Manual of Ideas interview with Chris Mittleman on the subject of “Value Investing With A Private Equity Mindset.”
Shai Dardashti, managing director of The Manual of Ideas, recently had the pleasure of sitting down for an exclusive interview with Chris Mittleman, Chief Investment Officer of Mittleman Brothers. Based in Melville, NY and with $400 million in assets under management, the firm has returned 736%, net of fees, since 2003, handily beating the S&P 500 and Russell 2000.
(The following interview has been edited for space and clarity.)
Q&A with Chris Mittleman
The Manual of Ideas: Your investment approach was recently referred to by Barron’s as applying a private equity mindset to investing in public markets. Please elaborate.
Chris Mittleman: The kind of businesses we’re targeting are the same kind of companies that private equity firms are attracted to. These are businesses that generate free cash flow on a sustained basis; free cash flows that are, if not predictable, at least somewhat repeatable, so that if I pay 10x FCF for this business today, hopefully in five years’ time, the cash flows are going to still be at some semblance of that level in a worst-case scenario.
We’re looking at a business based on, if we were to buy the whole company, what would be the cash-on-cash return we will get in year one, two, three, four? That’s what private equity does when they scout investments, but the key distinction is that we are not seeking to take control. We’re not looking at it from a real private equity point of view, but there is this aspect of it that ’s like private equity investing. Many of the companies that we’ve invested in ended up getting bought out by private equity, so you see that they’re looking for the same qualities in a business, a key difference being that they have to pay a control premium.
As an asset class, private equity has very good long-term returns, but we’ve been able to outperform that asset class, on average, over an extended period because we’re not paying that control premium.
We’re looking for the kinds of businesses where you have a fairly strong sense that the free cash flows are going to be reproducible and will hopefully grow over time, and you’re able to pay a low price relative to those cash flows. You’re not getting control, but you’re paying a much lower price than a private equity firm. Rather than pay 10x EBITDA or 15x free cash flow, we’re trying to pay substantially less. Obviously, the valuation depends on the nature of the business, but that’s how we end up outperforming the private equity asset class.
MOI: You have the benefit of liquidity, you’re not locked in…
Chris Mittleman: Public liquidity is a benefit , but not always. We have at times invested in situations where liquidity might be limited. We’re a large shareholder of Revlon. The largest shareholder is Ron Perelman who owns 78% of the stock, whereas we own ~3%, but we’re still the second-largest shareholder. Revlon is a sizable company but the float is small because of Ron Perelman’s ownership. Although Revlon has a market capitalization of nearly $2 billion, only about 20% of the stock is in the public float. It’s liquid, but it’s not so liquid that we can sell our whole position in a week. It would likely take us up to a couple of months to fully exit the position without a liquidity event, so we do tolerate some degree of illiquidity because we have a very good, long-term oriented client base.
Our client retention ratio over the course of thirteen years or so is on the order of 98%. Our clients understand the temperament and patience required to invest in a long-term oriented strategy like ours, in which we’re looking at every investment with at least a three- to five-year time horizon.
There have been some situations where an investment I thought would work out in three to five years actually took six to ten years to ultimately work out, and that ’s fine, if you’re getting the outcome you expected in the end. But you have to sometimes be willing to endure a period of time that is uncomfortably long to reap the benefits of the investment.
MOI: And that’s how you earn the result, by having patience?
Chris Mittleman: Patience is one of the most critical attributes for a long-term investor because you can be right and the market may tell you that you’re wrong, and it may tell you so for an extended period of time. It may reach the point where your sanity begins to be questioned by clients and even your colleagues. I’ve been in situations like that. There were many times where I’ve been involved in an investment, where it looks like it might not work out, and it ultimately did work out, and worked out wonderfully. Sometimes the difference between success and failure was not just about our understanding and steadfast belief in the value of a holding, but how long we were willing to wait to achieve that result.
There’s a quote by Michelangelo, “Genius is eternal patience.” But there’s another great quote by Johann Wolfgang von Goethe, “Genius is knowing when to stop.” Is genius eternal patience or is it knowing when to stop? It’s one of those two, or maybe it ’s both. But we can’t expect eternal patience. There has to be some kind of return on our investment at a point in time that ’s reasonable. But what is that point of time? That ’s a really difficult thing to say definitively. We can’t just say that if it doesn’t work out in five years, it’s wrong. Because I’ve had many investments that worked out in year six, seven, or eight. If I had sold in year five, we would not have achieved a desirable return. You really have to be capable of making these determinations about when patience is justified and when it’s cowardly self-delusion or denial.
There’s this balancing act between being stoic and an investor who’s maybe too ashamed to admit they’re wrong or in denial about being wrong. It’s a risk. If you’re so used to being right in the end, and if you’re used to your investment thesis working out in the long term, you can always lull yourself into a sense of complacency that everything will work out and that if you seem wrong today, you just wait a little while and you’ll be proven right. It can be a problem to trick yourself into believing too much in your own capabilities, if you are overly patient without being as discerning about whether it’s justified or not.
MOI: We love to ask managers about the difference between being early and being wrong…
Chris Mittleman: It’s so difficult to know because sometimes being wrong is expressed by the stock price not going up. Maybe it’s not dropping, but the stock may stay flat for a long period of time and although the business results are coming in okay, the lack of gains can be frustrating. We went through this with our investment in Icahn Enterprises.