John Huber’s presentation on Tencent Holdings from the Wide Moat Investing Summit.
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Dear Saber Capital Investors:
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
Back in June, I had the privilege of participating in an event called the Wide Moat Investing Summit put on by The Manual of Ideas (a group that writes an investment publication and hosts events and conferences centered around the principles of value investing).
I wanted to share my presentation with you, as it focuses on one of the stocks we own: Tencent Holdings (TCEHY).
I haven't mentioned Tencent in any investor letter yet, but we've owned this stock since late last year. The sentiment has been very positive on this company lately, and the stock is up over 60% year-to-date, but the business has one of the strongest competitive positions that I've ever studied. While I have no idea where the share price goes in the near term, I still think there is significant value at the current prices and my plan (as usual) is to be a long-term shareholder of this company as I believe its intrinsic value will continue to compound over time.
I will discuss Tencent more in future letters, but this will provide a background on the company for anyone that is interested.
Saber Capital’s Investment Approach
Saber’s strategy: Selective investments in high-quality businesses at attractive prices
- But, who isn’t trying to do that?
- Simple, but not easy.
- So how do we execute this approach successfully?
How to Produce Great Long-term Results?
Focus on reducing unforced errors.
- Reducing losses is critical to great long-term results.
- Best way to reduce losses is to reduce “unforced errors” (mistakes that could be prevented).
- How do we reduce unforced errors?
How To Reduce Unforced Errors?
Focus on investing in companies that are very likely to be earning more money in the future than they are today.
- Simple, not easy: Cheap stocks of poor businesses are a value investor magnet.
- Amateur tennis: “just focus on hitting it over the net”
- Better solution: stick with predictable earning power
- Mr. Market is moody: even stocks of the best companies are volatile
Price Moves More Than Values
Common Sense Approach to Investing
“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards -- so when you see one that qualifies, you should buy a meaningful amount of stock…
“...Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.” - Warren Buffett, 1996 Shareholder Letter
How to Estimate Future Earning Power?
Understand the company’s competitive advantage and estimate the durability of that advantage.
An Overview of Traditional Moats
- Barriers to Entry (Waste Management, Exxon Mobile)
- Network Effects (Facebook, CoStar, Priceline)
- High Switching Costs (SAP, IBM)
- Brand Power (Coke, Apple, Nike)
- Distribution (Wal-Mart, Kraft, Gillette)
- Economies of Scale (Amazon, Costco)
- Low-cost Producer (Bank of America, GEICO)
But Some Moats Are Eroding in Value
“Each day, you’re either getting better, or you’re getting worse.” - Bo Schembechler, former Michigan football coach
- Not all moats are created equal.
- Some of those competitive advantages are gaining strength, while others are seeing their importance eroding.
- For example, let’s look at distribution…
Distribution - This Time is Different
Distribution advantages have deteriorated for big, profitable incumbent companies:
- Costs of distribution have declined
- Companies can sell directly to the consumer much easier
- Products can scale faster
- Social Media has leveled the playing field for smaller companies with no advertising budget
- Consumers have many more choices now
Distribution – Gillette vs. Dollar Shave Club
- Gillette can no longer rest on the distribution advantages
- Gillette had shelf space, which gave it ability to charge high markups, which allowed for sizable advertising spend, which gave it greater scale, which further entrenched its incumbent position, making it difficult for competitors to attack
- But that advantage has been eroded thanks to technology (internet, social media)
- Dollar Shave Club and Harry’s can now bypass the middleman and sell directly to the consumer, avoiding the retail markup and thus providing better value to the customer
Moats - This Time is Different
So some moats are deteriorating. Distribution advantages have been mitigated due to the fast pace of change:
- Cable networks like ESPN or Discovery relied on the “bundle”
- Consumer brands used to have shelf space and consumer confidence, which allowed for sizable profit margins
- Now customers have more choices and better information on products, so no need to go with “trusted brand”
- Even some authors are choosing to “self-publish” on Amazon or elsewhere, bypassing the publisher and going “direct to consumer”
Key Checklist Question
- Is this company really providing an attractive value proposition for the end-customer?
Most Important Moat
- Management focused on long-term value
- Management that is willing to adapt to fast changing or adverse conditions
- A business that is providing the best value to customers
- I believe that a combination of these three factors leads to the most durable competitive advantage in today’s business world.
The Opportunity Bezos Capitalized On
“The balance of power is shifting toward consumers and away from companies. The right way to respond to this if you are a company is to put the vast majority of your energy, attention and dollars into building a great product or service and put a smaller amount into shouting about it, marketing it.” - Jeff Bezos
Tencent – A Huge Moat in China
- Companies that Buffett felt were sure to do well over time due to structural competitive advantages
- But some of these structural advantages have been eroded, due to unforeseen technology
- Today’s inevitables are not the companies that are resistant to change (because change impacts all now)
- Today’s inevitables understand change and can adapt, while always focused on customer value
- Google, Amazon, & Facebook exhibit these qualities
- There are also numerous “inevitable” companies today in China...
Note: “inevitable” doesn’t mean the stock is necessarily cheap, just that the business will likely continue to do well.
The Inevitable Trend in China
- These companies benefited from the “walled-garden” internet in China…
- But, more significantly, they’ve benefited from a rising middle class that is using the internet more, and spending more online
- This is a trend that in my view is an “inevitable”.
- Internet usage will certainly grow, and thus online ads, ecommerce, and mobile payments will follow suit
- Unlike the airlines in the 1950’s, this “inevitable” industry will create massive profits for its winners
- One of these inevitable companies that will capitalize on this inevitable trend is Tencent
See the full presentation below.