Business

Marathon Asset Management: Understanding Capital Cycle – Bjorn Wahlroos’ Case

A Capital Allocator by Marathon Asset Management, dated September 2010. This is discussed in their new book Capital Returns: Investing Through the Capital Cycle: A Money Manager’s Reports 2002-15 we think – anyway read it below.

The best managers understand their industry’s Capital Cycle and invest in a countercyclical manner

When an investor makes a long-term investment in a company, success or failure generally turns on the investing skills of senior management. Over the medium term, return on capital is generally determined by the CEO’s decisions about capital expenditure, merger and acquisition activity and the level of debt and equity used to finance the business. In addition, the question of whether to issue or buyback shares, and the stock price at the time of these decisions, can have a huge impact on shareholder returns. When portfolio managers buy shares they are effectively outsourcing investment responsibilities to the incumbent management team. The CEO’s “fund management” skills can be just as important as his skills in managing day-to-day operations. Unfortunately, as we have noted elsewhere, European business leaders tend to be herd-like and pro-cyclical when it comes to capital allocation.

The problem is they often lack the right skills. As Warren Buffett has pointed out:

“The heads of many companies are not skilled in capital allocation. Their inadequacy is not surprising. Most bosses rise to the top because they have excelled in an area such as marketing, production, engineering – or sometimes, institutional politics.”

Financial companies are probably the most challenging of all for CEOs to manage, as they require many more capital allocation decisions compared with, say, running a large food retailer or consumer products company. In recent years, there have been too many examples of bank CEOs wrecking their firms with ill-conceived capital allocation; of which the most notorious example is perhaps Fred ‘the Shred’ Goodwin’s decision to blow RBS’s balance sheet on the acquisition of ABN-Amro assets immediately prior to the onset of the global financial crisis.

Occasionally, though, a managerial exception to the general rule emerges. A case in point is Bjorn Wahlroos’ tenure as CEO and now Chairman of Sampo, a Finnish financial services group. This has been a long-term Marathon holding and is one of the largest financial positions in our European portfolios.

Bjorn Wahlroos arrived at Sampo in 2001, after selling his boutique investment bank (Mandatum) with excellent timing to Sampo for Eur 400m. The consideration was paid in Sampo shares, with Wahlroos’ 30 per cent holding in Mandatum converting into a 2 per cent stake in Sampo. The transaction was effectively a reverse takeover, with Wahlroos becoming CEO as part of the agreement. At the time, Sampo comprised three domestically-oriented businesses in banking, property & casualty (P&C) insurance and life insurance. The group owned around 1 per cent of Nokia’s outstanding shares, at the time worth Eur 1.5bn or 22 per cent of Sampo’s net asset value. One of Wahlroos’ first acts as CEO was to sell down the Nokia stake from 35m to 6.7m shares by November 2001 at an average price of Eur 35 per share. Today, the Nokia share price stands at Eur 7.2 per share.

His next step involved the company’s primarily Finnish P&C insurance business, which enjoyed a 34 per cent market share in the domestic market but was essentially mature. Wahlroos injected this asset into a pan-Nordic P&C business called “If” for which Sampo received a 38 per cent share (and half the voting rights), plus Eur 170m of cash. The combined group controlled a 37 per cent market share in Norway, 23 per cent in Sweden and 5 per cent in Denmark. New discipline (read: oligopolistic pricing) was introduced and the combined ratio1 was quickly reduced from 105 per cent in 2002 to 90 per cent by 2005.

In 2003, before the full benefits of the new strategy were realized, Sampo took advantage of the financial distress of its partners and bought out 100 per cent of the equity in the P&C operations at an implied value for the whole business of Eur 2.4bn. Today, the lowest valuation of “If” in brokers’ sum-of-the-parts valuations of Sampo is Eur 4bn and Mr Wahlroos has an open invitation to potential buyers of the business at a price tag of v8-9bn. The next major strategic move came in 2007, immediately before the global financial crisis struck, when Sampo announced the sale of its Finnish retail banking operation to Danske Bank. For this transaction, Sampo achieved a top of the market price of Eur 4.1bn in cash. Gradually, this cash has been reinvested in a higher quality retail banking franchise, as Sampo has since built up a stake of over 20 per cent in Nordea, the largest Nordic banking group. They have now invested Eur 5.3bn in Nordea at an average price of Eur 6.39 per share, which compares with the current price of Eur 7.70. Almost half of the position was acquired at a price of around 0.6 times book value, implying an impressive arbitrage compared with the 3.6 times book value achieved on the sale of the Finnish business.

The capital allocation master-stroke before the Lehman bust was Wahlroos’ decision to reduce the weighting in equities down to 8 per cent of Sampo’s investment portfolio, whilst maintaining a large position in liquid fixed income assets. As a result, the company was able to invest Eur 8bn–Eur 9bn in commercial credit in Autumn 2008, purchased at bargain prices from distressed sellers. Sampo was particularly active in acquiring bonds in Finland’s largest paper company, UPM-Kymmene, which at the time yielded over 8 per cent. The decision to invest in the bonds of this company must have been made easier by the fact that UPM’s chairman at the time was a certain Bjorn Wahlroos. This investment in corporate bonds has already yielded a Eur 1.5bn gain, according to the company.

As a result of these astute capital allocation decisions, the Sampo share price has comfortably outperformed its financial services peer group and has outperformed the overall European stock market by a factor of nearly 2.5 times since January 2001. The Sampo case study combines many of the key elements that we look for in management; namely, a chief executive who both understands, and is able to drive, the industry’s capital cycle (the Nordic P&C consolidation story); allocates capital in a countercyclical manner (selling equities prior to the GFC); is incentivized properly (large equity stake) and takes a dispassionate approach to selling assets when someone is prepared to over-pay (Finnish bank divestment). The pity is that there are so few examples of Sampo-esque management elsewhere in Europe.2


  1. Used in both insurance and reinsurance, the combined ratio is calculated as the sum of incurred losses and expenses, divided by earned premium. A combined ratio of more than 100 per cent indicates an underwriting loss, while below 100 per cent indicates an underwriting profit.
  2. Sampo’s share price has continued to perform strongly, up 75 per cent in US dollars from the time this article was written to the end of 2014.

Capital Returns Investing Through the Capital Cycle

Capital Returns: Investing Through the Capital Cycle: A Money Manager’s Reports 2002-15 1st ed. 2015 Edition by Edward Chancellor