Jeffrey’s presentation is titled, ‘Avoiding Complexity and the VAC Circle of Life’
Jeff opened his firm in 2000, and this is his second appearance at the value investing congress. Currently ValueAct manages $8 billion, and Ubben is one of the largest value-oriented activist managers out there today. He tries to manage money very simply, and ValueAct tries to focus on only a few very good ideas. He made so many mistakes investing in low quality businesses, that over the years he transitioned to investing in great businesses. In 2005 ValueAct began the activist strategy that they continue today.
They only have one-fund, and with his partners in 2000 they decided to build the organization out from within around simple, transparent investing strategies. The current team at ValueAct has been there for many years, and all 7 partners have public Board experience. He feels this experience is most helpful in times like 2008.
ValueAct found they had a mismatch between their investing style (3-4 years holding period) and their fund structure. ValueAct pushed out their GP incentives 3 – 5 years, and subjected them to an 8% preferred hurdle rate. Now they can spend all the energy looking for great businesses and don’t have the withdrawal pressure from before.
ValueAct tends to make only a few concentrated bets, and this can be a risky strategy. Key to their research process is multiple meetings with management. Ubben can’t understand how other value or activist investors make concentrated bets without getting to know management well.
Ubben likes to be in the board room, in a great buisness, taking part in the capital allocation decisions with an 8 – 10 year time horizon. The key qualities ValueAct looks for in a high quality business are: pricing power, attractive industries with high switching costs and few alternatives, and strong barriers to entry through IP, network effects, or regulations. This translates to buisnesses with high recurring revenue, predictable growth, and high free cash flow. Motorola is ValueAct’s largest holding, and Ubben believes their business checks all the boxes.
In general ValueAct avoids consumer business, and tends to focus on B2B companies that provide mission critical products. Additionally the industries they try to avoid are: retail, commodities, and financials (any business that is spread based). He thinks financials are particularly dangerous, because when they feel pressure to grow they lower their lending standards and go further along the risk spectrum.
What they do like are: differentiated business models, disciplined oligopolies, fee-based or recurring revenues, easy to understand financial statements, and proven management teams.
With that in mind, Ubben likes Moody’s (MCO) and CBRE (CBG)
He thinks of Moody’s as an established business with pricing power and a high moat in their industry. They really provide “schmuck insurance” for asset managers, and get paid well to do it. Moody’s ratings are like a currency, and are incredibly valuable. As a result they generate 40% – 50% margins. The analytics business has great pricing power and continues to grow despite headwinds in the financial services industry.
CB Richard Ellis has unmatched scale in the industry. CBG’s ability to cross-sell and meet the scale of global companies provides a competitive advantage. 50% of revenues are contractural, which drives their high margins. Since 2006 CBG has done a great job of transitioning from a brokerage model to now a business partners with companies like IBM.
With treasury rates so low, investors are very interested in real estate and many markets like Boston and San Francisco have sub 5% cap rates. Property sales are barely off the bottom, and basically at 2004 levels. Ubben thinks CBG makes ~$.90 per share on their recurring portfolio out of their total earnings of $1.20. Ubben also foresees a strong pickup in real estate M&A ans transaction volume from 2014 – 2016.
Overall ValueAct only owns 12 – 14 holdings at a time, and given their holding period they only look for 2 – 3 new ideas per year. With that in mind its critical they avoid mistakes. The key mistakes they try to avoid are:
Valuation: this is a mistake they just can’t make because really its just math. ValueAct aims to earn at least 10% cash-on-cash before factoring in growth. On top of that return they hope their investments grow 8% – 10% a year top line to supplement the total return.
Complexity: the simpler the better. If they can’t identify the key drivers and understand the economics of the business they avoid the company. They shoot for monolithic, pure play businesses that are market leaders and trade at valuations that meet their parameters.
Leverage: ValueAct tries to avoid highly leveraged businesses and instead places a high emphasis on organic growth. He admits he would never buy Valiant with the current leverage levels, but he is in the board room and trusts the CEO.
Governance: they don’t go looking for a problem to fix. ACXM was like Vietnam for ValueAct, they just couldn’t pull out. Now they avoid very entrenched boards, and avoid picking fights when at all possible. Other people are great at proxy contests, Ubben’s experience is that going public with an agenda before you are inside and actually know if its feasible is tough. What they focus on know is building relationships with the Board who help ValueAct understand the business. That way when they enter the board room day one they have a plan and are ready to go.
Compared to other activists, Ubben places huge emphasis on access. He likes to be on good terms with management instead of walking into the board room day one surrounded by lawyers.
ValueAct has a “farm team” for their younger employees. Younger guys will pitch ideas and really own the holdings. After 9 months or so, sometimes those holdings become core investments for ValueAct. This way the young guys at his firm learn more than just 2 – 3 ideas a year.
When Ubben used to work at Fidelity, he would go into Peter Lynch’s office all the time with ideas. Lynch would buy the stocks, but in very insignificant size. Ubben explains that really Lynch was just teaching him and that’s how ValueAct view the farm team.
Update on LBV (Steinway)? They have a small cap fund now because with their size they outgrew that space. One of the ValueAct partners runs that fund, and Ubben doesn’t know much about it because his team doesn’t spend any time on it. The small cap fund is totally separate from the core ValueAct fund.
What influences your sell decision as a longer term holder? When the coupon (cash on cash) on their investment fall below 10%, then ValueAct is really paying for growth. When that coupon falls below 7%, then they are out. When he is on the board he is also always looking for a sale of the company as an exit to capture the control premium.