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21st Century Value Investing

|About: The Walt Disney Company (DIS), Includes: BEL, CMCSA, FOX, FOXA

Notes for a recent value investing podcast.

Update on Fox and Belmond.

Click here to listen or read the notes below:

So tell our listeners a bit about yourself. When did you first become interested in investing?

Thanks for having me on, Jonathan.  I first became interested in investing as a kid. As most of my early positions were odd lots of under 100 shares, I first specialized in opportunities peculiar to odd lots, such as when an ADR is de-listed or a community bank goes dark. They often offer special deals to any account with fewer than 100 shares.

How long have you been doing this for and in what capacity?

Professionally, I analyzed DC risk for hedge funds for a few years, left to manage capital, then launched my own hedge fund, Rangeley Capital a decade ago.

Who are your investing heroes?

In terms of thinking in probabilities, Bob Rubin when he was on Goldman’s arb desk. In terms of my focus on event driven opportunities, Joel Greenblatt.

Tell us about your approach to investing and what makes it unique.

Unique is a strong word. Even cherry picking my best work over the course of my investment career, there has always been a community of likeminded investors. I have had completely original ideas and some good ideas, but most completely original ideas aren’t good and most good ideas aren’t completely original.

So even if I’m a special snowflake, I won’t have my feelings hurt if you claim to have heard of similar enough fellow snowflakes. For example, when I first started, I really thought a lot about combining value investing with the types of catalysts that one finds in corporate events. But then I presented at a few places with dozens of fresh faced young fund managers who also apparently invented value with a catalysts. So feeling special is easier the less you know.

But what makes me uniquish? My approach certainly fits within the value investing tradition that tends to set aside macro soothsaying, chart-based day trading, and investment fads in favor of thinking of investing in a businesslike manner. When it comes to sizing opportunities, the approach is based on evaluating the downside which in some cases is the assumption that all of the capital in a given position is at risk and the practically likely downside in that position is a total loss.

But markets are much more efficient than they were when Ben Graham was beating them a century ago or Warren Buffett was crushing the market a half century ago. So I focus specifically on the types of corporate events that complicate the valuation process – from M&A to spin-offs, squeeze outs, contingent rights, or demutualizations. It is still value investing, but value investing in situations where at least some investors shy away. It is always a good sign if the sell side has not picked up coverage or announces that they are dropping coverage due to some esoteric development.

So there is a value component and an event component. There is also a counterparty selection component. That is where we seek out arbitrariness in the form of non-economic constraints that force our counterparties’ hands. If a meaningful part of the market has to buy or has to sell based on something that doesn’t change our valuation, we will take a good look at taking the other side. In doing so, I want to serve as a counterparty to constrained counterparties. As Sir John Templeton said,

Help people. When people are desperately trying to sell, help them and buy. When people are enthusiastically trying to buy, help them and sell.

How do you generally identify new investing opportunities?

I wake up early and I read constantly. Most importantly, I focus almost exclusively on primary sources – SEC filings over news articles and industry conferences over investment conferences. Reading can get me much of the way towards identifying a place where value might be hidden.

However, it is like setting up a game board. Playing the game or doing the work requires a lot of constant follow up, especially with principals. I like reading the background section of proxies to get a sense on a deal’s interest but also to pick the individuals I want to speak with. It is sometimes their job to not answer but it is always my job to ask questions.

Discuss your biggest investing failure and what it taught you.

I have a broad mandate, but mostly focus on equities and mostly focus on the US. So when markets are very expensive, as they have been in 2017-2018, I struggle to put money to work in ideas that I love, trading at or near their downsides with big opportunities to unlock value. Sometimes the ideas that appear to be dollars trading at fifty cents are at prices that reflect data points, not opportunities. When markets are expensive enough, sometimes my only solace is in position sizing discipline and cash.

And then your proudest moment as an investor.

I invested capital through 2008 and early 2009 doing exactly what I want to be doing during the next market crash. It is actually far simpler – just stay rational. Rely on cash and sizing discipline to survive. Even a few near-term catalysts working helps too. Not trying to make any sort of macro call, simply putting money to work when the opportunities warranted, we were maximally exposed in March 2009. Ideas that were so far from unique, but instead were almost ubiquitous among hedge funds traded from good prices to great prices and finally to incoherent prices. One of John Malone’s Liberty vehicles had hit $10 per share with holdings based on market prices of over $25 per share and based on our valuations of around $50 per share. This wasn’t soothsaying; it was just counting. In the subsequent few years, prices corrected but the key was to stay sane, sober, free on my own recognizance, with a chip and a chair at the bottom. Counterparties didn’t disagree with my valuations; they were reacting to redemptions and liquidations.

How are these lessons reflected in your Sifting the World Service?

We have an active community of members who discuss odd-lot opportunities, some that I have presented and others that they have volunteered. I try to offer edgy, actionable contributions, but other members frequently beat me to the punch when new opportunities arise. In terms of member contributions, I emphasize local knowledge and try to draw people out when topics roll around to areas where they are most knowledgeable. When I was a kid and would pontificate on some general topic, my dad would say, “well I guess there’s no substitute for knowing what you’re talking about.” He didn’t mean it as a compliment. When I don’t know what I’m talking about on StW, it is typical that someone else does and they can chime in.

We also discuss M&A and frequently have an idea that I’ve mentioned get reactions from investors who are approaching it from the deal perspective and others who are already familiar with one or both companies from an industry perspective.

While we look at many different types of corporate transaction, there is a clear thematic commonality: pricing failure. Where does the price system not keep up? If the question is easy (heavily followed, large cap, liquid, famous companies), then the price is quite efficient, somewhat less so during corporate events (now the millions of investors gets thinned out to hundreds of hedge funds focused on event driven investing) and even less so on the very periphery of the public markets where demutualizations involve institutions creeping into the market with “owners” who barely understand what they own or even that they own something of value and where squeeze outs involve institutions creeping out of the market with majority holders who are ready to just get on with it and have limited patience for fussing over the price they pay us. If the price is quite likely to be completely off, it is where we try to be right, not relying on extreme precision but instead relying on extreme underpaying.

For an example of the kind of idea that I focus on, Disney (DIS) is in the process of buying the bulk of assets from FOX (FOX) (FOXA). Fox is a company that I have followed for many years, typically setting up its share class spread trade when the two diverge. Last year, it offered everything interesting in an event driven investment: It was a value stock that got caught up in an active bidding war that resulted in a definitive deal to get acquired by Disney with a clean regulatory and financing process resulting in a return of over 40% on the year. Why didn’t the target originally get the highest possible deal price? Largely due to the Murdoch’s focus on maximizing their own after tax outcome. Their low cost basis made them highly sensitive to being able to get stock which made them sensitive to which stock they would get. Also, the Roberts would continue to have complete control of Comcast (CMCSA) after a Fox deal, which was undesirable for the Murdochs who want a strong voice to go with their big stake.

But if the opportunity this time last year was terrific, it is still not bad today. The deal is likely to get Mexican and Brazilian approvals shortly. They are in the process of complying with their US antitrust conditional approval which requires the sale of their regional sports networks. That leaves current holders receiving about $38 in cash and Disney stock as well as a Fox spin-off that is currently valued at around $10 but could easily trade for closer to $12 and itself ultimately become a takeover candidate.

Only if there’s time for one more, Belmond (BEL) is up over 50% since it was first presented on StW last August. However, it is still extremely interesting. The original idea came from the fact that the founder had complicated rights to specific properties that they unwound earlier last year, facilitating a sale process. I love Belmond. Our shareholder vote is on Valentine’s Day, February 14, 2019. It will serve as a good reminder that I need to go buy some flowers and chocolates the next day. The deal process was extremely robust with interest from 127 potential suitors – 44 strategics, 20 PE shops, 4 sovereign wealth funds, and 10 family offices. Everyone wanted to own this for the right price. One bidder dropped out when advisors indicated that his $20 per share bid was insufficient to be relevant. Non-binding expressions of interest were submitted by 8 strategics, 8 PE shops, 2 sovereign wealth funds, and 4 family offices with a high bid of $25 per share (later accepted). Six parties made final acquisition proposals; two were binding and not conditioned on financing or additional due diligence. The chance that they would get at least one bid at a premium to its market price was >99%. The high bidder bid a knockout $25 per share price, defeating a $20 bid from a bidder who expressed a willingness to go to $23.50. The winner, LVMH (incidentally – worth doing more work on), has already bought 12% of BEL in the open market for an average of $24.84 per share, in part to lower their cost basis and also in part to defend their deal from interlopers. The deal needs approvals from Botswana, Brazil, the EU, Mexico, Russia, and South Africa. It is possible but not probable that approvals from Italy Portugal, Ireland and France would be needed in lieu of the EU. None present serious deal risk. All should be secured in time to close the deal by May. Today, it is a head’s you win – one of the 126 potential suitors comes back over the top and tails you essentially tie – and get $25 for a cost of $24.84.

Disclosure: I am/we are long BEL, FOX, FOXA.

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