Gary Claar, founder of Claar Advisors, and former portfolio manager at JANA Partners talks activism at NYU. Here are the highlights from the interview. Don’t forget – sign up for our free daily newsletter to stay in the activist investing know.
Mr. Claar, thanks for taking the time to speak with us. You started your career as a corporate attorney. How important was that early experience in the legal world, and how did this path ultimately lead to investment management?
Thanks for this opportunity to introduce myself as I prepare to teach Value Investing: Special Situations and Activism at NYU Stern next semester. Ultimately, I am very glad I got a background in corporate law for several reasons. It was great training in problem solving and in being precise and wholly accountable for everything you say. Surprisingly, this differentiated me in business as someone people could rely on and heap responsibility on. It also gave me a broader perspective as an investor, which was particularly valuable in the multi-disciplinary arena known as event-driven investing. Having a good feel for boardroom dynamics or the bankruptcy process or the mechanics of securities offerings are some examples. My path to investment management from law was not so smooth. I was an outsider who had to bang on the door for a while to get in. I was constantly learning on the fly. During this time, I discovered I had an entrepreneurial streak. I somewhat relished the opportunity to re-invent myself professionally and broaden my network in spite of all the risks and uncertainties.
In the mid-1990’s, you became in-house counsel with the hedge fund Perry Partners and eventually a principal at another hedge fund before launching your own. What were some of the fundamental lessons you learned in the early years of your investing career?
As I bounced around and tried to become a money manager, I learnt a lot. I saw Wall Street’s best and brightest move away from risk arbitrage, which had become too competitive. They began to embrace special situation equity strategies, which married both event analysis and fundamental analysis. Around this time, Joel Greenblatt wrote his first book, “You Can Be a Stock Market Genius”, which told where to look for the most inefficient markets. Joel has claimed the book only helped a few rising hedge fund managers, and I was fortunate to be among them. This stage in my career involved learning as much as possible while trying to earn enough to justify throwing away a perfectly good legal career. There were a lot of ups and downs. Other valuable lessons I learned were more entrepreneurial, such as how to communicate ideas, how to set realistic business goals and how to perform honest self-assessments.
In 1998, you founded your first firm, Marathon Advisors LLC. Tell us how you navigated the dot-com boom and bust. Did this experience impact the way you valued tech and Internet stocks in later years?
Yes, I was fortunate that the markets were so crazy in the first year of my launch – it kept my new business solvent at its critical early stage. The dot-com boom required those who were raised on value investing principles to think outside the box. A value investing discipline is not supposed to confine you to only low multiple, low growth stocks – its merits are in keeping you away from large losses. I was able to apply a value-investing framework to all kinds of businesses with undervalued optionality to the Internet. It helped me navigate the boom without getting caught in the bust. A memorable investment of the boom time was Nielsen Media. It was a small cap spinoff of Cognizant Corp. Shareholders dumped it because of its size. But it was basically a natural monopoly in audience measurement with a highly incentivized management team. Plus it had a “new economy” angle to potentially measure the Internet. It quickly tripled and got bought out. There was a silver lining to the bust and the bear market of 2000-2002 as well. Value stocks, especially small caps, had been absolutely left for dead in the mania. Not only were new economy stocks overvalued but also many blue chip stocks had risen to over 25x earnings. So in the wake of the mania, it was rather easy to outperform the market indices with off-the-run value stocks and special situations. The hedge fund industry blossomed at this time, especially long/short and event-driven strategies.
In 2001, you became a founder and comanager of JANA Partners with Barry Rosenstein. At the time, you were willing to fold your fund Marathon Advisors into JANA to amass roughly $50M AUM. Could you talk to us about the decision to link with JANA?
Marathon was a one-man shop. Though performance was fine, it was reaching its natural limits. In 2001, I was looking for the right partner or strategic alliance. Barry was also looking for a complementary partner for the public market activist-oriented vehicle he was planning. We met and found we had a lot in common. We recognized the activist opportunity in small caps but agreed it was best to make that part of a broader long/short, event-oriented strategy. We could see we had complementary skills and the division of function between us would be quite natural. Basically I’d work in front of screens while Barry would be out meeting investors and companies. There was synergy despite the fact that he lived in San Francisco and I was in New York. From our fairly modest beginnings, we built a strong firm and reputation. The activism set us apart from the many other funds popping up at that time. The earliest JANA crusade was Herbalife, many years before the current pyramid scheme imbroglio. Its founder and largest shareholder had died leaving behind chaos. It traded near net cash and had a high ROIC business. JANA and Steel Partners demanded that the board right the ship or sell the company. They soon sold to private equity at a big premium.
You were with JANA Partners for over a decade. In 2011, the firm forced the split of then 123-year-old McGraw-Hill into separate Global Markets and Textbook Publishing companies. Could you discuss your strategy before taking the position, and how you identified McGraw-Hill as a quagmire of locked-up value?
Certainly. McGraw-Hill is a terrific example of the great care an activist must take in selecting targets. For years and years there was talk about the clear merits of separating Standard & Poor’s and the higher-growth Financial group from the Education group. But conditions were never quite right for an activist. We needed to see sufficient stock underperformance and evidence of an elevated cost structure relative to peers. We needed to hear sufficient displeasure with management among the shareholder base. By 2011, the role of shareholder activists was more widely accepted and even century-old companies with founding family members in charge (like McGraw-Hill) were fair game. The bottom line is that an activist should know that if push comes to shove, he or she will have the votes. Very few activist campaigns go all the way to a proxy vote. This is because once management fears losing such a vote, they are willing to listen and settle. The split of McGraw-Hill was not the only thing we were after. They needed to reform the cost structure. They needed to optimize the capital structure. And ultimately, they needed new blood and fresh direction in the C-suite.
JANA Partners “applies a fundamental value discipline to identify undervalued companies that have one or more specific catalysts to unlock value”. Over the years, the firm has become a notorious “actively engaged” shareholder in several companies. In terms of idea generation and investment skillset, where do you feel you added the most value while you were a co-Portfolio Manager at JANA Partners?
I feel I was most valuable to JANA in the early years. I wore a lot of hats when the business needed me to, and ultimately hired the right role players. This eventually left me as more of a pure portfolio manager, focusing on position sizing, and adherence to strategy and risk control. As a unique team for activism formed around Barry, I became more of a sounding board for the activist ideas but still acted as a primary idea generator for all our other “value + catalyst” disciplines, like mergers, spinoffs and bankruptcies. My greatest strengths as an investor are pattern recognition and issue spotting. I think I’m pretty strong at synthesizing and simplifying reams of information into essential decision points. I think I also score pretty well on the competitiveness scale and I know how to think creatively in pursuit of answers to hard questions. A criticism I’ve heard is that I can be “a mile wide and an inch deep.” Perhaps that’s true – I’m unlikely to change that now.
In 2012, you left your throne at JANA to once again found your own firm, Claar Advisors. What prompted the change and how does the new firm differ in terms of strategy and style?
After 12 years at JANA, it was time for a change. The growing component of managing people in an institutional investment firm, which I did when I needed to, was something I never felt well suited for. After the financial crisis, JANA needed to rebuild itself around new talent. As a result, my transition was carefully planned over three years. I’m proud of my role in the rebuilding and JANA’s great successes since my departure.
Claar Advisors is in part a family office and in part an entrepreneurial stage investment manager. We have a public markets long/short portfolio and also see a fair amount of private deal flow. We are not pursuing public shareholder activism but have been a lead investor in several private situations. My investment style has certainly changed. I think longer term and primarily look for great entry points to great businesses I can hold as long as possible. I am averse to most crowded eventdriven names, not because I can’t compete, but because it seems senseless to do so. With all the short-term focus in the marketplace, longer tailed opportunities are naturally less well bid and less efficiently priced. However, markets are very much in the grip of the extraordinary monetary policies of central banks. That’s what makes investing so hard at present and why we are under-invested.
We took a peek at Claar Advisors’ most recently filed 13F, and noticed that you have high conviction long positions in Crown Castle International (CCI) and Macquarie Infrastructure Corp. (MIC). Very briefly, what attracted you to these names?
Core to value investing is predicting multi-year cash flows and, in today’s binary market environment, predictability is exceedingly rare. In the case of Crown Castle and Macquarie Infrastructure, you do have high visibility into the cash flows and the shareholder returns. Both are pure domestic businesses not making wild earnings adjustments for FX. Both are unusually stable but also benefit from durable secular growth trends. Wireless towers and long-tailed infrastructure projects are each exceptional business models that should always have a place in my portfolio. CCI and MIC have each earned the right to be valued on a “total return basis” – their dividend rate plus their cash flow growth rate should approximate your annual return (assuming constant multiples). Ironically, both CCI and MIC are high multiple businesses, but I submit deservedly so. This goes back to my point that value-investing principles need not lead you only to smokestack industries and metal-benders. Lastly, in the case of both CCI and MIC, I can point to transformative corporate events, yet they have not become too popular with hedge funds. A year ago, CCI listened to shareholders, tripled their payout, finalized their REIT status, shed their international exposure, and became very transparent about their growth guidance and capital allocation policies. All this enhanced their multi-year earnings predictability, which again is a holy grail for value investors though not that interesting to short-term profiteers. In mid-2014, Macquarie Infrastructure solved an impasse by buying out a partner in its largest business, IMTT bulk liquid storage facilities. After this transaction they raised their payout and growth guidance and extended the life of their income tax shield. MIC is now a company much more in control of its destiny. To me that is a transformative event and a likely precursor to many years of strong returns.
Regarding portfolio construction, it appears that your top 5 ideas account for close to 50% of your entire portfolio. What combination of factors leads you to move with confidence into a new investment; are there recurring themes?
The first lesson here is some legal background on Form 13F. A manager doesn’t include cash, short positions, or foreign or unlisted securities on such quarterly filings. Plus they are 45 days stale when released. My top 5 positions are actually about 30% of my portfolio right now though I’d love to see that grow, as I do believe in the goals of building conviction and increasing concentration. The factors we use to filter the many ideas we hear and to prioritize our workflow are three simple questions. First, is this a good business?
This question goes to the quality of management and their control of things within their control like capital allocation, employee morale, and customer relations. Is the business in a virtuous cycle or a vicious cycle? Many investors don’t seem to appreciate this.
Next we ask, is this a good industry? Is there something special about the business model, like a moat or network effects that will insulate them from competition and disruption. Do they set price or take price? Is there some secular growth trend they benefit from? We don’t agree with Warren Buffett that you can just “buy America” and everything will be ok. We want to stand on Buffett’s shoulders and reach higher, if you will, by being even more selective about business quality. Lastly, we ask, is this a good entry point? This is where valuation and catalysts come into play. We are looking for multiple ways to win and a margin of safety. Even the best businesses can yield poor returns if you buy them wrong.
Opponents of activism argue that it’s a destructive process, where activist investors pursue quick profits (generally capital return) at the expense of companies making necessary investments for the future (generally growth capex). What are the merits of this argument?
There are certainly instances of good and bad activism, but each case is unique and should be evaluated on its own merits. To me, it’s undeniable that the trend of shareholders having a greater voice is a positive change that is long overdue. The paradigm of entrenched CEOs with boards of cronies and only passive, index-hugging shareholders is certainly not ideal. You can argue all day whether to increase capital return or capex in a particular company – but that’s healthier than not having the argument at all. An activist shouldn’t have a short-term outlook. If he does, he may be grandstanding or pandering to investor pressures, rather than focusing on the issues. It’s the same with politicians. Some of the 1980s exploitation of high-yield debt availability goes down as bad activism. More recent successful multi-year turnarounds such as Canadian Pacific, Six Flags and Walgreens go down as beneficial activism.
Today many of the most influential investors on Wall Street (Bill Ackman, David Einhorn, Dan Loeb, etc.) are activists; this style of investing has exploded in popularity. As a member of the “old guard”, do you feel as though the activist space is getting more crowded? Is it now more difficult to create your own investment catalysts utilizing shareholder rights and public opinion?
Importantly, all of those influential managers are value investors first, and activists when necessary. This was an important consideration when we started JANA. It’s senseless to confine one’s self solely to conflict situations.
As far as crowding, I definitely feel it in the short selling arena and also in anything with a visible near-term catalyst. This is a function of the proliferation of active managers and the availability of capital itself. But this is no new phenomenon – investing success has always been about leading not following the herd. I do not think activism gets crowded in the same way. First of all, unlike other disciplines, there is strength in size and strength in numbers with activism. It wasn’t until recently that large cap companies became fair game for activists. Secondly, the wave of shareholder representation is here to stay and it will only gather steam. We have seen companies drop their knee-jerk defenses to activists and listen to their ideas. We have also seen a revolution in how large pensions and fund groups welcome change. Look at how many proxy initiatives are now filed annually by CalPERS or CalSTRS, for instance.