Ron Baron’s letter to shareholders for the third quarter 2014.
“I am not sure at all we are in the same business. I don’t know if we will use Apple products in 25 years, but I am sure we will still be drinking Dom Pérignon.” Bernard Arnault. Chairman. LVMH Moët Hennessy – Louis Vuitton. New York Times. October 4, 2014.
That was the response Bernard Arnault gave to Apple Inc. (NASDAQ:AAPL)’s Steve Jobs when several years ago Jobs reportedly asked Arnault “for some advice about retailing.” Arnault, the principal owner of LVMH Moet Hennessy Louis Vuitton SA (EPA:MC), is the wealthiest individual in France. According to Forbes, Arnault has an estimated net worth greater than $29.5 billion. This wealth is largely the result of Arnault’s successful efforts to build LVMH into the largest luxury conglomerate in the world. Among the brands LVMH owns is Moët & Chandon, the producer of Dom Pérignon champagne.
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Arnault created LVMH as a holding company for “family businesses” that share his values of providing enduring, relevant, luxury products and services. Arnault, like many owners of family businesses, usually thinks in terms of generations, not quarters. Arnault’s vision about what makes a business, product or service endure is consistent with the “Built to Last” theme of the 2014 Baron Conference scheduled for November 7th at the Metropolitan Opera House in New York City.
Just like Tom Pritzker, Elon Musk, Kevin Plank and many other executives who manage businesses in which we invest, Arnault invests in people, not only their products and services. Just like we do. Further, Arnault’s interest in businesses’ cultures and values has enabled LVMH to retain many owners who sold their family businesses to LVMH as actively involved managers. That is Warren Buffett’s playbook. That is why businesses owned by Arnault … Buffett … and Baron Funds are “built to last.”
Few businesses many think are “built to last” actually do. In 1958, the lifespan of a Fortune 500 company was 61 years. It is now 15 years. Less than half the “Nifty Fifty” of the‘60s and‘70s remain. It is often a failure of management’s vision to create consistent values and culture that causes businesses to fail. Making sure products and services are attractive and relevant … comes from the values and culture of a business.
Attention to detail by managers trying to create the best possible products and services for their customers is emblematic of a successful business culture. As a former Director of Enforcement at the Securities and Exchange Commission described the culture of a firm, “it comes from the top.” We agree.
When we attended the opening of Wynn Resorts Las Vegas in April 2005, we toured the property with Sol Kerzner and Sol’s son, Butch. The Kerzners were the developers/owners of the Atlantis resort in the Bahamas. Sol told us that Steve Wynn was quite upset because many of his guests didn’t like a show in which Wynn had invested $100 million. Sol told Steve not to worry – the problems with the entertainment were small and could be easily fixed. Butch turned to his dad. “You have got to be kidding!!!You told Steve not to worry about a show that cost $100 million that his guests didn’t like? Dad, you had a total meltdown after we opened the Atlantis when in the middle of summer a waiter served butter outside that had melted!!!!”
Ron Baron – Vail Resorts: Built to Last
Vail Resorts, Inc. (NYSE:MTN) is a business in which we have been a shareholder since 1997. We think Vail Resorts is“built to last.” To use Bernard Arnault’s touchstone, people will still be skiing in Vail in 25 years, just as they have over the 48 years since the town was incorporated in 1966. You could build another town likeVail. But you cannot build another Vail mountain. We thought Vail’s prior management was smart, but didn’t like their strategy of using Vail’s lift ticket cash flow to invest in the hotels of other resorts. Vail replaced that management in 2006. Its new team, led by Rob Katz, has been using the cash flow from its ski mountains to invest in $15 million high speed lifts, $10 million restaurants, more grooming equipment, and $80 million summer mountain rides. We believe the last investment could earn more than $75 million per year in a few years. Management is also making an effort to “regentrify” Vail Village by building … and then selling … new hotel and condo beds. This is forcing neighboring hotels and condos to upgrade their facilities or risk losing their customers to facilities that have been renovated.
Katz also focused on season pass sales. Vail now sells about 45% of its ski lift tickets in advance, immunizing its business from “poor snowfall” seasons. Finally, Vail has acquired several other mountain resorts, with the most important, Park City, at a distressed sale price. These additional resorts have created a network that Vail can leverage to sell its season passes. Since Vail’s management has changed, we have tripled our investment in this business with, in our view, exceptional competitive advantages and strong growth prospects … and with a stock that is cheaper than hotels’ but that we think should be more expensive. We expect to at least double our money again in the next five or six years … and, after that takes place, we believe Vail will still be an unusually attractive investment. This is all because management remains focused on improving the customer experience and investing in their business. That’s what we mean about culture and values.
Ron Baron – Manchester United: Built to Last
U.K. soccer team Manchester United PLC (NYSE:MANU) is the most popular sports team in the world. More fans watch televised soccer matches than any other sporting event. That is why we consider our investment in Manchester United to be an investment in the most popular television program in the world. Twenty five years from now, we believe huge audiences will still be watching this team that has won more championships than any other in its 138-year history.
Manchester United televises 38 of its games a year. On average, 47 million fans watch each of those games! The NFL’s Super Bowl is played once a year. In 2014, it had 115 million viewers. Accordingly, we think Manchester United’s televised games are the equivalent of 16 Super Bowls a year! Because fans like to watch sporting events live with their attendant commercials, not time shifted with commercials eliminated, sports teams are unusually valuable media properties. Manchester United’s sustainable competitive advantage is its brand derived from its storied history and huge fan base. Media and licensing opportunities provide significant growth potential. Its management is investing its cash flow in star players and a new coach of champion teams to win more championships and make its franchise even more valuable. Manchester United’s investment in its business to benefit its fans at the expense of its short-term profits demonstrates the values we think make this business attractive.
Ron Baron – Tesla Motors: Built to Last
“We are not currently showing all our cards.” That was Chairman Elon Musk’s memorable comment on Tesla Motors Inc (NASDAQ:TSLA)’s second quarter 2014 earnings conference call. He then told investors that by the end of 2015, Tesla would be producing cars at a rate of 100,000 per year. That translates to $10 billion in annual sales with potential after-tax profits of $2 billion, if Tesla were not penalizing its profits in its bid to grow five times as large by 2020. Elon hinted at something more to come. He was true to his word. On October 9th, he announced that four wheel drive and really cool new autonomous driving technology was being added to Tesla cars, making them even safer than they already are.
We are a fan of Tesla’s business and of Elon Musk. One competitive advantage that we think will make Tesla “built to last” and all of us likely Tesla customers in 25 years, is that its competitors are being compelled to build and sell electric cars. They do not want to build such cars. As a result, they are developing electric expertise so slowly that the lead Tesla has built up through its fast growing staff of Silicon Valley engineers may soon become nearly insurmountable. Car companies don’t want to build electric cars because their existing plants that make engines, transmissions and drive trains would become “stranded assets.” Their unions don’t want electric cars since they are simpler to manufacture than cars with internal combustion engines (ICE), which means fewer factory assembly workers. Dealers don’t want electric cars, either. Tesla bypasses franchised dealers to sell its cars directly to consumers. Franchised car dealers also make a lot more money servicing cars than selling new ones. Tesla cars need less service than ICE cars. A standard ICE automobile has more than 2,000 moving parts. Tesla cars have 18 moving parts!
Tesla’s culture is far different from that of other car companies. Tesla’s mission is to build the planet’s best AND safest automobile. Tesla’s car also happens to be best for the environment. The following says all we need to know about Tesla’s culture and why the best engineers in Silicon Valley want to work there. When Tesla began to manufacture its cars, its inspection process was not as strong as it needed to be. Elon then conducted line inspections personally until his fellow workers understood exactly how he wanted the process to work. Elon next moved his drafting table to the middle of the manufacturing floor to write software with his engineers. That was to make sure everyone knew how important the quality of the product was to him. Our kind of chairman, that is for sure. Our kind of culture, in which every employee does whatever it takes to provide Tesla customers with the best product possible.
One more thing. While many car companies doubt electric cars will ultimately represent a large portion of new car sales, BMW (XTER:BMW) is not one of those companies. Two of our research analysts recently visited BMW’s headquarters in Munich, as well as its electric vehicle and carbon fiber assembly plants in Leipzig, Germany, and its battery pack assembly plant and research facility in Dingolfing, Germany. The BMW financial team believes a revolution in drive train is underway. We believe that BMW will likely phase out internal combustion engines over the next 10 years!
“September and October 2008 was the worst financial crisis in global history, including the Great Depression.” Of the 13 “most important financial institutions in the United States, 12 were at risk of failure within a period of a week or two.” Ben Bernanke. Former Chairman, United States Federal Reserve Board. August 22, 2014.
The above was testimony given by former Federal Reserve Board Chairman Ben Bernanke in a $40 billion lawsuit by former AIG (AIG) Chairman Hank Greenberg against the federal government. From our reading of reports of the trial, Greenberg contends that AIG was “bailed out” under terms that were unfair because they were not as favorable as those given to other similarly situated financial institutions. The federal government contends it had broad discretion granted by Congress to lend on terms it thought appropriate. When it provided $184 billion of “bail out” aid and, in turn received a 92% stake in AIG, AIG had a $15.4 billion market cap. It also happened to be insolvent. Not only would AIG not have survived if it hadn’t been rescued, but if it had failed to meet its obligations to bank counterparties, our entire financial system could have collapsed. According to Bernanke, AIG had no other offers to “bail out” its business.
We believe the events of six years ago continue to have a detrimental impact on our financial markets. This is because many individual and institutional investors who experienced great losses then remain afraid to invest in stocks today. While most of us have expertise in the trade or profession we practice, since anyone can easily buy or sell publicly traded stocks, it may not seem that expertise is required to invest successfully in the markets. However, ownership of intangibles like stocks and the methods by which they are valued are abstract and challenging for most to understand. Valuations become even more difficult to understand when stock prices are volatile and change dramatically within a day or even an hour based on news reports. This is happening at the same time as investors and computers try to run ahead of each other to take advantage of what they believe is their special expertise in interpreting and evaluating the impact of that news on share prices. We consider such volatility to be “noise” and think that what is important is whether you have an investment in a business and whether that business will become twice as valuable in four or five years.
Ron Baron – Former Fed Chairman Ben Bernanke answers Carl Icahn’s questions at dinner
At a recent dinner I attended, Bernanke answered questions from about 25 investors regarding events in the fall of 2008 and their relevance today. The first question posed to Bernanke was whether what happened six years ago could happen again. Bernanke compared the Panic of 2008-09 to four other financial panics that had occurred in the United States since 1873. He differentiated it from past panics that were “runs on banks” and pointed out their analogies to the “sub-prime contagion” we recently experienced. He then explained that the Federal Reserve had since done a great deal of work to identify systemic vulnerabilities and would be proactive to prevent a recurrence of what had taken place. Basel III regulations, he noted, required a bank that became “too big to fail” to raise debt at holding company levels that would be forced to convert to equity were that bank to come under financial duress.
Bernanke was then asked for his reaction to recent market volatility. The former Chairman remarked that he thought it was in the range of “normal.” He opined that the very low stock market volatility in recent years meant “investors had become too comfortable extrapolating Fed policy,” which made that policy less effective.
When the discussion turned to interest rates, the former Chairman stated that interest rates are low everywhere, not just in the United States. “Rates are determined by markets, not by the Fed,” he remarked. “If the Fed were to raise the Fed funds rate in the short term, our economy would crater. Then rates would quickly return to zero.” Carl Icahn (Trades, Portfolio) then observed that low interest rates are causing higher unemployment. “Low cost money gives businesses the ability to take over other businesses and fire their employees.” Bernanke responded, “Interest rates have been low since 2008, and we have created eight million new jobs.” Carl seemed unconvinced. But since no one else in the room was worth $25 billion and no one else was 6’6” tall, no one wanted to argue with Carl and the conversation moved on.
When Bernanke was asked about Europe, he noted that ECB Chairman Mario Draghi was “delicately and painfully trying to get permission to buy the financial assets,” a process that Bernanke believes is necessary for that continent to rebound from an extended period of slow growth with little to no inflation. He was not optimistic that Draghi would be successful since Germany was opposed to the ECB head’s efforts to do “the right thing.”If economic conditions remain depressed in Europe, Bernanke said, it is likely that the United States economy will grow less than it would have otherwise and rates would likely remain lower than they would have otherwise.
Another dinner guest, restaurateur Tilman Fertitta, then observed that his hospitality business, which serves 60,000 people per day, was experiencing significant inflation and resultant margin pressures. “Food, labor and occupancy cost increases are significant,” Fertitta noted. Bernanke responded that inflation was not visible in the data he reviews. He suggested that Tilman speak to Carl who thought low interest rates were creating unemployment and downward pressure on wages. “Maybe Carl can assist your staffing team,” Bernanke helpfully suggested.
Bernanke next observed that he was disappointed that Congress was dysfunctional and had not done more to boost the growth rate of our nation’s economy. Bernanke believes that could be accomplished by increasing infrastructure spending, addressing high health care costs, attempting to reform our tax code, and legislating immigration reform.
Finally, before leaving the dinner Bernanke seemed to offer a somewhat more hopeful view of our nation’s prospects. He noted that United States demographics were better than in most other nations as a result of 1.5 million immigrants per year, that our higher education system was the best in the world, that our high tech industry was the envy of the rest of the world, and that venture capital and private equity in our country had made significant contributions to our nation’s economy.“We live on a dangerous planet, though, in part the result of terrorism threats. But we are the best horse in the glue factory.”
Ron Baron – Baron Investment Conference 2014. November 7, 2014. Metropolitan Opera House. New York City.
We hope you will be able to attend our 23rd annual investment conference on November 7th.The conference is designed to allow you to meet and question executives of businesses in which your hard-earned savings have been invested. It will also give you an opportunity to meet and question our portfolio managers and analysts, Linda and me, and our sales representatives, about our investment process, our portfolio investments, and any other topics on your mind … no questions are off limits. We hope you will think of this day as a chance to “kick the tires” of your investments in Baron Funds. On Thursday evening before our conference and the early part of that Friday morning, we have programs for institutional investors, registered investment advisers, independent financial advisers and consultants. At these programs, attendees will have a chance to meet and speak one-on-one with our analysts and portfolio managers. Our analysts and managers will be available throughout the rest of Friday to answer any questions any of you may have.
Finally, the entertainment. At lunch. At the end of the day. As usual, we think it will be very cool … outstanding, as a matter of fact.
Also, as usual, it will be at our expense, not yours. And as usual, it will be a surprise. No, we can’t tell you who it is. Only Linda and I know for sure. Linda because she signs the contracts and the checks. Me because I choose the entertainers.
We hope we’ll see you on November 7th. For those of you who can’t attend, you will be able to watch the live webcast on the Baron Funds website (except for entertainment, which we are contractually prevented from streaming). You can get a sense of our meeting by watching CNBC’s Squawk Box that morning from 6 a.m. to 8:30 a.m. EST. Becky Quick and I will be interviewing several executives with whom Baron Funds has invested and with whom we expect to make a lot more money … although we obviously can’t promise that. Becky will also interview me on Squawk Box live from the conference that morning.
We like to say, “We invest in people.” We hope when you attend our annual conferences, watch us on CNBC, or visit our website, you will gain a better understanding of the businesses in which we invest, and the character and talent of the executives who run them as well as the people who work at our Firm.
Thank you for joining us as fellow shareholders in Baron Funds. We will continue to work hard to justify your confidence in us. See you in November.
CEO and Chief Investment Officer
October 20, 2014
See full letter here.