I'm Canadian and a big fan of Warren Buffett and his approach to investing.
Up here in Canada, the man that we call the "Warren Buffett of Canada" is Fairfax Financial's (OTCQB:FRFHF) Prem Watsa. The returns (see page 14) that Watsa and his team have generated through Fairfax's equity portfolio over the long term are indeed very "Buffett like."
Merrill Lynch Corp Bond Index
I'm starting to think that his investment methods (while very successful) are quite different.
Watsa (through Fairfax) recently reported that he has increased his ownership position in SandRidge Energy (NYSE:SD) to over 10%. Watsa also apparently recently said that he thinks SandRidge's Tom Ward is one of the best operators in the business and that he thinks the company Ward has built (SandRidge) is poised to do well in the long term.
Watsa apparently invested in SandRidge because of Ward's skills as a manager; here is what Watsa said in Fairfax's 2011 letter to shareholders about Ward:
One more story about an extraordinary entrepreneur that Sam Mitchell identified for us: Tom Ward. In 2008, in an extraordinary move, Tom decided that because of the huge discoveries of shale gas, he would hedge all of SandRidge's natural gas at over $8/mcf through 2010 and would shift to oil by making two oil company acquisitions. Today, SandRidge Energy is predominantly an oil producer with natural gas production capability when the price of natural gas rises. More recently, Tom made another very accretive offshore oil acquisition at a very good price and immediately financed it. We have a total investment of $329 million in SandRidge, including just under $300 million in convertible preferreds. We particularly like the fact that Tom has hedged most of SandRidge's oil production for the next three to four years at about $100 per barrel. I don't think there is any other company in the oil and gas industry that has done that. We are very excited to be Tom's partner.
I'd always thought of Watsa as being an investor who employed an investment approach that he learned from studying Buffett. I had that opinion because that is what he has told us. Consider this excerpt from his 2011 Fairfax letter to shareholders:
I have attended the Berkshire Hathaway shareholders' meeting since there were only 200 shareholders in attendance about 30 years ago. I still find I learn something each year from Warren and Charlie. At the meeting in 2010, I met Bill McMorrow through Alan Parsow, who is a money manager based in Omaha and a great friend. Bill founded Kennedy Wilson, a real estate services and investment company, in 1988, and he now owns 26% of the company. As a result of this meeting, we invested $100 million in a Kennedy Wilson 6% preferred convertible at $12.41 per share, and later purchased $32.5 million of a 6.45% preferred convertible at $10.70 per share and 400,000 common shares at $10.70 per share. Fully diluted we own 18.5% of the company. In 2010 and 2011, we also invested $290 million in several real estate deals with Kennedy Wilson in California, Japan and the U.K. - deals at significant discounts to replacement cost and with excellent unlevered cash on cash returns, in which Kennedy Wilson is the managing partner and a minority investor. We are thrilled to be partners with Bill and his team, who always focus on the downside and have the expertise to manage these investments and finally harvest them. You never know what you will find at a Berkshire meeting!!
In no way am I questioning Watsa's ability as an investor, but I just can't reconcile his interest in SandRidge with an investment approach learned from Buffett.
Buffett as an investor has long focused on investing alongside management teams that put shareholder interests first and foremost. Here are a couple of his better known quotes on what he avoids in a management team when he is investing:
- Managers who pursue company acquisitions for reasons other than the good of the company - ego trips, the 'institutional imperative' of keeping up with other company acquirers, bad judges (they buy a toad and think that it will turn into a princess when they kiss it); as he famously said in 1981, 'Many managerial [princes] remain serenely confident about the future potency of their kisses - even after their corporate backyards are knee-deep in unresponsive toads'.
- Managers who enrich themselves at company expense by with extravagant salaries and the abuse of share option arrangements.
For these reasons and others, I don't think Buffett would touch SandRidge with a 10 foot pole.
Acquisition/Transaction Happy Management Teams
Buffett avoids management teams that are acquisition happy, and unable to control their animal instincts which drive them to constantly do deals. Consider the corporate transactions that SandRidge has entered into over the past couple of years:
November 2009 - SandRidge acquires Forest Oil's (FST) Permian Basin property for $800 million
April 2010 - SandRidge acquires Arena Resources for $1.6 billion
July 2010 - SandRidge sells some non-core Oklahoma acreage rights for $140 million
December 2010 - SandRidge sells some Bone Springs assets for $110 million
February 2011 - SandRidge sells New Mexico properties for $200 million
April 2011 - SandRidge raises $338 million through Mississippian Trust I issuance
August 2011 - SandRidge raises $500 million through Horizontal Mississippian Joint Venture
August 2011 - SandRidge raises $580 million through Permian Trust issuance
September 2011 - SandRidge sells some East Texas properties for $231 million
December 2011 - SandRidge announces $1 billion Horizontal Mississippian Joint Venture
February 2012 - SandRidge announces acquisition of Dynamic Offshore (DOR) for $1.275 billion
April 2012 - SandRidge announces Mississippian Trust II
Details on these transactions can be found here. And this long list excludes regular issuances of equity and debt.
This is the opposite of a preferred Buffett management style. These guys are an investment bankers greatest dream. It is like they have never seen an investment banking proposal that they didn't like.
Management Teams That Enrich Themselves At Shareholders Expense
Buffett has no problem with high levels of compensation, if it is well deserved. What he has constantly been outspoken against is management teams that enrich themselves at the expense of shareholders.
I don't believe Mr. Buffett would be interested in SandRidge Energy. Consider a couple of points about management compensation from the TPG-Axon which has taken an activist position in SandRidge and is trying to force a sale of the company.
- One fact summarizes the appalling corporate governance practices of SandRidge - despite the single worst stock performance of any energy company, and among the worst stock performances in the entire U.S. market, and massive discounts applied to the company because of management…payments to Mr. Ward from the company have totaled approximately $150 million over the past five years (astonishing, given the $3 billion market capitalization of the company).
- It is true that SandRidge has eliminated its Executive Well Participation Plan. However, it did so immediately after the market collapse in October 2008, by then paying over $67 million to Mr. Ward, even as 1) markets were collapsing, and 2) the company had less than $1 million in cash and was facing real risk of bankruptcy. Adding insult to injury, the wells that the company re-purchased from Ward were natural gas wells, even as Mr. Ward and the company were publicly proclaiming the need to abandon their natural gas focus and shift towards oil exploration and development. When the company disclosed the purchase, it cited a desire "to retain a greater working interest in future wells, thus increasing proved undeveloped reserves". This declaration was preposterous, considering its publicly stated desire to abandon the initial natural gas focus of the company and switch to oil. And, again, it was even more shocking when one considers the environment of that time - with markets collapsing, the company facing collapse, and natural gas facing collapse.
More Than One Way to Skin A Cat
I understand the attraction to SandRidge from a valuation perspective. I don't understand Mr. Watsa's attraction to the SandRidge management team, considering his investing background from the school of Buffett.
I won't be jumping on board SandRidge as an investor, but I will watch the activist efforts from TPG with interest and will be especially keen to see if Watsa and Fairfax go along with plans to sell the company.