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

                             Issue XX                                                                      Winter 2014
Inside this issue:
Ken Shubin Stein P. 3
                                                       Lee Ainslie—No Holds Investing
Lee Ainslie          P. 18
                                              Lee S. Ainslie III is the head of Maverick Capital, which he formed
Geoffrey Batt        P. 28                    in 1993. Prior to founding Maverick, he worked at Julian
                                              Robertson’s Tiger Management. He holds a bachelor's degree
Investment Ideas P. 42                        from the University of Virginia and an MBA from the University of
                                              North Carolina’s Kenan-Flagler Business School.
Jim Grant            P. 52                                                                                (Continued on page 18)

                             Lee Ainslie
Justin Muzinich      P. 60
                             Ken Shubin Stein—A Study                                   Geoffrey Batt—
                                    in Investing                                     Perception and Reality
                                              Dr. Kenneth Shubin Stein                              Geoffrey Batt is the
                                              is the Founder and                                    managing partner
                                              Portfolio Manager of                                  and founder of the
Editors                                       Spencer Capital                                       Euphrates Iraq
Chris Brigham                                 Management and the                                    Fund. He has been
MBA 2014                                      Chairman of Spencer                                   investing on the
                                              Capital Holdings.                                     Iraq Stock
Jackson Thies, CFA                            Spencer Capital is a value                            Exchange since
MBA 2014                                      -oriented investment                                  January 2008. Mr.
                             Ken Shubin                    (Continued on page 3)
                                                                                     Geoffrey              (Continued on page 28)
Jason Yang                     Stein                                                  Batt
MBA 2014
Matt Ford                         Jim Grant—Lifelong                                Justin Muzinich—Find
MBA 2015                               Observer                                        Good Businesses
Mike Guichon                                        James Grant is the             Justin Muzinich is a
MBA 2015                                            founder and editor             President at Muzinich
                                                    of Grant’s Interest            and Co. Inc., a pri-
                                                    Rate Observer, a               vately owned invest-
                                                    twice-monthly                  ment management
Visit us at:                                                                       firm with a focus on                               journal of the                                       financial markets.             rigorous credit analy-
                                                    After graduating               sis. Prior to joining
                                                    from Indiana                   Muzinich, he was a
                                                    University with a              Managing Director at
                                 Jim Grant         degree in economics             EMS Capital and             Justin
                                                   and Phi Beta Kappa              worked in the mer-        Muzinich
                              accolades and earning a degree in                    gers and acquisitions
                              international affairs from Columbia                  group at Morgan Stanley. Mr. Muzi-
                              University, he began his journalistic                nich holds a Juris Doctor degree from
                                                                                   Yale Law School, where he was an
                                                         (Continued on page 52)
                                                                                                          (Continued on page 60)
                 Page 2

                                Welcome to Graham & Doddsville
                                We are pleased to bring you      running a credit-oriented        nancial system, and discuss-
                                the 20th edition of Graham &     asset management business.       es how skepticism shapes
                                Doddsville. This student-led     He also talks about the op-      both better journalists and
                                investment publication of        portunity he sees in the         investors.
                                Columbia Business School is      European debt markets.
                                co-sponsored by the Heil-                                         This issue also contains pic-
                                brunn Center for Graham &        Geoffrey Batt shares his         tures from the 23rd Annual
                                Dodd Investing and the Co-       unique transition from a         Graham & Dodd Breakfast,
                                lumbia Student Investment        philosophy student to a          which took place on Octo-
                                Management Association           frontier markets investor        ber 4th at The Pierre Hotel
                                (CSIMA).                         focused on Iraq. He ex-          in New York, and featured
                                                                 plains his interest in the       Neil Petroff of the Ontario
Heilbrunn Center Director
Louisa Serene Schneider.        We were lucky enough to          Iraqi markets and describes      Teachers’ Pension Plan as
Louisa skillfully leads the     speak with five great thinkers   his process for searching for    the keynote speaker. Lastly,
Heilbrunn Center, cultivat-     and investors who provide a      equity markets that are on       this issue includes the win-
ing strong relationships        range of different perspec-      the verge of a significant re-   ning pitch from the 2013
with some of the world’s        tives and investment             rating. Mr. Batt also shares     Darden @ Virginia Investing
most experienced value          approaches to this issue.        some interesting ideas he        Challenge, and the four
investors and creating nu-      Lee Ainslie recounts how         currently sees in Iraq.          finalist pitches for the 2014
merous learning opportuni-      he founded Maverick Capital                                       Moon Lee Prize Competi-
ties for students interested
                                and shares his thoughts on       Ken Shubin Stein discuss-        tion.
in value investing. The clas-
ses sponsored by the Heil-      hiring analysts and structur-    es the structural and behav-
brunn Center are among          ing his team. Mr. Ainslie also   ioral elements of investing      We would like to thank our
the most heavily demanded       describes what he looks for      and describes the methods        interviewees for sharing
and highly rated classes at     in a good investment, shares     his firm employs to improve      their time and insights with
Columbia Business School.       an idea that he likes, and       its investment process. Mr.      our readers. As always, we
                                candidly recounts past mis-      Shubin-Stein also shares         invite you to contact us if
                                takes that he has learned        some present and historical      you have any comments or
                                from.                            ideas.                           suggestions, and we thank
                                                                                                  you very much for reading.
                                Justin Muzinich talks            James Grant discusses his
                                through his perspectives as a    career in investment jour-                - G&Dsville Editors
                                credit investor—both in          nalism, argues for significant
                                looking at credit ideas and      overhauls to the global fi-

Professor Bruce Green-
wald. The Heilbrunn Center
sponsors the Value Invest-
ing Program, a rigorous
academic curriculum for
particularly committed
students that is taught by
some of the industry’s best

                                 Neil Petroff speaking at the 23rd annual        Bruce Berkowitz speaking at the 2013
                                       Graham and Dodd Breakfast                 CSIMA Conference
Issue XXI, Issue 2                                                                                            Page 3

Ken Shubin Stein
(Continued from page 1)         it's difficult.                approaches that people
management firm with a                                         follow is wider. There are
successful long-term            But he makes it accessible     certainly lots of debates in
track record investing in       and that's how I became        health care but, in finance,
undervalued securities          interested. I started          we have different views on
and special                     investing early, and quickly   fundamental concepts about
situations. He is also an       took over handling             the way the world works
Adjunct Professor at            investments for my family. I   and there are conflicting
Columbia Business               was investing concurrently     ideas accepted at business
School, where he                                               schools—an obvious one is
teaches the Advanced                                           the efficient market
Investment Research                                            hypothesis, another is the
course. Dr. Shubin Stein                                       question of whether
is a graduate of the                                           volatility is risk. These
Albert Einstein College                                        simple, core questions are
of Medicine where he                                           debated decades after first           Ken Shubin Stein
completed a 5-year                  “We think about            being asked and I find that
medical and research                                           interesting.
program with a focus on            process a lot, and
molecular genetics. He                                         G&D: Are you still involved
has a B.A. from
                                       we’ve tried to
                                                               in healthcare other than
Columbia College,                    create a process          investing in it?
Columbia University
with a dual                       that maximizes our           KSS: I still have a passion
concentration in                                               for healthcare and a strong
Premedical Studies and              chance for great           network in that
Political Science.                                             world. Many members of
                                                               my family are doctors and
Graham & Doddsville                                            scientists, and I am on the
(G&D): You have a fairly                                       Board of Advisors at the
non-traditional background          For us, a process          Hospital for Special Surgery,
for a value investor. How                                      so I regularly speak with
did you become interested        needs to be explicit,         doctors, scientists and
in investing and how did you                                   healthcare executives.
make the transition from             repeatable, and           Additionally, I am involved
getting your M.D. to                                           from a public health
investing?                                 flexible.”
                                                               standpoint through
                                                               Crutches 4 Kids, a charity
Ken Shubin Stein (KSS):                                        that I co-founded to help
From an early age, I've                                        collect crutches from
always had an interest in                                      people who have and don’t
both health care and                                           need them any more, and
investing. My mom               with my science and medical    distribute them to children
introduced me to investing      training, and eventually       who need and don’t have
when I was a kid and she is     made a decision that I         them.
the first one who taught me     wanted to make investing a
about buying stocks. I was      career.                        G&D: How has your
exposed to Warren Buffett                                      medical and scientific
in the early '80s, and that     One of the things about        background helped you as
was pure luck. Buffett is so    investing that is different    an investor?
good at writing about it that   from a field such as health    KSS: It's been helpful in
he makes you think you can      care is that the spectrum of                 (Continued on page 4)
invest well too, even though
                 Page 4

                               Ken Shubin Stein
                               (Continued from page 3)           Murrell, both at the            on this topic. Dan Coyle’s
                               terms of understanding how        Hospital for Special Surgery,   book The Little Book of Talent
                               to perform research, how          and they both epitomized        has a great list of tools
                               to think about a question,        lifelong learning and           people can use to accelerate
                               how to think about what           continuous improvement.         learning. The Art of Learning
                               are the critical factors, and     They take it seriously and      by Josh Waitzkin is another
                               how to collect the data and       they're both very good at it.   good book on this topic.
                               analyze the results. We                                           We do active literature
                               think about process a lot,        G&D: You have spoken            searches where we assign
Columbia Business School       and we’ve tried to create a
students visited Warren
                                                                 before about learning to        researchers 10-50 hours to
                               process that maximizes our        learn, can you elaborate on     go through basic and clinical
Buffett in Omaha in the fall
                               chance for great outcomes.        this topic?                     science articles, as well as
of 2013.
                                                                                                 pieces on other fields, such
                               For us, a process needs to        KSS: Sure. Thinking about       as art, professional sports,
                               be explicit, repeatable, and                                      coaching, and all sorts of
                               flexible. If it's not explicit,                                   things. We try to be
                               then the process can't be                                         effective in this process
                               studied and used by                                               even though it’s not always
                               different people and, if it's       “We borrow tools              efficient.
                               not repeatable, then you
                               can't iterate and improve           from other fields.            We think about efficiency
                               the process. Lastly, a                                            and effectiveness a lot too.
                               process needs to be flexible        We look at what's             “Efficiency” is getting a lot
                               because there are many                                            of units of output for a unit
                               different situations in life.         available in the            of input. But you could be
                               Things change. The credit                                         efficiently running in the
                               markets change and                 science of cognition
                                                                                                 wrong direction and it
                               attractive opportunities           or decision-making.            would not be effective.
                               change. You may be                                                Sometimes, we know we're
                               evaluating a hard asset that          We think about              engaging in a process where
                               is not producing cash flow,                                       there’s no way to be
                               but has the potential to           how to apply to our            efficient and maximize
                               generate significant cash in                                      effectiveness. A good
                               the future. Or you may be          circumstances work             example of this is looking
                               evaluating a high return on                                       for certain types of
                               capital business, like an asset     that's being done
                                                                                                 acquisitions. There isn’t a
                               management firm, that              academically about             really efficient way to do
                               produces significant cash                                         this. You can't completely
                               flow, but the important             human thinking.”              screen for it and, if you're
                               assets of the firm walk out                                       looking for something that
                               the door every night. So                                          you can't screen for or
                               the process has to be                                             develop an efficient search
                               explicit, repeatable and          thinking, or metacognition,     process around, it means
                               flexible to allow it to be        has been around for a while     that, although you're going
                               improved over time.               and the field keeps             to try to head in the right
                                                                 improving. Something we         direction and be effective,
                               I learned to be a lifelong        try to do well is to think      you are going to have to
                               learner from my parents           about what we are doing,        turn over a lot of rocks to
                               and from my medical and           what we are trying to learn,    find what you are looking
                               scientific training. Early in     and how we can best learn       for. Another example of this
                               my career, I worked for two       it. There are some great        is literature searches. We
                               fantastic surgeons named          articles and books out there                  (Continued on page 5)
                               Russell Warren and George
Issue XXI, Issue 2                                                                                    Page 5

Ken Shubin Stein
(Continued from page 4)         process. Additionally, we       hypothesis. We iterate this
will read broadly with an       are fortunate to have some      four-step process over and
idea of what we're trying to    leading investors visit the     over again.
accomplish, but it's not        class and answer questions
always efficient. We think      in a small, off-the-record      We borrow tools from
about efficiency and            environment, which is very      other fields. We look at
effectiveness separately.       educational for both the        what's available in the
                                students and me.                science of cognition or
G&D: You’ve taught the                                          decision-making. We think
Advanced Investment             G&D: Can you share your         about how to apply to our
Research course at                                              circumstances work that's
Columbia for the past five                                      being done academically
years. What motivates you                                       about human thinking. We
to teach and has it affected
                                  “We think we can
                                                                put effort into applying
your investing?                   have four possible            these ideas; this requires
                                                                some creativity and some
I love teaching and have had     edges and we try to            guesswork. We make
an especially great                                             educated guesses about
experience teaching at           understand whether             how to apply something. I'll
Columbia. Bruce                                                 give you a specific example.
Greenwald and Louisa                 one or more is
                                                                Charlie Munger famously
Serene Schneider have been                                      has his list of 25
terrific in helping me grow
                                   present in a given
                                                                psychological tendencies of
as a teacher. They have           situation. The four           human misjudgment—25
been supportive and helpful                                     mistakes we make in how
as I learned how to organize            edges are:              we think. We went one by
the class and communicate                                       one through each cause,
effectively with students in         informational,             rephrasing it in our own
the business school                                             words, and tried to figure
environment. One great                 analytical,
                                                                out how we could apply it
aspect about teaching for                                       to our checklist process to
the past five years is that
                                    behavioral and
                                                                improve our decision-
most of my former students             structural.”             making.
are now analysts and
portfolio managers, or doing                                    Whether you call it
other interesting things in     process for evaluating a        behavioral finance or
the world. I actively stay in   prospective idea?               neuroeconomics or innate
touch with the class alumni                                     and acquired cognitive
and I get a tremendous          KSS: We use a four-step         biases, these terms are
amount of satisfaction          process for evaluating ideas.   circling around the same
seeing them progress in life.   Step 1 is to form a             basic issue: how do our
                                hypothesis. Step 2 is the       brains make decisions under
Teaching has also been great    study design, or, said          different circumstances? For
for me as an investor. The      another way, identifying the    decades, people have been
process of taking what I do     important questions and         trying to describe this idea
and making it explicit, of      developing a plan to answer     academically. Now there's
breaking it down into           them. Step 3 is doing the       diverse vernacular in that
discrete, teachable steps,      work to answer the              world because it hasn't
and of answering challenging    questions; this is analogous    coalesced into one unified
questions from smart            to running the experiment.      field yet, but what's really
students has refined my         Step 4 is analyzing the data    interesting to me is how to
thinking about every aspect     and then refining our                         (Continued on page 6)
of the investing
Page 6

         Ken Shubin Stein
         (Continued from page 5)                                          circle of competence.
         take that learning and          Having an analytical edge
         specifically apply it. How do                                    Behavioral edges are central
         we develop de-biasing                                            to value investing. It's being
         techniques? How do we                                            greedy when others are
         develop standard operating                                       fearful and fearful when
         procedures that can help us                                      others are greedy. It is
         make better decisions? It's                                      understanding the lessons of
         all very humbling because                                        behavioral finance and
         it's complicated and                 “This is where              neuroeconomics, and then
         nuanced; applying it is                                          applying them to the idea at
         difficult and, to a degree,           having deep                hand. These opportunities
         personal. So it’s going to                                       come up regularly. There
         work differently for              industry expertise             will always be the
         different firms and different                                    opportunity to gain a
         people, but we work hard           sometimes helps               behavioral edge because
         on applying it and making it                                     most innate cognitive biases
                                             because certain
                                                                          are Darwinian. Evolutionary
                                            information will              forces caused these
         G&D: How do you think                                            behaviors to evolve because
         about getting an edge? Is it       mean more to us               they were useful at a prior
         different from situation to                                      point in history even though
         situation and is there a               than to the               they are not useful in
         common thread?                                                   modern, complex markets.
                                                 market.”                 They are hardwired into all
         KSS: There is a common                                           of us.
         thread. We think we can
         have four possible edges and                                     With a structural edge, you
         we try to understand                                             know exactly why
         whether one or more is                                           something is cheap or
         present in a given situation.                                    expensive. For example, if a
         The four edges are:             means taking available           bond is downgraded from
         informational, analytical,      information and arraying it      investment grade to non-
         behavioral and structural.      so that we can glean better      investment grade, there are
                                         insights. This is where          certain holders who have to
         The first two edges,            having deep industry             sell it. If a stock is kicked
         informational and analytical,   expertise sometimes helps        out of, or included in, an
         are necessarily related and     because certain information      index, this will cause buying
         sometimes overlap.              will mean more to us than        and selling transactions that
                                         to the market—either we          are not based on the price-
         We work hard to find            are more aware of the            to-value relationship. Spin-
         information that is helpful     history of the industry or       off and distressed situations
         and legal to use. Sometimes     we have experience with          also regularly have these
         we are able to find great       the industry players and         forces at work.
         pieces of information that,     have a better behavioral
         combined with other             insight into those people.       G&D: Do you try to
         information, increase our       Analytical insights are          create structural and
         understanding of an             frequently possible and it's a   behavioral advantages inside
         opportunity. This is often      matter of arraying               of your own structure and
         referred to as the mosaic       information in a creative        process?
         approach, and it is the link    way and deeply knowing           KSS: We do. There are
         to the analytical edge we       something—having a good                        (Continued on page 7)
         regularly seek.
Issue XXI, Issue 2                                                                                       Page 7

Ken Shubin Stein
(Continued from page 6)           things all the time; it’s an     an example. Even once
plenty of managers who may        overarching theme of our         they're at the top of their
have a long investment            firm. We don't do what           field and at peak
horizon, but their clients do     Google does where we take        performance, they still use
not; therefore, they don't        20% of our time to pursue        coaches. They go over the
have strong hands for a true      pet projects—it’s not that       basics. They use the
long-term perspective.            structured. We are always        psychology of visualization.
There are few investment          talking about these things       They think about nutrition
firms that can execute on a       and asking ourselves, How        and rest in order to
long-term horizon. There’s        can we be better? What can       perform better. The system
an enormous amount of             we do? What are other            built around professional
institutional and retail          people doing that we can         athletes is impressive and
capital that has high liquidity   learn from?                      robust because the stakes
and, as a result, the manager                                      are high and measurable. So
doesn't have that much            There's a quote by Picasso,      we are always thinking
staying power or ability to                                        about how to improve and
invest in things that may                                          it permeates our firm.
take three, four, or more
years to work out. So firms                                        G&D: Is there a particular
that have patient capital           “There are plenty              strategy or type of
definitely have a structural                                       investment that you are
advantage.                           of managers who               comfortable with or have a
                                                                   particular expertise in?
We think about the                   may have a long
application of psychology                                          We're not dogmatic about
and the science of cognition       investment horizon,             investing in a cheap,
to both our analysis and our                                       mediocre company or a
portfolio management, and
                                    but their clients do
                                                                   non-earning, but
we have multiple checklists        not; therefore, they            undervalued asset, or a
and processes in place to                                          profitable company with
try to improve how we                don't have strong             sustainably high returns on
think and make decisions.                                          capital. We’ve done all of
It's not perfect. This is             hands for a true             them. What we are very
rough work, so while we                                            careful about is reflecting on
might use specific scientific             long-term                past mistakes and thinking
terms to describe                                                  about what works best in
everything, the work itself
                                                                   our hands. We have a
doesn't go out to the                                              pretty good idea of what
second decimal place. It's                                         works best for us, and part
really “best efforts” and                                          of the reason is because I
we're constantly trying to        which basically says good        really wanted to understand
improve. We’re constantly         artists copy and great artists   our difficult experience in
finding mistakes and fixing       steal. There's been a great      2008. Different techniques
them.                             deal written about looking       work differently in different
                                  at what other investors do       people's hands. We all have
G&D: How do you balance           that works and copying it.       different life experiences,
your time between doing           We look at other investors       different training, and
investment analysis and           and we also observe other        different brains. So
thinking about the                fields to see how star           something that works for
behavioral and process            performers do their jobs         someone else, I may not be
elements?                         and continue to improve.         able to do well. What I
                                  Professional athletes offer                    (Continued on page 8)
KSS: We think about these
Page 8

         Ken Shubin Stein
         (Continued from page 7)         employees to review every     manager. While these red
         really want to know is what     investment decision we’ve     flags don't mean we'll never
         I can do well, so I do more     made. We went through         repeat mistakes, they are
         of it, and what do I not do                                   cautionary flags. The red
         well, so I do less of it.                                     flags slow me down and
                                                                       make me think about a time
         After 2008, we did a one-                                     when I was confident that
         year project looking for                                      something similar to the
         mistakes we could learn                                       idea in front of me was a
         from. The challenging part                                    great idea, and then I made
         of this process was                                           a mistake and lost money. I
         differentiating between a                                     would say this is one of the
         true positive and a false        “If we're doing the          most helpful things we've
         positive and a true negative                                  implemented as a firm. To a
         and a false negative. It's          right thing, but
                                                                       degree, it comes out of
         important that you separate                                   Daniel Kahneman’s work
         process and outcome.
                                             occasionally it
                                                                       detailed in his book, Thinking
                                             doesn't work, it          Fast and Slow. The
         The best situation, a true                                    framework that he
         positive, is when you have a     doesn’t make sense           describes says that the brain
         good process and you have                                     has these two mechanisms
         a good outcome. If you have        to abandon that            of thinking—fast and slow.
         a bad process and a bad
         outcome, that's a true             process, because
                                                                       Basically, the idea is that, for
         negative. The tricky part is                                  the work we do, fast
         what happens if you're
                                          over time it will do
                                                                       decisions don't help. So we
         unlucky and you have a                    well.”              try to slow down. For
         good process, but a bad                                       example, we explicitly put
         outcome—a false negative.                                     circuit breakers into our
         It is important not to be                                     checklists now so that we
         fooled by false negatives. If                                 sleep on decisions. We have
         we're doing the right thing,                                  taken some of the learning
         but occasionally it doesn't                                   from the literature on
         work, it doesn’t make sense                                   decision-making and
         to abandon that process,                                      creativity research, and
         because over time it will do    this obsessively for a year   lessons from great creative
         well.                           and we came up with a list    thinkers and investors, such
                                         of about two dozen red        as John Griffin, who taught
         The riskiest thing is getting   flags of places where we've   the Advanced Investment
         lucky—a false positive. You     lost money in the past and    Research course for a long
         have a positive result, but     where, after much analysis    time. One take-away from
         your process was poor.          and debate, we decided it     this is the idea that putting
         That's the most dangerous       was because of a bad          yourself in different
         because, after a few false      process and not just bad      situations, sleeping on ideas
         positives, you typically go     luck.                         and letting yourself be
         bigger, and that leads to the                                 creative lets you engage
         old saying of “succeed small,   This review has been          your subconscious to
         fail big.” So we think about    tremendously helpful to our   process information.
         this pretty carefully.          investment process, it has
                                         helped make us better         In medicine, there is an
         We engaged an outside           analysts, and it has helped   acronym, HALT—hungry,
         analyst to help us and we       make me a better portfolio                   (Continued on page 9)
         invited back former
Issue XXI, Issue 2                                                                                                    Page 9

Ken Shubin Stein
(Continued from page 8)           actually is good for           an idea that hit a couple of
angry, lonely, and tired—         investment decision-making?    the edges we talked about.
and, under these conditions,                                     It was a post-bankruptcy,
decision-making worsens.          KSS: It seems to work for      small company that
For example, under these          Buffett, but not many          provided reagents and other
conditions, people who are        others.                        important things to
addicted to drugs will have a                                    laboratories. It was a
higher rate of recidivism,        G&D: Can you share a           straightforward investment
meaning they'll fall back on      couple of past investment      if you understood it,
their old patterns of             ideas, including an activist   because, coming out of
behavior even though they                                                                              Bill Ackman at the 2013
                                  idea? And any current ideas    bankruptcy, there were
know it is ruining their lives.                                                                        Pershing Square Competi-
                                  you would be willing to talk   structural issues of why              tion.
I've added a P for pain,          about?                         people couldn't buy it. It
which also has a direct                                          was inaccessible to some
impact on emotion and                                            firms due to its small size or
decision-making. So with                                         to firms without stable
HALT P, we try to think                                          capital. It required an
about both the                                                   understanding of how
psychological and                                                laboratories and the FDA
physiological framework for         “We tackle things            approval process works
making decisions. We ask                                         because some of the
ourselves, as we're making            not by trying to
                                                                 reagents that they provide
decisions and as we're                                           were actually written into
thinking about things, are
                                   prove them, but by
                                                                 the FDA approval process
any of these conditions             trying to disprove           for the test kits using their
present? Are we hungry,                                          reagents.
angry, lonely, tired or in          them. Falsifying a
pain for one reason or                                           When you run a laboratory,
another? And, if so, realize            thesis is the            you want to minimize
that it's suboptimal for                                         variation in processes so
decision-making and, if                 fundamental
                                                                 that your results are
possible, don't make the                                         reliable. So what can you
                                     approach of the
                                                                 control in a laboratory?
                                     scientific method           What are the variables?
Something else that's really                                     Well, the things that change
important is nutrition.                  and it’s an             in a laboratory are your
Blood sugar levels and                                           inputs such as your
general nutritional states           approach we use             reagents, so you usually
have an impact on cognition                                      have complete control over
and, I think, this is one of              and like.”
                                                                 that, and you don't want to
the areas that is                                                change them if you don't
underappreciated. Our                                            have to.
nutritional levels directly
impact our decision-making.                                      So, understanding that, you
Buffett talks a lot about fear    KSS: Sure. We have a           appreciate the durable,
and greed as frameworks or        concentrated portfolio and     competitive advantage of
contexts within which             we often hold investments      selling things that are small
decisions are made, I would       for several years. I'll talk   and relatively inexpensive,
add to that HALT P and            about a couple of past and     but critical to a large
nutrition.                        present ones.                  process. We invested in the
                                                                 company at around $3 per
G&D: So what you're               SeraCare Life Sciences was                  (Continued on page 10)
saying is that Cherry Coke
Page 10

          Ken Shubin Stein
          (Continued from page 9)         need to have a strategy to       insurance industry is AIG.
          share. We expected it to be     create value, but even with      What was interesting about
          worth $6 in two to three        that, you can lose an activist   AIG when we invested
          years and it was bought out     campaign if you dot your         several years ago was that, I
          in less than a year at $4. It   “i's” and cross your “t's”       think, it was one of the
          was good to be paid $4, but     incorrectly.                     most hated companies in
          I would have preferred to                                        America. When we were
          wait another year or two        The company makes the            making our investment,
          and been paid $6.These          gold-standard demineralized      there were bus tours in
                                          bone matrix product called       Connecticut taking people
                                          Grafton, which is frequently     to the homes of executives
                                          used in orthopedic and           who worked at AIG so they
                                          other types of surgery.          could see where the “evil”
                                          Osteotech spent a                AIG people lived.
                                          significant amount of capital
                                          on research that was             Think about that for a
                                          partially productive. They       minute. These executives
                                          had a dysfunctional sales        likely had nothing to do
                                          effort; they had a misaligned    with what happened; AIG is
                    “What was             management team, and they        a large global company.
                                          put much of the money they       Think about the implication
              interesting about           generated into various           of people paying to get on a
                                          things that weren't              bus to come see the home
                  AIG when we             productive. The latter is        where an executive who
               invested several           common in healthcare—            works for this hated
                                          often a company has              company lives. This is a
             years ago was that           something, a drug or device,     great example of behavioral
                                          that generates significant       bias. People were
              it was one of the           cash and management              embarrassed to say they
                                          invests it all in risky ideas    worked at AIG, and many
                    most hated            rather than returning the        portfolio managers were
                                          profits to shareholders.         reluctant to own the poster
                  companies in                                             child for the financial crisis.
                     America.”            So we got involved. We
                                          analyzed the situation and       Half a dozen government
                                          we went through our pre-         agencies had been living
                                          investment checklist for         inside of AIG, going through
                                          activism. Osteotech passed.      their books, and the
                                          We ran a campaign to             government owned the
                                          replace the entire board.        majority of the company.
                                          We met with ISS and a            We had the following thesis:
                                          number of large                  over five years the stock
                                          shareholders, and we made        would be at least a triple
                                          the case that our plan would     because we were investing
          things happen.                  create shareholder value.        at half of stated tangible
                                                                           book value, investment
          Osteotech was one of our        It was a good investment.        income was below normal
          activist ideas. Osteotech       Shareholders made a              due to artificially depressed
          was a situation where a         100% return in less than a       bond yields, and the
          large institutional investor    year from the time we            company was buying back
          asked us to partner with        became involved.                 significant amounts of stock.
          them. Activism is about         An example from the                            (Continued on page 11)
          strategy and tactics. You
Issue XXI, Issue 2                                                                                    Page 11

Ken Shubin Stein
(Continued from page 10)        made phone calls, we spoke      this case, and then trying to
We thought book value was       to people who work at the       understand a low case
conservatively stated           laboratory—the end-             earnings power analysis was
because the government          users—we spoke to the           possible, especially if you
agencies had a bureaucratic     buyers, and we investigated     understood health care as
incentive to come up with a     the regulatory framework.       an industry and where the
conservative number. There      Some of the information we      trends were going.
was new management in           knew already because it's a
place and their incentives—     health care idea.               With health care, often, the
like the incentives of most                                     problem is that, since we
new management in a turn-       One of the benefits of our      have a fundamentally
around situation—were to        business is that, once you      challenged industry, there
state all the problems up       develop expertise in an         will be a lot of changes to
front because none of it was    area, you don't have to start   reimbursements and the
their fault. Additionally,      from scratch every single       way margins are going to
bond yields were kept low       time. So, in this respect,      work in the future. That is a
by the Fed and we didn’t        SeraCare was both               problem for many health
believe that would last                                         care-related ideas. In the
forever. And lastly,                                            case of SeraCare, we
management was buying                                           understood how the issue
back large amounts of its                                       applied to the company and
stock, which was a powerful                                     why it was protected from a
signal that they believed the                                   lot of it. And it was
stock was significantly          “Another red flag is           undervalued enough that it
undervalued.                                                    was okay.
                                     investing in an
G&D: Could you share                                            With AIG, there were some
your analytical process or          average or less-            similarities and some
the research that you did on                                    differences. We have
the idea? What kind of work          than-average               invested in insurance for a
did you do to prove some                                        long time and this helps in
of the key points you              business without
                                                                understanding the industry
mentioned?                         multiple ways to             and the basic transaction.
                                                                We always try to
KSS: We tackle things not                  win.”                understand deeply why
by trying to prove them, but                                    someone buys or sells. Why
by trying to disprove them.                                     does someone buy this
Falsifying a thesis is the                                      product or service from this
fundamental approach of the                                     company and why would
scientific method and it’s an                                   they not buy it from that
approach we use and like.       interesting and relatively      company? These are basic,
                                straightforward in terms of     but important, questions.
I'll compare and contrast       the work, and we tackled it     And, in the case of AIG, we
SeraCare with AIG. One          using all the tools from        felt comfortable in our
was small, the other was        Advanced Investment             understanding of the
large. One was post-            Research and really tried to    components of the business
bankruptcy and a special        understand the specifics of     and industry. Even though
situation, the other was a      the buyers and sellers, the     we were not experts in
large, out-of-favor company.    industry, the trends, and the   some of the non-core
Thus, the processes were        supply/demand issues.           assets, we had a sufficient
different. With SeraCare, all   Understanding the switching     margin of safety and we
the research techniques that    costs became important in                    (Continued on page 12)
I teach are what we did. We
             Page 12

                            Ken Shubin Stein
                            (Continued from page 11)          How do you think about the      or not additive to the key
                            were comfortable with the         trade-off between the time      investment factors that are
                            liability analysis and the        spent and the knowledge         driving the investment
                            liquidation value, which          gained?                         decision. We also learn a lot
                            were significantly higher                                         from publicly available
                            than where we purchased           KSS: The general reading        materials that are not so
                            our stock and where it still      and research we do is the       obvious. For example,
                            is today.                         same for all ideas but,         government databases can
David Winters at the 2013                                     beyond that, we use our         offer very useful data, but it
Omaha Dinner.               When we think about               process to guide us in which    usually needs be carefully
                            intrinsic value, it is always a   research tools to use.          analyzed to gain insights
                            rough guess, a range. In my       Once we begin formulating       from it.
                            mind, if I throw out a            the questions we think are
                            number to you, such as, “I        important, then we figure       G&D: Have you
                            think intrinsic value for this    out what needs to be done       experienced any anchoring
                            stock is 100,” what I'm           to best answer those            effects in processing new
                            really saying, and the way        questions.                      information where, because
                            we internally use that                                            of the previous knowledge,
                            statement, is, “It's 100, give    Often, making research calls    you don't necessarily fully
                            or take 10 to 15%. It might                                       incorporate updated data?
                            be 85, it might be 115.” It's
                            100, with implied error bars                                      KSS: Yes, and AIG is an
                            around the statement.                                             example of that. AIG is a
                                                                                              company that I had followed
                            We are cautious about our            “We think about              for well over a decade, and
                            ability to really know what                                       there were a lot of things
                            something's worth, and we           risk as ‘How much             about the old way AIG was
                            only invest in situations                                         run that I didn't like. After
                            where the price is well            money can we lose              the credit crisis, I really had
                            below that range. With AIG,                                       to force myself to drop my
                            it was with the benefit of a          and what's the              prior thoughts, good and
                            political analysis, which we                                      bad, about the company and
                            do sometimes. And I don't          probability of losing
                                                                                              look at it fresh because it
                            mean “political” in the sense        it?’ It’s a private          was a different situation—
                            of “who's going to win the                                        different management,
                            election,” I mean “political”         business way of             different balance sheet, and
                            in understanding how                                              different asset collection. So
                            Washington works, because           thinking about risk           much was new that I, in a
                            that’s something you can                                          forceful way, had to take a
                            sometimes understand.              and it's simple, but           clean approach to it.
                            Washington works in a
                            specific way, with different             not easy.”
                                                                                              G&D: While we're on the
                            parts of the system having                                        topic of mistakes and biases,
                            different incentives and, if                                      are there any big red flags
                            you understand these                                              from the self-analysis you
                            dynamics, you can analyze                                         conducted that you would
                            situations as to how they're      to industry participants,       be willing to share with our
                            likely to work out.               employees, customers, and       readers?
                                                              others, is helpful, but there
                            G&D: How do you balance           are certain ideas where the     KSS: I'll throw out a couple
                            just reading the public           information those calls can     that we are now more
                            materials versus really going     give may already be known,                    (Continued on page 13)
                            in and kicking the tires?
Issue XXI, Issue 2                                                                                     Page 13

Ken Shubin Stein
(Continued from page 12)        for them personally and          his or her own self-interest
sensitive to than before the    their ability to keep their      might not be in your best
credit crisis. We are extra     elected position in the          interest. It’s important to
cautious if the company is in   union. One of the things I've    align incentives to ensure
a dynamic industry. If things   developed a greater              you’re operating toward a
are changing rapidly in an      appreciation for is that,        common goal. That's a
industry, it calls into         sometimes, I'll look at a        lesson that we’ve learned
question the durability of a    situation and think, “Oh,        the hard way.
competitive advantage; for      that person's not acting
example, maybe the buying       rationally.” However, what's     One last one that can be
transaction is changing. In     actually happening is they're    more subtle is the red flag
retail, Amazon is                                                that goes up when a
fundamentally changing the                                       company is either acquiring
way buying occurs and, if                                        other companies or
you're a retailer, you have                                      investing in capex projects
to think about the impact of                                     that are different from what
this trend. Some industries                                      they have done in the past.
are more difficult to            “Building a firm is a           The new acquisitions or
understand than others and,                                      projects may be different in
if they're changing, they're        combination of
                                                                 size and scope, or may be in
often too tough to analyze.                                      new areas but, either way,
                                   timing, skill and
                                                                 they pose a risk that needs
Another red flag is investing      luck, and what I              to be considered carefully.
in an average or less-than-                                      This is especially true if the
average business without         have learned is that            new large project is causing
multiple ways to win. For                                        the company to incur more
good businesses, sometimes,      it's a different thing          debt.
we have a clear thesis. We
understand what our edge           from just being a
                                                                 G&D: Are value traps on
is, and we have a clear idea                                     your list of red flags?
of the way it will work out.
                                    good investor.”
We think there's one highly                                      KSS: I don’t use the term
probable future path. In                                         “value trap.” I find it more
contrast, for average or                                         helpful to say, “Okay, I
below average quality                                            made a mistake. I didn’t
companies, more can go                                           understand a component of
wrong, so we prefer to have     acting rationally for their      this, so it’s not working
the potential for more than     circumstance, but we may         out.” Generally, if you’re
one thing to go right to        not know enough to               right in your analysis,
unlock the value we see.        appreciate the various           including understanding the
This “more than one way to      forces at work. In               incentives of the company’s
win” approach works better      Washington, you see this a       leadership, then most of the
for us than investing in such   great deal and you see it        time the market will agree
companies solely when they      with unions as well. You         with you in two to three
are available for purchase at   also see it with leaders of      years.
a low valuation.                organizations.
An additional red flag is the                                    G&D: Could you talk a
presence of unions. Union       This is why aligning             little bit about your process
leaders don't always act in     incentives is so important,      for sourcing ideas and
ways you would think are        because, if you don't align      figuring out what’s worth
best for their                  incentives, the rational thing   your time to analyze?
constituencies. Sometimes,      for a leader to do based on                   (Continued on page 14)
they act in a way that's best
Page 14

          Ken Shubin Stein
          (Continued from page 13)          fantastic CEO, David            think it’s worth, and if it is a
                                            Weinreb, and an excellent,      great asset or company,
          KSS: Sure, Charlie Munger         shareholder-friendly board,     then we are going to hold
          has spoken about there            led by Bill Ackman. I think     on longer. That’s our rough
          being three good ways to          that, even though the price     guideline, but we don’t have
          identify ideas. The first is to   has meaningfully                a mathematical rule. The
          look for companies that are       appreciated, its assets are     selling decision is also in the
          cannibalizing themselves by       going to continue to            context of what else is going
          doing significant share           improve for the next five to    on in the portfolio.
          repurchases. We look at           ten years and intrinsic value
          those and we think about          per share will increase.        I am also specific about the
          share repurchases, not in                                         way I phrased my earlier
          dollars or share count, but       G&D: How do you think           statement—if it’s not great,
          in percentage of shares           about the selling decision?     then we sell. That “if/then”
          outstanding. The second is                                        statement helps because, if
          in spinoffs, and we broaden       KSS: Selling is specific to     you put it the other way, it’s
          that to corporate situations                                      just too easy to take
          or special situations because                                     something that’s a little
          they have similar dynamics.                                       better than average and put
          And the third is cloning or                                       it in that bucket of, “Oh, we
          looking at other investors.                                       should hold it longer.” I
          We read what people do                                            have certainly made that
          and try to reverse engineer                                       mistake, so now I just think
          why someone bought                     “If things are             about it as, “Is it great? Yes
          something.                                                        or no?” If it’s great, fine,
                                             changing rapidly in            we’ll probably hold it longer,
          In addition to those three                                        but if not, if it’s anything less
          areas where we actively            an industry, it calls          than great, then we’re going
          look for ideas, we also                                           to sell it early.
          receive inbound ideas from           into question the
          investors we know or who                                          G&D: What are your
          are part of the Columbia               durability of a
                                                                            thoughts on shorting and its
          community. Generally, we                competitive               relationship to portfolio
          have more ideas than time                                         management?
          and we are usually trying to            advantage.”
          triage them and decide                                            KSS: We generally don't
          which ones to work on.                                            short. We have in the past
                                                                            and we have a good track
          G&D: Are there any ideas                                          record of doing it, but the
          that you’re particularly                                          reason for that record
          excited about right now?                                          might be because we've only
                                                                            done it occasionally. We've
          KSS: Howard Hughes is             the security and what we        done it in two situations—
          going to continue to              want in the portfolio, so,      both where it's been
          develop its assets and add        again, it’s rough work and      incredibly obvious and
          value over a long period of       we are constantly trying to     where there was a security
          time. We have owned it            get better at it. The way I     that lent itself to doing it,
          since it was spun-off from        broadly think about it is, if   like a very long dated put or
          General Growth Properties         it’s not a great asset or a     it was part of a cap
          when GGP was in                   great company, then we are      structure arbitrage where
          bankruptcy. In addition to        going to sell at the low end    we bought the parent and
          its tremendous assets,            of our range of what we                        (Continued on page 15)
          Howard Hughes has a
Issue XXI, Issue 2                                                                                         Page 15

Ken Shubin Stein
(Continued from page 14)          is inversely proportional to      of things we do are that
shorted out the subsidiary.       how challenging the               way.
But the latter case is not        environment is.
really shorting; it’s just                                          We will make something a
setting up a trade to isolate     G&D: Given your                   large position if we think
the asset that we wanted to       framework and portfolio           there is an extremely low
own.                                                                chance of losing money on a
                                                                    permanent basis. Even if we
After the credit crisis, we                                         think it might be a 4x
raised our standards and it’s                                       return, if the idea could be a
helped us, I think, be better                                       zero, it'll be a small position.
investors. Our current                                              For something to be a
framework for managing the         “I think it's actually           significant position, such as a
portfolio is: for the first                                         10-15% position, it has to be
80% of our capital, we'll               an aggressive               very safe, for example, a
only invest in something if                                         low-levered real estate
we think it's a double in two          strategic asset              opportunity such as Howard
to three years; for the next                                        Hughes.
10%, we raise the bar and           because it's one of
will only invest if we think                                        One of the reasons we
it's a three to four multiple
                                    the few things that
                                                                    invest in real estate, along
return in two to three             rises in value as the            with healthcare and
years; and then, for the last                                       insurance, is because it has
10%, which rarely gets               market plunges.”               distinct points of value
invested except during                                              creation. If you take raw
extremes, we'll only invest if                                      land and put in sewer and
we think it's a four to five                                        power, you have improved
multiple return in two to                                           it and it's a more valuable
three years. By following                                           asset. It's a step function. If
this simple portfolio             concentration, how do you         you then get easements and
management structure,             think about position sizing?      get permits to build big
we’re safer because if 2008                                         buildings and you land an
happens again (and surely         KSS: For us, position sizing      anchor tenant for a 20-year
another crisis will happen)       has to do with absolute risk.     lease, you've improved the
we'll know how much               We take the perspective           real estate again. So, if you
capital we can invest at          that, if you are not levered,     understand how real estate
those lower prices.               and your companies are not        development works, you
                                  too levered, then volatility is   can track these things.
On that topic, I'd like to talk   not risk. This isn’t always       Howard Hughes has made a
about cash for a second           true because of reflexivity       lot of improvements in
because I think it's an           and some other things but,        recent years, and they're
underappreciated,                 for our purposes, volatility      going to do a lot more, and
aggressive asset. Most            of a security price is not        that's why we think it's a
people say it's defensive, for    intrinsically risk, although      five or ten-year idea.
the obvious reason that, in       the two can occur together.
most normal environments,         We think about risk as            G&D: Let’s talk about the
if you're holding cash, it's      “How much money can we            experience of running your
earning close to nothing. I       lose and what's the               business. You've co-founded
think it's actually an            probability of losing it?” It’s   a couple of partnerships
aggressive strategic asset        a private business way of         along the way. How have
because it's one of the few       thinking about risk and it's      these experiences built on
things that rises in value as     simple, but not easy. A lot                     (Continued on page 16)
the market plunges. Its value
Page 16

          Ken Shubin Stein
          (Continued from page 15)           while I was holding onto         interested in buying a
          each other and compared to         their capital. I made what I     business. So I, along with
          each other and what have           thought was the right ethical    some of our former
          you taken away from each           decision, although it did hurt   investors, bought a
          of them?                           our business, to open up         reinsurance company, and
                                             the fund and, basically,         that reinsurance company,
          KSS: Building a firm is a          release the capital. We          Spencer Capital Holdings, is
          combination of timing, skill       became a funding source at       a client of our investment
          and luck, and what I have          a time when many hedge           management firm.
          learned is that it's a different   funds were gating their
          thing from just being a good                                        G&D: The reinsurance
          investor. Something I                                               business seems like a great
          appreciate more now than I                                          source of long-term capital,
          did 10-15 years ago is how                                          but if you underwrite poorly
          important communication is                                          you can certainly lose
          with your partners, your             “Be explicit about             money. How do you think
          investors, and all of your                                          about running and managing
          stakeholders.                            learning and               that business and acquiring
                                                                              the right talent for it?
          The second thing I would                  progressing.
          say is that it is a much                                            KSS: It is important to
          different environment today         Constantly trying to
                                                                              understand that our
          than it was 15 years ago.                improve and                reinsurance company is a
          The industry has changed                                            frequency business, not a
          quite a bit in terms of the           designing systems             severity one. A frequency
          investor base. It used to be                                        business underwrites
          a business of mostly                    for yourself to             generally predictable losses
          individual investors, and                                           and a severity business
          now it is a business of               accomplish goals              underwrites risks that don’t
          mostly institutional                                                happen often or predictably,
          investors. So if you want to          yields significant
                                                                              but when they do occur,
          build a business today, it's        rewards over time.”             they are usually severe and
          more challenging unless you                                         expensive. We can still lose
          come from a brand-name                                              money, but it's less often
          firm or you start at a certain                                      and less extreme than with
          size. Being small is great for                                      a severity business.
          investing but a challenge for
          building the business.             capital. The benefit of          Given the nature of our
                                             making that decision is we       losses, we have the latitude
          In our case, we have $80           had a lot of grateful clients,   to invest much of the float
          million in assets under            although we didn't have          in equities, which helps our
          management. We had                 their assets.                    returns most of the time. It
          $400 million before the                                             also makes us an attractive
          credit crisis and we made          We had to rebuild the firm       employer for someone
          the decision during the            after that happened. One of      interested in investing
          crisis to give cash back to        the ways I did it was by         because we have a lot of
          our clients who were under         putting a lot of thought into    flexibility in how we deploy
          extreme distress, even             trying to get more stable,       capital.
          though we had some capital         long-term capital, perhaps,
          locked up. I made the              in a different structure than    G&D: Did you decide to go
          decision that I didn't want        a hedge fund, or in addition     into reinsurance because of
          people to experience               to one. This led me to get                    (Continued on page 17)
          extreme financial stress
Issue XXI, Issue 2                                                                                 Page 17

Ken Shubin Stein
(Continued from page 16)         list. It is composed of ideas    are interested in a career in
your past experience?            we might want to own if the      investing?
                                 price changed, or a risk
KSS: Yes, I specifically         issue was resolved.              KSS: I would say only do it
wanted to be in reinsurance,                                      if you really enjoy it. If you
so I spent time looking at       When doing a deep dive           have a passion for the
ideas and deals before           into an idea, we sometimes       work—for solving
finding one that worked.         use external consultants to      problems, for constantly
That's an example of             help us deepen our research      learning, and for the
something I would say was        by focusing on one key area      psychological aspects of
effective but not efficient.     we want more information         investing—then try to get a
                                 on quickly or to help            job at a firm where you can
G&D: Do you have any             broaden our research by          learn from someone else’s
words of advice to investors     aggregating large amounts of     experience. This isn’t a
who are thinking about           information from diffuse         requirement, and I didn’t
starting a fund today?           sources. We’ve spent ten         have that experience but,
                                 years getting better at          generally, I think working at
KSS: My advice to anyone         working with outsourced          a place where you can learn
who wants to start a             research providers and now       from a more experienced
business is to have at least a   we can take virtually any        investor can accelerate your
five-year timeline. If you're    topic and find people with       development early in your
predicating your decision on     the appropriate technical or     career.
being profitable in the first    science or general
two to three years, I think      investigative journalism         The other suggestion I have
that's more challenging of a     backgrounds and outsource        is to get serious early in
choice.                          a research project to them.      your career about mastery.
                                 Our experience also enables      Be explicit about learning
G&D: How do you                  us to use research assistants    and progressing. Constantly
allocate time and how has        to do robust literature          trying to improve and
that fluctuated as the           searches. It is time             designing systems for
business evolved and             consuming and it lends itself    yourself to accomplish goals
developed?                       to outsourcing once you          yields significant rewards
                                 learn how to manage the          over time.
We use four lists to             process.
organize our ideas and                                            G&D: Ken, thank you very
prioritize our time. List #1     I try to receive information     much for your time.
is the ideas we currently        the same way every time
have capital at risk in—our      because it makes it more
current investments—and          efficient for me to go
this takes priority over         through large amounts of
everything else. List #2 is a    data, articles, and videos. It
small list of one to three       takes a lot of work on
ideas that we're actively        someone else's part to
doing deep research on.          collect and organize the
List #3 is a list of ideas we    information, but then I can
might do research on. We         get through it efficiently.
collect interesting ideas and    This has all been worked
put them on List #3 and,         out over ten years, but we
when space opens up on           still work to improve the
List #2, we'll discuss all the   process.
ideas on List #3 and decide      G&D: What advice would
which one to promote to          you give to students who
List #2. List #4 is our watch
      Page 18

                Lee Ainslie
                (Continued from page 1)          developed many friendships,     or books that you've read
                Graham & Doddsville              which have lasted the           that have really influenced
                (G&D): How did you get           twenty years since I left.      you?
                interested in investing?         We all had different pockets
                                                 of knowledge about              LA: At one point in time, I
                Lee Ainslie (LA): When I         investing, not only in terms    read every single investing
                was in eighth grade, my          of sectors and industries,      book I could get my hands
                father was the headmaster        but also different ways of      on. Then Amazon came
                of a boarding school, and        looking at and thinking         along, and the number of
                the school decided to start      about stocks. We spent a        investment books has
                an investing club. I thought     lot of time comparing notes     grown exponentially! In
                that sounded fun and             and playing devil's advocate    terms of who influences me
                interesting, so I asked if I     to each other, and so the       now, I would really point to
                could join that club, which      collective talent of the team   my peers at Maverick. We
                they let me do. I started        ended up being a great          have worked hard to
Lee Ainslie     keeping a paper portfolio,       benefit to my investing         recreate that part of the
                and my interest developed        education.                      culture of Tiger in that I am
                from there.                                                      surrounded by extremely
                                                                                 talented investors. If a
                G&D: It's well known that                                        week goes by that I haven’t
                you got your start under                                         learned something new,
                Julian Robertson at Tiger          “If a week goes by            then that is really a wasted
                Management. Was there                                            week. Sometimes, I’ll
                anything that was markedly            that I haven’t             discover another way of
                different than the public                                        evaluating a particular stock
                perception about the way           learned something
                                                                                 or hear about a decision by
                things were run at Tiger?                                        a management team that
                                                    new, then that is
                                                                                 could be interesting. Other
                LA: I'm not sure I have a            really a wasted             days, I’ll learn about a
                strong understanding of                                          development in an industry
                what the public perception         week. Sometimes,              that changes my perception
                is, so it's hard to say if                                       of the competitive dynamics
                anything was markedly             I’ll discover another          in that industry or recognize
                different. When I was                                            a certain macro
                there, it was a smaller firm.     way of evaluating a
                                                                                 development may have a
                When I accepted the offer,                                       meaningful impact on the
                                                   particular stock or
                they were managing around                                        environment. Whatever it
                $500 million. I was only               hear about a              is, I’m hopefully learning
                there for three and a half                                       every day. We have tried
                years, but by the time I left,         decision by a             to develop a culture where
                the firm had grown pretty                                        we have a group of people
                dramatically, both in terms        management team               who view themselves as
                of assets and in terms of                                        peers, who are not afraid to
                people. I certainly learned a         that could be
                                                                                 challenge one another, who
                great deal from Julian but                                       enjoy working together and
                also from my peers there.                                        who are driven by common
                What truly made Tiger a                                          goals and values. I believe
                special place was that you                                       I’m a much better investor
                were surrounded by so                                            today than I was twenty
                many individuals who were                                        years ago, and I really have
                not only very talented and       G&D: Since that time, have      my colleagues to thank for
                dedicated investors, but also    there been other investors                   (Continued on page 19)
                just really nice people. I
Issue XXI, Issue 2                                                                                    Page 19

Lee Ainslie
(Continued from page 18)        how critical integrity and      about those companies than
that more than anything         reputation are in the           you did. This objective was
else.                           investment business, and        possible because most folks
                                those are lessons I certainly   were responsible for
G&D: What led you to            took to heart.                  anywhere from a handful to
your decision to leave Tiger                                    a couple dozen positions in
and start Maverick Capital?                                     the portfolio. However, an
                                                                appropriately diversified
LA: That was an extremely                                       portfolio requires more
difficult decision because I                                    than a handful of stocks, so I
had been treated extremely       “There's a trade-off
                                                                needed a different approach
well at Tiger and had so           with having very             when starting Maverick.
much respect for Julian. I                                      Likewise, a properly
was approached by a family       narrow expertise. If           diversified portfolio is not
in Texas who were sort of                                       just focused on one sector
serial entrepreneurs and          one focuses on just           or on one region, and so
had decided that they                                           there was a period of time
wanted to help launch a          a very small number            when I was more dependent
hedge fund. I declined their                                    upon sell-side analysts and
offer to work with them           of names they can
                                                                friends than I was
more than once, but they            develop a deep              comfortable with. For
were persistent. I finally                                      someone who was very
recognized that even though        understanding of             accustomed to being
I was not sure I was ready                                      extremely close to each
to take on such                   certain companies             investment I was
responsibility, that when I                                     responsible for that was a
would finally be ready, the           but may lose              bit of a scary feeling. That
odds of finding this kind of                                    drove a very early effort to
opportunity would be slim         perspective of how
                                                                expand the internal
to none given their track        that opportunity set           resources at Maverick, but
record of success in a                                          initially during the first
number of different fields           compares to a              couple of years, that was
and their willingness to be                                     the biggest transition.
so supportive of this new         broader universe.”
venture. I am very thankful                                     G&D: That was a
to them. While they have                                        concerted effort when you
not been actively involved in                                   started to have analysts
the business for many years,                                    covering a smaller number
they remain good friends        G&D: What was the               of names. A lot of analysts
and significant investors.      toughest part of the            we talk to have pretty
                                transition going from           broad coverage universes,
G&D: What was Julian’s          working for Julian as an        so your goal was to have
reaction to it? Did he give     analyst to running your own     the depth of knowledge that
you any words of advice?        fund?                           comes with having a smaller
                                                                number of names.
LA: His reaction was            LA: At Tiger you were
understandably mixed. I         essentially expected to be      LA: There's a trade-off
don’t recall his giving me      the foremost authority on a     with having very narrow
any particular advice when I    small number of stocks. For     expertise. If one focuses on
told him about my decision.     the investments you             just a very small number of
However, by that point I        oversaw, no other public        names they can develop a
had already had three plus      investor should know more                    (Continued on page 20)
years of hearing from him
Page 20

          Lee Ainslie
          (Continued from page 19)         developments that may             the hope that together, as a
          deep understanding of            impact different industries       team, we would be
          certain companies but may        we established a stock            successful over time. They
          lose perspective of how that     committee that usually            had to have confidence in
          opportunity set compares         meets several hours each          our effort.
          to a broader universe. So        week. This group includes
          how do you have your cake        every sector head, our            Today, the majority of our
          and eat it too? We               Chief Risk Officer, and           investment team joined
          addressed this issue by          myself, and is chaired by         Maverick as an analyst.
          hiring what we refer to as       Andrew Warford. These             Typically, our analysts have
          sector heads who oversee         meetings are focused on           worked for two years at a
          our efforts in each of the six   evaluating and reviewing          Wall Street firm or a
          broad industry groups in         potential and current             consulting firm before
          which we invest. By 1998,        investments, and under            joining us. We make a two-
          we had heads for each            Andrew’s leadership we            year commitment to them
          sector so there was finally      have done a wonderful job         and expect the same in
          no stock in the portfolio        of maintaining a very             return, and some are asked
          where I was the only             consistent and very high          to stay longer. We usually
          individual tracking the          hurdle for including a stock      hire one to three analysts
          investment. The next five        in the portfolio.                 each year, and it’s a highly
          years were spent building                                          selective process. We
          out the depth and talent of      There's also a weekly             review hundreds of resumes
          those teams. Now we              portfolio management              from extraordinarily well-
          typically have three to six      meeting that I lead in which      qualified individuals. Our
          people on each sector team.      we consider our portfolio         selection process has
          Over the last decade, the        exposures and risks in light      improved meaningfully over
          incremental growth of the        of different developments         the last few years. First, we
          investment team has been         around the world. We have         changed our interviewing
          driven by developing             tried to find a balance that      process to make it very
          expertise that is beneficial     allows our sector teams to        targeted on evaluating
          to all the sector teams.         be quite focused on the           different skills and attributes
          Today, we generally hold         industries they cover and         that we believe are essential
          about four investment            yet to be fully informed          to success at our firm.
          positions per investment         about factors outside of          Secondly, we introduced a
          professional. At most            their universe that could         third-party testing
          hedge funds, this ratio          play a role in their decisions.   component which measures
          seems to average                                                   characteristics that the
          somewhere between 10 and         G&D: As you were                  interviewing process may
          20. This gives us a              building your analyst team,       not reveal. Thirdly, we
          significant advantage in         what did you look for in the      spent time analyzing the
          terms of the quantity and        people that you hired?            success of past
          depth of our due diligence                                         recommendations of the
          behind each investment           LA: The initial group             folks on our team who
          decision and how familiar        consisted of people whom I        conducted our interviews to
          we are with the companies        had known for a long time         understand who in the past
          in which we invest.              and had great confidence in       was adept at predicting
                                           their abilities. However,         good candidates—evaluating
          To ensure that our sector        each of these individuals         people and evaluating
          heads have a strong              were being asked to take a        securities are two different
          understanding of the relative    risk in that they would           skills.
          attractiveness of their          almost certainly make less
          investments to a broader         money in the short term in                      (Continued on page 21)
          universe and are attuned to
Issue XXI, Issue 2                                                                                    Page 21

Lee Ainslie
(Continued from page 20)       ability to recognize signals    every business in the world
The most important             that can help you determine     continually becomes more
components we gauge            whether someone is not          competitive. I'm sure that's
include competitiveness,       being forthright or honest.     true for the dry cleaner
mental flexibility and         This can come in handy          down the block—I bet their
emotional consistency—that     when you’re talking to a        business is more challenging
last trait is surprisingly     management team and             than it was a decade ago.
important. This is a very      asking difficult questions.     That's certainly true in our
stressful business. We are     We haven't found that these     field, and so you constantly
all human, and we all make     techniques provide some         have to find ways to
mistakes. How one                                              improve. If you’re not
responds to those mistakes                                     improving you eventually get
and whether someone can                                        left behind. So this training
keep a level head and make                                     really was a result of trying
thoughtful decisions is                                        to find ways to improve our
critical. Conversely, how           “This is a very            abilities. I heard about this
does one respond to a few                                      group of ex-CIA officers
big wins? With some folks,        stressful business.          who conduct this coaching
early success leads to                                         from one of our investors
inflated confidence that may     We are all human,             actually, and I think it's been
slow the recognition of a                                      helpful.
mistake.                          and we all make
                                mistakes. How one              G&D: How have your
At the end of the day,                                         responsibilities as a
investing is not rocket           responds to those            portfolio manager evolved
science. Most of the folks                                     over the years? Are you
we're interviewing are               mistakes and              still close to every
certainly bright enough to                                     investment decision you
discount a cash flow stream      whether someone               make?
or calculate a P/E multiple.
Productivity and dedication        can keep a level
                                                               LA: Over the years it's
can be much more                                               been a bit cyclical. If you go
important differentiators
                                   head and make
                                                               to the very beginning, we
than just raw brain power.      thoughtful decisions           had one investment
Intelligence helps, but                                        professional, so I was very
whether you’re driving a              is critical.”            close to every decision we
Porsche or a Ferrari doesn’t                                   made, for better or worse.
matter too much if the                                         There have been periods
speed limit is 65 MPH.                                         where the business itself has
                                                               required a larger investment
G&D: One thing we read         magical ability, but they can   of time as we were going
about was that your team is    help you understand             through changes in our
trained in lie detection and   whether someone is              process or rough patches in
interview techniques. Is       addressing a topic that gives   performance so investors
that an important process      them discomfort.                want to speak with me
when you are interviewing a                                    more. Other times, I end
management team or             G&D: Was this training a        up investing more time in
conducting channel checks?     result of you having been       evaluating and managing our
                               lied to by a management         investment team—these
LA: I'd say it's helpful but   team in the past?               responsibilities tend to ebb
not extremely important.                                       and flow. Over the past
There is some training you     LA: Not really, I think                       (Continued on page 22)
can do to improve your
              Page 22

                           Lee Ainslie
                           (Continued from page 21)         holding periods, as often        nature of these investments
                           couple of years, the amount      others begin to recognize        and that these positions
                           of time I have had to invest     some of the elements of the      turn over more frequently,
                           in running the business has      investment that we have          so having a deeper bench of
                           been relatively light.           been focusing on and the         such investments is helpful.
                                                            position becomes
                           We typically have about 150      incrementally less attractive,
                           stocks in the portfolio, and I   and of course other times
Professor Tano Santos at   am familiar with all of them,    we recognize that we’re
the 2013 Moon Lee Prize    but I am closer to our larger    wrong. Nevertheless on
Competition.               positions and investments        the long side, our typical
                           that have not worked the         holding period is still over a
                           way that we had expected.        year, and on the short side
                                                                                                “We believe that
                           So when I'm doing a deep         it is closer to nine months.
                           dive or going to visit a
                                                            Although our investment
                           management team, often the       horizon is similar for longs        responsibility for
                           P&L of that position has a       and shorts, our holding
                           minus sign in front of it.       period ends up being longer          both longs and
                           With Andrew’s role as chair      on the long side because we
                           of the stock committee,          have often been fortunate            shorts sharpens
                           both he and the relevant         to identify great businesses
                           sector head are very close       run by talented managers.
                                                                                              analytical judgment
                           to each investment, and to       When a business is
                           me it’s reassuring to know
                                                                                                and helps a team
                                                            generating a strong return
                           that we have at least two        on capital and the cash flow           build a more
                           senior, proven investment        stream can be reinvested
                           professionals very attuned       effectively, then we may able            complete
                           to the potential return and      to own that stock for
                           risks of each stock in the       several years. The short           understanding of a
                           portfolio.                       side typically doesn’t work
                                                            that way because when a
                                                                                              particular industry.”
                           G&D: Can you talk a little       company has significant
                           bit about the difference in      issues, these flaws usually
                           how you think about the          come to light sooner rather
                           timeframe and the sizing         than later. So on the short
                           between long and short           side, you often end up
                           ideas? How you think about       having more of an event          G&D: We've interviewed
                           the similarities and             orientation.                     investors who have said that
                           differences in regards to                                         it’s rare to find people who
                           portfolio construction?          In terms of sizing, our          are adept at both long and
                                                            average long is roughly          short investing. Have you
                           LA: I think compared to          twice the size of an average     found that to be the case?
                           many other hedge funds, we       short at Maverick, and our
                           may have a longer term           long portfolio is more           LA: I disagree with that
                           timeframe and tend to think      concentrated than our short      thesis. We believe that
                           very strategically when          portfolio. This construction     having responsibility for
                           evaluating different             allows us to maintain net        both longs and shorts
                           industries and companies.        long exposure typically          sharpens analytical judgment
                           We are typically looking to      between 30% and 60%. The         and helps a team build a
                           understand where a               greater level of                 more complete
                           business will be in two to       diversification of our short     understanding of a particular
                           three years. However, this       portfolio reflects the riskier                (Continued on page 23)
                           is different from our average
Issue XXI, Issue 2                                                                                     Page 23

Lee Ainslie
(Continued from page 22)         approach.
industry. In my experience,                                      G&D: Can you talk about
people that are solely           G&D: You said in an             your idea generation
focused on shorts tend to        interview a few years ago       process? Are you finding
become extreme pessimists.       that classic value investors    yourself looking more at
They look at any situation       often invest purely on          new ideas or at ideas that
and immediately start to         valuation and that was          you’ve been tracking for
find all of the things that      something that you just         many years?
may go wrong, while quickly      weren't comfortable with.
overlooking important            How much weight do you          LA: We have always
potential positives.             place on valuation?             considered our universe to
Furthermore, shorting is                                         be every stock in the world
more challenging for several     LA: To be clear, I think        that trades more than $10
reasons, one of which is         that valuation is a critical    million a day and has a $1
that the market tends to         component of                    billion market cap. As we
appreciate over time. So         understanding where             speak, there are almost
even talented short-sellers      investment opportunities        3,000 such stocks—this
who are generating alpha         may lie. But I think many       excludes A shares in China
tend to get rather frustrated    “value investors” purely        as US investors only have a
over time. These issues          focus on that metric and        limited capacity to invest in
may be even more acute at        may ignore other important      these stocks today. If we
Maverick than many firms         considerations. It’s one        did, it would add several
because all of our short         thing if you have a very        hundred stocks to our
exposure is achieved by          cheap stock and reasons to      universe. At Maverick, our
shorting individual stocks, as   believe that the cheap          investment process is driven
opposed to using ETFs, S&P       valuation will not persist:     by our six industry sector
puts, or other market-           there's a new management        teams, which have global
related instruments.             team, there's an activist       responsibility. Each sector
                                 shareholder, they’re            team has between three and
We have always held our          restructuring, they just        five people.
sector teams responsible for     made a decision to buy back
both long and short              stock, and so forth. I          Idea generation almost
investments, and our             believe it is important to      always takes place in these
investment process is pretty     identify a catalyst that        sector teams. There are
similar for each. To             should benefit the valuation.   times I have an idea that
dramatically oversimplify,       The approach of simply          merits further evaluation,
we are trying to identify the    identifying a very cheap        but most of our sector
winners and losers in each       stock that often has been       heads have spent their
industry in which we invest      cheap for a while and then      entire careers focusing on
and then evaluate the            just crossing your fingers      one industry, and they have
discrepancies between our        and hoping the world will       each proven that they are
conclusions and consensus        wake up and be willing to       very talented investors—so
views, and I believe that is     assign a higher valuation one   we would never move
an effective approach for        day soon is not a very          forward on an idea without
both longs and shorts.           effective approach in my        their input. Our sector
While many firms seem to         judgment. So while we           heads are probably
be markedly better on            place great emphasis on         responsible for the majority
either long or short             valuation in our investment     of new ideas, but even our
investments, at Maverick we      decisions, valuation alone      junior analysts are expected
have added 6% of alpha per       should never be the driver      to develop actionable
year on both longs and           of either a long or a short     investment theses. From
shorts, so I believe this        investment.                                  (Continued on page 24)
balance supports our
Page 24

          Lee Ainslie
          (Continued from page 23)           have a very deep                us. I believe that a
          that spark of an idea, if it’s a   understanding of the            successful investor must be
          company we know well, one          businesses in which we          very comfortable with a
          little data point can be           invest: the sustainability of   number of different
          enough for us to move              the business, of the growth     valuation methodologies and
          quickly. However, if it’s a        and of the cash flow. The       have the wisdom to
          company we have not                primary point of our            recognize which valuation
          analyzed before, it typically                                      approach is going to be the
          takes months before a stock                                        most relevant in different
          can make its way into the                                          situations. The most
          portfolio because we will do                                       commonly used valuation
          a deep dive not only on the                                        metric at Maverick is
          company in which we’re                                             sustainable free cash flow in
          considering investing, but                                         comparison to enterprise
          also on the competitors,                                           value. But we may also
          customers and suppliers of           “The most critical            consider metrics such as
          that company. For better                                           enterprise value to
          or worse, this process can           factor that we’re             revenues, book value, free
          take a very long time.                                             cash flow yield, P/E ratio,
                                             trying to evaluate is           dividend yield, and so forth.
          G&D: What do you look                                              Different metrics will be
          for in these deep dives?                the quality of
                                                                             more or less important in
          What qualities make for a          management—their                different situations.
          good investment?                                                   Finally, as I mentioned
                                                   intelligence,             earlier, we consider how
          LA: By deep dive, I mean                                           differentiated our view is;
          we typically have extensive         competiveness and,             not to say that we will only
          meetings with as many                                              invest in things where we
          different members of                 most importantly,             have a contrarian
          management as possible as                                          perspective. For example,
          well as managers of different           their desire to
                                                                             Microsoft in the early 1990s
          regions or product lines if         create shareholder             and Wal-Mart in the early
          possible. The most critical                                        1980s were consensus buys
          factor that we’re trying to                 value.”                among virtually all Wall
          evaluate is the quality of                                         Street firms, and yet they
          management—their                                                   were among the most
          intelligence, competiveness                                        successful stocks of their
          and, most importantly, their                                       day. So it's not impossible,
          desire to create shareholder                                       but the odds are against you
          value. At the end of the                                           if your view is the same as
          day, businesses are run by                                         everyone else's because that
          people, and different              extensive conversations         view is probably already
          management teams have              with customers, suppliers       reflected in a stock’s
          different motivations and          and competitors is the          valuation. Our most
          different abilities. As            evaluation a company’s          successful investments tend
          investors, it is critical that     strategic position and the      to be those where our
          we have a strong                   strength of a company’s         research process has led us
          understanding of the quality       moat or competitive             to a conclusion that is
          and the objectives of every        advantages. As we               different than the
          management team in which           discussed a few minutes ago,    perspective commonly held
          we invest.                         valuation is also an            by most investors, and these
                                             important consideration for                  (Continued on page 25)
          Of course, we also want to
Issue XXI, Issue 2                                                                                     Page 25

Lee Ainslie
(Continued from page 24)        insights gleaned through         the portfolio that I believe
deep dives allow us to          those conversations very         represents the optimal use
develop significant             helpful over the years.          of capital once again.
confidence in these
differentiated views.           G&D: You have been               This is exactly why we
                                quoted as saying there are       primarily invest in liquid,
G&D: You've met a lot of        no “holds.” You either           public equities—so we have
management teams over           “buy” or “sell”. How do          the ability to improve our
your career. Have you           you implement that               portfolio every day. If we
found more often than not       practically in your portfolio?   conclude that a 3% position
that they are thinking the                                       in stock X would be the
right things in regards to      LA: I think I have read          ideal position size, then we
creating shareholder value,     almost everything that           should try to get to that
or is it kind of the            Warren Buffett has written,      position size that day.
alternative where you're        and I agree with more than       Whether stock X is new to
generally disappointed?         95% of his thinking, but this    the portfolio or it’s a
                                is one area where I disagree.    position we’ve held for
LA: One of the things we        I understand the tax impact      years is not horribly
really try to make sure our     of turnover, but                 relevant. Likewise, whether
team understands is that if     nevertheless, I would argue      we entered that day with a
someone is able to become       that an investor should be       2% position or a 4%
the CEO of a Fortune 500        able to overcome the             position in stock X should
company, the odds are that      negative tax consequences        not play a role in our
individual is going to be       of shorter-term holdings         determination of the most
pretty impressive across the    through more efficient use       appropriate position size. I
conference table for 45         of capital. For example, if I    think too often investors get
minutes. These executives       am starting a new fund, and      wed to certain investments
are not dumb; they know         my portfolio is a blank sheet    that have worked well or
exactly what you're trying      of paper then I will evaluate    perhaps because they’ve
to get at, what you want to     the potential return of every    developed a nice
hear, what Wall Street          potential investment from        relationship with
thinks the right answers are,   the prices the market is         management that they don’t
and like all good politicians   offering that day. I can         want to disrupt, and so
they will do their best to      decide how much risk I am        investors often get
highlight the strengths of      willing to take to achieve       complacent and comfortable
their business. When you        expected returns, and I can      with their current portfolio.
delve into the potentially      evaluate how each                In my judgment, it is critical
weaker aspects of their         opportunity compares to          to attempt to identify the
company, they will typically    every other opportunity to       best possible use of capital
try to gloss over your          develop a portfolio which I      continuously.
concerns or even obfuscate      believe represents the
the issues. So when we          optimal use of capital. In my    The “no holds” concept
evaluate a management           view, tomorrow, I should go      simply reflects the approach
team, we’re much more           through the exact same           that every investment
focused on analyzing past       process taking into account      should represent a very
decisions and actions than      any new information              compelling risk/reward
simply reviewing their          including changes in the         opportunity from current
responses to our questions.     price of securities. If I        prices, and if that’s not the
We also invest a lot of time    conclude that a different        case then that capital should
in trying to interview people   portfolio would be               be redeployed into positions
they've worked with before      preferable then I should buy     that are viewed as very
or people they’ve competed      or sell securities to get to                  (Continued on page 26)
against and have found
Page 26

          Lee Ainslie
          (Continued from page 25)         in every industry and in        merger between Software
          compelling at current prices.    every region in which we        Etc. and Babbage's in late
          In the perfect world, every      invest. We try to avoid         1994. The companies were
          member of our investment         market timing or sector         the two largest sellers of
          team is pounding the table       rotation calls. Our returns     computer software and
          to increase the size their       are driven by our ability to    operated in malls around
          positions every day until        generate alpha within           the US. On paper, NeoStar
          they are at a maximum size       industries and regions.         was very attractively
          in terms liquidity or risk                                       positioned. By merging,
          contribution. When               G&D: Can you talk about a       these two competitors
          somebody tells me that they      mistake that you've made        would enjoy economies of
          don’t think we should sell a     on an investment that has       scale and could improve
          stock, but that they             changed the way you think       pricing. As this merger was
          wouldn't buy more at the         about things?                   taking place both Sega and
          current price either, then                                       Nintendo had roll-outs of
          that investment probably         LA: Unfortunately, I can go     their new game platforms,
          does not represent one of        through many examples of        both of which ended up
          our very best uses of            mistakes that we’ve learned     being bigger than people
          capital—unless the size of       from. In terms of risk/         expected. At the same
          the position is already at a     return management, we           time, Windows 95 was
          maximum from a risk              develop a risk case that we     coming out, so you had
          perspective. We want our         think has a 10% chance of       huge drivers to both PC and
          portfolio invested in the        taking place—so a case that     gaming software sales as
          most attractive use of           is not highly likely, yet       well as very significant
          capital today at current         certainly in the realm of       synergy opportunities.
          price points, and if a certain   possibility—and we              These businesses should
          position no longer               vigorously debate the           enjoy meaningful operating
          represents that then we          assumptions behind these        leverage, so just improving
          should sell. Sometimes,          risk cases. In measuring        comp store sales a few
          people have a hard time          potential downside, we have     percent should have had a
          with this because this           often used historical           nice impact on operating
          philosophy often means we        dynamics, such as trough        margins. Putting all these
          are reducing or exiting a        book value or revenue           factors together, we
          position before it’s reached     multiples. One of the           concluded that the company
          our expected price. For          lessons of 2008, and even       would earn significantly
          example, if a stock is 10%       more so in 2011, was that,      more than investors were
          away from our original           in certain environments         expecting. And we were
          target price, we are likely to   those historical patterns can   wrong. We were wrong
          sell because we think there      collapse. We took too           because management just
          are many other                   much comfort in the             blew it. When you asked
          opportunities with greater       thought that many stocks        me about characteristics I
          upside. Conceptually, our        were sitting at levels where    look for in stocks, I
          team has to accept this          the downside risks appeared     mentioned quality of
          concept of “no holds.”           very limited given they were    management is the most
                                           so close to the historical      important. While our
          G&D: Are there industries        lows on such metrics, and       investment case for NeoStar
          or countries that you have a     we were proven wrong.           was extremely compelling,
          different view on versus the                                     we were doomed by
          market?                          In terms of a specific          horrific execution. In doing
                                           company, we invested in a       a postmortem, it became
          LA: In our core hedge            company called NeoStar,         clear the merger was a
          fund, we try to maintain a       which was a result of a                     (Continued on page 27)
          balance of longs and shorts
Issue XXI, Issue 2                                                                                              Page 27

Lee Ainslie
(Continued from page 26)        investment career is not          can't be overcome, but it's
disaster. The companies         necessarily to work at a          certainly going to make
continued to be run as          hedge fund or at a large          raising capital harder. You
separate entities and           mutual fund complex. You          can’t just tell people not to
continued to compete            can start your career by          count your past record
viciously. There was huge       simply improving your             because you didn't know
in-fighting about who was       understanding of how              what you were doing. So
going to get what               different industries or           the first couple of years
responsibility. Instead of      companies work or how             become a make or break          Professor Bruce Green-
taking advantage of the         Wall Street works. Any            period. If it were me, I        wald and Heilbrunn Center
obvious synergies, they had     brokerage firm or Wall            would want to stack the         Director Louisa Serene
duplicate efforts on many       Street firm can be a path to      deck in my favor as much as     Schneider at the 2013
different fronts. One large                                                                       Graham and Dodd
                                an investment career. A lot       possible. When I decided
vendor told us that two                                                                           Breakfast.
                                of people move from the           to launch Maverick, I had
different people each           sell-side to the buy-side         been with Tiger for three
thought they were ordering      over time. We probably            years, and I was still scared
for all the stores and as a     have as many former               to death. I was young, naive
result, important orders        McKinsey consultants as we        and probably a touch
were placed twice, and they     do former Morgan Stanley          arrogant in hindsight. If I
literally ended up with twice   investment bankers.               had a better understanding
the expected inventory. It                                        of the challenges of
was just an unmitigated         G&D: A lot of our                 successfully starting a fund,
disaster. We bought the         students are also interested      I’m not sure I would have
stock right after the merger    in starting their own funds.      departed Tiger. Also,
in early 1995, and by 1996 it   Assuming they can raise           today's world is far more
was all falling apart. Our      capital, would you                competitive. The odds of a
strategic analysis proved       recommend that they spend         small group of people
correct—both the gaming         the first few years trying to     launching a small fund and
platforms were huge and         get training somewhere            growing that fund into a
Windows 95 became the           first, or do you think it is      large entity are just much
best-selling operating          okay to start right after         smaller today. When I
system of all time. Realizing   business school without any       started, there were
the potential synergies         formal training?                  probably about 100 hedge
seemed straightforward as                                         funds in the world. Today,
well. But the important         LA: The capital is                there are over 7,000.
lesson was that such            important, but the know-
considerations are not          how is even more
relevant if the management      important. The fear with          G&D: Lee, thank you for
team is subpar.                 starting right away without a     your time.
                                great deal of experience is
G&D: What advice would          you don't get many
you give to the students        mulligans in this field. If you
who are interested in a         launch a fund that has
career in investing?            disappointing performance,
                                then go to work for another
LA: Two things: first, read     firm for a few years and
a lot. Read as many             eventually try to launch
investment books as you         another fund—potential
can get your hands on. I've     investors are still going to
been able to learn              want to delve into the
something from almost           returns of your initial effort.
every book I have ever read.    Not that a poor record
Secondly, the path to an
       Page 28

                 Geoffrey Batt
                 (Continued from page 1)          because I couldn’t renew my       than cover my tuition and in
                 Batt launched the                student loans.                    the meantime I’d get to
                 Euphrates Iraq Fund in                                             learn about the world. He
                 October 2010. Prior to           I revealed this to him having     said something along the
                 his Iraq investments, Mr.        really no idea who he was.        lines of, “the last thing the
                 Batt was an analyst at           But then he started telling       world needs is another
                 Quantrarian Capital              me this story of how,             philosopher with no real
                 Management. He                   before school, he was             experience.” He was of the
                 studied philosophy at            running a fund that was one       opinion that philosophy
                 Columbia University.             of the first to invest in post-   provides a good training for
                                                  Soviet era Russian equities       financial markets.
                 Graham & Doddsville              during the 1990s. Russia
                 (G&D): Let’s start with          turned out to be one of the       I actually thought he was
                 your background—what             best places in the world to       nuts. He didn't fit my
Geoffrey Batt    drew you to investing, and       invest in at that time so it      conception of what an ultra-
                 in particular, to investing in   was quite successful, but he      high net worth individual
                 Iraq?                            also had a lifelong dream of      looked like. But I went to
                                                                                    the library and looked him
                 Geoffrey Batt (GB): I                                              up and it was all true. His
                 studied philosophy at                                              name was Dan Cloud. You
                 Columbia as an undergrad                                           couldn't bring up good
                 and had absolutely no                                              pictures on the internet at
                 intention whatsoever of                                            the time but I saw there was
                 getting involved in finance. I                                     a Barron’s article on him
                 didn't know anything about                                         that I had to look up on
                 the stock market. I honestly      “Philosophy teaches              microfilm. Everything he
                 didn't know the difference                                         said was there. So I decided
                 between a stock and a                   you to take                to give it a shot. I went to
                 bond. I was strictly                                               work for him, with his
                 interested in academics and            whatever the                family office, and learned
                 very much wanted to                                                about East Asia and the
                 pursue a Ph.D. in
                                                   prevailing wisdom is
                                                                                    markets that they were
                 philosophy. I took a               and challenge it.”              investing in—Thailand, Hong
                 graduate seminar in my                                             Kong, South Korea,
                 junior year and there was a                                        Singapore, Indonesia,
                 third year Ph.D. student in                                        Vietnam, et cetera. Dan was
                 the class who was much                                             very much a macro driven
                 older, maybe in his forties.                                       investor, looking at things
                 But he was, in my opinion,                                         from a top down point of
                 clearly the smartest guy in                                        view. What he had me
                 the room, probably smarter                                         looking for were countries
                 than the professor. He was       pursuing a philosophy             that seemed to have the
                 also a bit eccentric to put it   doctorate. It turned out          best potential to grow very
                 politely. He seemed very         that he was in the process        rapidly and had the most
                 interesting, though, and one     of starting a new family          interesting demographic
                 day we bumped into each          office to focus on investing      profiles.
                 other on campus, started         in East Asian emerging
                 talking, and a friendship        markets and asked if I’d be       I more or less just tried to
                 developed from that. After       interested in working for         learn on the job, and I
                 knowing him for a while, I       him during the time off. If it    would say after six months
                 mentioned that I was going       went well, he told me I’d get     or so I started getting very
                 to have to leave school for a    a bonus that would more                        (Continued on page 29)
                 year to save up money
Issue XXI, Issue 2                                                                                                    Page 29

Geoffrey Batt
(Continued from page 28)           And so I went back to             focus going to be initially?
interested in companies            school and had enough
themselves. I didn't have the      money left over to invest on      GB: Several different stock
slightest clue about how to        my own. And you know,             markets over time have
analyze or value them so I         before I started working for      gone through these historic
spent the next six months          him, my focus was 100%            equity re-ratings and what I
trying to learn. The first         philosophy. When I came           was really taught to do
thing I read was The               back, it was 50/50—50%            when I was working for
Intelligent Investor. I felt       philosophy and 50%                Dan, and what he was
pretty confident that I            markets. And as that year         taught to do when he first              “I'm not a value
understood it, so I went on        progressed, it gradually          got involved in the business,
to Security Analysis and read      shifted to 0% philosophy          was to find opportunities              purist in the sense
that. I still read it—to this      and 100% markets. Toward          for historic re-ratings.
day, I think I’ve finished it      the end, I was sitting in class                                           that I altogether
seven or eight times. Security     with my laptop open reading       Let me try to define what
Analysis gave me a basic                                                                                        shun macro
                                   10-Qs and 10-Ks rather            that is. It’s a type of secular
framework, however                 than paying attention to the      bull market that tends to
imperfectly I understood it,
                                                                                                            considerations. But
                                   professor. I was two classes      last for seven to fifteen
that I could use to approach       short of graduating and           years, In the case of Japan,             to me, the real
valuing companies on an            decided that I had enough.        their bull market started in
individual level. And that's                                         1950 and lasted until 1989.            interesting work is
when it became very                In retrospect, it was an          That is one of the longest
interesting to me. The             unwise decision because I         ones that I am aware of.               in finding the next
macro stuff, it has its place, I   didn't have as much money         Russia was fourteen to
suppose. I'm not a value                                                                                     big company, the
                                   as I thought I did. Maybe I       fifteen years. You can get a
purist in the sense that I         was a bit delusional in           secular bull market that lasts
altogether shun macro
                                                                                                              kind of deeply
                                   thinking it, but I was            for seven to fifteen years
considerations. But to me,         determined to just go out         and during that period                    undervalued
the real interesting work is       on my own and become an           companies on the exchange
in finding the next big            independent investor. I still     can see their profits go up            company that has
company, the kind of deeply        had library access at             20x. Initially they might be
undervalued company that           Columbia and there was a          trading at 2-4x earnings and            the potential to
has the potential to               Bloomberg there so I              by the end of the bull
appreciate ten, twenty,                                                                                       appreciate ten,
                                   thought it would be perfect.      market, they are trading at
thirty times over a ten year       I told Dan my plans and he        15-20x earnings. There’s an
                                                                                                            twenty, thirty times
                                   said, “Look, you can't just       improvement that gradually
                                   go out on your own and not        gets recognized. Initially, the          over a ten year
G&D: How did that year             have structure. You really        market goes up but the
working for Dan turn out?          need to have a mentor for         moves are commensurate                      period.”
                                   this process, somebody who        with profit growth. If profits
GB: The year went really           can help guide you if you're      grow 40% and the company
well. We were mostly               going in the wrong direction      is trading at 8x earnings,
invested in Thailand and I         or to provide you with            then the stock goes up 40%
think the market was up            advice and support and            but still trades at 8x
110% or so in 2003-04. I got       criticism.” So I decided to       earnings. But towards the
a bonus, which at the time         strike up that relationship       end, people get really
seemed quite large. In             with him informally where I       exuberant and assume that
retrospect, it wasn't, but         would start on my own but         the good times are going to
when you're approaching            he would serve as my              last forever and that’s when
things from the perspective        mentor.                           you see multiple expansion.
of what you're going to earn                                         So it’s when you get
in philosophy, it seemed like      G&D: And what was the                           (Continued on page 30)
quite a lot of money.
           Page 30

                        Geoffrey Batt
                        (Continued from page 29)           thing. He found it in Russia     is followed by a move away
                        significant profit growth          and launched his fund in         from whatever was plaguing
                        over a long period of time         1994. Russia from 1992-          it before to something more
                        coupled with multiple              1994 was also a basket case.     positive, more market and
                        expansion that you can get         Yeltsin lost an election in      capitalist oriented. If you
                        these spectacular stock            1993 but decided it wasn’t       can find that kind of
                        market moves.                      valid just by decree and         situation, that's a potential
                                                           suspended the constitution.      candidate for a historic
                        When Dan first got involved        Parliament was obviously         equity re-rating.
 “Several different     in the business, it was in         very upset about that so he
                        China in the 1980s. He             sent tanks in to fire on         G&D: What else goes into
stock markets over      finished school and went off       Parliament in 1993. Literally,   it?
                        to China to work for a             the President of Russia was
  time have gone        British brokerage firm. The        using the military to fire on    GB: There's a lot more but
                        guys who taught him made           the Parliament building and      that's the first thing you
   through these        their fortunes investing in        kill MPs. But it turned out      want to look for. It seems
 historic equity re-    Hong Kong and South                that was the ideal time to       to me at least, the greatest
                        Korea in the 1960s and             get involved in Russia. These    opportunities in any market,
ratings and what I      1970s. South Korea was             sorts of alarming states of      any asset class, any
                        socially and politically an        affairs, they really, it turns   investment generally that
was really taught to    utter basket case at that          out in retrospect, don't         you're going to make, are
                        time. It was ruled by a            matter much. They're             those in which there's a
  do when I was         dictator, Park, for around         terrifying and for that          very wide gap between
                        19 years. He was a guy who         reason most investors don't      perception and reality. So
 working for Dan,       had suspended the                  get involved in their            the perception of a country
 and what he was        constitution two or three          markets. When it's most          that has these
                        times, murdered the                opportune to invest in a         characteristics is obviously
taught to do when       opposition. Park was brutal        market, most people are          going to be very negative
                        but this was also the period       doing anything but investing     because there's political
he first got involved   that is referred to as the         there. They stay very far        instability, social instability,
                        South Korean economic              away.                            and so on. But if the
in the business, was    miracle. So despite the fact                                        economic situation is
                        there was quite a lot of           But he was there and             positive, if the country has a
      to find           political and social instability   started a fund, Firebird. And    couple years of very high
 opportunities for      in that country, it happened       I think that fund was up 50x,    GDP growth, inflation is
                        contemporaneously with an          net after two and twenty, so     relatively stable and they
historic re-ratings.”   economic miracle. These            it was an extraordinary run.     have price stability, then this
                        guys recognized that and           I think it was one of the        is where I think the macro
                        they believed that many of         best performing emerging         very much comes into play.
                        the things that typically keep     market funds in the world
                        people away from                   during that period. So that's    You want to look at things
                        markets—bombings,                  really what I was taught to      like, are deposits in the
                        violence, general                  look for—these types of          banking sector growing? Is
                        instability—really don't           really alarming and chaotic      the currency relatively
                        matter that much. As long          transitional situations in a     stable? Generally what
                        as it's not related to the         country that, for whatever       you're looking for are signs
                        economic development of            reason, was living in the        of macro stability and
                        the country, it doesn't            stone ages or had some           economic growth. If you can
                        matter. That was what Dan          kind of very flawed              find these things, then that
                        was taught.                        economic system in place         implies there are institutions
                                                           for decades. Something           in place that are capable of
                        So he later went off and was       transformative occurs that                     (Continued on page 31)
                        searching for the next big
Issue XXI, Issue 2                                                                                       Page 31

Geoffrey Batt
(Continued from page 30)           countries where there is        Dictatorships can be very
achieving this stability. If you   perceived political risk, how   stable, but, by their very
have price and currency            do you separate out the         nature, they're stable until
stability, that presupposes a      noise from true risk? Take      they're not. If there's an
central bank exists that is        Yeltsin for example, if you     issue, if suddenly the
capable of imposing stability      have a leader or autocrat       dictator can no longer rule,
on the system. And that also       who is willing to go and fire   what follows? Also if the
presupposes that you have          on Parliament, how do you       dictator goes crazy, there's
some sort of technocrat            get comfortable that he also    no mechanism to easily
running the institution. So if     isn’t also willing to devalue   remove him and then you
you have credible                  the currency?                   can get a dangerous
institutions at the financial                                      scenario where he just
and economic level that are                                        starts printing money or
able to achieve macro                                              devaluing the currency—
stability, then whatever has                                       you could have a revolution
been holding back that                                             or other undesirable
country from realizing its                                         developments follow. Still,
potential, if they can                                             the South Korean example
transition away from it,                                           under Park demonstrates
macro conditions aren't                                            that economic miracles and
going to interfere with                                            historic equity re-ratings can
development.                        “The South Korean              happen even in iron-fisted
If you look at countries that      example under Park
had the potential to do this                                       That said, I have a
                                     demonstrates that
but failed, like any South                                         preference for transitional
American country in the              economic miracles             countries where there is a
1960s, what destroyed them                                         democratic political system
is that they had chronically         and historic equity           in place. Taking Russia and
high inflation, they had                                           Yeltsin, you could make an
persistently weak                       re-ratings can             argument that what Yeltsin
currencies, and they lacked                                        was actually doing was
the institutional framework            happen even in
                                                                   establishing legitimacy of the
that was vital to achieve the                                      state itself—that the state
stability that you needed to                                       itself was being undermined
get that kind of economic              dictatorships.”             by a group that was trying
take-off. If you're a business                                     to take control, the former
person, how do you plan for                                        Communist party, and
the future if the currency is                                      Yeltsin was trying to
devalued by 80% and there's                                        prevent that. So you could
prospect for further                                               argue his aims were noble
devaluation? How do you                                            and he was actually trying to
plan for the future if you                                         install a capitalist,
cannot estimate what your                                          democratic framework, and
real returns are going to be       GB: Right. So this is           that action, though
because the currency and           obviously a key                 autocratic, was directed
prices are so unstable? It         consideration and a great       toward something that was
leads to a very short term         question. In South Korea,       ultimately in the country’s
outlook. That is what              I'm not so sure I could ever    best interest.
prevents an economy from           have gotten comfortable
realizing its potential.           with the fact that Park ruled   When you look at a country
                                   the way he did.                              (Continued on page 32)
G&D: In some of these
Page 32

          Geoffrey Batt
          (Continued from page 31)         enrichment. In the case of        die for it. Or you could stop
          that has a great deal of         Russia and also in the case       short and compromise and
          violence and where the           of Iraq, what you find is that    admit that some parts of
          political leaders have a         what these guys are really        your arguments are wrong
          reputation for ruling with an    doing is attempting to            or you’re not going to push
          iron fist, even if democratic,   establish the state’s             for certain parts of
                                           monopoly on the just use of       whatever you were striving
                                           force. That is a critical part    for. In Iraq, this is what we
                                           of establishing the legitimacy    tend to find. The various
                                           or sovereignty of a country.      political actors that are
                                           In these transitional             constantly feuding with each
             “I had thought of             situations, what seems to         other use heated and often
                                           matter most is that the           alarming rhetoric, but at the
               Iraq as a failed
                                           state demonstrates to the         end of the day, when
            state in the middle            people that only it has the       they’re on the brink, they
                                           authority to use force justly.    always pull back and make
               of a civil war. I           Really what the state is          some kind of pragmatic
                                           doing is demonstrating it has     compromise. And it tends
           knew nothing about              the capability and willingness    to be compromise that is
                                           to establish law and order.       rationally self-interested.
              it beyond what I             Sometimes that can be             That, to me, is very
                                           brutal. But if it’s done to       encouraging because you
              read in the New
                                           ultimately achieve                see the same, or similar,
            York Times or saw              democratic ends, then it          sorts of behaviors in
                                           seems like it’s justifiable and   democracies throughout the
               on TV. And so I             something that at least I can     world, including the West.
                                           get comfortable with. So I
            thought the article            think that probably applies       G&D: For instance, in
                                           to what Yeltsin did. And          raising the debt ceiling?
             was odd because               when I look at Iraq, I think it
                                           very much applies to what         GB: Right. And that to me
             how on earth is a
                                           has happened in Iraq since        is even more insane in a way
          failed state in a civil          2008. To the extent there         because, and I guess this is
                                           has been political violence,      contentious, at least in the
             war increasing oil            it’s been done for reasons        Iraqi political system they
                                           that are almost always            tend to be arguing about
                 production?”              justifiable in those terms.       things of great significance. I
                                           We observe the behavior of        mean this is a country in the
                                           the Iraqi political elite very    very early stages of its
                                           closely. What we ask is           development, ten years
                                           this—are they behaving in a       removed from Saddam, and
          the key is this: why are they    pragmatic way? Is there a         they have quite a lot they
          doing it? Are they doing it      rational self-interest to what    need to work out. In our
          to enrich themselves? Or is      they’re doing? Are they           country, this seems
          it mixed motives—maybe           able to make pragmatic            completely unnecessary—
          partially to enrich              compromise? Rather than           to put a gun to our head
          themselves but also to help      drive the car off a cliff, do     when we don’t really need
          the country? No one is           they actually stop short          to. So I would say, in a way,
          entirely acting out of           before they go over the           politicians in Iraq operate
          altruistic motives but in        edge? I mean, if you want         more rationally than
          dictatorships that lead to       to prove a point, you can         politicians in the US. This is
          disaster, it is often purely     prove a point and ultimately                    (Continued on page 33)
          just corruption and self-
Issue XXI, Issue 2                                                                                               Page 33

Geoffrey Batt
(Continued from page 32)         and so by that summer,          enough to convince you?
a sad state of affairs I         violence was about 75%
suppose.                         below its peak. Deposits in     GB: I went back to Dan
                                 the banking sector were         with the idea and he said
But getting back to how I        increasing, electricity         something like, “You’ve
found Iraq, I was searching      generation was increasing,      come to me with 100 ideas
for that next thing. In 2007,    and the economy was             and 99 of them were bad or
every market in the world        starting to grow pretty         okay, but I know this one is
was in a bull market. It’s       rapidly. When I looked at       good because the very first
hard to think of any asset       these macro variables, what     thought that I had when you
class that didn’t produce a      I found was that the            mentioned it to me was
fairly spectacular gain over     consensus view was very         how can I steal it from                 “I went back to
the prior five-year period.      much at odds with reality,      you?” But he said he would
Equity markets around the        that what you were seeing       help me pursue it. I should            Dan with the idea
world were strong,               on television was about as      study it for the next six
commodities were strong,                                                                                   and he said
                                 far removed from what was       months and see if I could
even certain currency            actually happening in Iraq as   confirm that the data is
markets had produced very
                                                                                                         something like,
                                 it could be. Yes, things were   accurate. So I studied the
strong returns. It was hard      awful but the media was not     country, its markets, its             ‘You’ve come to me
to find anything that fit into   making the distinction. They    political situation, and its
this category of deeply          weren’t showing you any         history for the next six              with 100 ideas and
distressed, transitional         improvements that took          months. And by the end of
situation. And it was right      place over that year. But it    2007, I was convinced that             99 of them were
around that time that I read     looked to me like there was     there was a legitimate
an article about how Iraq                                                                               bad or okay, but I
                                 pretty compelling objective     change taking place and that
was increasing its oil           evidence that Iraq had          the country had turned a
production, which I thought
                                                                                                        know this one is
                                 reached a turning point.        very important corner in its
was very strange.                                                development. Then the                  good because the
I had thought of Iraq as a       This is exactly the sort of     question became, how do
failed state in the middle of    situation that you want to      you take advantage of that?            very first thought
a civil war. I knew nothing      look for when you’re            It just so happened that
about it beyond what I read      searching for these potential   there was a stock market. It          that I had when you
in the New York Times or         historic equity re-ratings.     was very small and I was
saw on TV. And so I                                                                                    mentioned it to me
                                 There is objective data that    shocked to find it. I think at
thought the article was odd      portrays a positive picture     the time the whole market
because how on earth is a
                                                                                                       was how can I steal
                                 yet there is a perception       had a capitalization of about
failed state in a civil war      that none of that is            $2 billion, which was smaller            it from you?”
increasing oil production?       happening, there is a           than the Palestinian stock
You can’t reconcile those        perception that quite the       exchange which had only
two data points. Increasing      opposite is happening, that     launched in the summer of
oil production implies there     there is capital flight,        2007.
is a functional state that is    hyperinflation, chronically
capable of achieving this.       weak currency, falling oil      I e-mailed every broker that
One of those two points of       production, economic            was on the stock exchange
view had to be incorrect. So     depression, and so on. That     website, maybe 50 brokers,
I looked into the matter         was the image that I had in     and I got 5 or 10 replies.
more closely and saw it          my head; I think that was a     Only a few of them were in
wasn’t just oil production,      fairly representative view in   English and only one of
but that they had a              the West at that time and       them was in coherent
hyperinflation that started in   still is.                       English, so I chose him. I
1990 and ended in 2006.                                          wired $2,000 there, bought
They did have a civil war but    G&D: And was that                            (Continued on page 34)
it had ended by early 2007
             Page 34

                           Geoffrey Batt
                           (Continued from page 33)         what I thought was the next      about a lot of Africa right
                           a stock, sold it the next day    historic equity re-rating, and   now, which is interesting.
                           and wired the money back         only found it after I thought    Take Nigeria for example.
                           out of the country to see if I   I had pretty much exhausted      Nigeria has a serious and
                           could complete the whole         all of the options. It was a     growing problem with Al-
                           cycle. It turned out that it     complete shock that it           Qaeda. They don’t control
                           was very easy to do. So with     turned out to be Iraq            the northeast part of their
                           that, I put most of my           because it was the very last     country and it’s in a state of
                           investable assets into Iraq,     place that I would have          emergency. But if you look
Louisa Serene Schneider    and then around January
and Marty Whitman at the
                                                            anticipated. But that’s the      at the valuations in Nigeria,
                           2008, Dan gave me a              key, take some country with      consumer products
2013 Graham and Dodd
                           managed account and put          a stigma like North Korea        companies are trading for
                           me in touch with his two         or Myanmar—people are            30x earnings. They might be
                           partners at Firebird. I          really excited about             growing fairly rapidly but
                           presented the idea to them       Myanmar now, so maybe            the multiples being assigned
                           and they each gave me a          that’s not such a good           to their earnings are
                           managed account as well. I       example—and see where it         absurdly high and certainly
                           had my own money there           leads.                           don’t price in the risks.
                           and three managed accounts
                           for two years.                   G&D: Zimbabwe?                   Iraq, on the other hand, is
                                                                                             actually quite similar if you
                           Back then, I was probably                                         just look at the data. Iraq
                           one of the few, if not the                                        produces more oil and its
                           only person, in the West                                          oil production is increasing
                           who was investing in this                                         while Nigeria’s is flat. Iraq
                           market. I thought there                                           has substantially greater
                           could be demand for this                                          foreign exchange reserves.
                           kind of frontier investment       “Having him made                They produce more
                           and I was credibly in a                                           electricity with a smaller
                           position to create a fund to        it pretty easy to             population and their
                           capture what I thought was                                        electricity generation
                           untapped demand. The one
                                                               market. People
                                                                                             increases each year. GDP
                           problem was that I didn’t          thought, ‘The guy              per capita is higher and
                           have a track record and I                                         GDP itself is higher. Relative
                           had a very unorthodox            who found Russia is              to every development that
                           background so I needed                                            you can think of, Iraq has
                           someone with a pedigree.         now looking at Iraq,             the edge. Both have a
                           And that was Dan. I started                                       problem with Al-Qaeda and
                           the company and sold him            so there must be              the levels of violence are
                           20% of it, with the                                               somewhat comparable—
                           agreement that he would be
                                                                                             Iraq is worse but it’s not
                           a partner but not be              interesting there.’”            that much worse. But you
                           involved in day-to-day                                            can buy a branded
                           operations. Having him                                            consumer products
                           made it pretty easy to                                            company for 7x earnings in
                           market. People thought,                                           Iraq whereas in Nigeria it’s
                           “The guy who found Russia                                         trading at 30x earnings.
                           is now looking at Iraq, so
                           there must be something                                           So it’s fascinating when you
                           interesting there.”              GB: Actually, people are         look at the interest that
                                                            excited about Zimbabwe,          people have in Africa that
                           So that is how I got             too. They’re enthusiastic                      (Continued on page 35)
                           involved. I was looking for
Issue XXI, Issue 2                                                                                         Page 35

Geoffrey Batt
(Continued from page 34)          price risk. The places that        evaluating countries?
they completely disregard         you would last think you’d
the risks that are attendant      want to put money can turn         GB: Does the country
in those countries and take       out to be the most                 have the ability to become
those very same risks and         interesting. That’s how I          much larger in the future
exclusively focus on them in      found Iraq and it was quite a      than it is in the present? So
Iraq. The same is true in         surprise. But after I studied      in the case of Russia after
Mexico. Sixty thousand            it closely, it fit the narrative   the collapse of the Soviet
people died in Mexico from        beautifully. That’s why I am       Union, Germany and Italy
2007 to 2011 in what was          there.                             after World War II, and
very much a civil war. The                                           South Korea after the war
government still does not         G&D: You mentioned a               there, you were looking at
control parts of western          couple key indicators about        countries where the
Mexico. The police and                                               economies were quite small
military have given up. Look                                         for various reasons, but
at their consumer product                                            they had the potential to
goods companies—they                                                 become orders of
trade at 40x earnings. This                                          magnitude larger. When you
actually illustrates quite                                           look at a country like Sri
nicely the irrational               “So it’s fascinating             Lanka, what do they really
extremes that markets go                                             have? How much tea can
to. Do they teach efficient          when you look at                they actually export? How
markets theory at Columbia                                           much is that going to drive
these days?                           the interest that
                                                                     their economy in the next
                                       people have in                twenty or thirty years?
G&D: It depends. In some                                             There are markets that can
classes, they do, with limits.        Africa that they               be interesting for a year or
                                                                     two, maybe up to five years,
GB: But efficient markets                completely                  but you want more than
theory is completely                                                 that.
incompatible with value             disregard the risks
investing and I would                                                Does it have economic
imagine that for business           that are attendant
                                                                     scalability to it? You want to
schools generally, it is a part                                      look for the presence of
of the curriculum. Just look
                                     in those countries
                                                                     credible institutions that are
at the behavior of market          and take those very               capable of achieving the
participants and how they                                            macro stability that is
appraise value where the               same risks and                necessary for the country to
conditions are almost                                                grow over time.
identical, but the only            exclusively focus on
difference is geography or                                           And you want to look for
the name of the country. In            them in Iraq.”
                                                                     cheap assets. You must have
one situation the perceived                                          a mispricing. If Iraq was
risks are very low and the                                           already pricing all this in
valuations are quite high and                                        during 2007-08, if everyone
in the other country the                                             was optimistic about the
perceived risks are very high                                        future and stocks there
and the valuations are quite      Iraq, like power generation        were trading at 30-40x
low. It shows how far the         and natural resource               earnings, then you weren’t
investing community departs       production. Is there a             being compensated for the
from a rational assessment        standard set of data that          risk. After the other
of value and how difficult it     you look for when you are                       (Continued on page 36)
is for a market to accurately
Page 36

          Geoffrey Batt
          (Continued from page 35)         stayed away from Japan until    world has ever seen outside
          conditions are satisfied, that   the 1970s. During the 1950s     of Myanmar and North
          last factor is vital because     and 1960s they had capital      Korea. It was dreadful. By
          it’s your margin of safety.      controls in Japan so if you     the time Saddam was
                                           invested you couldn’t take      overthrown, GDP per
          G&D: Do you need foreign         your money out for two          capita was back to $500
          institutional investors to get   years and that kept a lot of    again. Oil production is right
                                           people away. Emerging           around the same level it was
                                           markets were something          at in the mid-1960s. The
                                           very few people went near       country was on a trajectory
                                           prior to the 1980s. So the      that was going to have it
                                           historic re-ratings that have   rival Saudi Arabia in terms
             “I think they have            taken place since then, I       of oil production and
                                           think, have had a foreign       exports, and have an
             an ability not only           component to them. But I        economy that was almost as
                                           don’t think it is essential.    large, but it was derailed. It
                     to matter             History shows that they’ve      was taken off course by the
                                           happened without foreign        mismanagement of a
             economically, not             money, particularly in a        dictator. That actually made
                                           petro-state. Take Saudi         Iraq stand out much more
            only to be orders of           Arabia—you can’t invest         than South Korea or, say,
            magnitude larger in            there directly and they’ve      Hong Kong. South Korea
                                           had spectacular bull markets    never really had a history of
           the future than they            that were driven entirely by    growth before the 1960s
                                           petro dollars and the oil       and 1970s. It was mainly
           are today, but to be            cycle.                          subsistence level agriculture
                                                                           with no real history of
               one of the most             G&D: How did Iraq fit into      modern economic
                                           that framework?                 development. Iraq had that
                    important                                              and they lost it. It was just a
              economies in the             GB: Iraq is a neat case. It     matter of whether they
                                           was a country that, in the      could get it back. When you
                world in 20-25             1960s and 1970s, was on         look at their oil industry,
                                           the verge of becoming one       they have the ability over
                       years.”             of the most powerful petro-     the next fifteen to twenty
                                           states in the world. Oil        years to rival Saudi. They
                                           production was around           could conceivably become
                                           500,000 barrels a day in the    the second swing oil
                                           1950s. By 1979, the year        producer in the world.
                                           Saddam comes into power,        Saudi would no longer be
                                           it was 3.5 million barrels/     the only country that has
          involved for a country to re-    day. GDP per capita went        enough spare capacity to
          rate?                            from $500 in the mid-1960s      meet unexpected demand
                                           to $3,500 by 1979. They         for the world. So I think
          GB: It depends. You would        had this extraordinary          they have an ability not only
          think that you absolutely        economic transformation         to matter economically, not
          need foreign money to fuel       taking place and Saddam         only to be orders of
          it but South Korea, to the       destroyed it all. For the       magnitude larger in the
          best of my knowledge,            next two and a half decades,    future than they are today,
          didn’t have that much            it was really one of the        but to be one of the most
          foreign money and neither        single greatest episodes of     important economies in the
          did Germany or Italy in the      wealth destruction the                        (Continued on page 37)
          1950s. Most foreign money
Issue XXI, Issue 2                                                                                                 Page 37

Geoffrey Batt
(Continued from page 36)         gives you an idea. And it’s      be the classic Ben Graham,
world in 20-25 years. And        very rare to find a market in    deep-value kind of
that’s not an overstatement;     a country that has that          investment. It's far from a
if they are producing 9-10       much scope for growth.           franchise. It's just simply
million barrels of oil a day,    That’s what I think makes        that net current assets are
that puts them right up          Iraq unique—it has more          “x” and the stock market
there with anyone else.          scope for growth than any        appraisal of that is 0.1x, so
And when you look at the         country I am aware of in the     you're buying a dollar for
tiny size of their banking       world today.                     ten cents. Most of the
sector, the tiny size of their                                    investments we make are
                                                                                                         “What I've learned
consumer product sector,         G&D: Once you found an           the first category.
the valuations that we found                                                                                from making
                                 interesting situation like
in their real estate markets     Iraq, how did you think          When I first started to                  investments in
in 2008-09 and even              about efficiently screening      invest in Iraq, I went more
present, it was a country        the opportunity set there?       towards the latter category,            companies that
which was stunted. It was                                         which I think was a mistake.
like a giant stuffed in this     GB: Well, thankfully there       What I've learned from                  seem very cheap
tiny little cage. It is very     are only about 90                making investments in
difficult to tell when it is     companies on the exchange        companies that seem very
                                                                                                         based on net asset
stuffed inside but once you      and I would say about 20-30      cheap based on net asset
take it out, it stands fifty                                                                              value is that it’s
                                 of them are what I would         value or net current asset
feet tall.                       call investable. It is a very    value is that it’s very easy to           very easy to
                                 narrow set of companies. So      underestimate
Take their banking sector as     a lot of this is simplified by   management's ability to                  underestimate
an example. In 2003, there       the small size of the            destroy value. Even slightly
were $300 million of assets      exchange and its limited         sub-par management can                   management's
in the private banks. Now        number of offerings.             make a series of decisions
the private banks have                                            that will wipe away your
                                                                                                          ability to destroy
about $16 billion. They’ve       We are really making two         initial margin of safety.
gone from $300 million to                                                                                value. Even slightly
                                 types of investments. We're
$16 billion in ten years.        investing in emerging            Then there's still the                       sub-par
GDP in 2004 was $25              franchises, which are            question of how you realize
billion. By the end of 2012,     companies that are outside       the value. Graham was of               management can
it was $210 billion. So even     the oil space and tend to be     the opinion that the market
though they have                 managed by entrepreneurial       would eventually correct                make a series of
experienced extraordinarily      people. They're very much        itself, that the market in the
rapid growth, banking assets     profit-driven. They're           short run was a voting
                                                                                                         decisions that will
are still less than 10% of       owner-managers, so they          machine and in the long run
GDP. The top five banks in                                                                                wipe away your
                                 have significant stakes in the   was a weighing machine so
Saudi Arabia have assets         business themselves.             that eventually, it will be             initial margin of
that are about 50% of GDP.       They're transparent and          valued correctly. That’s
So let’s say Iraq has a $600     they appreciate the              probably true in the West,                  safety.”
billion economy by 2030. If      importance of reputation,        but less so in a frontier
the top five banks were to       brand, and establishing          market, where you're going
equally split half of that, it   dominance in their               to have to be very careful
would be $60 billion in          particular industry. Because     about assuming an activist
assets for each bank. The        they’re able to achieve that,    role and you can't rely on
biggest bank right now has       it gives them pricing power,     the market to be even
$1.5 billion in assets and a     it gives them scale, and it      slightly efficient over a long
market cap of $300 million.      gives them all these other       period of time. It could stay
So when I talk about             benefits. Another, second        inefficient and undervalue an
scalable economic growth         category of company would                      (Continued on page 38)
and scope for growth, this
           Page 38

                        Geoffrey Batt
                        (Continued from page 37)         a few years. And after you       loan to deposit ratio go
                        investment for a decade and      travel there and meet the        from 5% to 40%. They have
                        you could end up in a value      people, you're in a much         a very low NPL ratio, ROE
                        trap for ten years. So it’s      better position to say with      has been trending up. All
                        difficult to realize the value   confidence if you should         the metrics that you would
                        if it's not destroyed, and       trust them.                      use to analyze a bank are
                        there's a high probability                                        not only looking positive,
                        that sub-par management          I think this is, again, the      but they're really strong,
                        will destroy it anyway.          market benefiting us.            and yet it's trading for just
                                                         Because there's such a small     5x earnings. If you see a
                        G&D: How do you                  group of companies that we       bank that is growing
                        approach portfolio               think are investable, it gives   earnings at 40% or 50% a
                        management given that            us the ability to concentrate    year, trades at 5x earnings
    “The largest        there are only 20 to 30          rather than look all over the    and a discount to tangible
                        companies you would call         place. There are some            book, and has a ROE of
 position is 30% of     investable?                      frontier market funds that       30%, that looks really
the portfolio, so we                                     have investments across          interesting, right? Then you
                      GB: We have twelve                 twenty countries. How on         meet the management, get
  obviously don’t     companies in our portfolio         earth could you possibly         to know them over a period
                      and the top ten make up            know the management in           of years, and that's what lets
 define risk as price 95% of it, so it's very            each country? And they           you build the confidence
                      concentrated. The largest          have fifty or more               there is something real
  volatility. We're   position is 30% of the             investments! How can you         behind those numbers.
thinking about it in portfolio, so we obviously          possibly know if you can
                      don’t define risk as price         trust these guys or not?         G&D: How long did it take
terms of probability volatility. We're thinking          Even a team of ten or fifteen    you to get comfortable
                      about it in terms of               people can't pay enough          enough to make your first
 of permanent loss probability of permanent              attention to each company        investment in Iraq?
                      loss of capital.                   to establish that.
    of capital.”                                                                          GB: Initially, I wasn't
                        The most important thing         I think trust in the people      comfortable with any
                        we look for is a business        managing the business is         particular company. In
                        where we can trust the           paramount, because it's          January 2008, when I
                        people who are running it.       pretty easy to spot a good       started, I bought everything
                        By definition, trust is          company. So, if you see a        that traded, so it was the
                        something that's built over      bank in a country like Iraq      exact opposite strategy.
                        time. For the first few years    that is experiencing its first   Back then, it was very
                        that I was involved in Iraq,     private credit cycle and has     difficult to find information
                        that's more or less what I       an economy that is growing       about these companies from
                        was learning—who I could         pretty rapidly, you’d expect     a distance. Quite a lot has
                        trust, what companies were       to see the balance sheet         changed since that time.
                        putting out financial            grow very rapidly. You look      Now, quarterly reports are
                        statements that faithfully       at the balance sheets over       published in a timely
                        represented the condition        time and it's pretty obvious     manner, sometimes even
                        of the business, which           which companies look             ahead of when US
                        companies seemed like they       interesting and which ones       companies file. It’s not
                        were doing well but may          don't. This one is growing       unusual in a very early stage
                        not have been accurately         but puts all its money into      frontier market to have
                        reporting performance,           T-bills. It's completely risk-   extremely limited data that
                        which companies had              averse. OK, that's not very      you can use to conduct due
                        unsavory people running the      interesting. However, this       diligence. The rational
                        business, and so on. You         one over here has seen its                    (Continued on page 39)
                        start to figure that out over
Issue XXI, Issue 2                                                                                        Page 39

Geoffrey Batt
(Continued from page 38)           history of philosophy, what      markets, or in business
strategy if you're going to        you find is that many of the     generally, you find they tend
invest in that setting is to       great philosophers were          to be people who are
have smaller positions. How        deeply skeptical people.         skeptical of whatever the
can you have conviction            They were like Steve Jobs in     prevailing convention is and
about something like that?         a way, iconoclasts who           will challenge it and try to
It's more of a macro               looked at convention as if it    change it. To get involved in
investment.                        was something to be              Iraq, you had to be very
                                   broken. Socrates is a perfect    open-minded and had to
What I've found is that            example of this. He walked       have a very skeptical view
having my own money                around Greece and                about the ability of the
invested in these companies        challenged any kind of           media to provide you with
is really what makes the           convention or power              an accurate portrayal of
difference. When you have          structure he saw. And I          reality. If I were not
money invested in a bunch                                           skeptical, I would have seen
of companies that you don't                                         the data, and I would have
know much about, you                                                said even if Iraq were
suddenly have a very strong                                         increasing oil production,
motivation to know as much                                          the country's still just a
about them as you possibly                                          basket case because that's
can. And so once the money          “What I've found is             what I read in the New York
was invested, I had to find                                         Times. Philosophy is useful in
out everything I could. And         that having my own              a general sense because it
that really was what the                                            can give you a skeptical
next two years were about.           money invested in
                                                                    world view.
It took about two years
after I made my first
                                    these companies is
                                                                    Then you can take that
investment before I felt             really what makes              skepticism and apply it at
confident that I really did                                         the company level.
understand which                       the difference.”             Thousands of years ago,
businesses were legitimate,                                         philosophers were asking
which ones should be                                                questions like how would
avoided, which ones could                                           you define a table? And if
go either way. And that's                                           you went around the room,
also why there wasn't a fund                                        each one of us would come
initially. I didn't feel as if I   think the general idea that      up with a definition of a
had the requisite                  you learn from studying          table and everyone else
understanding of the               these historical philosophers    would poke holes in it. The
companies and the market           is that there's a lot to be      smartest philosophers in the
until I was involved for           gained from a skeptical          world have struggled with
more than two years. So            world view. If you simply        these very basic ideas and
initially it was just a very       accept what you're told, if      they can't find a satisfactory
broad bet on the market            you are simply a receptacle      way to treat the problem.
and that later became a very       that takes in whatever           You realize that about
concentrated set of value          information is provided to       99.9% of everything you
investments.                       you without critically           hear is complete and utter
                                   accessing it, it's going to be   bullshit. Take the
G&D: What do you think             very hard for you to do          convention that markets are
makes philosophy a good            anything other than live a       efficient. Approaching it
training ground for                conventional life. If you look   from a philosophy
investors?                         at the people who have had       background, it was very easy
                                   the most success in                           (Continued on page 40)
GB: When you study the
Page 40

          Geoffrey Batt
          (Continued from page 39)        situation like that, then      Coke has struggled in Iraq
          for me to take that idea and    there's typically an           for a number of identifiable
          reject it.                      opportunity to profit from     reasons.
          I remember Caterpillar in                                      Baghdad Soft Drinks
          2010 or 2011 printing a five-   G&D: Would you mind            received its Pepsi license in
          year earnings forecast.                                        1984 and lost it in 1991
          We’re talking about                                            when sanctions were
          construction and mining                                        imposed on Iraq after the
          equipment, which are as                                        first Gulf War. By the time
          cyclical as anything can be.                                   Saddam was overthrown in
          How on earth can the CEO                                       2003, Pepsi was eager to
          know what their earnings                                       return to Iraq so they
          situation is going to look
                                              “The stock was
                                                                         reached out to Baghdad Soft
          like five years from now?        trading at about 3x           Drinks in order to
          And to the extent the                                          reestablish the relationship.
          market actually believes         earnings and had a            Some of their factories had
          what he is putting out and                                     been severely damaged by
          pricing it into the shares,      10% dividend yield.           the war. What hadn’t been
          that is an extraordinary                                       damaged was obsolete
          mistake. When I looked at        To give you an idea,
                                                                         because, while the sanctions
          the sell-side, they were                                       were in place, they couldn't
          pointing out just how bullish
                                                in 2012, the
                                                                         import equipment. So the
          they were on CAT. Since          company’s earnings            equipment from the 1980s
          then the stock has just gone                                   was still there in 2003. The
          sideways and now of course        actually grew over           company was just a mess.
          we're approaching 2015 and                                     Pepsi floated a $30 million
          they're guiding down             400%. We were just            loan to help rehabilitate
          because it's just not the                                      operations.
          market or economy they              scooping up as
          thought it was going to be.                                    The management at that
                                           much as we possibly
                                                                         point in time were ex-
          So when you apply                        could.”               Baathists. Saddam was from
          philosophy to your analysis                                    the Baath Party, and the
          of individual companies, it                                    party’s economic ideology
          makes you much more                                            was basically Arab socialism.
          skeptical of management's                                      You had 3,000 employees
          ability to forecast into the                                   when you needed just
          future. To the extent a                                        1,000. Pepsi, in one of the
          manager or a company is         talking about a specific       hottest places on earth and
          going to get your trust,        investment idea within Iraq?   where people don't want to
          they're going to have to                                       drink Coke, pretty much
          earn it and that's going to     GB: Sure, I can discuss        sells itself. You could put a
          take quite a long time.         Baghdad Soft Drinks, the       dog or a five year old kid in
          Philosophy teaches you to       Pepsi bottling and             charge and sales would
          take whatever the prevailing    distribution company there.    grow. The question is what
          wisdom is and challenge it.     Pepsi has 80% market share     part of that is going to fall to
          Sometimes it turns out the      in Iraq. It's one of the few   the bottom line. What I
          prevailing wisdom is right,     countries where it’s           found was that most of the
          so you should accept it;        dominant. Normally it's the    revenue growth in the
          other times it turns out the    reverse—Coke is closer to      company from 2003-2007
          prevailing wisdom is way off    80% and Pepsi is 20%—but                     (Continued on page 41)
          the mark. If you find a
Issue XXI, Issue 2                                                                                             Page 41

Geoffrey Batt
(Continued from page 40)          Soft Drink’s margins so          trading at about 3x earnings
was being soaked up by            they’re now about 15.5%.         and had a 10% dividend
these inefficiencies. By the                                       yield. To give you an idea, in
time you got to the bottom        The new owners spent a lot       2012, the company’s
line, there was nothing left.     of money up front to put in      earnings actually grew over
By 2007, the company was          a direct distribution system     400%. We were just
unable to service the loan        and it’s now paying off. The     scooping up as much as we
from Pepsi. It contacted two      public electricity grid at the   possibly could. That's why
local businessmen for help.       time was unreliable, so they     it's 30% of the fund. It was
The two guys looked at the        built their own generator to     15% but with the total
situation and eventually          make sure they could run         return, it’s since doubled.
approached Pepsi about            24/7. They made the              We haven’t sold a share. It
selling them the loan. Pepsi      company much more                still trades for around 6-7x
agreed and the businessmen        efficient and with a company     earnings and remains deeply
immediately converted the         like this, it's about volume     undervalued.
loan into a controlling stake
                                                                                                     “Iraq was the very
                                  growth and efficiency.
in the company, firing the                                         G&D: Before we finish, do        last place I thought
managers who had initially        Iraq consumes about 21           you have any thoughts on
asked for their help. They        liters of soft drinks per        where the next Iraq-type           I would find an
also fired 2,000 of the 3,000     capita. If you look at other     market opportunity may be?
employees and instituted a        emerging market countries,                                        opportunity like this
performance-based                 it's anywhere from 60-100        GB: It’s hard for me to
compensation scheme for                                                                             and I don’t know if
                                  liters. You have a growing       think of a place now. Maybe
the remainder. A year later,      population, growing GDP          Afghanistan? Five or ten
revenues had tripled and
                                                                                                     there is a similar
                                  per capita, and each year        years from now, maybe it
they turned their first profit.   they're consuming more           will be Iran. Iraq was the           place today.
They became fully certified       Pepsi. It's the dominant soft    very last place I thought I
by Pepsi for quality control      drink company there so           would find an opportunity          Maybe it’s still
and quality assurance for         there are compelling             like this and I don’t know if
the first time and the            reasons to believe that sales    there is a similar place                Iraq.”
thousand remaining                will continue to grow.           today. Maybe it’s still Iraq.
employees were paid double        Management has
what they made under their        demonstrated its ability to      G&D: Thank you so much
previous salary.                  improve operating                for sitting down with us, Mr.
                                  efficiency. If sales can grow    Batt.
Starting in 2007 and              at the 20%-35% rate we
continuing to the present,        expect and margins expand
the new management really         by 200-300 basis points,
focused on streamlining the       then suddenly earnings
operations and making them        could be up 100%. It's that
much more efficient. If you       kind of story.
looked at their EBITDA
margins under the old             We own 11% of the
management, they were             company. According to the
typically either negative or      CEO, we're the only
1%-2%. If you look at Coke        Westerner to ever visit the
and Pepsi bottling and            bottling facility. In 2012,
distribution companies in         there was a bear market in
comparable emerging               Iraq, with the market low
markets, the EBITDA               occurring sometime in the
margin range is normally          summer of that year. At
15%-20%. We've seen a             that time, the stock was
normalization of Baghdad
              Page 42

                               Rocket Fuel Inc. (Nasdaq: FUEL) - Short
                               Winner - 2013 Darden @ Virginia Investing Challenge
                               Matt Bracewell, CFA; Patrick Enriquez-Fischer; Brian Waterhouse
                                     Capitalization Summary                     Ownership Structure                      Share Price Performance
                               Share Price                  65.37    Holder                   % TSO ($MM) Sh. Price($)                               Vol (000)
                                                                     Mohr Davidow Ventures      33.4    716
                                                                                                               $75                                        3,000
                               Diluted Shares (MM)            39.5                                                                           +125.4%
                               Market Cap ($MM)            2,579.4   Nokia Growth Partners       8.2    176
                               Net Cash ($MM)                 98.4   Northgate Capital           6.3    135
                                                                                                               $50                                       1,500
                               Enterprise Value ($MM)      2,481.0   Labrador Ventures           4.6     99
                               EV / Sales 2014E               5.92x Total VC Holdings           52.5   1,126
                               Target Price                 29.00                                           $25                                           0
Matt is a first-year MBA       % Return                    55.6%     Insiders                   17.7    379   Sep‐13 Oct‐13 Nov‐13 Dec‐13          Jan‐14
student at CBS. Prior to       Short Interest % of Float    28.6%    Float                      29.8    639         Volume (000)   FUEL               S&P
CBS, he worked in private
equity at Navigation Capital   Recommendation:                                                                 EV / 2014E Sales

and in healthcare              Short FUEL with a price target of $29.00. As a demand side            5.9x
investment banking at          platform (“DSP”) operating in the ad tech space, FUEL is a recent 6x       4.9x

SunTrust Robinson              IPO issue enjoying substantial top-line growth and as a result,    4x           3.2x
                                                                                                                    2.9x 2.4x
Humphrey.                      currently trades at a high-flying valuation. At 5.9x 2014E reve-                               1.6x1.5x
                                                                                                  2x                                   1.0x 1.0x
                               nue, FUEL trades at a premium to the broader ad-tech space,
                               where the average comp trades for 2.2x 2014E revenue. How- 0x
Patrick is a first-year MBA    ever, after speaking with an array of industry participants, we
student at CBS. Prior to       believe FUEL is nothing special in an increasingly commoditized
CBS, he worked in              and competitive marketplace. We expect continued revenue
investment banking at          growth, but the street’s expectations of long-term growth with-
Morgan Stanley covering        out margin compression are reflective of exuberant irrationality. Because FUEL’s venture firm-
Latin America.                 concentrated investor base is well in the money, we expect selling pressure in conjunction with these
                               firms’ lock-up expiration in March 2014. Our target is 56% below a recent closing price of $65.37.
                               Company Description
Brian is a first-year MBA      FUEL is a DSP that leverages big data through artificial intelligence (“AI”) technology to optimize ad
student at CBS. Prior to       buying in a real-time buying (“RTB”) environment. FUEL’s predictive modeling solution is built on its
CBS, he worked at              optimization engine, which utilizes significant computational infrastructure to deliver automated,
Millennium Technology          measurable digital ad campaigns. Its solution is designed to optimize direct-response campaigns, as
Value Partners.                well as brand campaigns geared towards lifting brand metrics. FUEL primarily sells its solution to ad-
                               vertising agencies and advertisers. FUEL was founded in 2008 and IPO’d in September of 2013.
Matt, Patrick, and Brian       Investment Thesis
defeated 14 other top          FUEL is not a broken business, but our channel checks revealed that it is a much worse business than
business schools at the        valuations imply, and participants in the industry know this is true. The ad-tech space is an extremely
Darden @ Virginia Investing    crowded and competitive category, with participants ranging from massive, fully-integrated solution
Challenge.                     providers such as Google, Yahoo, and AOL, to digital ad agencies such as IPG and Publicis / Omni-
                               com, to scaled single-solution providers such as FUEL and Criteo (public) as well as Turn and DataXu
                               (private). Our original thesis is that FUEL could be instantly disintermediated by large providers such
                               as Google that operate on all sides of the ad tech ecosystem, or could be marginalized over time by
                               similar, scaled single-solution providers competing on the basis of price. To back up the thesis, we
                               conducted detailed interviews with 15 industry participants, including major FUEL customers, former
                               FUEL leadership and investors, ad-tech investors, and industry experts. The interviews confirmed our
                               margin compression thesis, but we were shocked at how cynical industry participants are towards
                               FUEL and DSPs in general. While we believe the entire DSP category is highly overvalued, FUEL
                               stands out, trading for 5.9x 2014E revenue versus 2.2x for the category, even though FUEL will not
                               generate any earnings or positive cash flow until 2016 at the earliest.
                               Undifferentiated provider in a crowded and competitive marketplace. We estimate that
                               FUEL is one of over 90 DSP solution providers, and we expect the continued commoditization of the
                               market to impact margins over time. One interviewee, who is an advertised FUEL “success story”
                               and CEO of a top-50 marketing firm, equated DSPs to the ad networks, whose gross margins have
                               been compressed from 40%+ in the 1990’s to less than 10% today. Channel checks reveal that there
                               is little differentiation across the industry, although everyone claims to have the same technological
                               advantages. For example, FUEL advertises itself as “AI, Big Data Driven Real-Time Programmatic
                               Buying,” virtually identical to competitors Turn and DataXu’s claims of “Data Driven Advertising Us-
                               ing Programmatic Solutions,” and “Programmatic Optimized Real Time Buying Leveraging Big Data.”
  Issue XXI, Issue 2                                                                                                                                                Page 43

Rocket Fuel Inc. (continued from previous page)
Poor competitive position. In addition to scaled single-solution providers, FUEL faces competition
from a who’s who list of media companies with fully-integrated platforms. FUEL generates the bulk of its
revenue by selling to marketing firms that own the client relationship; however, many of these firms
either have their own similar solutions, or have chosen to outsource the solution based on the view that
this portion of the value-chain will be commoditized. In addition, FUEL competes for ad dollars against
large media businesses such as Google that have their own DSP solution in addition to high value-added
offerings such ad networks and exchanges. These competitors have exhibited an increasing propensity
to internalize ad spending via large upfront ad buys on owned, high-value properties such as YouTube.
Unsustainable business model. We believe that FUEL’s current 40-50% gross margins are a result of
the industry’s nascence, but will be pressured over time. Industry experts agreed, by suggesting that
because gross margins result from taking advantage of an evaporating arbitrage on media costs, they will
get squeezed from both ends of the value chain. One customer noted, “DSPs are an arbitrage game and
this game is coming to an end. The technology is being commoditized...These companies try to capture
market share by losing money… their business model is not viable in the long-term.” The industry is
also plagued by low customer switching costs, and most advertisers utilize multiple DSPs to generate
price competition. We believe that the best positioned DSPs will be those that provide platform SAAS
solutions, such as DataXu. FUEL recognizes this and is currently working on a SAAS offering. Finally,
interviews with customers reveal their displeasure with certain FUEL business practices. These practic-
es, which included FUEL communicating a lower media margin than they were actually getting, did not
become known by a certain customer until he obtained detailed access to data on the campaign that
FUEL was running. We believe that increasing transparency from SAAS solutions will pressure margins.
Ad-tech mean reversion and a clear catalyst. Ad-tech                       Reversion to the Mean of Comparables
companies have IPO’d with high valuations due to substantial          6.0x
growth prospects; however, multiples tend to compress to-             5.0x
                                                                                        EV/ NTM Revenue

wards 1.0-3.0x NTM revenue over time. We analyzed multiples           4.0x
post-quiet period expiry on pure-play ad-tech businesses, and         3.0x
found that each firm traded down, with an average reduction of        2.0x

2.2x NTM revenue. This is due to the street’s tendency to             1.0x

reduce expectations from the lofty levels. To illustrate, most        0.0x
                                                                            0 30 60 90 120 150 180 210 240 270 300
FUEL initiation pieces assumed 42%+ 2012-2018 sales CAGRs                             Days  from Quiet Period
with no margin compression, and one DCF valuation assumed a
30x terminal multiple on 2023 FCF. CRTO and MM, the closest comps, trade for 3.2x and 1.6x 2014E
sales with their 33% and 32% 2012-2018 CAGRs, exhibiting the downswing in multiples even with still
high expected growth. We also believe that the lock-up expiry on 3/19/14 will serve as a catalyst. ~33%
of shares O/S are held by venture firm Mohr Davidow (~40 days of trading), and ~19% are held by other
venture backers. We expect significant selling pressure in conjunction with the lock-up expiry as MD
stands to generate a much needed 30x+ return on its investment at our $29.00 target. Channel checks
reveal that the MD fund that holds the FUEL stake has not yet had a big exit, and due to its 2007 vintage
and fund-raising cycle, we expect the firm to liquidate its FUEL holdings ASAP.
Valuation                                                                                                               Base Case vs. Analyst Estimates

Our valuation used 2014E and 2015E revenue multiples, and a DCF                                                Metric                       Base      Street
                                                                                                               2014E Sales                  388.9     419.8
assuming a 10-12% cost of equity. We believe that FUEL will have im-                                           2015E Sales                  555.9     679.0
pressive top-line growth in the coming years with a CAGR of 66% be-                                            2016E Sales                  810.7     1,000.3
tween 2012-16, comparing favorably to the industry’s 40%. However,                                             2014E EBITDA Margin         (0.8%)      0.8%
analysts are expecting a CAGR of 75% mainly from much too aggressive                                           2015E EBITDA Margin          2.9%       5.7%
assumptions on customer and ARPU growth (ARPU has remained flat in                                             2016E EBITDA Margin          7.8%      10.2%

recent qtrs, supporting our thesis). In addition, we expect competition                                        LT EBITDA Margin             15.0%     >20%
                                                                                                               Target Price                 29.0          63.0
to keep EBITDA margins to ~15% at best (CRTO disclosed in its in
                                                                                                               Implied EV / 2014E Sales      2.5x         5.7x
roadshow that ~15% margins are its long-term target) vs. margins of
20%+ from research analysts.
Summary of Key Financials
                             2012A       2013E      2014E      2015E     2016E     2017E                   2018E        2019E      2020E     2021E         2022E
Active Users                    536      1,018      1,579      2,131      2,813     3,572                   4,394      5,273       6,064      6,670         7,004
Growth (%)                             90.0%      55.0%      35.0%      32.0%     27.0%                   23.0%      20.0%       15.0%      10.0%          5.0%
Sales                       106,589    231,981    388,882    555,860    810,680 1,039,859 1,291,816 1,565,681 1,818,539 2,020,397 2,142,631
Growth (%)                  138.7%     117.6%      67.6%      42.9%      45.8%     28.3%     24.2%     21.2%     16.2%     11.1%      6.1%
EBITDA                       (2,981)    (5,244)    (3,025)    16,220     63,423   103,190                 144,986   192,946      235,018    271,207    319,754
Margin (%)                   (2.8%)     (2.3%)     (0.8%)      2.9%       7.8%      9.9%                   11.2%     12.3%        12.9%      13.4%      14.9%
Unlevered Free Cash Flow    (27,566)   (28,559)   (40,919)   (29,126)     7,524    24,192                  47,957       71,933    97,087    115,074    142,952
              Page 44

                               XPO Logistics (NYSE: XPO) – Long
                               Stephen Lieu

                               Investment Recommendation                                                     As of 1/29/14; in USD m except per share data

                               Buy the common shares of XPO Logistics with a three-year target                   Current Capitalization
                               share price of $49, which represents 87% total upside (23% IRR over Stock Price                                                     $25.96
                               three years). There are three main points to my thesis:             Dil. Shares Outs (M)                                              57.9
                                                                                                             Market Cap                                           $1,503
                               1)    Industry characteristics, which include a large and growing             Plus: Debt                                                 1
                                     market size, high fragmentation, long runway of acquisition             Less: Cash                                               (67)
                                     opportunities, and significant competitive advantages to scale,         Enterprise Value                                     $1,437
                                     provide for an attractive consolidation opportunity.
                               2)    Acquisition benefits, which include private/public multiple arbi-             Trading Statistics
                                                                                                 52-Week Range
                                     trage, revenue synergies, cost synergies, and strengthening of                                                          $15.48-$30.90
Stephen is a second-year             moat, are highly compelling.                                Dividend Yield                                                      0.0%
                                                                                                 Avg. Daily Volume (M)                                              435.0
MBA student, participant in    3)    XPO has everything in place – a CEO with a phenomenal track
                                                                                                 Short Interest as % of Float                                      20.7%
the Heilbrunn Center’s               record of consolidating industries, management team with
Value Investing Program,             substantial industry experience, significant insider ownership,                            Share Price History
and Co-President of the              and easy access to capital – to successfully execute its consoli-
                                     dation strategy.                                                                     41% IRR since CEO Brad Jacobs took over
Columbia Student                                                                                              $35
Investment Management          Business Description                                                           $25
Association (CSIMA). Prior     XPO is one of the largest third-party logistics providers (3PL) in      $20
to Columbia Business           North America, offering freight brokerage, intermodal, expedited        $15
School, he worked for four     transportation, and freight forwarding services to companies in a       $10

years in investment banking    wide variety of industries. The company essentially serves as a mid-     $5
and private equity. Stephen    dle man, connecting shippers (customers) with carriers                    Sep-11 Apr-12 Nov-12  Jun-13  Jan-14
holds a BS from the            (transportation providers), and collects a fee for brokering the trans-
                               actions. XPO has a network of ~12,000 active customers and ~24,000 transportation companies, and operates
Wharton School, University     124 offices in North America.
of Pennsylvania.
                               XPO is pursuing an aggressive roll-up of the industry. Since CEO Brad Jacobs joined the company in September
                               2011, XPO has made 11 acquisitions, increasing revenues from $175 million to a run-rate of ~$2 billion. Manage-
Stephen was a member of        ment has stated that its goal is to reach $5 billion in revenues and $300 million in EBITDA by 2017.
the team that placed 1st in
the 2013 Pershing Square       Investment Thesis
Challenge and a member of      1) Industry characteristics, which include a large and growing market size, high fragmentation, long runway of acquisition
the team that placed 2nd in    opportunities, and significant competitive advantages to scale, provide for an attractive consolidation opportunity.
the 2012 UNC Alpha             Large and growing market: U.S. trucking is a $350 billion market, of which only 15% (~$50 billion) is intermediated
Challenge.                     through 3PLs. The 15% penetration rate is expected to increase significantly over the next decade as more compa-
                               nies realize the economic benefits of outsourcing to 3PLs. Over the past five years, trucking brokerage has grown
Stephen is a finalist in the   at 2-3x GDP and is expected to continue at this pace.
5th annual Moon Lee Prize      High fragmentation and long runway of acquisition opportunities: The U.S. truck brokerage industry is highly fragment-
Competition.                   ed, with over 10,000 licensed truck brokers in the U.S. The majority of truck brokers are small: more than 99%
                               generate less than $10 million in EBITDA. With smaller brokers facing intense competition from increasingly larger
                               competitors (as XPO and others look to consolidate the industry) and operational headwinds (increased IT so-
                               phistication and working capital requirements), they are becoming more willing to sell their businesses.
                               Significant competitive advantages to scale: Potential customers are attracted to providers with a large network of
                               existing carriers, while potential carriers are attracted to providers with a large base of existing customers. This
                               benefits the large 3PLs as it creates a virtuous cycle of increasing customers and carriers, and creates an impedi-
                               ment to growth for smaller 3PLs.
                               2) Acquisition benefits, which include private/public multiple arbitrage, revenue synergies, cost synergies, and strengthening
                               of moat, are highly compelling.
                               Public/private market arbitrage: Large 3PLs (of XPO’s size) currently trade at an average 13x LTM EBITDA, in-line
                               with their 10-year historical average. XPO acquires mid-sized 3PLs at 8-11x LTM EBITDA, and smaller 3PLs at
                               5-7x LTM EBITDA, resulting in acquisitions being immediately accretive.
                               Revenue synergies: There are substantial cross-selling opportunities between XPO and acquired companies’ custom-
                               er bases. Further, the aggregation of the acquired companies’ route history data allows XPO to improve its pricing
                               algorithms and price more effectively, helping to increase both margins and customer satisfaction.
                               Cost synergies: XPO eliminates duplicative back-office functions, such as legal, IT, and accounting.
                               Strengthening of moat: XPO’s competitive positioning increases with each acquisition. As XPO gains scale, the com-
                               pany’s ability to attract new customers and carriers strengthens, and there is a virtuous cycle of growth. Scale
                               begets further scale.
 Issue XXI, Issue 2                                                                                                                      Page 45

XPO Logistics (continued from previous page)
3) XPO has everything in place – a CEO with a phenomenal track record of consolidating industries, management team with
substantial industry experience, significant insider ownership, and easy access to capital – to successfully execute its consolidation
CEO with a phenomenal track record: Over his 35-year career, Brad Jacobs has built four separate billion-dollar businesses
from scratch. At his two most recent companies, United Waste Systems and United Rentals, he successfully executed
roll-ups in the waste and equipment rental industries, respectively. During his tenure at United Waste Systems, the
company outperformed the S&P 500 by 5.6x. During his tenure at United Rentals, the company grew to become the
largest equipment rental company in the world, and outperformed the S&P by 2.2x.
Management team with substantial industry experience: Brad Jacobs has assembled a team of experienced transportation
industry veterans from large competitors like C.H. Robinson and Echo Global Logistics, as well as from investment
banks. For example, the Chief Strategy Officer was formerly the lead transportation analyst at Goldman Sachs, while
the CFO was formerly the lead transportation analyst at Stifel Nicolaus. The entire management team has a wealth of
experience, knowledge, insight, and contacts in the transportation industry.
Significant insider ownership: Management and the board own 41% of the company and Brad Jacobs has personally invest-
ed $75 million into XPO. Incentives are aligned with shareholders.
Access to capital: Given Jacobs’ strong reputation on the street, XPO has easily been able to raise capital for acquisitions.
Financial Projections and Valuation
I believe management’s goal to reach $5 billion in revenues and $300 million in EBITDA by 2017 is achievable, given
that XPO has already reached $2 billion in run-rate revenues in just over two years. I apply an 11.5x forward EBITDA
multiple (in-line with current average 3PL multiple) to 2017 EBITDA to arrive at a 2016 target share price of $49 for
87% total return, or 23% IRR over three years.

                     2013A 2014E 2015E 2016E 2017E ('14-'17)                                                 Bear      Base     Bull
Revenue (run-rate)   1,000 2,500 3,500 4,525 5,478                          Revenue (2017)                   4,382     5,478    6,573
 Organic                    250   500   525   453     1,728                 EBITDA (2017)                      219       329      460
 Acquisitions         450 1,250   500   500   500     2,750                  Margin%                          5.0%      6.0%     7.0%

EBITDA                   10      50     117     211     329                 Fwd. EBITDA Multiple              10.0x    11.5x    13.0x
   Margin%             1.0%    2.0%    3.3%    4.7%    6.0%                 Enterprise Value                  2,191    3,779    5,981
                                                                             Less: Debt (2016)                 (242)    (242)    (242)
Acquisition Price              396      200     200     200        996      Equity Value                      1,949    3,538    5,739
   EV/EBITDA                  10.3x     8.0x    8.0x    8.0x
 FCF                            20       52     106     181        359      Shares Outstanding (2016)         72.9      72.9     72.9
   % of Revenue               0.8%     1.5%    2.3%    3.3%                  Curr. Shares Outstanding         57.9      57.9     57.9
 Debt Issuance                    0     148      94      19        261       New Shares Issued                15.0      15.0     15.0
   Total Debt                    0     148     242     261
   Leverage                    0.0x     1.3x    1.1x    0.8x                Share Price                         $27       $49      $79
 Equity Issuance               376         0       0       0       376      Current Share Price                 $26       $26      $26
   Shares Issued              15.0      0.0     0.0     0.0                  Upside                             3%       87%     203%
                                                                             IRR                                1%       23%      45%

Investment Risks and Mitigants
1) Acquisition integration: XPO has been executing acquisitions at reasonably attractive valuations. Integrating them is the
single biggest risk, and the key to the company’s success.
Mitigant: Before closing any acquisition, XPO mandates all of its acquired companies’ employees to sign non-compete
agreements, helping to ensure that salespeople and their customer relationships remain with XPO. Additionally, Jacobs
stated that he deliberately delayed acquisition activity initially while he established the infrastructure to support signifi-
cant scale, showing that he understands the process of building large companies. Furthermore, Jacobs has done this
before, having acquired and integrated over 450 companies during his time at United Waste Systems and United Rent-
als. Finally, Jacobs and his management team have significant skin in the game (41% ownership stake) and are highly
incentivized to do well.
2) Competition for acquisitions: Other truck brokerage firms have recently been making acquisitions. XPO could be bid-
ding directly against its competitors for the same targets.
Mitigant: The U.S. truck brokerage market is very large and highly fragmented, with over 10,000 truck brokers. Further-
more, XPO has easier access to capital (given Jacobs’ prior track record) and an M&A team with significant experience
in executing acquisitions.
3) Shift from trucking to intermodal (rail): Improving reliability and timeliness of intermodal, rising diesel prices, increased
highway congestion, and a shortage of truck drivers are causing a secular shift away from trucking towards rail.
Mitigant: Increasing penetration of trucking logistics outsourcing will help drive organic growth. Additionally, XPO’s
recent entrance into intermodal through the acquisition of Pacer (third largest provider of intermodal services in North
America) helps hedge this risk and provides an additional avenue for growth.
               Page 46

                                   World Acceptance Corp. (Nasdaq: WRLD) - Short
                                   Patrick Stadelhofer, CFA
                                             CAPITALIZATION ($M)
                                             CAPITALIZATION ($M)                                  CURRENT VALUATION
                                                                                                  CURRENT VALUATION            $120
                                    Share Price as of 1/22/14
                                    Share Price -- as of 1/22/14   $88.97
                                                                   $88.97                                      LTM
                                    Total Diluted Shares (m)
                                    Total Diluted Shares (m)       12.478
                                                                   12.478                        TEV // Sales
                                                                                                 TEV Sales        2.3x
                                                                                                                  2.3x          $60
                                    Market Cap
                                    Market Cap                   $1,110.1
                                                                 $1,110.1                        TEV // EBITDA
                                                                                                 TEV EBITDA       7.3x
                                                                                                                  7.3x          $40
                                    Less: Cash and Cash Equiv.
                                    Less: Cash and Cash Equiv.      (14.5)
                                                                     (14.5)                      TEV // EBIT
                                                                                                 TEV EBIT         7.6x
                                                                                                                  7.6x          $20

                                    Plus: Senior Notes Payable
                                    Plus: Senior Notes Payable      486.9
                                                                    486.9                        Price // EPS
                                                                                                 Price EPS       10.3x
                                                                                                                10.3x            $0

                                    Enterprise Value
                                    Enterprise Value             $1,582.5
                                                                 $1,582.5                        Price Book
                                                                                                 Price // Book    2.7x

                                   Short World Acceptance Corp. (NASDAQ: WRLD) with a target price of $46, a 48% short up-
                                   side from its current level. WRLD provides a highly attractive risk/reward profile, as a lot of the short
                                   downside is already priced into the stock, with limited potential for large value creation by the com-
                                   pany but a significant potential for dramatic value destruction.
                                   World Acceptance issues and refinances installment loans to primarily subprime borrowers in the
Patrick is a second-year           U.S. and Mexico. WRLD has benefited from the weak economic climate since the recession, with the
MBA student and the                stock up over 430% over the past five years as the company’s portfolio and footprint have grown.
recipient of the Heilbrunn         Investment Thesis
Fellowship. While at               Core business continues deteriorating, with lower credit quality and interest rates:
Columbia Business School,          WRLD’s loans have increased nearly 95% since FY08, concurring with higher delinquency as it reaches
he has worked at VGI               more (and perhaps lower-quality) borrowers. 9.3% of the loan portfolio is currently delinquent (>30d
Partners, a high conviction        overdue). At the same time, WRLD has seen interest rate erosion due to regulatory pressure, com-
global equity manager,             petitive factors, and an increase in average balances. Many jurisdictions have usury laws regulating
which he will join after           maximum rates that can be charged; if states and courts impose or tighten rules, interest rates will
graduation as an Investment        come down further (e.g., there are ongoing efforts to impose a federal 36% interest rate cap).
Analyst. Prior to school, he
                                            Delinquent Loans (>30d) as % of Gross Loans                                         Interest Income / Average Gross Loans
was an investment banking
                                    10%                                                                          9.3%
Associate at Lazard. Patrick         9%                                                    8.4% 8.2%      8.4%          60%
                                                               7.9%                                  7.9%
holds a BBA from the                 8%   7.3%
                                                        7.1%          7.4%
                                                                                    7.0%                                                                55.2%        54.8%
                                     7%                                                                                 55%
George Washington                    6%
                                                                                                                              52.0%       51.8%         51.4%
                                                                                                                                                                     50.2%        49.7%
University and is a CFA              5%                                                                                 50%
charterholder.                       3%
Patrick is a finalist in the 5th     0%
                                                                                                                              Mar-09     Mar-10         Mar-11       Mar-12      Mar-13
annual Moon Lee Prize
                                                                                                                                 Interest Rate - U.S.           Interest Rate - Mexico
                                   CFPB cracks down on “add-on” sales of
                                   high-margin insurance: WRLD distributes
                                   insurance for a third party (see its confusing
                                   form at right). It earns high-margin commis-
                                   sions for distributing this insurance ($51.3m in
                                   FY13, nearly a third of pre-tax income). While
                                   there are clear legal requirements for proper
                                   disclosure, former employees are saying that
                                   “they were instructed not to tell customers
                                   the insurance is voluntary” (WLRD denies
                                   this). If it makes it appear to consumers that
                                   they are required to sign up for insurance, this
                                   “deceptive” marketing might be illegal. The
                                   Consumer Financial Protection Bureau has begun cracking down on deceptive practices, including
                                   against so-called “add-on” products. It considers the following factors in evaluating the effectiveness
                                   of disclosures at preventing consumers from being misled, including those related to add-ons: “Is the
                                   statement prominent enough for the consumer to notice? Is the information presented in an easy-to-
                                   understand format and at a time when the consumer’s attention is not distracted elsewhere?” A re-
                                   cent CFPB White Paper on payday loans and deposit advances concluded “that further attention is
                                   warranted to protect consumers” and that “the CFPB expects to use its authorities to provide such
                                   protections.” There is even legislative pressure, with Sen. Ron Wyden (D-OR) asking the CFPB at a
                                   July 25, 2013 committee hearing: “So what can be done about World Acceptance?”
 Issue XXI, Issue 2                                                                                                          Page 47

World Acceptance Corp. (continued from previous page)
Investment Thesis (continued)
Loan rollover model and capital structure present risks of a liquidity crunch:
Loan rollovers issues. Nearly 80% of WRLD’s loans outstanding are refinancings of existing loans (including
delinquent ones) or represent relationships with “former” borrowers; only 12% are completely new
customers. A loan that is constantly refinanced does not need to be paid back, becoming a permanent
part of the borrower’s “capital structure.” There is significant discretion in which loan gets refinanced or
charged off, which could mask deteriorating quality and lead to understated provisions. Currently the
new customers create inflows that continue the refinancing circle, but if WRLD were to run out of new
borrowers or if repayment patterns were to deteriorate, it could find itself in a liquidity crunch. Some
states (e.g. WA) have begun limiting the number of allowed refinancings per year. If WRLD left a state, it
could also create liquidity issues (e.g., TX, TN, and GA each contain more loans than all new borrowers).
Capital structure issues. Despite its large regulatory and economic risks, WRLD utilizes meaningful debt in
its capital structure and intends to continue to increase leverage through share repurchases. In fact, its
net debt balance has risen from 17% of net loans in March 2011 to 61% currently. WRLD is drawing on a
revolving facility that has been extended several times, most recently in September 2013, and expires in
November 2015. While the lenders were recently willing to extend this facility, such a willingness is not
guaranteed for the future, especially if WRLD encounters regulatory or operating headwinds.
Recent management disruptions might be a harbinger
of bad developments:
Departures. November’s unexplained departure (“personal
reasons”) of Mark Roland, COO, raises significant questions
about management. Additionally, CFO Kelly Malson announced
her “retirement” (at age 43) in September 2013; she had been
CFO since 2006 and is “pursuing other life objectives.”
Internal Controls Warning. Auditor KPGM identified a “material
weakness” in internal controls, concluding that WRLD “has
not maintained effective internal control over financial reporting.” WRLD did not have a documented
policy for establishing loan loss allowances. It also did not have a control to assess whether the account-
ing treatment of renewals was in accordance with GAAP and what impact renewals would have on the
estimate of the allowance for loan losses
Insider selling. Significant insider sales (chart above, sales are red) are also a negative signal for WRLD.
For the base case, modeling most of the business conservatively, with              TARGET PRICE - BASE CASE
key drivers being: continued office openings, continued growth in              DCF (10% WACC, 3% g)        $36.70
loans per office, interest rates continuing to decline, charge-offs and        EBIT Multiple (8x FY18)     $43.61
provisions increasing, and the insurance commission business shrink- EPS Multiple (10x FY18)               $58.78
ing to a fraction of its size under a regulatory crackdown.                    Target Today (Rounded)      $46.00
The target price of $46 is an equal blend of three valuation methods Current Share Price                   $88.97
(see right). A more aggressive bull case (disappearance of insurance           Short Upside/(Downside) %   48.3%
commissions by FY15) yields a target of $22 (75% short upside).
                                                   SUMMARY FINANCIALS ($M)
                           Actual      Actual        Actual     Model        Model       Model       Model       Model
                           Mar-11      Mar-12        Mar-13     Mar-14       Mar-15      Mar-16      Mar-17      Mar-18
 U.S. Offices                    972       1,032         1,084      1,134        1,179       1,221       1,257       1,295
 Mexican Offices                  95         105           119        134          150         167         183         202
 Total Offices                 1,067       1,137         1,203      1,268        1,329       1,387       1,441       1,497
 Average Gross Loans         $822.7      $923.9       $1,019.9   $1,115.1     $1,212.3    $1,311.0    $1,409.2    $1,508.6
   Per Office ($k )            $771        $813          $848       $879         $912        $945        $978      $1,008
 Average Interest Rate        51.6%       50.5%         49.6%      49.1%        48.6%       48.1%       47.6%       47.1%
 Interest and Fee Income     $424.6      $466.5         $505.5     $547.1       $588.9      $630.5      $671.0      $711.3
 Insurance Commissions          41.7        47.2          51.3       57.5         29.3        22.3        23.9        25.5
 Other Revenue                  25.2        26.5          26.9       27.9         28.9        30.0        31.1        32.2
 Total Revenue               $491.4      $540.2         $583.7     $632.5       $647.0      $682.8      $726.0      $769.0
   Change                    11.5%         9.9%          8.1%       8.4%         2.3%        5.5%        6.3%        5.9%
 Operating Income            $158.0      $173.8         $183.7     $201.7       $183.4      $183.4      $189.9      $195.1
   Margin                    32.2%       32.2%          31.5%      31.9%        28.3%       26.9%       26.2%       25.4%
 Diluted EPS                   $5.63       $6.59         $7.88      $8.61        $7.80       $7.93       $8.46       $9.03

Risks and Bear Case
Ongoing growth in lending and office openings could increase WRLD earnings.
Mexico (7% of revenues in FY13) could become large and drive future growth and profitability.
Short squeeze as 35% of CSO is currently sold short (mitigated by large passive institutional ownership).
CFPB could decline to investigate or investigate but not act, permanently validating the business model.
Without CFPB action, the base case still yields a 25% upside, implying CFPB is remaining 24% of upside.
The bear case of continued growth and improving rates and credit quality yields a $106 price target (19%
downside), indicating an attractive risk-reward versus the 48% base case upside and 75% bull case upside.
               Page 48

                                 Pandora (NYSE: P) - Long
                                 Akhil Subramanian
                                                                                                                                     Capital Structure
                                 Recommendation:                                                                                     Price (12/12/2013)                                          $26.82
                                 Buy Pandora ($26.82 as of 12/12/2013) with a probability-                                           Shares outstanding                                           192.15
                                                                                                                                     Market cap                                                    5,153
                                 weighted price target of $38 (40% upside)
                                                                                                                                     Cash                                                          (437)
                                                                                                                                     Debt                                                             0
                                 Background:                                                                                         EV                                                           4,716
                                  - Internet radio company with 72MM active users                                                    Consensus estimates             2013E         2014E          2015E
                                  - Pandora makes money via a) Subscription ($36/year, no                                            Revenue                          $628          $821           $976
                                 ads) or b) Ad-supported listening                                                                   % growth                                        31%            19%
                                  - Available on many platforms (PC, mobile, tablet, cars,                                           EBITDA                            ($2)          $41            $85
                                                                                                                                     EPS                             $0.02         $0.21          $0.32
Akhil is a second-year MBA       TVs, etc.). ~80% listening is non-PC, primarily mobile                                              EBITDA %                        -0.4%          5.0%           8.7%
student in the Heilbrunn          - Steadily capturing US terrestrial radio share; 8% today
                                                                                                                                     Multiples                      2013E          2014E          2015E
Center’s Value Investing         (vs 5% in 2011). Importantly Pandora is only 3% of the                                              EV/Sales                         7.5x           5.7x           4.8x
Program. Over the summer,        $17BN radio advertising market; they will close this gap                                            EV/EBITDA                        NA           113.9x          55.2x
                                                                                                                                     P/E                          1,158.6x         130.1x          84.3x
he worked at Owl Creek.
He and his team (Eric Lai        1. Revenue inflection point. Pandora has found a way to monetize mobile listeners and they still
and Jeremy Colvin) were          have many levers to pull. Furthermore, barriers to advertising are coming down
finalists at the 2013 Pershing   2. More and more ubiquitous. Advertiser ROI is favorable
Square Challenge, where          3. Relatively unfazed by competitor launches
they pitched LONG Dollar         4. Blue sky: Pandora could expand overseas or get acquired
Tree (DLTR). Akhil
graduated in 2008 from the       1. Revenue inflection point; barriers to radio advertising are coming down
University of Chicago; he         - Pandora has guided to 3MM paying subs and 69MM nonpaying subs (i.e. ad supported)
majored in mathematics and        - Mobile and PC RPMs were $34 and $58 respectively (RPM = revenue per 1,000 hours listened).
economics.                       Mobile RPMs have been increasing rapidly and this has been primarily due to a) Appointing a
                                 new CEO in 2013 (Brian McAndrews) who is an advertising expert, b) mix-shifting from national
Akhil is a finalist in the 5th   to local ads; local RPM = 3-4x national RPM, c) experimenting with ads (e.g. back to back spots)
annual Moon Lee Prize            and surgically inserting more ads without increasing churn
Competition.                      - In September 2013 Pandora removed a monthly listening cap (40 hours) on mobile devices, a cap
                                 that they put in place in May 2013 because they couldn’t monetize mobile listening. In my opinion,
                                 this was a revenue inflection point
                                  - Levers that Pandora can pull to increase Mobile listening: a) Ad minutes per hour (currently 2
                                 mins/hr versus 13-16 mins/hr on terrestrial radio, mgmt. stated that they want to go higher), and b)
                                 Revenue per minute of ads (breaking down unit economics => ~$11 per ad minute, this can go up
                                 to ~$14)
                                 Exhibit: How high can mobile RPMs go? Comparison of current ($35) versus Theoretical ($62)
                                 Mobile RPM breakdown:                                                                                                      Ad minutes per hour
                                  Mobile - Ad minutes per hour             2.0       3.0 Upper limit from Q2 call              $62       1     1.5    2     2.5     3        3.5    4      4.5     5
                                                                                                                               35%      $16   $24    $33   $41    $49       $57    $65    $73     $82
                                  Mobile hours listened (BN)               2.8       2.8
                                                                                                                               40%      $17   $26    $34   $43    $51       $60    $68    $77     $85
                                  # Mobile ad minutes                     5.58      8.37
                                                                                                                               45%      $18   $27    $36   $45    $53       $62    $71    $80     $89
                                                                                                                               50%      $19   $28    $37   $46    $56       $65    $74    $84     $93
                                                                                                                     % Local

                                   Mobile Ad RPM per minute             $17.66   $20.81 Mix-shift toward local ads             55%      $19   $29    $39   $48    $58       $68    $77    $87     $97
                                    % Audio                               60%      66%                                         60%      $20   $30    $40   $50    $60       $70    $80    $90    $100
                                   Mobile Ad RPM per minute (Audio)     $10.59   $13.75 Q3 call: "$9-$12 range"                65%      $21   $31    $42   $52    $62       $73    $83    $94    $104
                                                                                                                               70%      $22   $32    $43   $54    $65       $75    $86    $97    $108
                                    Local RPM                           $19.00   $19.00 High teens                             75%      $22   $33    $45   $56    $67       $78    $89   $100    $112
                                    National RPM                         $4.00    $4.00 Low-to-mid s.d.
                                   % local                                44%      65% 74% of radio is local ads

                                   Mobile Ad RPM per minute (Audio)     $10.59   $13.75
                                   Mobile Ad RPM per minute (Display)    $7.06    $7.06 No increase
                                   Mobile RPM                           $35.31   $62.44

                                  - Pandora needs a local salesforce if its going to sell local ads. These salesforces are being rolled out;
                                 Pandora is currently in 29 markets (50% of listeners) and my model assumes 50% increase in SG&A
                                 over next couple of years
                                  - Barriers to radio advertising are coming down. Pandora is now integrated into media-buying plat-
                                 forms (i.e. media buyers can look up Pandora audience size and compare to radio in various markets)
                                  - Furthermore, Nielsen recently bought Arbitron (the Nielsen of radio) and stated that it will now
                                 start ranking Pandora. Previously Arbitron did not rank Pandora and this meant that buyers couldn’t
                                 compare Pandora versus terrestrial radio ratings easily
  Issue XXI, Issue 2                                                                                                                                                                                                                                                            Page 49

Pandora (continued from previous page)
2. More and more ubiquitous. Advertiser ROI is favorable
 - At launch, Pandora was PC only. Today listeners can consume Pandora on mobile, tablet, TV, car, etc.
At some point it is likely that Pandora will offer separate advertising solutions for each platform
 - Advertiser ROI is superior to that of terrestrial radio because: a) Terrestrial radio tends to have 4-5
min ad blocks every 30 mins and users change channels during these blocks, b) an ad on terrestrial radio
is played to all listeners at the same time whereas an ad on Pandora is played to a user listening to a
custom-built station => advertisers can segment and tailor ads on Pandora, c) Pandora has untapped geo
-location potential, i.e. they could play you an ad for a store that you walk by (they don’t do this as of
today but they can) and these ads should have higher RPMs
 - To sum it up: 8% of listening share but only 3% of advertising revenues + good ad product
whose ROI is higher than terrestrial radio ROI + many RPM levers to pull

3. Relatively unfazed by competitor launches
 - Apple launched iTunes radio in September 2013 and claimed that they had 20MM users and 1BN songs
played in 1 month. 1BN songs = 4BN minutes = 67MM hours. 67MM hours / 20MM users = 3.3 hrs/mo
 - Pandora users average 18 hrs/mo, i.e. 6x as much as iTunes radio
 - The launch appears to have been quite underwhelming. Pandora’s active user count dropped from
72MM to 70MM but they made it back up 1-2 months later
 - Spotify launched an ad supported radio service in December 2013. They only have 24MM users (6MM
paying) so the impact on Pandora should be minimal. Pandora was down 7% on the day of the launch and
I think that this could be a buying opportunity

4. Blue sky: Pandora could expand overseas or get acquired
 - Pandora has 200MM users of which 72MM are active (streamed in the last month)
 - Competitors have chosen to build versus buy, but Pandora ($5BN market cap) would be a tuck-in deal
 - Gross margins are 44% so Pandora is worth a lot to a buyer who has a large salesforce (they could buy
the company and wipe out SG&A)
- Potential Catalyst: Outcome of royalty negotiations. Pandora will negotiate post-2015 royalty
rates in 2014, its possible that a buyer could emerge after those rates are set. Furthermore, Pandora
could strike a deal with music labels directly for royalties (currently it pays royalties under a federal stat-
utory license... but it could pay them directly to labels) and this could be another catalyst if the rates are
 - Pandora could also move overseas if it strikes a direct royalty deal with labels. Currently Pandora is
only available in Australia, New Zealand and the U.S. (as those countries have federal statutory licenses)
 - September 2013 equity raise could be catalyst for a direct deal with labels followed by overseas
expansion. Direct deals require upfront advances to labels and management stated that the equity raise
would allow them to address such opportunities “from a position of strength”

                                                                                                                                   Users and # hrs/mo
Valuation (2016E)                     Bull      Base      Bear
                                                                    80.0                                                                                                                                                                                                 25.0
Probability                             30%        50%       20%    70.0
Hours listened (BN)                      25.3      23.8      19.8   60.0

  Mobile RPM                             $73       $63       $54    50.0                                                                                                                                                                                                 15.0
  PC RPM                                 $96       $89       $78                                                                                                                                                                                                         10.0
Content acquisition costs % Revenue     38%        42%       47%    20.0

Revenue                                 1,870     1,566     1,144    0.0                                                                                                                                                                                                 0.0












Operating profit                          574       372       122
  Operating margin                       31%       24%       11%
EBITDA                                    619       410       150                                                                   Active users                                   Hours / Active user

  EBITDA margin                          33%       26%       13%
                                                                    $30.00                             Gross profit per sub per year (at Current RPMs)
EPS                                    $1.98     $1.55     $0.66    $25.00
 Multiple                               25.0x     25.0x     25.0x
Target price                             $50       $39       $16
 % upside                                85%       45%      -39%    $15.00
 IRR                                     36%       20%      -22%    $10.00

Probability-weighted Price               $38
  % upside                               40%                         $0.00
                                                                                                 10                     20                     30     40       50     60     70                                                                                     80
  IRR                                    18%
                                                                                                                                                  Hours listened / mo
                                                                                                                                              Paying                Nonpaying
              Page 50

                                Post Holdings (NYSE: POST) – Long
                                Jackson Thies

                                Recommendation                                                                       Capital Structure
                                                                                                                     Share Pr. 1/27/14          $54.80
                                Purchase shares of POST. My target price of $105 implies 90% upside over three
                                                                                                                     Shares Out. (mm)              33.0
                                years, or a ~25% IRR.                                                                Mkt. Cap. ($ mm)           1,808.4
                                                                                                                     + Debt + Pfd. (PF)         2,452.0
                                Business Description / History
                                                                                                                     ‐ Cash & Equiv. (PF)         359.1
                                POST is a consumer packaged goods company which manufactures and distrib-            Enterprise Value           3,901.3
                                utes ready-to-eat cereals in the U.S. with 10.4% market share (3rd largest). Addi-
                                tionally, POST has created two new platforms—active nutrition and private la-        Key Stats
                                bel—to capitalize on secular growth in the health and wellness category and in       52 Wk. hi/lo            55.9 / 36.7
                                organic and gluten free foods. Notable brands include: Grape Nuts, Honey Bunch-      Dividend Yield                0.0%
                                                                                                                     Short Interest                8.2%
                                es of Oats, Honeycomb, Pebbles, Raisin Bran, Premier Protein, Dymatize Nutri-
                                                                                                                     Avg. Dly. Volume (mm)           0.4
                                tion, and Dakota Growers among others.                                               Est. Intrinsic Val.           $105
Jackson is a second-year                                                                                             Upside (downside)             92%
MBA student, participant in     POST became a publicly traded company in early February, 2012 when it was
the Heilbrunn Center’s          spun-off from Ralcorp. POST was initially spun-out of Kraft Foods and merged into Ralcorp in 2007 for a total
Value Investing Program,        consideration of $2.6bn (including $950mm in debt), the TEV post spin-off from Ralcorp was roughly 2bn based on
                                a share price of ~$30. Shortly after the spin-off, in November 2012, ConAgra agreed to purchase Ralcorp (made
and Co-Editor of Graham &
Doddsville, the Columbia        the offer in 2011 before the spin and closed in 2013).
Student Investment              Investment Thesis
Management Association          I) The POST management team lead by Bill Stiritz is best in class
(CSIMA) newsletter. Over        A critical aspect of investing in POST is that William Stiritz became chairman and CEO of the spin-off. This is the
the summer, he interned at      same William Stiritz profiled in The Outsiders for his stellar performance running Ralston Purina. Over his 19-year
PIMCO in the credit             tenure at Ralston Purina, he delivered a 20% compound return through intelligent acquisitions, divestitures, and
research group.                 share repurchases (ultimately repurchasing 60% of the shares outstanding). Also relevant is that Stiritz pulled a
                                cadre of business managers from Ralston Purina to POST (CFO Vitale, COO Block, and EVP of Marketing
                                Holbrook), deepening the management bench and giving comfort that the right team is in place and focused on
Prior to Columbia Business
                                creating shareholder value.
School, he worked for the
Federal Reserve Bank of         In The Outsiders, Thorndike states: “Under Ralston’s management, distribution was expanded, redundant costs
Dallas. Jackson holds a BS in   were eliminated, new products were introduced and cash flow grew significantly...pretax profit margins grew from
economics and engineering       9 percent to 15 percent.” Stiritz is repeating the process. For example, he re-launched the Great Grains brand
from Southern Methodist         and grew volume 7.4% in 2012 and 9% in 2013.
                                Stiritz’s incentives are well aligned with shareholders – he currently receives an annual salary of $1 and all other
                                compensation in the form of stock options / share ownership. He currently has 1.55 million options with a strike
Jackson is a finalist in the
                                price of $31.25 and 600,000 options with a strike price of $40.30. In addition, he directly owns ~370,000 shares.
5th annual Moon Lee Prize
Competition.                    II) Acquisition strategy through platform expansion and increased attention to the historic Post cereal business
                                Stiritz made his intentions known in POST’s pre-spin S-1, “As an independent company, we will be able to allocate
                                capital more efficiently and have direct access to debt and equity capital markets. We anticipate that these charac-
                                teristics will improve our ability to continue to develop innovative new products, pursue acquisitions and other
                                growth opportunities, extend our brands into adjacent categories and increase our ability to motivate employees
                                by providing compensation that is tied directly to our business results.”

                                And in the 2012 annual report, “Post received less and less attention as it became part of an ever larger conglom-
                                erate…historical “best in class” margins reflected an insufficient amount of support for the portfolio…We believe
                                Post requires a top notch in-house sales force…Our business generates attractive cash flow and we intend to use
                                that cash to reduce debt, repurchase shares, and/or make acquisitions…We intend to expand our platform of
                                iconic brands by identifying organic opportunities to extend those brands into new product lines or markets. In
                                addition, we intend to pursue acquisition opportunities that can strengthen our current portfolio of branded prod-
                                ucts or enable us to expand into complementary categories, geographic regions or distribution channels.”

                                With Stiritz at the helm POST has been very acquisitive over the past two years – acquired roughly 50% of
                                POST’s pro-forma revenue – using FCF and leverage to purchase companies that now form the base of their
                                active nutrition and private label platforms. These platforms will enable management to rapidly drive efficiencies in
                                future acquisitions and fold new products into their existing distribution network. After accounting for synergies
                                and the NPV of tax benefits the average acquisition price has been 8.2x EBITDA. Not counting the NPV of tax
                                benefits I estimate POST is achieving an 8-9% levered free cash flow yield on its acquisitions. The historic POST
                                ready-to-eat cereal business has also benefitted from additional focus since the spin-off and has stabilized with
                                growth of 2.5% in 2013 compared to a category decline of 2.2%.
 Issue XXI, Issue 2                                                                                                                     Page 51

Post Holdings (continued from previous page)
III) POST closely resembles a publicly traded LBO providing significant upside for the equity
Indeed this is Stiritz’s intention, in the 2013 annual report he states, “Post Holdings competes for your capital alloca-
tion. To earn it we must deliver risk adjusted returns commensurate with your assessment of risk and your alterna-
tives. Perhaps uniquely, we view Post as a hybrid of a traditional public company and a private equity fund. We use
many of the same tools as a private equity company – relatively higher leverage, investment analysis and adaptive
management. We also view our portfolio as dynamic, reacting to opportunities as they develop. However, unlike most
private equity firms, we also provide Centers of Excellence to create competitive advantages for our operating com-
panies. And we do this in the public forum allowing our investors greater transparency and, most importantly, the
ability to act on their own accord.”

POST has undertaken six acquisitions since being spun off and financed a significant portion of the cash consideration
with debt. The leverage employed, while increasing risk to a degree, results in significant upside to equity holders and
is accomplished in a prudent manner as the consumer staples product is less cyclical. Added comfort is gained from
the significant cash flow generated by the historic POST cereal business as well as the newly acquired businesses.
POST is currently trading at 11.4x forward EBITDA after adjusting for recently completed and announced acquisi-
tions. While valuation is contingent on management actions and the opportunity for attractive acquisitions, recent
activity and comments on the latest earnings call regarding deal flow are encouraging. I assume POST will continue to
make acquisitions at a pace that keeps net leverage near current levels (roughly 5x) and that acquisitions are done at
8.5x. Holding net leverage
                                         Financials            2010    2011      2012    2013 2014PF 2015E         2016E    2017E
roughly constant I derive reve-
                                         Revenue             996.7    968.2     958.9 1,034.1 1,866.8 2,478.4 3,163.9 3,925.4
nue and EBITDA acquired based
                                           Growth             ‐7.0%   ‐2.9%     ‐1.0%    7.8%   80.5%     32.8%      27.7%    24.1%
on the assumption that the               EBITDA              265.6    256.6     202.3   191.3   341.3     459.3      594.2    747.1
EBITDA margin of future acqui-             Margin            26.6%    26.5% 21.1%       18.5%   18.3%     18.5%      18.8%    19.0%
sitions will be similar to the           FCF                 111.3    128.9     113.1    86.4   152.1     215.3      288.4    372.0
recent average (~18%). I esti-             as a % of Sales   11.2%    13.3% 11.8%        8.4%    8.1%      8.7%       9.1%     9.5%
mate organic growth at 3% and
modest EBITDA margin expan- Acq. Revenue                         nm      nm        nm      nm      nm     555.6      611.1    666.7
sion of 25bps annually. The              Acq. EBITDA             nm      nm        nm      nm      nm     100.0      110.0    120.0
result is $750mm in 2017                 Total Debt          716.5    784.5     945.6 1,408.6 1,900.0 2,400.0 2,950.0 3,550.0
EBITDA to which I apply a 10x Gross Leverage                    2.7x    3.1x      4.7x    7.4x    5.6x       5.2x      5.0x      4.8x
forward multiple
                       Recent Acquisitions                 Hearthside    Premier       Dakota    Golden Boy       Dymatize      Total
resulting in a $105
                       Purchase Price                           158.0      180.0        370.0          300.0         380.0 1,388.0
share price in
                       Multiple                                  8.8x        9.7x         8.4x          8.6x          9.0x       8.8x
2016, yielding a       Multiple adj. for tax benefits            7.4x        8.4x         8.4x          8.6x          8.0x       8.2x
~25% IRR over          Revenue                                   70.0      135.0        300.0          220.0         195.0     920.0
three years.           EBITDA                                    18.0       18.5         44.0           35.0          42.0     157.5

Investment Risks
I) Capital markets become less accommodative
Mitigant: While accommodative markets aid POST’s current strategy, and help the incremental upside, it isn’t the
whole story. Stiritz and his team operated Ralston for 19 years in varying market climates with great success. Ulti-
mately Stiritz repurchased 60% of Ralston’s shares and spun-off or divested multiple businesses in his quest to create
shareholder value.
II) Management becomes overly focused on the story and stretches on price for acquisitions
Mitigant: While at Ralston Stiritz was very calculated in his capital allocation decisions and would look at the prospec-
tive return on repurchasing stock as a benchmark against which other investments were compared. They also avoided
competitive auctions and only pursued acquisitions that were attractive using conservative assumptions.
III) Key man risk – Bill Stiritz is 79 years old
                                                                       Mitigant: This is a concern but as noted previously,
                     POST Historical Share Price                       multiple members of the top management team
                                                                       worked with Stiritz at Ralston with great success.
    55                                                                 Additionally, you’re paying 11.4x forward EBITDA for
    50                                                                 POST when General Mills is at 10.7x and Kellogg is at
    45                                                                 10.6x, so the risk of loss looks fairly minimal. You still
    40                                                                 have a very good management team in place but you
    35                                                                 may lose some incremental upside. That said, Stiritz
    30                                                                 looks like he is in good shape and purportedly drinks
    25                                                                 protein shakes (which POST now sells) on a regular
    20                                                                 basis.
     Page 52

               Jim Grant
               (Continued from page 1)          The Baltimore Sun—this was       the courage I needed. She
               career as a reporter for         in 1972—where I met my           said, “Well, let’s persist,”
               The Baltimore Sun and            wife, Patricia, and              and we did. We were lucky
               Barron’s. In 1983, he set        discovered my vocation.          enough to find an angel
               out on his own, founding         Financial news at The            investor named John
               Grant’s. He has written          Baltimore Sun was the least      Holman, now known on
               several financial                prestigious job on the           these premises as St. John.
               histories, biographies,          paper, a sure dead end. I        He invested $35,000 and
               and collections of Grant’s       didn’t know the phrase           that was all we needed. I
               articles, as well as the         “contrary opinion” but I         must say, he made a pretty
Jim Grant      introduction to the Sixth        seemed to have had a bent        good investment. That was
               Edition of Security              for it. I took that job and a    in 1984.
               Analysis. In 2013, Grant         couple of years later went
               was inducted into the            to Barron’s. That was in         My friend Lew Lehrman, a
               Fixed Income Analysts            1975. I was there about          successful entrepreneur and
               Society Hall of Fame.            eight years. I wrote some        a good investor, says that
               He is also a member of           editorials and originated the    you’re not a true
               the Council on Foreign           credit markets column,           entrepreneur unless you
               Relations and a trustee          “Current Yield.” I quit in       nearly go broke twice. I’m
               of the New York                  1983 to found Grant’s.           still waiting for number two,
               Historical Society.                                               but the first time was
                                                G&D: What prompted you           enough for me.
               Graham & Doddsville              to start Grant’s?
               (G&D): What first drew                                            G&D: Who do you
               you to the world of              JG: I picked the wrong side      consider to be some of the
               economics and what led you       in an intramural argument at     main influences in your
               to pursue a career in            Barron’s. I had to leave. The    economic philosophy?
               journalism?                      question was, Where could
                                                I go? I decided to start my      JG: In college, I loved the
               Jim Grant (JG):                  own paper rather than            writing of John Kenneth
               Circuitously, is how I           working for someone else’s.      Galbraith. My junior year at
               arrived here. I was a serious    I had no idea what a brave       Indiana, I went to the
               teenage French horn              plan that was. I started         American Economics
               player—serious and almost        Grant’s with the $75,000 I’d     Association annual meeting
               good enough to play              accumulated in my Dow            in Manhattan. I walked into
               professionally. Using a          Jones profit-sharing plan.       a room and at the end of
               baseball analogy, I was just     That lasted just about 8         the room was an elevator.
               good enough to play in the       months. Subscribers were         And in that elevator stood
               Cape Cod League.                 scarce, very scarce. It seems    John Kenneth Galbraith
                                                the world had enough to          himself, about seven feet
               So I went to Ithaca College      read even without Grant’s.       tall. I was awestruck. Before
               to become a music teacher.       I’d just published my first      very long, I am pleased to
               I quit after one semester,       book, a biography of the         say, my tastes matured. I got
               served in the Navy,              investor Bernard Baruch,         interested in free market
               returned to civilian life as a   which did not set the world      literature, laissez-faire
               clerk on a Wall Street bond      of literature on fire. Nor did   literature, the Austrian
               desk, and went back to           Grant’s set the world of         approach—Hayek, Mises,
               college, this time to study      journalism on fire. Nothing      Röpke, and the rest.
               economics at Indiana             was going well. We had two
               University.                      kids and not much money.         Good financial writing, to
                                                My wife, a banker at             me, is good writing. I have
               When the time came to get        Lehman Brothers, had all                      (Continued on page 53)
               a job, I joined the staff of
Issue XXI, Issue 2                                                                                     Page 53

Jim Grant
(Continued from page 52)         freedom and the price          you are Graham’s lessons
tried to emulate the             mechanism, each of which is    and how do they apply in
masters. Walter Bagehot,         a fine cause. Then, too,       the modern world?
the great Victorian editor of
The Economist, is one. I used                                   JG: Graham reminds us
to read old bound copies of                                     that markets are just as
The Economist in the New                                        efficient as the people who
York Public Library, just                                       operate in them. They—the
glorying in Bagehot’s                                           people—overreact. They
writing. Another is Frederic                                    underreact. They try to
Bastiat, who urged his               “My friend Lew
                                                                follow their heads but they
readers to look beyond that                                     often follow their hearts.
“which is seen” to that
                                        Lehrman, a
                                                                They ought to buy low and
“which is not seen”—in                   successful             sell high, but they tend to
other words, to imagine the                                     wind up doing the opposite.
unintended consequences of        entrepreneur and a
human action. I have learned                                    Graham knew all about the
from Henry Hazlitt, who            good investor, says          emotional side of investing.
wrote free-market editorials                                    Between the top of the
for The New York Times, if          that you’re not a
                                                                stock market in 1929 and
you can imagine that; John                                      the bottom in 1932, his
Brooks, author of Once in
                                   true entrepreneur
                                                                hedge fund was down by
Golconda; and Bray                unless you nearly go          70%. He picked himself up,
Hammond, author of a                                            dusted himself off, and
wonderful history entitled        broke twice. I’m still        wrote his magnum opus,
Banks and Politics in America.                                  Security Analysis. He might
                                   waiting for number           have given up, but he didn’t.
Then there’s the great Fred                                     By the way, Graham was a
Schwed, Jr., author of Where        two, but the first
                                                                wonderful writer as well as
Are The Customers’ Yachts?                                      an analyst. Security Analysis is
It’s delightful, word for
                                    time was enough
                                                                a model of expository
word among the wisest                     for me.”              prose.
books ever written about
Wall Street.                                                    G&D: A lot of value
                                                                investors have begun to
G&D: You mentioned                                              fancy themselves
Hayek and Mises. Why do                                         macroeconomists of late.
you think the Austrians                                         What do you think about
seem to be a source of           Austrian doctrine puts         value investors who are
controversy these days?          interest rates at the center   trying to be
Mainstream academia seems        of the theory of the           macroeconomists?
to write them off while          business cycle. Certainly,
others take them very            that rings a bell for          JG: Let me tell you first
seriously. What’s your take      someone whose publication      about the ones who refused
on Austrian economics and        has “interest rate” in its     to fancy themselves
where do you think it is         name.                          macroeconomists. Investors
better or worse than                                            who turned a blind eye to
traditional economics?           G&D: In your “increasingly     credit—to monetary policy,
                                 famous” cartoons, you          to the Federal Reserve—
JG: First, let me say that no    frequently reference Ben       didn’t notice the stupendous
single canon of economic         Graham’s concept of Mr.        buildup of bad debt through
thought has all the answers.     Market. How important to                     (Continued on page 54)
The Austrians preach
          Page 54

                      Jim Grant
                      (Continued from page 53)         specifically, the seasonally-     by no means generate all of
                      2007. They tended to own a       adjusted and hedonically-         the ideas.
                      lot of optically cheap           adjusted ones in the index.
                      financial stocks that got        It’s no easy thing to build a     Our readers contribute
                      cheaper and cheaper until        price index—the compilers         some of our best ideas. In
                      they weren’t there               must make all kinds of            2006, Alan Fournier,
                      anymore.                         choices that may or may not       managing member of
                                                       comport with your own             Pennant Capital
                      Seth Klarman, a renowned         ideas of relevance and            Management, suggested that
                      value investor, says that        fairness. It’s no easy thing to   we look into mortgage
                      run-of-the-mill talk about       interpret a price index,          derivatives. We did, under
                      the macroeconomic future         either. We shouldn’t be so        the somewhat uninviting
                      reminds him of sports radio.     quick to accept these figures     page one headline, “Inside
                      Everyone has an opinion,         at face value.                    ACE Securities’ HEL Trust,
                      and every opinion is equally                                       Series 2005-HES.” It was the
                      valid, or invalid, or vapid.     G&D: Howard Marks                 first of what proved to be
                                                       emphasizes not forecasting        many bearish stories on
                      We can’t know the future.        but simply knowing where          structured finance,
                      But we can observe the           you are in the economy.           mortgage derivatives and
                      present. Sometimes interest                                        the like. By 2008, our
“No single canon      rates and credit and the         JG: Exactly! We should be         readers were awfully glad
                      cycles of credit are more        more like Henry Singleton,        we’d published them.
   of economic        important than stock             the CEO of Teledyne in the
thought has all the   selection. That was true in      1950s and 1960s. Singleton        I’ll be forever grateful to
                      2007 and 2008, and it will       baffled his critics by doing      Alan for the idea and to Dan
    answers.”         no doubt be true again at        what hadn’t been done             Gertner, a Grant’s analyst at
                      some point.                      before. For instance, he          the time, for doing the hard
                                                       would purchase his own            work. Dan was a chemical
                      Allow me to suggest a book       stock in the market when          engineer by training. He had
                      on a related subject. It’s       he judged it was                  no experience with
                      Oscar Morgenstern’s On the       unreasonably cheap. His           mortgage-backed securities.
                      Accuracy of Economic             critics demanded that he          But he knew a bad idea
                      Observations. The second         present a long-range              when he saw one.
                      edition came out fifty years     corporate plan. Singleton
                      ago. In it, Morgenstern          replied that he had no plan       It actually helped, I think,
                      exposes the errors and           and wanted none—the               that he was not an expert in
                      fallacies that riddle            future was too full of            derivatives or structured
                      macroeconomic data. Don’t        surprises. His only plan, said    finance. It was the mortgage
                      settle for what the data say,    the visionary, was to come        experts who tried to tout
                      urges Morgenstern in so          to work in the morning with       us off the story. Nobody at
                      many words; ask what they        an open mind.                     Grant’s is an expert. We’re
                      mean. Marty Whitman,                                               all generalists.
                      founder of the Third             G&D: You have a whole
                      Avenue funds, has the same       team of analysts at Grant’s.      G&D: Do you prefer team
                      message for users of             How is the work organized         members who come from
                      corporate financial              and how does an issue of          economics or finance
                      information.                     Grant’s come together?            backgrounds?

                      To take an example, the CPI      JG: I sometimes wonder            JG: Yes. Smart people fit in
                      says that prices are rising by   myself. Ideas come into the       well, too, as do those who
                      a little less than 2% a year.    office; finished copy goes        are curious and tireless and
                      Which prices? The ones in        out. I write all the copy but                  (Continued on page 55)
                      the index, of course. More
Issue XXI, Issue 2                                                                                       Page 55

Jim Grant
(Continued from page 54)         your office, how much time        Warren Harding balanced
can write good, sound            do you devote to reading?         the budget and, through the
sentences. We publish every                                        Federal Reserve, raised
other week and have for 30       JG: I read when I’m not           interest rates. No
years. I’m no longer             writing. As far as that goes, I   “stimulus,” no TARP, no
surprised that we actually       read to write. I’m usually        QE, no ZIRP. Yet the
manage to produce a 12-          working on a book—a               depression did come to an
page issue of Grant’s, though    hobby, not a profit center, I     end (from top to bottom, it
I am always grateful.            can assure you. My new            lasted for 18 months), after
                                 book is a history of the          which the 1920s
I’ve got to say that ours is     depression of 1920-21. It         proverbially roared. There,
not the most electrifying        was the last laissez-faire        I’ve given away the plot.
newsroom you’ve ever             depression in America. In         Simon & Schuster will
walked into. It’s more like                                        publish it in the fall.
the reference room of a
public library.                                                    G&D: Do you have any
                                      “Investors who
                                                                   favorite books that you
There are seven of us, not                                         would recommend?
including the copy editor or
                                   turned a blind eye
the cartoonist, who work               to credit—to                JG: Besides the titles listed
only on the days we go to                                          on the Grant’s website, I’ll
press. There are three            monetary policy, to              mention two. One is James
analysts: Evan Lorenz,                                             Boswell’s 1791 Life of
David Peligal and Charley               the Federal                Samuel Johnson, a book
Grant (the last-named being                                        about life and therefore
my son). Del Coleman                 Reserve—didn’t
                                                                   about investing, although it
handles circulation, John                                          contains no actionable stock
McCarthy is the production
                                         notice the
                                                                   ideas. A true category killer,
chief and Eric Whitehead is       stupendous buildup               Boswell managed to write
the general administrator. If                                      the best biography in the
a subscriber needs a little       of bad debt through              English language that was
encouragement to renew                                             also the first biography in
his subscription, he will hear     2007. They tended               the English language. I read
from our discreetly                                                it over and over.
persuasive marketing man,             to own a lot of
John D’Alberto.                                                    The other—a little
                                     optically cheap
                                                                   different—is Banking and the
A proper issue of Grant’s is      financial stocks that            Business Cycle, by C.A.
a little like a bride on her                                       Phillips, et al. To my mind,
wedding day: something old           got cheaper and               it’s the best contemporary
(a little history), something                                      analysis of the Great
new (never hurts in                cheaper until they              Depression.
journalism), something
borrowed (credit is our                weren’t there
                                                                   G&D: Given your thoughts
main subject) and something                                        on the Fed and the gold
blue (we’ve been known to
                                                                   standard, what did you think
be bearish). The analysts                                          when Ron Paul suggested
submit memos, from which I       response to a collapse in         that if he were elected, he
write articles.                  prices and a surge in             would name you Chairman
                                 unemployment, the                 of the Fed?
G&D: Given the extensive         administrations of
research in your memos and       Woodrow Wilson and                             (Continued on page 56)
the very large bookshelf in
            Page 56

                          Jim Grant
                          (Continued from page 55)         government and Wall Street       Here at Grant’s, we call it
                          JG: Wise choice. And I can       have a vested interest in not    the Ph.D. standard. The
                          tell what I’d do. Day One, I     changing things. These are       FOMC has become a kind
                          would open the Fed’s very        potent constituencies.           of seat-of-the-pants
                          first Office of Unintended                                        economic planning bureau.
                          Consequences.                    Laura Ingalls Wilder             The gold standard, by
                                                           illustrates the moral side of    contrast, operates through
                          G&D: If you were                 the monetary question in         the price mechanism.
                          president and could not          one of her Little House          Money is defined in law as a
                          nominate yourself as Fed         books. This one, entitled        weight of gold. Paper dollars
                          Chairman, who would you          Farmer Boy, is set in upstate    are convertible into gold,
Alex Porter at the 2013   nominate?                        New York. One day, the           and vice versa, at the fixed
Moon Lee Prize Competi-                                    protagonist is at the fair,      and statutory rate.
tion.                     JG: My friend Lew                and his father gives him a
                          Lehrman, whom I                  50-cent piece. The father        Is that a good idea? It was a
                          mentioned a moment ago.          asks him, “You know what         good and serviceable idea
                          He made a lot of money by        this is?” Silence. “Well it’s    for most of American
                          building up Rite Aid, which      money. Do you know what          history and, as far as that
                          others subsequently unbuilt.     money is?” Again, silence.       goes, for most of the
                          He has devoted much of his       “Money, son, is work.”           modern commercial history
                          life to studying monetary        Here’s the question: Is          of the West. You asked
                          questions. He is the most        money work? Or is it an          about the “financial system.”
                          knowledgeable and world-         instrument of public policy?     Under the gold standard,
                          wise exponent of the gold        The voters will ultimately       banks were the property of
                          standard in America.             have to decide.                  the stockholders, not of the
                                                                                            taxpayers. If a bank became
                          G&D: What do you think           G&D: What would happen           impaired or insolvent, the
                          it would take to move back       in the economy if the US         stockholders got a capital
                          to the gold standard?            and presumably at that           call (that arrangement,
                                                           point, the world, moved          called “double liability,” was
                          JG: A clear demonstration        back to a gold standard?         phased out in the 1930s). I
                          that the non-gold standard       There are a lot of               believe that that is the
                          isn’t working. For me, I’m       arguments that it would          direction in which our
                          already persuaded, though        throw a wrench in the            financial reforms should be
                          many seem not to be. The         financial system, but in your    headed, not toward more
                          system in place is a system      opinion, what would that         regulatory
                          of price control and market      scenario look like?              micromanagement and not
                          manipulation. The Fed sets                                        more monetary
                          interest rates. It manipulates   JG: If I were king, or           improvisation, or “learning
                          the stock market. It             chairman, I would present        by doing,” as Chairman
                          materializes trillions of new    the gold standard to the         Bernanke candidly styled
                          dollars.                         nation as a monetary system      QE, zero percent interest
                                                           grounded in free markets         rates and the rest of it.
                          Unsound, I would call it, but    and individual responsibility.
                          the system does have its         The system we have is one        G&D: If you were to grade
                          beneficiaries. Washington,       of command and control.          Ben Bernanke’s
                          D.C., is one. Greenwich,         Sitting at the control panel     performance as Fed Chair,
                          Connecticut, is another.         are former tenured faculty       how would you evaluate
                          Ultra-low interest rates and     members—the cream of the         him?
                          fast-paced money printing        economics departments of
                          facilitate federal borrowing     the top universities. They       JG: I would say A for
                          and lubricate leveraged          do what they think is best.                   (Continued on page 57)
                          finance. Ergo, both the
Issue XXI, Issue 2                                                                                     Page 57

Jim Grant
(Continued from page 56)        risks in the economy at          environment, it sounds like
intentions, F for theory, C     large. How do you think          you perceive risks that
for short- and intermediate-    investors should look at risk    others do not. What facts,
term results. By results, I     and reward and how does          measures, or indications
mean that the world turns       that compare to how              bother you most?
on its axis; America is more    central bankers should think
prosperous than, say,           about it?                         JG: Here’s a fact: China’s
France; and most people                                          banking assets represent
who want work seem to be        JG: The manager of one of        one-third of world GDP,
able to find work. It’s a far   the world’s biggest hedge        whereas China’s economic
cry, though, from dynamic       funds looked into the            output represents only 12%
American prosperity. As for     CNBC cameras the other           of world GDP. Never
the long-term costs of this     day and said that risk is the    before has the world seen
extraordinary monetary          volatility of returns. I would   the likes of China’s credit
experiment, I expect them       say—many value investors         bubble. It’s a clear and
to be sky high.                 would agree—that risk is         present danger for us all.
                                the likelihood of the
I say that because price        permanent impairment of          And here’s a sign of the
control doesn’t work. As far    capital.                         times: Amazon, with a
as I know, it has never                                          trailing P/E multiple of more
worked. By controlling                                           than 1,000, is preparing to
some prices, e.g., interest                                      build a new corporate
rates, you invariably distort                                    headquarters in Seattle that
others. The Fed is trying to                                     may absorb more than
fool Mother Nature.                                              100% of cumulative net
                                                                 income since the company’s
G&D: Being a proponent           “We can’t know the              founding in 1994.
of the gold standard, what
do you think of Bitcoin?          future. But we can
                                                                 Now, there are always
                                       observe the               things to worry about.
Bitcoin is a monetary cry for                                    Different today is the
help by the technological                present.”               monetary policy backdrop.
elites. They don’t like the                                      Which values are true?
idea of government money                                         Which are inflated? In a
in general, and they                                             time of zero percent
disapprove of QE and zero                                        interest rates, it’s not
percent interest rates in                                        always easy to tell.
particular. Their solution is
a crypto-currency that                                           G&D: Where can the
governments can’t print. As     In the case of a central         average investor find
an alternative, allow me to     banker, risk is a little         income?
suggest a tangible monetary     different. As Ron Paul’s
asset that governments can’t    prospective Fed chairman, I      The average, risk-averse
print. One which has been       would define risk as the         investor can’t. There’s none
accepted as money for           chance that market               to be had, at least none in
millennia, which is scarce,     intervention in whatever         natural form. To generate
fungible, ductile, beautiful,   form winds up doing more         yield, you must apply
and universally accepted as     harm than good.                  leverage. This is the stuff of
money. Hey, Silicon Valley:                                      businessman’s risk. A pair of
You’ll never lose gold on       G&D: Given the current           examples: Annaly Capital
your hard drive.                state of the economy and         Management (NYSE:NLY), a
                                the low interest rate                         (Continued on page 58)
G&D: You focus a lot on
Page 58

          Jim Grant
          (Continued from page 57)           They inflate something—and     debt formation. The trouble
          mortgage real estate               that something, these days,    with debt is that it tends to
          investment trust, which            is investment assets. The      be deflationary. Leveraged
          changes hands at 83% of            Fed doesn’t seem to mind;      firms tend to overproduce
          book value to yield 11.4%;         higher stock prices are part   in order to generate the
          and Blackstone Mortgage            and parcel of the central      revenue with which to
          Trust (NYSE:BXMT), a new           bankers’ recovery program.     remain solvent.
          real estate finance company,       But when markets crash,        Overproduction presses
          which trades at 113% of            the Fed returns to do more     down on prices. Easy access
          book value to yield 6.43%.         of what levitated those        to speculative credit
          We judge both to be                markets in the first place.    prolongs the life of marginal
          reasonable risks. More                                            firms. They don’t go broke
          speculative, but—we think,                                        but continue to produce,
          also priced appropriately for                                     thereby adding to the
          the risk—are long-dated                                           physical volume of
          Puerto Rico general                  “A proper issue of
                                                                            production and so to the
          obligation bonds. The 5s of                                       overhead weight on prices.
                                                Grant’s is a little
          2041 trade at 65.40 to yield                                      Debt is deflationary the
          a triple tax-exempt 8.18%.           like a bride on her          more it drives production
          Widows and orphans stand                                          or the more it inhibits
          clear.                                  wedding day:              consumption.

          G&D: What about the                   something old (a            You see the problem. The
          great debate over tapering?                                       Fed is egging on inflation
                                                  little history),
                                                                            with one hand but
          JG: Grant’s is on record as                                       suppressing it with the
                                                 something new
          saying that the Fed won’t                                         other. It materializes the
          taper. Or, that if it does             (never hurts in            dollars that drive some
          taper, it will likely de-                                         prices higher. It fosters the
          taper—i.e., reverse course               journalism),             debt that drives other
          to intervene once more—                                           prices lower. What it
          because the economic                      something               refuses to do is let markets
          patient is hooked on                                              clear.
          stimulus.                            borrowed (credit is
                                               our main subject),           G&D: Do you think
          The source of the Fed’s                                           there’s a multi-year
          problem (which, of course,          and something blue            playbook that they’re
          is everyone’s problem) is                                         following or is it more day-
          that there ought to be              (we’ve been known             to-day?
          deflation. In a time of
          technological wonder,                  to be bearish).”           JG: Well, if they’re “data-
          prices ought to fall, as they                                     dependent,” as they insist
          fell in the final quarter of the                                  they are, they’re just as
          19th century. As it costs          The central bank did it in     good as the quality of their
          less to produce things (and        the early 2000s to bind up     data. And they’re just as
          services), so it should cost       the wounds of the dot-com      good as the soundness of
          less to buy them. In an            crash; and, of course, it’s    their theories. In short—by
          attempt to force the price         repeated the treatment,        my lights—they’re not very
          level higher by an arbitrary       only with much heavier         good.
          2% a year, the central bank        does, from 2009 to date.
          inevitably creates too much        Observe that ultra-low         G&D: Where in the world
          money. Those redundant             interest rates encourage                    (Continued on page 59)
          dollars don’t disappear.
Issue XXI, Issue 2                                                                                         Page 59

Jim Grant
(Continued from page 58)        no currencies. I don’t track     late 1980s and very early
do you see there being          our returns because they         1990s. Then he turned
attractive investment           wouldn’t be returns. They        bullish, did very well, and
opportunities right now?        would a journalist’s idea of     became much happier. His
                                returns.                         mother was the inspiration
JG: We are finding it                                            for one of my favorite
harder to find good long        G&D: There are some              Grant’s cartoons. A married
ideas, easier to find good      who compare journalism           couple is seen in the family
short ideas. Years ago,         and investing. In fact there’s   kitchen. They happen to be
when I believed I could         the notion that being an         bears. She is laying a paw
predict the future, I would     investor is like being an        consolingly over his
have answered your              editorialist because you         shoulder. Obviously, the
question by declaring that      have to find the facts and       market has been soaring.
the top is in: Sell             then connect them to form        “Don’t worry cupcake,” she
everything! Older and—                                                                               “Here’s the
                                an argument or opinion.          is saying. “I just know
maybe—wiser, I know that I                                       something terrible is going
don’t know that the top is
                                                                                                 question: Is money
                                JG: Plenty of people leave       to happen.”
in. What I think I know is      journalism to go to Wall                                          work? Or is it an
that risk increasingly          Street and find that investing   I am cyclically bearish and
overshadows reward in           is not as easy as it seemed      permanently—                    instrument of public
stocks and bonds alike.         while they were writing          temperamentally—skeptical.
                                about it. And there are          But one has to navigate this     policy? The voters
G&D: Have you tracked           plenty of people who invest      terrain between cynicism
the returns of the                                                                               will ultimately have
                                for a living whose annual        and skepticism. One cannot
investment ideas that you       letters are fun to read only     be bearish on life, and I’m
include in Grant’s?
                                                                                                     to decide.”
                                because the first paragraph      happy to say that I’m not.
                                says, “Dear investor, we
JG: No. I’m not sure which      were up 46% this year.”          G&D: What advice do you
is harder, investing or         Beautiful prose.                 have for students or
writing about investing.                                         investors in the early stages
What I do know is that they     G&D: How do you manage           of their career?
are different. For a decade     to maintain a healthy
and more, Alex Porter and I     skepticism without               JG: See the older gent
were the general partners       becoming overly cynical?         walking down the street,
of Nippon Partners, a long-                                      the one not checking a
only partnership that           JG: It can be hard. To           mobile device? He has
invested in Japan. We           anyone who was bearish on        money, security, position. In
worked hard at securities       the dot-com mania, as I was,     short, he possesses
analysis and portfolio          the year 1998 lasted for         everything you don’t have
management, but we didn’t       about 6 years; 1999 dragged      and desperately want. But
have to publish our findings,   on, seemingly, for another       do you know something?
in scintillating prose          15 years. But then,              The elderly gent would give
(complete with a funny          blessedly, came the year         his money, security and
cartoon) every two weeks.       2000. You start rooting for      position for your bounding
                                bad things.                      energy, full head of hair and
At Grant’s, we analyze                                           limitless prospects. You
securities and we comment       A friend of mine and a fine      should enjoy them!
on credit and on China and      investor, Frederick E.
on the prices of modern art     “Shad” Rowe, calls himself a     G&D: Thank you very
and on anything else that       recovering short seller. Shad    much for your time, Mr.
strikes our fancy. But we       was bearish with the rest of     Grant.
manage no portfolios. We        us skeptics and cynics in the
size no positions. We hedge
    Page 60

              Justin Muzinich
              (Continued from page 1)         side of investing?                 insight into how the law
              Olin Fellow in Law, Eco-                                           actually worked.
              nomics and Public Poli-          JM: Post-college, I worked
              cy, and an MBA from             at Morgan Stanley in their         G&D: You started out
              Harvard Business                mergers and acquisitions           doing equity investing and
              School, from which he           group and there I learned a        moved to fixed income.
              graduated with highest          lot about finance. That can        Why did you make the
              honors as a Baker Schol-        be a good or a bad thing, as       move and what do you see
              ar.                             an investor, because as a          as the primary differences?
                                              banker you can end up solv-
              Graham & Doddsville             ing for an outcome as op-          JM: I was very lucky out of
              (G&D): Can you tell us a        posed to taking an unbiased        graduate school to work for
              little bit about your back-     view as to what a company          a fund that had been spun
              ground and how you got          is worth.                          out of a family office with a
              interested in investing?                                           lot of capital. It was a very
 Justin                                       I went to business school to       small group of us and we
Muzinich      Justin Muzinich (JM):           round out my banking expe-         could think with a very long
              Sure, I’ve always been inter-   rience. I enjoyed finance,         horizon and look for good
              ested in investing. When I      but I also wanted to think         businesses. We did mostly
              was in college I ran a stu-     about businesses more ho-          equities, and I really enjoyed
              dent investment fund and        listically, learn how busi-        it.
              enjoyed it. I didn’t know       nesses think about sales,
              anything really about fi-       product development and            But there was something
              nance, which in some ways       management.                        especially stimulating to me
              was an advantage because                                           about fixed income. On the
              we thought more about the       I went to law school be-           credit side, whether you are
              companies—their business        cause I thought law was a          looking at senior loans, or
              model, products—than            very stimulating field. In law     high yield or emerging mar-
              about numbers in a spread-      school you get to think            ket debt, you have to do all
              sheet.                          about big questions and you        the analysis you do for equi-
                                              don’t get that opportunity         ties. You have to under-
              As your career progresses,      often in your career. Once         stand the companies to en-
              you understand how im-          you are working full-time, it      sure you are going to get
              portant thinking about com-     can often be more difficult        your coupons and principal.
              panies is as opposed to just    than you’d like to step back.      But there is also a much
              thinking about numbers. In      I was lucky enough to go to        broader analysis you have to
              college you take that ap-       Yale, which is a place that        do in terms of reading the
              proach out of naiveté. We       gives you lots of flexibility to   debt contracts and under-
              thought we had a compara-       follow your interests. It also     standing covenants; it’s
              tive advantage understand-      ended up being very helpful        more complicated and in
              ing technology stocks be-       in fixed income, since you         some ways that’s very ap-
              cause we were the genera-       deal with contracts and oth-       pealing.
              tion using their products       er legal and regulatory is-
              and we were more in the         sues all the time.                 Another difference is that in
              flow of what was popular                                           credit, you can be more
              than someone sitting behind     G&D: Did you ever think            certain of the outcome. You
              a desk in New York all day.     of practicing law?                 buy a bond and you have
                                                                                 three or four years left of
              G&D: You have both an           JM: Never very seriously. I        its life, either it’s going to
              MBA and a JD. What was          spent a summer practicing          pay you $100 or it’s going
              the rationale for pursuing      law to get a sense for what        to default. So the market
              both and has it helped you      it was like. I wanted more                      (Continued on page 61)
              being on the fixed income
Issue XXI, Issue 2                                                                                                 Page 61

Justin Muzinich
(Continued from page 60)         ness model and making sure       and Dodd emphasized fixed
can move against you for six     you are going to be paid in      income investing being a
months or a year, but if that    almost any circumstance is       negative art in that you
bond is money good it’s          really important. In some        don’t always have to pick
going to move back pretty        ways it is similar to the mar-   the right ones but you really
quickly because you have a       gin of safety concept on the     need to avoid picking the
pull to par.                     equity side.                     bad ones.

In that way you are reward-      There are two ways of            JM: It’s absolutely the case
ed quickly if your analysis is   looking at the bond market.      in fixed income because the
right. In equities something     One is to look at it as a        historical recovery rates in
can trade from 15 times to       securities market. Securities    the high yield market, for
10 times and can stay there      prices go up and down, and       instance, are typically forty
for years and years. Eventu-     you try to buy a bond today      cents on the dollar. So if
ally if you buy at a low         because you think in a           you make a mistake you are
enough valuation and you         month or a quarter it will       getting 40 cents back. That’s
are actually collecting divi-    be worth more. The equiva-       a lot of coupon you are                 “As your career
dends you’ll be fine, and        lent on the equity side is       giving away if you have a
that’s what value investing      technical investing or mo-       default. It is a negative art in        progresses, you
is, but it can take a really     mentum investing or some-        that sense. You’ve got to try
long time to be proven           thing like that.                 to make sure the business               understand how
right. Whereas in credit if                                       can withstand everything
you are right, generally you                                                                             important thinking
                                 Alternatively you can ap-        that’s happening around it in
see that in a shorter period     proach bonds as a market in      order to minimize your de-
of time. That’s, I think, an
                                                                                                         about companies is
                                 which you are lending mon-       fault rate.
important difference.            ey to companies. What you                                               as opposed to just
                                 care about is that the com-      G&D: Corporate credit
G&D: When looking for            pany and the business model      markets are very broad;                  thinking about
investments your criteria        are strong enough to pay         how do you narrow the
sound very similar to Buffett    you interest and principal       opportunity set?                           numbers.”
-style equity criteria, really   over the life of the bond. If
looking for a strong busi-       that is your approach you        JM: We segment the world
ness with competitive            have to be sure that regard-     by industry at an analyst
moats. How do you find           less of all the things happen-   level and do a first cut to
that working from the cred-      ing to a company that they       eliminate issues or compa-
it side? It gives you better     can’t control, that they can     nies that we aren’t going to
principal protection but it      still pay you interest and pay   spend time on, either be-
seems like an equity way of      you principal because you        cause they’re too small or
thinking.                        understand the drivers of        they’re just too illiquid. You
                                 their business well enough.      can cut the universe down
JM: That is something we         That approach is the equiva-     by one third—to one half—
think about a lot in fixed       lent, on the equity side, to a   depending on exactly what
income. Unless you are do-       margin of safety or value        you are looking for. From
ing distressed investing you     investing concept. That is       what’s remaining, we try to
are paid just for sitting        the approach we take be-         do work on most compa-
around—whatever the cou-         cause we take uncertainty        nies.
pon is, 7%, 8%, etc. What        very seriously.
you need to ensure is that                                        What’s really important in
you are going to be paid         G&D: That’s interesting.         narrowing the opportunity
back and avoid losses            Howard Marks spoke to            set is that you have a sense
through default.                 our class last week and          of what happens with com-
                                 talked about how Graham                        (Continued on page 62)
So thinking about the busi-
Page 62

          Justin Muzinich
          (Continued from page 61)         business. Here it’s attention    makes us better investors
          panies during difficult peri-    to protecting on the down-       with a broader opportunity
          ods. We think one of the         side and having the experi-      set to be able to invest in
          best ways to have that sense     ence to know what happens        European and emerging
          is to have experienced peo-      to companies in difficult        market credit, not just US
          ple on the team who have         times.                           credit.
          seen a number of cycles. It’s
          fine to think in the abstract    The other decision we’ve         G&D: Muzinich & Co. flies
          about what happens when          made is to stay focused on       under the radar more than
          the economy deteriorates.        corporate credit. Lots of        we would expect from a
          But when you actually know       asset managers, for a variety    firm with your AUM. Is that
          how companies behave and         of reasons, start with a fo-     a strategic decision or is
          what management teams            cus but then want to get         that just the fact that we
          have done, what companies        into a lot of different verti-   come from a non-credit
          try to do with covenants,        cals from a diversity of busi-   background?
          what happens to cash flows       ness perspective. So they’ll
          in cyclical industries—having    start in growth equity and       JM: It is a strategic deci-
          a team that has lived these      then move to value equities,     sion. We think what is going
          issues gives you a lot of        and maybe from value equi-       to matter over the long
          comfort as you go into a         ties move into converts and      term is doing a great job for
          downturn.                        credit.                          our investors. It doesn’t
                                                                            help us to do a great job for
          G&D: It would be interest-       I can see why people do          our investors by appearing
          ing to talk about the busi-      that, but we feel we have a      on TV. Our view is that we
          ness model of an asset man-      competitive edge by doing        just want to stay focused on
          ager and how you view it         nothing but credit. We are       what’s ultimately going to
          versus how some other            very aligned with our inves-     matter over the long run,
          large asset managers ap-         tors because we can’t do         which is picking good com-
          proach it.                       credit badly and then rely       panies at the right valua-
                                           on an equity team to per-        tions.
          JM: There are many sides         form well. This focus also
          to that question. How you        generates robust debate,         G&D: Do you find it af-
          set up your organization is      because credit is what peo-      fects your investment pro-
          really important for long-       ple discuss all the time, and    cess at all? There are some
          term success and there are       real debate is important to      people who deliberately try
          lots of decisions you can        the investment process.          to stay off the radar so that
          make that might enhance          Talking about credit all the     it’s easier for them to do
          short term profitability but     time might sound boring,         deeper due diligence.
          are the wrong long-term          I’m sure it does, but that is
          decisions for generating         what makes you good. So a        JM: Some might keep a low
          good returns, and ultimately     big business model decision      profile because their profile
          that is what matters.            has been to stay focused on      is not one which companies
                                           corporate credit.                they invest in would like.
          One decision we made on                                           But we’re generally inves-
          the business side is to have     A third business model deci-     tors that companies like to
          senior investment profes-        sion has been to be global.      have, because of our longer
          sionals, with the goal of min-   This requires investment         term outlook, so we don’t
          imizing defaults. While you      teams in several countries,      have a problem with access
          may not make this decision       and again is not something       to management etcetera.
          if you are focused on short      you would do if you were         For us it’s more just a mat-
          term profitability, we try to    focused on short term prof-      ter of where we put our
          keep sight of what’s really      itability. But we think it                    (Continued on page 63)
          important to success in the
Issue XXI, Issue 2                                                                                                    Page 63

Justin Muzinich
(Continued from page 62)          We also don’t do a lot of         2000, and at times we’ve
focus and what consumes           distressed investing. We          been totally out of indus-
our time every day. Spend-        have people who have done         tries when we think it’s the
ing time on TV does not           distressed, and we certainly      right thing. There are peo-
help us earn good returns.        can. But if you are going to      ple in the investment world
Time management is one of         do distressed full time, it’s     who look at benchmarks,
the most important things in      as much legal analysis as it is   but benchmarks don’t drive
investing and we just want        credit analysis and that is a     our investment decisions.
to be focused on what will        different skill set. Again, we
matter over the long run.         want to be focused on what        G&D: What kept you out
                                  we’re really good at.             of financials in 2008?
G&D: In terms of focusing
on corporate credit, you          G&D: So if one of the             JM: On financials, it wasn’t
                                                                                                            “We were out of
primarily do high yield, but      names you hold does move          a great insight that financials
will you branch into invest-                                                                                financials because
                                  into a distressed situation       were going to go through all
ment grade if you think           will you work with them on        the turmoil they ultimately                we couldn’t
there is some type of dislo-      a credit committee?               did. We weren’t totally
cation?                                                             comfortable with what was              evaluate them from
                                  JM: Yes, if that is the right     happening, but we didn’t
JM: The firm is not just          thing to do for investors,        make some great call that              a credit perspective.
high yield; we define it as       absolutely.                       there was going to be a fi-
global corporate credit gen-                                        nancial collapse either.
                                                                                                             The first rule of
erally. So we do a fair           G&D: In terms of portfolio
amount of crossover invest-                                                                                 credit investing is
                                  management, how do you            We were out of financials
ing between, for instance,        think about the number of         because we couldn’t evalu-              you don’t invest if
investment grade and high         positions you have and in-        ate them from a credit per-
yield because of structural       dustry concentration? Are         spective. The first rule of                 you don’t
reasons. When you make            you managing to a bench-          credit investing is you don’t
the transition from invest-       mark in some instances and        invest if you don’t under-               understand, and
ment grade to high yield          not others?                       stand, and that requires a
there are often a lot of                                            lot of intellectual honesty.
                                                                                                            that requires a lot
forced sellers and inefficien-    JM: We don’t manage to a
cies. Over time that’s been                                                                                   of intellectual
                                  benchmark. Certainly some         They were such black box-
an interesting area for us to     of our investors might be         es. I remember talking to a                 honesty.”
focus on.                         more benchmark oriented           very senior research analyst,
                                  than we are; it’s just a reali-   one of the most senior
We also invest in senior          ty of the investment world.       banking analysts on Wall
loans and we have a hedged        The way the industry is set       Street, at the end of 2007. I
vehicle which has a lot of        up you have investment            asked him, “Can you really
flexibility to put on arbitrage   committees and consultants        look me in the eye and tell
trades. We look at the            who use benchmarks so you         me that you understand the
whole credit universe, ex-        can’t avoid it to some de-        risks broker-dealers are
cept upper tier investment        gree.                             exposed to or is this a black
grade, because that is driven                                       box?” This guy who had
by interest rates. We don’t       But we don’t make invest-         made a career of financials,
think we can consistently         ment decisions based on a         who has been covering fi-
predict what’s going to hap-      benchmark. For instance,          nancials for 20 years and
pen to interest rates, which      we hardly held any financials     writes very long reports on
is a very liquid and efficient    going into 2008, even             these institutions, said that
market. So we try to be           though they were part of          at the end of the day, it’s a
very honest about that with       the benchmark. We hardly          black box.
our investors.                    held any telecom going into                     (Continued on page 64)
              Page 64

                            Justin Muzinich
                            (Continued from page 63)          good argument for diversifi-      There are two areas where
                            We just didn’t know what          cation. If you only have ten      we generally find opportuni-
                            exposures they had on their       names in an equity book and       ties. One is intra-capital
                            own book and what they            one triples, that’s great.        structure arbitrage. One
                            had done to hedge out ex-         That makes a lot of sense. In     company might have senior
                            posures. There wasn’t             credit you usually buy some-      loans and high yield bonds,
                            transparency, which you           thing at $100 or relatively       and let’s say the market has
                            need for credit investing.        close to par, unless it is a      really rallied and they’re
Professor Bruce Green-                                        distressed market, but you        trading at about the same
wald speaking at the 2013   G&D: Has that changed             are not going to get $300         levels. But senior loans are
CSIMA Conference.           since then? Have you guys         back; maybe you’ll get slight-    floating rate instruments
                            moved into more financials?       ly above par.                     and high yield bonds are
                                                                                                fixed rate, and the loans are
                            JM: In the case of broker-        So you don’t get the payoff       senior in the capital struc-
                            dealers for instance, we still    from being concentrated.          ture.
                            feel like we really can’t eval-   On the flip side you can get
                            uate the risks to the point       hurt if you hold ten names        With interest rates so low
                            where we are comfortable.         and something unexpected          now it’s difficult for them to
                            There are times when you          happens, and one position         go much lower. So you
                            might get paid for that un-       ends up being worth 40            should get paid more to
                            certainty. But you really         cents on the dollar. One          own high yield, because it
                            need to be paid a lot. That       way to control that risk is       doesn’t have a floating rate
                            said, there is a price where      diversification and that’s        feature and it’s lower in
                            taking on this uncertainty        why banks and lending insti-      capital structure. When
                            can make sense. We will           tutions also have diversified     credit markets rally it’s of-
                            invest in leasing companies       books.                            ten because of technicals in
                            where there is actually col-                                        the market, and the same
                            lateral you can understand        When I was spending a lot         when they sell off. Every-
                            and it’s much more trans-         of time on equities I came        thing will move up together
                            parent. But that’s just not       to dislike the word diversifi-    and often the price between
                            the case with the broker-         cation as an equity analyst.      these two securities in the
                            dealers.                          In fixed income I’ve come to      capital structure will con-
                                                              appreciate it.                    verge substantially. When
                            G&D: Coming back to                                                 that happens we can arbi-
                            diversification, how do you       G&D: Do you mind talking          trage the two against each
                            think about it in the context     a bit about what you do in        other. We short the bonds,
                            of fixed income portfolios?       terms of credit long-short        for instance, and go long the
                                                              ideas and where you see           loan. You largely offset your
                            JM: From the equity side          most opportunities?               cost of carry from shorting
                            there are pro and con argu-                                         the bonds.
                            ments for diversification.        JM: Sure, we see lots of
                            And there is certainly an         opportunities. Generally          Another area where we
                            argument to be made for           what we try to do is look         often find ideas are what we
                            just investing in a handful of    for companies that are            call intra-industry trades.
                            companies you know really         yielding a similar amount but     There will be two compa-
                            well, where you really un-        have very different risk pro-     nies in the same industry,
                            derstand what’s going on in       files. Over time yields gen-      one with a great business
                            the business.                     erally reflect risk profiles so   model and one we think is a
                                                              the securities eventually         very bad business model,
                            On the credit side, because       should converge to fair val-      more cyclical maybe or just
                            it’s a negative art, and be-      ue.                               a different cost structure.
                            cause so much of it is risk                                                      (Continued on page 65)
                            control, I think there is a
Issue XXI, Issue 2                                                                                                 Page 65

Justin Muzinich
(Continued from page 64)        trage those against names        and the fact that interest
Again, in a strong market,      that aren’t selling off as       rates are going to have to
bonds often move within         much, or aren’t as flow-         go up from here at some
the industry in the same        based.                           point, how are you thinking
way and then when there is                                       about duration?
pressure on the market,         G&D: Do you think the
bonds are differentiated. But   rise of high yield ETFs exac-    JM: For the more credit-
when everything is moving       erbates that sort of behav-      focused part of the market,
up the yields get pretty        ior?                             duration doesn’t matter too
close.                                                           much. The long term corre-
                                JM: It exacerbates some of       lation of the high yield mar-
G&D: On the opposite            that behavior. ETFs—we           ket to the ten year treasury
side, when spreads haven’t      could talk for an hour just      is zero. It’s actually very
                                                                                                          “For the more
necessarily converged, when     about this—create their          slightly negative even.
they’ve diverged, how do                                                                               credit focused part
                                own sets of inefficiencies
you go about identifying        around the market because        That’s because in a rising              of the market,
attractive trades?              they’re rule-based. They         rate environment compa-
                                operate based on arbitrary       nies are generally doing               duration doesn’t
JM: Often what we’ve seen       rules. Not rules that are        well, and likely have some
happening, and this is partly   based on the value of the        pricing power from inflation,          matter too much.
because the books of bro-       underlying company, but          so even if rates are moving
ker-dealers are smaller be-     rules that say you can only      up, spreads will often com-
                                                                                                          The long term
cause they are not making       own certain types of issues      press at the same time.
markets in the way they                                                                                 correlation of the
                                or certain types of securi-      That’s historically been true,
used to, is big liquid bond     ties. So if there are out-       but sometimes it doesn’t              high yield market to
complexes, in periods of        flows then that type of issue    happen. But generally it’s
stress, will trade off more     or that type of security gets    not illogical that you would              the ten year
than less liquid ones, be-      sold, it has nothing to do       be in a spread compressing
cause retail money is mov-      with the underlying value of     environment at the same               treasury is zero. It’s
ing in and out of the market,   the company, it’s just be-       time that rates are going up.
and retail focused funds        cause of some rule being         However you may get to a
                                                                                                          actually very
have to sell more liquid        executed. So we spend a lot      point where spreads can’t
bonds to satisfy redemp-                                                                                 slightly negative
                                of time trying to understand     compress anymore and
tions.                          those rules and the pressure     rates still rise.                            even.”
                                that those rules put on dif-
So we often see artificial      ferent securities.               Especially when rates are
pressure being put on big                                        low and the curve is fairly
liquid complexes and often      G&D: Based on that liquid-       flat, we’ll be on the shorter
these are companies where       ity aspect, will you typically   duration side. However, we
there is no question that       hold cash bonds or do you        don’t have an in-house view
they are not going to de-       consider using credit default    of where rates are going.
fault. They have huge equity    swaps (CDS) to gain expo-        But we can have a view that
market capitalizations and      sure?                            there is a lot of uncertainty
we know the business mod-                                        about rates and we’re not
els very well. It’s just that   JM: We’ll typically hold         being paid for that uncer-
the flows are causing move-     cash bonds. In our hedge         tainty. Also, in our hedged
ments in security prices        strategy we’ll use CDS, but      strategy, we have the flexi-
within the markets.             we typically transact in the     bility to arbitrage out dura-
                                cash markets.                    tion. If you put on a trade
So we’ll often see opportu-                                      going long loans and short
nities around flow-based        G&D: Given the current           the bonds you achieve this.
names when the market           interest rate environment                     (Continued on page 66)
sells off and we can arbi-
Page 66

          Justin Muzinich
          (Continued from page 65)         For a variety of reasons this   the investors in our funds.
          G&D: What about the              is putting more pressure on     We do have to match assets
          duration needs of your in-       small and medium size busi-     and liabilities because these
          vestors?                         nesses than on large busi-      are private loans. You are
                                           nesses. One of the ways         not going to get your mon-
          JM: Different investors          banks make money is cross-      ey back until the maturity of
          have different duration          selling. They don’t make        the loan so you have to
          needs. For instance, insur-      that much money on the          make sure your capital is
          ance companies often match       actual loans they make to       long term. But we see some
          asset and liability duration,    companies, but on selling       pretty good opportunities
          whereas endowments               foreign exchange services       and have been spending a
          sometimes do not. The du-        and a variety of other ser-     lot of time in Europe.
          ration needs of our inves-       vices to companies they
          tors can drive whether they      make loans to.                  G&D: What was it that
          invest with us in duration-                                      drew you to Italy? Was it
          hedged strategies or not.        Banks can do more cross-        the fact that their financial
                                           selling to large companies      institutions have taken a
          G&D: You are also in-            because their businesses are    particular beating or was it
          volved in opportunities out-     more international, there-      some other reason?
          side of the U.S., particularly   fore they need these addi-
          in Europe. Could you ex-         tional services. So as banks    JM: We’re looking at all of
          plain the opportunity you        are capital constrained,        Europe. In Italy and Spain
          see there?                       they’re focusing more and       the banks are in more trou-
                                           more on large companies.        ble than other countries.
          JM: The European debt            While all companies in Eu-      There are a lot of northern
          markets are really interest-     rope are feeling the pinch of   Italian business we know
          ing right now. The European      the credit crunch, the small    from experience are very
          high yield market developed      to medium size companies        well run. There are lots of
          after the U.S. high yield mar-   are most impacted.              great manufacturing busi-
          ket. The private equity mar-                                     nesses and a great manufac-
          ket there developed after        A lot of these businesses       turing culture.
          the U.S. private equity mar-     are great businesses. We’ve
          ket. On the debt side of         been spending a lot of time     We thought that in Italy,
          things they often take their     for instance in Northern        because it was one of the
          cue from the U.S. markets.       Italy, where there are a lot    powder kegs of Europe,
                                           of well protected niche         there was a good chance
          Several decades ago, small       businesses that have made it    the baby was being thrown
          and medium size businesses       through multiple cycles in-     out with the bath water.
          in the U.S. got a majority of    cluding 2008 and 2009. So       People didn’t want to deal
          their financing from banks.      the businesses which remain     with a company because it
          That’s come down over the        are often very good. They       had an Italian flag, even if
          last few decades to about 30     often have long-term inter-     most of its revenue came
          percent. In Europe, small        national contracts. But if      from outside Italy. Many
          and medium size businesses       they want to expand or they     businesses in Italy were just
          get about 90 percent of          have an opportunity to win      as solid as businesses in
          their financing from banks.      a new contract, they just       Germany.
          Banks in Europe are under        can’t get financing anymore.
          tremendous pressure, they                                        You still have to be sensitive
          are de-levering, and their       So through our investment       to the regulatory regime
          banks did not restructure in     funds we can provide financ-    and the bankruptcy regime.
          the way our banks did in         ing to them, which we think     But the different bankruptcy
          2009.                            is a good risk-reward for                     (Continued on page 67)
Issue XXI, Issue 2                                                                                             Page 67

Justin Muzinich
(Continued from page 66)          guy. It was a privilege to       talk about a mistake you’ve
regimes always existed,           work together. On the first      made, either in investing or
while the price that you paid     part of the question, how        in your career, and what
in 2007 versus 2008 or            does that overlap with in-       you learned from it? 
2009 really gapped out            vesting? I think investing is
when you looked at Germa-         about being curious and I        JM: Early in your career it’s
ny compared Italy. That’s         think that leads very natu-      easy to be overly focused
because companies were            rally to writing.                on numbers, especially if
being dismissed simply be-                                         you are coming out of an
cause of their Italian flag.      Investing is a never-ending      investment bank or out of
                                  stream of interesting ques-      business school, and I made
G&D: How do you build             tions. You can think about       this mistake. Numbers are
that business out, do you         business models, about the       really important and you
set up an origination team        world, about what other          certainly have to understand
on the ground and how             people are thinking and          valuation, but the most im-
time intensive is it?             where there are opportuni-       portant thing is finding good    “Numbers are really
                                  ties. Often, thinking about      businesses. I think it’s easy
JM: It took us a year and a       companies leads to thinking      early in your career not to      important and you
tremendous amount of              about some broader ques-         appreciate what really
work to set up before we          tion, because companies          makes a good business. I          certainly have to
were really comfortable           inhabit a world around           love reading Buffett’s letters
with it. If you are going do it   them.                            and his discussions about            understand
right, you’ve got to put the                                       moats around good busi-
infrastructure in place and                                                                          valuation, but the
                                  I also believe it is important   nesses, but until you inter-
hire a number of people in        to try to contribute to the      act with enough businesses         most important
Italy. Now we’re seeing           public debate if you have an     and understand what a moat
strong deal flow and a de-        idea, even if in just a small    actually is, you don’t really    thing is finding good
cent number seem to be            way.                             appreciate it.
very good risk-reward op-                                                                               businesses.”
portunities. They are good        In terms of the Fed, we have     G&D: Any parting words
business models with low          some views in our article        of advice to our readers,
debt to EBITDA that need          about what the Fed can and       and especially to any stu-
financing and we can be           can’t credibly do. We think      dents interested in careers
good long term partners           it’s difficult given the way     in investing?
because we have a long            the Fed is structured right
term view of the world and        now to credibly say they’re      JM: I’ll come back to some-
want to help them grow.           going to be very good at         thing I said earlier in the
                                  what’s called “macro pru-        interview, which is to try to
G&D: We noticed that              dential regulation,” which is    be really stimulated by in-
you co-authored an article        just a fancy word for trying     vesting and to keep a sense
with Dean Hubbard recently        to stop bubbles.                 of curiosity. I think that’s
and were curious what mo-                                          what makes the best inves-
tivated you to work on that       We should think about insti-     tors. It allows you to have
and how it relates to your        tutional reform rather than      insights into where there
investing? And is there a         lots of these small rules-       might be opportunities and
particular area that you          based reforms around the         that’s a very important
think the Fed should be           edges, which don’t funda-        starting point for investing. 
focusing on currently to          mentally change the man-
address excesses?                 date or structure of the         G&D: Thank you very
                                  Fed.                             much for your time, Mr.
JM: We co-authored one                                             Muzinich.
piece together and Glenn          G&D: Could you briefly
Hubbard is just a terrific
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                                    Graham & Doddsville 2013 / 2014 Editors
                                                    Chris Brigham is a second-year MBA student and a member of the Heilbrunn Center’s
                                                    Value Investing Program. Prior to Columbia Business School, he worked as an equity
                                                    trader for Bank of America Merrill Lynch and as a research analyst for Tiresias Capital,
                                                    an event driven hedge fund. Chris graduated Phi Beta Kappa from Claremont McKenna
                                                    College, where he received a BA in Economics. He can be reached at

                                                    Jackson Thies is a second-year MBA student and a member of the Heilbrunn Center’s
                                                    Value Investing Program. During the summer he interned at PIMCO as a high yield credit
                                                    analyst. Prior to Columbia Business School, he worked in the research department at the
                                                    Federal Reserve Bank of Dallas. He received a BS in Economics and Engineering from
                                                    Southern Methodist University. He can be reached at

                                                    Jason Yang is a second-year MBA student and a member of the Heilbrunn Center’s
                                                    Value Investing Program. During the summer Jason interned at Development Capital
                                                    Partners, a concentrated, value-oriented fund investing in sub-Saharan African equities.
                                                    Prior to Columbia Business School, he worked as a consultant in PWC’s Transaction
                                                    Services Strategy practice. Jason received a BS in Economics and Mathematics from Yale
                                                    University. He can be reached at

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