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					                                        Graham & Doddsville
                             An investment newsletter from the students of Columbia Business School

                             Issue XVII                                                                                  Winter 2013
Inside this issue:
Graham & Dodd
Breakfast     P. 3           JANA Partners —
JANA Partners        P. 4
                              Collaboratively Frank Martin
                              Unlocking Value      —
Daniel Krueger       P. 14                     Winning by
                                               Not Losing
Frank Martin         P. 28
                                                                                                                Frank Martin
Russell Glass        P. 42                                                Frank Martin is the founder and owner of Martin Capital
                                                                          Management, an investment partnership based out of Elkhart,
Jon Friedland        P. 50                                                Indiana. He is the author of two books on investing,
                                                                          Speculative Contagion (2005) and A Decade of Delusions (2011).
                                                                                                                           (Continued on page 28)
                             Barry Rosenstein        Scott Ostfeld

                             Founded in 2001, JANA Part-
                             ners is a value-oriented in-
Editors                      vestment advisor specializing                                                     Russell Glass
Jay Hedstrom, CFA            in event-driven investing.
                             G&D sat down with two of
                                                                                                                     —
MBA 2013                     the firm’s partners, Barry
                             Rosenstein and Scott Ostfeld
                                                                                                               Arbitrageur of
Jake Lubel
MBA 2013
                             ’02. Barry Rosenstein is the                                                          Value
                             founder and Managing Part-
                             ner of JANA Partners. Prior                             Russell Glass
Sachee Trivedi                                    (Continued on page 4)   Russell Glass is founder and managing partner of RDG Capital
MBA 2013                                                                  Management, a New York-based investment management
                                                                          firm that specializes in activist investing. Prior to RDG
Richard Hunt                                                              Capital, Mr. Glass served as President of Icahn Associates, the
MBA 2014                      Daniel Krueger                              investment firm of Carl Icahn. A passionate sports fan, Mr.
                                                                                                                           (Continued on page 42)
Stephen Lieu                  — “Uncertainty
MBA 2014                       is our friend”

Visit us at:
                                                                           Jon Friedland —
www.grahamanddodd.com                                                        Searching for
www.csima.org
                                                                             International
                                                                              Battleships
                                                                                                                    Jon Friedland
                                     Daniel Krueger
                                                                          Jon Friedland ’97 is the Director of International Research at
                             Daniel Krueger ’02 is a Man-                 Amici Capital (formerly named Porter Orlin). He is
                             aging Director and Partner                   responsible for sourcing and analyzing the firm’s international
                             at Owl Creek Asset Manage-                   long and short ideas. Prior to joining Amici in 2001, he
                             ment, a hedge fund in New                    worked at Zweig-Dimenna Associates, a New York-based
                                                (Continued on page 14)                                                    (Continued on page 50)
                 Page 2


                               Welcome to Graham & Doddsville
                               We are proud to bring you the        very attractive risk-return sce-   the coming years.
                               latest installment of Graham &       narios, as well as how he en-
                               Doddsville. This is the 17th edi-    courages his team, in their        Jon Friedland ’97 from
                               tion of Columbia Business            early work on a company, to        Amici Capital shared with us
                               School’s student-led investment      zero in on the key questions       the factors that make a com-
                               newsletter, co-sponsored by the      that need to be answered.          pany a ‘battleship’ company.
                               Heilbrunn Center for Graham &                                           He then conveyed the attrac-
                               Dodd Investing and the Colum-        Frank Martin from Martin           tiveness of searching for these
Pictured: Professor Bruce      bia Student Investment Manage-       Capital Management de-             companies in emerging mar-
Greenwald. The Heilbrunn       ment Association.                    scribed how he picks compa-        kets.
Center sponsors the Ap-                                             nies on a bottom-up basis, yet
plied Value Investing pro-     We were very fortunate to sit        spends much of his time thor-      This issue also contains pic-
gram, a rigorous academic      down with six well-respected         oughly studying the macroeco-      tures from the 22nd Annual
curriculum for particularly    and successful investors that        nomic environment. He also         Graham & Dodd Breakfast,
committed students that is     span the value investing spec-       explained his reasoning for        which took place on October 5
taught by some of the in-                                           having a conservatively posi-      at the Pierre Hotel in New
                               trum – they prove the old ad-
dustry’s best practitioners.                                        tioned portfolio today. Mr.        York. Investing luminaries
                               age, ‘there is more than one way
                               to skin a cat.’                      Martin goes into detail about      Tom Russo, Bill Ackman, Mario
                                                                    the behavioral aspects of in-      Gabelli, William von Mueffling,
                               Barry Rosenstein and Scott           vesting and what he does to        and others were on hand to
                               Ostfeld ’02 from JANA Part-          avoid traps to which many          mingle and listen to keynote
                               ners explained their process for     investors fall prey.               speaker Meryl Witmer from
                               constructively engaging manage-                                         Eagle Capital Partners.
                               ment in activist situations. They    Activist Russell Glass from
                               also talked about how their          RDG Capital made us very           We thank our featured inves-
                               entrepreneurial backgrounds          envious when he shared his         tors for sharing their time and
                               have helped shape their careers      unique business school and         insights with our readers.
                               and the way they look at compa-      early career experiences. Mr.      Please feel free to contact us if
                               nies.                                Glass thoroughly shared how        you have comments or ideas
                                                                    his firm has been able to profit   about the newsletter as we
                               Distressed expert Dan                handsomely by actively advo-       continue to refine this publica-
Pictured: Heilbrunn Center     Krueger ’02 from Owl Creek           cating for the sale of underval-   tion for future editions. We
Director Louisa Serene         Asset Management shared              ued companies. He also illumi-     hope you enjoy reading this
Schneider. Louisa skillfully   the intricacies of distressed debt   nated for us how the large         issue of Graham & Doddsville
leads the Heilbrunn Center,    investing that make it his favor-    amounts of cash in private         and find the interviews as infor-
cultivating strong relation-   ite hunting ground for ideas. He     equity and corporate hands         mative and thought-provoking
ships with some of the         also explained how the econom-       could lead to a robust mergers     in written form as we found
world’s most experienced       ics of averaging down create         and acquisitions environment in    them to be in person.
value investors and creating
numerous learning oppor-
tunities for students inter-
ested in value investing.      CSIMA Scholarship
The classes sponsored by
the Heilbrunn Center are
among the most heavily         The Columbia Student Investment Management Association (CSIMA) will be
demanded and highly rated      awarding its inaugural scholarship this spring with the proceeds from today’s
classes at Columbia Busi-      conference. Through this program, we will award a $10,000 scholarship to
ness School.
                               an incoming Columbia Business School student that exhibits an outstanding
                               aptitude and commitment to investment management. All incoming MBA
                               students in the Class of 2015 are eligible to apply and the recipient will be
                               chosen by a panel of CSIMA students.

                               We are excited to initiate this scholarship and look forward to making this
                               an annual tradition.
  Volume I,
 Issue XVII Issue 2                                                                               Page 3

       22nd Annual Graham & Dodd Breakfast, Oct 5, 2012 at Pierre Hotel




  Keynote Speaker – Meryl Witmer                   Bill Ackman     Mario Gabelli with William von Mueffling




Tom Russo in deep conversation with Sid and Helaine Lerner       Dean Hubbard thanks Ms. Witmer




           Prof. Greenwald makes a point                                 Engaged audience
                 “Bring a sharp pencil and leave your emotions at home!” – Meryl Witmer
         Page 4


                   JANA Partners
                   (Continued from page 1)           out of business school. The     answered the phone. I
                   to founding JANA Part-
                                                     interviews didn't go that       started talking as fast as I
                   ners, Mr. Rosenstein was
                   the founder and Managing          well for me, and there          could and he finally said,
                   Partner of Sagaponack             weren't big banking pro-        "Well, come on in." This
                   Partners, a private equity        grams like there are today.     led to me becoming Edel-
                   fund. Mr. Rosenstein re-          What did lead to a job was      man’s co-head of takeovers,
                   ceived his MBA from               cold-calling. The trick I       a job for which I really was-
                   Wharton and his B.S. from         used to get jobs coming out     n’t qualified.
                   Lehigh University. Scott          of business school was to
                   Ostfeld is a partner of           call people after 5:00 p.m.,    G&D: Can you tell us the
                   JANA Partners and is re-
                                                     when their secretaries had      story of how you actually
                   sponsible for special situa-
                   tions investments, includ-        left, so that the person I      got the job offer from Asher
                   ing active shareholder en-        really wanted to speak to       Edelman?
                   gagement. Prior to joining        would likely pick up the
Barry Rosenstein   JANA Partners, Mr. Ostfeld        phone themselves. In the        BR: Asher was the corpo-
                   was with GSC Partners in          case of my first job oppor-     rate raider back then, and I
                   its distressed debt private       tunity, I cold-called a Whar-   was a nobody associate at
                   equity group. Mr. Ostfeld         ton alumnus at a boutique       Merrill Lynch; no one there
                   received his MBA from             firm called Warburg,            even knew who I was. He
                   Columbia Business School,
                                                     Becker, Paribas. Unfortu-       started by telling me that
                   his J.D. from Columbia Law
                   School, and a B.A. from           nately, the first week on the   he'd been talking to the
                   Columbia University.              job, the firm was sold to       heads of the M&A depart-
                                                     Merrill Lynch and I was         ments at various investment
                   G&D: Can you tell us              again without a job. That       banks about coming to
                   about your background and         was the start of my career.     work for him to co-head his
                   how you became interested         Fortunately, Merrill called     takeover business. I didn’t
                   in investing?                     me about a week later and       understand why he was tell-
                                                     told me I could interview       ing me this as it had nothing
                   Barry Rosenstein (BR): I          for a job with them and,        to do with me. After about
                   wasn't one of these people        apparently, they needed         15 minutes, he turned to me
                   who invested when I was           bodies so they hired me. I      and said, "I think you and I
                   nine years old. I was good        worked in banking for about     are going to do a deal here."
                   at math and I was interested      two and a half years but I      I had no idea what he
                   in business. Frankly, I didn't    frankly didn't like it that     meant. Then he asked,
                   really know much about            much.                           "What's it going to take to
                   Wall Street at all but as I                                       get you to take this job?"
                   read more about the busi-         Back in the mid-80s, corpo-     At the time, I was making a
                   ness world when I was in          rate raiders were beginning     salary of $40,000 and hoping
                   college, it became clear to       to make themselves known,       for a $30,000 bonus, but my
                   me that I should go back to       and I would excitedly read      reviews were not strong so
 Scott Ostfeld     business school. I did so at      about their exploits at the     I didn't have high hopes. I
                   Wharton. There seems to           time. That was an interest-     had heard that the top mer-
                   be a hot industry anytime         ing world to me, so the         chant acquisition bankers
                   that you are in graduate          question was how to get         made $1 million, which was
                   school. When I graduated          into that field? I once again   more money than I had ever
                   from Wharton in 1984, in-         tried the cold-call technique   heard of in my life. So I said
                   vestment banking was the          (I don’t remember how I         to him, “one million dol-
                   hot field, so that's where I      found his number) to speak      lars." He stared at me for
                   focused my efforts.               to one of the main raiders      30 or 45 seconds, which is a
                                                     of the time – a guy named       long time when you're com-
                   I actually didn't have a lot of   Asher Edelman – and             pletely full of crap. Then he
                   luck getting a job coming         wouldn't you know it, he                      (Continued on page 5)
 Volume I,
Issue XVII Issue 2                                                                                          Page 5


JANA Partners
(Continued from page 4)             jaw hit the floor.                Asher. I learned technical
said, "Alright, done. You           G&D: Clearly you had a            balance sheet analysis and
just have to start tomor-           lot to learn essentially start-   business analysis more
row," to which I responded,         ing from scratch. What are        through working on situa-
"I'll start right now. I'll sleep   some of the things that           tions, talking to bankers,
here tonight if you want."          stand out in your mind that       and talking to some of the
That's how I became co-             you learned during that pe-       other people who were
head of takeovers for Asher         riod working for Asher that       working at the firm. But
Edelman. I wasn’t prepared          shaped the way you run the        from Asher, I probably
for the position when I                                               learned more important
started, so I had to figure                                           skills. These had more to
out the responsibilities of                                           do with taking risks while
the role as I went along.                                             not blinking and remaining
This made for a uniquely                                              fearless. I give him a lot of
amazing experience.                    “But from Asher                credit. He wasn't the most
                                                                      technically savvy guy, but he
G&D: How old were you                     [Edelman], I                had great instincts and he
then?                                                                 never showed fear, even if
                                       probably learned               he felt it at times. That was
BR: I was 27.                                                         an important lesson.
                                        more important
G&D: That was quite a                  skills. These had              G&D: Mr. Ostfeld, can you
career advancement at that                                            walk our readers through
age!                                   more to do with                your unique background?
                                                                      How has this background
BR: I'll add a funny post-             taking risks while             impacted your investment
script to it, as well. The                                            style?
very first deal I was working          not blinking and
on, we were trying to take                                            Scott Ostfeld (SO): I was
over a supermarket chain
                                      remaining fearless.
                                                                      an Art History major when I
called Lucky Stores and sure          I give him a lot of             was in undergraduate school
enough, Edelman had ap-                                               at Columbia, so that didn’t
proached Merrill Lynch for              credit… he had                necessarily portend a career
the takeover financing.                                               in finance. I started two
About a week into my job              great instincts and             businesses in college. I
as co-head of takeovers,                                              started a menu business
Merrill’s senior M&A team              he never showed                where the restaurants
came in to our office to talk                                         around Columbia paid me
to us about the financing. I         fear, even if he felt
                                                                      to put their menus into a
noticed the Merrill people             it at times. That              menu book that I distrib-
looking at me as they were                                            uted to students for free.
probably thinking, “What's            was an important                This was just before the
he doing here? I didn’t know                                          Internet had taken off,
he was assigned to the                       lesson.”                 which certainly would have
deal.” I was so insignificant                                         put me out of business. I
at Merrill Lynch that nobody                                          also started an event plan-
even knew I had left. So                                              ning business. One of the
Asher gave his 30-second                                              problems back then as a
introduction and then said,         firm today?                       Columbia undergraduate
"My co-head of takeovers,                                             student was that there was
Barry here, is going to take        BR: I didn't really learn         no central place to congre-
you through the financing           anything technical from                         (Continued on page 6)
we're looking for." Every
Page 6


         JANA Partners
         (Continued from page 5)          During my time in business       tender offer to try and buy
         gate at night – you may have     school and law school, I         a public company called
         seen somebody on campus,         spent a summer at Wachtell       Justin Industries, which was
         but you never saw them at        Lipton, which today happens      the largest manufacturer of
         night. So I started initiating   to be on the other side of       cowboy boots and bricks in
         events at different venues       our firm in activist situa-      the country. I never ac-
         for Columbia students,           tions. That was an interest-     quired control of the com-
         where I was paid to bring        ing experience that helped       pany, however. [Editor’s
         students. It grew to the         frame the debate on share-       Note: This Company was later
         point where I was organiz-       holder versus board and          acquired by Berkshire Hatha-
         ing events for Tahari and        management power. After          way in 2000.] It was an in-
         Lacoste in New York and          graduation, I went into in-      teresting experience being
         even Miami. Toward the           vestment banking, where I        the person on the firing line,
         end of my time as an under-      focused on helping compa-        as opposed to somebody's
         graduate, I applied to the       nies unlock value. From          right-hand man. It was also
         law school thinking I wanted     there, I moved into dis-         interesting trying to go after
         to be a lawyer, though not       tressed private equity. That     the oldest company in the
         necessarily understanding        was basically investing in the   state of Texas.
         what that meant. I also had      context of a legal process to
         an entrepreneurial orienta-      gain control of a company        I also became involved in
         tion, so on a whim I said,       and improve value as an          the cellular industry. I was
         “Maybe I should go to busi-      equity owner, which was          invited by a group of gentle-
         ness school as well.” I was      again leveraging many of my      men to form a partnership
         lucky because the business       skills and experiences. I then   that submitted applications
         school typically doesn’t ad-     moved to activism when I         for all of the remaining rural
         mit candidates with no real      joined JANA Partners about       cellular licenses in the U.S.
         work experience.                 seven years ago, which puts      that had not yet been
                                          all of my experiences to         awarded. The FCC didn't
         The foundation of entrepre-      work evaluating companies        hold auctions at that time –
         neurial experience, law          with an owner orientation        they just held a lottery – so
         school, and business school      to figure out how to unlock      all one had to do was apply.
         has helped me as an activist     value.                           We invested a relatively
         investor. Entrepreneurial                                         small amount of capital to
         experience gave me an            G&D: Mr. Rosenstein, you         meet the legal fees associ-
         ‘owner orientation’ that is      were involved in many en-        ated with applying and we
         very helpful in thinking         trepreneurial situations be-     then applied to every loca-
         about how to create value        fore you founded JANA –          tion in the country. We
         at companies. Business           will you talk about a few of     figured we had a one in
         school and law school gave       them?                            three chance of winning one
         me many of the foundational                                       of them. It was like playing
         tools to be a competent          BR: My career is not very        the lottery but with much
         analyst. Believe it or not, I    conventional. I didn't grow      better odds. In fact, we
         had never even used Excel        up in the hedge fund busi-       won Mississippi and the
         before I attended business       ness and work for a bunch        Poconos and, after building
         school. Courses like Ad-         of people and then decide        the necessary systems, sold
         vanced Corporate Finance,        to start my own firm. I was      them for a terrific return.
         Corporate Restructuring          kind of a serial entrepre-
         and Corporate Tax gave me        neur. Some things worked         I then moved to San Fran-
         a great foundation for ana-      and some things didn't           cisco at the end of 1991.
         lyzing companies and think-      work. When I left Asher, I       Remember that this was
         ing about ways to unlock         did two things. First, I went    back when New York was
         value.                           off on my own and I made a                     (Continued on page 7)
 Volume I,
Issue XVII Issue 2                                                                                                      Page 7


JANA Partners
(Continued from page 6)          and use them again and           was an incentive to get bet-
going through extremely          other people buy them for        ter pricing. He had all kinds
difficult times – the home-      the parts.                       of ideas that no one in his
less problem was out of                                           industry had done to date. I
control, Wall Street was         I became curious about auto      returned to my office in the
completely dead, and there       salvage after someone had        city and tried to scrape to-
was nothing to do. In the        mentioned that it could be       gether the $7 million to
meantime, I met some peo-        attractive. So I started call-   back him. I remember eve-             Pictured: Mario Gabelli at
ple in San Francisco who         ing one participant in the       rybody telling me that I was          Omaha Dinner in May 2012.
asked me if I wanted to join     industry after another, each     crazy being in this industry
them to start a new invest-      more unsavory than the last.     and backing this person.
ment and merchant banking        I finally met a guy named        But I just saw something in
business. Not having any-        Willis Johnson who had a         him. I was able to back him
thing else to do, I decided      little company called Co-        and he turned out to be one
to give it a try for a year or   part. At the time, Copart        in a million. He bought a
two and then return to           had one location in Califor-     number of companies, inte-
New York. I ultimately           nia, generated $8 million in     grated them very well, and
stayed in San Francisco for      revenue, and offered neither     started to build a real com-
16 years! After about five       audited financials nor GAAP      pany. Copart went public a
years of helping build that      accounting. Copart was           little over a year after my
successful little boutique       basically a dirt lot with a      investment. Today, it's a $4
business, I left to start my     barbwire fence and dogs          billion market cap company
own firm.                        running around. The head-        and it has hundreds of loca-
                                 quarters building was a tem-     tions all around the world.
G&D: Towards the end of          porary corrugated metal          Their business has shifted to
your time in San Francisco,      building, and Johnson frac-      the internet now, of course,
you made an investment in        tured the English language       and today it's the biggest
Copart, the salvage vehicle      regularly. The only thing        online seller of automobiles
auction company. Could           that I could think of, as I      in the world.
you tell us about this busi-     was trudging around in the
ness and your thesis at the      mud with the CEO, was            G&D: What inspired you
time?                            that I can't believe my ca-      to found JANA Partners and
                                 reer has fallen this far, this   to include a distinct activist
BR: That’s right. Near the       rapidly. Nevertheless, I         investing approach within
end of my time on the west       probably spent four hours        part of your business?
coast, I did a deal which was    with Johnson. I remember
something of a life changer      calling my wife on the phone     BR: So I made some
for me in certain ways. Yet      on the way back to San           money on my various ven-
again, I cold-called someone     Francisco and saying, "You       tures and that provided a
– this time it was a partici-    know, I think I just met the     springboard for me to start
pant in the auto salvage in-     smartest guy I have ever         my own private equity firm
dustry. Auto salvage is a        met in business."                in 1997. I ran that for about
fragmented industry that                                          three years and produced
runs an auction on behalf of     Willis Johnson was a self-       very average results for my
insurance companies for          taught, self-made business-      investors. It was a very
permanently damaged vehi-        man. He had a vision for         difficult time for the private
cles. This is the company        creating a national company      equity market and I was just
that the insurance company       and signing national con-        happy that the investors
calls and says, "Go pick up      tracts. He also believed he      were returned their princi-
the car for us, turn it into a   had a way of sharing the         pal plus a small return. But I
salvage vehicle, run an auc-     proceeds with the insurance      really didn't like the busi-
tion, and sell it." Some peo-    companies so that there                        (Continued on page 8)
ple buy the cars to fix them
                Page 8


                             JANA Partners
                             (Continued from page 7)           through 2008 and a big
                             ness. I felt like I couldn't be   downturn, with assets under        G&D: Does your activist
                             entrepreneurial – if we won       management falling a lot. I        approach stem from the fact
                             a deal, it was because we         restructured the whole firm        that you have a sense of
                             had offered to pay more           over the last couple of years      what good businesses are
                             than everybody else. It was                                          and how a business should
                             right around 2000 when I                                             be managed to get to the
Pictured: Louisa Schneider   decided to not raise another       “I think we’re ‘right-            private market value? Is
and Glenn Hubbard at Gra-    fund.                                                                that how you convince the
ham & Dodd Breakfast in                                           term’ because we
                                                                                                  management to unlock the
October 2012.                I instead saw an opportunity         try to consider all             value?
                             in the public markets to
                             close what I saw as a gap                  available                 BR: Right. Nobody was
                             between the price at which                                           really doing that when we
                             public companies were trad-           information and                started. There were a lot of
                             ing and what I felt their ulti-                                      companies that were value
                             mate private market values              construct the                traps. They either needed
                             were worth. So not know-                                             to restructure, sell off
                             ing anything about how a           optimal plan for the
                                                                                                  money-losing businesses,
                             hedge fund works, I set up a                                         spin off an unrelated busi-
                                                                company under the
                             hedge fund.                                                          ness, or they just didn't be-
                                                                 circumstances that               long independent and
                             I remember when I was                                                needed to be sold. My ini-
                             trying to raise money, trav-            are known or                 tial impetus was to try and
                             eling to various institutions                                        force that kind of change.
                             and talking about being an             knowable and
                             activist. People would say,                                          G&D: Many value inves-
                             “That's not a strategy; you'll      predictable over a
                                                                                                  tors talk about having a long
                             never raise money; nobody                                            -term approach, but at
                                                                 reasonable period
                             does that; forget it.” Things                                        JANA you have a medium-
                             have really changed. My                of time to best               term time frame. Why is
                             very first investor was Lee                                          this the right time frame?
                             Cooperman [Editor’s Note:                position the
                             Cooperman was featured in                                            SO: I wouldn’t even call it
                             Issue 13 of Graham &                    company for                  medium-term; I’d call it
                             Doddsville], who had been a                                          ‘right-term’. I think we’re
                             close friend for many, many           success. I think
                                                                                                  ‘right-term’ because we try
                             years and someone I viewed                                           to consider all available in-
                                                                that’s the right time
                             as a mentor. He largely                                              formation and construct the
                             understood the idea and            frame, frankly, for a             optimal plan for the com-
                             believed in what I was trying                                        pany under the circum-
                             to do. He backed me when                 board to be                 stances that are known or
                             nobody else really would.                                            knowable and predictable
                                                                    evaluating the                over a reasonable period of
                             I started with $17 million                                           time to best position the
                             and no expectations beyond          opportunity set for
                                                                                                  company for success. I
                             that. Before I knew it, the                                          think that’s the right time
                                                                    the company.”
                             business grew and by 2007,                                           frame, frankly, for a board
                             we had over $8 billion un-        and we are back flying again.      to be evaluating the oppor-
                             der management. We gen-           Other than probably 2008           tunity set for the company.
                             erated a pretty strong track      and a year or two after that,      So I think our horizon maps
                             record over this period of        it's actually been a lot of fun.                 (Continued on page 9)
                             time, as well. Then I lived
 Volume I,
Issue XVII Issue 2                                                                                      Page 9


JANA Partners
(Continued from page 8)           the last 10 years, but it's     you'll be pushed as far as
appropriately with the            never come down to a            you're willing to go and then
board’s horizon.                  proxy vote and you’ve           you have nothing. Nobody
G&D: How much overlap             never been very vocal about     ever questions whether
is there between JANA’s           your position. How do you       we're prepared to go all the
passive efforts (that is, non-                                    way. We are very careful
activist ideas in this context)                                   about how we prosecute
versus its activist efforts?        “Basically, we have to
                                                                  activism. We've never had
                                    be comfortable buying         one actually go to a final
SO: We are one team, one                                          vote because management
portfolio, all on one floor,        in at a valuation that
                                                                  comes to the realization
all interacting on a regular          provides us with a          that there's no point going
basis. So there is a constant                                     to a final vote because
flow of ideas from passive             margin of safety,
                                                                  they're going to lose.
to active, and frankly, many          irrespective of any
of us can’t separate our                                          The reasons are twofold:
brain and say, “This one’s             activism we will
                                                                  one is our approach and the
clearly active, this one’s         attempt to initiate and        other is our structure. In
passive.” Frequently posi-                                        our approach, we're ex-
tions fall in the middle. But            that may be
                                                                  tremely disciplined. I don't
my primary focus is on the         unsuccessful. We have          want to be only an activist
activist side, and that’s what                                    because then you force
I’m paying attention to 90%        to be comfortable that
                                                                  things and the quality of
of the time.                        if it really came down        your ideas is diluted. We
                                                                  don't ever have to be an
G&D: Does your activist            to a vote that we would
                                                                  activist here. We can just
style impact your portfolio            have shareholder           invest in event-driven situa-
construction – meaning,                                           tions. For something to be
does the fact that you are         support. And variety of
                                                                  an activist play, all of the
often the catalyst enable          ways to win – you want         criteria have to be present
you to be more concen-                                            for us. We came up with
trated than you would oth-            to make sure that
                                                                  this rubric we call V-cubed,
erwise feel comfortable             there's more than one         which is Value, Votes, and
being?                                                            Variety of ways to win.
                                     lever you can pull in
                                                                  Basically, we have to be
SO: Yes. Our highest con-             case circumstances          comfortable buying in at a
viction ideas are the ideas                                       valuation that provides us
where we have the most                  change. In my
                                                                  with a margin of safety, irre-
impact on the outcome.             experience, if you have        spective of any activism we
Those are our activist ideas                                      will attempt to initiate and
which tend to be our largest           all three of those
                                                                  that may be unsuccessful.
and highest returning posi-           checked off, you're         We have to be comfortable
tions in the portfolio.                                           that if it really came down
You’re also, frankly, doing a        guaranteed victory.”
                                                                  to a vote that we would
lot of work on these posi-                                        have shareholder support.
tions, so you want to bene-       engage management? What         And variety of ways to win
fit from that work by mak-        makes the strategy possible?    – you want to make sure
ing it a large position. So                                       that there's more than one
our portfolio can be a bit        BR: Well for the first part     lever you can pull in case
more concentrated.                of that, I would say you have   circumstances change. In
                                  to be prepared to go all the    my experience, if you have
G&D: You've been an ac-           way because if you're not,                   (Continued on page 10)
tivist in many companies in
Page 10


          JANA Partners
          (Continued from page 9)           are.                           reputation we are able to
          all three of those checked                                       attract very accomplished,
          off, you're guaranteed vic-       SO: When we become             experienced, and successful
          tory. If you're missing one       involved in situations, we     value creators who get a
          of them, there's a good           typically are working with     very good reception when
          chance you're going to lose.      industry operators who are     we do bring them to com-
          We're extremely judicious.        helping us carefully analyze   panies or run them for
                                            the situation and are on       slates. For example, when
          In terms of our approach, I                                      we were involved in CNET
          have no ego with respect to                                      in 2008, we ran a slate of
          these activist pursuits. I                                       directors to help turn the
          don't need to claim victory                                      company around. We had
          or get credit. I try to work                                     very qualified people like
          behind the scenes. I tell                                        John Miller, who had run
          every one of these CEOs                                          AOL, and Julius Gena-
          that they can be the hero,           “In terms of our
                                                                           chowski, who only months
          and we'll be their biggest                                       after being on our slate was
                                            approach, I have no
          advocate, if they do what                                        nominated by President
          we want them to do. In-            ego with respect to           Obama to be chairman of
          stead of going on TV and                                         the FCC. As with CNET,
          forcing people or embar-                 these activist          when we do run a slate, it’s
          rassing people, I find it much                                   designed and tailored to
          more effective when I give           pursuits. I don't           address the very specific
          them a chance and I treat                                        need at the company.
          them with respect. We can                need to claim
          go hard at somebody if we                                        G&D: How do you go
                                            victory or get credit.
          have to, but in my experi-                                       about finding your activist
          ence you convince people           I try to work behind          targets? Do you screen for
          to go along with you a lot                                       companies through valua-
          more successfully if you             the scenes. I tell          tion screens or do you gen-
          treat them the right way.                                        erally find your ideas
                                              every one of these           through other means?
          G&D: How is JANA Part-
          ners structured to conduct         CEOs that they can
                                                                           SO: A friend who works at
          activist investing?                                              another activist firm aptly
                                               be the hero, and
                                                                           described it: it’s a bit like
          BR: We run our activism                  we'll be their          panning for gold. You need
          activities like a machine. It's                                  a lot of throughput to find
          what these guys do every           biggest advocate, if          that gold nugget. I can’t say
          day, all day long. We also                                       we ever know where our
          bring in industry partners in        they do what we             next idea is going to come
          all of these situations; so                                      from, but looking for activist
          we're not just financial guys.      want them to do.”
                                                                           ideas is very similar to how
          We bring in industry opera-                                      you would look for tradi-
          tors who have greater ex-                                        tional investment opportuni-
          pertise and track records                                        ties in public equities.
          than existing management                                         There’s screening, reading
          teams, so it's very hard for                                     research reports, talking to
          the management teams to           standby to become board        industry operators, talking
          argue against us when             members if necessary.          to companies about their
          they're arguing against peo-      Given our successful track     competitors, and bench-
          ple who are better thought        record and collaborative                    (Continued on page 11)
          of in the industry than they
 Volume I,
Issue XVII Issue 2                                                                                                  Page 11


JANA Partners
(Continued from page 10)         sue us or put a poison pill in
marking peers. Ideas can         place. We don't get any of       G&D: What, in your opin-
come from other sharehold-       that anymore, because the        ion, is a driving motivation
ers calling and from follow-     companies have come to           behind the subset of corpo-
ing events that create op-       realize that all they're doing   rate America management
portunities such as an an-       is alienating their own          teams that have a penchant
nounced acquisition that         shareholder base and it's        for limiting or destroying
doesn’t make sense for           counterproductive. We            value for shareholders? Is it         “...we don't face the
shareholders.                    hire the same bankers and        related to self-preservation?
                                                                                                         kind of fights that
                                 lawyers all the time and we      Empire building? Disen-
G&D: Mr. Rosenstein, you         know what they tell man-         gaged boards?
said that last year was the
                                                                                                          we used to face.
                                 agement teams, at least in
strongest environment for        our case. They tell them,        SO: It’s very difficult to             Ten years ago, I'd
activist investors that you      “You can't ignore JANA.          answer because it runs the
had seen in your career.         They do their homework,          spectrum. You sometimes               show up in front of
Do you think that's still the    they come up with good           have companies with good
case, and why is this?           ideas, they're really tough,     operators who think they’re             a company and
                                 they're not going to go          doing things that make
BR: I do. I think there are                                                                              they would sue us
                                 away, and you're better off      sense for shareholders, but
a couple of reasons for this.    just trying to work things       they may not be as experi-            or put a poison pill
In terms of opportunity set,     out with them.” I think          enced navigating the capital
there are a lot of companies     those two broad dynamics         markets or as thoughtful              in place. We don't
that are undervalued. I find     continue to create a great       about ways to increase the
stocks at very reasonable        environment for what we          value of a stock. You also              get any of that
prices. I think that you still   do.                              have situations where CEOs
have a dynamic today that                                         or boards are not prioritiz-           anymore, because
exists where a lot of compa-     G&D: Has the recent in-          ing the right things. Some
nies are worth a lot more                                                                               the companies have
                                 crease in funds with activist    may be interested in grow-
than where they’re trading       strategies made it any           ing at the expense of                 come to realize that
and where they would trade       tougher for you to find your     unlocking value. Other
as private companies. I also     ideas?                           times you get people in                all they're doing is
think balance sheets are                                          situations that are not com-
very healthy with lots of        SO: There really aren’t          petent enough to execute              alienating their own
cash. You have financing         that many activists, and         the appropriate strategy to
rates that are very low.         there certainly aren’t that      maximize value.                        shareholder base
You also have the dynamic        many activists with a 12-
where companies and man-                                                                                       and it's
                                 year track record of col-        BR: A big part of the prob-
agements are having diffi-       laboratively unlocking value     lem is that the incentives
culty generating internal
                                                                                                        counterproductive.”
                                 the way that we have.            are all wrong. If these were
growth and so they're as         There are also not that          family businesses and they
open to value creating ideas     many activists that focus on     owned all the stock, they
as they have ever been.          the market cap size that we      probably wouldn't be mak-
That's from an opportunity       have participated in ($10-       ing a lot of the decisions
set standpoint.                  $20 billion), particularly in    that they're making. But
                                 the past two years. It is        they own very little stock
Then, if you think about the     actually much less competi-      and most of the stock they
environment for activism         tive today than it was prior     own has been given to them
and the market's perception      to the financial crisis when     or is in the form of options.
of activism, we don't face       everybody was an activist        Their current compensation
the kind of fights that we       investor. Yet the opportu-       is probably more valuable
used to face. Ten years ago,     nity set today is very attrac-   and important to them. As
I'd show up in front of a        tive for activism.                            (Continued on page 12)
company and they would
            Page 12


                        JANA Partners
                        (Continued from page 11)         tions where assets are held       back stock ahead of all that.
                        a result, the incentive is to    in inefficient structures, ei-    If an activist is pillaging a
                        run a bigger and bigger          ther because there is a           business for some kind of
                        company. The bigger the          more appropriate structure        short-term gain, then that’s
 “If you went back      company you run, the more        to own it in like an MLP, or      problematic, but if they are
 and looked at the      you can justify higher com-      you’re combining assets that      advocating steps that make
                        pensation levels and it          don’t make sense together.        the stock more valuable,
  activist situations   makes you feel like a big        I think it’s actually a coinci-   then they are doing exactly
                        shot in town. The incen-         dence that we’ve had a few        what the board and manage-
we’ve been involved     tives are all perverse. I        in a row that have been           ment are supposed to do. If
 in, and you were to    think ultimately when you        more spin-off focused. If         an activist were harming a
                        start to point out irrefutable   you went back and looked          company’s future prospects
categorize them, they   facts and you get share-         at the activist situations        every time they showed up
                        holder support they see          we’ve been involved in, and       at a company, they would
 are actually fairly
                        your point. I would say in       you were to categorize            not be successful winning
  balanced among        most cases, management is        them, they are actually fairly    over shareholders who may
                        trying to do the right thing,    balanced among capital allo-      end up owning the stock
 capital allocation,    but they're either blinded or    cation, capital return, block-    after the activist has sold
                        they are not necessarily         ing M&A deals, separations        and moved on.
   capital return,
                        always looking to maximize       or divestitures, buybacks,
blocking M&A deals,     value. They're just going        sales of companies, and op-       G&D: Is there any mistake
                        about their business every       erational turnarounds. The        from your career that might
   separations or       day and they're lost in the      common thread is that we          stand out or something that
     divestitures,      forest a little bit. But you     advocated steps that best         you really learned from
                        also have some people who        positioned the companies to       them that sticks with you
 buybacks, sales of     are just not thinking about      create value.                     today?
                        things the right way and are
  companies, and        thinking about themselves        G&D: One oft-heard criti-         BR: I’ve made so many
     operational        and not the shareholders.        cism of activist investors is     mistakes I can't even think
                        They may protest and say         that you are simply ‘pulling      about it. I'll give you one
 turnarounds. The       that's not the case but it is.   value forward’ and harming        thing that's not an investing
                        It's not until someone like      a company’s future pros-          concept, but something that
 common thread is       us shows up and they feel        pects. How would you re-          I've come to realize that
 that we advocated      threatened that they actually    spond to this characteriza-       might be helpful. Being po-
                        move. The proof is in the        tion?                             lite to people and treating
   steps that best      returns we generate. In                                            people with respect is good
                        virtually every situation, the   SO: As long as you’re do-         business. It's not just a
   positioned the       stocks have reacted ex-          ing something that doesn’t        good thing to do, it actually
companies to create     tremely positively and not       harm the value of the com-        inures to your benefit as
                        just short-term bumps, but       pany, accelerating the bene-      well. If you're a jerk to
       value.”          companies have been              fits to shareholders is ex-       somebody, they remember.
                        rerated. All of a sudden         actly what creating value is      They may never get the
                        companies go from being          all about. The best exam-         opportunity to pay you
                        value destroyers to value        ple, of course, is buying back    back, but if they do, they
                        creators.                        stock. If you have a great        surely will. I've had more
                                                         long-term story and a value-      instances where I've inter-
                        G&D: Recently, JANA has          creating plan ahead of you,       acted with somebody I don't
                        pushed for spin-offs in sev-     why would you wait and buy        even remember, perhaps 10
                        eral companies. Is that sim-     back stock after the market       years prior and this person
                        ply a coincidence, or do you     fully reflects the value?         shows up working for a
                        prefer to deal in spin-offs?     From a capital allocation         potential investor or is in-
                                                         standpoint, you want to buy                    (Continued on page 13)
                        SO: We like to find situa-
 Volume I,
Issue XVII Issue 2                                                                                                 Page 13


JANA Partners
(Continued from page 12)        hire people unless they have    some of these things. Just
volved with the company         significant work experience.    take chances, go for it, and
and they say, "You were         I don't necessarily care that   don't look down.
really good to me. You          they went to business
were really nice to me. I       school, but they've got to      SO: Investing is a lot
didn't forget that." And        have significant work ex-       harder than Columbia Busi-
they've invested with us or     perience at an investment       ness School. A hypothetical
they've helped us get a com-    bank and another hedge          'A' in the investing world,       Pictured: Bill Miller at CSIMA
pany to do something. To                                        the point at which you are        Conference in February 2012.
me there's no upside to                                         performing at the highest
treating people badly.                                          level, only requires being
                                                                right more than half the
SO: When I was working                                          time. The truth is investing
in investment banking, I had       “Being polite to
                                                                can be very frustrating, diffi-
this naïve and mistaken view    people and treating             cult, unpredictable, and gru-
that if you have a good idea                                    eling. So you should only
that a company should pur-       people with respect            pursue the career if you
sue, it will automatically be                                   have the passion, if you’re
adopted and pursued.               is good business.            intellectually curious, and if
Changing the status quo at a                                    you’re committed to it, be-
company isn’t easy and           It's not just a good           cause at every turn, you can
sometimes requires more                                         be very quickly humbled.
than just logic.                     thing to do, it
                                                                That’s the nature of the
                                  actually inures to            business.
G&D: Do you have any
advice for the readers who      your benefit as well.           G&D: Mr. Ostfeld, you
are keen to get into invest-                                    started with an entrepre-
ing or activist investing?        If you're a jerk to           neurial background and
                                                                ended up in a career in in-
BR: Go to places where             somebody, they               vesting. What advice would
you can learn. You can                                          you give students who are
learn from every experi-         remember. … To
                                                                interested in both investing
ence, but just provide your-                                    and being involved in an
                                     me there's no
self with the best opportuni-                                   operating business?
ties to work with people          upside to treating
who you think are smart                                         SO: If you learn how to
and who you respect.                people badly.”              invest and manage money
Maybe the world's changed                                       that’s portable to anything
and you can go right into                                       you want to do.
the hedge fund space today,
but I still think there's       fund or private equity fund,    G&D: Mr. Rosenstein and
something to be said for        and probably five plus years    Mr. Ostfeld, it’s been a
having more of a fundamen-      of experience before we'll      pleasure speaking with you.
tal background, getting         bring them in as an analyst
training at an investment       here. Don't be afraid to
bank or private equity firm,    make changes and jump. If I
and then moving into the        thought about the down-
principal side and the public   side, I wouldn't have done
markets. I think that's a       half the things that I did.
good way to access it. But      And after the fact, as I sit
again, maybe hedge funds        here, I think I must have
are hiring directly out of      been out of my mind to do
business school. We don't
       Page 14


                 Daniel Krueger
                 (Continued from page 1)          the debt was worth less         distressed. I really enjoyed
                 York that manages over $3
                                                  than face value and the eq-     the complexity, the way that
                 billion. He is Co-Portfolio
                 Manager of Owl Creek’s           uity was trading at option      different people had differ-
                 Flagship Funds and is the        value. I noticed that some      ent motivations, and that
                 firm’s Global Head of            representatives of a dis-       the power shifted from eq-
                 Credit. Prior to Owl             tressed hedge fund that         uity holders to creditors in
                 Creek, Mr. Krueger               owned the bank debt of one      such situations.
                 worked in distressed debt        of the companies were sit-
                 at Chase Securities and          ting silently in the back of    I eventually progressed to a
                 Angelo Gordon. Mr.               the room at every meeting       distressed analyst position
                 Krueger earned his A.B.
                                                                                  on the loan desk and then,
                 from Harvard College and
                 his MBA from Columbia                                            against the advice of my
Daniel Krueger   Business School.                                                 colleagues, decided to go to
                                                                                  business school. I went to
                                                    “It was very clear            Columbia Business School in
                 G&D: What was your in-
                 troduction to investing?           that the math had             2000. Right around that
                                                                                  time, the default rate had
                 DK: When I was graduat-           broken down, and it            started to ramp up. Every-
                 ing from college, I had no                                       body told me, “Krueger
                 idea what investment bank-         was because these             you're being an idiot. Why
                 ing was, but I knew that all                                     are you going back to busi-
                 of the smart kids were going
                                                      were distressed             ness school? You're picking
                 to New York to do it, so I                                       the exact wrong time to go.
                                                  companies where the             You're going to miss the
                 figured I would join them. I
                 came to New York and              debt was worth less            entire cycle.” I figured they
                 worked for five years at                                         may be right about that, but
                 Chase in investment banking       than face value and            I planned to be doing dis-
                 and private equity, as well as                                   tressed for a really long
                 on the distressed loan desk.         the equity was              time, not just for the next
                 As a junior analyst in the                                       few years. I thought the
                 healthcare group, I vividly
                                                     trading at option            tools I could gain in business
                 remember my boss and me                                          school outweighed not be-
                                                    value...it was very           ing able to work on a few
                 working on a proposed
                 M&A deal between two                 clear that [the             distressed credits over the
                 companies that had stock                                         next couple of years. Luck-
                 prices that were trading           creditors] were in            ily for me, they turned out
                 pretty close to zero. What                                       to be only partially right –
                 I had learned in analyst             charge, not the             although the default rate
                 training, and what had been                                      had moved materially higher
                 reinforced through that
                                                       stockholders.”             while I was in business
                 point in my career, was that                                     school, there was still a lot
                 the total enterprise value of                                    to work on when I got out,
                 a company is the sum of its                                      including Enron, Adelphia,
                 debt, plus the number of         and, even though they were      WorldCom, and others. I
                 shares times the market          creditors, it was very clear    started working at Owl
                 price of the shares, minus       that they were in charge,       Creek part-time during the
                 cash. But that math didn't       not the stockholders. As a      second semester of my sec-
                 really work in this situation.   junior analyst, a year out of   ond year at Columbia Busi-
                 It was very clear that the       college, I found that dynamic   ness School and stayed on
                 math had broken down, and        very interesting and very       full-time after graduating.
                 it was because these were        intellectually stimulating.     So I've been here for almost
                 distressed companies where       That gave me a taste for                     (Continued on page 15)
 Volume I,
Issue XVII Issue 2                                                                                                  Page 15


Daniel Krueger
(Continued from page 14)         ple of major distressed cy-       next 12 months – Greece
11 years.                        cles. I've certainly learned a    may do this, the Japanese
                                 lot from Jeff since I joined      Yen will do that, China may
G&D: How did you make            him and I've learned a lot        have a hard landing or a soft
the decision to join Owl         from being in this position.      landing – the liquidity of the
Creek, a start-up fund at the    I’m now a Co-PM of Owl            issuer, which we spent ex-
time?                            Creek’s Flagship and Credit       tensive time analyzing, is
                                 strategies and Global Head        almost entirely independent
DK: During the summer            of Credit.                        of those things. I know that
between my first and sec-                                          I don't need other investors
ond years of business
                                                                                                         “We take risk for a
                                 G&D: Could you share              in the market to pat me on
school, I worked at Angelo       some of the unique aspects        the back and say, "Good               living, all investors
Gordon, which was a leader       of distressed credit investing    job. That’s a smart invest-
in distressed debt investing.    that you particularly appre-      ment and now I want to                  do, and we are
I really liked my experience     ciate?                            make it too." The treasurer
at Angelo Gordon. Those                                            of that company will either            comfortable with
guys have mostly moved to        DK: I feel very fortunate to      wire us the money at ma-
different places now, but Jeff                                                                            that. What I like
                                 work in distressed debt,          turity or not. If they do,
Aronson and the other            especially in schizophrenic       then we know exactly what
members of the team are
                                                                                                         about the distressed
                                 markets like these where          our return profile will be –
some of the smartest guys        there is massive volatility all   the 20 points from 80 to              asset class, though,
I've ever been around. They      around the world. This is         100 plus the coupons.
weren't hiring full-time ana-    an event-driven investor’s        That's a huge asset to have           is that the risks we
lysts at the time, so they did   dream, and no style of value      in investing – these defined,
me a big service by intro-       investing is more event-          built-in events.                         are taking are
ducing me to other people        driven than distressed, in
like Jeff Altman, who is the                                                                                concentrated
                                 my opinion. I always ap-          We take risk for a living, all
Managing Partner of Owl          proach things with the same       investors do, and we are
Creek. When Jeff gave me
                                                                                                          around the things
                                 mindset asking myself:            comfortable with that.
an offer, it was really a no-    “What is it that I don't          What I like about the dis-             we are analyzing,
brainer because I was join-      know, and do I really know        tressed asset class, though,
ing somebody who already         any better than the next          is that the risks we are tak-            leaving fewer
had a tremendous pedigree        guy?” What I love about           ing are concentrated around
and background (from his         credit, and distressed in         the things we are analyzing,          unanalyzable risks
time at Franklin Mutual          particular, is that you have      leaving fewer unanalyzable
working with Michael Price),                                                                              to worry about.”
                                 built-in events that you can      risks to worry about. Your
who was a known money-           analyze. For example, here        results should, over time,
maker, and somebody from         at Owl Creek, most of our         more accurately reflect the
whom I would learn a lot. I      best investments are ones         quality of the work that you
was getting in at the ground     that we never need to sell.       do and the soundness of the
floor, so I looked at it and     We’ll buy loans or bonds          investment thesis, as op-
thought, “This is great, if it   and then get taken out for        posed to other big-picture
works it's going to really,      cash at maturity, or there        things that can make valua-
really work and I would          will be a liquidation.            tions move up and down
have been the first analyst      There’s an element of sepa-       every day.
that he hires. If it doesn't     ration from macro events.
work – I'm twenty some-          We may buy a bond at 80           G&D: Are you involved at
thing years old and single.      (meaning that the market          all in the equity side of
I'll go find another job.”       price equals 80% of the face      things?
Luckily for me, it did work      amount) that matures in a
and it's been a great ride       year, knowing that while the      DK: I will occasionally
over the past 11 years, dur-     market may move over the                       (Continued on page 16)
ing which we've seen a cou-
           Page 16


                       Daniel Krueger
                       (Continued from page 15)         for a security, which scenar-    well if they stick to their
                       work on equities. I head up      ios are more or less likely      discipline and don’t get car-
                       the credit side of the port-     to occur, and how much           ried away with the sea of
                       folio and my colleague, Jeff     money you can make or            noise that exists in the fi-
                       Lee, heads up the equity         lose in the different scenar-    nancial media.
                       side and we both report to       ios. Once you’ve estab-
                       Jeff Altman. But there have      lished a proper framework,       G&D: Could you talk a bit
                       been periods of time over        the answer jumps off the         about idea generation at
                       the past 11 years where          page, and it’s a matter of       Owl Creek?
    “If you use        there has been less to do in     deciding if the opportunity is
                       credit. Distressed is a cycli-   attractive enough to go into     DK: Ideas are generated by
intellectual honesty   cal business and you need to     the portfolio or not.            everyone, from Jeff Altman
                       know when to really press                                         at the top to the summer
     to ascribe        your bets and you need to        G&D: Do your analysts            analyst. We don't take a
  probabilities to     know when to walk away.          focus on specific sectors or     whole lot of pride in idea
                       The trick is that in those       are they generalists?            ownership here. We're
  different sets of    times when you are sup-                                           trying to make money with
                       posed to be loading the          DK: Most people here             the capital that we invest. If
 events, over time     boat, it usually makes you       start off as a generalist but    an analyst comes up with an
                       sick to your stomach to add      over time develop expertise      idea, they'll bounce it
  smart investors      risk, so it’s easier said than   in certain industries. In        around with the PMs and
                       done. But in those periods       terms of division of labor, it   other analysts, getting differ-
 should do well if     of time when we are doing        makes sense to have some-        ent people’s perspectives.
 they stick to their   less in credit, I might work     body who's already looked        As an example, one of our
                       on equities.                     at five media companies          analysts was a bankruptcy
discipline and don’t                                    look at the next one, if they    lawyer for a number of
                       The analyst team here is         can. On the other hand,          years before going to the
 get carried away      pretty fluid between credit      some of the most interest-       buy-side and his niche at
                       and equities. You don't          ing conversations we'll have     Owl Creek is to evaluate
  with the sea of      really notice a difference in    around here are the ones         the legal component of our
                       terms of the conversations       where we get a fresh set of      ideas – mostly on the credit
noise that exists in   around here, whether             eyes looking at an industry      side but occasionally on the
   the financial       you're talking about a credit    or company, which I think is     equity side as well. So you’ll
                       or a stock. It's all about:      what really separates good       usually have multiple people
      media.”          “What is causing the mis-        investors from average           chiming in on an idea. Our
                       pricing in the market price?     ones. We don't think that        belief is that the more peo-
                       What advantage do we             we're the smartest people        ple you have taking a look at
                       think we have in terms of        that work at hedge funds. If     something, the higher the
                       our view? How high is our        we’ve added a secret sauce       probability that you either
                       conviction level? What is        to our portfolio construc-       eliminate what is only a me-
                       our margin of safety for         tion, it has come through        diocre idea or recognize
                       being wrong?” The answers        our group dynamic, con-          when you’ve got something
                       to those questions help us       stantly reminding ourselves      pretty special. To us, that’s
                       decide whether an idea will      that we can be shocked by        just simple math. I hear
                       go into the portfolio or not,    things that were previously      some people at other places
                       and, if it does, what size it    unknown, and reminding           argue that if you open up
                       should be. The framework         each other to remain intel-      the discussion to too large
                       for analyzing risk/reward is,    lectually honest. If you use     of a group, then you make it
                       to us, identical no matter       intellectual honesty to as-      too hard to get ideas into
                       what type of security you’re     cribe probabilities to differ-   the portfolio, because it’s
                       looking at. Namely, you          ent sets of events, over time    easy for one or two people
                       need to understand the           smart investors should do                      (Continued on page 17)
                       range of possible outcomes
 Volume I,
Issue XVII Issue 2                                                                                                         Page 17


Daniel Krueger
(Continued from page 16)           if the price moves against        thought “Why did I buy in
to torpedo the sentiment.          us. If you think about it         the 30s?” Then it was in the
But I think that’s exactly the     mathematically, in a perfect      low teens and they thought,
point. There are thousands         world, if you're looking at a     “Wait a minute, what am I
of securities out there that       bond that's trading at 50         missing? I must not be get-
we can invest in today that        cents on the dollar and you       ting something.” Then the
are “pretty good,” but if          pass on it, if it moves to 49,    CDS [credit default swap]
that’s the burden required                                                                                  Pictured: Michael Karsch of
                                   it should be slightly more        auction (which occurs a                Karsch Capital Management
to get into your portfolio,        attractive now, assuming all      month after a default)                 at CSIMA Conference in
then what are you really           else is equal. And then at        priced the bonds around                February 2012.
doing to differentiate your-       48 it's even slightly more        nine. Granted, Lehman's a
self? You know when you            attractive, etc., etc. Eventu-    very bizarre animal because
have something special             ally it could get to a point      that was of course the big-
when four, five, or ten            where you think it's attrac-      gest bankruptcy of all time.
smart people can sit in a          tive enough to go into your       A huge amount of debt all of
room and agree that the            portfolio, and let's say that's   a sudden went from invest-
risk/reward is uniquely            at 43. Now, you couldn't          ment grade hands to looking
good, and I’m fortunate at         possibly want to make it a        for a home in the distressed
Owl Creek to be sur-               giant position at 43, other-      market, which was not
rounded by such people.            wise you should have              nearly large enough to ab-              “...a good investor
                                   bought some at 44 because         sorb that amount of paper.
G&D: When you’ve fully             the risk/reward isn't that        But that’s the point: a good                   needs to
analyzed something and             dramatically different. So        investor needs to under-
you’re comfortable that it’s       we'll usually dip our toe in      stand that the value of a              understand that the
still attractive, do you           to start and let the risk/        security is built from the
gradually build a position in      reward come to us.                bottom up, using good                   value of a security
the name or do you estab-                                            analysis, and that markets
lish the full position immedi-     Our best investments are          follow valuation. Not vice
                                                                                                               is built from the
ately?                             ones where we dip our toe         versa.                                   bottom up, using
                                   in at, to take the prior ex-
DK: As you can imagine,            ample, 43 cents on the dol-       G&D: Since it's more likely             good analysis, and
we pass on more than 90%           lar and a few days or weeks       that a judge or some other
of the things that we look         or months later it's trading      third party will get involved          that markets follow
at. If it does pass the initial    at 31. In distressed, that        in the distressed space rela-
smell test, analysts will          happens all the time. Bonds       tive to non-distressed credit          valuation. Not vice
come into my office if it’s on     can move up and down by           or equity investing, how do
the credit side or Jeff's office   10 points on headlines like       you get comfortable with
                                                                                                                     versa.”
if it's on the equity side, and    litigation outcomes, a            the risk/reward of your in-
we'll bounce the idea              busted financial covenant,        vestment ideas given this
around a little bit. If it con-    the sale of a business, or        additional layer of uncer-
tinues to look interesting,        something else significant,       tainty?
we'll usually get the whole        but sometimes the price can
investment team together           swing around on no news at        DK: That's a great ques-
to talk about it. The last         all. If the latter happens,       tion. You're teeing up an
component is to decide that        then you can load up the          answer that is very impor-
we’re ready to dip our toe         boat at the lower prices.         tant to get across in order
in. We very rarely will            Lehman Brothers is a great        to properly describe the
make something a full posi-        example of irrational price       opportunities in distressed
tion right off the bat. Usu-       moves – that bond started         investing. First of all, uncer-
ally what we prefer to do is       trading in the 30s the week       tainty, to us as distressed
make it a small- to medium-        that it filed, and then it was    investors, is our friend, be-
sized position but leave           in the 20s and people                           (Continued on page 18)
plenty of room to add to it
           Page 18


                       Daniel Krueger
                       (Continued from page 17)         man entities, you knew that      that a judge's decision on
                       cause uncertainty is some-       the numerator in a recovery      litigation is an unanalyzable
                       thing investors will pay to      calculation was going to be a    blue cell. We talk about
                       avoid – sometimes pay a          giant number.                    such things every day here
                       large amount. We love                                             at Owl Creek. We also
                       situations like Lehman which     At that point the analysis       hire outside counsel to
                       we call “high uncertainty,       turns to the denominator –       chime in on these issues,
                       low risk.” In those few          the other unsecured claims.      which is money very well
                       weeks after Lehman filed,        In that regard, some people      spent when considering we
                       any person's analysis of         were talking about these         manage a few billion dollars
“...uncertainty, to    what the ultimate recovery       really scary things, swap        of credit investments on the
                       would be on those bonds          contracts, guarantee claims,     long and short side. We
  us as distressed     had enormous holes in it.        customer losses, etc., and it    run a pretty concentrated
                       Every good analyst who was       sounded really bad. But          book. We're not the sort
  investors, is our    looking at that situation had    what you were supposed to        of investors that want to
  friend, because      dozens or possibly hundreds      be doing is building your        sprinkle our assets across
                       of unanswered questions.         waterfall model, under-          100 different ideas. Our 10
   uncertainty is      But we knew these would          standing all of the different    biggest positions represent
                       eventually get answered          variables, and coming up         the vast majority of the
something investors    over the coming months,          with a realistic range of out-   credit portfolio, so we
                       quarters, or years.              comes from bad to good. If       know those 10 positions
will pay to avoid –                                     you had done this, you           extremely well and we have
                       What's interesting about the     would have realized that         very high conviction in
 sometimes pay a       process, and about the dis-      even in the worst possible       them. I can assure you that
large amount. We       tressed asset class, is that     scenario, you still got an       as they're trading lower,
                       occasionally you'll be given     answer where you're not          with very few exceptions,
love situations like   an opportunity to buy            going to lose a lot of money     we're not selling them and
                       something at a price where       from nine cents on the dol-      running for the exits, we're
Lehman which we        even though you have a           lar because you were essen-      buying more. And when
                       hundred unanswered ques-         tially the most senior part of   they trade higher we try and
     call ‘high        tions, you realize that re-      the waterfall, and where         remind ourselves of the
                       gardless of what the an-         across most of the range of      need to have the discipline
 uncertainty, low      swers are, you probably          outcomes you would be            to start to sell things as the
       risk.’”         can't lose a lot of money,       making very good risk-           risk/reward becomes less
                       and most of the time you         adjusted returns. To put         favorable because of price
                       will make a little or a lot.     numbers around this, if your     moves. This buy and sell
                       This obviously assumes that      base case showed a recov-        discipline sounds pretty
                       you correctly understand         ery of 30 cents on the dol-      simple, yet all of us know
                       the capital structure, which     lar, your estimated claims,      that it’s a lot easier said
                       is key in distressed invest-     the denominator, could be        than done. We try to use
                       ing. Some people looked at       twice as bad as in your base     the group dynamic to re-
                       a Lehman Brothers holding        case and you’d still get a       mind ourselves of that on-
                       company bond trading at          recovery of 15 cents on the      going challenge and to make
                       nine cents on the dollar and     dollar and earn a double-        sure that we don't get
                       thought about the fact that      digit IRR over five years.       caught in a trap where we
                       if you deconsolidated the        That’s a pretty massive mar-     fall in love with our own
                       balance sheet and calculated     gin of safety. So high uncer-    positions.
                       what the assets of the hold-     tainty, low risk is a subcate-
                       ing company were, which          gory within distressed that      G&D: You mentioned at
                       included individual assets, as   we love.                         the CSIMA Conference last
                       well as tens of billions of                                       year that it's very important
                       dollars of intercompany          Secondly, we don't think                      (Continued on page 19)
                       receivables from other Leh-
 Volume I,
Issue XVII Issue 2                                                                                                   Page 19


Daniel Krueger
(Continued from page 18)         and build the model very         there is to know about eve-
to stick to your investment      early in the process. If I ask   rything else in the universe,
process. Could you de-           you to analyze a bond that's     and these were the last few
scribe Owl Creek’s invest-       trading at 52 cents on the       things you didn’t know. But
ment process and how you         dollar, and let's say it's a     most of the time there's
built it over the years?         company that makes TVs,          two or three big things that
                                 your first inclination is to     really matter and it makes
DK: Generally speaking,          read a hundred things about      sense to focus the research
we're big believers in the       the company and go talk to       effort there.                          “This buy and sell
notion that you need to          them and do a bunch of calls
focus early on in the analysis   and other stuff. That's all      In distressed, specifically,            discipline sounds
on the major drivers of          important work to do, of         sometimes you can have a
what's going to make or          course, but I might suggest      situation where the out-
                                                                                                         pretty simple, yet
lose you money in the in-        to you that you should do a      come is dependent on a
vestment, and avoid the                                                                                  all of us know that
                                 little bit of work first, and    single variable. For exam-
temptation to simply go out      then you should start to         ple, does the intercompany             it’s a lot easier said
and gather a lot of data.        think about what's going to      loan exist between Subsidi-
The reason I say that is not     make that price look cheap       ary A and Subsidiary B? It's           than done. We try
only because it’s a waste of     or expensive. Think about        either there or it's not, and
time to do the latter, but in    the variables that go into       if it's there your bonds are            to use the group
the worst examples, extra-       the analysis: sales growth,      worth par, and if it's not
neous data are a red herring     margins, capex, whether          your bonds are worth zero.
                                                                                                         dynamic to remind
that can cause a person to       they win or lose a contract,     In that scenario, does it
draw an incorrect conclu-                                                                                 ourselves of that
                                 things like that, and then       really make sense to ask
sion. There’s an interesting     build your valuation model       why ARPU at the holding                ongoing challenge
book written by the CIA for      in Excel, and think about        company was down 2% in
their internal use that talks    what the blue assumption         the third quarter? That’s an            and to make sure
about this concept. The          cells are. Without doing a       exaggeration, of course, but
book can actually be read        lot of hard work, you won’t      the point remains the same.             that we don't get
online for free on the CIA’s     yet have good views about
website – just Google “CIA       what the right numbers are       We also do a lot of primary
                                                                                                          caught in a trap
intelligence analysis book”      to plug into your blue as-       research. It's a cliché obvi-
and you should be able to                                                                                 where we fall in
                                 sumption cells, but you'll       ously, but then again there
find it. In it, it describes     then go out and talk to the      are a lot of things in invest-         love with our own
how the human mind can           company and be able to ask       ing that people can agree
keep very few concepts in        targeted questions that spe-     are important but which                    positions.”
mind at any one time. As an      cifically address the blue       they don't actually do. It's
example, the book asks the       cells. Over time the model       not enough to just hear
reader to try to multiply any    will evolve and become           from the sell-side that a
pair of two-digit numbers in     more refined, and you’ll be      certain contract has very
one’s head, say 47 X 63.         building on earlier work and     loose language surrounding
This is a task that is easy to   making improvements, not         the termination rights of a
do with a pen and paper but      just gathering more facts.       large customer. You need
is tricky to do in one’s head    What I found in my time          to go find that contract, if
because it’s hard to keep all    doing this and going to con-     it's in the public domain, and
the pieces of the puzzle at      ferences or sitting in small     you need to read it. Maybe
the forefront of one’s mind      group meetings, is that a lot    you need to ask a lawyer
together at the same time.       of people will have an hour      who's an expert in contract
                                 with the CEO and ask about       law to read it as well and
In that regard, what I say to    a lot of industry jargon that    give you his or her opinion,
the students in my class as a    could only possibly matter if    especially if that's a big part
tip, and something that we       you knew absolutely all                        (Continued on page 20)
do around here, is to try
           Page 20


                         Daniel Krueger
                         (Continued from page 19)        etc. – these are things for       mediocre to bad economy,
                         of the risk/reward.             which you need a special          because it has a lot of catch-
                         The process for analysis in     toolkit to analyze. You           ing up to do.
                         distressed is very tedious,     need to be willing to invest
                         very labor intensive, and       the time to look through all      Another thing we do as part
  “I think a lot of      very boring. Sure, parts of     of the documents and, let's       of our investment process is
                         it can be action-packed, like   not forget, this is all on top    remind each other to tune
people mistakenly        when you're sitting in court    of the valuation work that        out the market noise that a
                         and the judge walks out to      every analyst would need to       lot of us have been tacitly
 think the task in       give you the answer to the      do to analyze an equity. So       trained to tune in. I think a
investing is to try to   key question on your invest-    you need to be skilled at         lot of people mistakenly
                         ment, and you know the          valuation, but you also need      think the task in investing is
  predict in which       bonds will move 20 points       to be strong in your under-       to try to predict in which
                         in a few minutes, you’re just   standing of all of the struc-     direction market prices will
 direction market        not sure if it will be up or    tural aspects of distressed       go next. It’s a subtle differ-
                         down. But to get to that        investing. Then, if that          ence, but I think it’s a mis-
prices will go next.     place you need to have read     weren't complicated               take from the start to think
                         two credit agreements, 16       enough, you need to under-        about it that way, as op-
    It’s a subtle        indentures, understood the      stand the motivations of          posed to thinking about
  difference, but I      financial covenants back-       different people: What            potential outcomes and the
                         wards and forwards, mod-        does the LBO sponsor want         payoff structure across that
think it’s a mistake     eled out the company's op-      to do? Do they want to            range of outcomes. What
                         erations quarter-by-quarter     extend their option on their      the great investors that I
 from the start to       for the next eight quarters     out-of-the-money equity or        respect most recognize is
                         to understand exactly when      file the company tomorrow?        that the market is not some
think about it that      they'll run out of cash,        What currency might they          wild beast in need of being
                         looked through 8-Ks, pro-       have with which to get a          tamed, but that mispricings
way, as opposed to       spectuses, regulatory filings   deal done with creditors?         in the market are what cre-
  thinking about         to look for intercompany        What does management              ate the opportunities. And
                         loans or special dividends      want? What do employees           if your analysis causes you
potential outcomes       that could have been paid       want? What do competi-            to have a certain view, long
                         up or down in the struc-        tors want? How are com-           or short, you cannot expect
  and the payoff         ture, etc. We're generally      petitors going to react if this   that every day, or every
                         looking at big organizational   company goes into bank-           week, or even every year
  structure across       structures that have a lot of   ruptcy? For example, one          you will be rewarded for
                         different pieces, which in-     of our current investments        your view. We try to use
   that range of         creases the complexity and      is in an industrial company.      our team environment to
    outcomes.”           workload, but also maxi-        A few years ago when the          remind ourselves of that,
                         mizes the chances of finding    company was distressed and        and it’s easier to stick with
                         mispriced securities.           their EBITDA was negative,        one’s conviction when you
                                                         their competitors went out        have a lot of smart people
                         Take a company like TXU.        of their way to lower prices      around you also buy into
                         This was the largest LBO of     to make it that much worse        the investment thesis, as
                         all time, has a huge amount     and try and force the com-        opposed to being alone in
                         of debt, multiple layers of     pany to liquidate. The            your view.
                         the capital structure           whole industry got screwed
                         (subordinated, senior, and      up because of these pricing       G&D: Can you talk about a
                         secured) at multiple differ-    actions. That didn’t work         current investment idea that
                         ent subsidiaries with cross-    and the company is still in       you like?
                         guaranties, funds flows in      business today. Pricing is
                         many different directions,      now going through the roof        DK: There's a company
                         tax issues that arise from      in that industry, even in a                    (Continued on page 21)
                         the corporate structure,
 Volume I,
Issue XVII Issue 2                                                                                                      Page 21


Daniel Krueger
(Continued from page 20)         the company, and we cer-           would sue these companies
called Aiful where we own a      tainly didn’t believe that that    and drain out cash, and,
lot of debt. It's a Japanese     liability was fictitious or that   indeed, you could see in
company that does con-           it should be ignored. But          their historical financial
sumer finance. They pro-         what we did recognize was          statements the cash coming
vide consumers with small                                           out of these companies.
micro-loans, generally                                              What we liked about this
equivalent to a few thou-                                           dynamic and the risk/reward           Pictured: Bruce Greenwald
sand dollars. This business                                         of the position at the time is        at Graham & Dodd Breakfast
doesn't exist in the U.S.,                                          that their assets were                in October 2012.
where credit cards serve          “You need to be willing           largely unencumbered,
this purpose. The back-             to invest the time to           meaning they had not been
ground here is important,                                           pledged as collateral to
so let me spend a couple          look through all of the           other lenders, and, thus, the
minutes on that. The rea-           documents and, let's            company was free to use
son this company was inter-                                         these assets however it
esting to us initially was be-    not forget, this is all on        wanted. We reasoned that
cause they got into trouble         top of the valuation            one option for the company
a number of years ago when                                          was to sell those assets and
the Supreme Court in Japan        work that every analyst           use the proceeds to pay our
ruled that Aiful and certain        would need to do to             bonds as they came due.
competitors had been                                                Another option was to get
charging an interest rate         analyze an equity. You            us to voluntarily extend our
above the legal limit. You          need to be skilled at           bond maturities into the
might ask yourself why they                                         future if they granted us the
would do something that's         valuation but you also            assets as collateral. The
illegal. In Japan, there are        need to be strong in            latter was a deal we would
different interest rate caps                                        have done because we
based on different types of        your understanding of            would have gone from own-
businesses and these com-           all of the structural           ing unsecured bonds with a
panies always pushed the                                            lot of downside in the event
envelope in terms of what        aspects of the distressed          of a default to being secured
category they fell into. The        asset class. Then, if           and very well protected.
Supreme Court came back                                             Ultimately, the path chosen
and said, "You're wrong and              that weren't               by the company was one
you've been acting too ag-         complicated enough,              where the assets were
gressively all these years."                                        pledged to the banks to get
Overnight, giant contingent       you need to understand            them to extend their ma-
liabilities popped up for            the motivations of             turities a number of years.
these companies because                                             As soon as that was done it
their former customers              different people...”            cleared a pathway for our
would now be able to sue                                            bonds to get repaid at par
them to recover damages                                             upon maturity.
for this excess interest. The
size of this new liability                                          Fast forward to today –
caused Aiful’s bonds to          that the liability was not         what we own now is that
eventually trade down as         going to “mature” and be-          bank debt which got ex-
low as the 30s around the        come payable anytime soon.         tended, which is a different
summer of 2009, for bonds        In that respect, we viewed         bet. The original idea was a
that were maturing in a year     our near-dated bonds as            liquidity bet where if we got
or two.                          quasi-senior to these liabili-     it wrong we were going to
                                 ties. Over time, people                         (Continued on page 22)
We didn't necessarily love
            Page 22


                           Daniel Krueger
                           (Continued from page 21)         capped at par plus interest;     proved from 2-to-1 to 5-to-
                           get creamed in terms of our      i.e. the shareholders are        1. However much you liked
                           recovery, but where we           getting that 67% upside.         it at 50, you should really
                           thought our probability of                                        love it at 40. I think a lot of
                           getting paid off at par was      Lately, in this environment,     people miss this relationship
                           good enough to warrant the       we love buying 1st lien bank     because they are overly
                           downside risk. Today it's        debt. It's very comforting       focused on their base case
Pictured: Whitney Tilson   the opposite – it's a valua-
of T2 Partners LLC at
                                                            to know that when you're a       outcome and the return
                           tion bet, not a liquidity bet,   secured creditor, you are        that one scenario would
CSIMA Conference in Feb-
                           where we think our down-         first in line and that, almost   generate rather than think-
ruary 2012.
                           side is limited even in the      always, you will get some        ing about the range of possi-
                           worst case outcome. We           recovery on your paper           ble outcomes. If you're not
                           think that the assets of this    because it's highly unlikely     thinking about how much
                           company, in our base case,       that the residual recovery       capital you have at risk, i.e.
                           should create enough value       value on the assets after        the downside, then I think
                           for this bank debt to get        bankruptcy fees and liquida-     you're leaving out a very
                           back par. In addition to         tion fees would be zero. So      important part of the equa-
                           that, the fundamentals of        if you’re comfortable that       tion.
                           the company have been            you’ll have some recovery in
                           improving because the cash       a worst-case scenario, then      G&D: What is another
                           outflows from the excess         the upside/downside analysis     investment that you like
                           interest liabilities have been   becomes really important.        currently?
                           coming down recently. We         What we say to each other
                           think that the market has        around here is that it's only    DK: Sometimes distressed
“...it's only with the     been overly cynical about        with the benefit of under-       opportunities come in the
                           the ability of this company      standing your downside that      form of equities, and we’ve
      benefit of           to dig itself out of its hole    you can start to dream           played a lot of distressed
                           operationally. There’s a         about the upside. For ex-        equities over the years. We
understanding your         maturity date in the summer      ample, if you have 1st lien      like buying out of the money
downside that you          of 2014, so you’ll eventually    bank debt at 50 cents on         options at a cheap price,
                           get an answer to the ques-       the dollar, and you think the    and that’s what you get to-
can start to dream         tion. In our view, it has        ultimate recovery can be         day owning Leap Wireless
                           very good downside protec-       somewhere from 30 to 90,         equity. In fact we would
about the upside.”         tion because it is secured       you would probably buy it        argue it’s not even “out” of
                           debt, and you've already         because your upside is 40        the money. Leap is a wire-
                           built in a large margin of       points and your downside is      less company that trades at
                           safety just in the discounted    20 points, so you have a 2-      a little over $6 a share. The
                           price from par down to 60,       to-1 upside/downside ratio.      market value of equity is
                           where it trades today. The       Your expected return, as-        around $500 million, but
                           upside/downside is very          suming a normal distribu-        that represents only a sliver
                           compelling, meaning you can      tion, is +20% (from 50 to        of the total enterprise value.
                           make enough money on the         60). Now imagine that, on        What we love about this
                           upside owning it at 60 – i.e.    no fundamental news, the         idea, and the reason we
                           +67% on your money – to          bank debt trades down 20%        bucket this as a credit idea,
                           justify the downside risk.       to 40 – your upside/             is that you need to under-
                           That's very distinct from        downside is now dramati-         stand the capital structure
                           buying a bond at 100 cents       cally different, even though     and the liquidity of this com-
                           on the dollar, where your        the price is down “only”         pany in order to understand
                           valuation work may indicate      20%. Think about it, from        the risk/reward. We think
                           that you’re “covered” on         40, you've got upside of 50      the liquidity profile is decent
                           valuation by 67%, but you        and downside of 10, so your      enough that it doesn’t need
                           don’t keep that upside be-       upside/downside has im-                        (Continued on page 23)
                           cause a bond is always
 Volume I,
Issue XVII Issue 2                                                                                                  Page 23


Daniel Krueger
(Continued from page 22)         So we’ve got a highly vola-      ton of spectrum that it is
to file for bankruptcy any-      tile asset where we’ve made      not using and it seems sur-
time soon, and you’ve got a      a bet in a small part of the     prising that the management
very large shareholder as        capital structure and we         team has not tried to
Chairman of the Board, so        have a long period of time       monetize it sooner given its
you shouldn’t see manage-        to find out how things end       leverage profile.
ment proactively filing the      up. So, figuratively speaking,
company to the detriment         if we roll the “spectrum         DK: Actually, my under-
of shareholders. So our          valuation” die and it hits on    standing is that over the
starting point is that we’ve     one of the upside cases, we      past couple of years the
got an option that will sur-     should make multiples of         company has sold a signifi-
vive for at least a few years.   our money owning this eq-        cant chunk of out-of-
                                 uity. You can do this math       footprint spectrum to raise
Then we think about what         for yourself and you'll see      liquidity, so I don’t immedi-            “[With Leap
our asset is and what it         pretty clearly that you can      ately agree with the premise
could be worth in different      make two, three, four, five,     of the question. And as I              Wireless equity],
scenarios. A lot of people       six times your money in          said, we think the company
like to look at EBITDA mul-      scenarios that are not pie in    has a decent liquidity run-
                                                                                                          you can do this
tiples for this company, but I   the sky. Plus, we get to roll    way. Let's say we’re wrong,
think that’s really missing                                                                              math for yourself
                                 that die multiple times, given   though. The other possible
the point, because Leap’s        the company’s liquidity. If      path for this company is that            and you'll see
most important asset can-        we’re wrong, the stock may       they go into bankruptcy. As
not be discerned on the          go to zero, but we believe       I say to my students on the           pretty clearly that
income statement, but            even that is questionable        first day of class every year,
rather on the balance sheet.     given management’s expec-        bankruptcy has a negative             you can make two,
It’s not how much EBITDA         tations of turning the corner    connotation in society, but
they generated over the          and getting to positive free     bankruptcy and Chapter 11
                                                                                                        three, four, five, six
past 12 months, it's the         cash flow. The debt trades       exist for a reason. It exists
spectrum that they own, as                                                                              times your money in
                                 around par, at least for now,    to allow a company to tran-
well as the subscriber base      so raising some money in a       sition out of its old, bad             scenarios that are
that they have and all the       debt financing is another        capital structure into a new,
plant and equipment that         option for the company if        more manageable capital               not pie in the sky.”
they've accumulated over         they choose it. We would         structure as smoothly as
time. If you think about it      never make this a giant posi-    possible, as well as restruc-
that way and then you rea-       tion in our funds given the      ture operations via renego-
son that other people are        downside risk. Rather, we        tiation of leases, supply con-
buying and selling the stock     would size it so we can live     tracts, union agreements,
based on EBITDA multiples,       to fight another day if we       etc. So if Leap went into
it strikes you that you may      roll snake eyes. The point       bankruptcy, theory tells you
have something interesting       of portfolio construction is     that creditors will get into a
to look at here. We’re not       to have enough of a mix of       room and negotiate a plan
the world's leading experts      these in your portfolio          of reorganization, vote it
on spectrum and we’re not        where over time you should       through, and then come out
going to pretend to be, but      do pretty well if you’ve         of bankruptcy and continue
we know enough about it to       properly analyzed the prob-      along its path of operations.
know that most people are        abilities of various outcomes    But another thing that fre-
in the same camp as we are       and how much you make or         quently happens in bank-
in, even if they don’t admit     lose in each scenario.           ruptcy is that the assets get
it to themselves. The                                             sold to the highest bidder.
traded values of spectrum        G&D: What do you think           If that happens, and if you
over time have been all over     about the management team        go back to that bottom-up
the map.                         there? The company has a                      (Continued on page 24)
             Page 24


                           Daniel Krueger
                           (Continued from page 23)         nize that no amount of           including a lot of other good
                           valuation work around the        work can make an opportu-        short ideas, especially when
                           spectrum and other assets,       nity appear in front of you.     you think about the fact that
                           you can certainly build a        The best one can hope for        we're a global investor that
                           case for why this stock          as the reward for a lot of       can invest in any part of the
                           might be worth a lot of          hard work is to uncover          world. Today, we’ve got
                           money in a bankruptcy.           opportunities that already       roughly 40% of our credit
Pictured: Daniel Krueger   GGP is an example of a
at CSIMA Conference in                                      exist, but that is not a given   portfolio invested in situa-
                           stock that came out of           upfront. The reason I men-       tions outside the U.S. on
February 2012.
                           bankruptcy with substantial      tion this is that we try not     the long side.
                           value. So it wouldn’t be the     to get too wrapped up in
                           worst thing if this company      trying to predict what the       G&D: Do you utilize credit
                           was on the cusp of bank-         future opportunity set will      default swaps (CDS) and, if
                           ruptcy and the market in-        look like. We find that do-      so, how?
                           correctly traded the stock       ing so can sometimes cause
                           at pennies on the dollar         additional, unnecessary          DK: We tend to use CDS
                           because it equated bank-         pressure to trade.               a lot on the short side. Oc-
                           ruptcy with a worthless                                           casionally we use it on the
                           stock. Clearly, you should       The measure of how attrac-       long side as well. And
                           be adding a lot more stock       tive the opportunity set is at   sometimes we do both, on
                           in that scenario if the analy-   any given point in time is       the same company, by using
  “We don't play           sis hasn’t changed much and      how much stuff is getting        what's called the “CDS
                           if you thought the risk/         into the portfolio. Right        curve” to make very precise
very much at all in        reward was good at $6 per        now we’ve got over 60% of        credit bets at some precise
                           share.                           our assets invested on the       point in the future. The on-
 the new issuance                                           long side in credit, and         the-run CDS contract that
                           G&D: As a guest lecturer         we’ve also got a lot of expo-    most people quote is the
 market. We view           in Columbia Business             sure on the short side, so       five-year contract. This
                           School’s Special Situations      clearly we are finding plenty    represents how much you
 that as our future        class recently, Howard           to do. Remember that even        have to pay per year to buy
                           Marks showed several             when the default rate is low,    protection against the de-
supply of distressed
                           charts of how surprisingly       as it has been recently, you     fault of a company for five
       credits.”           consistent the high-yield        can still have situations        years. You pay the same
                           market cycles are. We've         where companies are get-         amount each year for five
                           been in a period of a lot of     ting into trouble but not        years, and if a default occurs
                           high-yield issuance and rich     defaulting, which creates        within the five-year period,
                           valuations for a while now.      opportunities for very high      then the owner of protec-
                           How are you positioned or        returns within a defined         tion gets the benefit of get-
                           thinking about taking advan-     period of time – i.e. owning     ting 100 cents on the dollar
                           tage of the eventual oppor-      stressed bonds to maturity.      for the notional amount,
                           tunities in that market?                                          and the protection holder
                                                            Like I said before, we run a     returns the post-default
                           DK: We don't play very           very concentrated credit         value of the bond to the
                           much at all in the new issu-     book. You don’t make             party who sold the protec-
                           ance market. We view that        more money by owning             tion. But think about it:
                           as our future supply of dis-     more names, you make             why five years? It’s a totally
                           tressed credits. We've seen      more money by owning             arbitrary number. If you
                           this movie before and How-       better names. So I don't         were properly analyzing the
                           ard Marks is telling you a       worry that we're not going       credit risk of a company,
                           story of how it ends – it        to be able to find 10 to 20      you should be able to form
                           usually doesn't end pretty.      high-conviction ideas to         a view of the credit profile
                           We don't disagree with that,     own at any one time, not                      (Continued on page 25)
                           but it’s important to recog-
 Volume I,
Issue XVII Issue 2                                                                                                  Page 25


Daniel Krueger
(Continued from page 24)         September 20th of 2013 for         they bust covenants due to
within discrete buckets of       which we paid 87 cents on          financial performance before
time.                            the dollar.                        the end of the third quarter.
Nowadays, a lot of traders                                          In that case, the company
will trade CDS contracts         So why did we do that? We          would survive past the expi-
that are four, three, two,       did that because this is a         ration of the CDS that we
and one years out, and           distressed company with            sold in September, so we
sometimes even shorter, in       bank debt trading at dis-          would again keep the 13
addition to the more cus-        tressed levels, and we think       points, as both the contract
tomary five-year contract.       that there's a reasonable          we bought and the contract
That's very interesting to us    probability that in the next       we sold would have expired
because in very complex          few months, the auditors           worthless. So we're fine
situations you could form        will go in to do their review      with the company defaulting               “So we've
the view, for example, that a    and they will look at the          before June, defaulting after
company’s credit risk is         company's liquidity profile        September, or never de-                   essentially
largely in the twelve months     and projections and say “no        faulting. If the company
between three and four           clean opinion.” If that hap-       defaults in July, of course,          constructed [using
years from now, but not          pens and they don't get a          we have a problem. But
before or after that. This                                                                                CDS contracts] a
                                 clean opinion in their 10-K,       that's a calculated risk we
sort of unnatural credit         that would be an event of          are taking, and we've sized           three-month bond
curve could exist for a lot of   default under the bank             the position accordingly. I
reasons, such as how much        agreement. We find it very         wouldn't advise you to put             that is issued on
cash the company has on its      unlikely that lenders would        your entire 401K into this
books versus the cash burn,      not use that as an opportu-        one trade, but within a               June 21st of 2013
whether it has an unfunded       nity to push the company           portfolio of a bunch of dif-
revolver, when it might vio-     into bankruptcy – and for          ferent event-driven ideas,             and matures on
late the financial covenants     good reason – because this         it's a good one to have be-
in the credit agreement,                                                                                  September 20th of
                                 company pays out an enor-          cause we think the ability to
whether it has a big subordi-    mous amount of money in            earn the equivalent of 15%            2013 for which we
nated bond maturity in a         coupons to junior creditors        for three months of risk, or
few years, whether it has a      every year. And every time         the equivalent of 75% on an           paid 87 cents on
big customer contract that       a dollar goes to a junior          annualized basis, is a mis-
might roll off, etc.             creditor, that's a dollar less     priced opportunity given the             the dollar.”
                                 that the first-lien secured        facts here. As we say
I won't mention the name,        creditors get to keep upon         around the office when try-
but right now we have a          a bankruptcy filing. So we         ing to illustrate the risk/
position in our books where      think they would love to use       reward of a binary-outcome
we own protection through        that as a lever to push the        idea, if we put this same
June 20th of 2013 that we        company in.                        trade on a hundred times
bought for 18 points up-                                            over our careers, we will
front, but we simultaneously     The timeframe for that de-         have done very well, even
sold protection through          fault exists before the expi-      though not every time will
September 20th of 2013 at        ration of our June protec-         we have made money.
31 points upfront. We’re         tion, and if there is a default,
long the credit risk of this     our short and long positions       G&D: Could you describe
company for only three           cancel each other out and          your strategy on the short
months, but we got paid 13       we keep our 13 points. On          side and how it’s different
points (the delta between        the other hand, if the com-        from your strategy on the
31 and 18) to take that risk.    pany gets a clean opinion,         long side, if at all?
So we've essentially con-        then it will keep chugging
structed a three-month           along – we don't think             DK: In terms of doing the
bond that is issued on June      there's any material risk that                  (Continued on page 26)
21st of 2013 and matures on
            Page 26


                          Daniel Krueger
                          (Continued from page 25)         if something bad happens –       tion per year for a couple of
                          analysis on the short side,      maybe supply and demand in       years, and we'll take the
                          it's the same as it is on the    the steel market gets out of     position off and move on
                          long side. As you might          whack because of all the         with life. But if any of these
“Let's remember that      guess, we tend to short          new supply in China, or          positions end up working,
                          companies that aren't yet        maybe there is a bad global      we'll make many multiples
    in credit – to        perceived as stressed or         slowdown – we would be           of what we're investing in
                          distressed. Occasionally         paid handsomely. We don't        this trade per year to keep
oversimplify it – you     we'll press a short when the     pretend like we can predict      it on. On the short side the
 are analyzing only       company has already bro-         with certainty what's going      analysis is the same but usu-
                          ken, but most of the time        to happen, but we own an         ally the attraction is that
two questions: First,     we will simply buy CDS on        option on something hap-         we're looking for problems
                          companies where we fore-         pening in a realm where          that the market doesn't give
     what is the
                          see some higher probability      there's a lot of inherent        much weight to today that
   probability of a       that things will get really      volatility due to operating      we think should have a
                          messy than what is reflected     leverage, financial leverage,    higher weight.
default, and second,      in current credit spreads.       and cyclicality.
                          Let's remember that in                                            G&D: You’ve been teach-
 if there is a default,
                          credit – to oversimplify it –    The one pushback we al-          ing at Columbia Business
what will the recovery    you are analyzing only two       ways get on this idea is that    School since 2006. Could
                          questions: First, what is the    in Japan, whenever compa-        you describe the genesis of
   on the debt be?        probability of a default, and    nies get into trouble, the       your class and whether
 Clearly the answers      second, if there is a default,   banks just come in and bail      you’ve seen any change in
                          what will the recovery on        them out. They say that the      the students since you be-
    to those two          the debt be? Clearly the         banks don't really do any        gan teaching it?
                          answers to those two ques-       credit analysis, it doesn't
questions depend on       tions depend on a thousand       matter what a company’s          DK: When they first asked
  a thousand other        other questions being an-        leverage is, what its cash       me to teach the class, I said,
                          swered, but if you're not        flow is – if it’s a big indus-   "No thanks. I think that's a
   questions being        thinking about it that way       trial company, it asks for the   poor idea for a class be-
                          then you're not really doing     money and gets it. First, we     cause distressed investing is
   answered, but if       credit analysis in my view.      disagree that this is always     really the intersection of
 you're not thinking      So as credit investors, and      true, as we've seen some         value investing (I'm not go-
                          especially as distressed in-     Japanese companies go into       ing to compete with Bruce
  about it that way       vestors, we're built to ana-     insolvency proceedings.          Greenwald and all these
                          lyze and opine on tail out-      Japan Airlines and Elpida are    other fabulous professors
then you're not really    comes.                           examples. I also feel like in    on value investing), bank-
doing credit analysis                                      an environment where             ruptcy law (no one can
                          Japanese steel companies,        there's already a tough eco-     compare to Harvey Miller,
     in my view.”         on which we own a lot of         nomic landscape, to think        who teaches that at the Law
                          CDS, are extremely lever-        that the system needs to         School), and turnaround
                          aged, and bankruptcies in        continue to exist to subsi-      management (again, some-
                          Japan tend to produce hor-       dize the highest-cost pro-       thing that is already taught
                          rible outcomes. I think the      ducer of steel in the world      very well).” They asked me
                          average historical recovery      doesn't ring true when           again a year later, and I rea-
                          over a long period of time       viewed through an eco-           soned that rather than try
                          has been roughly 13 cents        nomic lens.                      and teach those things, I
                          on the dollar, much worse                                         would just be the professor
                          than in the U.S. where it's in   We may get this wrong, and       who gathers it together and
                          the 40s. The steel industry      if we do we will have lost a     puts it in a package that
                          as we all know is a very         couple of hundred basis          involves making money –
                          cyclical industry. By owning     points on the notional posi-                  (Continued on page 27)
                          CDS we own an option that
 Volume I,
Issue XVII Issue 2                                                                                                 Page 27


Daniel Krueger
(Continued from page 26)          think it will be almost im-        bor. It was just the three of
making good risk/reward           possible to teach these 40         us on the investing side and
decisions.                        to 45 students about dis-          we were trying to make a
I tell my students that, first    tressed investing because          go of it. In that sort of sce-
of all, I truly believe the       it’s a very daunting topic and     nario, the world is your
class and the skill set of dis-   something that, in a lot of        oyster.
tressed investing is some-        ways, you really can't teach.                                            “In a Warren
thing that doesn't only apply     You learn it on the job over       In distressed specifically, like
to distressed investors. I                                                                                Buffett-style of
                                  a number of years. I still         I said before, you learn on
think it's a very useful class    learn something new every          the job. A lot of people in
to have taken if you're going
                                                                                                         value investing, if
                                  day, which is why I like my        distressed have a broad
to work in private equity or      job so much.                       array of different back-               your most
if you're going to work in                                           grounds: turnaround advi-
equities. How many times          G&D: Do you have any               sors, lawyers, bankers, sell-      important asset is
have we seen equity inves-        advice that you would give         side analysts, private equity
tors and equity sell-side         to students interested in          investors, etc. So if you're a     your human capital
analysts get caught in a trap     distressed investing?              second-year student at Co-
because they didn’t look at a                                                                            you need to set it
                                                                     lumbia Business School to-
company's capital structure       DK: My advice for business         day and you think you defi-
or think about its liquidity?
                                                                                                           on a growth
                                  school students generally is       nitely want to go into dis-
If you're just looking at a P/E   that the most important            tressed, don't think that if         trajectory with
multiple, you're not captur-      asset you have at this stage       it's not your first job out of
ing a lot of other things that    in your career is your hu-         business school that you           double digit CAGR
are important to your stock.      man capital, not your finan-       can't find your way in even-
Areas such as advisory and        cial capital. Occasionally I       tually. When we hire peo-           for a number of
consulting at some time or        see people worrying about          ple to come in at the analyst
another also touch the dis-                                                                             years. In a number
                                  who's going to pay them the        level here at Owl Creek, we
tressed landscape. Even if        most or which firm has the         expect them to have a pas-
you're the CEO of a com-
                                                                                                         of years that will
                                  most glamour attached to it,       sion for investing and a lot
pany and your company             which I think is a mistake.        of raw horsepower, but              have grown into
never goes into bankruptcy,       In a Warren Buffett-style of       they don't need to be Seth
your competitor might. If         value investing, if your most      Klarman their first day on          something that's
this happens, what is the         important asset is your hu-        the job. They need to be
competitor going to do?           man capital, then you need         people who are smart, who          powerful and useful
Who's going to buy them?          to try to set it on a growth       have the right skill set, and
Are they going to shut all of                                                                           and something that
                                  trajectory with a double-          who we think can develop
their plants? Are they going      digit CAGR for a number of         into good investors over
to slash their labor costs
                                                                                                         will be even more
                                  years. After a while, that         time.
and use that to under-price       will grow into something                                              important to you.”
you? There are a lot of           powerful, and then you’ll          G&D: Thank you very
different things that could       have many more options.            much for your time, Mr.
happen. So these are all          The way you do that is to,         Krueger.
things that pop up in dis-        first of all, find a job working
tressed and pop up in my          with people who you like
class.                            and in an environment
                                  where you can do meaning-
I've always been very im-         ful work and learn a lot.
pressed by the students in        Certainly that's what I got
my class. I'm always very         when I joined Jeff here at
excited to see the progres-       Owl Creek. It was Jeff, me,
sion from the first day of        and one of my classmates
class to the last day. At the     from Columbia, Shai Tam-
start of every semester, I
           Page 28


                          Frank Martin
                          (Continued from page 1)          a fighter or attack aircraft     primarily comes in print
                          After graduating from
                                                           off carriers. I defaulted into   form. I also watch Bruce
                          Northwestern University in
                          1964, Mr. Martin served as       my investment management         Greenwald, your professor
                          an officer in the Navy for       career because I flunked the     at Columbia Business
                          two years. He is an avid         flight physical three times      School, from time to time
                          reader, writer, and              due to an astigmatism,           on video, along with other
                          philanthropist. He is            which is a minor eye             investors I respect such as
  Frank Martin            founder and chairman of          disorder. So I didn’t lend       Kyle Bass and David
                          DreamsWork, a mentoring          Coke machines or conduct         Einhorn.
                          and scholarship program          other for-profit endeavors
                          for inner-city children. He
                                                           as the child prodigy, Warren     Another positive is that my
  “We call Elkhart        received his MBA with
                          honors from Indiana              Buffett, did.                    commute is 10 minutes.
      ‘Omaha              University South Bend in                                          Compare that to how long
                          1978.                            Finally, perhaps as a means      the average New Yorker
  East’ [laughs]. I                                        of compensation, a latent        spends getting to and from
                          G&D: Can you tell us             and almost insatiable desire     work, and you get an idea of
  can’t think of a                                         for knowledge and wisdom         the competitive advantage I
                          about your background and
 better place to be       how you became interested        emerged and I became an          have. But I also have
                          in investing?                    avid reader. I suspect I read    another edge. I get up
than in Elkhart, or a                                      at least 30 hours each week,     seven days a week at 4:30 in
                          FM: As an investment             between books, periodicals,      the morning. The first four
 better place not to                                       and the current news. I          hours are the most
                          management major, I took a
  be than in New          course during my senior          avoid all the social media       productive in my day.
                          year at Northwestern on          sites but am fastidious about    There’s an old adage that
York. I don’t get the     security analysis. The           emails.                          says, “An hour in the
                          teacher was an adjunct                                            morning is worth two any
 typical distractions                                      G&D: Your firm is located        other time of the day.” In
                          faculty member, Corliss
in Elkhart. … I think     Anderson, who was one of         in Elkhart, Indiana, far away    terms of staying current, at
                          the founders of Duff,            from New York City, the          4:30 I begin with the
it’s a lot easier to be   Anderson & Clark, which          hub of the investing world.      internet versions of the
                          was a Chicago-based              In what ways has this been a     Financial Times and The New
independent without
                          municipal bond firm that has     positive for you?                York Times. I then read The
  the herd pushing        since been broken into                                            Wall Street Journal and sign
                          pieces. Anderson was the         We call Elkhart ‘Omaha           onto Bloomberg early to
  you toward the          perfect mix between the          East’ [laughs]. I can’t think    read the news and check
                          theoretical and the practical.   of a better place to be than     the global markets. I usually
mediocre middle. I
                          He had been in the field,        in Elkhart, or a better place    get this done before 5:30 in
 know for sure it’s       and he used Graham’s             not to be than in New York.      the morning. The Economist
                          Security Analysis as his         I don’t get the typical          is on my list, but not as a
much easier to think      textbook. It was a               distractions in Elkhart. We      daily read. Given the
  independently.”         watershed event for me.          have no watering holes, at       abundance of information,
                                                           least so far as I am aware. I    the biggest challenge for all
                          But I have to tell you, unlike   haven’t been to a bar in my      of us is to separate the
                          a lot of the investors you’ve    life for after-work drinks. I    wheat from the chaff. By
                          featured in Graham &             think it’s a lot easier to be    limiting myself to an hour
                          Doddsville, if I had any         independent without the          for current news at the
                          epiphany, it really occurred     herd pushing you toward          beginning of each day, I
                          in slow motion. I went to        the mediocre middle. I           effectively impose a time
                          Northwestern primarily to        know for sure it’s much          filter that forces me to seek
                          become a Navy pilot, so I        easier to think                  out the meaningful over the
                          was a naval ROTC student.        independently. I control         trivial.
                          My dream as a kid was to fly     most of my input because it                   (Continued on page 29)
 Volume I,
Issue XVII Issue 2                                                                                       Page 29


Frank Martin
(Continued from page 28)           CDs yielding 14%, why           came down those high
G&D: What led you to the           would I lock myself into a      coupons kept looking better
founding of Martin Capital         20% tax-exempt bond?” As        and better. So I was kind of
Management?                        we know, one of the great       a local hero there for a
                                   challenges in our profession    while. Then, when the
FM: It took me 20 years to         is to see beyond the            municipal yields fell, the
get there! I started in 1966       moment, even though most        spreads narrowed. The
on the sell side with              people live in that space.      M&A world came alive. So
Walston and Company. My                                            since I was used to doing
mandate was to go out and                                          these kinds of long-tailed
sell. The product de jure                                          transactions, it was an easy
was, believe it or not,                                            transition to M&A. When
Hedge Fund of America. I                                           Walston failed, I sold our
was told as a rookie that          “At one point in the            office to McDonald and
Hedge Fund of America was                                          Company in 1974, which
designed to make money on
                                      early 1980s, the
                                                                   had a strong presence in the
the long and the short side.        lowest-yielding tax-           municipal market, and were
But I learned in 1969 that                                         guys who I greatly admired
you could actually lose             exempt bond I had              who were very skilled in the
people money, even with                                            M&A arena. They were
hedge funds, which left a           in my own portfolio            great teachers. One of
really bad taste in my                                             those teachers, Mark
mouth.                              was 14%. That was              Filippell, eventually co-
                                     back with 50% tax             founded Western Reserve
I didn’t like this idea of being                                   Partners and I sit on the
in a position where you             rates. So gross that           M&A firm’s board.
could actually lose people
money as a fiduciary. So I            up, and that’s a             I cut my investment teeth in
spent the next 10 years on                                         the early 1980s; I had to
the municipal finance side of         28% equivalent,              make one correct decision
the business. As interest                                          at that time – I had to
rates rose through the              which is three times           believe that interest rates
1970s, it was a very fun                                           would come down. That
business for me. At one
                                    the Ibbotson return
                                                                   was an easy call, I felt,
point in the early 1980s, the       since 1926. That’s             because the U.S. Dollar was
lowest-yielding tax-exempt                                         clearly the world’s reserve
bond I had in my own               a no-brainer type of            currency, and in that role,
portfolio was 14%. That                                            we simply couldn’t be
was back with 50% tax                   investment.”               running a double-digit
rates. So gross that up, and                                       inflation number indefinitely
that’s a 28% equivalent,                                           or we’d lose our credibility
which is three times the                                           completely. If interest rates
Ibbotson return since 1926.                                        came down, then P/E’s
That’s a no-brainer type of        Through sheer persistence       would come up, and stocks
investment.                        and force of will, I managed    would be an excellent play.
                                   to convince some people.        If interest rates came down,
Since I originated these           The nice thing about selling    bonds would be an even
financings and had some            people 20-year tax-exempts,     better play. I put my entire
access to investors in the         which were all callable in 10   retirement plan in 13.5% 20-
area, I asked them if they         years, is that they think       year zero-coupon bonds.
wanted to participate. Of          you’re a genius for the next    That was an automatic 12-
course, most of them said in       10 years because as rates                    (Continued on page 30)
the early 1980s, “Jeez, with
Page 30


          Frank Martin
          (Continued from page 29)        U.S. treasuries when             fascinating and equally
          bagger without any credit or    October 19th hit. I had been     perilous time because the
          duration risk – all in U.S.     writing for a long time          public, which had long been
          treasuries, which then          about the dangers that I had     absent from the market as
          allowed me to do a lot of       seen. So even though I was       measured by the ICI fund
          other things. In the 1980s I    a startup and didn’t have        flows, came back in spades.
          had more ideas than I had       that many clients, I was able    I think there were 5 million
          money. Three clients and I      to call all of them that night   families that were in funds
          bought a 25% stake in a         and say, “Your portfolios        at the beginning of the
          bank at 50% of book value       are actually up for the day      decade and nearly 50 million
          that was well capitalized and   because of the flight to         at the end. So it became an
          returning 15% on equity.        safety.” I got off on a good     increasingly retail-oriented
          Once again, the math is         foot with my new clients in      market. The 1990s were
          pretty simple – 15% on          1987.                            capped off with the dot com
          stated equity is 30% on my                                       bubble and the insane
          cost. I bought a lot of it,                                      valuations, so during that
          and it was ultimately a 10-                                      time I was mostly playing
          bagger. We had a few              “When it comes to              defense. Of course, I was
          other ideas like that and I                                      still collecting good coupons
          thought it was prudent to         compounding, I’m
                                                                           from the tax-exempt bonds.
          make big bets because                                            The year 2000 was a
                                            not sure everyone
          investors were generally                                         watershed year for me. I
          over consumed with                 understands that              thought anything technology
          avoiding risk. In other                                          -related or dot com-related
          words, the antithesis of           percentage losses             was insanely expensive. But
          today. The 1980s were just                                       the bifurcation of the
          an incredible time to be an        and gains are not             market was clear. I could
          investor. And I hope – and                                       buy mundane manufacturing
          expect – that someday we          equal. I’ve always
                                                                           companies – the ‘main
          may find ourselves in an                                         street’ companies, if you will
                                            managed to avoid
          environment where risk is                                        – on the cheap. So if you
          overvalued and return is            the large losses.            look at our investment
          underpriced! And this time,                                      results from early 2000 to
          double-digit interest rates       Imagine something              2001, we were up sharply
          may not be the cause.                                            while the market was down.
                                             as simple as that             As you can imagine, we fell
          When I was 36 (1978), I was                                      behind the markets in the
          diagnosed with multiple           being one of your
                                                                           late 1990s. There was no
          sclerosis (MS). I knew that                                      way you could keep up with
                                              secret sauces!”
          the life of a mergers and                                        the near doubling of some
          acquisitions banker, which is                                    of the technology-related
          all travel and pure madness,                                     indices during the height of
          would not be the career for     G&D: Given that the              the bubble. But we made it
          me in the later stages of my    macro environment plays an       up by going up when the
          life. So I went back to         important role in your           market went down in the
          school at night and had a       investment style, can you        early part of the next
          wonderful time earning my       talk about how you’ve            decade. When it comes to
          MBA and the CFA charter.        thought through some of          compounding, I’m not sure
          Just before the market crash    the significant events of the    everyone understands that
          in 1987, I hung out my          past 25 years?                   percentage losses and gains
          shingle. 1987 was beautiful                                      are not equal. I’ve always
          because I was fully invested    The 1990s were a                              (Continued on page 31)
          in tax-exempt bonds and
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Issue XVII Issue 2                                                                                      Page 31


Frank Martin
(Continued from page 30)        you hope to achieve              well. It was a simple call.
managed to avoid the large      competitive long term            Deep out-of-the-money
losses. Imagine something       compounding. Although            puts were exceptionally
as simple as that being one     most of the time I am a long     cheap, unlike today. You
of your secret sauces!          -only investor, the financial    almost couldn’t afford not
                                system had become so             to do it. Kyle Bass calls
The same thing really           untethered from reality that     such situations “asymmetric
happened later on as we         I wound up doing what            bets,” where the payoff is
approached the financial        Michael Burry later              many times the risk
crisis. It was pretty easy to   described as “going long the     incurred. They are as rare
see that what I called “the     short side.” I tried to sell     as they are profitable.
easy money fool’s rally” of     everybody in the firm on         [*Editor’s note: all of the
2003-2007 was going to end      the idea of buying puts on       opinions/events/decisions and
badly. You couldn’t             the investment banks. As         so on referred to in the
describe it exactly. Ben        was thoroughly documented        interview were chronicled real-
Graham said, “You don’t         in Chapter 10 of Decade of       time in Martin Capital
have to know a man’s exact      Delusions*, it was               Management’s annual reports
weight to know if he’s          understandably a tough sell.     – several reaching 100 pages
obese.” Like in the early       So I went through the            – that became the grist of two
1980s when buying long-         investment banking section       books, Speculative
term bonds, I only had to be    in Value Line and picked         Contagion (2006) and A
generally right. Anecdotally    four or five companies that I    Decade of Delusions
you could look at things,       thought were candidates.         (2011).]
such as house prices, the       Bear Stearns had won the
impending end-game of           Investment Bank of the Year      Let’s go back to the year
Hyman Minsky’s financial        award for three years            2000. I looked at valuations
innovation hypothesis, a        running, so I figured that       using a crude approximation
shamefully lax financial        they had lots of hubris. Like    of what Bob Shiller turned
regulatory environment, and     a superficial Michael Burry, I   into something incredibly
the perverse incentives up      read a couple of their high-     helpful. The Shiller P/E ratio
and down the food chain,        yield money market fund          uses inflation-adjusted data
which included the rating       prospectuses from cover to       and 10-year moving
agencies that became            cover, which was quite a         averages of earnings.
complicit by abdicating their   job. I thought, “Oh my           Valuations were in the
role as watchdogs. And the      goodness, these guys are         insane area – they were
list goes on. I looked at       smoking dope!” So Bear           much higher than where
structured finance deals, and   Stearns was an easy              they were in the late 1920s.
the whole idea of               candidate. Of course,            I looked at the broad-based
overcollateralization or        Lehman was always playing        inclination to take
redundancies, to the extent     it a bit fast and loose and      unrewarded risks – the
they had any, and the idea of   too close to the edge in         speculative contagion, which
layering risk in tranches to    terms of leverage, so it was     had permeated Wall Street
get higher ratings struck me    another easy candidate.          and particularly the retail
as insanity. I didn’t know it   Merrill Lynch was our            investor. We hadn’t gotten
would end as badly as it did,   custodian before we moved        into the huge leverage
however.                        to Fidelity, so I had some       problem yet. I believed
                                personal experience in           then as I believe now that
I came back from the            dealing with the chaos at        we were at a secular market
Berkshire meeting in May        Merrill. Call it envy, but I,    top. If you look at the
2007 thinking that Charlie      like Michael Lewis, always       Shiller data, these markets
Munger was right – you          felt that Goldman Sachs was      typically don’t clear until the
must avoid catastrophic         pushing the envelope as                        (Continued on page 32)
losses in your portfolio if
Page 32


          Frank Martin
          (Continued from page 31)          the downside. If our            FM: I would like to think
          Shiller P/E gets below 10         competitors behave that         that being defensive is an
          times, and sometimes              way and we understand the       educated conclusion. The
          materially below.                 difference between time-        first book, Speculative
                                            weighted and dollar-            Contagion, came out in 2006.
          Buffett at the same time was      weighted returns, the           At the time people said to
          writing about 17-year             “edge” of our sword cuts        me, “Gee, I like your book,
          cycles, which I had thought       two ways!                       but I have no idea how to
          a lot about, and I agreed                                         pronounce the title.” I
          with. Around 2000, I wrote                                        would say to them, “You
          that I wouldn’t be surprised                                      wait, in a few years, the
          if a 6% coupon U.S. treasury                                      word ‘contagion’ will be
          would outperform the                                              part of the common
          equity markets through the                                        vernacular of the trade.”
          next cycle. Once again, the                                       This is, of course, what has
          beauty is in its simplicity.       “The problem with              happened. So the title was
          Let's say in 2000 you bought                                      ahead of its time, but I’m
          a 6% 20-year zero-coupon                [investing in             not sure the book was. A
          treasury. Today, it’s got                                         Decade of Delusions was sort
          seven years to run. It             government bonds]              of a capstone in 2011 for
          would have cost you 33                                            the preceding decade, which
          cents on the dollar. I think        is the institutional          was a decade that I have felt
          because of the low five-year                                      had been way too risky for
          rates, it would be selling at      imperative. People
                                                                            two reasons. First,
          96 cents on the dollar.               don’t pay us to             valuations had been
          That's an internal rate of                                        stretched, certainly if you
          return of just under 9%,            think, they pay us            used the aforementioned
          versus a sub-2% return,                                           Shiller P/E. Second, because
          including dividends, for the        to act. They don’t            of increased financial
          S&P 500. The S&P 500                                              leverage throughout the
          would have to be at 3,500          pay you for playing            world, tail risks had
          to match the zero.                                                increased greatly. With that
                                              good defense; they
                                                                            overhang throughout the
          The problem with that is           pay you for playing            decade, I was thinking to
          the institutional imperative.                                     myself, “Wow, what I don’t
          People don’t pay us to think,         good offense.”              need to do is get blindsided
          they pay us to act. They                                          because we are paid on
          don’t pay you for playing                                         performance. I don’t want
          good defense; they pay you                                        to get underwater.” You
          for playing good offense.                                         can’t afford to get deep
          One would think that                                              underwater if you really
          everybody understands                                             expect to achieve good long
          Einstein’s great insight – that   G&D: Much like in the late      -term compounding. I’m
          compound interest is the          1990s, your defensive           invariably defensive too
          most powerful force in the        nature served you well          early as I was then. And I
          universe. We all are aware        during the market run-up        justified that because of the
          of the simple example that a      and collapse following the      optionality of cash, the
          50% loss requires a 100%          financial crisis. Could you     aforementioned
          gain to equal things out. Be      describe your defensive         overvaluation, and the tail
          that as it may, people would      nature and this latter period   risks that I think people had
          rather play offense and then      a bit?                          not priced in. I hope that
          lick their wounds after they                                                   (Continued on page 33)
          have a bad experience on
 Volume I,
Issue XVII Issue 2                                                                                                    Page 33


Frank Martin
(Continued from page 32)       I also think people’s            be on the global stage. I
sometime in the not too        expectations related to jobs     could see a renaissance in
distant future, the markets    have been greatly                manufacturing in America
will complete what I           downsized. People are            because of the traumatizing
consider the ultimate end      thinking much more               events through which labor
phase of a secular bear        rationally. A job is no          has gone. Workers have
market that really began       longer an entitlement, it is a   reordered their
with the peak in 2000. This                                     expectations – we’re not              Pictured: Mario Gabelli and
is clearly a minority view.                                     going to have folks at GM             David Winters at Omaha
                                   “I would ask the             making, with benefits,                Dinner in May 2012.
G&D: In your opinion, are                                       anything comparable to
the market and the                question, can the             what they made in the
American economy on their                                       heydays. I think we’re going
way to being mended and           excesses built up             to spend a lot of time
attractive or does it remain                                    focusing on those areas
as “deluded” as it was             from the success             where manufacturing can
during the last decade?                                         enjoy a renaissance and
                                generated by a long
                                                                where labor inputs will be
I would ask the question,        period of conserva-            reasonable on the world
can the excesses built up                                       stage. I think that’s really
from the success generated       tive economics and             exciting. Matt Ridley’s, The
by a long period of                                             Rational Optimist, helps one
conservative economics and         deregulation be              understand where the
deregulation be cleansed in                                     opportunities just might
a matter of six months from      cleansed in a mat-             arise.
September 2008 to March
of 2009? I don’t think            ter of six months
                                                                On the other hand, profit
human behavior works that          from September               margins are peaking. Top-
way. Most of us need to                                         line growth hasn’t been
have a trip to a woodshed         2008 to March of              there. You can’t cut costs
before we begin to mend                                         to prosperity. You
our ways. There’s a good         2009? I don’t think            eventually have to have top-
analogy with the labor                                          line growth. The economy
market. Labor has been             human behavior               continues to struggle. I’m
bludgeoned in part because                                      worried about the fact that
of the excesses in the             works that way.
                                                                tax revenues have averaged
financial sector. And many                                      18% of GDP – true over the
                                 Most of us need to
homeowners, who are part                                        long-term, with a low
of the labor pool, have also       have a trip to a             standard deviation, and
been suffering greatly. I                                       seemingly impervious to
think this will be resolved       woodshed before               how high the top marginal
through a significant                                           tax rate is – and we’re
behavioral change. People         we begin to mend              spending at a rate of more
will not use their home as                                      than 24%. It’s that issue
an ATM. They will not use              our ways.”
                                                                that I think we have to
homes as a way of making a     privilege. What’s going to       address at the legislative
quick profit. Throughout       happen, I think, is that the     level, which I don’t think has
my investment life, people     longer this goes on, the         much of a chance of
used their home as a way to    better our workforce’s           occurring for some time to
build up equity by paying      attitude toward laboring is      come.
down their mortgage, not as    going to be, and the more
a speculative vehicle.         competitive we’re going to                    (Continued on page 34)
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          Frank Martin
          (Continued from page 33)          today. That’s why I think        down, especially over the
          Additionally, I do think that     Dodd-Frank is the toothless      last decade, that I’ve missed
          the capital markets have not      tiger. All this leads me to      a lot of layups that I could
          gone through any kind of          believe that we’re just          have had if I had been just a
          catharsis of the sort that        playing games with               little more open-minded and
          labor has. Labor no longer        ourselves. The bell curve is     shorter-term oriented. I’m
          has a powerful lobby but          a joke, and value at risk is a   like Bob Rodriguez in that
          capital does. I recently read     concept that is a really lousy   I’ve been very defensive
          that $3.6 trillion of             measure of true risk. I think    since the summer of 2010,
          corporate bonds were sold         you’ve got to gross up risk      and that has not paid me
          by mid-December 2012 –            at the big banks, derivatives    very well because the
          who’s buying those? Well,         risk in particular. If you do    default asset class, for a guy
          it’s in part the small investor   that today you’ve got            who’s looking for some
          who’s disaffected with            yourself a crisis. So the        place other than the market
          equities and bound and            world’s financial system         to put his money, doesn’t
          determined to get some            remains in a critical state.     yield anything. So for the
          yield out of something, so        Basel II allowed the             first time in my investment
          he’s stretching out the risk      European banks to go to a        life, there is not an
          curve and scrambling for          2% capital ratio. Is that not    alternative that actually pays
          some sort of return.              a prescription for disaster?     me something.
                                            I just don’t think we’ve
          The shadow banking system         written the final chapter in     But believe it or not, when
          in the United States is $25       this. We are at a critical       it comes to individual
          trillion, I believe, and $65      state, but I have no idea        security selection, we are a
          trillion globally. Neither        what the catalyst is.            bottom-up firm. We’re not
          domestically nor globally                                          interested in cigar butts;
          have the numbers changed          G&D: Can you talk about          we’re a classic Buffett-type
          much since 2007. In the           the investment strategy at       investor. We want
          United States, total assets in    Martin Capital Management?       companies that we don’t
          our banking system are $13                                         have to sell unless the
          trillion. So the shadow           FM: I would like to say that     market bids them up to
          banking system, which is          we’re a situationally-           uneconomic prices. For
          mostly asset-backed lending,      sensitive value investor.        example, Gentex is one of
          is double the size of the         Everything is situation-         our current holdings.
          regulated lending market.         specific. The situation I’ve     We’ve actually bought
          Ben Bernanke really doesn’t       just described is one that       Gentex twice. I love buying
          have as much control over         suggests that tomorrow’s         the same company twice
          the financial mechanism as        opportunity set may be           because you’ve already done
          most of us would like to          better than today’s. So          your work. It’s very
          think. You would have             sometimes you have to play       efficient. I bought it the first
          thought that the whole            defense. You’re always           time in late 2008 and again
          shadow system – the arms-         trying to find fish that swim    recently. The business
          length securitization system      against the stream, but          performed beautifully during
          – would have collapsed, but       shopping in a crowded big-       the recession, but the stock
          the numbers suggest               box store shortly before         became too expensive.
          otherwise. This all tells me      Christmas is really              Then they had some news
          that 2008-2009 wasn’t             problematic. What’s your         regarding their rear camera
          cathartic, and that we’re         edge if you’re piling in there   display option, which was
          kind of back to the old           with everybody else? This is     negatively received. The
          games.                            often a significant failing on   cameras were going to be
                                            my part – I think I’ve been      placed on the dash instead
          The banking lobby is just         so preoccupied with top-                       (Continued on page 35)
          incredibly strong, even
 Volume I,
Issue XVII Issue 2                                                                                                 Page 35


Frank Martin
(Continued from page 34)         G&D: Many value                  both human and institutional
of in the mirrors on a           investors tend to avoid          behavior are vital to long-
couple of their big              macroeconomic thinking in        term investment success.
customers’ cars. But I           their individual stock           I’ve seen a lot of very smart
didn’t think that this           selection. Why is it so          people who have lacked
development was that             important to understand the      these virtues.”
material, and I love the         top-down perspective along
demonstrated productivity        with bottom-up analysis?         I was reading this and
of their research process.                                        thinking, “Where’s the
The stock tanked a number        FM: Because I think this is      bottom-up stuff in this?”
of months ago, so we took a      really a fascinating subject,    Was this kind of a quiet
big position in it again. I      and I notice that most value     warning to the world that                “But I think
also really admire the CEO.      investors are primarily          things were crazy? Based
                                 bottom-up. I took you            on his subsequent behavior,            [Warren Buffett]
The first document I read        through the decade of            I don’t think it was. But I
on any company is the            delusions, but let’s go back     think he hit the nail                     hit the nail
proxy statement because I        to 2006. The 2006                absolutely on the head.
want to know where the           Berkshire Hathaway annual        There are times where                 absolutely on the
incentives and rewards are.      report came out in March of      you’ve got to think top-
Obviously I like owner-                                                                                  head. There are
                                 2007, and the meeting was        down when the risks I
operators, but you don’t         May 5th of 2007. So I’m          mentioned earlier are                 times where you’ve
find those in the big-cap        reading the annual report        present, perhaps in spades.
companies. Then you’ve got       about what Buffett was           That’s why I think as I do,            got to think top-
to read the 10-K to find out     looking for in a successor.      and that’s why I hope that
what the real story is,          Let me read you these two        my job will become                     down when the
because the 10-K is the          short paragraphs:                immediately redundant
annual report without the                                         when we experience the                [macroeconomic]
adjectives. If you strip out     “Over time, markets will do      downside of the cycle. This
the adjectives in an annual                                                                              risks I mentioned
                                 extraordinary, even bizarre,     is really critical to how this
report, it looks pretty bland.   things. A single, big mistake    might differentiate me. As I          earlier are present,
Of course the 10-K requires      could wipe out a long string     say, it’s situational. When
disclosures like risk factors    of successes. We therefore       stocks are cheap, and tail                perhaps in
that you would never put in      need someone genetically         risks are priced in, or we’ve
an annual report. If you’re      programmed to recognize          gotten rid of some of the                  spades.”
comfortable with a company       and avoid serious risks,         tail risks by addressing some
after you get through those      including those never before     of the still excessive
two documents, then it’s         encountered. Certain perils      leverage throughout the
time to see if management        that lurk in investment          entire system, then you
squares up with what the 10      strategies cannot be spotted     really won’t have to worry.
-K says. I also always read      by use of the models             The biggest tail risk,
five years’ worth of glossy      commonly employed today          obviously, is still financial,
annual reports, and I always     by financial institutions.”      unless you listen to Leon
read them in one sitting.                                         Panetta saying that we might
It’s a great exercise. You       Now I would say that             have a cyber Pearl Harbor.
would not believe how            there’s nothing micro about      But that’s so abstract that I
many companies’ reports          that, nothing bottom-up.         can’t price it in. But the
are so different year-to-year    And then he goes on to say:      “gray” swan risk of another
that you don’t even                                               leg in the financial crisis is
recognize them as the same       “Temperament is also             real. While we can’t assign
company. I want to make          important. Independent           a probability to it, it’s
sure that one year is not        thinking, emotional stability,   nonetheless real.
inconsistent with the year       and a keen understanding of                   (Continued on page 36)
preceding.
             Page 36


                            Frank Martin
                            (Continued from page 35)         The Crowd, written in 1895      that we’ve barely begun a
                            G&D: Could you describe          by Gustave Le Bon, is           deleveraging cycle that will
                            the interaction between you      probably the most               impact growth for a long
                            and your team?                   instrumental book in            time, that’s not a bet I’m
                                                             framing my ability to go        willing to make.
                            FM: The dynamic tension          against the grain of
                            that exists between my           conventional thought and        At Northwestern I took a
Pictured: Bruce Greenwald   team and me is a good thing      not feel insecure. Le Bon       survey course in religion in
and David Einhorn at        because the guys force me
CSIMA Conference in Feb-
                                                             basically said that when one    which I read the great
                            to keep my bottom-up eyes        joins a crowd – when one        theologian Reinhold
ruary 2012.
                            open, and I force them to        becomes part of the herd –      Niebuhr’s Moral Man and
                            keep their top-down eyes         he tends to function at a       Immoral Society and was
                            open. So I like that tension.    much lower level. In the        enamored with it. It was
                            We all get along. This is a      capital markets – because of    my first introduction to
                            group that appreciates my        the Bloomberg terminal,         crowd behavior. When
                            perspective, and I appreciate    because of instantaneous        Extraordinary Popular
                            theirs. We have an open          communications, because         Delusions and The Madness of
                            forum – everybody can say        everything is live and online   Crowds came along, I
                            what’s on his mind.              – we can create                 devoured that. The title is
                            Ultimately, I make the final     instantaneous synthetic         so descriptive and so
                            decision, but I respect these    crowds. This whole              timeless; think of how well
                            guys, so I listen to them.       business with ‘the Fed has      it describes the mood of
                                                             our back, that as long as the   today. Bob Shiller is a
                            G&D: You said in your            Fed is going to keep the        leading light among a
                            book, A Decade of Delusions,     spigots open, you’re not        growing group of behavioral
                            that you attempt to              going to get a bear market,’    economists, and his Irrational
                            continually understand the       is a simple suggestion –        Exuberance, published in
                            psychology of the                according to Le Bon, the        early 2000, revealed his
                            marketplace to gain a            crowd loves simple              multidisciplinary capacity. I
                            competitive edge. What is        suggestions.                    almost didn’t read the
                            the genesis of your interest     Understandably, it is           second edition that came
                            in, and commitment to,           incapable of complex            out in 2005, because it was
                            understanding the                reasoning. Imagine the edge     essentially a reprint…
                            psychology of groups?            one has if one simply           except for a rather
                                                             disassociates himself from      fascinating discussion on the
                            I think this is something that   the crowd.                      emerging real estate bubble!
                            I hope you will put in your                                      What he said in a practical
                            mental hard drive, because       For example, I think many       sense resonated so well
                            it’s been a great asset to me    investors are misreading        with all the social science
                            over the years. Again, I live    what the Fed is doing today.    theory I had read. I’m
                            in Elkhart, IN. It can be        Once they submit to the         deeply in his debt. I just
                            very intimidating reading the    will of the crowd they are      read Daniel Kahneman’s
                            guys interviewed in Graham       almost Pavlovian in             Thinking, Fast and Slow, and I
                            & Doddsville, or, if I’m         responding to the simplicity    think that he and the late
                            inclined – which I’m typically   of the “Bernanke put” and       Amos Tversky are some of
                            not – to watch CNBC and          are thus oblivious to the       the great behavioral
                            the talking heads. There are     long-term consequences.         scientists. Since nobody in
                            some guys in this industry       Somehow this has to be          our industry thinks about
                            who are really smart. So I       unwound. Everybody              this very much, I think about
                            may ask myself, what edge        thinks, “Well we’ll just grow   it a lot.
                            do I possibly have with this     our way out of it.” Well,
                            crowd?                           perhaps we will, but given                   (Continued on page 37)
 Volume I,
Issue XVII Issue 2                                                                                       Page 37


Frank Martin
(Continued from page 36)         there’s a chance the future       that cash is a good hedge
G&D: Even Kahneman               will prove that I’m wrong         against deflation and a
admits that knowing about        about a decision that I’m         respectable hedge against
the failings of human            considering, whether I’m          inflation, and offers huge
psychology and decision-         wrong because of biases or        optionality, is that I’m going
making doesn’t mean you          I’m wrong because I               to let an opportunity slip by.
won’t still fall prey to them.   incorrectly assessed the          The beauty in this business
Are there specific steps in      situation, if the downside is     is that there are just hordes
your investment process          permanent loss of capital, I      of future opportunities
that ensure you won’t fall                                         waiting and some of them
prey to these biases and                                           may be huge if you’re
heuristics?                             “If there’s a              patient. And I think Ben
                                                                   Franklin summed it up well:
FM: That’s a problem                chance the future              “He who has patience can
everybody has to                                                   have what he will.”
acknowledge that they have.        will prove that I’m
It’s painful to read a book                                        For those who are long with
                                      wrong about a
like his because you wonder                                        the throng, they’re going to
just how much of your               decision that I’m              have to explain, if I’m right,
subconscious biases are                                            why they’re down, say, 50%.
ruling your decision-making.            considering,               I’ve never been in that
I try to benchmark my                                              position; our clients have
thinking, and thus try to          whether I’m wrong               never suffered a bear
override my biases, by                                             market. In bull markets,
frequently looking at a host        because of biases
                                                                   you underperform. Being
of charts I’d made using Bob                                       down under 7% in 2008 and
                                       or I’m wrong
Shiller’s 10-year moving                                           being up so nicely in 2009
average data. I’m aware                   because I                probably put us in the top
that biases exist. What I                                          5% of our class. But we
don’t know is to what                    incorrectly               trailed pretty significantly
extent they invade my                                              from 2003 to 2007. And
otherwise rational mind.                assessed the               I’m trailing now again. So
Clearly they do but I am                                           I’m a classic ‘win by not
utterly uncertain as to how          situation, if the
                                                                   losing’ guy, at least for the
much. I find some solace in                                        time being – at least in this
                                        downside is
the Bertrand Russell quote:                                        high-tail risk, overvalued
“The trouble with the world         permanent loss of              market. But I will welcome
is that the stupid are                                             when “this too will pass”
cocksure and the intelligent        capital, I can’t go            because this is no way to
are full of doubt.”                                                live. I’d rather be totally
                                    forward with that              focused on individual
I agree with Nassim Taleb –                                        companies, fully invested,
whose work I find incredibly             decision.”
                                                                   and sticking the ones I really
stimulating although he can                                        like in a lockbox – like
be an offensive writer – that    can’t go forward with that        Gentex – not even thinking
everything has to go             decision. If the downside is      about it for five or ten
through the Pascal’s Wager       the loss of an opportunity,       years.
filter (he couldn’t even         then I’m okay. By playing
resist taking issue with the     defense like I’m playing right    G&D: Your firm’s annual
great French                     now, the worst that will          report shows that since
mathematician’s and              happen to those for whom          2000, you’ve never been
probability theorist’s use of    I’m a fiduciary, if you believe                (Continued on page 38)
the spiritual metaphor!). If
Page 38


          Frank Martin
          (Continued from page 37)         nets around 5.6%. That’s         your hedge fund valuable
          more than 70% invested.          just awful. So I thought,        enough?” And I reply, “I
          Were there times in the          let’s come out with a pricing    don’t know. Look at our
          late 1980s or during the         structure that I would want      track record for yourself.”
          1990s where you were fully       when my estate comes to          And they say, “Well, your
          invested?                        be managed by my firm after      track record is pretty
                                           my death. So I came up           good.” And I say, “Why
          FM: I started managing           with a 90 basis points           should I charge 2 and 20?”
          money for others in 1987         maintenance fee for most         And they say, “Well, if you
          and for myself for many          accounts, or – ‘or’ is the       don’t, you give the
          years before. I was always       critical word – 10% of the       impression that your service
          100% invested. That could        gains above a high water         isn’t as valuable.” The “you
          be long tax-exempt bonds         mark. Granted, this is           pay for what you get” belief
          at 14%. It might have been       Elkhart, but this money          is so well entrenched – with
          owning a bank in the early       management business, if you      substantial justification in
          1980s. In fact, the 1980s        actually make money for          most cases – that the
          were a most atypical period      clients, is nicely profitable,   weaker players among the
          for me. I actually borrowed      even at 90 basis points or       hedge funds have been able
          money for a while. I’m a         10% of gains above a high        to thrive unexposed under
          guy who doesn’t like to use      water mark.                      that perceptual umbrella. I
          leverage. I haven’t                                               suspect that 2 and 20 will
          borrowed money for the           If you look at this in the       have changed dramatically
          last 30 years of my life for     context of the grand sweep       by 2020 because it simply
          anything – I pay cash for        of history, we are living in a   cannot survive forever in a
          everything, because I think if   most unusual time that is        low-return environment.
          an investment doesn’t work       surely getting long in the       Maybe we’ll be seen as
          without leverage, it’s not an    tooth. In finance everything     leading the charge.
          investment you should do.        is cyclical whereas in, say,     Admittedly, I think it’s hard
          But the 1980s were a time        technology, today’s ideas        for a value investor to
          where I had many more            are built on the shoulders of    understand the appeal of
          ideas than I had money. I        yesterday’s. Think iPod,         Veblen goods – like the high
          can envision a period in the     iPhone, and iPad. You can        -end German cars or Rolex
          future where this could          make incredible fortunes in      watches – or even most
          happen again. It’s easy to       this business, and you don’t     hedge funds.
          imagine a number of              have to overcharge to do it.
          scenarios that could cause       You get to build equity,         G&D: What was the
          prices to sell as dramatically   which means you never            impetus for launching your
          below what they’re worth         have to worry about your         first mutual fund in May of
          as they have been selling        finances, unless you’re a bad    2012?
          dramatically above what          investor. If anything, our
          they’re worth.                   industry has become an           FM: We never had a
                                           embarrassment of riches. In      marketing person until two
          G&D: Your separately             the aggregate, after fees we     years ago. We brought on a
          managed accounts don't           are a negative value-added       fellow who I believe is a
          have a traditional fee           proposition.                     great marketing thinker and
          structure. Can you talk                                           strategist. He asked me
          about your fee structure         People say to me at parties,     when he came aboard,
          and why you feel it’s a          “How come you’re not             ‘Why don’t you have a
          better alternative to the        charging regular hedge fund      product for the retail
          traditional 2 and 20?            fees?” (People mistake us        investor?’
                                           for a hedge fund because of
          FM: Obviously a 10% gross        our investment style.) “Isn’t                 (Continued on page 39)
          return with a 2 and 20 fee
 Volume I,
Issue XVII Issue 2                                                                                                       Page 39


Frank Martin
(Continued from page 38)          If you can reach those kinds     1989, ultimately getting as
Sometimes you need a              of people, you’ll have the       low as 7500 and currently
catalyst to overcome inertia.     kind of investors you want       trading around 10,800, it’s
First of all, it takes you        and deserve. We take the         been a trader’s or
about a year, if you are          relatively unusual tact of       contrarian investor’s
methodical, to get the            posting commentaries to          market. I hope that we
concept from inception to         the fund’s website [Martin       don’t go into a Japan-style,
market. Then we went out          Focused Value Fund] to           lethargic period, but unlike
and talked to some people                                                                                Pictured: Bill Ackman of Per-
                                  keep investors regularly         the post-2009 episode, I
that we like as long-term                                                                                shing Square Capital Manage-
                                  apprised of our thinking.        don’t think we’re going to            ment at Pershing Square Chal-
investors. We said to them,       The most recent was “Why         go back to the races                  lenge in April 2012.
“Are there buyers for a fund      Would an Enterprising            following the next down leg.
that is basically a call option   Investor Hold Cash Today?”       If it’s more like the post-‘74
on financial assets becoming      With our fund, like our          experience in the U.S.,
more rationally priced,           separately managed               sentiment will be negative
maybe even cheap?” Bob            accounts, we depart from         and prices will remain cheap
Rodriguez, who’s been as          the mainstream: we control       and investors will stay risk-
risk-averse as I have, says       the critical asset allocation    averse for a much longer
that in expensive markets,        decision like the FPA funds      time. Stocks will be
he'd try to get people to         do. Done right, it has a         unpopular and the whole
buy his fund. He'd say,           very salutary effect on dollar   process will be anything but
“We’ve got a lot of dry           -weighted returns. Most          glamorous. In that
powder take advantage of          investors chase                  environment, I think the
opportunities as they             performance while we are         fund could do well because
appear” (Of course they           looking for value. I doubt       then we could strictly focus
think 30% cash is                 that we will ever have a         on stock-picking and grow
extravagant. I think 30%          problem of too much              slowly, while attracting the
cash is straddling the            money coming in over the         kind of clients who just
fence!). What Rodriguez           transom. But still, biggest is   might stay the course. I
found is that they’ll say, “I     not always best.                 openly admit that trying to
don’t want to put my                                               find permanent capital in the
money with you now, and           If I can read the tea leaves     mutual fund space
pay fees, because you’re not      and we do go through this        admittedly may be insanity
earning anything. Call me         cathartic process, it’s          by another name. I think
when things get cheap.”           probably going to be like        Chuck Royce talked about
                                  post-1974. Buffett knocked       that in his Graham &
But, most investors are           the ball out of the park from    Doddsville interview (Fall
afraid to buy when                1974 to the early 1980s in a     2012 issue).
everything’s cheap. Even if       bumpy, flattish market. The
they know things are cheap,       public was exiting the           G&D: Can you walk us
they worry that they will         markets, particularly            through your process for
become cheaper and they           through funds. But what he       finding new ideas?
find it difficult to pull the     found was lots of individual
trigger. So the trick for us      values. If I could paint a       FM: Obviously one thing
is to see if we can get           picture of the future, I’d say   we don’t have, which
people into the fund              it’d be something like that,     Warren Buffett and Seth
without any assurance other       or maybe something like          Klarman do have, is
than that we have the             Japan. There have been           incredible sourcing
courage of their convictions      great opportunities in Japan.    opportunities for
– when prices were higher!        But ever since the Nikkei        investment ideas. We have
We’ve been good at                225 began its long               about 40 names that we’ve
stepping up when times are        meltdown from 39,000 in                       (Continued on page 40)
tough and stocks are cheap.
           Page 40


                         Frank Martin
                         (Continued from page 39)         G&D: What advice do you            managements and looking
                         identified as businesses we’d    have for students interested       for little clues about
                         like to own at a price. The      in the investment                  whether their behaviors
                         cost structure of building       management industry?               reconcile with their talk.
                         and maintaining an inventory                                        When I see a value investor
                         of “ideas” is quite different    FM: As soon as you can             who lives really big, it
                         from manufacturing. In our       disabuse yourself of the           strikes me as a
                         fixed-cost business, we          importance of money, it will       contradiction in terms. I
“People don’t talk       analysts think of ourselves      help you immensely. All the        know there are many
                         as Santa’s elves, working day    stuff that’s important in life,    exceptions and there are
about this very of-      in and day out to build          you get for free. All the          dangers in stereotyping –
                         inventory for Christmas.         stuff that’s unimportant, you      but when you see such
ten, but it’s clear in   Our job is to build an           buy with money. When I             lifestyles, it makes you want
                         inventory of investable          first started, I said to myself,   to dig a little deeper.
 John Templeton          ideas, so that when prices       ‘Boy, as soon as I make a
                         come to us, we’ll get to pick    million dollars, I will be         G&D: It’s obvious from
  and certainly in       maybe 15 or 20 names.            secure.’ Now that shows            this interview that you are a
 Buffett, that the       We’d like to get it up to        you how misguided I was.           voracious reader. Keeping
                         about 50, and then we’d like     But as a starving student,         the list pretty short, what
 great value inves-      to do what Gerald Loeb,          you’re really low on               books would you
                         from E.F. Hutton,                Maslow’s hierarchy. It’s not       recommend that students
tors have a lifestyle    recommended years ago –          unnatural to think, ‘money         read?
                         every time you add one, you      will fix my problems.’ But if
that’s earmarked by      take one away.                   you can disabuse the notion        Toward disabusing money
frugality. … In fact,                                     that money is a measure of         as a measure of success, I
                         We obviously won’t know          success, it will really help       recommend two books.
I’ve never really un-    in advance which                 you.                               One is Viktor Frankl’s Man’s
                         companies, out of these 50,                                         Search for Meaning. In that
derstood how a guy       we’ll buy, but we’ll follow      Money is very corruptive.          book, he says that success,
                         them closely and add them        Obviously it’s not been the        money, and all the
 can claim to be a       individually to the portfolio    case with Buffett. You’ll          accouterments of the so-
                         when they get down to a          notice the way he lives.           called “good life” should
  fully committed        price that is likely to          People don’t talk about this       never be sought for their
                         produce an expected              very often, but it’s clear in      own sake, but should be the
value investor and       return of, say, at least 15%,    John Templeton and                 unintended side effect of
      live big.”         properly risk-adjusted. So it    certainly in Buffett, that the     devoting yourself to a cause
                         won’t be top-down at all.        great value investors have a       greater than yourself, or
                         It’ll just be when individual    lifestyle that’s earmarked by      loving a person more than
                         names like Gentex fall to a      frugality. There is no doubt       you love yourself. If you
                         price range where I can say,     in my mind that Buffett            can identify what you’re
                         this thing’s going to double     discovered early on that           doing as a cause, and it
                         in five years or less. We’ll     redundant personal assets          happens to be remunerative,
                         default into being fully         are really liabilities in          it can be a good thing. One
                         invested. Obviously,             disguise – that you can easily     of the things I decided when
                         exogenous forces like bear       lose your personal freedom         I made my career choice is
                         markets produce a plethora       by becoming slave to your          that if I’m going to be good
                         of buying opportunities.         possessions. In fact, I’ve         at what I did, I’d like to be
                         One must be more                 never really understood            paid for it. This profession
                         circumspect when the             how a guy can claim to be a        does that. It’s what you do
                         precipitating forces that lead   fully committed value              with your largess that
                         to lower prices are              investor and live big. You         defines you. “The measure
                         endogenous.                      talk about going to see                         (Continued on page 41)
 Volume I,
Issue XVII Issue 2                                                                                 Page 41


Frank Martin
(Continued from page 40)          Adam Smith is famous for        exploiting the asymmetry of
of a man is not what he           Wealth of Nations. But my       information between agent
gets, but what he gives.”         favorite book of Adam           and principal in increasingly
                                  Smith’s is The Theory of        complex systems, capitalism
I’d also have people pick up      Moral Sentiments. Smith         broke down. It’s because
Kahlil Gibran’s The Prophet.      basically says, if you take     everybody forgot the
He writes about work, and         care of your customers’         second of Adam Smith’s
he writes about giving.           interest, you’ll take care of   two great books. It’s a
Those are two chapters that       your own. So if you sell the    great system, but only if the
I would highly recommend          best good and if you meet       players live by the Golden
to young people. I think          the customers’ needs better     Rule.
that will help shape who you      than your competitors,
become.                           you’ll always do well. The      Lastly, some of the most
                                                                  important of life’s lessons
I’m 70 years old and I’m in a                                     are not taught in books. By
wheelchair. Even though I                                         all means, find mentors who
no longer play golf, I’m like                                     you think are really worthy
the golfer who shoots                                             of respect, people who have
(works) his age [laughs]. It         “If you want to,             lived their lives in ways that
isn’t work at all. I love it. I                                   you admire. You can’t
don’t want to acquire               you can make all              imitate Buffett, but you can
knowledge for knowledge                                           emulate him. I have a
sake, rather for wisdom’s          the mistakes by try-           mentor wall that is the first
sake. When I read that                                            thing you see in my small
Todd Combs researches an            ing to learn every-
                                                                  office. By identifying men
idea for 500 hours before                                         who you really admire, you
                                    thing yourself, or
he buys it, that’s kind of                                        can shortcut your learning
impressive. That’s what all         you can sit at the            curve tremendously. You
of our analysts and I should                                      learn ethics by example.
aspire to. If you’ve read          feet of the masters,           Jack Bogle and Warren
Outliers, you’ll understand                                       Buffett, in terms of shaping
that you’ve got to do the         which I have chosen             my values, have really had a
10,000 hours. There are no                                        huge impact. And I
shortcuts. Too much IQ             to do, and shortcut
                                                                  probably have another 10 or
can actually be an                                                15 people on the list of
                                            that.”
impediment. When I read                                           people to whom I am in
the stories of the great                                          debt in perpetuity. If you
achievers in our industry,                                        want to, you can make all
most of them appeared to                                          the mistakes by trying to
have ample intelligence.                                          learn everything yourself, or
What seems to differentiate       theme of Smith’s second         you can sit at the feet of the
them is that they appear to       book explains why the           masters, which I have
have overcome the                 system broke down in the        chosen to do, and shortcut
limitation embedded in the        last 15 years. The Theory of    that.
idea that “because I’m so         Moral Sentiments spoke
smart I don’t have to work        about the importance of         G&D: Mr. Martin, it’s been
very hard.”                       ethical behavior throughout     a pleasure speaking with
                                  the system. So when             you.
Don’t limit yourself to just      people – and this is Charlie
reading business and              Munger’s big criticism which
economics. Read                   he calls “moral drift” –
philosophy and read the           started cutting corners and
great economic thinkers.
          Page 42


                       Russell Glass
                       (Continued from page 1)         construction figuring they       afternoon.
                       Glass is co-owner of the
                                                       do a great deal of future
                       New York Mets and is a
                       director of the San Diego       traffic pattern analysis and     After graduation from
                       Chargers. He also advised       demographic research to          Stanford Business School, I
                       Jerry Jones on the $140         determine attractive             set up Premier Partners, a
                       million acquisition of the      locations. A few years later,    merchant bank in Dallas
                       Dallas Cowboys when he          in high school, I used to        with a close friend and
   Russell Glass       was 26 years old. Mr. Glass     read Value Line investment       classmate of mine from
                       earned his B.A. in              research reports and was         Princeton. Our first
                       economics from Princeton        fortunate to get a summer        transaction was advising
                       University and his MBA
                                                       internship at LF Rothschild      Jerry Jones on the $140
                       from Stanford Business
                       School.                         Unterberg Towbin where I         million acquisition of the
                                                       worked in the risk arbitrage     NFL Dallas Cowboys when I
                       G&D: What was your              department. It was a great       was 26 years old. Although
                       introduction to investing?      learning experience to           many who did not know
                                                       analyze companies involved       him at the time thought
 “My schedule at                                       in M&A activity. I then went     Jerry may have overpaid
                       RG: Growing up, my main
   Stanford was        interests were investing and    to Princeton and majored in      because the highest price
                       sports, though I found I was    economics. After                 for an NFL franchise until
  unique in that I     more successful with            graduation, I started my         then was only $100 million,
                       investing. I have been          career at Kidder Peabody &       the investment has yielded
would go to class in   fortunate to pursue both        Co., where I worked in           greater than an estimated
                       these interests throughout      corporate finance advising       20x return, or $3.5 billion in
the mornings, then                                     companies on their defense       value, as the team is
                       my career. On the
                       investment side I have          of hostile takeovers, which      currently appraised for
frequently take the                                    put me at the forefront of       approximately $2 billion and
                       served as the President of
 Spanos corporate      Icahn Associates, the           the 1980s hostile takeover       has probably generated
                       investment firm of Carl         wave. Afterwards, I decided      cumulative operating profits
   jet to attend       Icahn, and later as the         to go to Stanford Business       in excess of $1.5 billion.
                       founder of RDG Capital          School where I had a             The Cowboys went 1-15
 business meetings     Management. On the              roommate who happened            during Jerry’s first year of
                       sports side I recently          to be the nephew of Alex         owning the team but ended
during the day, and                                    Spanos, the owner of the         up winning the Super Bowl a
                       became a co-owner of the
                       New York Mets and, for a        NFL’s San Diego Chargers         few years later. The fact
  later fly back in                                    and founder of the A.G.          that Jerry was able to sell
                       number of years, I have also
time to attend class   been a director of the          Spanos Companies, one of         luxury suites in a very weak
                       Spanos-family-owned San         the top real estate              economy at the time and
in the afternoon.”     Diego Chargers. My              developers in the country.       turn around an
                       interest in investing started   Eventually, I started working    uncompetitive team early in
                       at an early age. I made my      as a financial advisor for the   his ownership tenure
                       first investment at age 13      privately held Spanos            demonstrates what a
                       when I bought some              organization on a part-time      consummate marketing
                       California real estate in       basis while in graduate          expert and extraordinary
                       northern Los Angeles            school. My schedule at           entrepreneur he is.
                       County prior to the             Stanford was unique in that I
                       construction of a new           would go to class in the         G&D: How did your
                       highway that would reduce       mornings, then frequently        career progress from
                       commute time from the           take the Spanos corporate        advisory into investing?
                       property to downtown by         jet to attend business
                       half. I purposely selected      meetings during the day, and     RG: My focus has always
                       land close to a new             later fly back in time to        been on investing in
                       McDonald’s that was under       attend class in the                           (Continued on page 43)
 Volume I,
Issue XVII Issue 2                                                                                               Page 43


Russell Glass
(Continued from page 42)        as well as investor Carl        whom you’ve worked with
companies that are              Icahn. After some time          or have come in contact
undervalued – I’m a value       though, I realized that being   with throughout your                   “The idea of the
investor. After advising        a principal had a number of     career?
Jerry Jones on the Dallas       advantages over being a                                                 fund was to use
Cowboys purchase, I set up      research analyst.               RG: In my opinion, Carl
an independent investment                                       has been the pioneer of                    corporate
research firm called Premier    I decided to partner with a     catalyst-driven, activist
Investment Research and                                                                                governance as a
                                group of former executives      investing. He is both a pure
served as an investment         and associates of T. Boone      value investor and tactician            means to hold
advisor to a select group of    Pickens forming Relational      who has produced
investors including the Hunt    Investors, an activist fund     investment success with a                management
family, owner of the NFL        based in California. The        multitude of companies,
Kansas City Chiefs, led by      idea of the fund was to use     both on the long and short              accountable to
Lamar Hunt, who was both        corporate governance as a       sides. Carl’s returns have
a sports visionary and          means to hold management        been excellent and he is an           shareholders. I saw
successful businessman.         accountable to                  impressive short seller,
Our investment research                                                                                 the efficacy of
                                shareholders. I saw the         which most people don’t
firm provided investors with    efficacy of being a proactive   know or pay attention to.              being a proactive
in-depth, fundamental, 100-     investor in companies years     His investments have
page research reports. We       earlier, after seeing Boone     compelling risk-adjusted                   investor in
were hired on an annual         Pickens’ success with Gulf      return profiles. When you
retainer basis – so it was      Oil, which when he invested     look at other investors or             companies years
truly an independent            in it, was trading at a steep   hedge funds, you cannot just
research service with no        discount to the intrinsic       look at the headline return.          earlier, after seeing
conflicts of interests. We      value of its reserves because   You need to know how
were not paid on our ability                                                                            Boone Pickens’
                                it was so poorly managed.       much leverage was used and
to trade or set up              After a couple of years at      what other types of risks              success with Gulf
management meetings, but        Relational, Carl Icahn          were taken to generate
rather on our ability to help   recruited me to become          those returns. Carl’s                 Oil, which when he
our clients find profitable     President of Icahn              portfolios are prudently
ideas. Back then, 99% of        Associates. Carl was a          hedged, so I would say that           invested in it, was
Wall Street research had a      great mentor. He is a self-     his risk-adjusted returns are
‘Buy’ recommendation, but       made professional with          even more impressive than             trading at a steep
our research was 1/3 ‘Buy’,     great intelligence and          most realize.
1/3 ‘Sell’, and 1/3 ‘Fair                                                                               discount to the
                                strategic acumen – he went
Value’.                         to Princeton from a public      G&D: Can you talk about               intrinsic value of its
                                high school that had            your current firm, RDG
We took the approach of         probably never sent a           Capital?                              reserves because it
looking at public companies     student to Princeton before.
from the perspective of a       Carl was one of the first and   RG: At RDG, I have                       was so poorly
private equity owner. Our       most prominent investors        essentially replicated the
research consisted of           who believed in taking a        staffing and structure at                 managed.”
thorough due diligence as       proactive approach to           Icahn Associates. We have
opposed to just predicting      investing in public             four investment
next quarter’s earnings.        companies. When I joined        professionals, all of whom
This thoroughness caught        his firm he had already         have M&A backgrounds.
the attention of a number of    established himself as a        Our investment style is
mutual funds, hedge funds,      legendary investor.             private equity oriented – we
and investment managers                                         employ a hybrid private
such as Fidelity Investments,   G&D: How does Carl              equity / public investment
Wellington Management,          compare to other investors                   (Continued on page 44)
and Neuberger & Berman,
          Page 44


                       Russell Glass
                       (Continued from page 43)        if we believe an opportunity     opening expenses, growth-
                       strategy. We look for           is compelling, not just          oriented R&D and capital
                       undervalued public              because we have to put           expenditures, or other
                       companies that can benefit      money to work. As a result       costs associated with
                       from a catalyst to both         our investment process           investing for the future. If
                       enhance and unlock value.       yields a high rate of            you find cheap companies
                       We focus on U.S. equities,      profitable investments           that are unfairly penalized
                       consider ourselves to be        because we have such a high      for making long-term
  “I have always       industry agnostic, and invest   threshold for value – we         investments in the business,
                       across the market               typically require at least a     those investments can
 believed some of      capitalization spectrum,        50% “margin of safety” as        become very productive and
                       although most of our            Seth Klarman from Baupost        yield significant returns for
the best investment    historical investments have     would say.                       the business and its
                       generally been in small and                                      investors. We also favor
decisions are those    midsize companies. Among        G&D: Can you give us a           companies which trade at
you choose not to      the catalyst events we          little detail on your research   low valuations relative to
                       generally focus on are                                                            their
make. Our special      private equity                                                                    sustainable
                       and strategic                                                                     free cash
     situations        buyouts,                                                                          flow that
                       corporate                                                                         have
    investment         spinoffs and                                                                      operating
                       divestitures,                                                                     margin
approach allows us     monetization                                                                      improvement
  to invest if we      transactions of                                                                   potential and
                       non-core                                                                          which often
    believe an         assets, share                                                                     have a sum
                       buybacks,                                                                         of the parts
  opportunity is       special                                                                           value in
                       dividend                                                                          excess of
compelling, not just   distributions                                                                     their trading
                       and other                                                                         price.
because we have to
                                                        RDG Capital team
   put money to                                                                                          Once having
                       recapitalization events, and    process?                         identified interesting
      work.”           improvements in operating                                        undervalued companies, we
                       management and corporate        RG: We first conduct a           then conduct extensive due
                       governance.                     statistical valuation screen     diligence with management,
                                                       to generate ideas, and if        industry analysts, customers,
                       Historically we have            they pass our screen, we         competitors, bankers, and
                       structured special purpose      perform a more detailed          often private equity firms
                       investment partnerships         quantitative assessment and      who have relevant sector
                       with co-investors who we        analyze companies on a           expertise. I have also been
                       believe bring strategic value   qualitative basis. While our     on the board of several
                       or industry experience to       systematic screen finds          companies in an array of
                       each investment                 public companies that trade      industries, including real
                       opportunity. I have always      at a significant discount to     estate, energy, biotech,
                       believed some of the best       peers, we also look at things    manufacturing, and business
                       investment decisions are        others often do not focus        services. These
                       those you choose not to         on or issues for which the       directorships give our team
                       make. Our special               market unjustly penalizes        insights into many types of
                       situations investment           companies, such as pre-                       (Continued on page 45)
                       approach allows us to invest
 Volume I,
Issue XVII Issue 2                                                                                                 Page 45


Russell Glass
(Continued from page 44)         million, despite the fact that   independently), improving
businesses and provide           the company had only             staff scheduling, increasing
valuable operating executive     recently invested $150           higher-margin beverage
relationships. We have a         million in cumulative capital    revenue mix, and licensing
great pool of industry           expenditures over the prior      the Benihana brand to
contacts that we can call on     few years. The market was        selected grocery products.               “As industry-
when we need to do a deep        discounting the recent           Finally, we were also
dive to learn about an           capital improvements by          attracted to the fact that in         agnostic investors,
investment opportunity. If       50% and assigning zero value     addition to owning its
we still find the opportunity                                                                            we look for public
                                 to the existing restaurant       flagship restaurant chain,
attractive after such an         chain generating $25 million     Benihana also owned two
evaluation process, we then
                                                                                                          companies that
                                 in recession-level EBITDA        other restaurant concepts,
consider what catalyst           which you were essentially       New York-based Haru and               would be better off
events may enhance and           getting for free.                Mid-Atlantic-based RA
unlock shareholder value.                                         Sushi. These restaurant                  being private
Finally, we consider the         At the time, the company         chain subsidiaries separately
corporate governance             was trading at less than 3x      were worth nearly the                 entities. If you look
structure and shareholder        EBITDA and, moreover,            entire market value of the
composition of a company                                                                                at a typical industry
                                 owned about $50 million          parent company.
to determine the feasibility     worth of real estate
of implementing the desired
                                                                                                         -focused fund, the
                                 underlying several of its        We decided to team up
catalyst initiatives.            restaurant locations which       with a restaurant-focused                sector that it
Ultimately, we seek to           could be monetized via a         private equity firm and
invest in those companies        sale/leaseback transaction.      made a buyout offer to the             focuses on would
which meet all our               If you took the near $75         company. Though our offer
investment criteria. It is a     million enterprise value and     was rejected, the company             likely be compelling
very time- and labor-            subtracted the approximate       subsequently hired Jefferies
intensive process, as we                                                                                as an undervalued
                                 $50 million in real estate       to explore strategic
want to understand the           value, the company was           alternatives and eventually
business and not just the
                                                                                                         opportunity only
                                 really trading at just 1x        sold itself to Angelo
security. That process           EBITDA adjusted for the          Gordon. The stock went                5% of the time, and
usually takes about three to     modest incremental rent          from $4 to $16 per share in
six months before we make        expense. Furthermore, at         less than two and a half                  it would be
each investment. By              the time of our initial          years.
maintaining these                investment, the economy                                                 reasonably valued
investment disciplines and       was just starting to come        As industry-agnostic
acting like private equity                                                                               or overvalued the
                                 out of the recession, and we     investors, we look for public
investors in publicly traded     believed that the company        companies that would be
companies, we have
                                                                                                         other 95% of the
                                 could increase EBITDA            better off being private
historically generated           from $25 million to $40+         entities. If you look at a                   time.”
unlevered IRR in excess of       million just based on a          typical industry-focused
30%.                             recovery in same store sales     fund, the sector that it
                                 growth and without any           focuses on would likely be
G&D: Can you provide an          operational improvements.        compelling as an
example of this strategy as it   Yet, we were also able to        undervalued opportunity
applied to a past                identify a number of             only 5% of the time, and it
investment?                      operational improvements         would be reasonably valued
                                 that could be made,              or overvalued the other
RG: A couple of years ago,       including centralization of      95% of the time. This is the
we invested in Benihana, the     purchasing (many of the          nature of a reasonably
Japanese steak house chain.      restaurants at the time had      efficient capital market –
At the time, the enterprise      been buying supplies                          (Continued on page 46)
value was less than $75
             Page 46


                           Russell Glass
                           (Continued from page 45)          professionals have M&A       retail and manufacturing
                           much of what is out there is      backgrounds, which we find   industries. For large
                           fairly priced at any given        helpful to navigate these    retailers and manufacturers,
                           point in time. We try to          corporate governance         this is mission critical
                           focus on the 5% of                matters.                     software – approximately
                           companies that are valuation                                   75% of the top retailers and
                           outliers, regardless of the       G&D: Can you talk about a    manufacturers use JDA’s
Pictured: Tom Russo        industries that they’re in,
speaks at the Omaha Din-                                     recent investment?           software. The supply chain
                           and because of this, we will                                   management software
ner in May 2012.
                           typically only invest in half a                                industry has been
                           dozen to a dozen companies                                     undergoing significant
                           on an annual basis.                                            consolidation.

                           G&D: What is your                                              When we started looking at
                           targeted time horizon for a                                    the company, we were able
                           typical investment?                                            to identify a high quality
                                                                                          company trading at a low
                           RG: We’d ideally like to                                       valuation relative to its
                                                               “We’d ideally like
                           see value created within a                                     sustainable free cash flow
                           year’s time, if not sooner,        to see value created        with significant costs that
                           but we are not short-term                                      could be cut out by a
                           opportunists. As                   within a year’s time,       strategic acquirer. Trading
                           arbitrageurs of value we are                                   around $27 per share, the
                           content to invest in longer-        if not sooner, but         company had an
                           term opportunities. Our                                        approximate $1 billion
                           investments have generally          we are not short-
                                                                                          enterprise value and,
                           ranged from six months to           term opportunists.         generating nearly $200
                           two years. The longer                                          million in EBITDA, was
                           you’re in an investment, the        As arbitrageurs of         trading at only 5x EBITDA,
                           longer you’re subject to                                       or an approximate 20% free
                           exogenous risks. If you can            value we are            cash flow yield given the low
                           influence change sooner, it                                    capital-intensive nature of
                           increases your IRR and             content to invest in        the business, with
                           reduces macroeconomic                                          substantial recurring
                           risk. We aim to generate                longer-term
                                                                                          revenue from long-term
                           the highest return with the                                    software maintenance
                                                                 opportunities.”
                           least amount of risk, so the                                   contracts. Based on our
                           faster we can help push                                        analysis, we believed a
                           along the value-unlocking                                      strategic buyer could
                           moves that need to be                                          extract as much as $125
                           made, the better.                                              million in synergies so, in
                                                                                          reality, the company could
                           We also view a company’s                                       generate more than $300
                           annual meeting as a way to                                     million in adjusted EBITDA,
                           enact change and gain             RG: Several months ago,      implying an approximate 3x
                           support from other                we became involved with an   pro forma EBITDA multiple,
                           shareholders. Every public        enterprise software          an especially attractive
                           company is required to hold       company called JDA           discount to the 10-12x
                           an annual meeting, and            Software. JDA is primarily   average EBITDA multiple of
                           some companies allow for          known as a best-in-class     its enterprise software
                           the calling of a special          supply chain management      industry peers.
                           meeting. As I mentioned           software vendor for the                   (Continued on page 47)
                           earlier, all of our investment
 Volume I,
Issue XVII Issue 2                                                                                                 Page 47


Russell Glass
(Continued from page 46)        recently completed               spent in the next 24 months
At the time, the company        acquisition and the pending      before LP capital
was under investigation for     introduction of new              commitments expire.
accounting irregularities by    products. JDA also had an        Private equity firms are                   “We figure
the Securities and Exchange     M&A value according to our       eager to put this capital to
Commission. We looked           analysis that indicated a        work. We figure altogether             altogether there is
into the accounting issue       private equity or strategic      there is $300+ billion in
and determined that it was                                                                                $300+ billion in
                                acquirer could justify paying    private equity “dry powder”
not fraudulent in nature, but   $45+ per share or a 50%+         plus $750 billion in readily
rather a minor issue
                                                                                                        private equity “dry
                                premium and still expect to      available low-interest debt
regarding the historical        generate an attractive 25%+      financing in a robust credit           powder” plus $750
timing of revenue               equity IRR and an active         market (in which leveraged
recognition. JDA was also       shareholder base with            buyout debt/EBITDA                      billion in readily
in the process of completing    customary corporate              multiples have increased to
the integration of an           governance policies. In fact,    near historic levels); this              available low-
acquisition and preparing to    we believed the private          translates into $1+ trillion in
introduce a promising new                                                                                  interest debt
                                market value was double          private equity-sponsored
multi-channel software          the public market value.         acquisitions in the next 24-
product, so we expected
                                                                                                           financing in a
                                                                 36 months. Additionally,
better results going            We liked the investment          there is $1.7+ trillion in                robust credit
forward.                        because there were multiple      cash on the balance sheets
                                ways to win, either through      of non-financial                        market (in which
Based on the steady nature      an accretive share buyback       corporations, nearly one
of its business – high-margin   or a sale of the company at      third of which is higher than          leveraged buyout
long-term contracts, sticky     a substantial premium. In        amounts typically held under
customer relationships, and                                                                                debt/EBITDA
                                the end, the company             normal economic
low churn – we thought the      recently received a $45 per      conditions. We believe a
company could easily do a
                                                                                                          multiples have
                                share buyout offer from Red      reasonable portion of this
highly accretive leveraged      Prairie, an enterprise           capital (together with new             increased to near
recapitalization share          software company owned           public equity issuance and
buyback which would result      by private equity firm New       additional debt financing)             historic levels); this
in stock appreciation from      Mountain Capital. It was a       will be directed toward
$27 to $40 per share. One       good outcome for                 public company M&A                     translates into $1+
of the two largest              management, private equity       activity.
shareholders had already                                                                                 trillion in private
                                investors, and shareholders.
achieved board                                                   Our thesis is that in the last
representation and was
                                                                                                         equity-sponsored
                                G&D: In a recent guest           few years, most companies
advocating for a sale of the    lecture at Columbia              have grown earnings by                 acquisitions in the
company. The company’s          Business School you              cutting costs. By now, most
valuation metrics and           mentioned that you believe       companies cannot cut costs                 next 24-36
fundamentals were               there will be a tsunami of       much more because there is
compelling. It had a low EV/    buyouts in the next couple       no room. Economic growth                    months.”
EBITDA multiple on both an      of years. Could you expand       is going to be slow for the
absolute and relative basis     on that?                         foreseeable future, which
compared to its peers, was                                       means that for most
trading at a 20% free cash      RG: We estimate there is         companies, top-line revenue
flow yield, was growing         approximately $150 billion       growth will be sluggish.
revenue and earnings at high    in private equity capital that   Therefore, in order for
single digits on an organic     was raised a few years ago       companies to grow bottom-
basis, and had operating        in vintage 2007-2008 buyout      line earnings there is strong
margin improvement in           funds that has yet to be         motivation to acquire
process from the cost           deployed and needs to be                       (Continued on page 48)
savings implemented in a
Page 48


          Russell Glass
          (Continued from page 47)        RG: Working with Carl          at companies through the
          industry competitors and        (Icahn) helped me see the      lens of a private equity
          eliminate duplicative costs.    merits of being a proactive    investor. We like a hybrid
          This scenario should result     investor in companies. Just    approach – being a public
          in an increase in both          as Steve Schwarzman and        shareholder but thinking and
          friendly and hostile M&A        Henry Kravis find attractive   acting like a private equity
          activity in the next few                                       fractional business owner.
          years. In fact, this                                           Although we lack the
          expectation is supported by                                    absolute control of a private
          a relatively recent Ernst &                                    equity owner, in cases
          Young survey which                                             where we garner the
                                            “It’s important to look
          indicated that 36% of U.S.                                     support of a majority of
          corporations intend to            at companies through         shareholders, we become
          engage in M&A activity                                         the informal voice of the
                                             the lens of a private
          within the next year or so.                                    majority and thereby have
                                           equity investor. We like      influence on management.
          G&D: It sounds like some                                       In the past we have hosted
                                             a hybrid approach –
          of those supportive                                            informal shareholder forums
          dynamics have been in place           being a public           to discuss the management
          for a while. Why do you                                        and future direction of
                                               shareholder but
          think the buyout activity                                      companies in which we are
          hasn’t ramped up this year?      thinking and acting like      a stakeholder. The benefit
                                               a private equity          of being a public investor is
          RG: The election certainly                                     that you can typically
          played a part – corporate           fractional business        acquire equity at a
          executives don’t like to                                       significant discount to its
                                             owner. Although we
          make important M&A                                             intrinsic private market
          decisions in an uncertain            lack the absolute         value (rather than a buyout
          environment. They want to                                      premium), employ no
                                             control of a private
          know what the tax,                                             leverage (rather than 4x or
          healthcare, and regulatory        equity owner, in cases       often greater debt/EBITDA
          environment is going to                                        in an LBO), and still have an
                                             where we garner the
          look like. With the election                                   element of constructive
          over, there is more clarity.     support of a majority of      influence on the company.
          Companies have reached
                                               shareholders, we
          the end of their cost-cutting                                  There’s been a positive
          ability, as well. To put this     become the informal          change towards shareholder
          in a sports analogy, we                                        activism in the past 10
                                             voice of the majority
          believe that we’re in the 7th                                  years. The rise of proxy
          or 8th inning of companies          and thereby have           advisory firms has provided
          reducing internal costs and                                    a level playing field. After
                                                 influence on
          will now begin to see a shift                                  recognizing years of
          to acquiring businesses.              management.”             corporate mismanagement
                                                                         and malfeasance,
          G&D: Do you think activist                                     institutional investors have
          investors are still viewed                                     become justifiably more
          with a stigma? It seems like                                   active and now have a
          it is now more socially         businesses and enhance         greater willingness to
          acceptable, if you will, to     those businesses, we believe   support dissident
          engage management and           professional public market     shareholder initiatives.
          advocate for change than it     shareholders can do the        Unlike in the past when
          was 10 or 15 years ago.         same. It’s important to look                (Continued on page 49)
 Volume I,
Issue XVII Issue 2                                                                                            Page 49


Russell Glass
(Continued from page 48)          management does not have        10-15 years ago?
institutional investors           their personal interests
almost always sided with          properly aligned to             RG: While the number of
incumbent management              maximize shareholder value.     activists has grown modestly
against activist shareholders,    In these cases, we organize     in recent years I believe the
in recent years dissident         shareholder forums, engage      opportunity set has grown
shareholders have actually        in proxy contests, and          more and that we are still at
more often than not won           exercise other corporate        the early stage of public
the majority of proxy             governance measures to          shareholders taking more
contests or reached
                                                                                                        “In a study
                                  hold management                 initiative in the governance
favorable settlements, such       accountable to serve the        of the companies they own.          conducted by
as board representation, to       best interest of
avert a proxy contest.            shareholders.                   G&D: Can you talk about a           researchers at
Although there is still the                                       few mistakes you've made in
classic management / agency       G&D: You’ve done                your career?                        Wharton and
dilemma in corporate              academic research around
America, the board and                                                                             Columbia Business
                                  activist investing and how      I should have bought more
management of more                once an activist becomes        land in southern California
companies, recognizing their
                                                                                                   School, companies
                                  involved, a company’s stock     when I was 13 years old.
fiduciary duties to               price outperforms the                                            which had been the
shareholders, have become         market. Can you talk a little   G&D: What’s the best
appropriately more                about your research?            advice you’ve ever received?        subject of 13D
responsive to activist
investors. We think activist      RG: As an undergraduate         RG: Working with Alex            filings indicating the
investing is still in its early   majoring in economics at        Spanos taught me to have a
stages here, and                                                                                     presence of an
                                  Princeton I wrote an            “can-do” attitude. From a
international markets are 10      academic research report        man who overcame
to 20 years behind the U.S.
                                                                                                   activist shareholder
                                  on the efficiency of capital    adversity early in his life to
with regard to corporate          markets and the economic        become one of America’s                generally
governance and activism.          benefits of shareholder         true Horatio Alger success
                                  activism and hostile            stories, Alex advised me to       outperformed the
G&D: In terms of the              takeovers. Since then, there    set achievable goals in life
range of activists, from          have been numerous              and, when confronted by              S&P 500 by
friendly activists such as        academic studies highlighting   challenge, to act with
Relational at one end to the                                                                       approximately 5%-
                                  the efficacy of shareholder     integrity and dedication to
more antagonist activists on      activism on investor returns.   “just make it happen.”
the other end of the
                                                                                                     7% per annum.”
                                  In a study conducted by
spectrum, where do you            researchers at Wharton and      G&D: Thank you very
stand? Why is this                Columbia Business School,       much for your time, Mr.
approach best for you?            companies which had been        Glass.
                                  the subject of 13D filings
RG: We are in the middle          indicating the presence of an
of the activism spectrum          activist shareholder
with flexibility to work on a     generally outperformed the
constructive, collegial basis     S&P 500 by approximately
with incumbent                    5%-7% per annum.
management to the extent
they are legitimately willing     G&D: Do you feel that the
to explore ways to enhance        activist investor field is
shareholder value, but also       getting crowded? Are there
to work as a staunch              still the same opportunities
defender of shareholder           for you that were available
rights in cases where
          Page 50


                      Jon Friedland
                      (Continued from page 1)          the stock was widely owned      backpacked around Asia.
                      hedge fund, where he was
                                                       by many hedge funds. After      This was perhaps my first
                      responsible for media,
                      entertainment, and leisure       a few years at that fund, Pat   explosive learning
                      ideas for the firm. Mr.          Duff, a fellow CBS Alum         experience. I traveled by
                      Friedland received his B.A.      who had been one of my          boat, bus, train, and plane all
                      in Political Science from        visiting Security Analysis      over China, Tibet, Thailand,
                      Vassar College in 1991 and       professors, introduced me       Vietnam, and Nepal. For
                      his MBA from Columbia            to Paul Orlin and Alex          someone that grew up in
                      Business School in 1997.         Porter of Amici Capital.        Ohio, this was really an eye-
                                                       We hit it off very well in      opening trip. I fell in love
                      G&D: How did you first           terms of investment             with learning about different
  Jon Friedland       become interested in             philosophy and approach.        cultures, which led me to a
                      investing and what brought       That was over 10 years ago      five-year career in foreign
                      you to Amici?                    and I still come to work        aid prior to attending CBS.
                                                       happy every day.
                      JF: At Columbia Business                                         The great thing about the
                      School, I took a number of       G&D: What is the meaning        investment business is that
                      classes that had a profound      behind the name of your         there are investment
                      impact on the course of my       firm, Amici Capital?            opportunities to suit
                      career. Bruce Greenwald’s                                        anyone’s background,
 “The great thing     Value Investing class was        JF: As of January we            interest, and creativity.
                      one. The creativity and          changed the name of the         When I came to Amici in
    about the         clarity with which he            management company from         2001, there was little
                      analyzed businesses was          Porter Orlin to Amici           international investment.
investment business   fascinating. Second was          Capital to align it with the    Then in 2002 we saw a
                      Security Analysis with Jim       name of our funds. ‘Amici’      number of restructurings of
 is that there are    Rogers. He put students in       in Latin means ‘friends’. The   international companies in
                      the role of a real time          capital that was initially      industries that I had studied
    investment        company analyst. New             raised was from friends, so     carefully in the U.S. –
 opportunities to     York-based investment            from the beginning Amici        specifically the
                      managers with expertise on       was used in our funds’          telecommunications and
   suit anyone’s      our companies would come         names. Since the firm’s         cable television industries.
                      to Jim’s class to grill us. It   establishment in 1976, we       Companies like NTL
   background,        was great. It gave me a          have maintained the             Incorporated in the UK and
                      sense of how much you            philosophy that our             pan-emerging market cell
   interest, and      should know before making        investors and partners          phone operator Millicom
                      an investment. And I fell in     should be treated as friends.   International were trading at
    creativity.”      love with the explosive          Amici is also reflective of     distressed levels because of
                      learning process that            the cooperative culture         forced sales and complexity.
                      accompanies primary              within the firm.                The comfort that I had from
                      research on an industry or                                       my foreign aid work in
                      company.                         G&D: What drew your             Africa, Asia, and Latin
                                                       initial interest to investing   America was important. It
                      I was hired out of CBS by a      primarily outside of the        helped us to become more
                      large hedge fund because I       U.S.? What are some of the      comfortable applying the
                      had done some original           advantages and                  Amici investment process of
                      primary research on an           disadvantages with an           deep fundamental business,
                      ultrasound system                international focus?            industry, and valuation
                      manufacturer for that                                            analysis to recognize that
                      Security Analysis class. My      JF: Halfway through my          these companies were
                      research suggested the           college career at Vassar, I     trading at a significant
                      company’s stock was highly       took a semester off and                       (Continued on page 51)
                      overvalued, at a time when
 Volume I,
Issue XVII Issue 2                                                                                      Page 51


Jon Friedland
(Continued from page 50)         How do you narrow down           inwardly driven. Imports to
discount to intrinsic value.     your hunting ground to a         GDP plus exports to GDP
                                 manageable level from            sum to a mid-30% of GDP
Around this time we were         which to sort through to         in both, which is quite low
also short automotive            find new ideas?                  by comparative standards.
manufacturers in the U.S. in                                      We like internally-driven
large part because               JF: We try to invest in the      economies because they are
competitors in Japan and         same way and in the same         less subject to global
elsewhere were gaining           types of companies no            economic winds.
market share and operated        matter where we invest.          Increasingly we have also
with structural advantages.      We are looking for great         developed contacts and
Additionally, we were short      franchises trading at            experience in these
some IT consulting               substantial discounts to         countries, which has
companies in the U.S. as         intrinsic value.                 increased our comfort level
their most profitable                                             further.
business lines were facing       We invest in emerging
stiff and increasing             markets because our view is      Secondly, we invest in global
competition from Indian IT       that consumers, corporates,      companies that do business
outsourcing companies.           and sovereigns in emerging       in a portfolio of emerging
                                 markets have far better          markets countries, many of
I think at that time, and        balance sheets than they do      which we would not invest
increasingly since then, the     in the developed world. As       in directly. We are able,
ability to apply our             a result, we believe that        through a portfolio
investment process to an         economic growth in               approach, to take advantage
expanded universe of             emerging markets is going        of positive trends in
investment candidates            to be far greater than it will   countries in which we
improves the likelihood of       be in the developed world.       would not take a
our success. I think this is a   The World Bank just              concentrated position.
big advantage for us.            published a study projecting     Brazil and India have
                                 that GDP growth in               predictable government
G&D: Are international /         developed countries in 2013      policies and a rule of law
domestic pair trades, such       will be 1.2% and in              that we understand. We
as the aforementioned ones       developing markets it will be    cannot say this about many
from a decade ago, a big         5.5%, which is a huge            other countries.
part of what you look for?       differential.
                                                                  G&D: How do you go
JF: We do not seek out           Within that context we take      about looking for new ideas?
pair trades. We are quite        a multi-pronged approach.
active in our industry           First, we invest in              JF: As our team travels,
analysis in trying to identify   companies doing business in      reads, and speaks to people,
both winners and losers.         specific emerging market         we are always looking for
Sometimes this will result in    countries, India and Brazil      great companies that we
a short or hedge from the        being primary examples,          would love to own at the
same industry, but each          where we have a high             right price.
investment, long or short in     degree of confidence in the
our portfolio, goes through      long-term macro outlook.         We enter these companies
the same investment              Both countries have large        into a database and refer to
scrutiny and must stand on       populations and diversified      these companies as our
its own.                         economies that are capable       ‘Battleships’. These are
                                 of supporting world-class        large, highly profitable, and
G&D: There is an                 companies. Second, both of       well-capitalized companies
extensive universe of            those countries are fairly                    (Continued on page 52)
international companies.
              Page 52


                             Jon Friedland
                             (Continued from page 51)         opportunities presented to     list, the 101st company?
                             that have demonstrated           them. We have met and
                             pricing power in                 studied management at          JF: It comes slowly. We
                             consolidated industries with     most of these companies,       may add two to five
                             low competitive intensity.       and have done extensive        companies a year, while at
                             They are run by                                                 the same time a few
                             management teams that                                           companies will come off of
                             have established a record of         “We believe that           the list if some missteps
                             intelligent capital allocation                                  have happened or the story
                             and have made strategic                 investing in            has changed. We do a lot
                             decisions we understand.                                        of traveling to Latin
                             We believe that investing in            ‘Battleship’
                                                                                             America, Asia, and Europe
                             ‘Battleship’ companies, as        companies, as distinct        looking for new ideas and
                             distinct from very small                                        we like to meet with new
                             upstart companies with                from very small           companies. We are always
Pictured: Jon Friedland
speaking at the Moon Lee     illiquid stock, gives us an                                     looking for new candidates.
                             added margin of safety              upstart companies
Prize Competition in Janu-
ary 2012.                    because these companies             with illiquid stock,        G&D: How important is
                             are less likely to be blown                                     meeting with a management
                             around by economic                  gives us an added           team face to face?
                             volatility. We believe this is
                                                                  margin of safety
                             an important risk                                               JF: It is very important.
                             management component                  because these             We believe that strong
                             when investing in emerging                                      management teams play a
                             markets, where both                 companies are less          critical role in the ultimate
                             operating performance and                                       success of an investment.
                                                                 likely to be blown
                             stock price performance can                                     We need to know that
                             be more volatile.                  around by economic           management teams are
                                                                                             thinking like owners and we
                             G&D: It sounds like you           volatility. We believe
                                                                                             have to understand their
                             are looking for ‘Warren                                         long-term outlook for their
                                                                this is an important
                             Buffett-like’ companies and                                     company and their industry.
                             have a longer-term time              risk management            We need to understand
                             horizon than the typical                                        what is important to them,
                             hedge fund.                         component when
                                                                                             how they incentivize their
                                                               investing in emerging         employees, and what their
                             JF: In a way that is right.                                     company culture is like. For
                             Our Battleships list contains      markets, where both          us, this interaction is
                             roughly 100 international                                       important and can be telling.
                             companies that we would                  operating
                                                                                             I can recall one otherwise
                             like to own at the right             performance and            promising investment that
                             price. We may own only a                                        we passed on after meeting
                             certain number of these                 stock price             the CEO who was very
                             companies at any given time,                                    crude, which we feared was
                             but pick our entry and exit        performance can be
                                                                                             an indication of poor
                             points based on current               more volatile.”           judgment in other areas.
                             valuations. They may not all
                             be attractive investments in     work on them over the          G&D: How do you manage
                             any particular year, but the     years.                         your long and short
                             common thread is our high                                       exposure? Is there any
                             degree of confidence in          G&D: How do you find           mathematical component to
                             their long-term ability to       the next name to add to this                (Continued on page 53)
                             capitalize on the
 Volume I,
Issue XVII Issue 2                                                                                                Page 53


Jon Friedland
(Continued from page 52)        that the much faster growth      RFPs for $65 billion worth
it, or is it more based on      rates of the developing          of infrastructure products.
the quality of long and short
                                                                                                         “Sometimes you
                                world economies described
ideas at a point in time?       in the World Bank report         A lot of emerging markets              have to go outside
                                we discussed, coupled with       are turning the global
JF: The Amici Global Fund       a valuation discount to          liquidity surge from                    the U.S. to find a
that I manage is somewhat       developed market stocks,         developed market central
different than our core         creates a rich opportunity       banks into their advantage,            ‘grand bargain’. We
funds. It offers                set in emerging countries.       trying to steer capital
concentrated exposure to                                                                                  believe that the
                                                                 toward foreign direct
the international positions     Now is an interesting time       investments as opposed to
within our core Amici funds
                                                                                                        much faster growth
                                to invest in emerging            portfolio flows. We look at
managed by Paul Orlin. The      markets because emerging         this as a third, and smarter,              rates of the
Amici Global Fund was           market governments are           stimulus tool in addition to
established to take             increasingly making positive     the more conventional fiscal            developing world
advantage of the attractive     long-term policy decisions,      and monetary tools.
emerging market dynamics        having exhausted most                                                       economies
we discussed before. It         other options. This is in        G&D: Can you talk about
generally has a larger net                                                                                described in the
                                part because many                an idea that you like right
long exposure and accepts       countries are bumping up         now?                                   World Bank report
more volatility on the          against more governors on
assumption of a highly          their growth rates than they     JF: Our compliance                     we discussed [1.2%
attractive long-term            have in the past decade.         department will not allow
opportunity. At any given       Inflation recently has been      me to mention specific                      growth in
time, our exposure is a         stubbornly high and a lot of     names, but I can speak more
function of the risk/reward     labor has already come into      broadly. Real estate in India          developed countries
opportunities we are seeing     the labor pool. More             is currently an area that is
with individual stocks. We                                                                               vs. 5.5% growth in
                                fundamental changes and          ripe for investment. There
are not macro investors.        action from governments is       are a few ‘Battleship’                 emerging markets],
                                required than has been           companies that have
We also pay close attention     necessary over the past          managed to come through                  coupled with a
to valuations across the        decade. What gives us            the latest down-cycle intact
emerging market asset class     comfort is that we are           and are in a good position.            valuation discount
on an absolute basis and on     starting to see that happen.     We have a position in a
a relative basis compared to                                     company that owns a land                  to developed
developed markets. This         For example, in India since      parcel outside of a major
analysis goes back 20 years                                                                               market stocks,
                                September we have seen           Indian city, in an area akin to
to give us a sense of           liberalization relating to       Greenwich, Connecticut
whether the odds are
                                                                                                           creates a rich
                                foreign direct investment in     outside of New York, which
stacked in our favor.           retail and aerospace, a          it is developing into                   opportunity set in
Emerging market stocks are      reduction in subsidies for       residential and commercial
volatile and correlated, so     diesel and natural gas prices,   space. We believe it has an                 emerging
we think it is important to     and the first hike in            asset value substantially
be conscious of this data.      government-run railroad          greater than its current                   countries.”
                                fares in a decade. Real          market value. The question
G&D: Where are we               interest rates in Brazil have    is whether this asset value
today in terms of emerging      plummeted from over 10%          will ever be realized for the
market attractiveness versus    to less than 2% in the past      benefit of minority
developed markets?              eight years, much of this        investors.
                                reduction in the last year
JF: Sometimes you have to       and a half. The government       We are seeing signs of
go outside the U.S. to find a   in Brazil has recently issued                  (Continued on page 54)
‘grand bargain’. We believe
               Page 54


                                Jon Friedland
                                (Continued from page 53)         Brazil. But to support          catalysts to help get the
                                positive strategic changes in    growth, Brazilian               Brazilian government to
                                operating practices that         homebuilders began to           take some positive actions
                                suggest the asset value may      outsource oversight of          as discussed earlier.
                                become visible and we are        construction to such an
                                hopeful that it will             extent that they lost           G&D: It seems that you
                                appreciate in the next year.     complete control of the         are primarily focused on
Pictured: Paul Orlin of         We have seen developers          process. The cost and time      hard asset plays in emerging
Amici Capital speaking at the   sell down crown-jewel            overruns were enormous          markets. Do you spend
Moon Lee Prize Competi-         assets and non-core assets       and destroyed profitability.    much time looking at other
tion in January 2012.           to shore up their balance        Because of the way things       types of businesses in these
                                sheets. We see a                 are accounted for, the          markets?
                                willingness to re-focus          entire hit to profitability
                                business models on core          comes at the end of a           JF: Absolutely. There are
                                competencies. The roots of       project – you can’t go back     such powerful tailwinds
                                these management teams           and restate prior periods.      behind consumers, such as
                                are as buyers, developers,       Financial results look          rapidly rising wages and
                                and marketers of land.           terrible now but new            standards of living.
                                They have now outsourced         construction launches have      Consumer-focused
                                construction and project         declined substantially from a   companies are among our
                                management to best-in-class      few years ago. We think         favorite investment themes
                                companies and substantially      that profitability of these     in developing markets, as
                                reduced the volume of            companies may very well         long as we can purchase
                                product they seek to bring       return to high levels. These    them at reasonable
                                to market annually. This         companies are currently         valuations. We have
                                will improve quality, pricing    trading at or below             invested in drugstore and
                                integrity, and ultimately cash   liquidation value, with no      mall companies in Brazil.
                                flows.                           value ascribed to the           There is a big secular shift
                                                                 ongoing value of the            from informal to formalized
                                Furthermore, in India we         business.                       retail in the country. Some
                                think there is a good chance                                     of these companies that
                                that interest rates come         G&D: We remember the            have scale, buying power,
                                down in the next year,           impact that the Beijing         and systems are benefitting
                                which will increase              Olympics in 2008 had on         tremendously. In India we
                                valuations and will increase     the level of investment         have invested in beverage
                                the availability of mortgages    spending in China. How          companies. Last year we
                                from extremely low levels.       much do the impending           invested in a company that
                                Mortgages are below 5% of        2014 World Cup and 2016         had substantial share in the
                                GDP in India, well below         Olympics impact the way         beverage industry. It ran
                                the global average.              you look at construction in     into some distribution
                                                                 Brazil?                         issues that had impaired
                                We see a similar situation                                       profitability in the short
                                with Brazilian homebuilders.     JF: I look at these events as   term. We studied how
                                Over the last residential real   helping force good              similar disruptions had
                                estate cycle, all of the         decisions. Airports, rail       impacted profitability at the
                                developers raised money at       lines, and roads around the     company over medium-term
                                the same time and began to       country are going to have to    periods, and realized that
                                grow launches at multiples       see some investment. Brazil     the company was likely to
                                of prior 5- and 10-year          has among the worst             recover and pass through
                                rates. Unlike in India,          infrastructure in the world.    incremental costs that it
                                project oversight and            I am hopeful that these         faced. In fact, it was one of
                                management was a core            events are serving as                        (Continued on page 55)
                                competence historically in
 Volume I,
Issue XVII Issue 2                                                                                            Page 55


Jon Friedland
(Continued from page 54)        Your Core funds were             ultimately becomes a long-
the largest contributors to     down less than 6% versus a       term proposition, but once
last year’s profitability.      37% decline for the S&P          you are seasoned and have
                                500. How were you able to        some maturity allowing you          “We have an
G&D: What is Amici’s            achieve such a great year        to understand yourself
“secret sauce?” What has                                                                          investment process
                                when many other hedge            better, you might discover
led to you outperformance       funds and the broader            that you should be              that has been refined
over the long term?             market struggled?                elsewhere instead. Find a
                                                                 place that you are               since 1976 and we
JF: We have an investment       JF: We have a culture of         comfortable with. I was at a
process that has been                                                                                seek constant
                                risk management at Amici         growth-oriented hedge fund
refined since 1976 and we       Capital. It is always primary    prior to coming to Amici        improvement in that
seek constant improvement       in our minds. We are never       and found myself as the ‘low
in that process. We know        going to chase performance       -beta’ guy there, whereas at     process. We know
how to identify great           if we don’t think the            Amici Capital I tend to be
businesses and broken                                                                            how to identify great
                                opportunity set looks            more comfortable as the
businesses. We have the         attractive. We are heavily       ‘high-beta’ guy. Find a place   businesses and broken
ability to judge management     short single names – this is a   where you can bring your
teams by meeting with them      core part of what we do. In      interests, your passions, and   businesses. We have
and by analyzing quantitative   the process of turning up        your experience and try to
changes that occur in a                                                                           the ability to judge
                                great businesses you are         differentiate yourself.
business while a specific       always going to turn up                                           management teams
team is in charge. We also      some losers. It is important     G&D: Thank you for
constantly assess risk/         to hedge the portfolio with      sharing your thoughts with      by meeting with them
reward in our individual        a set of companies that are      us, Mr. Friedland.                and by analyzing
positions and pockets of        misunderstood from a
risk in the portfolio.          perspective that is too                                          quantitative changes
                                optimistic. Our
Over the past eight years,      performance in 2008 was a                                           that occur in a
we have developed a wide        function of sensing the risks                                       business while a
array of contacts across the    in the global
globe. There are not many       macroeconomic                                                      specific team is in
funds that are U.S.-based       environment and reducing
value investors that have the                                                                      charge. We also
                                exposure slightly, and, most
ability or the inclination to   importantly, having a set of                                     constantly assess risk/
look intensively for single     shorts that were oriented
names in many foreign           toward the leverage that                                             reward in our
countries. We’ve found          had built up in the system.
ourselves increasingly                                                                            individual positions
capable of monitoring many      G&D: Do you have any                                             and pockets of risk in
different situations via our    parting words of wisdom
list of ‘Battleship’            for our readers?                                                    the portfolio.”
companies. When a
disruption takes place with a   JF: As you come out of
company on this list, due to    business school it is
our team-oriented nature,       important to take the best
we are capable of collapsing    opportunity you can find
a lot of resources on an idea   where you can get the best
and quickly coming to a         exposure to a variety of
conclusion.                     situations so you can see
                                what you like and what you
G&D: Amici had great firm       are good at. Ideally that job
-wide performance in 2008.
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 jhedstrom13@gsb.columbia.edu
      jlubel13@gsb.columbia.edu     Please also share with us any suggestions for future issues of Graham and Doddsville:
    strivedi13@gsb.columbia.edu


                                    Graham & Doddsville 2012 / 2013 Editors

                                                     Jay Hedstrom is a second-year MBA student and a member of the Heilbrunn Center’s
                                                     Value Investing Program. During the summer Jay worked for T. Rowe Price as a Fixed
                                                     Income Analyst. Prior to Columbia Business School, Jay worked in investment grade
                                                     fixed income research for Fidelity Investments. He can be reached at jhed-
                                                     strom13@gsb.columbia.edu.



                                                     Jake Lubel is a second-year MBA student and a member of the Heilbrunn Center’s
                                                     Value Investing Program. During the summer he interned at GMT Capital, a long-short
                                                     value fund. Prior to Columbia Business school he worked under Preston Athey on the
                                                     small-cap value team at T. Rowe Price. He received a BA in Economics from Guilford
                                                     College. He can be reached at jlubel13@gsb.columbia.edu.



                                                     Sachee Trivedi is a second-year MBA student. Over the summer this year, she in-
                                                     terned at Evercore Partners in their Institutional Equities division as a sell-side research
                                                     analyst. Prior to Columbia Business School, Sachee worked as a consultant in KPMG’s
                                                     Risk Advisory business and at Royal Bank of Scotland in London. She can be reached at
                                                     strivedi13@gsb.columbia.edu.

				
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