Value Investing

Sam Zell: To Catch A Falling Knife

To Catch A Falling Knife: A Conversation With Sam Zell by Diane C. Swonk, Chief Economist and Senior Managing Director, Mesirow Financial

“Professional Opportunist”

I was recently asked to interview Chicagoan Sam Zell for the National Association for Business Economics (NABE) annual meeting in Washington, D.C. Sam considers himself a “professional opportunist,” which in economics is akin to buying low and selling high, something few investors actually do. Most of us prefer the comfort of a crowd to the loneliness of buying low. This has made him a lot of money—something he is not shy about—and an anomaly.

This report provides excerpts of that conversation with some observations of my own about what his comments mean for the overall economy. We covered a broad spectrum of topics including the oil sector, real estate and emerging markets. We also talked about immigration, which is at the forefront of the policy debate. That discussion was particularly illuminating as it revealed why Sam Zell is such a nonconformist and willing to take risks that others are not.

His comments reflect his own views and not those of Mesirow Financial. His remarks are in italics; mine are not. [Listen on the Mesirow Financial website.] Be forewarned that his actual comments are less filtered than those below. Sam is not known to parse his words.

Sam Zell’s Oil Investments Tripled

“Over the last 12 months we probably tripled our investments in energy. Why? Because energy is cheap or we think energy is cheap. There is a lot of distress in energy. And a lot of long-term investments to finance with short-term capital; that obviously creates opportunities…I [also] think that the perception that North American energy production has been priced out of the market is absolutely dead wrong…

“We are drilling in the Bakken today, which is North Dakota. We are selling oil at slightly over $40 a barrel and we are making money.

“Now, I would tell you that two years ago, if the circumstances were identical, we would have been losing money. The difference is technology. The technology movement in the energy space is misunderstood and underappreciated. In this particular case, we applied a new technology called gas lift where you inject gas. And what we’ve discovered is that it’s extending the life and doubling the production.

“I don’t know whether that’s going to happen everywhere else…but everywhere in the United States, at a minimum, I think the cost of drilling has gone down by 20 percent. And it’s probably gone down by 30 or 40 percent. Half of it is in the margin of the provider and half of it is technological change.

“The reason that U.S. oil production is not going down as fast as everybody predicted is that the technology changes are changing the economics of the drilling and the oil business in the United States.”

Sam Zell’s views on the drop in oil production were echoed by economists at the conference. Most had expected oil production to fall even faster than it did. The squeeze on margins, however, is real and has shown up as large cuts in both investment and employment. Clearly, not everyone is as adept at adapting to new technologies as Sam is.

There is significant concern about a rise in oil imports to the U.S. Production elsewhere in the world remains strong, most notably in war-torn parts of the Middle East and Russia. This has kept prices down and given foreign producers an advantage in some markets. Imports from Russia, in particular, picked up last year. That, coupled with geopolitical concerns, has intensified the debate about our ban on exports. There could also be a geopolitical advantage to exporting to our allies in Europe. (They are not happy about their dependence on Russian oil products.)

“I think whoever came up with the idea of banning exports was out of their mind. I mean, that’s just stupid. Okay? Are we banning the sale of corn? Are we banning the sale of wheat? Are we banning the sale of iPhones? Why would we ban the export of oil? “Now, maybe in 1973 everybody got scared and they passed dumb legislation…but the last time I checked, 1973 was 40-some odd years ago. And it’s 40 years later and we’re still a victim of policies that were created in the early ‘70’s under a completely different set of circumstances.”

We expect supply and demand for oil to come closer into balance next year. That will show up as a modest firming of oil prices in our forecast. A surge in prices in the near term remains unlikely, especially in light of the supply we are likely to see come on line from Iran. A lifting of sanctions would allow Iran to immediately sell inventories it has stored and open the door to repairing and upgrading dilapidated oil fields.

Sam Zell – Manufacturing Malaise

Sam Zell chairs several boards in the manufacturing sector, which prompted me to ask him about the competitiveness of U.S. manufacturing. He lamented that the dollar is the primary hurdle.

“The difference between our currency losses in the past and our currency losses currently is 10 versus five-to-one. And it’s impacting everybody across the board. U.S. companies operating outside of the United States today are just getting pummeled by the currency.”

Volatility in currency markets has also come up as a primary concern among the executive boards I consult. Far too much market attention has been on interest rate risk and not enough on currency risk. It is hard to know where to hedge as a manufacturer, given the volatility we have seen and the uncertainty about which country might devalue next.

Sam Zell – Real Estate

Sam Zell, who is widely considered one of the founders of the modern REIT market, was ambiguous about real estate. It is telling that he doesn’t see a lot of low-hanging fruit to be picked, particularly in the U.S. He was more animated when discussing demographic shifts.

Sam Zell

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