Jeffrey Ubben: Standing On Principal
Combining a keen eye for value with a tenacity for instigating corporate change has proven to be a winning formula for Jeffrey Ubben’s ValueAct Capital.
ValueAct Capital’s Jeffrey Ubben describes how he hedges without shorting, why he may take 18 months to build a core investment, why he expects M&A activity to take off in the coming year, why he resists the “macro” fetish, and why he sees unrecognized value in Willis Group, VeriSign, Valeant Pharmaceuticals, C.R. Bard and Misys.
In what ways do you distinguish your style of activist investing from what you see others doing?
Jeffrey Ubben: We've seen public-market activism become more synonymous with media-driven campaigns meant to generate short-term price moves, so we have felt the need to distinguish that style from our own so as not to be tarred with the same brush.
Our interest starts first with the quality of the business. We're not looking for trouble, for quick deals to be made, for fixes, per se, or even for board seats. We buy good businesses at good prices, where we're willing to take on the short-term risk – the near-term negative data point – because we think the long-term gain is compelling. If the stock goes up, we look like traditional value investors who made a nice investment.
But probably half the time things don't work out that way. We're 18 months in, with a full position, and the stock is where we bought it or lower. But we've proved out the industry structure, we've proved out our investment thesis and we really believe in the asset. It's at that point we go to the board and management and say we've been your default buyer, we own 5-10% of your company, and we'd like to buy more but we won't do so without a board seat. The stock is underperforming, we believe we have a deep understanding of your business, we have a deep knowledge of capital markets, and we want all the information that's available to board members to help craft a strategy that creates value for all shareholders. We ask management and particularly the board to do the same level of due diligence on us that we have done on them, and provide them with a list of references who can attest that we have been patient, constructive board participants.
What are the key elements of what you consider a high-quality business?
Jeffrey Ubben: At a basic level, the product or service being sold is critical to customers but is only a small part of their cost structure, and the customer relationship tends to be sticky and recurring. So you think of a VeriSign, whose customers pay them $7 per year for a web address that is central to their business. Or a C.R. Bard, whose catheters protect against infection and make up only a small part of the total cost of a surgical procedure, but if they don't work, the patient dies. Or a Willis Group, which as an insurance broker helps provide risk-management solutions that are clearly on the critical path for all businesses. Generally, we end up in intellectual-property-based businesses that can price off of a value-add rather than some sort of cost basis.
We also focus on industry structure. We like concentrated industries with two or three primary players. As value investors, we are typically buying the underperformer. There are issues to fix, but the customers are rooting for you and the leading competitor, with high margins and a high stock price, is probably not going to go for the jugular. In the past that's meant buying, say, Reuters against Bloomberg in information services, Reynolds and Reynolds against ADP in auto-dealer software, or Insurance Auto Auctions against Copart in the salvage business. Today it's something like Willis against a Marsh & McLellan or Aon in insurance brokerage.
For quality-of-business reasons, we now focus on companies with between roughly $1 billion and $8 billion in market cap. The $500 million company is unlikely to have as global a footprint and as diversified a customer base as we want, and the business generally is less mature and more volatile. We've invested successfully in smaller companies over the years, but it can be more hair-raising than I'm comfortable with at our current asset size.
Why not go higher than $8 billion?
Jeffrey Ubben: We want to eliminate the “what you don't know” risk. With bigger companies there can be many different business units with distinctly different trajectories, making it harder to identify the core engine that truly drives the bottom line. There's also just a greater possibility that you miss something important, like environmental liabilities, or underfunded multi-employer pension plans, or work rules in a region that limit your ability to sell businesses. When you have a true owner mentality about companies you invest in, you have to care about those types of risks and liabilities that increase the real price you’re paying for the enterprise.
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