all? To really understand the nuance of it.
One of the most important things for us is that we actually are investing in people – not just businesses. We like to say we’re betting on jockeys – not just horses. We need the right jockeys. That’s why it is so critical to get out and talk to them.
When we are getting out there and talking to management teams and individuals, and the families that control these businesses, we see really it’s subtle, but it’s accelerating. The energy – the level of perspective on taking advantage of opportunities. It’s been so tough in Europe for so many years that you’re seeing companies that have really learned to adapt.
It’s the old line, “Adapt or die.” Well, these guys have, “Adapted or fired.” They fired a lot of managers. We’ve seen families kick out their own family members and put professionals in to help run these businesses more competitively. They’re not competing with the guy down the street anymore, only. They’re competing with everybody in their industry.
What we’re specifically hearing is, they have the capital to take advantage of adding more products and services. They’re finding new ways to cut costs. Stories like the company that’s a conglomerate that has 15 different IT departments and realizes it should only have one, because 15 of them don’t talk to each other. So they start cutting costs and start refocusing.
You can’t cut your way to success completely. But the focus on streamlining of operations and cost-cutting is critical.
Additionally, supply-chains are evolving around the world because of the trade war. In some cases, even for us, we start to think about, “Do our companies sell to China or if they sell indirectly to China?” Meaning if we have a French company that sells to a German company – they sell to somebody. It really pushes us to rethink how stocks in our portfolio work and how they make money.
These managers are really positive about the opportunities for their businesses. They see the chance, again, to make acquisitions. They have already cut costs. They’re seeing a pick-up in order-flow. Funny enough, in some cases, because of the trade war – as I say – supply-chains change. In some cases, Chinese companies were buying from the US; now they’ll buy from Europe. Sometimes it’s dramatically different.
We can’t count on those changes forever, but the point is, they’re taking advantage of it. Even the shipping companies that we tend to own and like – for them, it’s all about what you would call ton miles. How many miles are they selling – much more than where the customer is. “Is it a Chinese customer or a US customer?”
Trade wars are actually creating longer trade routes, as Chinese companies are buying more from Latin America. It’s just all these things. That’s why I say bad headlines are not always bad for the companies.
Yes, they’re really seeing this and feeling it. The perspective is very positive.
I have to say, some of our companies – they’re not even feeling it at all. They’re saying we don’t have any impact at all from trade war. One of the stocks I had on my slide on the special-situations page is called “Aurelius.” That is a publicly-traded private-equity business, headquartered in Germany.
Actually, just this morning, we spoke with management. They were talking about the two most-recent acquisitions they made. Both UK-based.
They said if it weren’t for Brexit, they never would have bought those businesses. They buy castoffs from larger companies that are getting rid of non-core businesses. The fear has taken some companies to say, “We want to get out of our businesses in the UK.”
The CEO was saying that the deals they struck in the UK were two of the best deals they’ve seen in quite some time. The sellers were extremely motivated. They as the buyer took their time and did their homework. They were able to buy things really cheap.
This had been publicly-announced already by them. Then they turned right around and went back to the seller, who needs the product, anyway. They signed a 5-year contract that they are the only use of this fleet. They bought a fleet of trucks and of course all kinds of services for a service company.
They negotiated really good deals. That’s just one little example.
But it’s out there. That’s why for us, we’re always looking. We dig deep. As I say, a bad headline might scare investors away, but it actually drives us to think about if that’s an opportunity; not just a threat.
The key is, and your question is a great question, because it is about getting out there. Taking the temperature. Feeling the pulse and understanding if they’re really focused on taking advantage and not sitting back and just watching the world pass them by. That is what has really happened in Europe. I think most American investors really just think it’s the same-old-same-old. It’s not.
R: Thanks, David.
D: I’ll add one more thing. We don’t want to buy everything. We’re not just saying –
I think it’s so important to say we’re not buying everything. We’re not saying you have to buy Europe. I’m saying there are unique opportunities in Europe that we can take advantage of. That’s why we’re so fixated on building together for Litman Gregory a portfolio of one-off situations. Where each one is unique unto itself, and when you add them together, you get a nice complexion for a portfolio of different characteristics. Different expectations. Different opportunities. Different risks.
But the combination together really is powerful.
R: Thanks, David. It’s interesting that whatever you’re seeing and hearing jives with our top-down analysis that we do for our advisory-client business.
Scott, may I request if you could start the q-and-a?
S: Sure. Yes. Thank you, Rajat. I’d just like to remind our participants on the webinar that you are able to type directly in your questions, and we will look at those and pass them on to David or to Rajat. Again, a reminder to the participants that you can ask your questions directly by typing them in to the webinar. Thank you.
R: While we’re waiting, David – could you talk about what characteristics you want to see before you buy a stock in the Masters sleeve that you manage?
We want to see companies where we have a compelling valuation. We can look at different kinds of valuations, depending on the underlying business.
An insurance company, you’re going to value differently than an industrial business. But we’re looking for low multiples of free cashflow, of cashflow. We’ll look at P/E for certain kinds of businesses, but we’re really cashflow-focused.
That’s just the starting point for understanding the situation.
Interestingly, for us, we actually don’t screen for numbers to kick off our analysis. When we’re doing our work, we start with words. We do keyword searches. We look for phrases like – just doing things on a search for spinoffs. “Post-reorg-equity.” That’s something coming out of bankruptcy. Restructuring. Transformation. Management changes.
We cobble together different phraseology that helps us find “Change.” A numbers-screen might show something’s been cheap for years. Maybe they’ve announced they’re going to spin off non-core businesses, but it hasn’t happened, yet. So it’s not in the numbers.
You want to get in that window of opportunity by searching for the words. We start with that keyword search. Once we have an idea, we ask the first question. “Is it cheap?”
Then if we say it is cheap, we say, “Okay. Why is it cheap?”
I don’t think enough investors ask that question. “Why is something cheap?” Sometimes it’s not cheap enough, because it’s a tough business. Maybe it’s got drugs coming off-patent that we’d need to value differently. You really have to understand better why something’s cheap.
These are the characteristics that we’re looking for. Why?
Then the next is, “What’s going to make it less cheap?” That’s code-word for, “What’s going to make it go up?” We want the highest-quality businesses we can find at the lowest multiples.
We’re willing to have businesses that are good businesses. Characteristics can be companies that are good businesses that have stumbled, but we think can get back on track. In fact, those are our favorite kinds of characteristics.
They’re good businesses that have stumbled and had a couple of bad quarters. The market’s given up on them. But we think that there’s a unique opportunity there. Maybe they’ve changed management and so forth.
It’s a cheap stock. Why is it cheap? What’s going to make it less cheap? We have to time-weight that.
We say, “Okay. We think it’ll take two years; let’s build in three years.” You want to tee yourself up for success. So you assume three years, even though you believe it’ll take two years to work. You build in there years, so if it actually only takes two years, it’ll compound better than you’d modeled in. You don’t want to be on the other side of that.
Those kinds of characteristics. But then always focusing on the strategic change element. “What’s going to make this work? And why?” And of critical importance – I said it earlier –
Across all of our accounts, it’s true – but of course especially for Litman Gregory – “Who are we investing with?”
Just like you vet managers to pick guys like me for this portfolio, we’re doing the same thing. Our managers are the CEOs of the companies. Or the main shareholder. Who are they? How have they treated their shareholders? Where do they come from? What’s their track record and history?
Same kind of thing. I think of those guys as money managers. I think it’s critically important to understand that.
I don’t think a lot of investors focus on the quality of the people as much as I think is critically important as a characteristic – as part of the investment process.
R: We have one question.
D: I think it’s, “Keyword focus,” rather than “Numbers.” It just gives you a different perspective, and it really does help you get in the game a bit earlier than numbers-only focused investors. Sorry – what were you saying?
R: Sorry to interrupt. We have one question that’s come up. One follow-up on what you just said. How do you decide within this criteria which ones are the most-compelling to own in the Masters sleeve, amongst all the other broader portfolio of stocks that you own?
Are there certain areas that you weigh more when picking stocks for Litman Gregory Masters International?
D: Well, yes. For Litman Gregory Masters International Fund, we are not replicating our existing portfolio. We’re picking sort of and selecting individual names. We have a limited number of slots that we can put in.
Everything we own for any of our clients, we think, are great investments. But because we have a limited space in the sleeve, we really take a step back and think about it. How long will it work? What are the risks associated with it? The same kinds of questions, but we think in terms of, “If I can only have a portfolio of one-third of the positions I have in my main portfolio, what are the ones that we think can achieve the best level of performance and total-return?”
How timely is it? What’s the liquidity? We really try to factor in many different things. But we do think about this account differently from the standpoint that we have a specific amount of space and can only utilize that.
What we don’t like is to create friction cost. We don’t like to trade if we don’t have to trade. We’re not wishy-washy about it. We’re not going to put something in the portfolio and then two weeks later say, “Ah – we shouldn’t have bought it. This other one’s better. Let’s get out of this and into that.” That creates a lot of friction cost.
We try to do all of that work before we ever pull the trigger. Once in a while we make a mistake. But the fact is, we really try to spend so much time understanding.
I look at the Litman Gregory portfolio very differently because I have this significant restriction on space. We want really –
I hate to say it like we’re trying to put our best ideas in, because I believe everything we have is amongst our best ideas. But we really want to blend the capacity and time that we’re going to hold it. Seeking long-term gains. Really, just adding all of these characteristics together to come up with the ones that we think have the best potential for return.
Where I can sit back and do as little as possible. Meaning the activist – the guy that pushed for change or is now pushing for change –
It’s the companies themselves. It’s real change that’s going on that really doesn’t work overnight necessarily. These could be real compounders over time.
You have been talking to me and our fund here for quite some time, now. Years! Literally!
D: Many years. Many years longer than we’ve been part of your portfolio. I think you know that we’re very consistent on how we look at ideas. We take it very seriously that this is real capital people are entrusting with us to manage on behalf of themselves or their clients. We really treat it very gingerly, but at the same time, aggressively. We are here to make money.
Our goal is to take qualified and educated risk. But it takes a lot of work for us to pull the trigger on a name. We really want to buy things that, even though they’re going through some sort of a change, they’re stocks that we really expect to be with for some time. So we can generate compelling long-term gains.
The last thing I’ll say on that point is, I think a lot of times when you talk to value investors – and I’m sure I’ve said this to you before – but somebody will say, “Oh, yes. I bought that stock at 8 and now it’s 12.” You have to remind them that they started buying it in 1978. Meaning they compounded extremely poorly. They’ve owned it forever.
We’re very aware of holding periods, and compounding and rates of return. Just because the stock went up doesn’t really mean you did a great job. It needs to compound at the right level.
That brings you full-circle back to Europe. Buying stocks that are at the kinds of discounts that we are seeing. They really don’t even have to get to the same multiples in the US. Just as they work their way to close the gap modestly, the potential for outperformance is so dramatic.
They don’t have to work perfect. They just have to work “Somewhat.” But we think they’ll do better than “Somewhat.”
R: Thanks very much David.
One question from the audience has come out and would love to get your thoughts on this.
Vincent Bolloré has been a controversial figure. What are the risks that you see in investing in his holding-company? And how have you gained comfort with it?
D: Vincent Bolloré controls Bolloré, which is in our Compounder section of the portfolio. Bolloré, in turn, controls Vivendi, which I discussed earlier.
I started meeting Vincent Bolloré over 20 years ago, in the 1990s, before he was a billionaire. He was just a well-known guy in France, who was building – as the sixth-generation of his family — to take over the company.
He transformed it from a sleepy backwater bankrupt situation to really a global business.
How did I get comfort with him? He has been so aggressive in what he does. Hostile corporate raider. Aggressive manager of the businesses. Yes, he’s had some issues. They have more ports in Africa than any other public company, yet they also own media and telecom businesses.
Recently he announced he was retiring as the chairman of this group. He’s promoted his two sons – Yannick Bolloré and Cyrille Bolloré – to take over.
I’ve met the sons over the years, but I went to France right after this announcement. Actually earlier this year, I spent some time with both of the sons, to talk to them. What are they going to do differently? How much influence does the father have?
Frankly, you want the father involved. He is an unbelievable value- creator. He’s created an enormous level of return, here.
We tracked the issues that they had in Africa. Questions on how they got some of the port contracts. They’re not being investigated by either of the African countries; it’s the French regulators that are looking at them. Their view is that the way they conducted business may not have been perfectly above-board.
We read all the documents and we talk to them and specifically asked Bolloré directly about this. Their view is, we could probably pay a fair chunk of money and this all goes away; you just pay a settlement. But their view is, “For us to admit guilt when we’re not guilty? We’re not going to do it.”
So, they’re fighting it. In the meantime, the transition is accelerating to the sons.
I have to tell you, it was such a good meeting. I met the two of them separately. They each gave me more than two hours. One is now the chairman of Vivendi. The other one’s the chairman of Bolloré, itself. The family’s conglomerate.
They talk differently than the father. Less about acquisitions and more about how the father made all these acquisitions over so many years. They basically articulate that he’s very good at buying things cheap, but when it came to management, they haven’t always rationalized and restructured.
They were talking about all the low-hanging fruit they had throughout their empire – of places to streamline. Cross-promoting products and services.
I love it from an investment standpoint. I think there are many years of potential value to be created here. It’s already done very well overall. But we’re always going to track and watch it.
I believe that even if there were an issue for those two specific ports in question, and they somehow lost those contracts, it’s a blip for the company. It’s less than 6% of their business. Where this case has not moved forward, it’s been two years into this already. Nothing’s happened.
We’ve seen companies from GE to Siemens to all kinds of big conglomerates get into similar kinds of issues for how they got into contracts in certain markets. Normally what ends up happening is there usually are cash-settlements to the governments that are investigating them. Then they change their business practice.
If you want to be a little more cynical, like myself, I actually think it’s a good thing. Why? This cleans up the old way of doing business. They bring in more regulation and more structure. More focus.
The seventh generation of the family just operates differently. These are guys that went to business school and have a different focus on how to do business. I just see it as an evolution of this multi-generational conglomerate to be more streamlined and more corporate governance. More focus on doing things the right way.
We see that not just at this company. We see that at other companies, as well. It’s a big theme in Europe. It really is.
A lot of these families didn’t think about corporate governance or anything of that nature. It’s a huge focus, now. There are so many rules and regulations that have come into play in the different markets.
If you want to say the US has really brought something that people haven’t focused on, it’s this. It’s harmonizing corporate governance levels and goals and structures. It’s having real ramifications for a lot of these companies.
I think that’s another impetus. I didn’t even have it on my list. But it’s another impetus to why there’s change now more than ever before.
D: It’s a positive with a question mark. But yes.
R: Interesting, David.
We have another question which actually dovetails well with what you just said.
The question is, and I’m going to try to do justice to it –
You are open-minded to having these family-owned/controlled businesses such as Bolloré that we just talked about. Then it says, “Since we all know about short-sleeves to shirt-sleeves in three generations, how do you get comfortable with these companies in terms of the next generation of leadership?”
Do most of these holdings bring in outsiders to be CEO and provide some independence?
I guess there’s a sub-question, since you already talked about Bolloré and the sons – and you met them and you came away very pleased.
In how many instances of these family-controlled businesses do you find that the next-generation or the sons or whatever they bring in, you’re not enthralled with and pass?
Then could you speak to the related part of the question, as well? How many of these holding-based companies do you find are bringing in outsiders to be CEO and have independence? Real independence – without family?
I think you touched upon that in your earlier comments. If you could still elaborate on these two sub-questions, I’d appreciate it.
D: Sure. It’s true. People assume the old view that by the third generation, it’s over with. Remember, Bolloré is the sixth-generation of this family. His sons will be the seventh generation.
I will tell you, the fifth-generation of Bolloré basically put the thing into bankruptcy. When he took over almost 40 years ago, it was a defunct group with assets and massive amounts of debt. He cobbled together a few bucks or French francs in those days, and built it into a €12 billion market-cap today or whatever the number is. It’s around that.
This is one where –
I’ve been meeting family-controlled businesses as really a cornerstone of what I’ve been doing for pushing 30 years, now. Starting when I went to Sweden. The first country I ever went to in the early ’90s.
What I’ve found is that you have all kinds. You have the head of the group that does not groom the next generation. They treat them very poorly, in fact. Sometimes they ship them out to the furthest reaches of their empire and say, “See if you can learn your way back.”
Other times, they kick them out completely. We’ve seen fights where the next-generation has to fight its way back in. We’ve seen it all.
In the case of Bolloré, his son Yannick is in his late 30s. His son Cyrille is in his early 30s. Cyrille, when he was in his early 20s, his father shipped him to Africa. He said, “You’re going to go work in the logistics business. If you can figure out how that works, I’ll give you another one.” And he did!
Then, the dad eventually said, “You know what? My younger son is the one that’s going to take over this whole empire; not my oldest.” The older son runs Vivendi. He’s very good at those things. But he started him off within Havas – one of the largest advertising agencies in the world.
I would tell you right out of the gate, he did a horrible job. Horrible. Well, he learned at the shareholders’ expense in those days.
He eventually bought 100% of Havas, and it’s part of Vivendi. Today he’s chairman. He’s a completely different person. He was groomed as a young guy in his early to mid-20s to late-20s to 30s. Now he’s pushing almost 40. It’s just a remarkable transformation.
I’ve asked people at competing companies – you met Yannick Bolloré in the past. Now you see him running what he’s running. You get the same feedback, which is the father put these guys through the wringer to learn. That’s them.
We have companies we don’t own, where the next-generation is not creating value. But you know what I find is in that talking to those CEOs – families – it’s critically important. It’s really like getting the map to the minefield – they’re learning what to avoid.
They don’t realize that they’re value-destroyers. They think they’re value-creators. So you want to meet them.
But there’s focus on who they are. It goes back to that concept of, “Who are the jockeys on the horses?”
In the case of Bolloré, that’s the case. In the case of Exor, John Elkin – who’s the patriarch of the family – is in his 40s. When this guy was 22, his grandfather said, “I pick you. You will one day take over the empire.”
He started grooming him in his early 20s. When he was 28, the grandfather died. He took over.
Everybody thought, “My God. This guy’s going to destroy this thing.”
Back then, Fiat was not doing well. His crowning achievement was bringing –
Unlike his grandfather, who was a power-guy controlling these businesses, Elkin’s attitude was, “I need to bring in smart guys who are smarter than I, and unleash them.” That’s what he did. That’s professional management. He brought in one of the great auto-industry executives, whom I’m told at the time, was not an auto-industry executive. Sergio Marchionni. He was running a different business for the Agnallis.
He said, “You’re going to help me turn the auto business around.”
He had to go to his family and beg them to give him money to reinvest in the auto sector, because it was dying. He unleashed Marchionni, who has become one of the legends, now. Unfortunately, he died last year. He transformed it.
Elkin got very good at finding talented people, bringing them in and unleashing them. That’s a hybrid. You have the family in control, but bringing in professionals alongside them. They don’t mastermind it. They let these guys do their thing.
The guy after Marchionni was a guy named Mike Manley. He was groomed by Marchionni. So it’s a chain, now.
They’re trying to merge with somebody else. Maybe Renault; maybe somebody else, because the scale in the auto industry is changing.
But to your question, Bolloré is staying in the family. Interestingly, some of their key guys are getting older. They’ve already talked about slowly replacing them. We’re going to track who those new guys are. But they’re very good at bringing talented people. Exor, the same. Very talented people have been brought in, who are professionals.
I can tell you, this guy Elkin is ruthless. I see him at the Berkshire Hathaway meetings. I’ve gone for 20 years. He goes there. He’s a huge believer in value investing. But when I say he’s ruthless, he’s brutal when it’s time to buy assets cheap. When they sell assets, they really are aggressive in how they conduct business. He holds the bar high for everybody, including himself.
There are wonderful interviews with him out there. I’d say it’s worthy of looking that up.
It’s that kind of focus that we do, where you have these hybrids, where it’s the family and the new guys from outside. Even at Frontline, that’s not even in my compounder bucket, there was a huge article that John Fredriksen is almost 80 years old. His two daughters are not interested in taking over the business. The headline is, “I’m looking for great people.”
He’s slowly working his way through his empire, and stealing people from other groups to put key people in place, as all of his public companies transition to the next generation.
We think the CEO he picked at Frontline – Robert McLeod, who’s a young guy in his 40s – again, an outsider who was brought in — this guy is phenomenal. Before we ever bought that stock, we went to Oslo, London and wherever this guy was, to just meet with him. Just to understand who he is, how he thinks, and how he does his business, before ever buying one share.
Even though it’s a commodity business, it’s still about the people.
R: Okay. Thanks. Thanks, David.
We’re very close to the end of the call. Before I turn it to Scott, I just wanted to thank everyone. Thank the audience for the great questions and for your time. I hope you’ve found it useful.
David Marcus, we think, is a unique investor. We are very fortunate, we think, to have him amongst the five managers we have currently on the Litman Gregory Masters International Fund.
Thank you again, Scott.
S: Thank you, Rajat. Thanks to everyone for taking time out of your day to join us on this webinar. I would like to thank David Marcus and Evermore Global Advisors for their time, as well.
I would also like to thank Rajat for his time. We appreciate your interest in our International Fund. If you have interest in any of the Litman Gregory Masters Funds or would like to learn more, please reach out to us at Litman Gregory. Visit our website at www.MastersFunds.com.
Thank you everyone; have a great day!