A senior member of our investment team read this transcript and couldn’t help but replace the words “investment management” in lieu of the subject being discussed. Worth reading and thinking about.
A recent article in the Wall Street Journal penned by Michael Dell is so full of self-serving garbage it is difficult to know where to start. (Click here to go to the op-ed at WSJ.) What is clear in most companies is that the fish rots from the head and Dell’s decade of miscues—led by Michael Dell and his hand-chosen successors— brought it to a position of miserable valuation, investor apathy, and then finally investor activism…not the other way around as Mr. Dell implies.
If a company clearly delineates a course of strategic investment, provides clear accounting into how results of this investment are measured, and most importantly, provides accountability if money is wasted, then it will attract an intelligent group of long-term shareholders who will properly discount the detraction from short-term earnings. That might explain the “sage” ability of investors to value the hundreds of billions of dollars invested in life science research which are almost by definition difficult to handicap, not to mention the hundreds of billions of dollars of market value accorded to any variety of seemingly overvalued (by our standards) technology companies. While there is “bad” activism, there is equally disastrous capital allocation by entrenched management teams. The two extremes deserve each other and somehow life manages to go on.
I have listened to a dozen thoughtful CEO’s who tell me they “love” buying companies from private equity because they know that many have been starved for capital for innovation and growth and blossom once given a chance. Michael Dell apparently didn’t have enough of a tough skin to address shareholders like adults and admit any variety of corporate mistakes that plagued Dell in the midst of an admittedly tough period for his industry. Instead, he took advantage of his inside ownership and the canniness of one of the great short-term public/private traders—Silver Lake Partners—to push a short-term trade on his public investors. I dread the hubris that spews from their mouths when they file to go public again.
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CLICK HERE to download “The hipster effect: When anticonformists all look the same” by Jonathan Touboul
This is a very nicely done and thoughtful piece about a topic that every serious long term shareholder eventually faces despite best intentions.
CLICK HERE to download PDF
CLICK HERE to download Cove Street Capital’s September 2014 Strategy Letter Number 18, “Metastability”
Of the myriad of reasons proffered daily as to why we are the verge of stock market doom, a “decline in share repurchase” has come up a lot. We would note the following:
As the below chart suggests, shares outstanding for most of the S&P 500 as a whole have not changed in a decade. Material share repurchase that actually reduces shares outstanding is not the majority rule. If it has been the prop for the market going up, it will not be the reason for a decline.
So where do all these hundreds of billions of dollars of share repurchase go as a whole? It is a correct statement that many Boards and management simply don’t understand the corporate finance behind effective share repurchase and use it to disguise the very high cost of dilution to shareholders from aggressive compensation programs. See the chart again.
Boards and management are like many investors — they buy at the top when they are “confident” and freeze at the bottom when things are “uncertain.” Sad but true and very difficult in practice to change. It is tough to say en masse that share repurchase “signals” anything anymore as it has become so widely used as a PR prop.
What an intelligent share repurchase plan does is buy small pieces of a business below a reasonable estimate of intrinsic value. When pursued like this, there is no debate — how can you argue with its logic? As a secondary effect, how can you argue with using free cashflow to return cash to shareholders and enable those who stay to own more and more of a worthwhile business on a tax free basis?
After 30 years of talking to CEO’s, I am not sure I can count on one hand CEO’s that have told me they are NOT going to make a worthwhile corporate investment in order to buy stock. What I have seen hundreds of times is management pursue out and out silliness to the tune of hundreds of billions of dollars in wasted and inopportune spending on corporate acquisitions, capital spending at the top of cycles, R+D wasting ventures, and other grand scheme, consultant-driven ideas that get hatched in apparently very fertile boardrooms. THAT is the bigger destroyer of value — NOT intelligent share repurchase.
Politics aside, we are regularly asked by large institutional clients, “How is Climate Change affecting the way you invest?”
Our short and practical answer is “It doesn’t.” This piece by longtime favorite economic and environmental thinker Bjorn Lomborg is a more detailed version of that answer. It also suggests some subtle moral ambiguity in what some would consider to be “conventional wisdom” on the topic.
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In regard to Tesla…
Having defended our more cautious stance for over a year, we find ourselves torn in upgrading as it is clear substantial risks remain. This is, in part, given (1) the lack of available data to question management’s claims with respect to battery pack durability (among other long-term warranty / residual / service / charging infrastructure related issues), and/or (2) despite lofty expectations, Tesla has never generated even one-sixth of the profitability per share based on the Street’s 2016 EPS outlook (even less based on our updated 2017 estimate), while tax incentives are waning and Gigafactory construction is looming. We have no clarity on battery input costs and take management at face value relative to the estimated $200-300/kWh (kilowatt-hour) starting point while targeting $100/kWh ICE (internal combustion engine) cost parity inside of a decade. We are also relegated to performing various mathematical gymnastics to ascertain the cadence of Model S demand in its most mature market, the U.S., each quarter.
While there are no fewer than a half-a-dozen other key concerns we share with industry purists, the reality is that these issues simply do not matter with respect to Tesla’s stock. Tesla sentiment is like a freight train, in our view, benefiting from a well-manicured growth story that has caught the eye of a much broader investor base relative to most auto stocks. Tesla has positioned itself as the smart vehicle of the future, with a glimpse into smart purchasing and smart infrastructure. Tesla has captivated a global audience, some of whom have lost interest in distinguishing horsepower ratings among the dozens of $100k-plus luxury vehicles, others that would have never considered spending six-figures on anything but a house. Like Tesla’s right place/right time purchase of the NUMMI facility, or the astounding political energy around renewables (again), our call ultimately comes down to timing. We believe our risks remain legitimate, just much further out than we anticipated. Tesla will eventually face stiffer competition from traditional OEMs, we think, and will reach a ceiling of consumer support. But it is clear from our recent factory visit and conversations with investors, customers, and management that these concerns are at the earliest, late decade issues at best.
To that end, we note our call does not hinge on Gigafactory timing, nor Model III pricing/volume expectations for 2020 and beyond. We are focused on the Model S and X alone. We are simply more optimistic of Tesla’s success as a “slightly bigger than niche” global luxury auto manufacturer, and like the head start management has carved out for the brand.
(from Stifel Nicolaus Analyst James Albertine)
by Ben Claremon | Research Analyst
As long term-focused investors, we have a certain disdain for the quarterly earnings rigmarole and the associated maniacal focus on “beating” what are somewhat irrelevant earnings per share estimates. The truth of the matter is that, more often than not, what happens during an arbitrary 90 day period has very little bearing on the long-term opportunity for a company or on its intrinsic value. As such, the huge price moves—both up and down—that occur as a result of singular quarterly earnings reports are always somewhat amazing (and sometimes amusing if we don’t own the stock) to us. The most unfortunate outcome of this focus on the short run performance is that certain management teams succumb to the pressure they receive from certain members of the investment community. In doing so, they risk managing the business to achieve near term results and thus not thinking enough about what they want the company to look like in five years. In a perverse way, the desire to meet probability expectations on a quarterly basis and avoid a potential drop in the stock price actually can impair the value of the franchise if the management team is too focused on this month’s margins as opposed to investing for the future.
Given all of that, it was very refreshing to read Jamie Dimon’s comments on JP Morgan’s Q2 earnings call. After being barraged with questions from the sell side community regarding millions of details that likely had no bearing on the value of the company, Dimon responded with the following (emphasis added):
No. No, look, I can’t overemphasize this. We do not run the company for quarterly profits. We make long-term decisions on people, systems, technology, products, services, stuff like that. And a lot of things drive short-term profits, but the profit you have at any one quarter relates to the decisions you made for the last 5 years, and so we feel great about these companies. The big weak spot, which we all acknowledge, is mortgage, and we’re going to put the — we’ve got great people there. We’re going to put elbow to the metal there. We’re going to invest some more money in their systems. We’ve got some catch-up to do. We got caught in the middle of, as you know, WaMu, Bear Sterns, origination platforms. But usually, if you look at these businesses, they’re all doing fine, and we’re looking at how we can grow them over the next 5 to 10 years. And that’s what we’re going to do, and I honestly mean it. I don’t care whether FICC is up 10% or 15% or down 10% or 15% in the next quarter. I think — I actually think that this is a complete waste of time.
Channeling our inner Charlie Munger: we have nothing to add.
CLICK HERE to download Cove Street Capital’s July 2014 Strategy Letter Number 17, “Hockey is Nothing Like Investing”