1 year ago

Graham & Doddsville


Page 34 Simeon Wallis

Page 34 Simeon Wallis has to devote the resources to be involved three to five years at a board level. That’s the right mindset. We try to determine how we can have an impact on operating improvements, incentives, and capital allocation decisions. At the same time, we have to be willing to accept a lack of liquidity because that’s a tradeoff for joining the board. We haven’t found the right situation where we’ve been able to partner with a management team where they wanted to bring in a concentrated investor to help build the business in the public markets. In one situation we considered, it was an industry executive that had followed the target company for years, knew that the existing management was ruining the business, and sought capital to help effectuate change. We came close as the valuation was incredibly compelling if we could change management, but we passed due to our research. We realized that the business was inappropriately levered, and the more work we did on the operations and capital structure, the more we became uncomfortable with existing management’s ability to generate ample cash to service the debt. We didn’t think our new management team would have the time and balance sheet necessary to realize the company’s intrinsic value. When we look at small caps, we’re looking for good managers who would be good partners, as opposed to an antagonistic situation where we’d become activists. It’s really special situations where we have someone in place that we know would be an ally to help us run the business. Down the road, there might be a real opportunity for us to exert that type of influence. But given current multiples and debt levels, it’s probably not very fruitful now. G&D: Would you like to talk about some past public market investment ideas? SW: On the public ideas, one that ended up being very fruitful for us and is representative of our approach was the title insurance company Fidelity National Financial (FNF) in 2013. FNF operates in a relatively consolidated industry. It provides a necessary service unless there are legal changes to eradicate title insurance, which we didn’t see on the horizon. Bill Foley ran the company, and if you look at his track record, it is very similar to John Malone’s at Liberty. Foley has deftly used the public markets to buy and sell assets, timing the markets very well to create significant value for his shareholders. He’s willing to run with some leverage and make very difficult decisions very quickly. He simplified his business. He very much fit the profile of what we were looking for. It was pattern recognition. He’s created, I believe, close to $40B worth of enterprise value from deals and compounded returns for shareholders at very high rates. He built a company called Fidelity National Information Systems which he eventually spun out. He has used a tracking stock for his financial crisis-era investments, FNF Ventures (FNFV), to highlight value and repurchased shares when FNFV traded below intrinsic value. He acquired previously spun-out technology businesses when valuations were depressed, and he’s spinning that out again as Black Knight Financial Systems. That’s one of those structural aspects that we try to take advantage of. Many investors are wedded to how financial models look in spreadsheets. Yet our operating experience has taught us that business is not linear and often value creation doesn’t model well. We bought FNF at 8x to 10x our estimates of normalized earnings, and we received all of Foley’s capital allocation prowess for free. We held FNF for about two-and-a-half years and when we started to sell the publicly traded portfolio, we exited FNF. With the spin-off of FNFV and other maneuvers, FNF was a very good investment for us. Foley represents another aspect that we look for with managers, which is managers from outside of an industry, who can apply what they’ve learned from outside that industry to the new industry. That allows the manager to do things that are different from the conventional wisdom. Foley’s background was in the military. He has a law degree. He eventually bought a title insurer out of bankruptcy, and then proceeded to roll up the industry. It was a very different perspective from the traditional, slow-moving insurance company competitors and the executives who grew up in the industry. G&D: Any current holdings or ideas? (Continued on page 35)

Page 35 Simeon Wallis SW: Currently we don’t have any investments in the public market. One thing that’s been on our radar is another insurance company, Assurant (AIZ). Assurant has been a quirky, niche insurer that has consistently evolved the products and services that it’s insuring. Occasionally it becomes very cheap when investors believe that a line of business AIZ is in is about to fall off a cliff. Management has been very good capital allocators, knowing to repurchase shares when investors price in Armageddon and to increase the dividend when investors are not concerned. Over the last decade, AIZ had been an aggressive cannibal of its own shares, as share count has declined greatly when AIZ traded below book value. About two years ago, the chief of strategy, Alan Colberg, was promoted to CEO. Colberg came from outside the industry. He was an ex-Bain partner who possessed a materially different perspective for growth, and quickly made difficult decisions to exit legacy businesses that were structurally challenged; Assurant received good value in exiting them. An investor could follow Colberg’s playbook, which was taken out of one of Bain’s published books, Profit from the Core. He focused on providing additional services to existing customers in highly profitable niches, where he could make tuck-in acquisitions and use capital to grow in a relatively low-risk way. When we normalized for the different segments of the business, the upside when we were looking at it, about 18 months ago, was a double. The stock price was around $65, and we thought it could be worth upwards of $125 to $130, looking out several years. The process is still going on. Assurant is about $95 a share now, and we believe that there’s still upside. We haven’t allocated much into the public markets recently because we’ve had some private opportunities that are more compelling. “A second piece of critical advice I have is the importance of removing one’s ego. Ego is the driving force behind most intelligent people’s mistakes.” G&D: Is that more a consideration of how good the private deals are, or are you just not seeing adequate returns in the public markets? SW: It’s the latter. Generally, we haven’t seen compelling valuations. As I mentioned, in the last year we purchased a hospital we knew out of bankruptcy. Several portfolio companies had reinvestment opportunities at rates well above what we could receive in the public markets. In the public markets, we’re looking to double our money every three years. We generally don’t like when there’s a very levered balance sheet. What’s been cheap the last few years is where there’s been some balance sheet concern in addition to being in a commodity business. That’s not the right risk for us. On the private side, valuations are not great either, but occasionally we find ideas from proprietary deal flow or provide capital to our operating companies for tuckin acquisitions at 3x pretax profit. As I mentioned before, that’s hard to beat. G&D: That definitely sounds compelling. Do you have any advice for students? SW: For students who want to get into this business, the business is changing significantly on the public side. I see parallels between what’s occurring with the traditional retailers and the threats posed to asset managers and hedge funds. Competition is emerging from low-cost sources and technology; for retailers, the threats are the Costcos, Dollar Trees and Aldis of the world, and for investment firms, lowcost passive vehicles such as ETFs and index funds. It’s also coming through technologydriven interaction with the end user, whether it’s Amazon and the Internet-based direct-toconsumer business models in retail, or quants, factor-based investing, and robo-advisors with computer-driven investing models for the traditional investment firms. These competitive threats may result in fewer analyst opportunities; anyone who wants to join our industry needs to be 100% committed to it, and eat, sleep, drink, and breathe investing, and understand their own personal points of differentiation for a potential employer. Our industry attracts a concentration of type-A driven (Continued on page 36)

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