Jeff Ubben: Carrying A Big Stick by Value Investor Insight
Jeff Ubben of San Franciso’s ValueAct Capital explains the two most important things he learned from Peter Lynch, why technology companies are ripe targets for activism, what leads him to pick a fight with management and why he sees great value in Reynolds and Reynolds, Catalina Marketing, Williams Scotsman, Gartner Group and Seitel.
The epiphany came to Jeffrey Ubben while managing the then $5 billion Fidelity Value Fund in the mid-1990s:
“I just didn’t know what I owned. With so much new money coming in, I was constantly adding to 150 positions, which to me was a recipe for mediocrity.”
Since leaving Fidelity to join merchant bank Blum Capital and then starting ValueAct Capital in 2000, Ubben’s results have been anything but mediocre. By making large bets and working with management and boards to increase shareholder value, ValueAct has returned an annual 18.1% net of fees over the past five years, vs. 6.3% for the Russell 2000. Jeff Ubben is finding his best value opportunities today in mature segments of growth industries, including technology, life sciences and business services.
You earned your value-investing stripes at Fidelity, which isn’t known for its value orientation. How did that come about?
Jeff Ubben: As the restaurant analyst in the early 1990s, I had to fight off growth portfolio managers who were beating me up for not participating in the restaurant-IPO boom at the time. The stocks were trading like they were the cure for cancer but so much of it was just a silly paper game. It was clear the industry had attracted too much capital and there was no real focus on the underlying supply/demand dynamics over a longer period of time – it was just a total growth story, with investors dropping ever increasing new stores into their paper models. To me, that’s just guessing how long the paper game lasts, not really investing.
Did Peter Lynch influence how you think about investing?
Jeff Ubben: Peter’s greatest influence, which still pervades Fidelity, is that you pick up the phone and call companies. At the end of the day, if you haven’t spoken to a few companies in existing positions or on new ideas, you go home a failure. That’s a good discipline – you should spend your day talking to operators, not to Wall Street. Another thing Peter does really well is to figure out how else to make money on a good idea. Look right down the industry structure and figure out the other ways that this particular information can generate an edge. In our portfolio today, we identify a theme – say consumer-driven health care – and then we try to figure out where all the opportunities are.
What or who else has had a big influence on your investing style?
Jeff Ubben: I went to work with Dick Blum at Blum Capital Partners in 1995 because he was an originator of the idea of strategicblock investing, which is sourcing ideas in the public markets, committing to a long-term time horizon, and working directly with the companies to fix things. Early in my time at Blum I saw the power of this type of investing through an investment we made in Kinetic Concepts, which makes high-end therapeutic beds and wound-healing devices. The company had a rental model, with very good unit economics and strong growth, but they were in the market with a secondary offering and nobody showed up. We bought 10% of the company, which was still 60% owned by the founder, and got to know them very well. In 1998, we took a plan to go private to the CEO because the public market just wasn’t recognizing the company’s value. We ended up doing a $900 million LBO that just worked on all fronts. Making that work from beginning to end was a real breakthrough for me.
Does strategic-block investing describe what you do today?
Jeff Ubben: Yes. We focus on a portfolio of approximately 15 companies. In every company, we try to identify simple things that can be done with the business to create value independent of the market and then we take an active approach in working with management and the board.
What types of companies attract your attention?
Jeff Ubben: We try to focus on businesses that are so good that they’re hard to screw up, but many times when management seems to be trying to do just that. Industry structure is very important – we favor relatively slowly evolving industries that are duopolies or have three primary players. Most of the time we’re picking up the pieces after a high-growth company hits the wall at 80 miles per hour, having made at least one too many investments to try to sustain an unsustainable growth rate. Public markets can actually conspire to screw companies up. When you’re growing fast, you get this big P/E and pretty soon you have all the wrong investors with ridiculous expectations. You try to meet those ridiculous expectations and do things contrary to shareholder value.
That explains your many investments in technology companies.
Jeff Ubben: We’re focused on intellectual property and service businesses – technology, life sciences and business services. The boards of once-high-growth companies are usually still venture-capitalist driven and often don’t understand that you can’t grow your way out of problems any more. Many technology-based industries are mature, with recurring revenue making up a higher percentage of sales. Companies with more-predictable revenue streams should be doing things like leveraging their balance sheets, paying dividends and cutting costs rather than chasing revenue growth.
We don’t like to take technology risk, which often leads us to software companies or instrument companies that have a significant service element to them. Our biggest investment is Applied Biosystems [ABI], which is a market leader in producing instruments used as tools for analyzing DNA, RNA, proteins and other molecules. It’s been around for a long time, has great intellectual capital and a tremendous installed base. But until two years ago they were run by scientists who were over-investing in R&D and just weren’t focused on the bottom line. When they brought in a business person as CEO they stopped wasting R&D money, started taking advantage of their installed base and started caring about margins and cash flows. The upside from all that can be huge.
Is management change often involved in the companies you target?
Jeff Ubben: You don’t find great businesses at great prices with great management. Given that, we’ll take significant risk with management because as activists we can change that. I would say 80% of the time we’re investing around a management change initiated by the board on their own or at our urging. Leadership is everything – it’s fascinating how differently the same business can perform with two different leaders.
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