Larry Robbins at the 3rd Annual New York Value Investing Congress, reported by Marcelo Lima:
Larry Robbins of Glenview Capital gave a humorous and information-packed presentation. He said that there are two ways to make money: earnings growth or multiples growth. He said that for the first time he’s backing down from his usual aggressive style and cautioning investors not to bet on earnings growth.
Early in his talk he made a very good point: if Merrill Lynch, which has perfect information of its own balance sheet, swings by about 100% within a few weeks on its estimate of how many billions of write-downs it will have to make, there’s no hope for him, or anybody in the audience, of estimating what any of these banks will have to write-down on their balance sheets.
Last year Larry was able to pitch ideas that were reasonably priced, growing dramatically, and had no economic sensitivity. He said that this year he can’t find similar ideas, and that he’s going to have to be patient. “If there’s one lesson we can give you today, it’s that in this environment we encourage patience. And frankly patience isn’t something Glenview has been known for in our history and so this is a meaningful departure from our normal aggressive style.”
Before I continue with Larry, one note on the overall macro scenario: it’s not pretty. If you’re Warren Buffett and you’re buying stocks to hold them “forever” in an investment vehicle like Berkshire Hathaway, perhaps you can afford to ignore the cycle and buy cheap stocks regardless of what the economy is doing. But in fact there’s a thin line between being early and being wrong (to paraphrase Bill Miller). In this context, Whitney Tilson made a very interesting comment following an audience member’s question on Delta Financial:
I just wanted to make one comment on what the lesson may be for Delta Financial or for value investors. We’ve had similar suffering in our portfolio on the retail side.
One of the dangers or traps value investors fall into plenty of times is we tend to be bottoms-up, company specific analysts. When we get killed it’s often because there are big macro factors affecting an entire industry. It doesn’t matter if you’re right on the company if the big macro factor – which is very hard to predict – Warren Buffett and Peter Lynch say “I spend 5 minutes a year thinking of macro factors” – well, if those macro factors turn south, it doesn’t matter if Delta Financial didn’t participate in any of the stupidity in the subprime area, they’ll still get massacred.
It doesn’t matter that Target, our largest holding, is one of the best managed retailers in the country, with embedded value in their credit card and real estate portfolios and a great catalyst in Bill Ackman working hard on it.
You can ride those coattails, but the stock is still down a bunch since we bought it because the consumer is crapping out and people are worried about what consumer spending will be next year.
Good lesson, and I’m not sure I have any easy answers for you except that sometimes you better think about those big macro factors even if they’re hard to predict because they might destroy all the micro-level company work you’ve done.
With this advice – which Whitney gave us the following day, after Larry’s presentation – it’s easier to appreciate that Larry’s long ideas were among the best at the Congress because they don’t depend necessarily on US consumer spending.
His first ideas were United Health Care (UNH) and Wellpoint (WLP). They each have their unique sets of scandals. The CEO of UNH walked away with hundreds of millions of dollars after backdating numerous stock options (he was since refunded a whopping $600m back to the company).
Wellpoint had a CFO who was dating eleven women at the same time on Match.com and using the corporate “summer house” to meet them. He was forced to resign for violating corporate ethics policies which, as Larry joked, “Was limited to dating only six at the same time. Talk about multi-tasking.”
Larry likes the HMOs because there are only four players. The cost line goes up every year but because they don’t want to lose margin, they price accordingly, and membership usually tends to go up. Of course, if there’s a recession, that would imply job losses and fewer members, but Larry still thinks revenues can grow 7-9% next year. Because of operating leverage, they can grow EBIT at a faster clip. They’re both overcapitalized, cheap (circa 13x ’08 EPS), and buying back stock at a rate of 3% per quarter. So over three years, Larry sees overall 15-17% EPS growth.
The prevailing wisdom is that you don’t want to touch these stocks during an election year, but Larry thinks that regardless of who wins, the managed care organizations will benefit from the fact that healthcare is the #1 domestic issue being talked about by all candidates.
Onto UK pubs. Larry mentioned three companies: Enterprise Inns (ETI LN), Punch Taverns (PUB LN) and Mitchells & Butlers (MAB LN).
The last one gets the most press because of an activist investor, Robert Tchenguiz, who’s taking a large stake, but Larry thinks the other two are far more interesting. (Since Larry spoke, Mitchells & Butlers was downgraded by Lehman and taken off the FTSE 100 index, and the stock is off over 20%.)
ETI trades at 12.3x ’08 EPS and PUB at 9.5x ’08 EPS, but Larry prefaced his thesis by saying that at Glenview they’ve made the most money on simple analogies. And the simple analogy for these UK pubs is that they are cell-phone tower-like. Not quite as good as cell phone towers, but they’re cheap enough and enjoy secular growth.
The reason is that the tenanted model of operation – whereby the company owns the real estate and leases it out to the pub operator – allows for yearly rent increases, much like the cell phone towers. It also allows for a cut of revenues. This is a stable and growing annuity, which allows the company to employ high leverage. Larry loves this model – by keeping high constant leverage, the company can use its free cash flow plus 7x income into EBITDA for new pubs, dividends and share repurchases.
These pub companies are under pressure to split into operating and real estate businesses, which on a blended multiple basis provides a lot of upside (based on where they historically trade). Larry doesn’t think this is likely in the next year or so but believes this opportunity will come back once the credit markets stabilize.
The most important catalyst is conversion to REIT status. Only in January of this (2007) year has the UK enacted REIT laws and Larry thinks that the chance of these companies converting in the next two years is about 75%. Naturally, when companies retain more money instead of paying it to the government, the enterprise increases dramatically in value, especially if it’s levered like these are. Upside is anywhere from 30-100% depending on whether conversion to REIT status happens or not.
His last idea was Burberry, the UK upscale retailer. It’s cheap because “nobody wants to own a good house in a bad neighborhood.” Peers such as Nordstrom and Coach have come down a lot because of profit warnings and slowing top-line growth, respectively.
Burberry is currently undergoing an SAP installation which is depressing the numbers. But they’re moving to higher margin items – Larry used $1,000 handbags as an example – and so Burberry is essentially following the script that allowed Coach to reap much higher margins and a headier valuation.
Two other key points are that Burberry has 40 stores in the US and Coach has 272. He doesn’t think Burberry will get up there, but doesn’t think it’ll stay at 40, either. Furthermore, the new CEO has reversed the idea that it’s not good for Burberry to set up inside other larger department stores, saying that this is just lost revenue.
The thesis follows:
1. SAP installation ends and expenses fall out
2. Move to higher margin items
3. Expansion in the US (which is only 29% of revenues today) causes operating leverage to kick in
4. Multiple expansion from 12x ’09 EPS to match other luxury retailers, closer to 20x