On October 18th and 19th, 2017, join 400 world-class investors from prominent family offices, pension plans, and asset managers at Arcadian Court in Toronto
Over 20 world-renowned money managers will present their highest conviction ideas and discuss industry trends.
All proceeds help solve the toughest challenges in children’s brain and mental health.
- Q2/H1 Hedge Fund Letters – Letters, Conferences, Calls, And More
- Warren Buffett And The Curious Case Of Tesco Shares
- Seth Klarman – Value Investing Is Like The E=mc2 Of Money And Investing
An Interview With Alex Roepers
CAPITALIZE FOR KIDS: Can you walk us through how Atlantic Investment started and how the firm has been able to generate attractive risk-adjusted returns over a period that spans almost three decades?
Alex Roepers: I spent six years in the 1980’s working for two conglomerates in New York. One was Dover Corporation, a publicly traded industrial conglomerate and the other was Thyssen-Bornemisza Group, a European privately-held conglomerate. In both cases, I was involved in corporate development, mainly the buying and selling of companies.
I learned a few things while working for these companies: number one, the importance of due diligence and the analysis that comes with it; secondly, I learned to dislike paying premiums to gain full control – which you have to do if you’re an industrial buyer or private equity group. I also disliked the inability to trade positions and not have the liquidity to sell. So, I took my toolbox into the public market by starting Atlantic in 1988 and focusing on a well-defined universe of midsize industrial and consumer companies. Atlantic was started with a single purpose: to achieve a long-term record of superior capital appreciation using a concentrated value investing approach that was rooted in my experience with these two companies.
What gives an investment management firm like Atlantic the right to exist is the generation of superior capital appreciation over time. To get there, you need to concentrate capital. If you look like an index, you are unlikely to outperform in a significant way. Concentration of capital is a key ingredient needed to be able to provide superior outperformance.
But if you concentrate capital, you need some rules of the road because you have to be careful to avoid any significant losing positions. In venture capital, people expect that some investments are writeoffs. If you have ten investments, you can expect the majority to be failures while a few winners should not only make up for the failures but also provide the overall return. Even in the private equity space, you can expect to have some complete write-offs. If you’re in the public equity market on an unlevered basis and you put together a concentrated portfolio, which in our case is six stocks for our flagship U.S. fund, any write-off on one of those positions would be a disaster that can put an end to your fund or business.
How do you avoid losses in a concentrated public equity portfolio? We start with carefully defining our universe. Think of a pyramid of all public companies from small to largecap. The bottom part of the pyramid represents all firms with market caps below one billion, which we avoid as we seek adequate liquidity in order to be able to get in, to get out and to properly size positions during the holding period. The top of the pyramid represents companies with market caps of over $30 billion, which are not of interest to us either.
Our reason for excluding largecaps is that we are seeking to have multiple catalysts for unlocking value. Corporate action, activism, and takeovers are three ways to unlock value. For over $30 billion market caps, activism is less prevalent and/ or productive and takeovers are typically stock-for-stock deals that yield less upside than cash deals that are often seen in the mid-cap range where we invest.
With regard to unlocking value, we focus on the corporate action side, as an actively engaged shareholder to help management define and implement all the various ways we believe they can enhance shareholder value. This ranges from corporate development activities and uses of cash to improving operations, working capital management, corporate governance and the makeup of the portfolio – it’s a broad range. Regardless, these actions are usually both easier to implement and more meaningful at medium-sized companies.
Our target companies often generally need to improve their operations. When we get there, they are typically trading at a historically low valuation level and they need a sense of urgency to improve their results and valuation in order to get out of what we call the “vulnerability zone”, where they are potential takeover candidates, trading at just 6x EBITDA, 8x EBIT, or 10x forward earnings on lower-than-normal potential earnings.
At our initial CEO-level due diligence meeting, we discuss with top management the steps they intend to take to improve shareholder value. We will also follow up with our own recommendations for the initial actions the company should undertake to get the stock up 20% to 25% near term and out of the “vulnerability zone” and of course actions that create sustainable long term shareholder value over time for much more upside in the shares.
In our chosen mid-cap range, we seek to be a substantial minority shareholder, typically owning 2% up to 7% of the shares outstanding, which gives us the best of both worlds: credibility and access to top management as well as reasonable liquidity to trade and get out of the position.
If you look at any top 20 shareholder lists of publicly-traded companies in our universe, you will see that 2% ownership typically puts you in the top 10. Examining the top 20 shareholders a little closer reveals that we are in a world of passive investing, a world of widely diversified investors, including massive mutual fund complexes, ETFs, custodians and index funds. Typically 17-18 of the top 20 shareholders of almost any public company are these largely passive shareholders.
We feel being concentrated and a top 10 shareholder gives us a tremendous edge, because when we talk to management, they appreciate that this commitment separates us from just about any other large shareholder. Company boards and management teams don’t often get to talk to large shareholders that are as deeply knowledgeable about their company and industry as we are given our focus, concentration and almost three decades of investing in this space. Additionally, there are only a few investment firms that are as concentrated as we are. Fact is, virtually all professionally managed public equity portfolios hold more than 30 stocks. Most of the highly concentrated funds that make up the small minority are activists with varying styles along the typically used spectrum of “hard to soft” activism. We use a different spectrum, namely, “illiquid to liquid” activism. We see most activists as “illiquid activists” due to their overt public campaigns, waging proxy battles and obtaining board seats. If you think about the purpose of activism, which is to enhance or accelerate shareholder value creation, what really matters is that you will be able to capture the value created. We stay away from illiquidity for the simple