Circle Of Competence Issue #9

April 29, 2018

Department of General Finance

 

Discussion at Markel

Wonderful presentation by John Huber at Markel Insurance on the incredible economics of Tencent Holdings. He runs the investment site, basehitinvesting.com as well as serving as portfolio manager of Saber Capital Management. I have read every single one of his posts since he began writing and believe they are worth the read! See his in depth Markel Investment Presenation (as well as a fantastic primer on insurance companies) here: Markel Presentation.

 

Buffett's Edge

A list of Warren Buffett’s edges... or what I may call lessons from his playbook. 

 

Dr. Henry Singleton & Teledyne

A brief but solid history of Singleton and his skills as a businessman and investor.

 

 

Department of Economics

 

Yield Curves Flattening in High Income Countries

Interesting graphics on how yield curves are flattening globally.

 

Weekly Initial Claims Data

Interesting article showing how weekly initial unemployment claims are at their lowest levels since 1969. That is not a typo.
 

 

Department of Special Situations

 

Costa Coffee is Spinning from Whitbread

Didn't take long for Elliott Management to spur some action out of Whitbread to spin the Costa Coffee Division. The interesting thing about this spinoff however is that it is slated to occur in 2020, and anything can happen between now and then...

 

 

Department of Technology

 

Gene Editing for Good

CRISPR is another technology that could hold massive promise in fighting disease, increasing crop yields, and more in the future. This is a great article by Bill Gates on its future uses in some of the poorest areas in the world. 

 

Notes from the AI Frontier: Applications of Deep Learning

Interesting article from McKinsey on the potential future value and impact of deep learning on various industries. Just an overview. 
 

Palantir Knows Everything About You

Deep, long read on Palantir, Peter Thiel’s data mining company and implications for using its software on US Citizens. No warm and fuzzies found here. 

 

 

Department of Real Estate

 

BiggerPockets Podcast Episode 275

Great episode on scaling a real estate investment operation from 1 unit to 300 units using friends and family money and moving on to outside investor money... all while working as a full time lawyer. 
 

 

Department of Startup Land

 

A Seed Investing Framework

Solid due diligence framework for early venture investments from a UK VC. 
 

The Numbers Behind WeWork

A glimpse into the numbers behind WeWork, the large real estate shared workspace startup and their business model as they tap into debt capital markets. Community adjusted EBITDA - what is this exactly? And why would debt investors care? Starting to smell a bit fishy.  

 

16 Startup Metrics

A list of metrics used by Andreesen Horowitz to evaluate startup progress.

 

Eric Ries' Long Term Stock Exchange Explained

We have heard of this LTSE for a while, but Eric Ries goes into it in more detail with more color around the governance structures and issues related to the LTSE incentives towards long term shareholders.

 

The Next Warby Parker

An in-depth article on the direct to consumer space that is in full blossom at Wharton's graduate school of business. Very interesting points around how the space is developing and the risks of DTC. 

 

 

Department of Letters

 

Bill Miller Q1 2018 Market Letter

Legendary investor Bill Miller doesn't seem to think the markets are too pricey relative to 10 year treasuries.

 

IMC 2017 Annual Letter (Public Equities Portfolio)

Wonderful post from John Huber at Saber Capital on Connor Leonard’s annual letter at IMC - he manages the public equities portfolio at this private holding company out of Raleigh, NC. 

I would highly recommend Huber’s series on ROIC mentioned in the article. Great explanations on why a company’s reinvestment prospects matter over the long term for shareholders. 

On Conner’s letter, I really enjoyed reading about the way they categorize business groups (reinvestment moat, legacy moat, capital light compounder, etc.), his goal for 2017 of 100+ annual reports, and the brief synopsis of one of his most successful investments in a German online retailer. 
 

 

Highlighted Companies - Fairfax & Exor

 

Exor

 

Exor 2013 Letter to Shareholders

Interesting discussion on major investments including Fiat Chrysler, Juventus, Cushman & Wakefield, CNH Industrial, as well as their capital restructuring away from bank debt (leaning more on private placements and public bonds). 

 

Compounded growth of book value of 25.4% per year from 2009-2013. 16.2% in 2013. 

 

Exor 2014 Letter to Shareholders

Book value growth of 16.4%.

Good discussion of merger of Fiat and Chrysler. Also discusses The Economist, CNH industrial, and Ferrari.  

Interesting charts on debt funding source evolution and maturity dates. 

 

Also discusses Cushman Wakefield and their record year.
 

Exor 2015 Letter to Shareholders

I found this to be the most interesting shareholder letter out of 2013-2016.

 

Book value growth of 21.2%.

 

Highlights sale of Cushman & Wakefield for net capital gain of $722 million. Held for 9 years from 2007-2016. 

 

Acquired PartnerRe for $6.9 billion and gave a few points on why they found the business to be a good addition to the portfolio:

 

1. Reinsurers have historically beaten the MSCI index from 1995-2015.

 

2. Generates strong cash flow with little need for extra capital expenditures.

 

3. The industry will be needed for the foreseeable future and does have disruption risks.

 

4. A financial services company diversifies the Exor portfolio from a more capital heavy to a portfolio with more moderate needs.

 

5. Large balance sheet allows for large capacity to serve customers in many types of reinsurance lines.

 

6. Global company with diversified lines of business.

 

7. ROE of 13.1% and book value growth of 13.1% from 2005-2015 (this includes the great recession!). 

 

8. Conservative underwriting culture.

 

One of the more interesting tidbits in the letter is this quote:

 

"Ajit Jain, to whom we owe a lot for sharing his insights into the industry with us, has been very clear publicly that “what was a very lucrative business is no longer a very lucrative business going forward”. We made our investment in PartnerRe with a clear understanding of these realities."

 

It seems clear from what I have read on other reinsurance companies (see week 6, 7, 8 for more on Renaissance Re and the current reinsurance market) that the reinsurance business is facing a softening in pricing due to the influx of capital - both traditional reinsurance companies as well as alternative money (hedge funds).

 

Next, the purchase of a large block of shares of The Economist is discussed along with some financials. It is interesting to note that in the age of the dying print newspaper, blogs, and such... that the Economist shows remarkable staying power based on subscription revenues and other areas such as advertising (which actually decreased as a percentage of revenue), paid content B2B, and the Economist Films.

 

A particularly enlightening part about the economics of auto manufacturers as well as other capital intensive companies when Fiat Chrysler is discussed. I would highly recommend reading this section - note how massive consolidation positively affected returns on capital in the defense, pharmaceutical, and airline industries. On the other side of things, note how low the returns on capital are in the auto industry 

 

Finally, I enjoyed the section on the Ferrari spinoff. Another one of my favorite investors, Mohnish Pabrai, made quite a bit of money from owning FCAU and Ferrari in 2016-17. 

 

Exor 2016 Letter to Shareholders

Book value increased 9.6% in US dollars.

 

This letter includes a wonderful discussion of PartnerRe's portfolio construction. 

 

Very interesting charts and facts on the newspaper publishing industry over the past century. We consume news... but not papers (and have been consuming less for decades!). 

 

Fairfax

 

Fairfax 1995 Letter to Shareholders

20.1% Return on shareholder equity. Interesting to note that directors and officers own over 20% of outstanding shares of Fairfax. They eat their own cooking!

 

Fairfax 1996 Letter to Shareholders

One of the better shareholder letters. I notice several interesting points in the letter:

In 1997 Canada began taxing unrealized capital gains! Could you imagine having to pay taxes on an unrealized gain, only to have it melt away, and you’re on the hook for the loss as well as unrealized gains taxes? 

They purchased two reinsurance companies and essentially formed a global reinsurance operation using shares and public debentures to finance both acquisitions. This seems to be Watsa’s method - issue shares and debentures to finance acquisitions (does not use much capital from holding company) and then buys back shares over time. Obviously shareholders trust him with their funds and are willing to buy equity in Fairfax when it has compounded book value at over 40% for 11 years. 

The section on the frothiness of Canadian and US markets is particularly interesting given that the market would rally for another couple of years, but at least Management was aware of price risk and reduced potential volatility in their portfolio. Watsa states that this is the lowest percentage of capital allocated to stocks since they took over operations in 1985 (14%).
 

 

What are you reading this week? Drop me a line or send me a tweet @competence_co

 

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