Michael Price Lecture, A Discussion on Value Investing, at Fordham Law School H/T to a reader for sending this
First met Mario Gabelli while working on International Mining, which held seven stocks, in 1977/78. Fresno, Tantalum Corporation of America, Molycorp (almost bankrupt today), etc. controlled by Lou Arthur. Someone comes by and takes the big spreadsheet of my desk - it was Mario (Price and Gabelli tell this story in the book Investment Gurus by Peter Tanous on pages 35 and 77). Mario recently sent me a copy of his report on International Mining in 1977/1978. We have been like ice dancers finding value in the market over the years.
Value investing is simple. Works over time. Problem is people call themselves value investors and they aren't. Value investors don't short stocks. Speculators short stocks. Value investors will engage in arbitrage and will have short positions that way, but value investors do not short. Value investors typically don't buy levered companies. Hedge funds have incentives to purchase levered assets.
I'm on endowment committees that invest in funds. People will claim to be value investors and when I ask what their top three positions are they say Google or Apple. I will ask how many shares are outstanding and these money managers won't know. Layne Christensen (points to Mario) - he'd know how many shares they have - 19.8M. (GAMCO has a stake).
The world’s a simple place. Wall Street invents things and makes it complicated. They have to create things to buy. Wall Street is in the business of generating fees. Our job as value investors is to pick through the paper Wall Street creates, bonds or stocks, and find those that are too cheap. They get 7% on underwriting fees, 3% on M&A.
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Look at MLP blowups. REITs are next. Not easy to sort out things. Have to wait for Wall Street to present deals below intrinsic value. Wall Street won't do research on certain things. Want to go where the Street isn't looking. We look to bad earnings, dividend omissions - not record earnings and dividend raises.
The MLP crash is a great value vs. Wall Street example. Low interest rates attract yield pigs. What happens to a security in low interest rate environment? Wall Street bids them well above intrinsic value because of the yield. Retail investors bid them up. They invent funds to invest in these assets. How many billions are created? MLPs now down 40%. Oil and gas gets a toll to transport oil and gas. Kinder Morgan cut the dividend like 80%. What happens to the stocks when they cut the dividend from 8% to 2%? They sell. Questions about debt to service, etc., so debt trades down. Without yield pigs propping prices up they may now be interesting.
On REITs: Real estate is illiquid. With large amounts of buildings it could take years to sell the assets. You may have vacancies, and the REIT's ability to service the dividend erodes. Then you may be able to buy below intrinsic net asset value.
We wait for litigation, bankruptcies. Things like that. Intrinsic value is not the present value of future cash flows. It's what a rational businessman would pay for the entire business. We want to pay 30% less than that - that's margin of safety.
We have three jobs everyday:
1. Work on what we own. Analysts show intrinsic value - Sum of the parts minus debt and all liabilities. We can drill down on what it's worth. We look at what people we respect do. Icahn bought more Cheniere (LNG), we looked at it. Too much debt for us.
2. React to news. Hospira - went from $50 to $28 because the FDA shut a plant down. Lost $9B of value. We did the research, found it may cost $1-$1.5B to rebuild plant. Then they sell to Pfizer at $90. We consult lawyers, read releases. When it went to $28 the growth guys were selling. We knew it wouldn't grow for the next two years.
Now MLP guys are going to value investors. Always had problems with MLPs - they're capital intensive businesses. How are you going to raise capital for capex? Now have to sell stock below NAV. Sometimes they'll have rights offerings - we love rights offerings. Forced to sell stock to pay debts, sometimes asset sales; but asset sales can only last so long.
Rights offerings – stock’s high, then there's some uncertainty on the financing that drives the stock down. They announce the offering and the stock opens higher now that the financial risk is gone.
3. Come up with new ideas - but there's no time for that after the first two (jokingly).
So many events - makes it fun. Dow Chemical announced today - they did one thing right, hired the right guy. That's what's fun.
When we wake up - ask where can I find value? Not what Wall Street is selling. We want meetings no one attends. John Templeton would invest in South Korea because no one would invest. European companies said we were the first American analysts they met. They had conservative accounting that led to a ton of hidden assets. We had a ball for 4-5 years.
Oil and gas, metals and mining, and commodities are all very interesting today. We’re on the verge of a slew of energy bankruptcies. 100’s of bonds trading for 25-35. Most of the time companies go bankrupt because of too much debt. Sometimes fraud, etc., but mostly because of debt. Cheniere, Chesapeake – the debt is really equity and the equity is a call.
Have $10B of assets, $8B of debt with $2.5B of cash flow with oil at $80 – now only have $1B or $800M of cash flow to service $8B of debt – you can’t service it.
California Resources - $6/7B of debt, they have to do something. Can’t even give away California energy assets – they’re the most restrictive in terms of environmentalists. Wall Street sells senior unsecured bonds - $6B of it to people who gobbled it up, now at $0.40. Maybe worth $5B, but with the debt at $3.2B, it’s interesting.
Value investors buy distressed to create value. Debts tricky, but can be the way to play – to create new company asset values.
In the 70’s when I was starting out, it was railroad bonds. (I missed the Company he started talking about) – You had $10M of bonds trading at a nickel. Backed by warehouses, railroads you could melt down and sell, rail cars – figured it was worth par plus the accrued interest.
Can trace senior unsecured back to Milken.
Q&A with Michael Price:
Q: Valuation is an art and science – two investors could vary on what they think intrinsic value is. Can you share thoughts on your valuation process?
A: If we ask the right questions, go to original sources of information (not inside information) – whatever you can dream up – you can figure out what a Company is worth. Saying a 12 P/E stock will go to 15 P/E isn’t value. Is the cash off-shore? Then it’s worth $0.70-80 cents on the dollar. People take Apple at 100%. I don’t. You’ll have to repatriate that cash. Maybe you get a tax holiday. Is the PPE properly depreciated? Brand names? Could be worth a lot, could be worthless. Goodwill is zero. Max Heine always put it at zero. Liabilities are 100 cents on the dollar. Look for pension, legal, environmental, etc. Do the work. Dig.
Q: Chipotle (CMG) a buy?
A: Too expensive. I don’t know. Ruth’s Chris had too much debt; read they were selling buildings. We bought into the rights offering. PE fund that owned them couldn’t buy since that specific fund was fully invested. We bought the rights. We bought at $2.50, opened up at $5, now at $17. Restaurant stocks usually not value unless there’s real estate. Unlikely to go there (meaning CMG).
Q: What about Yahoo?
A: Visteon (VC) was a domestic auto parts company that we owned. (I missed some comments here, didn’t capture his point with the Visteon example). Hard to kick the tires in China – Chinese don’t have the governance we do. Don’t have the same culture. I don’t trust Alibaba – do I need to be there? Even if you try to arb – you won’t get back what you could use to cover your short. VMware was the same thing. You get the tracking stock. You don’t need to go there. Don’t know how to value Yahoo’s core business. You see Yahoo all over CNBC, the papers – it’s all worthless (the news, not the Company).
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