Value Investing

Markel 2015 Shareholder Meeting Notes

Markel 2015 Shareholder Meeting Notes – Thanks to a reader for sending this to us.

OMAHA, May 3 — On the weekend of the Berkshire Hathaway 50th anniversary gala that drew visitors from all over the world, Markel celebrated the 25th anniversary of its morning-after brunch much more quietly. There was no movie. Tom Gayner didn’t offer to fight Floyd Mayweather, or even Manny Pacquiao, although he did have some very nice things to say about former Lakers power forward Kurt Rambis.

Also, your humble correspondent got up the nerve to go to the mike and ask the questions he complained were not asked at the 24th brunch a year ago, as you may or may not recall. He also got a chance to follow up with Gayner after the brunch, all of which we will get to in due course. But let’s start at the beginning.

The contingent of Markel executives at the head table was double the size of last year’s, partly by accident and partly by design. There were supposed to be three last year, but Richie Whitt, the president and co-COO, had a conflict, so there were only two: vice chairman Steve Markel and president and chief investment officer Tom Gayner. Whitt made it this year and they also added Anne Waleski to the mix. She’s vice president and chief financial officer. To meet Alan Kirshner, the CEO, you have to go to the annual meeting in Richmond (next week) because he’s “the most camera-shy CEO,” according to Whitt.

Recalling the origins of the Omaha meeting, Gayner said the thinking was, “The people who are most likely to understand what we’re trying to do are people who already own Berkshire.” The brunch meeting, Gayner said, is “the only investor presentation we do all year.”

Markel followed by thanking the several hundred people who filled the main Hilton ballroom for making a special trip to Omaha to hear them and hoped we all found something to occupy our time on Saturday. He also offered the baseline history: Markel was founded by Sam Markel as a small insurance agency in 1930. Steve joined in 1975. The company went public in 1986, raising about $5 million in an initial public offering. It was still a very small enterprise at that point with a market cap of $30-$35 million. Today the market cap is $10.4 billion, “so we’ve come a long way.”

“We’re really just getting started,” Markel said. “The opportunities for us in the world of insurance and the world of other businesses is really unlimited.”

In a tradition I explained in last year’s post, money manager and sometimes-activist-investor David Winters asked the first question. Picking up on introductory remarks by Markel about the “Markel style,” which he said “defines how we do business,” Winters wanted to know what specific characteristics comprise it.

Gayner said it’s a value system and a system of brain wiring. It is a “geometric challenge” to maintain it as the organization grows, he said, but after a while “it’s almost like the organism rejects someone” when they aren’t in sync with Markel’s values.

Markel was more specific. He said people who fit with the Markel style value teamwork over individual achievement; have a disdain for bureaucracy and bureaucratic processes; believe in the primacy of serving shareholders; and prefer a meritocracy to a general sort of egalitarianism.

“If someone is more focused on net income than net worth,” he or she is probably not a fit. A person who cashes stock options after two years to buy a boat would be less likely to fit that someone who still held them 10 years later.

The next question was about CarMax, which allowed Gayner to praise its fixed-price model, an innovation in the used car business. Another questioner later would point out that Warren Buffett and Charlie Munger both opined the day before that people really seem to like negotiating when they buy big-ticket items like houses and cars and they didn’t see much chance of that changing. To that later question, Gayner replied:

“It’s a big world. There’s room for both models . . . Some people like it and some people don’t and it’s a big enough world for both.”

The first CarMax question included a characterization that it was Markel’s biggest position. Gayner said it shows up that way on many lists because Markel’s Berkshire position is bifurcated into A and B shares, but when you combine them, Berkshire is its biggest position.

This is not what dataroma shows as of year-end 2014, when it reported a 75 percent reduction in Berkshire A shares, leaving a combined allocation to Berkshire of about 7.6 percent, compared to 8.7 for CarMax, but Gayner ought to know. I have not looked at the most recent filings to resolve this, but suffice it to say they are Markel’s two largest equity positions, adding up to about 16 percent of the stock portfolio a of the last dataroma report.

The next question came from a woman who said she was glad to see Waleski on the podium, but looking at the corporate officers, they seemed very white and very male and she wondered about encouragement of diversity.

“Well, speaking personally, I’m pretty much stuck as a white male,” Gayner said.

Waleski said she was glad Gayner hadn’t mentioned gender when he introduced her as an addition to the front table because Markel’s “environment is you get rewarded for hard work regardless of ethnicity.”

Gayner said statistically women make up a large portion of No. 1 and No. 2 executives within Markel Ventures and he mentioned Kirshner’s “partnership for the future” program, which mentors minority high school students in the Richmond area.

There was a question about alternative sources of capital moving into the reinsurance business, taking off from a discussion by Buffett and Munger about reinsurance being used as a “beard for asset management” by hedge funds. Both said it was not as attractive a business as it used to be as a result.

The Markel people seemed much less worried about this, although they acknowledged it’s an issue at the moment. The complaint is that hedge funds aren’t as concerned with profitable underwriting because they basically value it as a cover for their asset management business. Markel pointed out that if this new capital generates negative or substandard returns, it will stop being so popular. He suggested “a major event,” insurance-speak for a disaster, natural or otherwise, will cull the herd. “If we’re right, they’ll make substandard returns and disappear,” he said.

Whitt put this more succinctly:

“One thing I’ve noticed: It appears God hates cheap reinsurance. He punishes it relentlessly.”

Because reinsurance is 20 percent of Markel’s business, the company has the flexibility to turn down business when it’s priced poorly, as opposed to a 100 percent reinsurance business, which has no choice about participating in the market.

“We’ve got a 360-degree view of the best thing to do with money,” Gayner said. “Reinsurance is not inherently a good business or a bad business. It’s a tool. If it’s not all you do, you can use it as appropriate.”

Someone asked them to name the greatest threat to their business.

Markel started by saying, “I feel awfully good about our business,” and it’s a challenge to think of one big danger. In fact, he said, this may be the biggest danger. And then he used a word that wouldn’t get by the Motley Fool profanity censor the last time I checked, so I’m going to do the dash thing: “We don’t want to believe our own b—s— all the time.”

Waleski mentioned liquidity. She said they’re in good shape and very conservative, but as CFO she is paid to worry about “a major event” combined with “a market event,” which would be insurance-speak for a disaster, natural or man-made, and market crash at the same time.

Gayner mentioned monitoring the sorts of mistakes the company makes. “As Alan Kirshner says, it’s OK to make mistakes at Markel, just don’t keep making the same dumb-ass mistakes.” He also said complacency can make you so happy with what you’re doing that it’s easy to say no to new risks and new things, which stifles innovation. “The success that breeds complacency is an extremely dangerous thing.” He mentioned three people who don’t mind telling him when he’s wrong, among them Steve Markel and his wife, Susan, a chemical engineer by training who works for Markel as well. Gayner admitted he “can be a little thin-skinned” when Markel tells him he’s making a mistake, but Markel has the useful trait of being critical when things are going well and supportive during the tough times.

There was a question about Fairfax India, a $1 billion fund to which Markel contributed $40 million poised to make investments in India. Markel said they like the prospects in India, but it’s a relatively small investment.

An 8-year-old asked for advice. “I would say listen to your dad,” Gayner said.

A mike was open so I took it and asked Gayner to provide some insight into the way his brain works as an equity investor. I pointed to several specific areas: his investment in Amazon, the poster child for mockery by value investors; his long-held position in Brookfield Asset Management, which has been criticized for its accounting; a larger number of equity positions (over 100) than Berkshire with a much smaller amount of money involved. And I asked him to clarify the percentage of investments devoted to equities.

It’s hard to take notes and make eye contact with someone trying to answer your question at the same time, so most of this is paraphrased, but it just happened, so I’m still pretty clear on it, I think. I’m no accountant, so anybody else who was there should feel free to correct me if necessary.

First, he went into the percentage devoted to equities because I’d mentioned at least three percentages that represented different things or conditions. I’d mentioned 80 percent, the number he cited before the Alterra acquisition; 40 percent, the number he mentioned after the Alterra acquisition, and 22 percent, the number mentioned in the annual report.

The 22, he said, is the percentage of total investments, which includes collateralized insurance reserves and other things that would not be considered part of the investible portfolio. The 80 was the pre-Alterra high and remains the long-run target for the investment portfolio. The 40 included not only dilution of the equity portion from acquiring the Alterra fixed-income portfolio, but also losses in equity positions as a result of the market crash of 2008-09. Currently the correct number is in the “mid- to high-50s,” and stay tuned next week for the specific number when they report first quarter results.

He combined his answers to the Amazon and number of positions questions. The top 20 positions in the portfolio represent 70 percent of the value, he pointed out. “It’s almost like a baseball organization,” he said. Those top 20 names are the major league roster. The rest are the farm system, going from Class AAA to Class AA to Class A to Rookie League as the allocations decline.

He bought Amazon, he said, because “this is an important company” with which a very large percentage of Americans interact in some way. He bought it “to make myself think more deeply about it. I think more about a company if I own it than if I don’t own it.”

He doesn’t exactly think of each company as its own distinct position. For example, he owns four companies that sell alcoholic beverages. “Is that four positions or one?” he asked. “Neither. Is it 1 1/2, 2 1/2?” He encouraged me to look at investments in similar companies, or companies in similar circumstances, collectively, or piled on top of one another.

On Brookfield, I had asked whether, as an accountant, he goes into the weeds on all the related-party transactions and other accounting maneuvers that have drawn criticism, or if he simply trusts Brookfield management since he knows them.

“I do know and trust those people,” he said. When Steve Markel needed financing for some Markel project, it was a Brookfield sub that provided it, he said. And then Gayner harkened back to his answer on reinsurance about the virtues of a 360-degree view that doesn’t tie you to any particular investment universe if it happens not to be a good deal at that time.

“The No. 1 reason I like Brookfield is they come to work looking at the whole world,” he said.

The brunch meeting starts at 10 — actually 9:55 this year — and ends at noon so that investors and shareholders in town for the Berkshire meeting can make their flights home. But Gayner and the others stick around and speak with smaller groups for a bit afterward. So I joined the after-meeting scrum around Gayner and got a chance to follow up.

I asked him when he buys and then sells Amazon, as he did a couple of years ago, if that reflects a change in his thinking, a change in the company’s performance, or something else. He said in that particular case it may have been that he bought it at 250 and watched it go to 500 and decided to take the cash because he really hasn’t figured out the company yet and so doesn’t know if he wants to own more of it or less of it.

So I asked him more generally when he invests in an Amazon or a Google, which Markel owns in a small position, how he evaluates such growth names from a value sensibility. He said a lot of what makes Amazon look so unattractive to traditional value investors is just accounting. If all the money it spends to build its brand was instead spent on plant and equipment, it would be depreciated over time, allowing more of its revenue to fall to the bottom line. Amazon expenses it all immediately, making it look worse from a profitability standpoint. He was clearly simplifying for a non-accountant, and said as much, but he suggested that he sometimes translates the accounting into a more traditional form in order to project cash and earnings going forward.

So anyway . . . it was satisfying to get him to address these things and I feel I have a better understanding of the way he thinks about them. He did tell me not to be surprised if Amazon shows up on Markel’s holdings list again, but he admitted again that he just hasn’t figured them out yet.

When I resumed taking notes following the public portion of my exchange with Gayner, Steve Markel was being asked about Germany, much as Buffett and Munger were the day before. He noted that Markel has been an international company for only 10 years, so it has a lot to do to earn the sort of global reputation it has earned as a national company.

Gayner picked up on the idea of reputation, quoting a commercial real estate agent in Chicago who told him, “I don’t remember everybody who paid me, but I guarantee I remember everybody who didn’t.”

“The best way to be trusted is to is to trust, to extend that,” Gayner said. “Either it’s reciprocated or it isn’t and you move on.”

There was a question about insurance in Florida, which allowed Steve Markel to explain the strange dynamics of hurricane country. If a fair rate is 100, he said, picking a round number out of the air, it will drop every year there is no major event. So, if you have a number of years without a big hurricane, as Florida has recently, the rate will drop as low as 50 or 40, which is not nearly enough to account for the actual risk. Immediately after a big hurricane, on the other hand, the rate will spike to maybe 120. “That’s the place to write business,” Markel said.

Gayner told the story of a turkey that is given food and water by its owner every day. Based on this treatment, the turkey decides the owner must love him. Gayner told the story from the view of the turkey. “He loves me!” Then, on Thanksgiving Day, the owner comes out and breaks its neck. “He didn’t love me!”

As it applies to the insurance pricing dynamic Markel had just described, Gayner said the question for Markel is, “Are we the turkey here?”

There was a question about cyber security insurance in which the questioner rattled off all the parts of his business that Markel insures, then mistakenly called it Fairfax, damaging his attempt to curry favor. In any event, Whitt said fear of cyber attack is high and Markel gets a lot of inquiries about cyber security insurance, but has a hard time closing sales. “The area is still developing,” he said. Whitt mentioned that hackers seem a step ahead of security and law enforcement, so it’s dangerous. I’m guessing that also makes the insurance pricey, which may be why it’s hard to close sales since it would be a new expense for many firms.

There was a question related to the discussion at the Berkshire meeting about 3G Capital, in which a shareholder criticized Berkshire’s association with the private equity firm and Buffett and Munger defended it. Gayner basically repeated Buffett’s and Munger’s argument. “No business can stay in business . . . without earning some appropriate returns on capital. There’s nothing untoward or unholy about that.”

Markel differed slightly. “I happen to agree that the approach that Berkshire has with 3G is different from the approach they had” before, he said. In any case, Markel does not have the skill set to go into major reorganizations. “We won’t be buying businesses that are distressed and need to be fixed,” Markel said.

Gayner pushed back a little, pointing out that it’s hard to find businesses that have no problems selling for reasonable prices, especially with the market awash in private equity. “As we gain skills and talents, we may indeed consider opportunities where we need to be more operational than we’ve been,” he said.

So somebody else followed up by asking if Markel might partner with a 3G-like firm that had operational expertise. This produced one of Gayner’s less transparent analogies. He asked how many people in the room had heard of Rambis, the least glamorous of the ’80s Lakers who did the dirty work on the boards and let Magic Johnson and the crew do their Showtime thing. Gayner called him “my favorite NBA player of all time” and “a spectacular rebounder” who knew what his role was and hung around the boards to do it.

Berkshire, Gayner said, got the opportunities it got during the financial crisis, as well as the opportunities presented by 3G, because it was “hanging around the boards.” People knew what it could do and found it when they needed it. This led to a downright philosophical observation about how much time it took Buffett to make the Bank of America deal.

“Either he made it in a minute or he made it in a lifetime,” he said.

Someone from Venezuela asked about opportunities in Latin America. Nobody took the opportunity to make a joke about his home country, which I’m not sure Munger would have resisted. Whitt said Markel has relatively small Latin American operations at the moment. “It’s incredibly competitive in Latin America right now,” he said. Everybody wants in, so pricing isn’t great. Steve Markel agreed, saying the company would like to do a lot more there, but margins are “skinny” at present.

Another investor allowed his child to ask a question. The boy asked what Markel’s goal is.

“We want Markel to be one of the world’s great companies,” Gayner said. “It’s a big dream.”

With that, he thanked everybody for coming. Seemed like a good note to end on.

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