General Chocolate: A Complaint (2003) – Marathon Asset Management

General Chocolate: A Complaint (2003) – Marathon Asset Management

General Chocolate: A Complaint by Marathon Asset Management. 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.

Introduction: General Chocolate – A Complaint

Marathon occasionally receives letters of complaint from the managers of companies whom we have interviewed as part of the investment process. We recently received the following letter from the chief executive of General Chocolate (formerly, albeit briefly, known as Momentum Technologies):-

Dear Mr. Hosking,

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I am writing to express my disappointment about the experience my team and I had at a recent meeting with investment analysts at Marathon. Your corporate brochure states that “Marathon is an independent investment firm with a high level of professionalism, innovation and flair”. However, the impression that we were left with after the meeting was not a reflection of these qualities.

The meeting was one of a series of meetings arranged by Greedspin Partners as part of our “non-deal” road show as we relaunch General Chocolate following the difficulties experienced under the previous management after the acquisition growth phase of the late 1990s. We came with a detailed presentation pack of our new “We have Lift-Off” strategy which is the product of a great deal of work by McTavish, our strategic consulting adviser. I am particularly pleased with our China strategy based around the “chocolate chip for every China-man” concept. Many of the slides are complex – indeed I have spent many hours understanding their full meaning – and require a detailed understanding of certain technical terms and acronyms. Most of the analysts we met that day had taken the trouble to become fully conversant in our new private language. Imagine our dismay therefore when your analysts insisted on pursuing a quite different course during the meeting.

First your team questioned the very idea that we should grow! This is very demotivating for my team as you can imagine. That growth is good should be self-evident even to your analysts with their didactic overtones. However, they seemed to want us to shrink the business back to its profitable core and, by buying back shares, maximise the return on capital employed. There are several reasons why this is patent nonsense. Our major institutional shareholders (whose feedback we receive via Greedspin) want us to grow as they have considerable funds to invest and having a capitalization of less than $10bn is a constraint for them. Unlike yourselves, these shareholders have armies of analysts to consider this issue, in addition to having the financial firepower to support substantial acquisitions. Shrinking the business would represent a failure of management imagination. Furthermore, this sort of strategy has never been proposed to us by Greedspin who currently have a whole cornucopia of acquisition ideas. Growth is also essential if we are to achieve our career goals. Bigger companies are able to reward top talent and we need to get onto a level playing field. Buying back shares would reduce liquidity and make the investor’s job more difficult. Surely you can see that. We are very proud of the fact that 10% of General Chocolate’s free float is now traded each month. Yet still we think we can increase this level by providing greater news flow. We are currently considering offering a new “instant guidance” service for shareholders that will be automatically triggered by every 1% point movement in the cocoa bean price.

Even in the non-controversial area of earnings management there was no meeting of minds. Your colleagues appeared to suggest that we should raise costs in areas such as marketing and research. This would result in lower earnings, hardly something we could present to our institutional shareholders. Whilst the front cover of our annual report does indeed state that people are “our most important asset”, we must weigh this against the productivity-enhancing redundancy programme that specifically targets non-customer facing, non-measurable, up-front expenses with uncertain long-term pay-offs. This improves visibility and short-term profits and that’s what we’re in business for.

As the meeting progressed it became clear that your colleagues were not even specialists in the confectionery area. This was a complete contrast to our meeting earlier in the day with Lobster Pot Asset Management where we met two articulate young men who were fully immersed in the chocolate industry. As a result it was possible to place General Chocolate firmly in the context of its two peers worldwide and examine all comparable metrics in considerable detail. We had a particularly fruitful discussion of the new C-WONK chocolate whipple technology. This specialization is fully in accord with the new General Chocolate shareholder agenda; the distractions of Momentum Technologies are behind us and there is little point in crying over spilt milk.

Your analysts, by contrast, insisted on pursuing ridiculous and irrelevant questions about our largest shareholder, Duo-Pump Enterprises, headed as you know by Mr. Peccavi, our former chairman (my father). The questions included how Duo-Pump might react in far-fetched, hypothetical situations far outside the scope of our transparent put and call arrangements, details of which are available on request in person at our office in Lugano. Your colleagues questioned the validity of the 20% economic interest combined with 51% “turbo” voting rights. They seemed to overlook the benefits we receive from Duo-Pump. After all, Duo-Pump has a good handle on the company having seen good and bad times. I can tell you that our major institutional shareholders were relieved when Duo-Pump was prepared to buy their shares when the price fell during the Iraq conflict earlier this year and sell them back later. This is part of long-established Duo-Pump strategy. Using its privileged position to increase or reduce its ownership at times of market mispricing is welcomed by most shareholders as it reduces volatility. That it enhances Duo-Pump’s returns above those enjoyed by General Chocolate as your team suggested is entirely incidental. As for the non-compete fees paid to our former chairman, these are standard practice in the industry and are immaterial when compared to our turnover figure. They certainly do not merit the prurient and cynical questions of your analysts.

Attention then turned to my own incentive arrangements. May I say first of all that I find it embarrassing to have to discuss these matters in front of colleagues. Secondly may I assure you that there is no link whatsoever between the date of the pricing of the management share options and the announcement of our Year Zero asset write-down programme. Besides, the exercise price for the options was set at the market price following our Year Zero announcement and was by definition (according to the efficient market theory) reflective of the underlying value of the company at that time.

As far as we are concerned, these questions are far beyond the scope of information reasonably required to make an investment decision. Adding to our frustrations, the meeting ended with absurd comments from your analysts regarding the Peccavi family’s influence on General Chocolate’s operations. Remarks such as these are not only unacceptable but grossly inappropriate. In addition to the family members, the board includes distinguished figures such as General Manuel Tapioca who brings a distinguished military and diplomatic record and my father’s second wife who has a wealth of experience in the couture fashion business. We also benefit from my father’s longstanding association with Lord Blue of Crosstemper who has been at the forefront of the war on corporate governance terror.

As I see it, the job of the analyst is to understand the growth prospects of the business in order to forecast earnings per share growth over the coming weeks and months. We are perfectly prepared to have a discussion along these lines. I would therefore suggest that you invest in re-training your analysts in order to upgrade their skills, understanding and professionalism. I should point out to you that it also transpired at the meeting that one of your analysts actually owned shares in General Chocolate. May I suggest that you review your internal compliance procedures given the obvious conflict of interest this represents.

Finally, over the years I have found that it is convenient for our major US-based shareholders to finish meetings by 4pm. I understand that fund managers need to get back to their desks after 4pm in order to carry out trades before it is too late in the day. Indeed we have been offered preferential access to successful late trading funds for various Peccavi family and Duo-Pump portfolios. Because of this deadline we have fixed our executive jet getaway schedule so that we finish all investor meetings at 4pm throughout the world as a matter of policy. It is therefore extremely unhelpful to have to answer obsessive questions from corporate governance zealots on the minutiae of our major shareholder’s ownership structure well beyond 4pm.

Yours faithfully
For and on behalf of
General Chocolate

Julius Peccavi
Chief Executive

cc: Stanley Churn – Head of Sales, Greedspin Partners

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

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